Lamb Weston Holdings, Inc. Q4 FY2022 Earnings Call

Good day, and welcome to the Lamb Weston Fourth Quarter and Fiscal 2022 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Dexter Congbalay. Please go ahead, sir.

Good morning and thank you for joining us for Lamb Weston's fourth quarter and fiscal 2022 earnings call. This morning, we issued our earnings press release, which is available on our website lambweston.com. Please note that during our remarks, we'll make some forward-looking statements about the Company's expected performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our SEC filings for more details on our forward-looking statements. Some of today's remarks include non-GAAP financial measures. These non-GAAP financial measures should not be considered a replacement for and should be read together with our GAAP results. You can find the GAAP to non-GAAP reconciliations in our earnings release. With me today are Tom Werner, our President and Chief Executive Officer; and Bernadette Madarieta, our Chief Financial Officer. Tom will provide some key highlights for fiscal 2022 as well as an overview of the current operating environment. Bernadette will then provide details on our fourth quarter results and our fiscal 2023 outlook. With that, let me now turn the call over to Tom.

Thank you, Dexter. Good morning and thank you for joining our call today. We delivered solid results in fiscal 2022, and I want to thank all my Lamb Weston colleagues for navigating through this difficult and volatile environment these past two years. We've worked together as a focused team to weather the pandemic, supply chain, and macroeconomic headwinds while continuing to support our customers, improve our operations and execute on our long-term strategic objectives. Specifically, in fiscal 2022, we delivered a record year of $4.1 billion in sales, driven by a combination of favorable price/mix and volume growth as restaurant traffic and demand for fries continued to recover from the depths of the pandemic. We implemented pricing actions across each of our sales channels to mitigate some of the highest input and transportation cost inflation that we've experienced in 40 years. This helped to drive year-over-year gross margin expansion in the second half of the year, and we expect to realize a carryover benefit of these pricing actions in fiscal 2023. We simplified our portfolio by eliminating SKUs, drove productivity savings and worked with our customers to secure product specification changes to offset much of the cost and operational impact of a historically poor potato crop. We also made tough, but necessary decisions around customers, sales channels, production, and service levels and adopted tools and practices to better manage our customer and product portfolio. In our production facilities, we continue to leverage our Lamb Weston operating culture and changed our ways of working, including how we manage crewing schedules. This helped to better attract and retain employees, and we're making progress in getting our facilities fully staffed. We started up a new chopped and formed production line in Idaho and broke ground on our capacity expansion and modernization projects in Idaho and China. While our plant in China remains on track to be operational by mid-fiscal 2024, we pushed back the completion of our new fried line in Idaho at least a few months to mid-fiscal 2024 as a result of some equipment delays. We completed the design work for the second phase of our new enterprise resource planning system. We'll build and test the new system in fiscal 2023 and implement it in fiscal 2024 in a phased approach. We issued our third environmental, social and governance report, which has been prepared in accordance with leading industry standards such as the global reporting initiative. This report includes our progress towards specific ESG goals for 2030. We refinanced more than $1.7 billion of senior notes, which extended our debt maturities and reduced our weighted average interest rate. And finally, we increased our dividend for the fifth straight year and stepped up share repurchases to boost capital return to shareholders. In our joint ventures, Lamb Weston/Meijer announced its intention to withdraw from its joint venture in Russia in response to Russia's invasion of Ukraine and the devastating humanitarian crisis the war created. In July, we increased our interest in our joint venture in Argentina from 50% to 90% and will now consolidate its sales and earnings in our results. In short, we've been managing through a turbulent market to build good operating and financial momentum by controlling what we can control while continuing to best to support long-term growth. That said, we expect the environment going forward will remain very challenging with inflation continuing to pose the biggest threat to our cost structure and fried demand. Although the cost of some inputs, such as edible oils, energy, and transportation, have come off their highs in recent weeks, they remain elevated relative to the past few years. Labor availability continues to be an issue while other key inputs, such as ingredients for fried coatings, remain costly and in short supply. As a result, we expect input, transportation, and labor costs will be a significant headwind through fiscal 2023. Rising food, energy, and housing prices have also affected restaurant traffic and consumer demand in