Lamb Weston Holdings, Inc. (LW) Q1 2021 Earnings Call Transcript

Lamb Weston Holdings, Inc. (NYSE: LW) Q1 2021 earnings call dated Oct. 07, 2020

Corporate Participants:

Dexter Congbalay — Vice President Investor Relations

Tom Werner — President and Chief Executive Officer

Robert McNutt — Senior Vice President and Chief Financial Officer

Analysts:

Chris Growe — Stifel — Analyst

Andrew Lazar — Barclays — Analyst

Bryan Spillane — Bank of America — Analyst

Tom Palmer — JPMorgan — Analyst

Rob Dickerson — Jefferies — Analyst

Adam Samuelson — Goldman Sachs — Analyst

Bryan Hunt — Wells Fargo Securities — Analyst

Sarah Clark — JPMorgan — Analyst

Presentation:

Operator

Good day, and welcome to the Lamb Weston First Quarter 2021 Earnings Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Dexter Congbalay, VP, Investor Relations of Lamb Weston. Please go ahead.

Dexter Congbalay — Vice President Investor Relations

Good morning and thank you for joining us for Lamb Weston’s first quarter 2021 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 Rob McNutt, our Chief Financial Officer. Tom will provide an overview of the current operating environment as well as other business updates. Rob will then provide some details on our first quarter results as well as some trends that we’re seeing so far in the second quarter.

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

Tom Werner — President and Chief Executive Officer

Thank you, Dexter. Good morning, everyone, and thank you for joining our call today. I hope that you and your families continue to be well.

Let me just start off by saying that I feel good about our performance in the quarter and how we are executing as a company. This is a testament to the Lamb Weston team, and I want to thank them for their commitment to each other and our company, as well as their continued service to our customers, suppliers and communities.

As we navigate this challenging environment, our first priority remains ensuring the health and safety of our employees. Since the onset of the pandemic, we have instituted more rigorous operating protocols across the company, especially for our production and front-line teams that work to keep feeding the world while keeping our manufacturing facilities and products safe. In some cases, this has created additional burdens for our team members and their families, and I want to thank them for their commitment and understanding.

I continue to be inspired by the spirit of teamwork that our employees show every day, and that makes me proud to be a part of this great company.

In addition to the hard work by our team, our improved financial performance versus our fourth quarter of 2020 reflects two broad factors. First, the operating environment has steadily recovered over the past few months with restaurant traffic and fry demand improving in North America and most of our key markets. Second, we have gotten better at managing through the disruption that the pandemic has created in our manufacturing operations, as well as controlling costs across the business.

With respect to the operating environment, we are optimistic about the sequential improvement, breadth and pace of recovery in restaurant traffic and fry demand. However, we also remain cautious about the uncertainty of the recovery stability with COVID continuing to be a challenge in the U.S. and some key international markets.

In the U.S., overall restaurant traffic and fry demand steadily improved early in the quarter, then largely stabilized at levels that were below what we saw just before the pandemic. Traffic at large quick service chain restaurants approached prior year levels, especially during the latter half of the quarter, by leveraging drive-through, takeout and delivery formats.

Full-service restaurant traffic also improved as the quarter progressed, then stabilized at about 75% to 80% of prior year levels as governments relaxed restriction for on-premise dining, and restaurants lean more on carry-out delivery and outdoor dining to generate sales.

Traffic and demand at non-commercial customers, which includes lodging and hospitality, healthcare, schools and universities, sports and entertainment and workplace environments remained at less than 50% of prior year levels for the entire quarter, although it did improve modestly as the quarter progressed.

In Retail, demand growth in the quarter was strong. After peaking at more than 50% weekly category volume growth in April and May, weekly volume growth steadily moderated to between 15% and 20% growth by August, as restrictions on restaurants eased.

In Europe, which is served by our Lamb-Weston/Meijer joint venture, fry demand approached prior year levels by the end of the quarter, although it’s important to note that demand at this time last year was somewhat soft for us due to a poor potato crop.

Demand improvement in our other key international markets was mixed. In China and Australia, demand steadily improved and approached prior year levels by the end of the quarter. In our other key markets in Asia and Latin America, the improvement in demand was uneven as governments employed differing approaches to contain the spread of the virus.

In short, demand steadily improved in the U.S. and across most of our international markets as summer progressed, then stabilized below pre-pandemic levels.

Along with that steady recovery in demand, our teams leveraged lessons learned when COVID first hit and have adapted our operations to better manage through the current environment. As I noted earlier, since the onset of the pandemic, we’ve stepped up our employee safety and sanitation protocols at each of our manufacturing, commercial and support locations, which has resulted in earlier detection of COVID among our workforce.

We’ve also steadily become more efficient in minimizing disruptions to our manufacturing facilities and service levels, including isolating specific areas of our facilities that would be needed to shut down, sanitize and restart after members of our production team are affected by the virus, as well as increasing flexibility to adjust production schedules and run times across the network.

