Earnings Call Transcript - SJM Q1 2022

Operator, Operator

Good morning and welcome to the J.M. Smucker Company's fiscal 2022 first quarter earnings question-and-answer session. This conference is being recorded. I will now turn the conference over to Aaron Broholm, Vice President, Investor Relations. Please go ahead.

Aaron Broholm, VP, Investor Relations

Thank you. Good morning and thank you for joining our fiscal 2022 first quarter earnings question-and-answer session. I hope everyone has had a chance to review our results as detailed in this morning's press release and management's prerecorded remarks which are available on our corporate website at jmsmucker.com. Additionally, we will post an audio replay of this call at the conclusion of this morning's Q&A session. During today's call, we will make forward-looking statements that reflect our current expectations about future plans and performance. These statements rely on assumptions and estimates, and actual results may differ materially due to risks and uncertainties. Additionally, we use non-GAAP results to evaluate performance internally. I encourage you to read the full disclosure concerning forward-looking statements and details on our non-GAAP measures in this morning's press release. Available today on the call is Mark Smucker, President and Chief Executive Officer; and Tucker Marshall, Chief Financial Officer. We will now open the call for questions. Operator, please queue up the first question.

Operator, Operator

Our first question today is from Andrew Lazar from Barclays.

Andrew Lazar, Analyst

I believe there will be a lot of discussion about inflation, costs, pricing, and related topics. I want to focus on your comments regarding the recovery of the Nutrish brand, which is not meeting expectations. You mentioned that you are currently evaluating additional actions to better position the business. Can you elaborate on this? Are you considering further portfolio optimization moves, repositioning the brand or its pricing strategy within the category, or something else entirely? I'm looking to understand why it’s lagging and what actions are being considered.

Mark Smucker, CEO

Thank you for the question, Andrew. It's Mark Smucker. I want to make a few brief comments about the business first, then I'll address the Nutrish question. We are very pleased with our results this quarter, marking six consecutive quarters of meeting or exceeding expectations. When looking at the prepared remarks and excluding factors like divestitures, the total company grew by 1%. All of our U.S. businesses experienced growth, with a 6% increase in top line growth over two years. This indicates that our underlying business fundamentals remain strong and demand remains robust. Our investments are paying off across nearly every aspect of our business, and our brands are strong. Two-thirds of our portfolio is growing, which is a significant improvement from a couple of years ago when only a quarter of our brands were seeing growth. We are quite happy with the progress we've made, especially in the last 18 months during the pandemic. However, we have not been satisfied with Nutrish dry dog. The overall pet business is performing as expected, with around 3% growth, which aligns with our algorithm of 3% to 4%. We have seen growth in dog snacks and cat food, but Nutrish dry dog is the exception. We remain committed to the brand and have continued to work on portfolio and packaging optimizations, and we are in the early stages of launching Big Life, so we still believe there is potential for the brand. However, we have not been satisfied with certain marketing investments, which haven't yielded the necessary returns. As a result, we are dialing back some marketing expenditures while still supporting the master brand and Big Life, ensuring that our spending is effective. We will temporarily reassess some of these investments, which is why we expect a delay in the full recovery of the Nutrish brand throughout the remainder of this fiscal year.

Operator, Operator

Our next question is coming from Ken Goldman from JPMorgan.

Kenneth Goldman, Analyst

I wanted to just dig in a little bit. One of the questions we're getting this morning is, not only on the first quarter but on the second quarter, the timing of shipments versus what we saw at Nielsen or really just takeaway overall beyond Nielsen as well. First, was there any mismatch between those two in the quarter just reported? And then does your outlook for the second quarter include any assumption that maybe some of your customers will buy a little bit ahead of some announced price increases?

Tucker Marshall, CFO

Ken, as it relates to first quarter shipments, the first quarter from a big picture perspective came in line with expectations. But we did have two areas that were a bit softer than anticipated. One, due to labor and transportation issues throughout the entire network, there were some shipments left on the dock that occurred at the end of July that should pick up into August. And secondly, due to some specific situations with two e-commerce retailers, e-commerce in the quarter was a little bit softer. So we would anticipate in the second quarter and beyond shipments to recover and then also a bit of return in the e-commerce channel.