the U.S. in the past few months. While traffic at quick service restaurants, which account for more than 80% of fried servings, has held up fairly well, traffic at casual dining and other full-service restaurants have softened recently as consumers scale back dining out occasions or shift to QSRs. Despite pressure on overall restaurant traffic, the demand for fries remains solid as the fry attachment rate in the U.S., which is the rate in which consumers order fries when visiting a restaurant or other food service outlets, remains above pre-pandemic levels. Going forward, we expect restaurant traffic and consumer demand in the U.S. will be choppy and less predictable in the near term as consumers face significant cost inflation. Fry demand in retail channels, however, should continue to benefit if demand in out-of-home channels is pressured. Outside the U.S., consumer demand trends in Europe have been similar to what we have experienced in the U.S. as a result of inflationary pressures, which will also likely lead to a more unpredictable operating environment in fiscal 2023. Outside of China, demand in Asia has been relatively stable. The recovery in demand in China has been uneven as the government there maintains its Zero COVID policy. In addition, our shipments to Asia continued to be constrained by the limited availability of shipping containers, although that availability did improve somewhat in the fourth quarter. The bottom line is that we're forecasting that cost and demand in this near-term inflationary and volatile macroeconomic environment will be difficult and require us to remain flexible in managing our supply chain and commercial operations. Despite these short-term challenges, we're confident in the long-term resiliency and growth prospects of the category in the U.S. and in our key international markets. With respect to pricing, our price/mix growth accelerated for the third consecutive quarter as we continue to execute on our product and freight pricing actions. In early July, we began implementing our fourth round of pricing in the past 12 months in our Foodservice and Retail segments. We expect to see the benefit of these pricing actions as well as the one that we took in April to gradually build as we progress through the first half of fiscal 2023. In our Global segment, it's clear that in the back half of fiscal 2022, we benefited from price escalators included in multi-year agreements and had some success in securing price increases outside of these contractual escalators. However, it's equally clear that we have yet to fully offset inflation and other costs given the more rigid structures and terms of customer agreements in this segment resulting in a 110 basis point decline in product contribution margin percentage in the fourth quarter. As you may recall, most of our chain restaurant contracts in our Global segment are multi-year agreements, and we're in the process of negotiating renewals representing about one-third of our global segment volume this year. We're being aggressive in discussions with customers to secure price increases to offset inflationary pressures, so that we can gradually restore profitability towards pre-pandemic levels. We're also seeking to modify other key terms to reduce the chances of, again, facing a significant pricing lag to recover rising costs. For those agreements up for renewal this year, we'll generally begin to see the results of these new pricing structures during the second half of fiscal 2023. However, it may take up to a couple of years before we can fully recover costs across our global segment customer portfolio. For those multi-year contracts that were renewed over the past couple of years, we'll continue to realize the price escalators embedded in those agreements. With respect to this year's upcoming potato crop, we expect the crops in our primary growing regions in the Columbia Basin, Idaho, Alberta, and the Midwest to be largely in line with historical averages. While cooler than average weather in the spring and early summer slowed the crop's progression, it is largely caught up to historical averages with warmer temperatures and sunny days in recent weeks. We'll provide more detail on the crop when we report our first quarter results in early October, in line with our past practice. As we've previously discussed, we've agreed to a 20% increase in the contracted price per pound, reflecting our approach for annual price changes that reflect the cost to grow plus an appropriate return for our growers such that they are viable over the long term. We'll begin to see the impact of these higher contracted potato prices during the second quarter of fiscal 2023, as we begin to process the early potato varieties that are harvested in mid-summer. So in summary, we delivered solid results in fiscal 2022, including record-high sales in the fourth quarter and for the year. We continue to successfully execute pricing actions and cost mitigation efforts as we look to offset input cost inflation and the impact of a historically poor crop. We remain confident in the resiliency and the long-term prospects of the category, although near-term demand will likely be choppy and difficult to predict. And at this time, this year's crop is on track to be in line with historical averages. Let me now turn the call over to Bernadette to review the details of our fourth quarter results and our fiscal 2023 outlook.

