藍威斯頓 (LW) 2021 Q4 法說會逐字稿

Good day, and welcome to the Lamb Weston Fourth Quarter and Fiscal 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.

Good morning, and thank you for joining us for Lamb Weston's Fourth Quarter and Fiscal 2021 Earnings Call. This morning, we issued 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; Rob McNutt, our Chief Financial Officer; and Bernadette Madarieta, our CFO [testament]. Tom will provide a brief overview of fiscal 2021 as well as the current operating environment. Rob will provide some details on our fourth quarter results and Bernadette will discuss our fiscal '22 outlook.

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

Thank you, Dexter. Good morning, and thank you for joining our call today. Let me start by saying that I'm proud of how the entire Lamb Weston team stepped up this year to navigate through the most challenging operating environment in our company's history. We took necessary steps across our organization to focus on the health and well-being of our employees while continuing to focus on supporting our customers. At the same time, we continue to make timely investments to execute on our long-term strategic objectives.

For our larger customers in our Global and Foodservice segments, we work through production and distribution challenges to maintain customer service levels and support them as they manage through near-term volatility in demand and inventories. We also partnered with several large chain QSRs to broaden our menus with new products and limited time offerings and to position them for a more aggressive set of offerings in a post-pandemic environment.

In our Foodservice segment, despite lower volumes in the near term, we maintained our direct sales force that services independent restaurants. We believe it was important to continue to invest in these sales capabilities to provide these customers with uninterrupted support as they adapted to capacity restrictions in new operating models. That investment is now paying off as sales of Lamb Weston branded products have rebounded.

In Retail, the surge in food-at-home consumption during the pandemic provided a strong tailwind to our branded portfolio. Each of our Alexia, Grown in Idaho and licensed restaurant brands gained share as compared to pre-pandemic levels. Our branded portfolio market share in aggregate has nearly doubled in the past 5 years, and we've significantly closed the gap with a leading branded competitor. Including what we produced for private label retail customers, we are now the clear leader in the category.

In our supply chain, we're making some significant investments to support long-term growth and profitability. First, we began construction of a new chopped and formed line in our facility in American Falls, Idaho, that will be available in spring 2022.

Second, we announced major capacity expansion projects in China and the U.S. We expect both lines to be operational in the next couple of years, which will have us well positioned to support market growth.

In addition, through our joint venture in Europe, Lamb-Weston/Meijer, we announced a capacity expansion project in Russia. And just this morning, a GBP 400 million expansion in the Netherlands. These 2 expansions will be focused on supporting continued growth in their respective primary markets.

Finally, we began to implement our Win As One series of safety, quality and productivity initiatives in our manufacturing facilities and across our procurement, transportation and distribution networks. This is an ambitious program that adopts and tailors lean manufacturing and other productivity tools that have been successfully used by other world-class manufacturing organizations. We're excited about how these initiatives will further strengthen our Lamb Weston operating culture of continuous improvement and drive financial benefits that should enhance margins and cash flow over the long term.

We're targeting up to $300 million of gross productivity savings by reducing variable costs and waste, while also increasing potato and asset utilization. We're also targeting up to GBP 300 million of incremental capacity from debottlenecking and other tools to increase throughput on existing assets. To put that into context, GBP 300 million is equivalent to a new production line.

Finally, we're targeting up to a 10% reduction in finished goods inventory, while continuing to target high service levels and case fill rates. As I mentioned, these are long-term targets. We expect benefits from the Win As One initiatives to gradually build as they become fully incorporated across the entire supply chain organization.

We completed the initial phase of a new enterprise resource planning system early in the year. However, we deferred the second phase, which would have had a more direct effect on our manufacturing facilities at a time when those operations were managing through pandemic-related disruptions. We continue to map out Phase II and expect to begin implementation later this fiscal year. This project will tie into our Win As One initiatives to provide better data and systems to drive more efficient execution.

So although our results in fiscal 2021 were somewhat choppy due to the pandemic, we focus on the right near-term priorities, while making sure we continue the pursuit of our long-term strategic objectives. The pandemic showed the resilience of the category and our business model, with demand in most of our Foodservice segment channels largely offset by the performance in QSR and at Retail. Our operating cash flow and financial liquidity were solid, enabling us to invest in the infrastructure to support growth opportunities. As a result, I'm confident that we are well positioned to drive sustainable profitable growth and create value for our stakeholders over the long term.

Now turning to the current operating environment. While the pandemic continues to impact people and economies in the U.S. and around the world, we believe the worst of its direct effect on our business, restaurant traffic in french fry demand is behind us. We're encouraged by the pace of recovery in restaurant traffic in the U.S. While overall restaurant traffic remains below pre-pandemic levels, it's recovered much of the lost ground and continues trending in the right direction.

