Good morning. Welcome to The J. M. Smucker Company's fiscal 2023 Q2 earnings question and answer session. This conference is being recorded and all participants are in listen only mode. Please limit yourselves to two questions and re-queue if you have additional questions. I will now turn the conference call over to Aaron Broholm, Vice President, Investor Relations. Please go ahead, sir.
Good morning. Thank you for joining our fiscal 2023 Q2 earnings question and answer session. I hope everyone had a chance to review our results as detailed in this morning's press release and management's prepared remarks, which are available on our corporate website at jmsmucker.com. We will also post an audio replay of this call at the conclusion of this morning's Q&A session. During today's call, we may 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.
Participating on this call are Mark Smucker, Chair of the Board, President, and Chief Executive Officer, and Tucker Marshall, Chief Financial Officer. We will now open up the call for questions. Operator, please queue up the first question.
Thank you. The question and answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers. Should you require a question, please press star one on your telephone. If you wish to withdraw your question, please press star two. For operator assistance, please press star zero. As a reminder, please limit yourselves to two questions during the Q&A session. Should you have additional questions, you may re-queue, and the company will take questions at this time. Please stand by for the first question. Our first question today comes from Andrew Lazar from Barclays. Your line is now live.
Great. Thanks so much. Good morning, everybody.
Morning.
I was hoping to start off on gross margin, if we could. I guess excluding the impact from the Jif recall in the quarter, trying to get a sense of what adjusted gross margin would have looked like and whether that would have been a sequential improvement from fiscal 1Q, again, excluding the Jif recall. Basically, I'm just trying to get an understanding of what sort of underlying gross margin trends look like, and maybe more importantly, what caused the move to highlight a full year gross margin now at the low end of the previous range.
Andrew, good morning. We believe there was about a 50 basis point impact to the Q2 as a result of the Jif peanut butter product recall. We would have been at a 33.7% gross profit margin as compared to the 33.2% that we reported. We remain very confident in the outlook for our gross profit margin for the full fiscal year and have really focused in on the 33.5%. Again, that does have a 100 basis point impact due to the peanut butter recall.
I would also acknowledge that it also accounts for material year-over-year cost inflation, where we have told folks that we would be mid to high teen increases in our total cost of products goods sold. We are also seeing the impact of business volume mix on that gross margin for the full year. As we continue to work through the second and Q3s, we would anticipate the gross margin improve, with the Q4 being our best gross margin quarter.
Great. Thanks for that. Then, you are flowing through to the, to the full year a bit less than the fiscal 2Q upside you saw in EPS. I guess what are any discrete reasons for this? Or is there perhaps still some conservatism built in just given how dynamic the environment continues to be? Thanks so much.
Andrew, we're pleased to be able to take both our top line and bottom line guidance up. Let me begin with the top line. We are taking the midpoint of our previous guidance range up 150 basis points to approximately 6% on a reported basis. When you think of that 150 basis points, it's really coming across continued momentum in our pet portfolio and our consumer portfolio as well, along with expectations coming out of the Q1 for our coffee portfolio playing out as expected. As you translate the $0.15 improvement to the bottom line of our adjusted earnings per share, going now up to $8.55 at the midpoint as compared to $8.40, that $0.15 benefit is really broken down by two things.
$1.27 benefit from the volume mix due to the top line uplift, offset by $0.12 of additional investment, primarily through SD&A for business initiatives. I do wanna call out that the portion of our Q2 over delivery was due to timing of SD&A expenses that will reverse into the Q3, and that was also what is causing the new outlook for the Q3. We are taking both top line and bottom line up.
Thank you. Next question today comes from Peter Galbo from Bank of America. Your line is now live.
Hey, guys. Good morning. Thank you for taking the questions. Tucker, maybe we could just unpack a bit on the top line or the revised top line. Is it fair to assume that the full raise is really on the volume mix side? I think previously you had said, you know, you had about 15 points of price that you expected for the year. I just wanted to make sure that that, you know, number hadn't moved.
That is correct. It's largely driven by volume mix across our portfolio.
Okay. Maybe if we could just talk a little bit about coffee. You know, coffee costs, I think green coffee costs have started to roll over. Just seeing the change that Andrew brought up on the gross margin side, understanding there's a bit of timing. When might we expect some of that, you know, benefit if coffee prices have rolled to kind of start to flow through and impact the gross margin?
