Flowers Foods, Inc. (FLO) Earnings Call Transcript & Summary

Hello, everyone, and welcome to the prerecorded discussion of Flowers Foods' second quarter 2021 results. This is J.T. Rieck, SVP of Finance and Investor Relations. As a reminder, we released our second quarter results on August 12, 2021. Along with a transcript of these recorded remarks from our CEO and CFO, you can find the earnings release and related slide presentation in the Investors section of our website. We will host a live Q&A session on Friday, August 13, at 8:30 a.m. Eastern. The details are posted in the Investors section of flowersfoods.com. Before we get started, keep in mind that the information presented here may include forward-looking statements about the company's performance. Although we believe these statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to what you hear in these remarks, important factors relating to Flowers Foods' business are fully detailed in our SEC filings. Providing remarks today are Ryals McMullian, President and CEO; and Steve Kinsey, our CFO. Ryals, I'll turn it over to you.

Thanks, J.T. It's a pleasure to share our results with you today. We believe the environment in which we're operating remains favorable. We continue to benefit from the mix shift to branded retail, though we have seen some reversion as consumers begin to eat out more and foodservice recovers some of its sales declines. Not content to simply rely on a favorable demand environment to drive growth, we are pushing forward with our strategies to further improve our performance, including portfolio strategy, portfolio optimization and our digital transformation. These initiatives are already bearing fruit, and we expect continued benefits from them in the future no matter the environment. And these initiatives were just a part of the many steps we've taken over the last few years that we believe will drive our growth at least in line with our long-term financial targets. Among these steps are the organizational realignment we undertook to support powerful investment and focus on our leading brands. As part of that realignment, we have made numerous additions of high-caliber talent that have substantially strengthened our team, standing up a distinct agile product innovation group to drive future sales and the creation of our transformation office to direct our digital initiatives, which we expect will facilitate top line growth and margin improvements. In addition, we enjoy a successful track record and ongoing strategy of pursuing smart M&A, the 2 most recent of which are projected to account for approximately $1 billion in retail sales this year. Now our investors rightfully have an expectation that we will achieve our long-term financial targets, and we are taking all the necessary steps to meet those expectations. To highlight the opportunity a little bit clearer, should we meet the midpoint of our long-term financial targets over the next few years, we would expect our EPS to grow from our 2019 base of an adjusted $0.96 to well above the adjusted $1.31 we realized in 2020 during the height of the pandemic. We are focused on driving profitable growth for our shareholders' benefit, and by successfully executing on our 4 strategic priorities, we are confident that our long-term financial targets are achievable. To provide some context on our results, I'll discuss the current business environment and the steps we're taking to succeed in it through the lens of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. So starting with our team. I'd like to begin by once again expressing my sincere appreciation to the entire Flowers team for their continued devotion to producing quality products for our consumers and faithfully serving our markets. The current labor market certainly does present some unique challenges, particularly regarding availability and turnover. Like many other companies, in some locations, it can be difficult to hire new employees and sometimes difficult to retain them. Operating in such an environment increases recruiting, training and overtime expenses, so we are taking steps to mitigate the impact of these headwinds, including reviewing compensation and instituting quality of life initiatives such as improved work schedules. Despite these challenges, our team has selflessly pitched in where needed to minimize the impact of these headwinds, and you can see the results of their efforts in our financial results. We're supplying the products our customers demand and doing so effectively and efficiently. Our second strategic priority is focusing on brands. Our leading brands are driving current performance and setting us up for future growth. We believe our brand portfolio has never been stronger, as evidenced by our continued market share gains. In the second quarter of 2021, our dollar share increased to 17.7%, up from 17.4% a year earlier and 16.7% in the second quarter of 2019. We expect the investments we're making in marketing and innovation to continue to strengthen our brands and market share. For example, we recently launched new Dave's Killer Bread and Nature's Own Perfectly Crafted advertising and media campaigns targeting selected markets. Later on the call, I'll go into more detail on the advantages our leading brands provide. Our third strategic priority is margins. And second quarter results continue to demonstrate our success in that area. Comparisons to the prior year are difficult at the moment because of the extraordinary demand in those periods driven by the pandemic, but we are well ahead of second quarter 2019 results. With sales up 4.3% over second quarter 2019, adjusted EBITDA margins increased 120 basis points to 12%, driving adjusted EBITDA growth of 15.4% compared to the second quarter of 2019. The key driver of that margin expansion is the mix shift to more branded retail products, but we're also working hard to maximize our internal efficiencies. Our portfolio optimization project is on track to reach our target savings of $30 million to $40 million this year, making the full value of this program over the last 2 years close to $60 million. We also expect our digital transformation initiatives to drive efficiencies far into the future, enabling us to meet or exceed our long-term financial targets. Our fourth priority is smart M&A. Deal flow activity is ramping up following the pandemic-induced lull in 2020, and we're proactively exploring our options. Our steady free cash flow and strong balance sheet provide the flexibility to act when we have strong financial, commercial and operational conviction. And as always, we will maintain our disciplined approach. Now I'll turn it over to Steve to review the details of the quarter, and then I'll come back later to discuss our outlook for the current business environment. Steve?

