Lamb Weston Holdings, Inc. (LW) Q1 2022 Earnings Call Transcript

Lamb Weston Holdings, Inc. (NYSE: LW) Q1 2022 earnings call dated Oct. 07, 2021

Corporate Participants:

Dexter Congbalay — Investor Relations

Tom Werner — President and Chief Executive Officer

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Analysts:

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

Rob Dickerson — Jefferies LLC — Analyst

Andrew Lazar — Barclays Capital — Analyst

Peter Galbo — BofA Securities, Inc. — Analyst

Matt Smith — Stifel Financial Corp. — Analyst

Presentation:

Operator

Good day and welcome to the Lamb Weston First Quarter 2022 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Dexter Congbalay, VP and Investor Relations of Lamb Weston. Please go ahead.

Dexter Congbalay — Investor Relations

Good morning and thank you for joining us for Lamb Weston’s first quarter 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 comments on our performance as well as a brief overview of the current operating environment. Bernadette will then provide details on our first quarter results and fiscal 2022 outlook.

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

Tom Werner — President and Chief Executive Officer

Thank you Dexter. Good morning and thank you for joining our call today. We’re pleased with our strong sales growth in the quarter, which reflects the on growing broad recovery in demand across our out of home sales channels as well as continued improvement in our key international markets. However, our margin improvement lags our volume recovery as a result of the timing of pricing actions to offset cost inflation as well as challenging macro factors that increase our cost and affected our production run rates and throughput.

These ongoing challenges combined with the extreme summer’s heat negative, negative impact on potato crops in the Pacific Northwest will result in higher costs as the year progresses. As a result, we now expect our gross profit margins will remain below pre-pandemic levels through fiscal 2022. We believe many of these costs and supply chain challenges are transitory and we’re taking aggressive actions to mitigate their effects on our operations and financial performance. We’re confident that our actions along with our investments to improve productivity and operations over the long-term will get us back on track to deliver higher margins and sustainable growth.

Before Bernadette gets into some of the specifics of our first quarter results and outlook, let’s briefly review the current operating environment starting with demand. In the U.S., we continue to be encouraged by the pace of recovery in restaurant traffic and demand for fries. Overall, restaurant traffic has largely stabilized at about 5% below pre-pandemic levels led by the continued solid performance at quick service restaurants. Traffic at full service restaurants continued to rebound in June and July, but it did soften a bit in August as the Delta variant surged across most of the country.

Demand improved at non-commercial Foodservice outlets especially in the education market, which help to offset the near-term slowdown in full service restaurants. The fry attachment rate in the U.S. which is a rate at which consumers order fries when visiting a restaurant or other Foodservice outlets also continued to help support the recovery in demand by remaining above pre-pandemic levels. Demand in U.S. retail channels also remained solid with overall category volumes in the quarter still up 15% to 20% from pre-pandemic levels. Outside the U.S., overall fry demand continued to improve in the quarter, although the rate of improvement varied widely among our key international markets. Demand in Europe, which is served by our Lamb-Weston/Meijer joint venture gradually recovered as vaccination rates climbed.

Demand in Asia and Oceania was solid but also softened in August due to the spread of the Delta variant and South America remain challenged especially in Brazil. So overall, we’re happy with the recovery in global demand and believe it provides a solid foundation for continued volume growth in fiscal 2022. With respect to the pricing environment, I’m pleased with the progress of our recently implemented pricing actions demanded sharp input costs inflation. In our Foodservice and Retail segments as well as in some of our international business, we’ll begin to realize some of the pricing benefits in the second quarter and more fully in the third quarter.

In our Global segment, the contract renewables for large chain restaurant customers have largely progressed as we expected and we’ll generally begin to see the impact of any pricing actions associated with these contracts in our third quarter. In addition, we’ll continue to benefit from price escalators for most of the global contracts that are not up for renewal this year. These price adjustments reset based on the underlying timing of the contract renewals were largely during our physical third quarter. Overall, we expect our price increases across our business segments will in aggregate mitigate much of the cost inflation.

However depending on the pace and scope of inflation and the increase of potato cost resulting from this year’s poor crop we may take further price action as the year progresses. In contrast to demand and pricing, the manufacturing and distribution environment continues to be difficult. Our supply chain costs on a per pound basis have increased significantly due to input and transportation cost inflation as well as labor availability and other macro supply chain disruptions that are continuing to cause production inefficiencies across our global manufacturing network.