Peter, it's Mark. Thanks for the question. Just, you know, as we always say on coffee, we, you know, it's largely a pass-through category, and we will pass through cost increases or decreases at the time that we realize them. Although we are not transparent with our hedging practices, we do take a very prudent approach to how and when we pass those costs through. I guess I would also just highlight that, you know, our strategy has been to ensure that we are recovering dollar for dollar cost. That continues to be the case. As we did lead on the way up in pricing, we have now seen and continue to see competitive price gaps close, and the performance of our portfolio and aggregate has been satisfactory.
You know, obviously the solid top line growth, continued share growth, as well as, our ability to meet, consumers across the entire value spectrum continues to be very important.
Peter, I also want to remind you that the first and Q2s were the highest green coffee costs year-over-year for us, and then it begins to moderate in the third and Q4s. As such, you should anticipate the margin profile within our coffee business to improve as we continue to work through the Q2 and into the Q4 as we step into those year-over-year changes.
Thank you. Next question today is coming from Ken Goldman from JPMorgan. Your line is now live.
Hi. Thank you. Can we just get a little bit of a clearer sense of what your marketing dollars are expected to look like in the Q3 versus the Q4? Just because there's such a shift, it might help us sort of model that a little more cleanly. Then I guess I'm curious, where do you expect in terms of categories or brands for some of these dollars to go in the back half of the year?
Ken, good morning. Just acknowledging that we remain committed to reinvesting in our business and building our brands. We continue to support a 5.5% spend of net sales against our marketing budget. Just acknowledging there was some timing favorability in the Q2 that is trending into the Q3. We will be slightly above that 5.5% in the quarter, as you think about modeling and the flow for the year.
You raised your outlook for earnings, but not for CapEx or free cash flow. What's incrementally negative in operating cash flow that's, you know, perhaps offsetting that expectation for higher net income that'll keep free cash kinda constant versus your prior expectation?
Ken, we maintained our capital expenditure outlook at $550 million for the fiscal year. The predominance of that is in support of our strategic growth around the Uncrustables brand. Acknowledging we did not take our free cash flow guidance up. That was largely due to an additional estimated cash tax payment that we forecasted in for the fiscal year.
Thank you. Next question is coming from Robert Moskow from Credit Suisse. Your line is now live.
Hi. Thanks. just looking through our Nielsen tracking data, it looked like there was actually a pretty significant slowdown in your single-serve coffee sales. Is that a good reflection of what's going on? If so, can you talk about the drivers for it?
Sure, Rob, this is Mark. You know, I think when you look at the total coffee category, coming back to this notion of ensuring that we're addressing all the needs of consumers, we did see a little bit of a shift, as you highlight on K-Cup. You know, we watch consumer behavior very closely. There may have been some folks brewing more drip coffee. You know, we don't necessarily view that as a sustainable trend. Obviously, you know, brewer penetration in the Keurig brewers has grown significantly over the last several quarters. We would expect over time that would continue to benefit us. There was a little bit of a deceleration in premium coffee. That would be across the segment, as opposed to our brands specifically.
You know, as, again, price gaps in the premium coffee space have continued to close. We would expect over the subsequent quarters to continue to see growth for our Dunkin' business as well as our single-serve business.
Okay. Just to follow up, you know, you've said actually, I think for several months, that you are prepared for an environment where coffee costs fall and you're
You're taking more steps in advance to prepare for it. Can you be more specific as to maybe something you're doing differently this time so that the flow through is more seamless?
The first thing that we've, you know, tried to remind everyone is that we haven't seen record coffee costs like we saw, you know, a decade or so ago. The environment as we've managed through it has been, you know, the playbook has remained the same. We continue to execute against those same activities that we always would, whether that's, you know, being very prudent about passing through the pricing, being, you know, thinking about promotional activity in a, in a normalized way, so in other words, not out of the ordinary. And very importantly, and maybe most significantly, continuing to invest in our brands, even in a period of inflation.
Just, you know, always taking the approach, Rob, of balancing pricing, volume mix, and our the ways in which we support our brands, both with the consumer and customer, we've got to continue to take a balanced approach, and that has served us well, and we believe it will continue to do so.
Thank you. Next question today is coming from Chris Growe from Stifel. Your line is now live.
Hi, good morning.
Morning.
Good morning. I just had a question for you first on a bit of a follow-up from an earlier question on inflation. Is there any nuance to how much inflation you realized in the Q2? Is that pretty well in line with what you expect for the year? If I could just add to that, is pricing offsetting cost inflation on a dollar basis in the Q2? Have you gotten to that point yet?