Kenneth Goldman, Analyst

Okay, great. That's helpful. And then just quickly to follow-up on something. I appreciate you don't buy forward or hedge everything out. You may still have some exposure to spot markets each quarter. But I'm a little surprised why the near-term headwind is this much worse, right, in particular, for 2Q. So is there any way to help us order or size some of the incremental cost challenges, right, whether it's direct inputs for food stocks or packaging or labor? Just so we better understand a little bit what's hitting you harder than you initially thought.

Tucker Marshall, CFO

Ken, as we came into the fiscal year, we were anticipating mid single-digit cost inflation as a percent of our total cost of goods sold. Now we're seeing high single-digit cost inflation as a percentage of our total cost of goods sold. The change from our initial expectation is really driven within our commodity ingredients area, transportation, and then packaging. And when you think of commodity ingredients, there have been a few factors that have been driving that. One is weather-related, so that would impact coffee, particularly with Brazil weather patterns. The second was also weather patterns in the West, specifically the Pacific Northwest that impacted fruit. So those are two areas of commodities or ingredients where we've seen inflation come through, particularly in the second half of our fiscal year. Transportation, due to the volatility and tightness of the supply chain, continues to be real not only from a labor standpoint but also from a unit standpoint, and just an overall sort of backlog in the system that has persisted throughout the entire pandemic. And then on the packaging front, packaging continues to have the implications of just ongoing pricing pressures that continue candidly from the weather disruption that occurred in the wintertime in Texas due to the freeze. And so as a result of this persistent inflation, we continue to manage through very effectively not only through our supply chain and relationships with our suppliers and the great work by our teams, but we've got to acknowledge this inflation in our P&L and we need to recover it. And we are going to recover it through additional pricing actions this fiscal year that we anticipate in the second and third quarters in order to recover that. So we do believe this is a timing impact. And as a result of the timing impact, it should have pressure on the margin that we noted as well. But I do want to acknowledge two things. We remain confident in the way we've executed throughout the entire pandemic, and we will going forward. And I also want to acknowledge that this is not a symptom specific to Smucker. Candidly, this is a symptom specific to the entire economy.

Operator, Operator

Our next question is coming from Chris Growe from Stifel.

Christopher Growe, Analyst

I just had a quick question to follow up on some of the supply chain issues and kind of the labor-related issues. I guess I want to understand the degree to which those are an incremental factor in the lower gross margin outlook in relation to the inflation, is there one that's more than the other? Just how to frame those two in relation to the gross margin softness you're going to see relative to your previous guidance?

Tucker Marshall, CFO

Chris, definitely, there are two factors that are driving the inflationary environment for us. One is just the underlying input commodity and ingredient. The second is transportation, as you have noted. And that has been a persistent headwind not only last fiscal year but it continues to be one this fiscal year. And again, it is predominantly driven by the availability of labor and it’s also driven, to some extent, by the capacity of the system. And so that’s what we continue to manage through. We have been very successful in managing not only our long-term contracts but also our spot rate contracts as well. We continue to do our best. But as you bring material in, as you produce and you ship material out, the entire network right now is impacted from a transportation standpoint. And it is material.

Christopher Growe, Analyst

And so, Tucker, that transportation factor, is that half the gross margin decline? Is it that big? Or ingredient is a bigger factor? I'm just trying to get a relative size on how big each one could be?

Tucker Marshall, CFO

No. The commodity and ingredient would be the leading factor. A very close secondary factor would be transportation and packaging if you're thinking in terms of order of magnitude.

Christopher Growe, Analyst

Okay. And then just a follow-up to that. Is this something you can adjust pricing for? Looking broadly, do you see these costs as temporary? Or is there a possibility for another price increase to account for the additional costs you are experiencing?