In May, QSR traffic was down low single digits versus pre-pandemic levels, which is a modest improvement versus what we saw earlier in the year. The larger QSR chains have been generally outperforming small and regional ones with chicken-based chains outperforming more burger-oriented chains.

Overall traffic at full-service restaurants in May was still down mid-teens as compared to pre-pandemic levels. But that's a significant improvement versus down mid-20s that we saw just a few months ago. This reflects fewer social restrictions and consumer's increased willingness to eat on-premises.

What's helped to offset the effect of lower restaurant traffic during the year has been an increase in fry attachment rate. Simply put, this is a rate at which consumers order fries when visiting a restaurant. The increase in fry attachment rate has been largely consistent through most of fiscal 2021, and we believe that rate may have some staying power. We believe that if fry orders continue at the higher rate as restaurant traffic normalizes, it would lead to a meaningful amount of additional volume demand in the U.S. annually.

The increase in fry attachment rate in part helps to explain how our shipments in most of our key restaurant and food service channels have already reached core or close to pre-pandemic levels on a run rate basis despite restaurant traffic not yet fully recovered it.

Our shipments to large QSR chains essentially reached at level last fall as customers leverage drive-thru and delivery formats. Shipments to commercial customers in our Foodservice segment have essentially returned in aggregate to pre-pandemic levels in the last few months behind strength in small and regional QSRs as well as independent restaurants.

The recovery shipments to our noncommercial foodservice customers, which include lodging and hospitality, health care, schools and universities, sports and entertainment and workplace environment, continues to lag that in restaurants. However, we expect the rate of improvement will steadily increase through the fall, especially in our education, lodging and entertainment channels.

While restaurant Foodservice demand continues to recover, demand in the Retail channel continues to be strong. May volumes for the category were 15% to 20% above pre-pandemic levels and our shipment of branded products were in line with those trends. However, we expect category growth will likely slow as it laps strong prior year results and as consumers step up food away from home purchases. We have seen these factors already begin to play out in the fourth quarter and in the first couple of months of fiscal 2022.

In short, we feel good about the frozen potato category in the U.S. because of increasing strength in restaurant and Foodservice channels as well as continued solid performance in Retail. As a result, we remain confident that overall U.S. fry demand will return to pre-pandemic levels on a run rate basis by the end of calendar 2021.

Outside the U.S., it's a more complicated story. While demand has improved in Europe and our key international markets, the pace of recovery has been much more uneven and generally behind that in the U.S. as a result of slower vaccine availability and rates. In addition, the spread of COVID variants in many markets has also led governments to delay lifting and, in some cases, reimposing social restrictions which has further increased volatility in demand and stretched out the timing of recovery.

Overall, we expect the pace of recovery outside the U.S. will continue to vary, with Europe and the developed markets in Asia continuing to generate gradual improvement in demand. We expect the pace of recovery in emerging markets in Asia, Latin America and the Middle East to be more volatile and take a bit longer.

With respect to supply chain in our cost environment, as with the pandemics impact on fry demand, we believe the worst of its effect on our supply chain is also behind us. We're making progress in stabilizing our manufacturing operations with a number of production days and throughput at most of our plants during the fourth quarter, improving on a year-over-year basis as well as sequentially versus the third quarter. However, we're not yet consistently operating at targeted levels across our network, and it will take some time as we gradually return to operating and normalized levels.

In the near term, we'll realize incremental costs and inefficiencies incurred during and since the fourth quarter as we sell finished goods inventory in the first half of the year. Going forward, the lingering effects of the pandemic and the sharp recovery of the broader economy in the U.S. has disrupted supply chain operations across all industries, including ours, which has resulted in increased costs. As a result, we expect input cost inflation, especially for edible oils, packaging and transportation, to be a significant headwind for fiscal 2022.

Our goal is to offset inflation using a combination of levers, including pricing. To that end, we just began implementing broad-based price increases in our Foodservice and Retail segments and don't expect to see the most of their benefit until our fiscal third quarter.

Before I turn the call over to Rob, let me review a couple of items. First, a few words about the current potato crop. We have recently begun processing early potato varieties in the Pacific Northwest. And early indications are that the recent high temperatures in the Pacific Northwest did not have a negative impact on yield or quality.

With respect to the main crop that we harvest in the fall, we expect the recent heat waves may have some negative effect on yield and quality, but it's too early to tell. We'll provide our usual updates on the crop when we report our first and second quarter earnings.

Second, as you may have seen last week, we announced an expansion of our facility in American Falls, Idaho, which will add about 350 million pounds of french fry capacity. The total investment of around $450 million over the next couple of years is for a new production line as well as to modernize the infrastructure at the facility. We anticipate starting up the new line by mid-2023, just as we expect capacity will be needed to support demand growth.