Our supply chain team has been able to significantly reduce our incremental production costs and inefficiency as compared to what we incurred in the fourth quarter of fiscal 2020. We’ve also taken a range of steps to aggressively manage our selling, general and administrative expenses, including shutting down all travel and large meetings and deferring other discretionary expenditures and projects.

However, one project that we did not defer was implementing Phase 1 of our new enterprise resource planning system, as we believe it will be a key enabler to driving efficiencies over the long-term. We are currently evaluating options for when to begin implementing Phase 2.

Before handing the call off to Rob, let me update you on the potato crop and the pricing environment. With respect to the crop, on a preliminary basis, we believe the crop in our growing areas in the Columbia Basin, Idaho, Alberta and the Upper Midwest will be consistent with historical averages in the aggregate. Our early read on the European potato crop is that it will also be consistent with historical averages, and that’s a welcome sign given the poor crops in recent years.

As usual, we’ll provide our updated view of the crops yield and quality and how we expect the crop to hold up in storage when we report our second quarter results in early January.

With respect to contract discussions and pricing, we’re largely through the negotiations for the domestic large chain restaurant contracts that are up for renewal this year. And in the aggregate, we have maintained stable pricing in the portfolio. For those contracts yet to be finalized, we will remain disciplined and take an approach designed to maintain and reinforce our strategic customer relationships.

Outside of these large chain restaurant contracts, on balance, domestic pricing continues to hold up well. However, we have begun to see increased competitive activity in some domestic market segments, as well as more value-oriented product segments in some international markets. As demand continues to strengthen, we expect pricing pressure in these segments will lessen.

In summary, we feel good about our performance in the quarter and how we’re executing as a company. We’re optimistic about the positive demand trends in the U.S. and in our key international markets, but we remain cautious due to the continued uncertainty with the current operating environment.

We’re navigating through the crisis by prioritizing the health and safety of our employees, leveraging our manufacturing footprint and operational agility to make sure we service customers and aggressively controlling cost across the entire company. And finally, we’re encouraged about the health of this year’s crop, as well as the overall pricing stability across our portfolio.

These are challenging times, which we expect will be around for a while, but we also believe that by focusing on our strategies and our commitment to our employees and servicing our customers, we’ll emerge as a stronger company.

Now, let me turn the call over to Rob.

Robert McNutt — Senior Vice President and Chief Financial Officer

Thanks, Tom. Good morning, everyone. As Tom noted, we believe that we weathered the worst of the pandemic’s effect on our operations during the fourth quarter of fiscal 2020. Demand across most restaurant sectors has improved from the lows of Q4, providing a backdrop for us to deliver a 3% sequential sales growth in our first quarter.

The sequential increase in earnings was more dramatic. We nearly doubled gross profit from $111 million to $214 million, and increased EBITDA, including joint ventures, by more than 2.5 times from $78 million to $202 million, as we increased operating leverage and we greatly improved our ability to control cost and managed through the disruption that the pandemic has on our manufacturing network and distribution chain.

While our results remained below pre-pandemic levels and down versus prior year, the sequential improvement in the demand environment and our financial performance is encouraging.

Now, turning to our year-over-year results. Net sales declined 12% versus prior year quarter to $872 million. Sales volume was down 14%, as frozen potato demand outside the home continued to be affected by government-imposed restrictions on restaurant traffic and other foodservice operations.

However, after realizing some benefit from customers reloading inventories early in the first quarter, our weekly shipment trends in each of our domestic channels and most of our international markets steadily improved as the quarter progressed. I’ll discuss this in more detail when reviewing our business segment performance.

Price mix increased 2% due to improvements in both the Foodservice and Retail segments. Gross profit declined $35 million with about $16 million due to pandemic-related costs on our manufacturing and supply chain operations. That $16 million is down from $47 million of pandemic-related production costs that we incurred in the fourth quarter of fiscal 2020.

Of this $16 million, about $6 million were utilization-related costs and inefficiencies arising from disruptions to our manufacturing network. That compares to about $25 million of costs for utilization-related costs that we incurred in the fourth quarter.

As a reminder, these costs largely relate to labor and other costs to shut down, sanitize and restart manufacturing facilities impacted by COVID, costs associated with modifying production schedules and reducing run times across our network to compensate for facilities impacted by COVID, and incremental costs and inefficiencies related to manufacturing retail products on lines primarily designed for foodservice products.

The other $10 million of the $16 million consists of non-utilization related costs and included about $3 million of expense to the remaining crop — year 2019 raw potato purchase obligations, and about $7 million for enhanced employee safety, sanitation protocols as well as for incremental warehousing, transportation and supply chain costs.

As we previously discussed, we expect to incur utilization and non-utilization related costs and inefficiencies as long as our manufacturing and supply chain operations are impacted by the pandemic.

The remaining $19 million decline in gross profit largely reflects lower sales volumes partially offset by favorable price mix, a $5 million year-over-year change in mark-to-market adjustments and cost efficiency savings.

SG&A in the quarter was essentially flat. Cost management efforts, including a $3.5 million reduction in advertising and promotional expense offset $1 million of non-recurring expenses associated with implementing our new ERP system, and $4 million of pandemic-related expenses largely related to net costs of retaining certain sales employees.