Although we’re making gradual progress to mitigate these challenges, they have slowed our efforts to stabilize our manufacturing operations during the first half of physical 2022. As a result, we expect the turnaround in our supply chain will take longer than we initially anticipated. Now turning to the crop, the early read on this year’s crop in the Columbia base in Idaho and Alberta indicates that it will be well below average levels and both yield and quality due to the extreme heat over the summer. As we’re still in the middle of the main crop harvest, the extent of the financial impact of the crop condition will be determined over the coming quarter as the harvest is completed.

While we expect this impact will be significant, we’re examining a variety of levers to mitigate the effect on our earnings as well as on customer service and supply. As usual we’ll provide a more complete assessment of the crop and its impact on earnings when we release our second quarter results in early January. So in summary, I feel good about the overall pace of recovery in French Fry demand especially in the U.S. and believe it provides a solid foundation for future growth.

I also feel good about the current pricing environment and how we’re executing pricing actions in the marketplace. We do expect higher potato costs input and transportation inflation, labor challenges and other industry-wide operational headwinds to continue for the remainder of this fiscal year. While we’re taking specific actions to mitigate these challenges they will keep our gross margins below pre-pandemic levels through fiscal 2022. And finally, I’m confident that we’re taking the right steps to get our company back on track to delivering more normalized profit margins.

Let me now turn the call over to Bernadette to review the details of our first quarter results and our fiscal 2022 outlook.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Thanks Tom and good morning everyone. As many of you know, this is my first earnings call as CFO of Lamb Weston. I’ve now been in the role for about nine weeks. For those on the line that I haven’t met, it’s a pleasure to meet you over the phone. I’m looking forward to meeting many of you in person over the coming months as we get back into the cadence of in-person investor meetings and industry events. As Tom discussed, we feel good about the health of the category and our top line performance in the first quarter and expect our gross margins going forward will improve as we benefit from our recent pricing actions, as well as from other actions that we’re taking to mitigate some of the macro challenges affecting our supply chain.

Specifically in the quarter, sales increased 13% to $984 million, with volume up 11% and price mix up 2%. As expected, volume was the primary driver of sales growth reflecting the ongoing recovery in fry demand outside the home in the U.S. and in some of our key international markets, as well as a comparison to relatively soft shipments in the prior-year quarter. Lower retail segment sales volume partially offset this growth, largely as a result of incremental losses of low-margin private label business. Overall, our sales volume in the first quarter was about 95% of what it was during the first quarter of fiscal 2020 before the pandemic impacted demand.

Moving to pricing; pricing actions and favorable mix drove an increase in price mix in each of our core business segments. As I’ll discuss in more detail later, our pricing actions include the benefit of higher prices charged to customers for product delivery in an effort to pass through rising freight costs. The offset to this is higher transportation costs in cost of goods sold. Gross profit in the quarter declined $63 million, as the benefit of higher sales was more than offset by higher manufacturing and transportation costs on a per pound basis. The decline in gross profit also includes the $6 million decrease in unrealized mark-to-market adjustments, which includes a $1 million gain in the current quarter compared with a $7 million gain in the prior year quarter.

The increase in cost per pound, primarily related to three factors. First, we incurred double-digit cost inflation for key commodity inputs, most notably edible oils which has more than doubled versus the prior year quarter. Other inputs that saw significant inflation include ingredients such as wheat and starches used to make batter and other coatings and containerboard and plastic film for packaging. Higher labor costs were also a factor as we incurred more expense from increased unplanned overtime. Second, our transportation costs increased due to rising freight rates as global logistics networks continue to struggle.

Our costs also rose due to an unfavorable mix of higher costs trucking versus rail as we took extraordinary steps to deliver product to our customers. Together, inflation for commodity inputs and transportation accounted for approximately three quarters of the increase in our cost per pound. The third factor driving the increase in cost per pound was lower production run rates and throughput at our plants from lost production days and unplanned downtime. This resulted in incremental costs and inefficiencies. Some of this is attributable to ongoing upstream supply chain disruptions including the timely delivery of key inputs and other vendor supplied materials and services.

However, most of the impact on run rates was attributable to volatile labor availability and shortages across our manufacturing network. So what do we do to mitigate these higher costs and stabilize our supply chain? First, price; we are executing our recently announced price increases across each of our business segments and implementation of these pricing actions are on track. Our price-cost relationship will progressively improve as our pass-through pricing catches up with deflationary cost increases. We’ll begin to see some benefit from these actions in the second quarter and it will continue to build through the year.

If needed, we will implement additional rounds of price increases to mitigate the impact of further cost inflation. We’ve also increased the freight rates that we charge customers to recover the cost of product delivery. And we are adjusting them more frequently to better reflect changes to the market rates. These adjustments have also lagged the cost increases. While we saw some benefit in the first quarter, we expect to see more of a benefit beginning in the second quarter. In addition, we’re significantly restricting the use of higher costs spot rate trucking.