So in summary, while this has been a challenging year, I'm proud of how the team has navigated through the pandemic's impact and remained focused on supporting our customers in the near term, while continuing to execute on our long-term strategic priorities. We're pleased by the strong recovery in demand in the U.S. and continue to believe that it will be back to pre-pandemic levels on a run rate basis by the end of calendar 2021.

And finally, while our supply chain is not yet operating where we wanted to be, I'm encouraged by the improvement that we're making towards getting back to normalized levels as well as the actions we're taking to offset input cost inflation.

Finally, as we announced a couple of months ago, Rob will be retiring after more than 4 years with Lamb Weston. As part of the leadership team, he's been instrumental in setting up Lamb Weston as an independent company and creating a world-class finance and IT organization. With his past experience in manufacturing companies and capital markets, along with his insights into the business, Rob has been a valuable voice as we drove growth, broaden our global footprint and navigated through the challenges of the pandemic.

As you know, Bernadette will be succeeding Rob as CFO on August 6 after serving as our controller since just before the spin. Bernadette has been a key member of the leadership team from the beginning and has had a hand in all our major decisions and initiatives. This succession has been long planned, so we expect a smooth transition. So I just want to say thanks, Rob, for being part of the Lamb Weston family. I'm grateful to have Bernadette stepping into her new role.

And with that, here's Rob to review our fourth quarter results.

Thanks, Tom. Good morning, everyone. Overall, we delivered solid top line results in the fourth quarter as demand trends improved, while our earnings continue to reflect pandemic's disruptive impact on our supply chain as well as higher inflation. Specifically in the quarter, sales increased 19% to more than $1 billion, which is a company record for the fourth quarter and within about $10 million of our best quarter ever.

Volume was up 13%, and price/mix up 6%. Excluding the benefit of the extra selling week last year, net sales increased 28% and volume was up 21%. The sales volume increase largely reflected the strong recovery in demand in the U.S., especially at full-service restaurants as well as improvement in some of our key international markets. It also reflected the comparison to soft shipments last year due to the pandemic, which included the impact of customers significantly destocking inventories as they adjusted to the abrupt change in the operating environment. The increase in price/mix was driven by favorable price and mix in each of our core business segments.

For the year, net sales, exclude benefit of the 53rd week last year, was down 2%, with volume down 6% and price/mix up 4%. Gross profit in the fourth quarter increased $87 million, driven by higher sales and lower supply chain costs on a per pound basis. The overall reduction in cost per pound as compared to the prior year was largely driven by lower incremental cost and inefficiencies related to the pandemic's disruptive impact on our manufacturing and distribution operations. It also includes a $27 million year-over-year benefit from unrealized mark-to-market adjustments as well as the absence of a $14 million write-off of raw potatoes that we incurred last year.

The reduction in per pound cost was partially offset by inflation for key inputs, especially for edible oils and packaging. Canola oil prices, in particular, have nearly doubled in the last 12 months. Our transportation costs were also up sharply. While we've reduced pandemics downstream disruptive effect on our distribution network, we continue to use an unfavorable mix of higher cost trucking versus rail as we took extraordinary steps to maintain customer service levels as demand turned up sharply. However, the significant increase in our transportation cost was also driven by inflation as rail, trucking, and ocean freight suppliers all struggled to keep up with demand as economic activity surged.

Moving on from cost of sales. Our SG&A increased $19 million in the quarter. The increase was largely driven by 3 factors. First, it reflects higher incentive compensation expense, which was significantly down in the first quarter -- fourth quarter last year after the pandemic hit.

Second, it reflects investments we're making behind our supply chain productivity, commercial and information technology initiatives that should improve our operations over the long term. And third, it includes an additional $3 million of advertising and promotional support behind the launch of new branded items in our Retail segment.

Equity method earnings were $10 million. Excluding the impact of the unrealized mark-to-market adjustments, equity earnings increased $14 million versus the prior year. Higher sales volumes compared to soft shipments in Europe and the U.S. last year as well as lower manufacturing costs per pound drove the increase.

Diluted EPS in the fourth quarter was $0.44 compared to a loss of $0.01 in the prior year. The increase reflects higher sales, income from operations and equity method earnings. For the year, adjusted diluted EPS was $2.16, down $0.34.

Adjusted EBITDA, including joint ventures, was $166 million, which is up $88 million. The increase was driven by higher sales, income from operations and equity method earnings. For the year, adjusted EBITDA, including joint ventures, was $748 million down, $51 million.