Equity method earnings were $12 million, up $1 million from last year. However, excluding the impact of unrealized mark-to-market adjustments, equity earnings declined $2 million, with half due to pandemic-related costs, similar to what we incurred in our base business. While down versus last year, equity earnings increased sequentially as a result of significant decline in pandemic-related costs in the first quarter, as well as steady improvements in our weekly shipments by our European joint venture.

EBITDA, including joint ventures, was $202 million, down $31 million. About $21 million of the decline was due to pandemic-related costs I’ve discussed. The remainder of the EBITDA decline was driven by lower sales and gross profit.

Diluted EPS in the quarter was $0.61, down $0.18 or 23% from last year.

Now, moving to our segments. Sales for our Global segment, which includes the top-100 U.S.-based QSR and full-service restaurant chains, as well as all sales outside of North America were down 14% in the quarter. Price mix declined 1% as a result of negative mix. Volumes fell 13% due to the decline in demand for fries outside of the home. However, weekly shipments to large QSR chains, which historically comprise about one-half of Global segment sales improved from around 85% of prior year levels at the end of May to near prior year levels by the end of the first quarter.

Weekly shipments to large full service chains, which historically comprised about 10% of global sales, improved from 45% to 50% in May to 70% to 80% by the end of the first quarter, as governments relaxed restrictions on on-premise dining and as restaurants improved carryout and delivery capabilities.

International sales, which historically comprised about 40% of segment sales, were mixed.

As Tom noted, monthly shipments in China and Australia approached prior year levels by the end of the quarter as demand steadily improved. Monthly shipment trends in other markets in Asia-Pacific and Latin America were uneven. This mirrored pattern in demand recovery, but also generally lagged as the rate of custom — lagged the rate of improvement as customers and distributors in these markets continued to right-size their inventories.

Global’s product contribution margin, which is gross profit less A&P expense declined $25 million to $78 million. Pandemic-related costs accounted for about $9 million of the decline, with the remainder driven by lower sales.

Sales for our Foodservice segment, which services North American foodservice distributors and restaurant chains outside the top-100 North American restaurant customers declined 22% in the quarter. Price mix increased 6% behind the carryover benefit of pricing actions taken in the latter half of fiscal ’20.

Mix was unfavorable for two reasons. First, independent restaurants, which purchase a high amount of Lamb Weston branded products, have been disproportionately impacted by the pandemic. And second, some customers have traded down to more value-oriented products in order to reduce costs. It’s important to note that this impact was more pronounced in the fiscal fourth quarter and we’ve steadily regained much of this business as restaurant traffic improved in recent months.

Volume declined 28%, reflecting the continued impact that government-imposed restrictions have had on consumer traffic. Our weekly shipments to full-service and small and regional quick service restaurants, which together have historically compromised three quarters of the segment sales, improved to 80% to 85% of prior year sales by the end of the first quarter. Our weekly shipments to non-commercial outlets, which have historically compromised the other 25% of the segment sales, modestly improved as the quarter progressed, but were soft at about 50% of prior year levels.

Foodservices product contribution margin declined $17 million to $86 million, with pandemic-related costs accounting for $4 million of the decline. The remainder was primarily driven by lower sales, offset by favorable price mix.

Sales in our Retail segment increased 19% in the quarter. Volume increased 11%, although this masks the performance of our branded portfolio, which historically has compromised about 40% of the segment’s volume.

Our brands are winning. Volume growth of our Grown in Idaho, Alexia and licensed brand products was up together more than 30% in the quarter. That’s well above weekly category volume growth rates, which range between 15% and 25%. However, Retail segment’s volume growth was part — growth was partially offset by a decline in private label shipments, which reflects the loss of certain low margin private label business that largely began during the third quarter of fiscal 2020.

Price mix increased 8%, reflecting that favorable mix of more branded products. Retail’s product contribution margin increased $7 million to $36 million and was driven by higher sales volumes, favorable mix and lower A&P expense. This increase was partially offset by $3 million of pandemic-related costs.

Moving to our cash flow and liquidity position. In the first quarter, we generated more than $250 million of cash from operations. That’s up $12 million versus last year. Our top priorities in deploying cash continue to be investing to grow the business and returning cash to shareholders. In the quarter, we spent $33 million in capex, including for our new ERP system.

Given the outlook for the business, cash flow and improved liquidity position, we’re increasing our capital expenditures target for the year to $180 million from $140 million, as we invest in productivity and optimization projects as well as some targeted growth capacity.

With respect to capital returns, we declared a regular quarterly dividend two weeks ago.

Since the pandemic began, we’ve taken steps to enhance our liquidity and further strengthen our financial position by entering into a new $325 million term loan and completing a $500 million note offering.

In September, we amended our credit agreement to put in place a new three-year $750 million revolver to replace the $500 million facility that was set to expire in November of 2021. The new revolver remains undrawn and fully available.

In conjunction with the revolver, with more than $1 billion of cash on hand, we chose to prepay the approximately $270 million outstanding balance on the term loan that was due in November 2021.

