Good day, and welcome to the Lamb Weston 4th 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 4th quarter and fiscal 2021 earnings call. This morning, we issued our earnings press release, which is available on our website, landweston.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 With me today are Tom Warner, our President and Chief Executive Officer Rob McNutt, our Chief Financial Officer and Bernadette Madriena, our CFO, Detonette. Tom will provide a brief overview of fiscal 2021 as well as the current operating environment. Rob will provide some details on our Q4 results and Bernadette will discuss our fiscal 2022 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 and demand in inventories. We also partnered with several large chain QSRs to broaden their 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 and 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 produce 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 Chompton form line at our facility in American Falls, Idaho that will be available in spring 2022. 2nd, 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 Meyer, We announced a capacity expansion project in Russia and just this morning a £400,000,000 expansion in the Netherlands.
These two expansions will be focused on supporting continued growth in their respective primary markets. Finally, we began to implement our WinasOne 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 We're targeting up to $300,000,000 of gross productivity savings by reducing variable costs and waste, while also increasing potato and asset utilization. We're also targeting up to £300,000,000 of incremental capacity from debottlenecking and other tools to increase throughput on existing assets.
To put that into context, £300,000,000 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 2nd phase, which would have had a more direct effect on our manufacturing facilities This project will tie into our Win is 1 initiatives to provide vendor data and systems to drive more efficient execution. So although our results in fiscal 2021 were somewhat choppy due to the pandemic, we focused 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 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 consumers' 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 or are close to pre pandemic levels on a run rate basis despite restaurant traffic not yet fully recovering. Our shipments to large QSR chains essentially reached that level last fall as customers leveraged drive through 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 in shipments to our non commercial food service Customers, which include lodging and hospitality, healthcare, schools and universities, sports and entertainment and workplace environments, 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 Q4 and in the 1st 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 variance in many markets has also led governments To delay lifting and in some cases reimposing social restrictions, which has further increased volatility and 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 and our cost environment, As with the pandemic's 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 During operations with a number of production days and throughput at most of our plants during the Q4 improving on a year over year basis as well as sequentially versus the Q3. However, we're not yet consistently operating at targeted levels across our network We'll realize incremental costs and inefficiencies incurred during and since the Q4 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 increase in our Foodservice and Retail segments and don't expect to see the most of their benefit until our fiscal Q3.
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.
2nd, as You may have seen last week, we announced an expansion of our facility in American Falls, Idaho, which will add about £350,000,000 of French fry capacity. The total investment of around $450,000,000 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-twenty 23 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 20 And finally, while our supply chain is not yet operating where we want it to be, I'm encouraged by the improvement that we're making towards getting 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 Lem Wesson 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 6th 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 4th quarter results.
Thanks, Tom. Good morning, everyone. Overall, we delivered solid top line results in the 4th quarter as demand trends improved. Our earnings continue to reflect the pandemic's disruptive impact on our supply chain as well as higher inflation. Specifically in the quarter, sales increased 19% to more than $1,000,000,000 which is a company record for the 4th quarter And within about $10,000,000 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 excluding the benefit of the 53rd week last year was down 2% With volume down 6 and price mix up 4. Gross profit in the 4th quarter increased $87,000,000 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 $27,000,000 year over year benefit from unrealized mark to market adjustments As well as the absence of a $14,000,000 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 Pantemic's 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 struggle to keep up with demand as economic activity surged.
Moving on from cost of sales. Our SG and A increased $19,000,000 in the quarter. The increase was largely driven by 3 factors. First, it reflects higher incentive compensation expense, Which was significantly down in the Q4 last year after the pandemic hit. 2nd, it reflects investments we're making behind our supply chain productivity, commercial and information technology initiatives This should improve our operations over the long term.
And third, it includes an additional $3,000,000 of advertising and promotional support Behind the launch of new branded items in our Retail segment. Equity method earnings $10,000,000 Excluding the impact of the unrealized mark to market adjustments, equity earnings increased $14,000,000 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 4th 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 $166,000,000 which is up $88,000,000 The increase was driven by higher sales, Income from operations and equity method earnings. For the year, adjusted EBITDA, including joint ventures, was $748,000,000 down $51,000,000 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, We're 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 multi year Customer contracts as well as favorable customer mix. Global's product contribution margin, Which is gross profit less A and P expense increased 68 percent to $56,000,000 Higher sales volumes, favorable price mix And lower manufacturing and distribution costs per pound drove the increase.
Sales for our Foodservice segment, With Services North American Foodservice Distributors and Restaurant Change 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 Soft shipments in the prior year quarter as customers significantly destocked inventories. Our shipments to non commercial customers Increase at a more modest rate and currently remain at about 2 thirds 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 Q4 of fiscal 2020 as customers, which primarily included independent restaurants, Destocked inventories were 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.
Food Services product contribution margin rose 127 percent to $96,000,000 Higher sales volumes, favorable price mix and 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 Q4 of fiscal 2020, Which included weekly retail sales for the category that were up around 50% on average as consumers Switch 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 outlets. 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 percent to $21,000,000 Lower sales volumes and a $3,000,000 increase in A and P expenses support the launch of new products 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 $550,000,000 of cash from operations, Which is down about $20,000,000 versus last year due to lower sales and earnings, partially offset by lower working capital. We spent $161,000,000 in CapEx, paid $135,000,000 in dividends and bought back nearly $26,000,000 worth 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 $785,000,000 of cash on hand and our revolver was undrawn. Our total debt was more than $2,700,000,000 and our net debt to EBITDA, including joint ventures ratio, was 2.6 times. Before turning the call over to Bernadette, I want to thank Tom and the entire Lan Weston family Thank you 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 months. 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 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 Q3. Price in the global segment in the second half Mix should benefit as our shipments continue to steadily recover in some of our non commercial 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 Q3. 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 1st and second quarter results from the disruption in our manufacturing assets in the past few months. We expect inflation 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. 2nd, there's mix. As I also mentioned earlier, we expect a continued recovery in shipments to customers in higher margin foodservice channels.