Thanks, Tom, and good morning, everyone. I want to start by echoing Tom's comments and thanking our employees for their hard work and continued dedication to drive our solid operating and financial performance during these challenging times. We delivered fourth quarter sales growth of 14% or a record $1.15 billion with all of the growth coming from price/mix as we continued to execute our previously announced pricing actions in each of our core business segments to offset cost inflation. Sales volumes declined 1%, primarily reflecting lower export volumes due to limited shipping container availability and disruptions to ocean freight networks. Total North American volume grew this quarter behind strong sales to large chain restaurant customers. While consumer demand in our Foodservice and Retail channels also grew, our sales volumes to those customers fell as we were unable to fully serve this demand as a result of lower production run rates and throughput at our production facilities. For the year, sales increased 12% to nearly $4.1 billion, a record high with price/mix up 9% and volume up 3%. Gross profit in the quarter increased $56 million and gross margin expanded 230 basis points versus the prior year quarter to 22%. Product and freight price increases drove the improvement, more than offsetting the impact of higher costs on a per pound basis and lower sales volumes. Cost per pound increased double digits for the fourth straight quarter with inflation accounting for essentially all of the increase. Higher prices for inputs, such as edible oils, ingredients for batter and other coatings, and packaging were the primary drivers. Labor costs were also notably up, reflecting broad competition for production team members. Transportation rates also rose sharply versus the prior year. Transport costs increased as we continue to rely on an unfavorable mix of higher-cost trucking versus rail to meet service obligations for certain customers. And as Tom mentioned, while the cost of some inputs and transportation have come off their highs in recent weeks, they remain elevated relative to the past few years and will continue to pose a headwind through fiscal 2023. We also continue to incur higher potato costs as a consequence of the poor crop that was harvested last fall. We will continue to realize the financial impact of this poor potato crop through most of the second quarter of fiscal 2023. And finally, we continue to incur higher costs and operational inefficiencies associated with labor, spare parts, ingredient shortages, and other industry-wide supply chain challenges. Increased downtimes associated with scheduled maintenance also reduced production run rates, lowering our fixed cost recovery. Partially offsetting these higher costs per pound were benefits from our portfolio simplification, cost mitigation, and other productivity efforts. Moving on from the cost of sales, our SG&A increased $19 million in the quarter, largely due to higher incentive compensation expense and a $3.5 million contribution to our charitable foundation. Equity method earnings from our unconsolidated joint ventures in Europe, the U.S. and Argentina declined $57 million. This included a $63 million noncash charge associated with the European joint venture's intent to withdraw from its joint venture that operates a production facility in Russia as a result of the war in Ukraine. Excluding the impact of this charge as well as mark-to-market adjustments associated with currency and commodity hedging contracts, equity earnings increased $2 million versus the prior year. So putting it all together, adjusted EBITDA, including unconsolidated joint ventures, increased 21% while adjusted diluted EPS rose 48%. Higher sales and gross margin expansion drove the increases. Moving to our segments. Sales in our Global segment were up 10% in the quarter. Price/mix drove the entire increase, reflecting domestic and international pricing actions associated with customer contract renewals, inflation-driven price escalators, and higher prices charged for freight. Overall segment volume was flat. We drove solid growth in shipments to large QSR and casual dining chains in North America. However, this growth was offset by a more than 10% decline in international shipments, reflecting limited shipping container availability and disruptions to ocean freight networks. While still down versus the prior year, international shipments improved sequentially versus a decline of 20% in the third quarter as more shipping containers were made available. Global's product contribution margin, which is gross profit less advertising and promotion expenses, declined 1% to $56 million. Higher manufacturing and distribution cost per pound more than offset the benefit of favorable price/mix. Sales in our Foodservice segment grew 21%. Price/mix increased 24% as we continue to drive product and freight pricing actions that we announced earlier in the year to mitigate cost inflation. Sales volumes decreased 3% as labor and commodity shortages as well as scheduled maintenance downtimes impacted run rates and throughput at our production facilities, creating the inability to fully serve customer demand. We did see sales volumes slow each successive month during the quarter as restaurant traffic, especially in casual dining, softened as consumers responded to accelerating inflation. Foodservices product contribution margin rose 47% to $142 million as favorable price more than offset higher manufacturing and distribution cost per pound. In our Retail segment, sales increased 20%. Price was up 22%, reflecting product and freight pricing actions across our branded and private label portfolios as well as favorable mix. Volume fell 2%, reflecting incremental losses of certain lower margin private label products. This was partially offset by higher shipments of branded products, although this growth was tempered by our inability to fully serve customer demand due to lower production run rate. Retail's product contribution margin nearly doubled to $42 million behind pricing actions, favorable mix with the sales of more branded products, and a $3 million decline in A&P expenses. This was partially offset by higher manufacturing and distribution costs per pound. Moving to our liquidity position and cash flow. We ended the quarter with $525 million of cash and a $1 billion undrawn revolver. We had net debt of about $2.2 billion, which corresponds to a 3.1x leverage ratio. For the year, we generated about $420 million of cash from operations, which is down about $135 million versus the prior year, largely due to higher working capital. Capital expenditures for the year were about $305 million. That's up about $145 million as we completed the chopped and formed line in Idaho and began construction of our capacity expansion in China. For the year, we returned nearly $290 million of cash to shareholders in the form of dividends and share repurchases and have just under $275 million of authorization for this program. Now turning to our updated fiscal 2023 outlook. As Tom noted, we anticipate the overall operating environment to continue to be challenging, with inflation continuing to affect our cost structure as well as consumer demand. Accordingly, we're taking a prudent approach to our fiscal 2023 outlook. We're targeting sales of $4.7 billion to $4.8 billion, which implies a growth rate of 15% to 17%. We expect that price will be the primary driver of sales growth as we continue to implement our previously announced pricing actions in our Foodservice and Retail segments and secure price increases in contracts up for renewal with customers in our Global segment. With respect to volume, forecasting demand has become increasingly difficult. Overall, we expect U.S. demand to remain solid but will also likely be affected by the significant inflation that consumers are facing. In the event of an economic recession, we expect demand for French fries will be resilient, although with little to no growth. That's consistent with what we experienced during the great recession from 2008 to 2010. Consumer behavior during inflationary or recessionary times may also have an effect on sales channel and product mix. QSRs and retail outlets may benefit, but this may be at the expense of casual dining establishments. We've already seen some indications of this in the past few months. In addition, we expect our volume growth will be limited by near-term production and throughput constraints as we continue to face labor shortages, disruptions in the availability of key product inputs and spare parts, and limited access to shipping containers for exports. For earnings, we expect net income of $360 million to $410 million, diluted EPS of $2.45 to $2.85, and adjusted EBITDA, including unconsolidated joint ventures, of $840 million to $910 million. Using the midpoint of this EBITDA range implies growth of about 20% or about $150 million versus the prior year. We expect the earnings increase will be driven primarily by sales growth and gross margin expansion. Favorable price/mix and productivity savings should more than offset input, manufacturing, and transportation inflation as well as the cost inefficiencies and potato crop challenges that pressured our results last year. During the first half of fiscal '23, we expect our gross margin to improve versus the first half of fiscal '22, but will continue to be pressured as compared to our normalized seasonal rates. This reflects the implementation of our pricing actions, lagging inflation, as well as the impact of higher raw potato costs on a per-pound basis due to the poor crop that we harvested last fall. We also expect our gross margins will be pressured by ongoing industry-wide labor and logistics challenges. During the second half of fiscal '23, we expect our gross margin will approach our normalized annual rate of 25% to 26%, assuming four key factors. First, an average fall 2022 potato crop. As Tom noted, at this time, we believe the crop in our primary growing regions in the Columbia Basin and Idaho will be consistent with historical averages. Second, the continued successful implementation of our pricing actions to offset input and transportation cost inflation. As our recent results have shown, we've been able to successfully increase price across our portfolio. Third, the continued easing of labor pressures that have affected our production run rates and throughput. While factory labor availability remains challenging, we feel good about the actions that we've put in place to attract and retain production workers. And finally, the continued easing of logistics pressures that have constrained our shipments, especially our exports, the availability of domestic rail and trucking assets has improved in the past few months, along with access to shipping containers. However, we're closely monitoring the recent expiration of the West Coast dock workers union contract and what impact, if any, it may have on our exports. We're projecting the strong increase in sales and gross profit will be partially offset by higher SG&A expenses. We're targeting total SG&A expenses of $475 million to $500 million, which is about $100 million higher than fiscal 2022, using the midpoint of that range. The increase largely reflects higher compensation and benefit costs as we adjust our compensation packages to reflect a very competitive environment to attract and retain talent. Additional headcount, recruiting, training, travel and meeting expenses as we look to fill open positions to support growth over the long term and continue to emerge from pandemic-related restrictions. Higher spending to build and test our new ERP system, in addition to other IT infrastructure upgrades, higher advertising and promotion expenses, predominantly in support of our retail segment, and finally, overall inflation for third-party services. We expect equity earnings to be $25 million to $30 million, which is up from about $16 million in fiscal 2022 after excluding the $27 million of mark-to-market commodity and currency contract gains as well as the impairment charge and about $10 million of earnings from the Russia joint venture. In addition to our operating targets, we expect total interest expense of around $115 million, an effective tax rate of approximately 24%, total depreciation and amortization expense of approximately $210 million, and capital expenditures of $475 million to $525 million, which includes about $285 million for the construction of our capacity expansions in Idaho and China as well as capital associated with our new ERP system and other IT upgrades. Finally, as Tom noted, we recently acquired a controlling interest in our joint venture in Argentina for $42 million and will now consolidate their results. We do not expect the joint venture to have a material contribution to either sales or earnings growth this year. So, looking at our fiscal 2023 outlook at a high level, we're targeting sales of $4.7 billion to $4.8 billion, largely driven by price/mix, and we're targeting adjusted EBITDA, including unconsolidated joint ventures, of $840 million to $910 million, largely driven by strong sales growth as well as gross margins that approach a normalized annual run rate of 25% to 26% during the second half of the fiscal year. Now, here's Tom for some closing comments.

