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Lamb Weston Q1 2023 Earnings Call Transcript

Corporate Executives

  • Dexter P. Congbalay
    Vice President, Investor Relations
  • Tom Werner
    President and Chief Executive Officer
  • Bernadette Madarieta
    Senior Vice President and Chief Financial Officer
Operator

Good day and welcome to the Lamb Weston First Quarter Earnings Conference Call. [Operator Instructions]

At this time, I'd like to turn the conference over to Dexter Congbalay. Please go ahead.

Dexter P. Congbalay
Vice President, Investor Relations at Lamb Weston

Good morning, and thank you for joining us for Lamb Weston's First Quarter 2023 Earnings Call. This morning we issued our earnings press release which is available on our website at 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 an overview of the current environment. Bernadette will then provide details on our first quarter results and our fiscal 2023 outlook.

With that, let me now turn the call over to Tom.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Thank you, Dexter. Good morning and thank you for joining our call today. We're pleased with our performance in the quarter, we drove strong sales growth, expanded our gross margin and nearly doubled adjusted EBITDA, including unconsolidated joint ventures. Our results reflect our continued focus on implementing pricing actions to offset input and transportation cost inflation, driving productivity and cost saving initiatives, increasing service levels for our customers in each of our sales channels and supporting our people and talent. We've built good operating momentum over the past few quarters by focusing on these near-term objectives and we are confident in our ability to deliver the upper end of our sales and earning target ranges for the year.

I'm especially proud that Lamb Weston team has continued to generate solid results in a very difficult macro economic environment. We expect this environment to remain challenging, at least through fiscal 2023 as inflation, a growing threat of recession, and industry-wide supply chain disruptions continue to pressure demand for fries, as well as our cost structure. It's no surprise that inflationary transfer food, energy, and housing have affected restaurant traffic in the U.S. over the past six months. We saw a similar restaurant traffic trends during the great recession as the consumer discretionary income came under pressure.

While traffic at quick service restaurants has held up relatively well, it has come at the expense of casual dining and full service restaurants as consumers increasingly choose less expensive options when dining away from home. In the past month or so, we've seen casual dining and full service restaurant traffic tick up from summer lows, but traffic remains below levels achieved just prior to the war in Ukraine. Unlike traffic trends, fry demand continues to be solid with dining out. The fry attachment rate which is the rate at which consumers order fries when visiting a restaurant or other food service outlets remains above pre-pandemic levels. Fry demand in Retail channels has also benefited as restaurant traffic slows.

Overall, we expect volatility in restaurant traffic and demand trends will continue through fiscal 2023, but history has shown that this category is resilient during economic downturns. Although we may see some category weakness in the near-term, we remain confident in the long-term growth prospects of the category in the U.S. and in our key international markets. In addition, as category growth returns to historical rates, we should be well positioned to capture at least our share of growth with our investments in new processing capacity in Idaho and China, as well as our newly announced expansion in Argentina.

With respect to pricing, our overall price-mix growth accelerated for the fourth consecutive quarter. In our Foodservice and Retail segments we continue to realize a carryover benefit of multiple product pricing actions that we have taken over the past 15 months and expect to benefit of these actions will continue to gradually build through the first half of fiscal 2023. In our Global segment, we made good progress in increasing price-mix through price escalators included in multi-year contracts, while also securing some price adjustments outside of these agreements. In addition, we've nearly completed negotiation -- negotiating contract renewals that represent about a third of our Global segment volume. Overall, we feel good about how the discussions played out and we'll generally begin to see the results of these new pricing structures during the second half of fiscal 2023.

Finally, with respect to this year's potato crop. Our preliminary view is the potato crop in our growing regions, in the aggregate, will be around the lower end of historical average range. Specifically, the overall quality of the crop including shape, color, level of defects and solid content is good and consistent with historical averages. Yields, however, are below average. The unusually hot weather during August affected the growth of the potatoes and resulted in a greater than average proportion of potatoes failing to bulk up to the desired size. In response, we've already begun to secure the additional potatoes needed to meet our production forecast and expect to purchase most of this from growers in the Columbia Basin and Idaho. That's in contrast to last year when we purchased potatoes at significant premiums to contracted prices and transported them from as far away as the East Coast.