Moving to our segments. Sales for our Global segment, which generally includes sales for the top 100 North American-based QSR and full-service restaurant chains as well as all sales outside of North America, were up 19% in the quarter, with volume up 16% and price/mix up 3%. Excluding the extra selling week last year, sales increased 28% and volume was up 24%. The volume increase largely reflected the year-over-year recovery in demand, especially at large chain QSRs and full-service restaurants in the U.S. Shipments to these customers in the aggregate have essentially returned to pre-pandemic levels.

Shipments to customers in our key international markets also increased in the aggregate but remain below pre-pandemic levels as demand recovery continues to lag the U.S. in some of these markets. In addition, traffic and logistics issues affecting ports along the West Coast hindered our export shipments in the quarter.

The 3% increase in price/mix reflected the benefit of inflation-driven price escalators in our multiyear customer contracts as well as favorable customer mix. Global's product contribution margin, which is gross profit less A&P expense, increased 68% to $56 million. Higher sales volumes, favorable price/mix and lower manufacturing and distribution cost per pound drove the increase.

Sales for our Foodservice segment, which services North American foodservice distributors and restaurant chains generally outside the top 100 North American restaurant customers, increased 82% with volume up 64% and price/mix up 18%. Sales increased 94% and volume rose 74%, excluding the benefit of the extra selling week last year.

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 as governments further ease social restrictions. The increase also reflected a comparison to soft shipments in the prior year quarter as customers significantly destocked inventories.

Our shipments to noncommercial customers increased at a more modest rate and currently remain at about 2/3 of pre-pandemic levels. As Tom noted, we expect the rate of improvement to steadily increase through the fall as travel and lodging continues to ramp up and as schools and universities return to full capacity.

Overall, shipments by our Foodservice segment exited the quarter at around 95% of pre-pandemic volume. The increase in the segment's price/mix largely reflected the benefit of favorable mix from higher sales of Lamb Weston branded and premium products. As you may recall, sales of these products declined sharply in the fourth quarter of fiscal 2020 as customers, which primarily included independent restaurants, destocked inventories or traded down to more value-oriented products during the early days of the pandemic. Since then, our direct sales force has steadily rebuilt shipments of Lamb Weston branded products close to pre-pandemic levels.

Foodservice's product contribution margin rose 127% to $96 million. Higher sales volumes, favorable price/mix, lower manufacturing and distribution cost per pound drove the increase. Sales for our Retail segment declined 28%, with volume down 30% and price/mix up 2%. Excluding the extra sales week last year, sales declined 22% and volume declined 24%. We expected this decline as it was against a very strong fourth quarter of fiscal 2020, which included weekly retail sales for the category that were up around 50% on average as consumers switched consumption patterns due to government-imposed stay-at-home orders.

The decline in sales also includes the loss of certain low-margin private label volume, which will continue to be a headwind through fiscal 2022. With social and on-premise dining restrictions largely lifted in the U.S., consumer consumption patterns have begun to swing back towards restaurants and away-from-home out flex. Despite this trend, the frozen potato category at retail remains strong. Overall category sales are currently up about 25% from pre-pandemic levels, and each of our branded equities continued to outperform the category.

The Retail segment's price/mix increased 2%, reflecting favorable mix benefit of our branded business. Retail's product contribution margin declined 32% to $21 million. Lower sales volumes and a $3 million increase in A&P expense to support the launch of new products drove the decline.

Moving to our cash flow and liquidity position. We continued to generate solid cash flow even while the pandemic severely impacted demand. In fiscal 2021, we generated more than $550 million of cash from operations, which is down about $20 million versus last year due to lower sales and earnings, partially offset by lower working capital.

We spent $161 million in CapEx, paid $135 million in dividends and bought back nearly $26 million worth of stock at an average price of just over $78 per share.

We continue to be comfortable with our liquidity position. And at the end of our fiscal year, we had nearly $785 million of cash on hand, and our revolver was undrawn. Our total debt was more than $2.7 billion, and our net debt to EBITDA, including joint ventures ratio, was 2.6x.

Before turning the call over to Bernadette, I want to thank Tom and the entire Lamb Weston family for letting me be part of the team. It's been an incredibly rewarding experience, and I know that this team will continue to drive the company's success.

In terms of my successor, I've known and worked with Bernadette for around 20 years on and off. And I expect that you'll find that she and I approach things in many respects with a similar mindset. As Tom said, she's been deeply involved in all of the key decisions at Lamb Weston, and that's certainly true in developing the broader finance team and strategy. I'm excited for Bernadette to step into the role and see the impact that I know she'll deliver.

Now here's Bernadette to review our fiscal 2022 outlook.

Thanks, Rob. Good morning, and I look forward to meeting everyone in the coming month. As you've heard this morning, we feel good about our top line momentum in the past couple of quarters and expect that to continue in fiscal 2022.