Second, we’re optimizing our portfolio. We’re eliminating underperforming skews to drive savings through simplification in terms of procurement, production, inventory management, and distribution. We’re also partnering with our customers to modify product specifications without comprising food, safety and quality. These modifications will help mitigate the impact of lower potato crop yields from this year’s crop as well as some of the impact of reduced potato utilization that results from poor raw potato quality. Third, we’re increasing productivity savings with our Win As One program.

While realized savings to-date have been small given that the initiative is still fairly new we began to execute specific cost reduction programs around procurement, commodity utilization, manufacturing waste, inventory management and logistics as well as programs to improve demand planning and throughput. We expect savings from these and other productivity programs will steadily build as our supply chain stabilizes. And finally, we’re managing labor availability and volatility. This includes changing how we schedule our labor crews, which provides our employees more control and predictability over their personal schedules and reduces unplanned overtime.

We’re also reviewing compensation levels to make sure we remain an Employer of Choice in each of our local communities. This is in addition to the other recruiting tools and incentives such as signing and retention bonuses. Moving on from cost of sales; our SG&A increased $13 million in the quarter. This increase was largely driven by three factors. First, it reflects the investments we’re making behind information technology, commercial and supply chain productivity initiatives that should improve our operations over the long term. About $4 million this quarter represents non-recurring ERP related expenses. Second, it reflects higher compensation and benefits expense.

And third, it includes an additional $3 million of advertising and promotional support behind the launch of new branded items in our retail segment. This increase compares to a low base in the prior year when we significantly reduced A&P activities at the onset of the pandemic. Diluted earnings per share in the first quarter was $0.20, down from $0.61 in the prior year, while adjusted EBITDA including joint ventures was $123 million, down from $202 million. Moving to our segments, sales for our Global segment were up 12% in the quarter with volume up 10% and price mix up 2%. Overall, the segments’ total shipments are trending above pre-pandemic levels due to strength in our North American chain restaurant business especially at QSRs.

Our international shipments in the quarter also approached pre-pandemic levels, despite congestion at West Coast ports and the worldwide shipping container shortage continuing to disrupt our exports as well as softening demand in Asia due to the spread of the Delta variant. The 2% increase in price mix reflected the benefit of higher prices charged for freight, inflation driven price escalators and favorable customer mix. Global’s product contribution margin, which is gross profit less advertising and promotional expenses declined 45% to $43 million.

Input and transportation cost inflation as well as higher manufacturing costs per pound more than offset the benefit of higher sales volume and favorable price mix. Moving to our Foodservice segment, sales increased 36% with volume up 35% and price mix up 1%. The strong increase in sales volumes largely reflected the year-over-year recovery in shipments to small and regional restaurant chains and independently-owned restaurants. However, shipments to these end customers along with restaurant traffic slowed in August due to the surge of the Delta variant across the U.S.

Volume growth in August was also tempered by the inability to service full customer demand due to lower production run rates and throughput at our plants largely due to labor availability. Our shipments to non-commercial customers improved through the quarter as the education, lodging and entertainment channels continued to strengthen. Overall non-commercial shipments were up sequentially to 75% to 80% to pre-pandemic levels from about 65% during the fourth quarter of fiscal 2021. The increase in price mix largely reflected pricing actions including the benefit of higher prices charged for freight.

Foodservices product contribution margin rose 12% to $96 million. Higher sales volumes and favorable price mix more than offset input and transportation cost inflation as well as higher manufacturing costs per pound. Moving to our Retail segments; sales declined 14% with volume down 15% and price mix up 1%. The sales volume decline largely reflects lower shipments of private label products, resulting from incremental losses of certain low margin business. Sales of branded products were down slightly from a strong prior-year quarter that benefited from very high in-home consumption demand due to the pandemic, but remained well above pre-pandemic levels.

The increase in price mix was largely driven by favorable price including higher prices charged for freight. Retails product contribution margin declined 59% to $15 million. Input and transportation cost inflation, higher manufacturing cost per pound, lower sales volumes and a $2 million increase in A&P expenses to support the launch of new products drove the decline. Let’s move to our cash flow and liquidity position. In the first quarter, we generated more than $160 million of cash from operations. That’s down about $90 million versus the prior year quarter due primarily to lower earnings. We spent nearly $80 million in capital expenditures and paid $34 million in dividends.