As you may recall, our financial targets for the year were predicated in part on an average potato crop and we believe this crop is broadly consistent with our expectations. While below average yields will result in additional open market purchases at higher than contracted prices, we do not expect this to affect our ability to deliver our financial targets. To be clear, we view this crop as significantly better than last year's which was poor both in terms of yield and quality due to the prolonged extreme summer heat in the Pacific Northwest. We'll provide our final assessment of the crop, including how it performs out of stores, when we report our second quarter results in early January.

So in summary, we generated strong sales and earnings growth in the first quarter by executing pricing actions in each of our business segments and driving productivity savings. We expect restaurant traffic and fry demand will be volatile in the near-term as consumers continued to adjust to the inflation or inflationary environment. And on a preliminary basis, we believe the potato crops in our growing regions are at the lower end of historical average range and that any effect on our operations or financial performance will be manageable.

Let me now turn the call over to Bernadette to review the details of our first quarter results and our progress towards our fiscal 2023 financial commitments.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Thanks Tom, and good morning everyone. As Tom said, we're pleased with our performance in the quarter and we are confident in our ability to deliver at the high end of our financial target ranges for the year. In the quarter, our sales grew 14% to more than $1.1 billion. Price-mix was up 19%, as we continued to benefit from product and freight pricing actions that we announced last fiscal year and as we began to execute new pricing actions during the fiscal, for the first quarter.

Our sales volumes were down 5%, primarily reflecting the softer restaurant traffic trends in U.S. casual dining and full-service outlets that Tom described earlier, as well as the timing of shipments to large chain restaurant customers. In Retail, while branded product volumes were up, overall Retail segment volumes were down with the ongoing effect of losing certain low margin private label business. Sales volumes in Foodservice and Retail also continued to be affected by our inability to fully serve customer demand as a result of constrained production at our facilities.

Gross profit increased $122 million to $273 million in the quarter. Gross margin expanded nearly 900 basis points versus the prior year quarter and 230 basis points sequentially to more than 24%. Pricing actions and productivity savings drove these improvements, more than offsetting the impact of higher costs on a per pound basis and lower sales volumes. Cost per pound increased high single digits, with inflation again accounting for essentially all of the increase. Higher prices for inputs such as edible oils, ingredients for batter and other coatings, labor and transportation were the primary drivers.

Potato costs were also up as a result of the poor crop that was harvested last fall. We'll continue to realize the financial impact of this crop due most of the second quarter of fiscal 2023, as we sell the final finished goods produced from the crop. And finally, we continued to incur higher costs and operational inefficiencies associated with labor, spare parts, and ingredient shortages and other industry-wide supply chain challenges. Benefits from our portfolio simplification and other cost mitigation efforts, however, offset some of these higher costs.

Moving on from cost of sales, our SG&A increased $25 million, $116 million, largely due to higher compensation and benefits expense and expenses related to improving our IT infrastructure, including designing a new ERP system. Equity method earnings from unconsolidated joint ventures in Europe and the U.S., increased nearly $170 million. More than $140 million of the increase was related to the change in unrealized gains from mark-to-market adjustments, related to changes in natural gas and electricity derivatives, as commodity markets in Europe have experienced significant volatility. Another $15 million at the increase relates to a gain recognized in connection with us acquiring an additional 40% interest in our joint venture in Argentina.

Excluding these comparability items, as well as other mark-to-market adjustments not associated with natural gas and electricity derivatives, equity earnings increased $13 million. This largely reflects improved results in our joint venture in Europe. In addition, in September, our European joint venture withdrew from its joint venture in Russia, after receiving all regulatory approvals. In the prior year quarter earnings from the Russia joint venture were not material. So putting it all together, adjusted EBITDA, including unconsolidated joint ventures nearly doubled to $228 million, while adjusted diluted earnings per share more than tripled to $0.75 per share. Strong sales growth and gross margin expansion, primarily drove the increases.

Moving onto our segments. Sales in our Global segment were up 12% in the quarter. Price-mix was up 14%, reflecting domestic and international pricing actions associated with customer contract renewals, inflation driven price escalators, and higher prices charged for freight, mix was also positive. Overall segment volumes declined 2% as North American volumes fell, primarily due to the timing of shipments to large QSR chain customers, including the effect of lapping a notable limited time product offering in the prior year quarter. Global's product contribution margin which is gross profit less advertising and promotion expenses, nearly doubled to $84 million. Favorable price-mix more than offset the impacts of higher manufacturing and distribution cost per pound.

