J & J Snack Foods Corp. (JJSF) Q2 2022 Earnings Call Transcript

J & J Snack Foods Corp.  (NASDAQ: JJSF) Q2 2022 earnings call dated May. 03, 2022

Corporate Participants:

Norberto Aja — Senior Managing Director

Dan Fachner — Chief Executive Officer

Ken Plunk — Chief Financial Officer

Analysts:

Ryan Bell — Consumer Edge Research — Analyst

Rob Dickerson — Jefferies — Analyst

Todd Brooks — The Benchmark Company — Analyst

Presentation:

Operator

Good morning, and welcome to the J&J Snack Foods Second Quarter Earnings Conference Call. My name is Brandon, and I’ll be your operator for today.[Operator Instructions]

And I will now turn it over to Norberto Aja, Investor Relations at J&J Snack Foods. And you may begin, sir.

Norberto Aja — Senior Managing Director

Thank you, operator, and good morning, everyone. Thank you for joining the J&J Snack Foods Fiscal 2022 Second Quarter Conference Call. We’ll just start in just a minute with management’s comments and your questions. But before doing so, let me take a minute to read the Safe Harbor language. This call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements made on this call that do not relate to matters such historical fact should be considered forward-looking statements, including statements regarding management’s plans, strategies, goals and objectives, our anticipated financial performance, industry-wide supply constraints and the expected impact of COVID-19 on our business. These statements are neither promises nor guarantees, but involve known and unknown risks, uncertainties and other important factors that may cause our actual results and performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

Factors discussed in our annual report on Form 10-K for the year ended September 25, 2021, and other filings with the Securities and Exchange Commission could cause actual results to differ materially from those indicated by the forward-looking statements made on this call today. Any such forward-looking statements represent management’s estimates as of the date of this call, May 3, 2022. While we may elect to update such forward-looking statements at some point in the future, we disclaim any obligation to do so even if subsequent event causes our views to change. In addition, we may also reference certain non-GAAP metrics, including adjusted EBITDA, which is reconciled to the nearest GAAP metric in the company’s earnings release, which can be found in the Investor Relations section of our website at jjsnack.com. With us on the call today are Dan Fachner, our Chief Executive Officer; and Mr. Ken Plunk, our Chief Financial Officer. Following management’s prepared remarks, we will open the call for questions. With that, I would now like to turn the call over to Dan Fachner, J&J Snack Foods Chief Executive Officer.

Please go ahead, Dan.

Dan Fachner — Chief Executive Officer

Thank you, Norberto, and good morning, everyone. We appreciate you joining us this morning to discuss our second quarter results. J&J Snack Foods had a number of accomplishments throughout the quarter, including new customer wins, successful product launches and expanding product distribution. We delivered an all-time high second quarter net sales of nearly $282 million despite the unexpected challenges related to the early February implementation of a new ERP system. We intentionally planned the ERP system launch during fiscal Q2, which, as many of you know, are seasonally slowest volume quarter. The implementation created unforeseen temporary operational, manufacturing and supply chain challenges that affected the performance of our Food Service and Retail segments during the quarter. Our Frozen Beverage segment, which already runs on JD Edwards’ platform was unaffected by the implementation.

You’ve heard us talk about picking up some big boulders in order to best position J&J for the future. And the ERP system was the largest and most necessary change required to strengthen our supply chain. Having a robust ERP platform provides a more seamless integrated process from raw materials through production, warehousing, inventory management and electronic order fulfillment. It is also vital to supporting many of the key initiatives we have discussed over the past several quarters, focused on increasing operational efficiencies, expanding capacity, accelerating our growth and improving margins. We are confident that this system will strengthen our operating infrastructure and deliver meaningful benefits to our customers and shareholders today and for many years to come. We estimate that these issues had a one-time impact on fiscal second quarter sales of approximately $20 million and approximately $4.5 million in operating income. Taking the one-time impact of the ERP implementation, sales across Food Service and retail would have grown by approximately 11% with overall sales growing by approximately 18%, along with the improved results across much of the rest of the income statement.