We also bought back nearly $26 million worth of stock or about double what we have typically repurchased in prior quarters. During the quarter, we amended our revolver to increase its capacity from $750 million to $1 billion and extended its maturity date to August 2026. At the end of the first quarter, our revolver was undrawn and we had nearly $790 million of cash on hand. Our total debt was about $2.75 billion and our net-debt-to-EBITDA including joint ventures ratio was 2.7 times. Now, let’s turn to our updated outlook. We continue to expect our sales growth in fiscal 2022 to be above our long-term target of low to mid-single digits.

In the second quarter, we continued to anticipate sales growth will be largely driven by higher volume as we lap a comparison to relatively fast shipments during the second quarter of fiscal 2021 due to the pandemic. We expect price mix will be up sequentially versus the 2% that we delivered in Q1 as the execution of pricing actions in all of our segments remain on track. For the second half of the year, we continued to expect our sales growth will reflect more of a balance of higher volume and improved price mix as we begin to lap some of the softer volume comparisons from the prior year and as the benefit from our earlier pricing actions continue to build.

Our volume growth, however, may be tempered by global logistics disruptions and container shortages that affects both domestic and export shipments. It may also be tempered by lower factory production due to macro industry and labor challenges, as well as a poor quality crop. With respect to earnings, we expect net income and adjusted EBITDA including joint ventures will continue to be pressured through fiscal 2022. That’s a change from our previous expectation of earnings gradually approaching pre-pandemic levels in the second half of the year.

Driving most of this change is our expectation of significantly higher potato costs, resulting from poor yield and quality of the crops in our growing regions. We previously assumed the potato crop that approached historical averages. Outside of raw potatoes, we expect double-digit inflation for key production inputs, such as edible oils, transportation and packaging to continue through fiscal 2022. We had previously assumed these costs would begin to gradually ease during the second half of the year. We also expect the macro challenges that have slowed the turnaround in our supply chain to continue through fiscal 2022.

That said we expect the labor and transportation actions that I described earlier along with our Win As One productivity initiative will help us continue to gradually stabilize operations, improve production run rates and throughput and manage costs as the year progresses. For the full year, we expect our gross margin may be at least 5 points to 8 points below our normalized annual margin rate of 25% to 26%. While we recognize this is a wide range, it reflects the volatility and high degree of uncertainty regarding the cost pressures that I’ve discussed.

Consistent with prior years, we’ll have a better understanding of the crop’s financial impact in the next couple of months and we will provide an update when we release our second quarter results in early January. Below gross margin we expect our quarterly SG&A expense will be in the high 90s as we continue our investments to improve our operations over the long-term. While equity earnings will likely remain pressured due to input cost inflation and higher manufacturing costs both in Europe and the U.S. We’ve also updated a couple of our other targets for the year.

First, we’ve reduced our capital expenditure estimate to $450 million from our previous estimate of $650 million to $700 million. This significant reduction is due to the timing of spend behind our large capital projects and effectively shift the spend into early 2023 — fiscal 2023. Despite the shift in expenditures, our expansion projects in Idaho and China remain on track to open in the spring and fall of 2023 respectively. And second, we’re reducing our estimated full year effective tax rate to approximately 22%, down from our previous estimate of between 23% and 24%.

Our estimates for total interest expense of around $115 million and total depreciation and amortization expense of approximately $190 million remain unchanged. So in summary, the strong recovery in demand helped fuel our top line growth in the first quarter, but higher manufacturing and distribution costs led to lower earnings. For fiscal 2022, we expect net sales growth will be above our long-term target of low to mid-single digit, but that our earnings will continue to be pressured for the remainder of the year due to higher potato costs from a poor crop and persistent inflationary and macro challenges. Nonetheless, we expect to begin to see earnings improve in the second quarter behind our pricing actions and the steps we’re taking to improve our cost.

Now, here’s Tom for some closing comments.

Tom Werner — President and Chief Executive Officer

Thanks, Bernadette. Let me just sum it up. We feel good about the near-term recovery in demand in the U.S. and our key international markets, as well as the long-term health and growth of the category. We’re taking the necessary steps with respect to pricing and continuing to focus on stabilizing our supply chain to mitigate near-term operational headwinds and improve profitability. We’re on track with our recently announced capacity investments to support our customer and category growth, as well as our long-term strategic and financial objectives.

Thank you for joining us today. Now we’re ready to take your questions.

Questions and Answers:

Operator

[Operator Instructions] We’ll take our first question from Tom Palmer with J.P. Morgan.

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Good morning and thank you for the questions.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Good morning, Tom.