Sales in our Foodservice segment grew 14%. Price-mix increased 26%, as we continued to drive product and freight pricing actions that we announced throughout fiscal 2022 and earlier in the quarter to counter inflation. Sales volumes decreased 12% as casual dining and full service restaurant traffic softened. While traffic trends progressively softened each month since the war in Ukraine began at the end of February, it began to tick upward in August. Sales volumes were also affected by the timing of incremental losses of certain low margin, non-commercial business, as well as our inability to fully serve demand as a result of constrained production. Foodservices' product contribution margin rose more than 40%, to $138 million, as favorable price more than offset higher manufacturing and distribution cost per pound and the impact of lower volumes.

In our Retail segment, sales increased 28%. Price-mix was up 32%, reflecting pricing actions across our branded and private label portfolios, as well as favorable mix with the sale of more branded products. Volume was down 4%, reflecting incremental losses of certain lower margin private label products. We'll be lapping the loss of our lost private label business in the second quarter. Sales volumes were also tempered by our inability to fully serve customer demand due to the constrained production. Retail's product contribution margin more than tripled to $49 million behind pricing actions and favorable mix. This was partially offset by higher manufacturing and distribution cost per pound.

Moving to our liquidity position and cash flow. We ended the quarter with $485 million of cash and a $1 billion undrawn revolver. While our net debt remained relatively flat at about $2.25 billion, our leverage ratio fell to 2.7 times from 3.1 times at the end of the fiscal 2022, as earnings grew. We generated more than $190 million of cash from operations, which is up about $30 million versus the prior year quarter, largely due to higher earnings.

Capital expenditures were about $120 million, that's up about $40 million as we continue to construct new French fry lines in Idaho and China. In addition, we paid about $42 million to acquire the additional 40% interest in our joint venture in Argentina, we now own 90% of that joint venture. We returned $64 million of cash to our shareholders in the form of dividends and share repurchases and have about $240 million of authorization, remaining under our share repurchase program.

Turning to our fiscal 2023 outlook. Our financial targets for the year remain unchanged, as we continue to build our operating momentum. While the macroeconomic environment remains volatile, we're on track to deliver at the high-end of our sales target of $4.7 billion to $4.8 billion, with price driving the growth. We'll continue to realize the carryover benefit of product pricing actions in our Foodservice and Retail segments, and in our Global segment, we expect to see the benefit of pricing actions, including pricing structures for contract renewals build as the year progresses.

Forecasting volume continues to remain more difficult due to the near-term volatility in restaurant traffic and demand. As we saw in the first quarter, we believe that consumer behavior during inflationary or recessionary times will continue to affect overall demand, as well as our sales channel and product mix with QSRs and retail outlets benefiting at the expense of casual dining and full-service restaurants.

In addition, we expect our sales volumes will be affected by near-term production and throughput constraints, as we continue to face disruptions in the availability of key product inputs and spare parts. Additionally, while labor and access to shipping containers have improved, we continue to see the impact of shortages. We're on track to deliver at the high end of the range of our earnings target, including adjusted net income of $360 million to $410 million, adjusted diluted earnings per share of $2.45 to $2.85, and adjusted EBITDA including unconsolidated joint ventures of $840 million to $910 million. These targets exclude the items impacting comparability that I described earlier.

We expect our earnings increase will be driven primarily by sales growth and gross margin expansion. We continue to expect gross margins during the second half of fiscal '23 that approach our normalized annual rate of 25% to 26%, and we feel good about the four key factors underlying this target.

First, as Tom noted, we believe the potato crops in our primary growing regions will be at the lower end of the historical average range, and that any effect on our operations and financial performance will be manageable. Second, we're pleased with the continued progress in implementing pricing actions to counter cost inflation. Third, we're making steady progress in adding production workers in order to ease labor pressures in our factories. And finally, the availability of domestic rail and trucking assets, as well as access to shipping, containers continues to improve.

While a broad rail strike has likely been averted, we continue to closely monitor the status of discussions with the West Coast Dock Workers' Union and the impact of potential work slowdown or stoppage may have on our exports.