While we are disappointed by the impact that this had on our Q2 results, I am proud of the way that our team stepped up to resolve these issues and to serve our customers. Thanks to their efforts, our business has accelerated in April, and we are confident that these issues were isolated this quarter and should not have any further material impact going forward. As we have discussed on prior calls, our industry continues to experience sustained inflationary pressures across the supply and production chain, rising costs from sourcing ingredients and manufacturing to packaging and distribution continue to pose a significant headwind to our margins and bottom line. For the quarter, key product ingredients like flour, eggs, dairy, oils, chocolates and meats increased by more than 10% to our cost just three months ago.

To offset these challenges, we implemented two price increases totaling a 9% to 10% increase, and we expect to institute a third round in the near future that would most likely become effective sometime during our fiscal fourth quarter. Our most recent price increase did not take full effect until early April and was, therefore, only partially reflected in our second quarter results. As a reminder, many of our partners and customers require a 60-day notice before a price increase can be implemented. And the same time, we are aggressively implementing numerous cost reduction initiatives across procurement, R&D, production and distribution to drive additional efficiencies and cost savings.

We remain confident in our plans to build stronger margins in this business as we execute on a mix of price increases and ever sharper promotional strategies as well as a disciplined initiatives to reduce costs. Despite these near-term challenges, we remain extremely optimistic about J&J ‘s future. The biggest affirmation of our growth opportunity is the strength of our products and brands, which are beloved by customers of all ages and backgrounds. Incremental distribution across all classes of trade, together with continuous innovation and enhanced brand marketing will remain key levers for further accelerated growth. As Ken will discuss in greater detail, we generated record second quarter net sales, and it was our third consecutive quarter of net sales exceeding pre-COVID levels.

Now commenting on each of our three segments, Food Services continues to see healthy results, led by strong growth in our pretzels and churro products as well as our handhelds, which despite having a difficult comp versus the prior year, still grew by 2.6%. Key drivers of this performance were organic growth, aided by continuous Food Service recovery as well as accelerated pace and new customer wins. Other product lines such as firms and novelties were impacted by the ERP delays and saw a 31% decline in Q2. However, I’m pleased to report that frozen novelties sales have experienced a rebound in April. Our Retail segment, which was also impacted by the ERP delays as well as a challenging comparison versus a strong performance in the prior year. Net sales in our Retail segment increased 19% versus the comparable 2019 period despite the ERP impact, led by sales of our pretzel products. For the full portfolio, we expect positive effects of current and new distribution gains, increased promotional activity and the effects of the price actions to drive momentum for our third and fourth quarters.

Moving to our Frozen Beverage segment, this segment was not impacted by the various ERP disruptions that should be more reflective of the underlying momentum in our business. Sales grew by 50% versus Q2 of 2021 to $64.4 million from $42.9 million. We are seeing strong growth not only in our ICEE products, but also in the sales and servicing of machines. As it relates to customer wins, we continue to have a healthy pipeline of new customers, including Mose, Peter Piper Pizza and Landmark Cinemas as well as continued strong demand and growth opportunities with existing customers, including America’s leading copy retailer, convenience stores and movie theaters. Now let’s talk more about product launches and innovation. We recently launched the Gelato line under our Luigi’s brand with flavors, including Mint Chocolate, Italian Cannoli and Sweet Cream Churro. In our Frozen Beverages, we have some great new ICEE flavors being released.

In Retail, we are piloting and researching new ICEE sandwich cream cookies. We are also preparing to launch new Superpretzel filled bite flavors and a Sweet Cinnamon Pretzel line extension later this year. We also are getting ready to launch a new churro brand in Food Service. This will be supported by fresh traffics and targeted promotions. Churros are trending up with 78% awareness in the U.S., offer solid margins and are easy to prep for operators such as quick serve restaurants, movie theaters and adventure parks. Finally, we continue to see significant opportunity in the Pet segment.