All in, the financing actions we’ve taken since the pandemic began, have increased our liquidity by nearly $1 billion, lowered our weighted average interest rate and stretched our debt amortization, while only increasing our expected annual after-tax interest payments by about $11 million.

So, along with our ability to continue to generate cash, we feel good about our current liquidity position.

Now, turning to some demand trends that we’re seeing in the second quarter. As Tom mentioned, in the aggregate, the demand environment and our weekly shipments have largely stabilized during the latter half of the first quarter and into the first four weeks of September. Specifically, in the U.S., shipments to-date in the second quarter are approximately 90% of prior year levels.

In our global segment, weekly shipments to our large QSR and full-service chain restaurant customers in the U.S. are trending at around 95% of prior year levels. While QSRs are likely to be largely unaffected, we anticipate that shipments to full-service restaurants could take a step back, as outdoor dining options become more limited with the onset of colder weather.

In our Foodservice segment, weekly shipments to our full-service restaurants, regional and small QSRs and non-commercial customers in aggregate are trending at approximately 80% of prior year levels. Shipments to full-service restaurants and small and regional QSRs have been trending above that rate, but could soften due to colder weather.

Shipments to non-commercial customers have been trending well below that rate and are likely to remain so until the spread of COVID is broadly contained.

In our Retail segment, weekly shipments are trending even with prior year levels, with strong volume growth of our branded products offset by a decline in shipments of private label products. In Europe, weekly shipments to-date in the second quarter by our European joint venture are approaching prior year levels, although consumer demand at this time last year was somewhat soft due to high prices and quality concerns as a result of the poor crop.

As in the U.S., we believe that shipments to full-service restaurants in Europe may also begin to soften as cold weather reduces outdoor dining options.

Shipment trends in our other international markets are mixed. In China and Australia, shipments are approaching prior-year levels. In other markets in Asia Pacific and Latin America, demand has improved since the end of the first quarter, although our shipments continue to generally lag demand improvements as customers and distributors continue to right-size their inventories.

As a reminder, all of our international sales are included as part of our Global segment results. In short, overall demand across our markets is largely consistent with what we observed during the latter half of the first quarter, although we remain cautious about the effect of the onset of colder weather on outdoor dining as well as a continuing spread of the virus in the U.S. and its resurgence in some key international markets.

In addition, when estimating sales for the quarter, recall that our second quarter results last year benefited from strong sales of customized products including limited time offerings, as well as from additional shipping days related to the timing of the Thanksgiving holiday.

With respect to costs, as we’ve previously discussed, we plan to process potatoes from the 2019 crop through early September, which is couple of months longer than usual. We stretched out the old crop in order to manage inventories in light of the pandemics impact on fry demand. Processing older crop results in higher cost as a result of higher raw potato storage fees and lower recovery rates.

Since we typically carry upwards of 60 days of finished goods inventory, we’ll realize the impact of these higher costs in our second quarter income statement as we sell that inventory over the coming months.

Now, here’s Tom for some closing comments.

Tom Werner — President and Chief Executive Officer

Thanks, Rob. Let me just quickly sum up by saying it was a solid quarter in the context of the current operating environment. And I’m proud of how our manufacturing, commercial and support teams have continued to focus on the right strategic and operating priorities to serve our customers.

We are optimistic about the steady improvement in restaurant traffic and fry demand in most of our markets, as well as our ability to control costs, and manage through the pandemics impact on our operations. However, we do expect some choppiness in demand as the world continues to manage through the crisis.

We remain confident that Lamb Weston is well positioned to emerge as a strong company once we get to the other side of the pandemic and create value for our stakeholders over the long-term.

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

Questions and Answers:

Operator

[Operator Instructions] And we’ll take our first question from Chris Growe with Stifel.

Chris Growe — Stifel — Analyst

Hi, good morning.

Tom Werner — President and Chief Executive Officer

Good morning, Chris.

Chris Growe — Stifel — Analyst

Hi. Thank you for the time. I just had a — just to start off, I had a question for you on the gross margin. Obviously, it was a marked improvement sequentially, you talked about the leverage, you talked about — you had lower COVID costs, as an example. One of the element of this that we’ve seen is stronger price and mix, and it was stronger than I expected, especially in the Foodservice division. I just want to get a sense of, it sounds like mix was positive, you have some pricing coming through as well. I guess, I’m trying to think about the first quarter versus the fourth quarter, and how important that component was to the gross margin performance or was it more the levers in that price mix improvement?

Tom Werner — President and Chief Executive Officer

Yeah, Chris. This is Tom. The important thing comparing to Q4, it’s really about the volume returning. And because Q4, we just fell off a cliff in Foodservice. And as you guys know, that’s one of our stronger margin segments, so it’s a combination of pricing flow through and really the restaurants reopening and volume starting to recover in Q1 that really drove the sequential improvement.

Chris Growe — Stifel — Analyst

And in relation to that, from the pricing, you had the pricing in the fourth quarter, just was masked by mix. Is that the way to say it in that Foodservice division?