We continue to target SG&A expenses of $475 million to $500 million, which reflects higher compensation and benefits expenses to attract and retain talent, higher spending for our new ERP system and other IT infrastructure upgrades, higher advertising and promotion expenses as we look to return support back to historical levels and overall inflation for third-party services. We continue to expect equity earnings of $25 million to $30 million, excluding items impacting comparability, but also expect increased volatility, given the likelihood of a poor crop in Europe, as well as possible limitations on natural gas usage that may affect our production.

In addition, we believe that the severe inflation outlook for Europe will likely translate into more pressure on restaurant traffic and demand. Our estimates for our other financial targets are unchanged, including capital expenditures of $475 million to $525 million, excluding acquisitions. Interest expense of approximately $115 million, depreciation and amortization expense of about $210 million and an effective tax rate, excluding items impacting comparability, of about 24%.

Now here's Tom for some closing comments.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Thanks Bernadette. Let me quickly sum up by saying we are managing well through this challenging environment and continue to build good operating momentum. We're well positioned to deliver at the upper end of our financial target ranges for the year and we're making the necessary investments in our production capacity and operating infrastructure to support long-term growth and create value for our shareholders.

Thank you for joining us today. And now we're ready to take your questions.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Well, thank you. [Operator Instructions]

Our first question will come from Chris Growe with Stifel.

Chris Growe
Analyst at Stifel Nicolaus

Thank you, good morning.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Good morning, Chris.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Good morning.

Chris Growe
Analyst at Stifel Nicolaus

Hi. Thanks you, hi. I just had a quick question for you. And that was a very strong first quarter performance, congratulations on that. Obviously, you are looking more towards the higher end of your guidance now for the year. With this strong first quarter and this recovery in the gross margin, it would seem like you could see a even stronger EBITDA performance. I realize it's early in the year, but I just want to get a sense of items, maybe like an SG&A, if there is investments you can make there or perhaps even in, as you start to kind of rebuild your production with better labor and availability and that. If there are some items like that we should keep in mind as we move through the year, that could put a bit of a limit on the EBITDA performance?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, Chris, this is Tom. I'll just reiterate, we're off to a terrific start this fiscal year and our focus -- you think about a year ago, our focus has been rebuilding our margin structure back to pre-pandemic levels, that's the focus of the team, and they've done a terrific job. And just in terms of SG&A, and I'll let Bernadette add-on to this, we had some elevated spend due to the ERP, a lot of it. There is some wages also that has increased our SG&A based on the market conditions we have, but it's really about focusing on the mix, margin management, that's what we've been focusing on for the last year, when I started talking about it.

The team has done a great job executing that, it's the volumes a little bit choppy right now and I think that's going to continue for the balance of this fiscal year, just based on the economic environment we're all operating in, and as well as some of the supply chain issues we continue to experience within freight and containers, and those kind of things. So it's early, we got to understand how the crop processes through the factories in the next 60 days. And on that note, in Q2 we'll reassess kind of how we're feeling about the year.

Chris Growe
Analyst at Stifel Nicolaus

Okay, thank you. And just a follow-up question on your gross margin. Obviously it's a much stronger gross margin here in the first quarter than we expected and really more like your historical first quarter gross margin performance. I realize there's a lot going on in the gross margin today from pricing and cost inflation and the old crop and all that. I just want to get a sense of the factors that are aiding the gross margin performance this quarter? And maybe along with that, just to get a sense of how much these supply chain challenges are still weighing on the gross margin? Thank you.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, Chris, the main factor, if you think about a year ago, we were at 15% margin. And so it's really focused on pricing through inflation. We have absorbed a tremendous amount of cost inflation in this business, just like everybody else has in this space. So it's really driving pricing to offset inflation and we're making obviously great progress against that. We have a lot more to do. It's still, from an input cost standpoint, we're going to see more inflation coming at us in the future, so we're adjusting our pricing architecture to offset that as much as we can and we believe we will. So that's kind of -- that's the driver, Chris.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes, and we are making steady progress as we add production workers based on some of the actions that we've taken to attract and retain employees, while there is still those labor shortages. We are seeing the impact of that and some of the changes we've made the shift schedules and other things, just getting back to your run rates and throughput question.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, and just -- one of the big challenges we still have is container issues for our international business, Chris. And it's -- while it's getting better, it's still hindering our ability to ship to some of our international markets in a pretty significant way, which is impacting the overall volume in our Global business unit. The team is working through as best we can. But it's still challenging from a container standpoint on the West Coast.