Mark Smucker, CEO

Sure, Chris. This is Mark. As we think about cost and pricing recovery, we really try to take a holistic view and make sure that, as we've said before, we are working with our retail customers in a prudent and fair way to recover essentially the aggregate costs. And so when we look at costs and how they impact the finished product, we really look at that in totality. And as we go forward with our retail partners, just making sure that we have an open and transparent dialogue of what needs to happen so that we can indeed recover those costs through our entire tool kit, whether that's list price, net revenue optimization, or what have you.

Operator, Operator

Our next question is coming from Bryan Spillane from Bank of America.

Bryan Spillane, Analyst

I have a question about coffee. It seems that coffee costs were higher this quarter, and since it appears to be affecting you relatively quickly, does this indicate that your hedges were not as long as usual? I'm trying to understand the situation with green coffee costs, which have clearly increased, and how you were positioned or hedged for these higher costs.

Tucker Marshall, CFO

Bryan, as it relates to our cost position for the year, as we said, coming into our fiscal year, we knew that we would have year-over-year cost inflation, which was inclusive of our coffee portfolio as well. And we knew that, that inflation was going to begin to hit us on a 12-month basis and that we were taking initial pricing actions in July to begin to recover that initial wave of inflation. And so the margin in coffee for the quarter, but yet the margin for the entire business for the quarter does reflect that inflation ahead of the pricing recovery. As you think about what's happened since our initial guidance, we began to have weather impacts in Brazil that began to affect the underlying commodity. And as a result of that, we've been managing through how we think about delivering the balance of the year. While we'd like to give you the specifics on our hedging position, we don't disclose that. But what we can share is, is that coffee costs have gone up and that we will take additional pricing actions and measures to ensure that we recover the inflationary impact that we're seeing to the P&L.

Bryan Spillane, Analyst

Okay. Given that weather has been a factor, are there concerns regarding the availability of green coffee? Are you worried at all about the supply of raw materials?

Mark Smucker, CEO

Yes, Bryan, it's Mark. Generally, the frost in Brazil, which Tucker mentioned, will have some impact on coffee availability over a longer period, specifically a 12-month period. However, as the largest roaster in the U.S. and one of the largest in the world, we can still meet our needs. As Tucker noted, prices will be higher, which we plan to manage using our strong hedging tools. We believe we can navigate this situation, but it's important to recognize that both the Brazilian crop and ongoing transportation issues are contributing to these costs.

Bryan Spillane, Analyst

Okay. Could you provide some perspective on the current situation with coffee, particularly regarding rising costs and pricing? We've seen periods in the past where inflation affected coffee prices and there was some elasticity in the industry. Do you think this time will be an unusual period in terms of price increases and consumer response, or is this a typical response for a category that allows for price adjustments?

Mark Smucker, CEO

Sure. I guess the headline there would be that as we have managed through this initial phase of pricing, which is now in effect, the elasticities that we have modeled have generally performed as expected. We can't predict what green coffee is going to do over the long term in terms of costs, but we are certainly not at historical highs and so we would anticipate that as we think about further pricing actions and elasticity, that we should be able to manage through that. And even though no elasticity model is ever perfect, we do have confidence that we'll be able to manage through that in a realistic fashion.

Operator, Operator

Our next question today is coming from Alexia Howard from Bernstein.

Alexia Howard, Analyst

Can you share what the main sources of uncertainty are and what the biggest risks might be in the next few quarters? It seems that the uncertainty surrounding supply chain disruptions, and the overall vulnerability of the supply chain, has increased. This appears to differ from past commodity cycles, which mainly involved managing increased cost pressures and pricing. Other companies have mentioned that it's currently quite challenging to obtain products, whether sourcing ingredients from overseas or shipping domestically in the U.S. due to trucking issues. I would like to know what you perceive as the most significant pain points and risks for the upcoming quarters, as well as your current concerns. I'll hand it over to you.