Tom Werner — President and Chief Executive Officer

Well, yeah, absolutely. And it’s — we had significantly lower volume in Q4, so it was a major component of that. And as you look at — we talked about Q1, it’s really volume and price flowing through and volume returning like I said. Yes.

And in Foodservice, Chris, that — it’s not a — that price increase comes through over time. I mean, it’s not one customer. They’re all different contracts, so they roll at a different time. So, some of that has a little bit more impact in Q1 than we saw in Q4.

Chris Growe — Stifel — Analyst

Okay. I had just one more follow-on to that, and I’ll let it go. But my question on the gross margin would be, as I think about normally from Q1 to Q2, you have a nice sequential improvement in gross margin. It sounds like that you have some residual costs coming through from utilizing your old crop, as an example, and utilizing the inventory. You have a tough comp as well. Do we think about the gross margin, is it just contingent on volume or is there enough in the cost side there that we should think about the gross margin maybe being a little softer in Q2 versus Q1, even though sequentially that normally is better [Speech Overlap]?

Tom Werner — President and Chief Executive Officer

Yes, I think you’re spot on, Chris, that — one — we’ve got some cost carryover that we don’t normally have in Q2. Q2, normally, we’re selling crop that was processed directly out of field, so no storage cost to it and they’re fresh potatoes, so they process better. So, that’s going to have some impact on our Q2 margin. And in addition, as I mentioned I think in my comments that recall that Q2 last year, we had strong performance in LTOs and other specialty products like that that help on the pricing side.

Chris Growe — Stifel — Analyst

Okay. Thank you for the time.

Tom Werner — President and Chief Executive Officer

Thank you.

Operator

We’ll take our next question from Andrew Lazar with Barclays.

Andrew Lazar — Barclays — Analyst

Good morning, everybody.

Tom Werner — President and Chief Executive Officer

Good morning, Andrew.

Andrew Lazar — Barclays — Analyst

Hi. First thing, I think, Tom, you mentioned, it sounds like there is some maybe increased competitive pressure in some segments of the U.S., maybe outside of some of the large chains and some of the more value-oriented, I think, international segments you may have said. I was hoping you could just maybe go into that a little bit more and give us a sense of sort of what’s happening there. And is it through sort of contracts or not necessarily contract pricing, just kind of more like spot pricing types of competitive dynamics? I’m trying to get a better handle on that.

Tom Werner — President and Chief Executive Officer

Yes, Andrew, it’s predominantly spot pricing in certain regions in the North America and it’s a — I would characterize it this way, it’s a bit more pronounced than normal. And like I said, everything overall — from a pricing standpoint — is pretty stable. It’s nothing that we haven’t seen before, so we’re watching it carefully. But obviously, with capacity available, we just need to manage through it and we will.

The international side of it, the way to think about it, the pricing pressure is on the lower line flow type items that we characterize as non-value added. So, we play in that a little bit in a lot of these markets, but our — most of our focus is on the value-added, like CrissCut, curly fry type items in the international markets, but it is getting competitive on the lower value than on value-added side.

Andrew Lazar — Barclays — Analyst

Got it. And then you talked about sort of sequential demand trends and traffic trends certainly improving pretty dramatically over the course of the quarter, of course, from the lows, if you will, in the fourth quarter. But that maybe in the last couple of weeks, it seems to have kind of like stabilized or plateaued a little bit at some of the levels that Rob went through. Trying to get a sense of what you think is driving that sort of a moderating pace, right, of sequential improvement in sort of restaurant traffic or away from home eating, because obviously we haven’t necessarily come into like super-cold weather and things, to your point, have kind of moderated or the pace, right, of sequential improvement has moderated a bit. So, trying to get a sense of what you’re seeing out there and what you think is driving that? Thank you.

Tom Werner — President and Chief Executive Officer

Yes. Some of the Q1 — think about it this way, Andrew. In Q1, as we reopened up, a lot of our customers started to rebuild and stocking inventory because they dramatically decreased their orders and — sorry, in March, April, May, so there was a restock happening kind of mid-May through June, and everybody trying to get caught up. And so, I think as I think about where we’re at today in terms of demand, it’s been pretty stable at the levels that we talked to in the script. And the thing we got our eye on is as the weather changes and you have flare ups and COVID hotspots, we certainly have data where we look at the markets that are potentially put more restrictions on, we’re watching those ordering patterns very closely.

So, those are a couple of things that, while we continue to remain cautious about, we just got to work through it and it will actualize itself over the next 90 days, but we’re watching it carefully.

Andrew Lazar — Barclays — Analyst

Got it. Thanks very much.

Operator

We’ll take our next question from Bryan Spillane with Bank of America.

Bryan Spillane — Bank of America — Analyst

Hey. Thank you and good morning, everyone.

Tom Werner — President and Chief Executive Officer

Hey, Bryan.

Bryan Spillane — Bank of America — Analyst

So, just a couple of questions. First on the — on margins and I guess as we’re thinking about cost going forward, understanding that some of the COVID cost could probably stay in the base for a while. Can you just give us a sense for how much expenses maybe you’re deferring into the out years? So, just how much cost avoidance is happening this year and that we might have to think about adding back into the out years? And then also just as we’re talking about cost, if you can comment at all on just what you’re seeing in terms of freight cost and if that’s something we should be thinking about?