Chris Growe
Analyst at Stifel Nicolaus

Okay. Well, thank you. It was a lot of good color, I appreciate it.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Thank you.

Operator

Thank you. Our next question come from Peter Galbo with Bank of America.

Peter Galbo
Analyst at Bank of America Merrill Lynch

Hey guys, good morning. Thanks for taking the question.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Good morning.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Good morning.

Peter Galbo
Analyst at Bank of America Merrill Lynch

Tom, I just wanted to ask actually like more of a technical question, I guess, around the 2022 potato crop. Realizing that yields are down and maybe the sizing is down a bit, but with the quality being good, can you just, I guess, educate us a little bit more on why the quality being above average or very good kind of helps pull up maybe a down yield year, what that does for you from a manufacturing standpoint?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes. So, the way to think about it is, the quality of the potato as we're manufacturing and running it through the factories, it will provide good solids and good color and the length is fine, which last year we had all kinds of issues with the crop. So set that aside, so quality is good, you're going to be able to -- the finished product is going to be more normalized, I'll say. The yield impact is literally -- there is just less potatoes on the plant as it grows than what we historically have. So, it's just, you just have less potatoes per acre. And so we're -- I feel great about our ability to procure open potatoes as we have every year. We do it every year, so it's -- while it's not at historical levels, like we said on the call, we will manage through it. We have a great ag team that will help us manage through it and procure the potatoes and we'll be able to deliver our customers the product they need.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

And Tom, if I could add on to that. In terms of the quality component, being better this year versus last year. Last year, that lower quality really resulted in lower potato utilization, so we required more potatoes to produce the same amount of finished goods, and we're not going to have that issue this year with a better crop in terms of quality. And then potato quality also affects Line-Speed times in our plants. Again, we won't have that issue this year with a better quality crop.

Peter Galbo
Analyst at Bank of America Merrill Lynch

Got it. That was going to be my follow-up, so thanks for that, Bernadette. And then maybe just as a second question, more of a technical question for modeling purposes. Just can you quantify at all the shipment timing impact on QSRs in the first quarter. Does that shift to the second quarter at all? And then just, again seasonally, historically gross margins tick up from 1Q to 2Q in a normal year, should we expect some of that normal sequential acceleration into the second quarter? Thanks very much.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes. As it relates to our gross margin, we'll continue to see the normal seasonality. And then as it relates to the first question and the impact of the QSR, we don't give certain guidance as it relates to specifics, but essentially that will flow through in the second quarter in terms of timing, just given the delay in shipments.

Peter Galbo
Analyst at Bank of America Merrill Lynch

Great. Thanks very much.

Operator

And our next question comes from Tom Palmer with JPMorgan.

Tom Palmer
Analyst at JPMorgan Chase & Co.

Good morning and thanks for the question.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Good morning, Tom.

Tom Palmer
Analyst at JPMorgan Chase & Co.

I wanted to ask on COGS inflation expectations. It sounds like, based on Bernadette prepared remarks, that maybe it decelerated just a little bit in the first quarter, is the assumption that as the year progresses, you see the rate of inflation ease a little bit. Just wondering what's kind of embedded in that?

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes. So we did end the quarter with high single-digit cost inflation, including transportation, but then we also had some of the increased costs related to inefficiencies for run rates. So those are the two pieces. As it relates to inflation though going forward, although they've come off their recent highs, they still do remain well elevated compared with pre-pandemic levels. And then it also will be impacted going forward by the timing of when some of our hedges drop off for some of our natural gas.

Tom Palmer
Analyst at JPMorgan Chase & Co.

Okay. Understood. And then just maybe get a quick recap of pricing actions at this point. You cited list price increases that flowed through during the first quarter. So I guess, presumably there'll be carry over in the second quarter. From a list price standpoint, is there anything beyond that at this point or is kind of the next step up as we move into the new year and global contracts are adjusted?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes. So the big thing, Tom, is our global contract negotiations are kind of wrapping up for this next fiscal year. Most of those will start falling through in the back half. And as I said in the remarks, we feel good about where all those ended up. So, we'll start seeing and realizing those in the back half. In terms of the other segments, we've been ahead of the curve in terms of the pricing to offset inflation and we, as we always do, we'll continue to evaluate based on what we're seeing on our cost structure, evaluating when we go to market and change prices going forward in the Retail and Foodservice segment.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes, that's right. And then the last price increase that we announced in Foodservice, Retail in July, you'll begin to see more benefit of that in Q2, Q3.