Thanks, Bernadette. Let me quickly sum up by saying we delivered solid results in fiscal 2022 by focusing on what we can control and have built good operating momentum as we enter a new year. We've taken a prudent approach to our fiscal 2023 targets as we expect the operating and demand environment to remain highly challenging, and we're confident in the long-term prospects of the category and remain committed to executing on our strategies and investing in our global network to support growth and create value for our shareholders over the long term. Thank you for joining us today, and now we're ready to take your questions.

And we'll take our first question from Peter Galbo with Bank of America.

Tom, I just wanted to maybe unpack your comments around volumes for the year and kind of what you're expecting. I think in the press release, it does talk about positive volume growth, marrying that against your comments about maybe a little bit of slowing demand, just how you're thinking about the ability for volumes to grow throughout the year, maybe that means you have more potatoes given a better crop or how we should think about that? And then just the cadence of volume growth throughout the year as well would be helpful.

Yes. So Peter, the indicator is restaurant traffic, and we keep a close eye on that. QSR traffic looks relatively healthy. As we've seen in the past few months, the casual dining traffic has slowed down a bit, and we'll keep a close eye on that. Retail volumes continue to be pretty resilient. So it's not a matter of potatoes to support the volume, it really comes down to restaurant traffic. And you guys see the syndicated data just like we do. So that's something we keep an eye on really closely, but that's going to be a leading indicator of the volume for the year. I'm confident, as I think about the next year, certainly, there's concern about the economy. But the French fry category, even though we get into a situation where there's some economic slowdown, over time and historically, as we mentioned in our prepared remarks, there may be some switching from casual dining to QSR, but the overall category, I'm confident will continue to grow.

Okay. Okay. That's helpful. And Bernadette, I just want to ask about the cadence of gross margins for the year. So understanding that the first half, you should still be up year-over-year, maybe down versus your historical levels. But I guess why would the first half gross margins, if at all, kind of step back versus the fourth quarter? I think historically, first quarter and fourth quarter gross margins tend to be relatively similar. 2Q tends to be kind of plus or minus 100 basis points versus the first quarter. So just help us kind of understand the first half as we then think about approaching the second half at a more normalized rate.

Thank you, Peter. The first quarter is usually our lowest margin quarter of the year, which we experienced last year as well. We will be accounting for the costs associated with the potatoes we processed in the fourth quarter, which were higher costs, and we will continue to recognize these elevated costs throughout the first half of the year until we deplete this old crop. As we begin to harvest and acknowledge some of the higher costs related to this year's crop, we won't see much of a change in the cost of our potatoes since, as Tom mentioned earlier, we faced a 20% increase in the cost of this year's crop. However, we anticipate greater yields and other factors that will help reduce these costs and enhance our margins in the latter half of the year. I hope that makes sense.

Yes. No, it does. Thank you.

We'll now take our next question from Tom Palmer with JPMorgan.

Maybe Just kick off on following up on this cost inflation. I guess, quite simply, you've got a lot of moving parts with especially the crop rolling over into the new one, which has the big step-up in pricing. If we think about that double-digit rate of inflation that you discussed throughout this year, how does that change as we look towards next year? And is there a shift from quarter to quarter or maybe one period is more onerous than another?