And 3rd, we expect to steadily drive increased productivity with our WinisOne lean manufacturing initiatives. 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 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 $115,000,000 We estimate a full year effective tax rate of between 23% 24% and expect total depreciation and amortization And finally, we expect capital expenditures of We will now begin construction of new French fry lines in Idaho and China. It also includes capital associated with the 2nd phase of our ERP implementation.
So in sum, we expect net sales growth for the year We'll 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, We'll 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 I 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 is 1 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.
And we'll pause for just a moment to allow everyone an opportunity to signal. We'll take our first question from Tom Palmer with JPMorgan.
Good morning. 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 Q4, 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. In terms of COGS inflation,
first
remind you that our COGS does have some seasonality just As the crop, the storage in the crop, so encouraging those incurring the storage costs as well as the physical deterioration of the crop Impact yield, so that's seasonal. So pull that aside, the key elements of the inflation have been in Outside of that just normal seasonality, you've been in edible oils, where we've seen sharp inflation in that Really over the last 12 months, that started moving up, 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. 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, Canadian board producers having the same challenges production wise as everybody else is. So Those are two key elements that are driving our cost of goods manufactured up. Another piece that's driving our cost of goods manufactured up or Factured Upper 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 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. 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 And I think it's pretty prominent 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 more normalized mix of rail truck freight, but we think that there's still Some choppiness is going to incur in cost in terms of spot trucking and certainly ocean freight 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 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 a kind of a long winded answer, but I think it Covers the bases there.
Okay. Thank you for all that detail. 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 2019?
Yes, that's what we're expecting. Again, Rob walked through this is Tom Warner, Rob walked 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, in the back half, we think things margins will be back to pre pandemic levels.
Okay. Thank you. I'll leave it at that.
Yes.
We'll take our next question from Adam Samuelson with Goldman Sachs.
Yes, thanks. Good morning, everyone.
Good morning,
Adam. Good morning. 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 impact in the quarter and what you're We're expecting over the next couple of quarters is kind of unit cost and efficiencies as it relates to the manufacturing plants and kind of all the COVID impacts relative To underlying kind of non potato cost inflation, freight and kind of oils, etcetera?
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 prepared remarks, That's continued to improve through the quarter. So we exited the quarter in better shape than we started the quarter in terms of
the Okay. All right. 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 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, put 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.
The team is doing a great job managing the volatility in the demand forecast plus Throw 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 It's 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, it's pretty, I'll call it normalized to what it's been. 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 experience It's 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 number one 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.
All right. That's actually helpful color. I'll pass it on. Thanks.
Our next question comes from Rob Dickerson with Jefferies.
Great. Thank you so much. 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 come through in Q4, Especially in foodservice and then kind of where demand seems to be coming in, you're 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 side.
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 12 months. So I think the demand is going to be there. It's just we 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 Buenaventhes 1 program, I heard you say in the remarks, I think it was $300,000,000 And 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 3 years or 5 years. And I obviously am asking because at least ex reinvestment, dollars 300,000,000 And that 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. Thanks.
Just in terms of the cost reduction, You said variable, it's really cost cuts manufactured. So some of that is related to Getting more productivity out of a line and so you're spreading the same fixed costs over more pounds. And so Think about it is if you've got consistently higher line speeds, your changeover 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, etcetera. In terms of the timeframe, we haven't put a timeframe to that specifically externally at this point.
Okay, fair enough. I'll pass it on.
Our next question comes from Peter Galba with Bank of America.
Hey, guys. Good morning. Thanks for taking the question.
Good morning.
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, in 3Q of 2022 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 4th quarter, just Just wanted to get a sense maybe just where those came in relative to your expectations, when you had kind of provided Some thoughts around it at 3Q. Understanding going forward into the Q1, 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 Q4 relative to your own internal expectations?
Yes, I'll take that. This is Rob. 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 hotshotting to 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 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 margin Pressured a little bit more than what we had anticipated.
Got it. Thanks very much.
Our next question comes from Jenna Giannelli with Goldman Sachs.
Hi, there. Thanks for taking my question. You talked about it a little bit with respect to the international business, 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 non commercial customers that this strong demand that we've seen could Pause 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 through 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 servicing the customers.
Thanks for that. And that actually took me to my next question, the higher incidence and just the higher freight 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 has been menu simplification and a lot of independence. 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 1. Number 2, 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 Antoinette, 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, The 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.
Appreciate it. Thanks for the color.
And our final question comes from William Reuter with Bank of America.
Hi. My question is around, you guys remain below your leverage target of 3 to 4 times. I guess given the high CapEx this year, you're certainly going to be burning through some CapEx and the conversation around EBITDA being pressured in the first half of the year. Do you have a sense 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 of 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, 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 have 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?
The color I'll give you is it's The tone is normalized 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'll see where it all lands. But Early indications are we're in a good spot.
Great to hear.
All right. That's all for me. Thank you.
Thanks, Bill.
And that concludes today's question and answer session. At this time, I would like to turn the conference back to Dexter Congbile for any additional or closing remarks.
Thanks everyone for joining the call today. If you want to set up a call with me, please e mail me and we 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.