Mark Smucker, CEO

Alexia, it's Mark. As we've discussed thus far, we've talked a lot about inflation and cost pressures, and that is of course the primary driver. And then the second one is supply chain, as you noted. I mean if we really want to simplify, it's primarily those two factors. There's a lot of unknowns, of course, about the pandemic and what course that may take, so we're watching that extremely carefully. But as to the supply chain, specifically, we do believe that the reason that we have had success is because of our ability to execute and manage the supply chain. There is no question that it is tight and there are a variety of issues, tightness spanning from all the way upstream to all the way to the shelf at the retailer. But I would submit that our team and our people have done such a good job of managing every single step of the way, engaging with suppliers and customers all the way through to the retail shelf that has been key to our success. And so much so that it has allowed us to actually gain distribution at shelf because we generally have been able to deliver to our customers. We've gained some space in recent shelf set resets because of our ability to execute. And so if you think about that factor coupled with our new commercial model, which is truly focused on the retail shelf and delivering, I think that really has been critical to how we've been able to deliver results thus far, and we would anticipate continuing those trends.

Alexia Howard, Analyst

And as a follow-up, can I ask about the magnitude of pricing that you're expecting across the portfolio? I mean, obviously, you've got pricing actions that have just gone into place. How much pricing do you anticipate being able to realize over the next few quarters or for the remainder of the fiscal year? And I'll pass it on.

Tucker Marshall, CFO

Alexia, I think the way that we've articulated this consistently is that we're experiencing double-digit commodity inflation that is resulting in high single-digit cost of products, goods sold inflation, which is then resulting in kind of low to mid-single-digit pricing at the total company level. We haven't necessarily disclosed by each given commodity or business the pricing amounts or actions. But that sort of formula should be able to give you a sense. And then I would also share that on an underlying organic basis, we are anticipating at the new guidance range to be up at about 2 points. And as a result of that, you're going to see some top line pricing being offset by some underlying volume as well. And so that should help you get a revised organic of about 2.5%.

Operator, Operator

Our next question today is coming from Rob Dickerson from Jefferies.

Robert Dickerson, Analyst

Great. My first question is just a quick follow-up to Alexia's question on the kind of cadence for the year, and then just a question on the pricing. So Tucker, your last answer was helpful in terms of kind of how to think about that magnitude that we're seeing. But kind of more specifically, I'm just curious, can the coffee business actually grow revenue this year, right? And we always sometimes, let's say, see the top line can decline, but gross profit still growing. In this case, just given this near-term pressure on cost, I'm curious, could we be looking at a retail division that's flattish for the year, maybe down a little bit? Because I think that would help us also be able to rightsize the total company as we get through the year.

Tucker Marshall, CFO

Rob, as it relates to coffee and its growth trajectory, I think what we would say is, is that we're probably anticipating kind of flat to up based on what we're seeing today. But that would be inclusive of additional pricing actions. I think it's difficult for us at this point to continue to break down each of the business units. I think we've talked about kind of an underlying organic for total company being up 2.5 points. On the pricing front, just from a cadence standpoint, we took pricing in July. It's reflective, we've discussed that. We've also acknowledged that the additional pricing actions would likely come through in Q2 and Q3. So that also should give you a sense of timing as well.

Mark Smucker, CEO

Rob, it's Mark. I want to add something about coffee. Our strategy has been to participate in all segments of the category while also shifting our portfolio towards the growing segments. Dunkin', Café Bustelo, and K-Cups are all outpacing the category. Even the Folgers brand is gaining share, especially in K-Cups, where its growth has been strong. As we continue to shift our portfolio, we are making progress towards our strategy.

Robert Dickerson, Analyst

Okay. Fair enough. And the follow-up kind of flows to what you were just discussing, Mark. In the prepared remarks, again referencing the coffee business, there's a line that says came in a little bit lower than expectations, right? Just a little lighter. But then there's also the commentary around this increased distribution coming from Folgers. So I'm just trying to kind of rightsize that like why do you think maybe things were a little bit softer than you thought, but then also at the same time, what's really driving that increased distribution on the Folgers brand? That's it.

Mark Smucker, CEO

Yes. Looking at coffee over a two-year period, we are seeing an 8% increase, which is very strong. The distribution gains mentioned refer mainly to recent shelf resets and new pickups with key customers. Although these gains have not yet impacted our profit and loss statement, they will certainly help us moving forward.