Yes. So Tom, this is Tom Werner. Here's the way to think about it. Our guidance takes into account the potato cost inflation, all of our input cost inflation, obviously. And as we think about our pricing strategy and the timing of pricing that gets to the market, there is a lag. There's been a lag in the global business unit, as I commented on. It's going to be building over the course of this fiscal year in terms of regaining our margin structure to pre-pandemic levels. So there's a lot of noise, and you're absolutely right. We've got the old crop we're working through, as Bernadette had just said. So we have a higher cost crop we're processing right now. We have inflationary inputs for this next year. So it's going to be a build, as I've said for the past year. I'm confident where the commercial team has done a tremendous job getting to the market and executing our pricing strategies. So it's going to take until the back half of next year that we're going to get back to our pre-pandemic normalized margin levels, and we're going to build and we will be approaching those levels as we get through the back half of the year.

Okay. And I wanted to ask on the SG&A side. Pretty big step-up guided this year. I think you've highlighted a few areas, right? Some of it is very ongoing in terms of labor, just getting paid more effectively. But you've also called out investments in IT and in the ERP system. And it sounds like there's kind of two pieces, right? Maybe there's an ongoing piece to that once it's fully rolled out, but there's also implementation costs that are rolling through the P&L. So to what extent is this stepped-up cost space here to stay versus might we actually see a little easing as we look towards future years and those investments aren't needed anymore?

Yes. No, thanks, Tom. As it relates to SG&A, we have stepped up our guidance there, it approximates about 10% of our sales, including advertising and promotion expenses, as we discussed. We're bringing that back more to levels that we had prior to the pandemic. And then we do have these incremental ERP expenses that we are incurring. The piece that's going to be more here to stay is going to be as it relates to the compensation and benefits, as I referred to in my prepared remarks that have increased as we've worked to grow the team as well as attract the talent that are needed to continue to execute our strategies over the long term.

Okay. So no quantification on maybe what might roll off in coming years?

No quantification at this time. But having said that, we're always looking for ways to become more efficient, and we'll continue to do that.

We'll now take our next question from Adam Samuelson with Goldman Sachs.

So, the first question pertains to the margins, and you mentioned aiming to return to the historical range of 25% to 26%. How do you plan to approach this in the latter half of the fiscal year? It appears that the composition will differ from previous trends, particularly in terms of contributions from Global relative to Foodservice and Retail. The contribution margins across different units seem to be shifting compared to pre-pandemic levels based on your exit from fiscal '22. Considering the level of inflation you are planning for, it seems that by the end of the fiscal year, per pound margins could potentially exceed pre-pandemic standards if those targets are met. I would appreciate your thoughts on what would drive the need for higher per pound unit margins over time in this space, aside from a shift towards increased sales in the broader Foodservice Retail channel versus larger QSR customers.

Yes, Adam, I’d like you to consider it this way. It’s a quite complicated process. We have been focusing extensively on our mix management for the past 12 to 15 months. With the challenges in the supply chain and changes in our throughput efficiency, we have to be very selective with our mix management to ensure we are servicing our strategic customers. However, this also provides us the opportunity to evaluate the overall customer mix, and we’ve performed exceptionally well in this area, though it requires a careful approach. When we implement our pricing strategies, there is a delay in their impact on our profit and loss statements, so it takes time to realize these changes. We've mentioned that we've initiated several pricing actions to address various areas of the company, and we expect to see the effects of these actions build, but this will take some time. I am confident in our commercial teams and their execution. While the volume trends appear strong, there might be fluctuations in volume across different channels. It is a process, and I believe that in the latter half of the year, we will see progress.

Yes. And Adam, I think it's just critical to recall that with our global contracts, about one-third of those come open each year. And so it's going to take time, to Tom's point, as we continue to negotiate those each year. And that's essentially what's driving some of that difference.

Okay. If I look at fiscal '22 and consider where you're concluding the year or the full year, how would you assess capacity utilization for your business today? There are many variables at play, including labor and the potato crop throughout different times of the year. I'm trying to understand the potential for volume growth within the current operations and how much additional volume we can anticipate in the next couple of years when the China and Idaho plants come online.