Robert McNutt — Senior Vice President and Chief Financial Officer

Yeah. Thanks, Bryan. In terms of deferring costs, I mean, those inefficiency costs and the COVID costs and so forth, those are flowing straight through the inventory. Now, if you’re asking about, are we deferring any maintenance costs or things like that that might bite us in future years? None of that. We continue to maintain our facilities as we normally do, and so nothing there. So, really nothing that I would say gets deferred into out years. Now, we did mention last call that we had deferred some expansion capital that we were looking at, but again that’s — we’ll reassess that as the market recovers.

In terms of freight costs, I’ve heard others have had challenge with some near-term freight. We tend to contract a lot of our trucking as opposed to play a lot in the spot market, where we’d had some freight volatility may be more in Q4 is in — early in Q1, which is we were trying to catch up those inventories and hot shotting somethings, our rail truck freight had some negative impact to it, but that we pretty well stabilized. And, again — so because we contract the trucking largely, we’re not as exposed as maybe some others that you may have heard.

Bryan Spillane — Bank of America — Analyst

Okay. And then just tying back to Andrew’s question around pricing and just the competitive dynamics in the market, can you give a sense now of kind of where capacity utilization rates are or just how much slack there is in the system in North America? And again, I think we spoke about this last quarter, it seems like there were some plant — older plants maybe that have been taken out of commission and — so it’s a little bit difficult I think from the seats we’re sitting in really to get an understanding of just where the industry sits right now in terms of utilization rates. So, any color you can help us with that would be would helpful.

Tom Werner — President and Chief Executive Officer

Yes, Bryan. I’m not going to get into a specific number on utilization rate because it’s really a moving target right now. And we — if you think about Lamb Weston, obviously, our utilization rate is below where we’ve historically operated. But on top of that, we — as we have shutdowns and start ups over the past — since the pandemic started, it really muddies the waters on what your overall capacity is. Now, we know the absolute number historically, but it’s about running production as much as you can in light of the disruptions we’re experiencing and they’ve gotten a lot better and we’re getting — like I noted in my remarks, we’re a lot better at adjusting and moving production around when we have a disruption to service our customers, which also there is a cost element to that.

So, I think as this becomes more stabilized, Bryan, we’ll have a better understanding of the overall capacity utilization across the industry and the competitive set is experiencing some of the same things that we are. So, it’s a bit of a moving target right now.

Bryan Spillane — Bank of America — Analyst

All right. Yes, I appreciate that. Thank you.

Tom Werner — President and Chief Executive Officer

Thanks, Bryan.

Operator

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

Tom Palmer — JPMorgan — Analyst

Good morning and thanks for the question. I wanted to ask on the retail shipment side. I was a bit surprised the quarter-to-date figure was only flat, given how robust your branded takeaway is. I appreciate branded much stronger than private label. So, do you think that the quarter-to-date shipment purview is an accurate reflection of overall takeaway trends for you at retail or are shipments may be lagging that take away a bit?

Tom Werner — President and Chief Executive Officer

Yes, I think that — again, as I said in prepared remarks that on our branded business, we continue to perform very well. And private label, we’ve seeded some of that volume that started really in Q3 of last year. And so, I think that our branded performance, I think, is — continues to be very strong, but that private label offsets our overall sales out of the retail, I think that accurately reflects it.

Now, category trends out of the retail stores, I mean, you get the Nielsen data as we do. And so, you see those are — continue to be pretty strong overall. But for us, it’s that mix trade.

Tom Palmer — JPMorgan — Analyst

Okay, thanks. And you mentioned the tough comp for LTOs next quarter, we see QSR volumes at least beginning to trend more favorably. Are you seeing those customers turning back towards or starting to plan limited time offers and to what extent might those start to flow through in the next quarter or two?

Tom Werner — President and Chief Executive Officer

Yes, Tom. I won’t get into specifics on customers and LTOs. What I will say is there is renewed interest across many of our customers, but those obviously take some time to get through the innovation and then get it on menu. So, more to come on that, but all I’ll say is there is some renewed interest in it.

Tom Palmer — JPMorgan — Analyst

All right. Thank you.

Tom Werner — President and Chief Executive Officer

Yes.

Operator

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

Rob Dickerson — Jefferies — Analyst

Great, thank you so much. So, just in terms of the crop this year, it sounds like what you were saying in the prepared remarks is basically the crop maybe in your sourcing areas sound about average this year, which is good. But just given the reduction in number of potatoes that went into the ground this year for this year’s crop, kind of where we are in terms of the harvest timing, do you kind of currently find the demand-supply equation fairly healthy at this point when you look at the overall broader crop? And then just secondly, could others be maybe somewhat disadvantaged, given the re-emergence of demand, but maybe some varied regional supply sourcing? Thanks.