For the year, we expect sales growth will be above our long-term target of low to mid-single digits, with the drivers of that growth being somewhat different in the first half versus the second. For the first half, we expect growth to be largely driven by higher volume, although we also anticipate that overall price/mix will be positive. The expected volume increase reflects the continuing recovery in demand in the U.S. and our key international markets as well as the comparison to our relatively soft shipments during the first half of fiscal 2021 due to the pandemic.

For the second half of the year, we expect our sales growth will reflect more of a balance of higher volume and improved price/mix. While the volume drivers should be similar to those in the first half, the benefit of the shipment comparisons will be less pronounced, especially late in the year.

Pricing in the second half will benefit from the broad-based actions in our Foodservice and Retail segments that became effective in mid-July but won't be mostly realized until our fiscal third quarter.

Price in the Global segment in the second half should also benefit from price escalators built into multiyear customer agreements. In addition, mix should benefit as our shipments continue to steadily recover in some of our noncommercial channels in our Foodservice segment. And as Tom mentioned, we continue to expect overall U.S. french fry demand will return to pre-pandemic levels on a run rate basis around the end of calendar 2021, which is essentially the beginning of our fiscal third quarter.

With respect to earnings, we expect adjusted EBITDA, including joint ventures and net income to gradually normalize as the year progresses, but it will be pressured during the first half by a step-up in input and transportation cost inflation as well as some residual effects of the pandemic's disruptive impact on our manufacturing and distribution operations.

As we noted earlier, we believe the worst of the pandemic's impact on our operations is behind us. So we expect these near-term cost pressures will steadily ease as we progress to the second half of the year. As you may recall, we generally hold about 60 days of finished goods inventory. So production costs that we incurred within the last couple of months are held on our balance sheet until the inventory is sold.

Accordingly, we already have a good idea about the expected impact on our fiscal first and second quarter results from the disruption in our manufacturing assets in the past few months.

We expect inflation to be a headwind throughout fiscal 2022, especially in the first half of the year. As Tom noted, we expect volatility in the broader supply chain as the overall economy continues to recover from the pandemic's impact. We believe this will contribute to significant inflation for key inputs, especially edible oils, transportation and packaging, continuing the trend that we began to see during the latter months of fiscal 2021.

That said, we're pulling a combination of levers, which may collectively offset most of these inflationary pressures.

First, there's pricing. As we've discussed, we began implementing a round of broad-based price increases in our Foodservice and Retail segments a couple of weeks ago. These increases generally take 3 to 6 months to be mostly realized in the market and will, therefore, lag the impact of inflation by a couple of quarters. We're also not ruling out the possibility of subsequent rounds of price increases based on the pace and scope of inflation.

In our Global segment, we're in the middle of negotiating contracts for our larger customers, and the results of those discussions, including price, won't be known until later this year. However, we will continue to benefit from inflation-driven price escalators built into multiyear customer contracts.

Second, there's mix. As I also mentioned earlier, we expect a continued recovery in shipments to customers and higher-margin foodservice channels.

And third, we expect to steadily drive increased productivity with our Win As One, lean manufacturing initiative. So while the ongoing impact of the pandemic is uncertain, we expect these levers together may largely offset inflation and allow us a more stable manufacturing and distribution operations will enable us to improve gross profit during the second half of fiscal 2022.

We expect that some of this improvement will be offset by continued investments in our supply chain, commercial and IT operations, especially in the first half of the year. These investments will increase our operating expenses in the near term but should improve our ability to support growth and margin improvement over the long term.

In addition to our operating targets, we anticipate total interest expense of around $115 million. We estimate a full year effective tax rate of between 23% and 24% and expect total depreciation and amortization expense will be approximately $190 million.

And finally, we expect capital expenditures of $650 million to $700 million depending on the timing of spending behind our large capital projects. This CapEx amount is high relative to our past annual levels and is largely a function of growth capital to complete the construction of our chopped and formed line in Idaho as well as to begin construction of new french fry lines in Idaho and China. It also includes capital associated with the second phase of our ERP implementation.

So in sum, we expect net sales growth for the year will be above our long-term target of low to mid-single digits, with growth largely driven by volume in the front half and more of a balance of volume and price/mix in the back half. We expect adjusted EBITDA, including joint ventures, will grow for the year with earnings pressure in the first half and gradual improvements towards more normalized results in the second half as operations stabilize and price/mix improves.

At this time, we're taking a prudent approach by not providing a specific earnings growth target, given the increased volatility of key input and transportation costs as well as the potential impact of the recent heat waves in the Pacific Northwest on potato yield and quality.

Now here's Tom for some closing comments.

Thanks, Bernadette. We feel good about how well the category has been recovering from the pandemic and believe these positive trends provide a good tailwind for above algorithm sales growth in fiscal 2022. We're making progress in stabilizing our manufacturing network, and we're pulling the right levers to gradually normalize operations and offset significant inflationary pressures to improve profitability as the year progresses.