Recent selling and promotional focus on Dogsters has resulted in a significantly 22-point gain in ACV at retail and a 14% increase in sales. As we focus efforts on Dogsters through fiscal 2022, we will build this momentum in 2023 with a new fully integrated marketing campaign. As it relates to M&A, we continue to be highly focused and disciplined in our approach. We are actively evaluating opportunities that will be accretive to our business, fit within our portfolio and complement our areas of expertise. We are confident that there are opportunities for us to grow inorganically and hope to be in a position to extend our long and successful track record on the acquisition front in the near future. In closing, while there is no doubt that — the operating environment remains highly dynamic, our strategy remains the same: to execute for sustainable growth through strengthened capabilities and operations, innovation, marketing and execution.

Looking ahead, consumer spending remains healthy despite macroeconomic challenges — and we continue to see strong demand for our products as a growing number of consumers return to their favorite amusement parks, restaurants, retailers and outdoor venues. One trend that stands out is that consumers are more willing than ever to treat themselves and enjoy our products inside or outside their home. We expect these positive trends and the operating and financial benefits of our recent initiatives to become more visible in our results as we move into the second half of fiscal 2022.

I would now like to turn the call over to Ken Plunk, CFO, to review our financial performance. Ken?

Ken Plunk — Chief Financial Officer

Thank you, Dan, and good morning, everyone. Taking a look at the results for the second quarter of fiscal 2022, we are pleased with the continued strength and resiliency of the business, surpassing pre-COVID sales for the third consecutive quarter. Net sales increased by 9.9% year-over-year to $281.5 million and by 1.9% when compared to fiscal Q2, 2019. These top line results represent the highest fiscal second quarter revenue in the company’s 50-year history. At the same time, our performance could have been even better this quarter, but was negatively impacted by the ERP conversion challenges Dan mentioned earlier. We estimate that the operational slugging challenges resulting from the ERP implementation impacted sales by $20 million in the quarter. Our improving sales performance was led by a 4.1% increase in Food Service to $176.3 million, a 50% jump in the Frozen Beverages segment to $64.4 million partially offset by a 7.2% decline in our Retail segment to $40.8 million.

Our Retail business was lapping a 17% increase in last year’s second quarter. Food Service continues to be our largest segment, representing 63% of total sales, while the Frozen Beverages segment accounted for 22% of total sales in our Retail segment representing the balance or 14% of — overall sales for the quarter. Food Service growth of 4.1% was led by 17.6% growth in pretzels and 18.5% growth in churros as we prioritized customer opportunities in these core products. Also, sales of handhelds increased 2.6% on top of a 168% increase last year. This growth was offset by flat sales in bakery and declines across frozen novelties. The decrease in Retail sales was led by a 52.3% decline in handheld sales, 12.4% decline in biscuits and a 2.4% decline in frozen novelties. Soft pretzel sales were flat year-over-year. Regarding our third segment, Frozen Beverages, the 50% increase reflected healthy sales growth across all the segments, including a 90.9% increase in beverage sales and 15.3% and 33.2% increase in maintenance and machine sales, respectively.

This led to a gross profit of $65.3 million or increase of 7.3% compared to the previous year, and at gross — where we had a gross margin of 23.2%. This is a slight drop compared to 23.8% in Q2 of fiscal 2021. As Dan mentioned, the combination of our ERP delays and the ongoing inflationary challenges combined to have a marked impact on our margins. However, we are confident in our plans to resolve and manage these headwinds as we move forward and expect gross margins to improve in the back half of the year. Moving down the income statement, total operating expenses increased from $53.7 million to $61.3 million, representing 21.8% of sales for the quarter compared to 20.9% in Q2 of 2021.

These results largely reflect the negative impact caused by the ERP implementation disruptions and to a lesser degree, the inflationary pressures across certain expense line items, such as depreciation expense, which was 10.1% of sales compared to 9.9% in fiscal 2021. Overall operating income declined from $7.2 million to $4.1 million for the quarter compared to the prior year, after taking into account income taxes of $0.9 million compared to $1.8 million in Q2 of 2021. Net earnings decreased to $3.3 million, resulting in diluted earnings per share of $0.17 a share compared to $0.32 a share in the prior — in the prior year period. Our effective tax rate was 22% for the quarter. And on an adjusted EBITDA basis, we saw a decline of $18 million from $21.8 million in the prior year on the back of the decrease in net earnings. Year-to-date, adjusted EBITDA has improved 22% compared to the first six months of fiscal 2021.