Chris, what we would say is that the Q2 did have a higher level of inflation, primarily due to the impact of green coffee. We, in the green coffee space, recovered on a dollar for dollar basis that cost inflation, and we put the predominance of our pricing actions in place prior to the beginning of our fiscal year, that we believe that we are recovering our inflation as we come through the fiscal year.
That comment then, Tucker, was more than just coffee. Overall for the company, you have pricing in place to offset inflation. Is that correct?
Correct.
Okay. Just one follow question, if I could. I think about the gross margin, and you talked about in a couple areas of your business where you have higher manufacturing costs. I think you mentioned it in coffee and consumer. Is that sort of ongoing supply chain, you know, challenges that every company has seen, perhaps lower volume as well? I'm guessing, what I'd like to get to, if I could, would be to what degree you're seeing a gross margin drag today from these supply chain challenges. Like, how much can the gross margin improve from here if you had a more normalized supply chain environment?
You know, Chris, as we think about our full year outlook for the gross profit margin at 33.5%, really what that reflects is, again, the year-over-year cost input inflation. It reflects the impact of the Jif peanut butter recall. It does have a component of supply chain environment, and it also acknowledges that the volume mix profile of the business has evolved, particularly as you sell more pet food. As a result of that's all comprised within the gross profit margin guidance.
As we move forward, and when we begin to experience cost moderation or even deflation, when we see stability in supply chains, and as we continue to advance the strategy of the company, particularly on the growth front, but also as we bring along continuous improvement programs, such as our transformation office, those will all continue to support the margin profile of the company over time.
Thank you. Next question is coming from Steve Powers from Deutsche Bank. Your line is now live.
Yes, thanks. You may have sort of just addressed this, but I just wanted to clarify, 'cause you cited volume mix, you know, as coming in better just related to your higher top line and dollar-based profit outlook on the year. You also have cited, you know, that same volume mix as the primary reason for full year gross margin moving to the lower end of the prior range, just given that inflation and pricing seem largely unchanged on the year. Could you just unpack that a bit more? Is that the mix shift to pet food that you just mentioned, just so we understand the move lower to 33.5% gross margin on the year alongside the better top line?
I think the 33.5% re-reflects our best outlook for the back half of the fiscal year and therefore the full fiscal year, acknowledging that as we took up our top line, we took into account the portfolio and the growth across pet and consumer, and that's all embedded in our $0.27 uplift due to volume mix. That's being partially offset by some business investments through SD&A.
Okay. Thank you.
Thank you. Next question is coming from Jason English from Goldman Sachs. Your line is now live.
Hey, good morning, folks. Thanks for slotting me in.
Morning.
A couple of quick questions. You mentioned your confidence in your ability to hold coffee prices until you see the deflation.
Yeah, assuming that's a couple of quarters from now, are you happy with where price gaps are today? Or for you to be able to hold for that long, do you need to see competitors continue to raise prices and close the gaps from where they are?
Jason, for the most part, we've seen the gaps close. As I mentioned in an earlier question, on premium, we're seeing those gaps close now over these last several weeks, and we think that will continue to be the case. Again, the a little bit of that shift in the premium space has been indicative of the entire segment as opposed to maybe just our brand. We think that those competitive gaps will come back in line, as have the gaps have closed meaningfully in the mainstream space as well. Just continuing to leverage, you know, the entire spectrum, the value spectrum of our portfolio will continue to bode well for us.
Okay. just to paraphrase real quick to make sure I understood. You've seen the gaps close, but you expect to see them to close further. You do need further convergence?
Well, no.
Is that correct?
I think on the premium. No, in most segments we have seen and in premium, they have largely closed to the extent that we would expect the competitive dynamics to normalize.
Got it. Quickly on pet. There's about one and a half billion dollars worth of capacity coming online in the U.S. in pet next year. How do you expect that to impact the competitive environment?
Well, first, what I would highlight is that there have been, as you know, some supply chain challenges across pet in general, and that's an industry comment. We have continued to fare very well throughout the dynamic. Our focus has been on optimizing our portfolio, focusing primarily, as you know, on pet snacks and cat food. The optimization, in particular in our dog food portfolio, has performed very well and has allowed us to capture value there, as well as experience some stabilization and some moderate growth in the dog food space. Again, you know, at the end of the day, we've got to remain focused on snacks and pet because that's where we have the ability to continue to lead.