Thank you, Ryals, and hello, everyone. I'd like to echo your comments and express my sincere thanks to our incredible team whose efforts have been nothing short of outstanding. Now turning to the quarterly results. The pandemic continues to influence our results, though we do see some indications of mix reversion. That said, we are pleased with overall sales and mix in Q2 of 2021. Like last quarter, because of the uniqueness of the year-over-year comparisons, in some circumstances, we will also provide comparisons to the pre-pandemic results in the second quarter of 2019. Total sales declined 0.8% from the prior year period but increased 4.3% compared to the second fiscal quarter of 2019. Lower volumes drove the decline, down 3.9% due to difficult prior year comparisons in most channels aside from foodservice. Partially offsetting the volume decline was a 3.1% increase in price/mix, which was more heavily weighted to price than mix, driven by promotional efficiency. As comparisons with the prior year eased throughout the quarter, results versus the prior year improved as well. Relative to the pre-pandemic levels of 2019, results were strong throughout the quarter. Looking at the sales by channel. Branded retail sales decreased $14.1 million compared to the prior year or 2% to $674.7 million. Despite the difficult comparisons, Flowers' fresh packaged bread sales gained 30 basis points of market share in tracked channels, with sales of Dave's Killer Bread up 9.4% and Canyon Bakehouse up 16.9%. Compared to the second quarter of 2019, branded retail sales increased 15.2%, higher than the first quarter '21 growth rate of 13.7% as our leading brands continue to benefit from pandemic-related demand increases and our initiatives to drive further growth. Our total market share increased 100 basis points to 17.7% over pre-pandemic levels. New products such as our Nature's Own Perfectly Crafted buns were particularly strong contributors to the growth, up 75% compared to the prior year and gaining 60 basis points of market share. Store branded retail sales decreased $13.6 million year-over-year or 9.4% to $131 million as consumers continue to express a preference for more differentiated, branded products. The store branded category as a whole lost 90 basis points of market share, declining to 19.5%, a downward trend that has endured for more than 5 years. Compared to the 2019 second quarter, store branded sales were down 19.5%. Nonretail and other sales increased $19.1 million or 9.9% to $211.5 million as we lapped significant pandemic-induced declines in the prior year period. Nonretail sales benefited from improved price/mix, partly due to internal initiatives to improve the profitability of this business. Foodservice recovery was particularly noteworthy. Nonretail and other sales overall remained below pre-pandemic levels, with sales down 6.8% compared to the 2019 second quarter, though fast-food and foodservice are the exception and are higher versus 2019. As nonretail sales continued their recovery, that business is coming back at higher margins than before due to the initiatives we've taken to improve the profitability of the business. In the quarter, gross margin as a percentage of sales, excluding depreciation and amortization, decreased 20 basis points to 50.5%. Margin was impacted by lower sales and increased returns of unsold products, partially offset by $1.5 million of start-up costs in the year ago period relating to the conversion of our Lynchburg, Virginia facility to an organic bakery. Rising commodity costs were partially offset by positive price/mix and improved promotional efficiency. Selling, distribution and administrative expenses increased 140 basis points as a percentage of sales in the second quarter. Excluding the items affecting comparability detailed in the press release, adjusted SD&A expenses increased 30 basis points to 38.4% as higher logistics cost and increased marketing investments were partially offset by lower distributor distribution fees due to the mix shift and higher scrap income. GAAP diluted EPS for the quarter was $0.26 per share compared to $0.27 in the prior year period. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter was $0.32 per share, down $0.01 from the prior year period. Turning now to our balance sheet, liquidity and cash flow. Year-to-date through the second quarter of 2021, cash flow from operating activities decreased $52.4 million to $223.4 million compared to the prior year period, primarily due to changes in working capital. Capital expenditures increased $11.7 million to $58.3 million. And dividends paid increased $4.4 million to $87 million. Our financial position remains strong. At quarter end, net debt to trailing 12-month adjusted EBITDA stood at approximately 1.2x, equal to leverage at the end of the first quarter and down from the 1.3x at 2020 year-end. At quarter end, we held approximately $292 million in cash and cash equivalents and had approximately $663 million of remaining availability on our credit facilities. Now turning to our adjusted outlook for 2021. We are forecasting sales to decline between 2% to 3% versus 2020, an increase at the bottom end from our prior guidance. Relative to 2019 results, our guidance implies growth of 3.2% to 4.3%. For earnings, we are raising our guidance range to adjusted EPS of $1.17 to $1.22 compared to our prior guidance of $1.10 to $1.17 and 2019 adjusted EPS of $0.96. Our updated guidance range is within or above our long-term financial target ranges of 1% to 2% sales growth and above the 7% to 9% EPS growth range off the 2019 base, even with the $0.05 headwind from our digital ERP initiatives and no benefit from M&A. As a reminder, 2021 shifts back to 52 weeks, 1 fewer week than 2020. The additional week in 2020 contributed 1.8% to full year sales and approximately $0.02 to EPS. As we completed the first half of the year, the market environment remains better than we initially forecasted. In fact, our most profitable segment, branded retail, constituted 66.3% of our total sales in Q2 compared to 66.1% in Q1, 67.2% in the prior year second quarter and 60% in the pre-pandemic second quarter of 2019. Branded retail has largely maintained its increased percentage of our total sales despite the partial recovery in our nonretail and other business. Some of the factors we considered when setting guidance included the impact of the pandemic on the pace of reopening as well as inflationary commodity costs. We've been successful in offsetting much of the inflationary pressure so far. The biggest swing factor in determining our results for the second half of 2021 will be the back-to-school season. As kids go back to school and parents have more flexibility to return to the office, we should get a better sense for what the new normal demand environment could look like. However, the rise in COVID cases caused by the Delta variant can prolong the impact of the pandemic. So we are watching those developments carefully. In a moment, Ryals will share more color on the factors we are watching in 2021. Free cash flow generation is expected to be strong, and our capital allocation priorities and philosophy remain consistent with our focus on maximizing return on invested capital and growing shareholder value. Although our first half CapEx spend of $58 million is somewhat below our full year run rate, we do anticipate the pace of investment to pick up over the second half of 2021. We reduced our capital expenditure guidance to the range of $125 million to $135 million, down from $140 million to $150 million for the year, largely due to delays caused by the pandemic. As a reminder, this level was somewhat elevated compared to recent years, primarily due to targeted investments to support supply chain optimization and our digital transformation. Thank you. And now I'll turn it back to Ryals.