Taking a look at our balance sheet and our liquidity position, we continue to have a healthy balance sheet and overall liquidity position with $231 million in cash and marketable securities and 0 debt. Our cash position did decline in the quarter, driven by timing of strategic capital investments, higher cost of goods impacting inventory valuations and temporary working capital impacts due to the ERP implementation. The second quarter is historically our lowest cash flow period for the company as we build inventory for the spring and summer seasons. In closing, our second quarter results reflect a resilient and healthy business as sales continue to grow despite the temporary impacts of the ERP implementation. As I hope we made it clear on today’s call and in our previous communications, the management team and the Board are aligned on our strategy and focus on the long-term — success of the company. We are making the necessary investments to build additional capacity, improve operating efficiency and leverage our winning portfolio of brands to continue the 50-year legacy of J&J Snack Foods.

I would now like to open the call to questions. Operator?

Questions and Answers:

Operator

[Operator Instructions] And on the line we have Ryan Bell.

Ryan Bell — Consumer Edge Research — Analyst

Hi, You highlighted some pricing increases that you took in early April. Would you be able to elaborate a bit on the magnitude of those price increases? And then maybe how you think about that impacting margins over the next two quarters?

Dan Fachner — Chief Executive Officer

How are you today? We did highlight that. We did take a second price increase that went into effect some in the first quarter, but will be fully impacted in our second quarter. On the ICEE side, we had the full impact in the second quarter. But — excuse me, on the J&J side, full impact on the third quarter, not in the second quarter, full impact on the — third quarter and a partial impact on the second. As far as a percentage, we’re in that 9% to 10% price range of an impact for us. And we expect that to have a significant meaning as we go forward through the second half of the year. In addition to that, I also highlight that we’re taking a look at implementing a third price increase that would come into play probably later in our fourth quarter.

Ryan Bell — Consumer Edge Research — Analyst

And then in terms of the price increases that are in the market, how much is the increase in the costs would that cover as you’re contemplating, I guess, another price increase on the horizon?

Ken Plunk — Chief Financial Officer

Yes, Ryan, the challenge with that question is the pace upon which cost increases are coming. Just — if you just look from Q1 since say, December to Q2, our key commodities and packaging collectively probably increased 10%. So you’re looking at $8 million, $9 million of cost of goods increase just since the end of Q1. So I think as we respond and look at what we’re doing on pricing, it’s kind of — one of the big challenges is walking that in, right, as the costs continue to go up. Just to give you a few examples. Flour went up 8% since the end of Q1. Eggs went up 37%. Dairy went up 12%, meats went up 18%. Packaging went up 14%. Some of that’s tied to commodities like wheat that have gone up over 30% since October of last year, and fuel has gone up almost 50%.

So I think as we answer those questions, the thing we have to keep in mind is the pace upon which these costs continue to increase. The pricing action that we’ve taken both last year and then what’s hitting really most of it in April forward collectively is expected to cover $28 million to $30 million of cost increase since last year Q4. As we look at the third price increase, that is anticipation of covering what we saw happen in Q2 and then expectations in Q3 and Q4 continued increases in some of these commodities. So it’s all about trying to keep up with the pace of those increases.

Ryan Bell — Consumer Edge Research — Analyst

And then for your ERP system that you implemented, you highlighted some challenges that were there with the initial implementation. Would you be able to talk about whether or not you’ve gotten most of the kinks worked out or the degree to which that’s something that’s behind us at this point?

Dan Fachner — Chief Executive Officer

Ryan, we really feel like it is. Like any of these that get implemented and sometimes go south a little bit, there’s always a continual progression to make it better and better each day. And that is the process that we’re in today. We do see, as I talked about earlier, we see April bounced back to normal and above range. We say our first week of May continuing that. So we have all signs pointing towards that we are out of the worst of it, and now we’re just fine-tuning a few pieces of it.

Ryan Bell — Consumer Edge Research — Analyst

That April bouncing back, that’s talking more about the issues that you had with the ERP system versus underlying demand trends?