Tom Werner
President and Chief Executive Officer at Lamb Weston

You might start to see a little bit of slowdown in transport though to see, you have that. Remember, we've been talking about product pricing here, but transport has start to come off a little bit, just as the cost of transport goes down. And most people on the call know that we're try to make that as a pass-through as possible. It's a -- over time and it tends to be gross profit neutral, but it will be a little bit more volatility on the top-line because of that.

Tom Palmer
Analyst at JPMorgan Chase & Co.

Okay. Thanks for all the detail.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Thanks Tom.

Operator

And our next question will come from Rob Dickerson with Jefferies.

Rob Dickerson
Analyst at Jefferies Financial Group

Thanks so much. Let me just -- I've got a follow-up for the gross margins, specifically in the back half. Q1 gross margins [Indecipherable].

Tom Werner
President and Chief Executive Officer at Lamb Weston

Hey Rob, you're breaking up a little bit.

Rob Dickerson
Analyst at Jefferies Financial Group

I'm sorry. Yes, sorry, I was just saying, gross margin in the first quarter was obviously impressive, not that far from expectations in the back half. And then it sounds like, contract negotiations this summer in Global gone well. So I guess, as we think kind of just to that Q3 time period with some of the incremental pricing coming through. Tom, what would you consider, some of the drivers that might just get to the high end of that gross margin guide in the back half, maybe some of the drivers will get you the to the lower half and if -- or took a lower end and it sounds like it's kind of more of the demand side relative to maybe volatility on cost or pricing, and what do you think around the crop? Thanks.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, Rob, the -- as we've been very consistent, I feel good about where our gross margins are going to progress towards our historical averages in the back half pre-pandemic. So that's what our focus is on and we're off to making good progress against that obviously. And so I feel confident about us returning back to normalized levels. And so I'm not going to talk about high-end, low-end, all those kinds of things, Rob, I just -- it's about making progress and we're doing that as an organization and the team is executing against that.

Rob Dickerson
Analyst at Jefferies Financial Group

Right. Fair enough. And then just quickly, Tom, I know you said early on in the call, it sounds like you've been able to secure incremental supply just given a little lower yield on the crop. At this point, kind of given where do you stand, is it fair to say that you have plenty of supply, right. You have plenty of potatoes as you kind of get through the fiscal year, this shouldn't be like an issue we're sitting here in March or April, such that the market is all out trying to fight for potatoes in the open market. That's it, thanks.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, Rob, I feel great. We have great partner growers. We work in tandem with them on our needs and we got a great ag team that has tremendous relationships with our growers. So, we feel confident that we'll be able to execute against our production plan and sales plan for the year and we have some things we can do to adjust new crop, old crop. So, I feel good about where we're positioned going forward.

Rob Dickerson
Analyst at Jefferies Financial Group

All right, super. Thanks a lot.

Operator

And our next question will come from Adam Samuelson with Goldman Sachs.

Guillermo
Analyst at The Goldman Sachs Group

Good morning, everyone. Thank you for taking my question.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Good morning, Adam.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Good morning, Adam.

Guillermo
Analyst at The Goldman Sachs Group

It's actually Guillermo [Phonetic] stepping in for Adam. I was wondering if you could help us understand a little bit better your underlying assumptions as it relates to your guidance, you reaffirmed it, now that we have three more months, has anything changed in terms of your underlying price-mix assumptions or volumes?

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes, I think that no, there is four key factors that we've alluded to in our prepared remarks, as it relates to our guidance that we've been watching and that's crop, pricing, our run rates, and then logistics. And we feel good about where we're at on all of those. And therefore, I think we'll be at the higher end of the range of our earnings targets that we have outlined. So, feel good about all of those factors.