Tucker Marshall, CFO

Rob, I would also remind you that a year ago, we were experiencing the continued momentum of the early stages of the pandemic in our first quarter, and we had inventory replenishment during that time. This creates a significant comparison period related to COVID, especially for our consumer and coffee businesses.

Robert Dickerson, Analyst

Yes. I mean, bottom line, it seems like you can get pricing in coffee that's obviously coming through again once you've lapped the inventory build in Q1 and you get some incremental distribution. It doesn't seem like we're thinking of drastic elasticity as we get through the year. Is that fair? I'll leave it at that.

Tucker Marshall, CFO

The direction that you're sharing seems reasonable.

Operator, Operator

Our next question today is coming from Jason English from Goldman Sachs.

Jason English, Analyst

I have two quick questions. I understand the extent of inflation pressure the industry is facing continues to rise and is greater than we expected a few quarters ago. We have been discussing renewed inflation for about nine months now, yet there seems to be no price increases reflected in your financials, even in areas like pet products where you are comparing against price declines from the previous year. What has hindered the implementation of price increases in the system so far?

Mark Smucker, CEO

There haven't been any obstacles, Jason. Most of the pricing changes took effect in July and are now in stores. You will see that initial impact in the second quarter. As we continue to implement additional pricing across our business, as Tucker mentioned earlier, it will likely take effect towards the end of the second quarter or the beginning of the third quarter. So yes, we are confident in our ability to manage this, and it will be reflected in our results. I'm sorry, could you repeat the first part of your question?

Jason English, Analyst

You addressed it. We're fine, we're fine. So let me move on to my second question. Tucker, based on some of your earlier comments regarding pricing, it seems to be around 4%, indicating that volumes may be declining by about 1.5 points. This suggests a lower elasticity function compared to your historical norms. When I look at your trade spend, it was noted in your last 10-K that it's now 39% of sales, which is an increase of about 800 basis points from five years ago. It appears that you're now more dependent on promotions to boost volume than you have been in the past. In fact, you are one of the few companies that didn't benefit from reduced trade rates during COVID. Given this increased reliance on promotions, shouldn't we anticipate higher elasticity than what you've seen historically? What gives you confidence in assuming a lower elasticity function moving forward?

Tucker Marshall, CFO

Jason, I would say that on a year-over-year basis, pricing is going to contribute sort of up to mid single-digit growth. And it's going to be offset by sort of low single-digit growth of volume/mix/other. And what you have to be careful about in the volume/mix/other is, one, it's underlying business momentum for the Smucker's Uncrustables brand, continued advancement of Café Bustelo and Dunkin' and advancement of our pet snacks portfolio, along with a return in the Away From Home business. But then it is offset by a decrease in at-home consumption. It is also offset by supply chain disruption, which we are experiencing through our pet food portfolio, particularly in wet pet, and it's also offset by any additional trade promotion like you've talked about. But that trade promotion isn't the biggest bucket of what's causing sort of that change. And then lastly is I would just acknowledge that in our volume mix bucket, we also have factored in price elasticities for our pricing actions across the portfolio.

Jason English, Analyst

Got it. There are some positive mix benefits to consider. You’re not anticipating volumes to only decrease by about 1.5, right? I believe that's the answer, correct?

Tucker Marshall, CFO

Correct. There's a big bucket in there, to your point, where there's more than one variable.

Operator, Operator

Our next question today is coming from Pamela Kaufman from Morgan Stanley.

Pamela Kaufman, Analyst

Can you elaborate on the factors that contributed to the sizable margin pressure in the pet segment this quarter? This was the lowest operating margin that you've reported in the segment to date. And how are you thinking about your outlook for segment profitability over the course of the year?

Tucker Marshall, CFO

Pam, as it relates to the profitability margin for the pet food segment in the first quarter, you are correct, it did experience a decline quarter-over-quarter. I think you have to acknowledge the cost inflationary pressures in that business driven by the underlying commodities such as animal fats and proteins, along with the impact of transportation. And again, that was ahead of any pricing benefit due to pricing actions that were taken in July. So we would anticipate that the profitability in pet food come back in the back half of the year as pricing begins to reflect a half a year benefit against sort of a partial year first half, and then it will be down year-over-year due to the timing of price recovery against cost inflation.