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Thanks. Just to kick off maybe asked on the pricing side, I know your initial round is just starting to work its way through market but it sounds like it’s not going to fully offset inflation. Could you maybe talk about at what point, just from a timing standpoint, you could think about that second round being instituted? And then, to what extent do you think you’ll be able to price for potato inflation — I know that your sourcing is maybe a little bit different than what the broader U.S. might be facing this year in terms of potato costs. So just trying to kind of understand that pricing dynamic. Thanks.

Tom Werner — President and Chief Executive Officer

Yeah. So the pricing — this is Tom Werner. The pricing generally — we have priced through to offset inflation across the portfolio. It’s a matter of timing. So as we’ve stated, we’ll start realizing some of that here in Q2. But the full impact of our pricing actions across our segments will start to realize in Q3 and that’s pretty typical in previous years. And one of the things that impacted this quarter is we got behind on it quite frankly. So we’re catching up. And as we’ve — as we evaluate the go-forward, we’re closer to it. We’re taking a number different actions particularly in our trade freight to pass those costs through based on freight availability and managing customer service. So we’ve adjusted and we’ll evaluate it going forward and determine based on how inflation is coming at us, we’ll react a lot quicker.

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Okay. Thanks for that. And then, I know this is a small segment, but it actually was a, I guess, a meaningful margin overhang this quarter, the other segment swinging to the loss despite mark-to-market gains. What drove that this quarter? Is that something we should expect to recur or was it kind of unusual item?

Dexter Congbalay — Investor Relations

I can — hey, Tom. It’s Dexter. You had a sizable gain I think last year. It’s so in mark-to-market that flows through other and the gain in mark-to-market this year is smaller.

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Okay. Yeah, I mean, even excluding that, I think, you’re looking at around a $15 million decline year-over-year.

Dexter Congbalay — Investor Relations

Oh, no, no, no. I have to look that up again, but it’s not that. It’s much smaller than that, I mean, the details on that will come on the K off hand. But we’ll circle back on this call to give you the answer on that, but we’ll just look it up real quick.

Tom Palmer — J.P. Morgan Securities LLC — Analyst

Okay. Thanks.

Operator

And we’ll take our next question from Adam Samuelson with Goldman Sachs.

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

Yeah, thank you. Good morning, everyone.

Tom Werner — President and Chief Executive Officer

Good morning.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Good morning.

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

Good morning. So — first, I’m hoping to ask on some of the gross margin commentary, Bernadette that you just gave in your prepared script. The 2022 gross margins coming in 500 basis points to 800 basis points below your normalized range. And I know that there was expectations of the first half of the fiscal year would have lower gross margins than the second half when you reported back in July. So I’m just trying to get a sense of how much that has actually changed and what the increments to — or the decrement to the outlook is this year on margins and specifically in terms of how that outlook has changed, how much is the potato crop at this point?

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah. Thanks for your question. The 5 basis points to 8 basis points that we referenced a lot of that is due to the potato crop. So the things that I mentioned that has changed is we’ve got a worse potato crop than we’ve seen in many years. There is a couple of things that we’re doing as I mentioned in terms of SKU rationalization and the product spec changes that we’re doing, that we’re hoping to offset some of that impact on cost. But most of that is related to a poor crop and then the other thing that I mentioned is that we had previously anticipated the inflation would gradually ease and we do no longer expect that. So we’ve given the guidance of five to eight points but we will come back in January and we’ll update that further depending on what we learn more about the crop as we typically have done.

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

So just to be clear because there wasn’t a similar kind of margin number framed back in July, what — how much did it change versus the outlook in July?

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Well I think the outlook in July we said we were approaching our normal margins which is the 25% to 26% and so now we’re saying its 5 points to 8 points below.

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

Okay. And I guess the second question is more of a conceptual one because clearly these inflationary dynamics are not easing. Is the goal not just to recover cost one for one but actually to price for margins as well? It’s a very different item if we’re thinking, okay, well, unit margins on a per pound basis go back to pre-pandemic levels as opposed to percent margins in an inflationary environment go back to pre-pandemic levels. And I’m really also thinking as we go into calendar ’22 and even your fiscal ’23 the way some of these input markets would be shaping up it would seem like your contracted potato costs for next year are going to be up a lot. And I’m just trying to think of it conceptually is it — is the goal to price per unit margins or is the goal to actually price for those percent margins?

Tom Werner — President and Chief Executive Officer

Yeah. Adam, so the goal is to continue to price through inflation and at levels we historically do. So that’s number one. Number two, the 2022 crop — I’ll comment on that as we do as we get through negotiations on how that’s shaping out for the next crop year. The good — the thing I would just want to remind everybody is we’re dealing with a challenging crop, there’s no question about it. And we’ll work through it. We’re focused on all the right things. The good news in this business, we get to start all over for the next crop. So we’ll manage through it as best we can. We’re focused on all the right things. But as things start playing out like I said to the previous questions, we’ll evaluate additional actions we need to take to price through inflation.