With our Win As One productivity initiatives, we're putting in place the lean manufacturing and productivity tools to improve our operations and cost structure so that we can return to or even exceed pre-pandemic margin levels in the coming years.

And finally, I'm confident that we're making the right investments to strategically expand our production capacity so that we can deliver sustainable, profitable growth and create value for our stakeholders over the long term.

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

(Operator Instructions) We'll take our first question from Tom Palmer with JPMorgan.

I look forward to working with you, Bernadette. And Rob, congratulations on your retirement. Thank you for your help over the past few years. I wanted to ask about how costs have ramped over the past few months. Do you expect COGS inflation in the first half of the fiscal year to come in above the COGS inflation you faced in the fourth quarter? Is there a range you can provide? What are the items that have gotten worse over the last couple of months? And then just to what extent did your COGS inflation ramp subsequent to you announcing these recent price actions?

Yes. This is Rob. I'll take that. The -- in terms of COGS inflation, first, remind you that our COGS does have some seasonality just as the crop, the storage and the crops so encouraging, incurring the storage costs as well as the physical deterioration of the crop impact yields. So that's seasonal, so pull that aside.

The key elements of the inflation have been in -- outside of that just normal seasonality have been in edible oils, where we've seen sharp inflation in that really over the last 12 months. That started moving up about -- not quite a year ago, about almost a year ago and has been moving up. Now recently, there's been a little bit more up and down rather than steadily up. So we'll see how that continues to develop and evolve.

The other place where we've seen inflation is in packaging. I think that's just driven by general demand for packaging and again, the packaging producers, canola oil producers having the same challenges production-wise as everybody else. So those are two key elements that are driving our cost of goods manufactured.

Another piece that's driving our cost of goods manufactured up or has had an impact on it has been the volatility in our manufacturing operations that have -- is really a carryover from some of the pandemic-related things and as we recover. What we're seeing is, as demand comes up sharply, and we're trying to maintain customer service levels that we're doing some more break-in to meet customer service levels on manufacturing. The -- and so those are the elements driving manufacturing.

On the operations side, as I think as Tom mentioned, we're stabilizing those operations and seeing significant improvement there. The other piece that gets into cost of goods sold is transportation. Two elements to that. One is just the overall inflation, and that's really happening in trucking, in rail and in ocean freight across the board. And I think it's pretty common across industries to see that.

The other piece, again, is we're maintaining customer service levels at a high level. We've been incurring more spot truck than we have our normal mix of primarily rail to move product to the East Coast. So those are the elements in it.

In terms of the outlook for inflation, again, the oils, we continue to hedge those. And so a lot of that oil is hedged through the year. The transportation, as we continue to stabilize operations and as demand stabilizes, we expect that we'll get to a more normalized mix of rail, truck freight. But we think that there's still some choppiness going to occur in cost in terms of spot trucking and certainly, ocean freights off the West Coast for us as we ship to our export markets.

So it's a bit of a mixed bag. We think that, that a lot of the oil inflation feels like it's more behind us, not to say there won't be more, but the rate of increase over the last 12 months, as I mentioned, has really doubled in canola. So that's kind of a long-winded answer, but I think it covers the -- covers the basis there.

Okay. In the press release and then on the prepared remarks, you referenced earnings gradually normalize in the second half of the fiscal year. Could you maybe clarify what normalized means? Should we think about margins back within historical ranges, such as what we saw in 2018 and 2019?

Yes, that's what we're expecting. Again, Rob walked through. This is Tom Werner, Rob walked through, the inflationary challenges we're facing and as we've priced in the market, pricing will catch up in the back half, we expect our operations, manufacturing plants to hit pre-pandemic throughput levels. And therefore, on the back half, we think things -- margins will be back to pre-pandemic levels.

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

Yes. And Rob, congratulations on the retirement. I guess first, maybe continuing on Tom's line of questioning. I just want to see, if we could maybe dimensionalize a little bit kind of how much of the margin kind of impacts in the quarter and what you're expecting over the next couple of quarters is kind of unit cost inefficiencies as it relates to the manufacturing plants and kind of all the COVID impacts relative to underlying kind of non-potato cost inflation in freight and edible oil, et cetera?

Yes. Just as a -- I'm not going to get into specifics line-by-line item. But I will tell you that more than half of that is related to just inflation, with less of it being in terms of operating performance. And again, as I mentioned -- as we mentioned in the prepared remarks, that's continued to improve through the quarter. So we exited the quarter in a better shape than we started the quarter in terms of the...