Pamela Kaufman, Analyst

Got it. And then I guess related to that, how are you thinking about your ability to take pricing in pet at a time when the business is underperforming your expectations?

Mark Smucker, CEO

Pam, we have been able to take pricing and pass that through. And as we observe the market, we have seen our peers and competitors do similarly. And so we have confidence that we will continue to do that. And just reminding that pet snacks is really a key part of our strategy, and we do lead there. So we are clearly not only in pet snacks but in other portions of our business have been able to do so. So again, just to point, the headline being that our pet business is performing to expectations with the exception of Nutrish. And so we have delivered against our algorithm on pet.

Operator, Operator

Our next question today is coming from Ryan Bell from Consumer Edge Research.

Ryan Bell, Analyst

I was just wondering how you're thinking about some of the structural changes to your demand, not particularly around breakfast and lunch and pet snacks given some of the incremental at-home activity that we've seen. And how is this reflected in your guidance?

Mark Smucker, CEO

Thanks for the question, Ryan. It's Mark Smucker again. As I mentioned at the start of the Q&A, demand has generally stayed strong. For instance, 75% of coffee cups are still consumed at home, and there are more coffee brewers available. Additionally, there are more pets, which means pet snacks will continue to meet our expectations as consumers keep treating their pets. Furthermore, as I have mentioned before, even after the pandemic, however we define that period, it's clear that many professionals will continue to work from home more than they did before. This trend will benefit us, especially regarding breakfast and lunch occasions. We're particularly optimistic about our spreads, such as peanut butter and jelly, as well as our Uncrustables business, and we expect this to positively influence our performance.

Ryan Bell, Analyst

Is there any sense for the magnitude of some of those impacts that you're modeling into your guidance? Or is that a little bit less so for fiscal 2022 and it's more of a longer-term question?

Tucker Marshall, CFO

Ryan, we are anticipating continued momentum in at-home consumption and our coffee portfolio, as Mark acknowledged, and our consumer portfolio also driven by the Uncrustables brand along with the pet dynamics. And so as we continue to see how the pandemic plays out, as we continue to ensure the investment and reinvestment in our brands for the long-term health of our business and therefore for the benefit of at-home consumption and the stickiness of households that we've gained, we hope to continue that momentum in this fiscal year and beyond. Today is probably not the time to quantify what we think that is, but the momentum that we've generated continues to perform.

Ryan Bell, Analyst

That's helpful. And then last question for me. Where do you stand having a normalized SKU assortment given some of the supply chain issues that have been experienced?

Tucker Marshall, CFO

Ryan, what we continue to focus on are two things: one is advancement of our strategy, and a component of advancing the strategy is our portfolio reshape. And a component of the portfolio reshape is making sure that we have the right SKUs in order to advance the given brand or category and that we would eliminate any unperforming or nonperforming SKUs. And so that remains consistent in any financial plan. And then I would say beyond that, we do continue to look at our inventory levels from a working capital standpoint so that we can continue to ensure that we have the right level of raw material and finished goods in support of our supply chain, but also in support of our customers and consumers. And so those are two areas where we continue to focus on in the near term. But right now, we feel very comfortable with the assortment that we have behind the business.

Operator, Operator

I will now turn the floor back over to management to conclude.

Mark Smucker, CEO

Thank you for your time and interest in our call this morning. We do remain confident in our strategy and the delivery of our business, the underlying fundamentals and the fact that we are still able to continue to invest in our business to ensure that we deliver against our strategy. So we hope that many of you will be able to join us virtually for our presentation at the Barclays Global Consumer Staples Conference in a couple of weeks, and hope everyone has a great day and a good weekend.

Operator, Operator

Ladies and gentlemen, this concludes our conference call for today. Thank you all for participating, and have a nice day. All parties may now disconnect.