Adam Samuelson — Goldman Sachs & Co. LLC — Analyst

Okay. All right. That’s helpful. I’ll pass it on. Thanks.

Operator

We’ll take our next question from Rob Dickerson with Jefferies.

Tom Werner — President and Chief Executive Officer

Hey, Rob.

Rob Dickerson — Jefferies LLC — Analyst

Hi there. Thank you so much.

Tom Werner — President and Chief Executive Officer

Hey, Rob. Can you hold off for a second, I just want to close off Tom’s question on the other product margin. Year-over-year with the reported basis down 20, ex mark-to-market were down 4. So as you can see the biggest wins is due to the mark-to-market in this year and last year — from an operational basis again down $4 million, that’s due to manufacture — higher manufacturing costs and lower volumes in our vegetable business. Sorry Rob.

Rob Dickerson — Jefferies LLC — Analyst

No, problem. That’s okay. Great, thanks. I guess just first question. It felt like, upfront you said demand is — overall maybe around 5% lower than it was pre-pandemic but maybe shipments are a little bit lower just kind of given all the supply chain issues. So as you then speak to — trying to stabilize the supply or improve the cost situation going forward. Like how do you kind of view that shipment piece relative to demand? Because demand seems strong, maybe you’re kind of underperforming a bit relative to that demand equation, but it sounds like there’s obviously a good line of sight how to get there. So I’m just kind of curious as the cadence for the year. Thanks.

Tom Werner — President and Chief Executive Officer

Yeah. So this is Tom. The International business has been — with the container shortages, challenges on the ports and the exports and even the containers coming in — we’re essentially allocated a certain number of containers. So we’re managing to that level based on our freight partners. And every day is a little bit different. So the team is doing a good job making sure we’re allocating the product to our key customers internationally, but it’s a challenge.

And on the flip side to that, that does — as we look at our forecast weekly, we’re managed in the pile on production and other customers domestically to ensure they’re getting their product. So it’s a really dynamic situation with the containers and even the trucking and the rail and all those things. But essentially we’re managing to what we can ship based on our allocation of containers and that’s what we’re dealing with. And as that frees up and we get more containers available, that’ll help the exports to our international markets.

Rob Dickerson — Jefferies LLC — Analyst

Okay, great. And then Tom maybe just kind of an another — just a question on kind of broader competitive dynamic. I’ve heard some people say maybe including yourself that kind of given your geographic sourcing focus then maybe you might be in less of a — kind of beneficial competitive position versus some of the other larger processors. That being said, I’ve also heard some of the other processors say kind of not so fast, just given where demand is and kind of where kind of overall crop is coming and that supply in general could just be short, right, not just for you. So just curious if you can provide any color — basically your perspective around kind of where you stand potentially in this environment relative to some of the other players that you’re aware of in the market? And then I have a quick follow up.

Tom Werner — President and Chief Executive Officer

Yeah, Rob it’s a fluid situation right now because we’re right in the middle of main crop harvest. So obviously, we’re — we’ve got — we’re getting an early read like I said on how the quality and the yields are. We really won’t have a clear view until the end of this month on what the overall potato yields, what that means. We have an idea. And I’d rather as I do every year at January give you a clear understanding. So right now, it’s — we’re just learning how the main crop is going to perform as we harvest and how it’s running through the plants and we’ll have more info on that in January.

Rob Dickerson — Jefferies LLC — Analyst

Okay, fair enough. And then just a quick technical question. In the Foodservice division in Q1 price mix was up 1%. Obviously, there was some material deceleration relative to what we saw in Q4 which is likely very mix-driven. Just any clarity as to kind of how we should think about that going forward on the mix side just given the Delta Q1 — sorry, Q4 to Q1. Thanks.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah. A lot of that — this is Bernadette, Rob. A lot of that is mix driven. And then what we see in the Foodservice side is we’re not going to see a lot of those pricing increases effective until second quarter and then more in third quarter as we discussed. But then again two, we are seeing increases in our non-commercial segment in first quarter relative to fourth quarter. We’re now 70% to 80% there. So a lot of its mixed.

Rob Dickerson — Jefferies LLC — Analyst

Okay. Got it.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Branded products.

Tom Werner — President and Chief Executive Officer

And then last year Q4 was such an anomaly because that’s the first quarter that was really impacted by the pandemic. And a lot of the — we saw a lot less branded product during that quarter as inventories were destocked.