Okay. All right. That's -- that's really helpful. And then maybe just on the demand side, you went through some of this in the prepared remarks, Tom, but just especially on the Global business internationally, just it seems like things are a little bit kind of more uneven between different geographies. Any color you could provide there? And specifically how to think about potential competition from European spot suppliers in some of your export markets over time?

Yes. Adam, it's really choppy in the international markets. And -- I mean you read the headlines every day and some countries are shutting down, putting more restrictions on. We're certainly seeing it in our markets in Asia, Oceania and Europe. So it's really kind of week by week on what's going on, especially with the delta variant that's going on.

So the team is doing a great job managing the volatility in the demand forecast plus, through on top of that, container challenges that every manufacturing company is having, especially on the West Coast, just getting product to the markets.

And -- so while all that is being -- is pretty volatile right now, we're just managing through it real time, just like everybody else. So -- that said, the second part of your question is the competitive landscape right now from the Europeans is pretty, I'll call it, normalized to what it's been. It had -- there hasn't been any -- there's always spot pressures in certain markets, but it's been pretty, I'll call it, normalized. And that's -- one of the things I attribute that to is everybody's experiencing the same thing we're experiencing. So it's manufacturing challenges, it's shipping challenges, a number of different things just to get product to the market and serve your customers. And that's the #1 goal right now, I think, for everybody.

So I think it's going to be choppy, especially in the international markets with all the freight pressure going forward until things kind of normalize. And the question is, when is that going to happen? And right now, we're going to see freight challenges in the near term for a while, and it's just going to be the way we have to operate.

Our next question comes from Rob Dickerson with Jefferies.

Great. So just first question, I just want to focus on the top line for a minute for cost. So Tom, it seems like just kind of given some of the pricing that we saw comes through in Q4, especially in foodservice and then kind of where demand seems to be coming in your kind of forecast for that demand through the end of the year -- the fiscal year. Is it fair to say that although kind of profits are more back-half weighted that we're also thinking just in terms of year-over-year growth that revenues could be up, let's say, like mid-teens first half, but then like maybe mid-single back half, just trying to get proper cadence for the year on the top line.

Yes. I mean that's specifically I don't know what the -- it's a comparable year-over-year but that's fair. And I would say, one of the things that I feel really great about is, how the category has responded. And it's been sharply -- lately, it's been really strong in the U.S., specifically. And I noted in my prepared remarks about fry incident rate, that's a big deal in terms of when people go to restaurants, they're ordering fries versus a different site. So that's good for the category, and that certainly has -- that's helped the category rebound and we feel good about it. And obviously, over the long term, we are very bullish on the category based on all the investments we've announced over the last 12 months. So I think the demand is going to be there. It's just we've got to execute our operational side of it.

Okay. Fair enough. And then I guess...

Rob, just one thing on -- you talked about Foodservice pricing, and really, the bulk of that was related to mix, the improvement there.

Okay. Fair. Right. And then the rest comes through in Q3?

Yes.

Got it. Okay. Cool. And then you -- I think, at least, you provided some incremental detail around the Win As One program. I heard you say in the remarks, I think it was $300 million in targeted variable expense reduction. So just kind of want to get a little bit more color on that. I know these -- as you said, these are long-term targets, I don't know long term, maybe I mean 3 years or 5 years. And obviously, I'm asking because at least ex reinvestment is $300 million and then variable expense reduction implies a 30% lift to pre-COVID EBITDA. So maybe if you could just kind of talk about that for a minute, and I'll pass it on.

Just in terms of the cost reduction, you said variable, it's really cost go to manufacturers. So some of that is related to getting more productivity out of the line, and so you're spreading the same fixed costs over more pounds. And so think about it as, if you've got consistently higher line speeds, your change over times are down. Those kinds of things, optimizing the mix line by line, those kinds of elements are part of that. And so part of it is fixed cost, but part of it is variable cost, whether it's recovery or usage of raw, usage of oil, et cetera. In terms of the time frame, we haven't put a time frame to that specifically externally at this point.

Our next question comes from Peter Galbo with Bank of America.

Just wanted to ask one specific on Global. I know you said, we would know kind of more later this summer around the pricing and contract negotiations. But for the inflation escalators, do those kick in, 3Q of '22 as well? Or is it sooner than that?

Yes. It varies depending upon the contract renewal date. So it's really mixed. But generally, in general terms, the contracts that we have in place today will be in 3Q.

Got it. Okay. And then just on the gross margins in the fourth quarter, just wanted to get a sense maybe just where those came in relative to your expectations when you kind of provided some thoughts around it at 3Q? Understanding going forward into the first quarter, it seems like a lot of that is just being driven by higher finished goods inventory, but just wanted to kind of understand where you landed in the fourth quarter relative to your own internal expectation?