Tom Werner — President and Chief Executive Officer

Yes, Rob, I think overall how I’ll characterize it is, right now based on our overall demand forecast, we’re balanced from a raw need. I think the industry is kind of in the same spot. So, as we do every year, as the — our forecast change, we quickly align that with our raw needs and our ag team does a great job canvassing our growing areas and ensure that we’re covered to service our customers, so I think everything is pretty balanced right now.

Rob Dickerson — Jefferies — Analyst

Okay, great. And then also we’ve heard recently a large competitor of yours has restarted construction on one of their plants, they were constructing it, they stopped construction when COVID hit the back building. Obviously only willing to say so much. But I’m just curious if you’d be willing to comment on just maybe like if that’s a signal of confidence on the overall industry, right, structural basis of the industry as we think about even going into calendar ’21? Because a lot of questions will be asked around utilization now, but for taking out 12 to 18 months and the large competitor is back starting the plant, it seemed to me that the industry is saying, yes, we’re trying to get through this, but we also have to be prepared for when demand comes back because the industry overall is structurally impaired at this point. Thanks.

Tom Werner — President and Chief Executive Officer

Yes, absolutely. It’s a vote of confidence for the category. We feel the same way. And so, one of the — I think one of the main reasons for our increasing capital is we’re having chopped and formed capacity. And that kind of — that product category has been growing over the years, so we’re evaluating. We’re thinking about two years out. And as this thing returns back to normal, I think everybody is going to going to start dusting off their tariff plans and move to come — move the category forward. And I think it’s absolutely a vote of confidence.

Rob Dickerson — Jefferies — Analyst

Okay, great. Thank you. I’ll pass it on.

Tom Werner — President and Chief Executive Officer

Thanks, Rob.

Operator

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

Adam Samuelson — Goldman Sachs — Analyst

Yes, thanks. Good morning, everyone.

Robert McNutt — Senior Vice President and Chief Financial Officer

Good morning, Adam.

Tom Werner — President and Chief Executive Officer

Good morning, Adam.

Adam Samuelson — Goldman Sachs — Analyst

Maybe kind of keying off of Rob’s question just on the raw supply, I believe the contract rate in the Pacific Northwest this year was up about 3%. And I’m just trying to make sure, when you say pricing is stable in terms of your contract negotiations with your customers, is that pricing stable a net number or is that a gross number and so we got to think about flat top line products and there should be kind of low to mid-single-digit inflation on the potato cost side?

Robert McNutt — Senior Vice President and Chief Financial Officer

Yes, Adam. In terms of the pricing negotiations with customers, I think what we were speaking to is that generally the pricing negotiations were consistent with expectations. And so, I think there was some concern that some had expressed on our last call that there might be some pricing pressure and we just hadn’t seen that.

Now, recognize that in our global business unit, those big chain customers, we tend on average to have about a-third of those contracts come up every year and those contract structures are different. Some have cost pass-through elements, some have just cost inflation elements and so forth. And so, that — it’s fairly variable in terms of how those contracts work, but I think — overall, I think the read is that pricing in our marketplace for sales continues to be in good shape, stable from our expectations. On the raw side, the crop is in good shape and we’ve got what we need to service our customers for this year.

Adam Samuelson — Goldman Sachs — Analyst

Okay, that’s helpful. And then the follow-up, just thinking about the SG&A line and any way help frame how — what that can look like this year? I know you’re probably keeping a very tight lid on a lot of the discretionary spending and some things I’ve seen here [Phonetic] fairly easy to control in the current environment, but what that could look like? And corollary is, any update on the ERP project in terms of timing of the completion?

Tom Werner — President and Chief Executive Officer

Yes. Adam, this is Tom. In terms of SG&A, we’ve early on, like we mentioned, put a lid on, stopped all non-discretionary spending and projects and travel, those kind of things and we’ll continue to do that. As — so in terms of levels of SG&A, I think we target around 8%, 9% of the sales. And the — with that said, as things continue to improve, there are some things we may choose to invest in within SG&A, but we’ll manage that tightly like we have and the team has done a good job putting a lid on cost of non-discretionary.

In terms of the ERP —

Robert McNutt — Senior Vice President and Chief Financial Officer

Yes, I’ll take that Tom. In terms of the ERP, we have implemented — released one of that ERP, which covered our financial reporting, covered our maintenance in the plants and covered our indirect procure to pay cycle. And that’s been implemented and is now operating, and standard ERP exercise not perfect, but not horrible, it’s all — it’s fine and operating well. The team has done a great job with it.

In terms of release 2, that impacts more customer-facing and inventory elements. And given the current environment, we’re really stepped back from that, one, to let the key people in the business run the business in this challenging time and, two, just managing through the risk. So, we’re going through the assessment now to determine what the timing is to do that, but we haven’t re-launched it at this point.

Adam Samuelson — Goldman Sachs — Analyst

Okay. That color is very helpful. Thank you so much.

Operator

We’ll take our next question from Bryan Hunt with Wells Fargo Securities.

Bryan Hunt — Wells Fargo Securities — Analyst

Thanks for your time this morning. My question has to do with your potato supply. You had said coming into the year you were contracting down 20% to 25% and you made some earlier comments that you’re balanced from a raw perspective relative to your forecast. How much latitude do you have to catch up with demand with spot potatoes if you were to see demand come in stronger than your forecast?