Guillermo
Analyst at The Goldman Sachs Group

That's helpful. Thank you. And as a follow-up, as it relates to your investment in Argentina, how does it benchmark in terms of profitability versus the rest of the portfolio?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Well, this is Tom. It's right in line with our long-term strategic growth plans. It gives us in-country production capabilities alongside of our -- we have a joint venture down there and it gives us a footprint in the South American market, which is a huge market and we're under indexed in terms of share. So, and a super cost competitive. So, I feel good about our investment. It's right along our strategic long-term plan that we've been executing against for the past 6 years. I mean I'm excited about it and it's going to give us a tremendous competitive advantage in that market down there going forward.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes. And we expect that the return on that expansion to be attractive and in line with our other expansions.

Guillermo
Analyst at The Goldman Sachs Group

That's very helpful. Thank you. I'll pass it on.

Operator

And moving on to William Reuter with Bank of America.

William Reuter
Analyst at Bank of America Merrill Lynch

Hi, good morning. I just have two. The first is, with the second year of kind of below average crop yields, has there been any change in the amount of area or land that is being dedicated to the production of potatoes? I'm wondering whether there could be long term implications if some of the growers aren't making as much money as they historically did?

Tom Werner
President and Chief Executive Officer at Lamb Weston

No, I mean -- this is Tom. The acres fluctuate a bit, nothing major. So the acres around our growing areas has been pretty consistent over time. There is some change, but it's really not -- has not been material, as long as I've been around this business.

William Reuter
Analyst at Bank of America Merrill Lynch

Great to hear. And then kind of on a related topic. There is some trade press that suggests that some of your contract negotiations in the Columbia Basin are already complete for calendar year '23, is there anything you can provide there in terms of color?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes, no, we won't provide any color on that in the next couple of calls as some of those things finalize. As we always do, we'll communicate that on one of these calls in the near future, once everything is done.

William Reuter
Analyst at Bank of America Merrill Lynch

Understood. Sounds good. Thank you.

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes.

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Thank you.

Operator

[Operator Instructions] And moving on to Carla Casella with JPMorgan.

Carla Casella
Analyst at JPMorgan Chase & Co.

Hi, thanks for taking the question. Wondering, you've been making a lot -- you've been spending a lot on -- of your investing on additional capacity, can you talk about your -- whether your view towards M&A or further JV investments may change as those facilities are done or is that not inhibiting any of your M&A, JV investment opportunities?

Tom Werner
President and Chief Executive Officer at Lamb Weston

Yes. This is Tom. The -- strategically our investment in expanding capacity has been very consistent. As we see the category growth and we think about the next really two, three, four, five, seven years as the category continues to grow, even at low-single digits, it's a big growth number in terms of overall volume. So, over time, we're going to continue to invest in the business and invest in the growth of the category. In terms of M&A, I've been very consistent since I've been sitting in this chair that we are as active as we can be and pursuing M&A actions, but the timing of those are always hard to predict, but it is absolutely going forward, part of our growth, strategic plan, organic capacity investment and potential M&A as those opportunities present themselves.

Carla Casella
Analyst at JPMorgan Chase & Co.

Okay, great. And then can you -- did you -- I might have missed it, did you give a leverage target?

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes, so our leverage target remains the same at 3.5 times to 4 times, certainly, we're considerably below that right now. But we maintain that strong balance sheet during these periods of economic volatility and it preserves optionality for M&A.

Carla Casella
Analyst at JPMorgan Chase & Co.

That's great. And then just one last one on hedging. Can you just talk about what you can and are hedging and if your policies are changing there just in light of the current environment?

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

Yes, just high level, we do hedge our natural gas and oil that's used in processing our potatoes. Our policies have not changed. We've always had a Risk Oversight Committee that has monitored the markets and we've entered into those contracts as we've seen appropriate.

Carla Casella
Analyst at JPMorgan Chase & Co.

Have you said how much you're hedged in for the year?

Bernadette Madarieta
Senior Vice President and Chief Financial Officer at Lamb Weston

We haven't disclosed that.

Carla Casella
Analyst at JPMorgan Chase & Co.

Okay, great. Thank you.

Operator

Thank you. And that does conclude the question-and-answer session. I'll now turn the conference back over to Mr. Congbalay, for any additional or closing remarks.

Dexter P. Congbalay
Vice President, Investor Relations at Lamb Weston

Thanks for joining us today. If you want to serve a follow-up call, please email me and we can set up a time either today or in the following days. Thanks again for joining and I'll talk to you later. Bye.

Operator

[Operator Closing Remarks]

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