I'll take that. This is Rob. The -- we weren't that far off. I will tell you that the pieces that maybe were sharper on the COGS side than we had anticipated, transportation was a bit sharper. And then really, one of the things that -- volume was stronger than we probably anticipated going into Q4. And so there was more volatility and so more break into lines, more hot shotting, maintain customer service levels, those kinds of elements. And so as we think about it, we think that the long term of maintaining the customer service levels is a lot more important than incurring a little bit of extra cost in this kind of an environment in the short term. And so that's where maybe that you'd say that our margins were pressured a little bit more than what we had anticipated.

Our next question comes from Jenna Giannelli with Goldman Sachs.

You talked about it a little bit with respect to the international business, the delta variant. But I guess I'm curious, there still seems to be a high degree of confidence for just U.S. demand being back towards pre-pandemic levels by the end of this year. I guess, are you hearing anything from your customers, whether it's the restaurants or some of your noncommercial customers that the strong demand that we've seen could cause a little bit with the onset or the growth in the delta variant here in the U.S.?

Yes. Thanks for the question. It's Tom. It's really -- it's hard to -- we're not hearing things directly from the customer in terms of a pause or what they're thinking about. If you think about our large -- in our Global business unit, our large QSR customers, they're pretty much back, and they've been operating through drive-thru format or takeout. And they've been at or exceeded pre-pandemic levels for quite some time now.

And as I talked about, the independent smaller QSR chains in our Foodservice segment have steadily recovered and they're down somewhat, but they continue to improve. And it -- with the new variant, it's hard to say, and the barometer for me is some of the international markets that have reimposed restrictions, and we've seen volume step back. But this whole thing is going to depend upon the restrictions that are imposed or not imposed. And if we kind of navigate through it, here in North America, we expect, with fry incident rates that I alluded to in my remarks, if that continues and holds, which we believe it will, then the volume is going to be there. It's just a matter of service and the customers.

And that actually took me to my next question, just the higher incidents and just the higher fry attachment rate that you were talking about that is really interesting. Is this something that you've seen before? I guess just any like thoughts on what's driving it. Is that menus are more limited? or perhaps people haven't been out in a while, so they're more willing to forge on french fries? I guess just the thoughts on the drivers and the sustainability of that trend?

Yes. It's -- I'll give you a couple of different perspectives in my mind. First of all, there's been menu simplification in a lot of independents. And what does that mean? That means they're slimming down their menu, so you may not have as many site menu items. That's number one. Number two, the fry offering is very important and profitable to our customers across all outlets. So that's important, especially in times like this, when you're fighting for incident -- when you're trying to get people in the restaurant. So that's a couple of different perspectives.

But I think the other thing to remember, fry incident pre-pandemic was pretty steady. You look over the years, it's been pretty flattish. And the uptick is because everything I just said. So -- and fries, it's a great -- obviously, a great product and people love it. And so we'll see where it all goes. But if it does stick, it's going to be meaningful volume going forward.

And our final question comes from William Reuter with Bank of America.

My question is around you guys remain below your leverage target of 3 to 4x. I guess, given the high CapEx this year, you're certainly going to be burning through some CapEx in the conversation around EBITDA being pressured in the first half of the year. Do you have a sense where EBITDA where leverage may peak this year? And at what time of that year that will be? And then when we might see leverage declining again?

Yes. This is Rob. I think as we had mentioned that the pressure on the margins in the first half of the year, and as Tom mentioned, a more normalization to the back half of the year. And so I'll let you guys run your models for what EBITDA is going to do. I will tell you that the spending on that those -- especially those 2 large capital projects in China and American Falls, those are going to play out through this year and next year. That's really a kind of an 18-, 24-month build is the bulk of the spending there. And so it will ramp up. So a lot of that spending is going to happen in the back half of this fiscal year and the front half of next fiscal year.

Okay. And then one more, if I could. Just in terms of those contracts that you're negotiating now that perhaps 3- to 6-month timing delays. I guess, in terms of the tone of those conversations, do you guys have a high degree of confidence that the price increases will be implemented pretty much broadly and more or less that there won't be customer pushback, or you haven't heard customers pushing back?

I'll -- the color I'll give you is it's -- the tones normalize just like it has been every other year, certainly, everybody understands the inflationary pressures we're all dealing with. But you go through the process, negotiate in good faith, and we we'll see where it all lands. But early indications are we're in a good spot.

And that concludes today's question-and-answer session. At this time, I would like to turn the conference back to Dexter Congbalay for any additional or closing remarks.

Thanks, everyone, for joining the call today. If you want to set the call with me, please e-mail me, and we can set it up for later either today or later this week. And enjoy the rest of the day. Thank you.

Once again, that does conclude today's conference. We thank you for your participation. You may now disconnect.