Tom Werner — President and Chief Executive Officer

We have a — like we do every time this year, we have a pretty good idea of working with our growers, strategic growers of potential open potatoes available and we make decisions. We made decisions this year already to make sure that we have raw available based on the changing forecast and we’ll continue to make those decisions throughout the course of the next 60, 90, 120 days as things change. So, there is some flexibility in the system. And the whole industry does kind of the same playbook.

So, like I said, we feel — we’ve made some decisions to do some things, to keep a balance right now based on our latest thinking on how the demand is going to play out for the balance of the year. And we’ll continue to evaluate it and we have a great ag team that has a very good understanding of what’s available in the market. So, I have no concern that will be — if things improve dramatically, we have a plan in place to make sure we stay balanced.

Bryan Hunt — Wells Fargo Securities — Analyst

Great. My next question is, you touched on LTOs, the potential — and the margin opportunity that you’ve seen historically in LTOs. In your discussions with in contracting for the upcoming year with your QSR customers, what is their mindset around LTOs? Is there potential for more of them or lesser than year-over-year? Can you just touch on the potential quantity of LTOs on a year-over-year basis?

Tom Werner — President and Chief Executive Officer

Yes. I think the way to think about it is, there was a period where a lot of customers of all different sizes were focused on menu simplification based on the environment that unfolded in the last six months. And I think now that there is a return of demand, the mindset with some of our customers is certification. So, that’s leading towards renewed discussions on LTO activity and what that could look like for some of our customers. And every customer is different. So, some of them are more aggressive on menu items than others. And the thing to remember is once those discussions starts, it does take some time to get them in the marketplace and on menu.

Bryan Hunt — Wells Fargo Securities — Analyst

And then my last question is you — and you touched on this briefly. When you look at capital allocation, you talk about growth, returning cash to shareholders. Given the lower capacity utilization in the industry, we could see there might be from the outside looking in opportunities to maybe make some capacity acquisitions at more favorable multiples than you have in the not too distant past. Can you touch on maybe what the M&A pipeline looks like today versus a year ago? And do you feel more confident in putting money to work on acquisitions versus returning it to shareholders? That’s it from me. Thank you, Tom and Rob.

Tom Werner — President and Chief Executive Officer

So, consistent to what I’ve talked about in the past, one of our strategic pillars is invest for growth and important part of that is M&A. And we continue to canvas the industry. Even in the last six months, we’re staying as in touch with opportunities as possible. And it’s an environment that may lead to some opportunistic M&A. And the great news is Rob and his team have done a good job getting our — getting the revolver down in this environment and building some additional debt. So, we got cash on the balance sheet, we got a lot of firepower. And if the opportunity presents itself, we’re ready to play. So, we continue to do everything we can to move some forward and we’re ready to go.

Bryan Hunt — Wells Fargo Securities — Analyst

Thank you for your comments.

Tom Werner — President and Chief Executive Officer

Yes.

Operator

We’ll take our next question from Carla Casella with JPMorgan.

Sarah Clark — JPMorgan — Analyst

Hi. This is Sarah Clark on for Carla Casella. On your COVID-related costs, thanks for breaking that out in more detail, what percent of those do you expect to recur each quarter going forward throughout this year?

Robert McNutt — Senior Vice President and Chief Financial Officer

Yes. This is Rob, I’ll — it — that’s so hard to determine because what you’re trying to forecast there is how many infections you’re going to have, where they’re going to come, on what line, and so how you shut that down? So, I think that’s a challenge to forecast. So, the best that we can do is disclose what has happened and disclose enough of the detail, and then I’ll let you do your own forecast on COVID in these spots.

Sarah Clark — JPMorgan — Analyst

Got it. Thank you. And then how are you evaluating your shelf space at retailers? Do you feel like you have the right SKUs at retail and then how are you looking at this in the foodservice space as well?

Tom Werner — President and Chief Executive Officer

Yes. I think from a retail standpoint, we feel good about our shelf space and facing. As Rob mentioned, the branded offerings on shelf are doing pretty well. And we are continually evaluating shelf set. So, we feel good about all that. In terms of the Foodservice, I’m not quite following your question.

Sarah Clark — JPMorgan — Analyst

Just — that’s fine, the retail view is fine. And then last question. In terms of margin differential by product, have you ever broken out the difference between branded and private label margin?

Robert McNutt — Senior Vice President and Chief Financial Officer

No, we don’t.

Sarah Clark — JPMorgan — Analyst

Okay, thank you.

Tom Werner — President and Chief Executive Officer

Thank you.

Operator

That concludes today’s question-and-answer session. Mr. Congbalay, at this time, I’ll turn the conference back to you for any additional remarks.

Dexter Congbalay — Vice President Investor Relations

Thanks to everyone for joining the call this morning. If you would like to set up a follow-up call, please e-mail me and we can get something set up either today or for the next couple of days. Again, thanks for joining, and this ends the call. Thanks.

Operator

[Operator Closing Remarks]