Dan Fachner — Chief Executive Officer

No, it is — our demand has been strong all along. It is with the ERP system and some of the picking and scheduling issues that we had with that.

Ryan Bell — Consumer Edge Research — Analyst

Thank you.

Operator

We have Rob Dickerson online.

Rob Dickerson — Jefferies — Analyst

Great. Thanks so much. So I just have a question on the margin side. Obviously, margins squeezed in Q2 given the cost price lag what I’m kind of hearing is your demand is still strong, but given the increase — incremental increase on the cost side and then kind of the third round, hopefully coming sometime Q4 that we should still be expecting some margin pressure right in Q3? And then the hope would be as incremental pricing come through Q4, you’re hoping you’re taking enough pricing to kind of, hopefully, let’s say, get back to more kind of pre-COVID margins, but that’s more of a ’23 event, if that makes sense period, just help me with that?

Dan Fachner — Chief Executive Officer

Yes, I think that’s — I’ll let Ken talk to it in a minute. Rob, how are you doing? But I think you said that pretty well. We’ll continue to have some pressures into the third and fourth quarter. However, we have a good increase, taking effect, fully taken effect beginning April. That will lighten that some, right? And we’ll continue to monitor what happens as we get into our third one. And as that helps out in the fourth quarter, I think we had talked about getting back to pre-COVID margin levels by the end of this year. And I think the last time you and I talked, we talked a little bit about that being delayed maybe three to six months. And that’s probably the range that we’re in, but you’ll continue to see the margins improve throughout that period.

Rob Dickerson — Jefferies — Analyst

Okay fair enough. And then just one last one from me, on the inventory side, you made the comment in the prepared remarks just around kind of how you normally would build some inventories in Q2, right, as we get through the heavier seasonal part of the year? I guess just with the kind of ERP challenges you had through Q2 and usually, right, the step-up on the revenue side in Q3, Q4? Like how are you doing with those inventories? Is there any risk to that inventory as we ended Q3 or ERP situation with fixed inventories in a great spot demand good, etc?

Dan Fachner — Chief Executive Officer

Yes and again, I’ll talk and then Ken, if you have anything to add to it. Demand is high, right? So we feel very comfortable with the demand out there. Our inventory is in a good spot to be able to supply that, and our ERP system looks to be fixed in a way that we’re able to get it out the door and into our customers’ hands. So we’re feeling comfortable with all three of those.

Rob Dickerson — Jefferies — Analyst

Thank you guys.

Operator

[Operator Instructions] And up next, we have Todd Brooks.

Todd Brooks — The Benchmark Company — Analyst

Good morning Dan. Few questions for you one, can we talk to — I know you talked about $20 million in revenue loss to give the impact of ERP during this quarter. Is that $20 million fully lost or is there any of that that’s deferred into Q3, either due to customer inventories being drawn down and you need to replenish those as you’re working your way through the ERP issues. I just wanted to size if this revenue, if we see any of this come back in Q3?

Dan Fachner — Chief Executive Officer

I think it’s a great question, Todd. It’s hard to put your finger on completely. I do think that inventories were drawn down in our customers that we have an opportunity to refill that pipeline. And I believe that is happening. We also have strong demand. So do I believe that we can pick up some of that $20 million absolutely, how much of it, it’s pretty hard to put a number to.

Ken Plunk — Chief Financial Officer

Yes, I would answer the same exactly Todd. Certainly, some of that, we think, will come in Q3, but I certainly couldn’t say and tell you how much of it. I mean, there’s, some loss sales in that number. But the other side that points to a little bit of that moving is that sales in April have started out really well. Again, as we’ve gotten beyond some of the challenges with the system that impacted Q2, we now start to see sales double-digit growth — over 2019. So my hunch is, some of that is a bit of like Q2 flipping into Q3.

Todd Brooks — The Benchmark Company — Analyst

That’s great. And then just a follow-up on that, when you look at the disruptions from the implementation, how impacted did your customers get where stock-outs a problem? And is that any issue as you’re now negotiating this next round of pricing increases that will go kind of into effect in Q4 — was there any kind of service issue at the retail or the food service customer level that undercuts maybe your ability to fully get the price increases that you’re targeting?

