J & J Snack Foods Corp.

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. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, during which you may dial 01 if you have a question. Please note it is 01, not star 1. As a reminder, this conference is being recorded, and I will now turn it over to Noberto Aja, Investor Relations at J&J Snack Foods, and you may begin, sir.

Thank you, Operator, and good morning, everyone. Thank you for joining the J&J Snack Foods Fiscal 2022 Second Quarter Conference Call. We'll get started 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 of 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 risk, uncertainties, and other important factors that may cause or 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 estimate 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 Fatchner, 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 Fatchner, J&J Snack Foods' Chief Executive Officer. Please go ahead, Dan.

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, our 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 statements. 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 at 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 in our handheld 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 frozen novelties, were impacted by the ERP delays and saw a 31% decline in Q2. However, I'm pleased to report that frozen novelty 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 quarter. Moving to our frozen beverage segment. This segment was not impacted by the various ERP disruptions. Thus should be more reflective 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 IC 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 Moe's, Peter Piper Pizza, and Landmark Cinemas, as well as continued strong demand and growth opportunities with existing customers, including America's leading coffee retailer, convenience stores, and movie theaters. Now let's talk more about product launches and innovation. We recently launched a 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 icy flavors being released. In retail, we are piloting and researching new icy sandwich cream cookies. We are also preparing to launch new super pretzel 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 graphics 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, 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 strength and capabilities in 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?

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 supply chain 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 23% of total sales, and 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 prioritize customer opportunities in these core products. Also sales of handhelds increased 2.6% on top of 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 an increase of 7.3% compared to the previous year, where we had a gross margin of 23.2%. This was 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 combine 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 due to 2021, net earnings decreased to $3.3 million, resulting in diluted earnings per share of 17 cents a share compared to 32 cents a share in the prior year period. Our effective tax rate was 22% for the quarter. And on an adjusted EBITDA basis, we saw a decline to $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 $235 $1 million in cash and marketable securities, and zero 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 and focused 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 brands to continue the 50-year legacy of J&J Snack Foods. I would now like to open the call to questions. Operator?

Thank you. We will now begin the question and answer session. If you have a question, please dial 01 on your touchtone phone. If you'd like to be removed from the queue, please dial 02. If you're on a speakerphone, please pick up your handset first before dialing. Once again, if you have a question, please dial 01 on your touchtone phone. And on the line, we have Ryan Bell. Please go ahead. 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 few quarters?

Yeah, good morning, Ryan. 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 IC 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 on 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.

Thanks for those details. And then in terms of the price increases that are in the market, how much of the increase in the costs would that cover as you're contemplating, I guess, another price increase on the horizon?

Yeah, Ryan, you know, the challenge of that question is the pace upon which cost increases are coming, you know, and just if you just look from Q1, so 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, you know, I think as we respond and look at what we're doing on pricing, you know, it's kind of one of the big challenges is locking that in, right, as the costs continue to go up. You know, 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%. You know, 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, you know, 28 to 30 million in 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, you know, it's all about trying to keep up with the pace of those increases.

Thanks. And then for your ERP system that you implemented, 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?

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 see 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.

Thanks. And that April bouncing back, that's talking more about the issues that you had with the ERP system versus underlying demand trends?

No, 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. Great. Thank you. That's it for me. Thank you.

We have Rob Dickerson online. Please go ahead.

Rob Dickerson Great. Thanks so much. So, I just have a question around the margin side. Obviously, margin squeeze Q2, given the costs, you know, price lag. You know, what I'm kind of hearing is your demand is still strong, but given, you know, the increase, incremental increase on the cost side, and then kind of a third round, hopefully coming sometime Q4, you know, that we should still be expecting some margin pressure right in Q3. And then the hope would be as incremental pricing would come through Q4, you know, 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. I don't know if that makes sense. Just help me with that.

Yeah, I think that's, you know, I'll let Ken talk to it in a minute. Good morning, too, 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 taking 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 margin to improve throughout that period. Okay, fair enough.

And then just one last one for me. On the inventory side, you know, you made the comment in the prepared remarks just around, you know, kind of how you normally would build some inventories in Q2, right, as we get through the heavier seasonal part of the year. You know, 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, you know, with those inventories? Is there any risk to that inventory as we get into Q3 or, you know, ERP situation with fixed inventories in a great spot, demand is good, et cetera? Thanks.

Yeah. Again, I'll talk to him, 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.

All right, super. Thank you, guys.

Thank you, Rob. Thanks, Rob.

Once again, if you have a question, please dial 01 on your touchtone phone. And up next, we have Todd Brooks. Please go ahead.

Hey, good morning, Todd. A few questions for you. One, can we talk to, I know you talked about $20 million in revenue lost due to 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.

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.

Yeah, I would answer the same exact way, Todd. Certainly some of that we think will come in Q3, but I certainly couldn't sit here and tell you how much of it. I mean, there's some lost cells in that number. But the other sign that points to a little bit of that moving is that cells in April, you know, have started out really well, again, as we've gotten beyond some of the challenges with the system that impacted Q2. We're now starting to see sales double digit growth over 2019. So my hunch is some of that is a bit of that Q2 flipping into Q3.

That's great. Thanks, Ken. And then just to follow up on that, when you look at the disruptions from the implementation, how impacted did your customers get? Were 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?

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. 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, yeah, we do have to live up to great service, and that's what we believe the full conversion that J.D. Edwards will do for us. So that's a good question.

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'm wondering with the reality of the increases that we saw, have contracting or hedging practices changed? 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?

Yeah. 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 inflationary environment any of us have faced in our career you're going back 45 to 50 years i think until these kinds of increases were hitting you uh but they just took me through a review a couple of weeks ago and do a really good job of hedging you know whether you're talking about flour eggs oils um Flower, for example, I think we're hedged about 14 days, depending on the type of flower. I mean, not days, 14 weeks, depending on the type of flower. Many other categories over 20. But even the decision on when to hedge, you know, obviously is a challenge. The situation in Ukraine is not getting any better. And the outlook on 2023 as it relates to wheat, continues to be a concern for all the companies that use that, you know, as an ingredient in their products. But I would speak for that group, and I think Dan would agree with me that, you know, we are hedging, you know, to the best ability that we have, and I think doing it in the right way, but it's a day-to-day challenge.

The team's done an outstanding job, Todd, especially in the environment that we're in today.

Okay, great. And the final one for me, if I can. And 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?

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 that started to continue to rise. But I don't know that we've put a number to that. Ken, have you thought about that at all?

No, I haven't. You know, again, we tried to highlight it in the script. You know, when we look at adding the 20 million back and you look at the growth versus 19 and 20, you know, I'd feel pretty good about that given the conditions, given you're seeing elasticity kick in in some areas. You know, we beat 2019 and last year even with the challenges of that. So, you know, January, you know, 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 theaters in the month of January, but I wouldn't call it significant, Todd.

Okay, great. Thanks to you both. I'll pass it along.

Thank you, Todd. Thank you. We have no further questions at this time. I will now turn it back to your CEO, Dan Feschner, for closing remarks.

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.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for joining. You may now disconnect.