I can't provide a specific number regarding our current capacity utilization, but it's below our historical levels. The China plant is set to come online in mid-2024. We have opportunities to enhance our throughput within our current capacity, and we are seeing improvements. We've also opened our chopped and formed line, which has added capacity for those products. As we continue to hire for our plants, labor conditions have improved over the past six months, giving me confidence that as the market and category grow, we will get our plants operating close to historical averages to meet demand. I'm optimistic about the category, and I've consistently supported it, especially with our investments in China, American Falls, and Europe. We need to improve efficiency and build upon our current capacity to meet demand, and I am confident we will achieve that. We have a plan.

And if I could squeeze one more. In the quarter, 15% price/mix, I know you started invoicing for freight surcharges, how much was freight surcharges of the price/mix?

Yes. We're not breaking that out from our product price increases.

Our next question will come from Chris Growe with Stifel.

I have a follow-up question regarding your comments on the global contracts. I want to clarify your expectations for pricing in those contracts. Do you anticipate that in fiscal '23, the pricing in that division will be enough to offset inflation, or will it take longer to implement those pricing changes?

Chris, this is Tom. Think of it in terms of this. We're, again, focused on pricing to get to pre-pandemic margin levels, and we're having discussions with customers. It is a layering effect. So, all contracts don't go into effect at the same time. So you won't see a full annualized price realization in some of our global contracts because they may start in October or November or December or January. So there's going to be a lag still just like we always have. That's been the case forever in this business. But on the other side, you get the carryover effect. So there is a lag. Again, this is why we've been really consistent to ensure that everybody understands that it's all about getting the discussions, the strategies in place and in the back half of fiscal '23, we'll start seeing the margins approaching pre-pandemic levels.

Okay. And then in relation to the pricing coming through in the Global division today, is that mostly the escalators kicking in that you've built into some of these contracts?

Yes, Chris, that's exactly right.

Okay. And just one other question regarding a situation where, for example, the yields from this year's potato crop are greater than average. How limited are you in producing that product? If you have more supply, can you increase volumes once the crop comes in? Are there still ongoing limitations related to what you can make, such as labor or general supply constraints?

Yes, Chris. We contract most of our expected volume needs each year, but we also keep a percentage of open potatoes that we can purchase depending on how the category is growing and the opportunities that arise. We have the flexibility to buy in the open market as we assess how the yields and acres are progressing through the growing season and evaluate our overall forecasted demand. This approach has worked well for me throughout my time running this company. While it's fluid, we don't face concerns about having enough potatoes to meet demand. We usually decide early in the harvest season if we need to purchase additional potatoes in the open market, as we have done in previous years. I feel optimistic about our balance and the crop's performance this year. In the next six weeks, we will determine whether to procure additional open potatoes from the market.

To clarify, if you have a surplus of potatoes from this crop and therefore had to buy less in the open market, I'm really more interested in your capacity. Can you produce and sell more of the product if you can bring in more supply?

Yes. If we have more potatoes due to higher yields, we will produce our standard Lamb Weston SKUs. However, it's important to note that we are still focused on improving our run rate.

We'll now take our next question from William Reuter with Bank of America.

I just have two. The first is, is there any way to quantify what the impact of the poor potato crop was on your fiscal year '22 EBITDA?

Yes. We haven't quantified that impact to discuss outside. But it is in excess of what we experienced in 2014. The last time we had a poor crop, which was about $30 million that we disclosed at that time. We're continuing to work through this crop. As we said, we'll continue to recognize the impact of that through the first half of fiscal '23.

That's helpful. Regarding your capital allocation and share repurchases, your leverage target range is 3x to 4x. When considering next year, how will you approach share repurchases? Should we expect that nearly all free cash flow generated will be directed towards shareholder activities like that?

Yes. So as it relates to our buyback program, we've disclosed and discussed previously that it's really in place to offset equity dilution. We've demonstrated, though, that we will be more aggressive if it makes sense. But our plan is in place to offset equity dilution.

Okay. And the target leverage range is 3x to 4x. I do have that correct. Is that right?

3.5x to 4x.

Okay. And is that net or gross?

That's net.

And it appears there are no telephone questions. I'd like to turn the conference back over to Mr. Congbalay for any additional or closing remarks.

Thank you for joining us today. Any follow-up questions, please e-mail, maybe we can set up a time. And everybody, have a good day. Thank you.

And once again, that does conclude today's conference. We thank you all for your participation, and you may now disconnect.