Dan Fachner — Chief Executive Officer

Well, it’s certainly a concern. We value our customers deeply. And so we tried to handhold people throughout this period of time. Our sales staff did a tremendous job stepping up and communicating with the customers and alongside the operational team, letting them know where we stood. We are getting the products back out there today. I feel like that we have the opportunity to pass on that third price increase because of what’s happening in the commodity side of things, and they’re aware of that. But yes, we do have to live up to a great service, and that’s what we believe the full conversion that JD Awards will do for us. So it’s a good question.

Todd Brooks — The Benchmark Company — Analyst

Okay. Two more quick ones, one Ken, you were talking about the commodity cost pressures in the quarter. And I think originally, our outlook was that maybe we’d see some moderation in the second half of the calendar year on commodities. I just — I’m wondering with the reality of the increases that we saw, have contracting or hedging practices change, just now kind of saying, okay? We think this is going to persist through calendar ’22? And are you more fully contracted or hedged than where you were entering this quarter? And if so, any key categories you can share with us that you’re hedged on?

Ken Plunk — Chief Financial Officer

Yes well, first of all, procurement team, I think Todd, particularly in this environment, we all talk about this being kind of probably the most difficult place of environment you’re guys are facing our career. You’re going back 45 to 50 years I think until these kinds of increases were hitting you. But they just took into a review a couple of weeks ago and do a really good job of hedging when you’re talking about flour, eggs, oils. Flour for example, I think we’re hedged about 14-day, depending on the type of flour, I mean not days 14 weeks, depending on the type of flour, many other categories over 20, but even the decision on when to hedge obviously is a challenge. The situation in Ukraine is not getting any better in the outlook on 2023 as it relates to wheat continues to be a concern for all the companies that use that as an ingredient in their products. But I would speak for that group, and I think Dan would agree with me that we are hedging to the best ability that we have, and I think doing it in the right way, but it’s a day-to-day challenge.

Dan Fachner — Chief Executive Officer

The teams done an outstanding job, Todd especially in the environment that we’re in today.

Todd Brooks — The Benchmark Company — Analyst

Okay great and the final one for me, if I can, I know given what kind of we’ve gone through since the onset of the war and obviously, with just battling through ERP that you guys had in the quarter. You didn’t really call out Omicron impacts in January? Is there any way you can size maybe any sort of revenue fall off that you saw either from ability to staff and produce on your end or maybe end customer demand in January. I’m just trying to normalize what this revenue number for this quarter could have looked like without really three discrete headwinds on your part?

Dan Fachner — Chief Executive Officer

Well, if there was an impact, it would have been in early January, right? And so we probably had a slight impact maybe even in the theater group as it started to continue to rise. But I don’t know that we put a number to that. Ken, have you thought about that at all?

Ken Plunk — Chief Financial Officer

No, I haven’t. I think again we tried to highlight it in the script. When we look at adding the $20 million back and you look at the growth versus ’19 and ’20, I feel pretty good about that given the conditions, given you’re seeing elasticity kick in, in some areas. We beat 2019 and last year, even with the challenges of that. So January, we were tracking along pretty well and pretty pleased with where our business was. We’re adding new customers, adding new SKUs. So there’s probably — if there was an impact, it was probably in theatres in the month of January, but I wouldn’t call it significant Todd.

Todd Brooks — The Benchmark Company — Analyst

Okay, great. Thanks you both for past along.

Operator

We have no further questions at this time. I will now turn it back to your CEO, Dan Fachner, for the closing remarks.

Dan Fachner — Chief Executive Officer

Thank you, operator. I want to take this opportunity to express my deep gratitude and appreciation to all of our employees who have consistently demonstrated their ability to offset challenges, putting J&J Snack Foods on a path for continued success. Our greatest asset is our people, whose commitment helps us to achieve our goals. We are also very grateful to our customers for their patience and loyalty as we work to resolve the ERP transition issues in the second quarter. Thank you, everyone, for joining us on the call today. We appreciate your interest and continued support and look forward to updating you on our progress during our third quarter. Thank you very much.

Operator

[Operator Closing Remarks]