Executing the playbook that we've previously talked in our dog food portfolio is yielding fruit.
Okay. All right. Thanks a lot, guys. I'll pass it on.
As a reminder, that's star one to be placed into question queue. Our next question is coming from Cody Ross from UBS. Your line is now live.
Good morning, folks. Thank you for taking our question.
Morning.
I just wanna go back to one of the responses you gave earlier, just around the $0.12 EPS impact from SD&A expenses. I believe that's a shift. Can you just unpack that a little bit more? What is shifting from 2Q to 3Q? Can you just perhaps quantify it a little bit for us? Thank you.
Cody. The $0.12 impact to the $0.27 top line improvement due to volume mix is largely due to new additional business investments that we are making. An example of that would be in support of our transformation office. I would also acknowledge that a portion of our $0.21 over delivery in the Q2 was due to timing of SD&A, and some of that will now transition into the Q3. You will have a portion of the incremental $0.12 investment in the Q3, a portion in your Q4, you will have timing from the Q2 of already previously planned SD&A fall into your third.
That's helpful. Thank you. Just real quick, I wanna pivot back to your pet segment. You grew 14% organically, which is quite substantial, but it trailed Nielsen in the quarter by roughly 4 points based on our calculations, and your growth decelerated on the three-year stack basis. What is causing the mismatch between consumption and shipments today? Thank you.
Well, again, you know, let me just start, Cody, with pet snacks. You know, we grew in our pet snacks business at two times the category rate and gained a meaningful amount of share. Where our strategy hinges first and foremost on pet snacks, we're very pleased with our performance. That is a comment that is relative to both our core biscuit business as well as the innovations that we've launched against our snacks primarily in the premium space. You can't deny the growth on Meow Mix of, you know, significant growth in 19 of the last 20 quarters. Where we have focused and really executed our strategy, the portfolio is performing exactly as we would have expected and in many cases has exceeded our expectations.
Thank you. Next question is coming from Max Kofler from BNP Paribas Exane. Your line is now live.
Hey, thanks for the question. With price increases-
Morning.
Continuing to hit the shelf and the consumer continuing to feel more of an impact from the economic environment, are you starting to see more significant signs of price elasticities or trade down emerging in any categories? If so, are there any similarities that these categories share?
Max, this is Mark. You know, I would start by highlighting that our categories are very advantaged, you know, particularly in the fact that we have, we under index in those categories as relative to private label. Some of the return or share growth that you've seen in private label is attributable to the fact that those brands had many supply chain challenges during the pandemic, and that supply chain has gotten a bit better for some of the store brands and has allowed them to recapture some of the share that they had lost in the pandemic. Overall, our categories remain extremely strong.
Our brands remain strong, and the fact that we provide the consumers with a number of different options across the value spectrum, consumers will continue to be able to find brands in our portfolio that meet their budget and deliver ultimately value for them. We continue to remain very confident in our strategy, and our ability to meet consumers' needs across that spectrum.
Thanks. One follow-up. You recently reduced the SKU count of your Smucker's fruit spreads by 30% in order to position the business for improved profit opportunities for growth and continued category leadership. You mentioned in your prepared remarks that velocities are up 40%. Could you discuss what other impacts you've seen from this adjustment so far?
Well, first, I'd actually like to thank you for highlighting that. you know, that is obviously our namesake business. of course, it's not our largest business, but, you know, over the years, we've had a very significant proliferation of SKUs. As we looked at that business and got much more strategic about it, realized that we stand to benefit from a significant optimization of the portfolio. basically, what you said came true, is that we reduced our SKU count and we saw significant flowback into core items, which has benefited both top and bottom line. Again, it ultimately comes back to a strategy of being focused.
Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing comments.
Well, first of all, I'd like to thank everyone for taking the time on a holiday week, on early on a Monday morning for being with us. Just really appreciative of the fact that we've had another very strong quarter, that's a tribute to our employees, who, at the end of the day, are responsible for our results and execute tirelessly every day and with a lot of passion.
I really wanna thank them for the great results. We really look forward to seeing all of you on our Investor Day, which is Wednesday, December 14th, in New York. For any additional details, you can reach out to Aaron. We wish all of you a very happy Thanksgiving and a great holiday week. Have a great day.
Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time. Have a wonderful day. We thank you for your participation today.