Rob Dickerson — Jefferies LLC — Analyst

Got it. Got it. All right, thank you so much.

Operator

And we’ll go to our next question from Andrew Lazar with Barclays.

Andrew Lazar — Barclays Capital — Analyst

Thanks. Good morning, everybody.

Tom Werner — President and Chief Executive Officer

Good morning, Andrew.

Andrew Lazar — Barclays Capital — Analyst

Hi. I seem to remember at one point having a conversation around and correct me if I’m wrong about back many years ago when it was like the worst potato crop — anyone in the industry sort of could remember, it was sort of like a $25 million hit to EBITDA for Lamb Weston at the time. And I may be off on that. But I’m curious if there’s any way and it might be tough to do, but to dimensionalize what kind of an impact to EBITDA that specifically sort of this crop is likely to have on EBITDA this year? And maybe it’s just too early to do that. But do I have that data point right and would this crop be worse than the one previously that was the worst that anybody in the industry had seen? I’m just trying to get some perspective on that.

Tom Werner — President and Chief Executive Officer

Yeah, Andrew. I think the — how you framed up what we talked about on the $20 million, the worst crop historically.

Dexter Congbalay — Investor Relations

$14 million.

Tom Werner — President and Chief Executive Officer

Was $14 million. So your numbers around $25 million to $30 million are right. And secondly, Andrew, it is too early to frame it up in terms of what the overall financial impacts are going to be. And what I will say is its worst — this crop is going to be worse than the previously worst crop ever. So the financial impact, we’ll put some guardrails around it in January as we get it harvested and we’ll run it through the plant and we understand what we’re dealing with.

Andrew Lazar — Barclays Capital — Analyst

Yeah. That’s helpful. Thanks for that. And then I guess as we — I think a lot of us certainly knew that even from the fourth quarter call that there was going to be a lot of pressure points and sort of pain points on the cost side for a host of reasons in fiscal ’22 and that it was really all about just like sequential improvement as you went through the year. And obviously that will take a little more time now.

So I’m trying to think out, if we just think ahead for a minute to fiscal ’23 and just maybe if you play out the sort of the potential sort of puts and takes, what are the things that in theory could be more positive? Where are some of the things that maybe you still don’t really have a lot of clarity on? You’re clearly putting a lot of pricing through, potentially you could put more through. There’s always a little bit of a timing lag. But one would think that’s going to certainly better help you get a lot closer to where your costs are. I’m trying to — my struggling with like the labor piece and are you making progress on that?

Is it just slow and I’m trying to get a sense if some of is negative can kind of bleed into ’23 or is there a reason that there could be a pretty dramatic bounce back in operating margin and gross margins in ’23? Like, do the next three quarters give you enough time essentially to figure out some of these issues or frankly are some of these thorny enough that they could go beyond that? Even if you don’t think there’s some structural reason quote longer term to not get back to historical margins.

Tom Werner — President and Chief Executive Officer

Yeah. Andrew, I am a 100% confident over — we don’t have any structural issues in the company. And everything you’re poking at, we’ll focus on addressing labor challenges — Bernadette made a number of references of what we’re doing differently and we’re seeing progress. It’s just slow going. The thing that will take time is even within our supply chain and our supplier’s supply chain is disrupting our production and driving inefficiencies in our plants that — we’re doing a number of things to address that as well. And from last summer to now it’s just going to take more time. We are seeing progress. It’s not as fast as we — any of us want. But as I think through the next three quarters where we will be a year from now with the things we’re doing in the company in terms of addressing inflation, adjusting how our supply chain, we’re focused on our supply chain differently, some the actions we’re taking.

And a year from now we’re in a new potato crop and that’s going to be hopefully back to average normalized levels. We will have certain amount of probably inflation over that time that we’ll address. But everything we’re doing it’s going to take time Andrew. And the category is very healthy and so we’re preparing for it to — with the of number of capacity investments that we’re doing right now our long-term strategy is sound. It’s just we’re going be a little choppy in the near-term but the things we’re doing operationally, I’m a 100% confident. It may take more time than any of us want but we’re addressing all the right things.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah and then Andrew.

Andrew Lazar — Barclays Capital — Analyst

Hi Bernadette.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

I was just going to add that the portfolio optimization that I talked about, that’s just going to benefit us even more into fiscal ’23 and then the increases in productivity around a lot of those cost reduction programs around Win As One. Again, that should just continue to gain momentum into fiscal ’23 as well.

Andrew Lazar — Barclays Capital — Analyst

Great. Thank you so much.