Thank you, Steve. You've heard the financial details of the quarter, of which I'm very pleased, and now I'd like to focus on the current environment and steps we're taking to succeed now and in the future. We continue to execute our portfolio strategy of becoming a more brand-focused company, a plan that we put in place prior to the onset of the pandemic. The pandemic has presented challenges, but it has also highlighted the benefits of our strategy. By shifting our sales mix to a greater percentage of more profitable branded retail products, we've expanded margins even with lower overall volume. We've talked about our portfolio strategy before, particularly in the context of improving margins, but it's especially important in the current environment. Branded retail sales are off their peak from the height of the pandemic but remain well above pre-pandemic levels. Foodservice demand is recovering, though still below 2019 levels, and private label has continued its multiyear decline as consumers seek out differentiated products that are generally only offered by brands in our category. The decline in private label bread is in stark contrast to most other store categories, where private label market share is increasing. Part of the reason for this dynamic is that the bread category is undergoing a premiumization process, led by brands like Dave's Killer Bread, Canyon Bakehouse and Nature's Own Perfectly Crafted, in which consumers are deliberately seeking out products and brands with improved health and indulgence attributes. We believe this trend will persist and that it bodes well for our leading differentiated brands. With our enhanced agile innovation capabilities, we expect to continue bringing new, exciting and differentiated products to the market under our leading brands, which we expect to fuel future growth. Although we'd expect some longer-term impact on food-at-home demand from the pandemic, it also seems reasonable to assume some reversion toward prior levels. In such an environment, we believe our brands will allow us to capture greater market share from consumers who recognize the unique quality and flavor profiles of our products. And so far, we've been able to do just that. As Steve noted, in the second quarter, our fresh packaged bread market share rose 30 basis points to 17.7% compared to the prior year period and 100 basis points compared to the same period in 2019, thanks to the continued growth of brands like Dave's Killer Bread and Canyon Bakehouse. And we are experiencing success in our targeted geographies. For example, the Northeast has been an attractive source of growth for us, gaining 80 basis points of share in the quarter and 210 basis points over the last 3 years. And we're investing to drive further gains in this crucial market. We also intend to build on the success of the new products developed by our innovation team such as our brioche buns and rolls and have an exciting pipeline of disruptive innovation that we expect to help drive future sales growth. Of all the new products in our category tracked by IRI over the last 2 years, Nature's Own Perfectly Crafted brioche hamburger buns were #1. In addition to the sales and market share benefits that our leading brands provide, the current inflationary environment highlights another advantage, the ability to raise prices when necessary to offset higher costs. Now pricing is only one of the tools we consider, including other options such as operational efficiencies and internal cost savings. However, in periods like the current one, where we do see significant inflation, those other methods are not always sufficient to offset the higher costs. Inflation has been a slight headwind in 2021. And as we mentioned last quarter, should commodity prices remain at current level, we would expect more meaningful inflation in 2022. Our hedging strategy in which we attempt to lock in commodity prices 6 to 9 months out provides visibility into the future inflationary environment and enables us to be proactive in offsetting potential cost increases. So far, we've been successful in obtaining the higher prices necessary to offset inflation in the current year. And we are optimistic that combined with other internal actions, we will be able to use pricing to mitigate the impact of inflation into 2022 as well if necessary. We believe the strength of our leading brands and our improving market share make pricing conversations with customers a little easier and increases consumers' willingness to pay a bit more to enjoy the differentiated attributes of our products. To add some historical context, we experienced similar inflation leading up to and into the Great Recession of 2007 to 2009. In that period, we were able to offset the inflation with pricing as we've been doing now. The major difference between the 2 periods is that back then, we only have one major brand, Nature's Own, compared to the portfolio of leading brands we have today. Further, our national market share was only approximately 8% in the second quarter of 2009 compared to 17.7% now. In closing, I am extremely proud of our performance in the first half of the year, and I'm quite optimistic about the initiatives we have in place to ensure our future success. We are prospering in the current environment, and our best-in-class team and leading brands position us better than ever to deliver results in line with our long-term financial targets. So thank you very much for your time. This concludes our prepared remarks. I'd like to invite you to listen to our live question-and-answer webcast, which will begin at 8:30 a.m. Eastern Time on Friday, August 13, and will be available for replay on the Investors section of flowersfoods.com. Thank you, and take care.