Operator

We’ll take our next question from Peter Galbo with Bank of America.

Peter Galbo — BofA Securities, Inc. — Analyst

Hey guys. Good morning. Thanks for taking the questions. Maybe just to piggyback off of Andrew’s question there. I guess Bernadette as we’re thinking about some of the things that are within your control, some of the SKU rationalization and cost savings. Just is there any way to kind of help us frame how much of that 500 basis points to 800 basis points of normalized margin that you’re losing this year. Like, how much could that potentially make up as we start to think about a normal — a more normalized year for fiscal ’23?

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah. So the way I’d answer that Peter is a lot of the decrease that we’ve explained in terms of the 5 points to 8 points, that’s taking into consideration that SKU rationalization and the spec modifications. So the impact of the crop is what is significantly decreasing our margin estimates. And then we are looking to get some gains on that to get to the 5 basis point to 8 basis point decrease with the SKU rationalization and product spec modifications. Otherwise, it could have been even greater without that is the way I would explain it.

Peter Galbo — BofA Securities, Inc. — Analyst

Got it. Okay. No, that’s helpful. And then I guess just as we’re thinking about the second quarter. I think you had mentioned kind of sequential gross margin improvement. Can you just mention maybe a little bit more how you’re thinking about that? And Tom I know you talked about on-premise or Foodservice kind of in August being impacted by Delta. But just how did September trend? Was it materially better, worse or kind of the same? Thanks very much.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah. So for second quarter and the sequential improvement that we’re expecting to see there, generally, our lowest margin quarter is our first quarter and even though the crop is not what it has been in the previous years, we are going to get some benefits in the second quarter of running out of field and not having to move those potatoes to storage before we start running those through. And then additionally, these other actions that we’re taking in terms of further SKU rationalization, we’re going out with our second round of those and then the product spec changes. We’re expecting to see some benefit from that and should see an increase from Q1, which again is our lowest margin quarter historically.

Peter Galbo — BofA Securities, Inc. — Analyst

Thanks. And Tom, anything on September?

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Oh, and the pricing, absolutely, we’ll definitely see the benefit of pricing. And I’m sorry, Peter, was there another follow-on question that I missed?

Peter Galbo — BofA Securities, Inc. — Analyst

Yeah, sorry. Just on kind of Foodservice. Tom had talked a bit about the softening in August, but just was curious if there was any early takes on September or even the first week of October?

Tom Werner — President and Chief Executive Officer

Similar to August. Yeah, that’s pretty similar to August. I mean, it’s softened a bit, but it’s kind of leveled out.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

And what I’d say there, Peter is that that Foodservice demand is there and we are seeing just difficulty in some respects and making sure that we can provide that product given the lower throughput that we’re getting through the plants.

Tom Werner — President and Chief Executive Officer

And the logistics.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

And the logistics issues.

Peter Galbo — BofA Securities, Inc. — Analyst

Right. Thanks very much.

Operator

And we’ll take our next question from Matt Smith with Stifel.

Matt Smith — Stifel Financial Corp. — Analyst

Hi, thank you. I just had a question for you. In addition to the margin headwind, I believe you mentioned volume growth may be tempered by the challenges you’re seeing in global logistics and supply chain disruption and the potato crop. Is that potential volume weakness reflected in your guidance calling for sales growth above your long-term targets?

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yes. That has been included.

Matt Smith — Stifel Financial Corp. — Analyst

Okay. And then is the potential impact from the potato crop, should we think of that more as a second half event as you run some older potatoes with poor quality?

Tom Werner — President and Chief Executive Officer

Yeah. It’ll definitely be in the second half. It’ll start manifesting itself.

Matt Smith — Stifel Financial Corp. — Analyst

Okay. And then as a follow up to that is there — can you talk about how you can mitigate the impact of that as we look forward to the first half of next year? And I’ll leave it there and pass it on.

Bernadette Madarieta — Senior Vice President and Chief Financial Officer

Yeah. Matt, as I referenced, the way we’re looking to mitigate that is with some of our product spec changes and the other things that we are doing by working with our customers.

Matt Smith — Stifel Financial Corp. — Analyst

Great. Thank you.

Operator

And this concludes today’s question-and-answer session. Mr. Congbalay, I’ll turn the call back to you for any additional or closing remarks.

Dexter Congbalay — Investor Relations

Great. Thanks for joining today. I’m happy to take some follow up questions. If you would just please send me an e-mail that we can schedule something for either later this week or today or later this week or sometime next week. Appreciate the time. Thank you.

Operator

[Operator Closing Remarks]