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

Hi, everyone, and thanks for joining us to go over Flowers Foods' results for the third quarter of 2022. I'm J.T. Rieck, Senior Vice President of Finance and Investor Relations, and the earnings came out on November 10, 2022. You'll find the earnings release and the related slide presentation, together with a transcript of these remarks, in the Investors section of flowersfoods.com. Additional details are posted in the Investors section of our website. Before we begin, please note that what we present here may contain forward-looking statements regarding the company's performance. While we consider these statements reasonable, they carry risks and uncertainties that might make actual results differ materially. Beyond what you hear in these remarks, important factors tied to Flowers Foods' business are fully described in our SEC filings. Speaking today are Ryals McMullian, President and CEO, and Steve Kinsey, our CFO. Ryals, over to you.

Thanks, J.T. It's great to have everyone with us on this call. We kept executing at a high level during the third quarter of 2022, pushing quarterly sales to record highs. Given the unusual difficulties the present environment has created, I'm especially proud of what we achieved. Recessionary economic forces and inflation stayed major factors, and I'll go into those subjects in greater depth a bit later on the call. You can be sure that those near-term issues won't pull our attention away from the enormous longer-term opportunities that lie ahead of us. Even with inflationary pressures everywhere, the robust results of our leading brands keep showing that consumers favor differentiated products. IRI data shows Nature's Own posted the biggest sales dollar gain of any brand in fresh packaged bread, and in tracked channels it added 10 basis points of unit share — the largest increase among major brands. Even after double-digit price hikes meant to counter inflation, our two premium brands, Dave's Killer Bread and Canyon Bakehouse, kept their unit share in the fresh packaged bread category as measured in tracked channels. With private label bread gaining share in tracked channels during this period, outcomes like these highlight both the strength of our product portfolio and how resilient demand continues to be. The supply chain challenges that weighed on our performance in the first half of the year became less severe in the third quarter. Amid significant volatility, our procurement group has been doing outstanding work—securing extra sources of supply and minimizing price increases wherever they can. I'll now move on to the 4 strategic priorities that we believe will propel our results in 2022 and beyond: developing our team, concentrating on our brands, putting margins first, and pursuing smart M&A. As always, I want to begin by thanking the Flowers team for their dedication and hard work, which enabled our strong performance. Hurricane Ian's destruction touched a large number of our team members, and I'm glad to report that every one of them made it through unharmed. Our people have risen to the occasion in comparable circumstances more times than I can count, and they did so again—furnishing supplies and ramping up output at sibling bakeries so we could satisfy the greater demand from consumers. The way we answered makes me proud; it reflects both the dedication our team brings and their devotion to the customers we serve. Turning to our second strategic priority, we are concentrating on our brands. Continued growth is being propelled by our accelerated-growth and learn-improved portfolio roles. For the quarter, dollar sales in tracked channels came in strong for our top brands: Nature's Own rose 13.2%, Dave's Killer Bread gained 11.1%, and Canyon Bakehouse climbed 18.5%. Our lineup of new and innovative products is doing even better than we anticipated. Recent introductions are showing encouraging results, among them DKB, Epic Everything Breakfast Breast, the Nature's Own Hawaiian loaf, Canyon Bakehouse brioche rolls, and Nature's Own Perfectly Crafted sourdough. As we look forward, developing fresh revenue streams beyond our core business is essential. We're investing heavily in our Agile Innovation Group, which is leveraging the strength of our #1 brands to reach past the traditional bread aisle. The group under our Chief Marketing Officer, Debo Mukherjee, concentrates on launching inventive goods via an asset-light framework, and that strategy enables quicker reactions to consumer insights minus large upfront capital outlays. DKB snack bars represent the initial items developed through this fresh capability, and since they performed well in test markets, we feel encouraged to expand distribution nationwide beginning January 2023. We are additionally testing a high-protein DKB snack bar range in select markets, and a robust pipeline of further new products is planned. This new innovation capability and its potential for future growth excite us tremendously. Should you wish to try these items ahead of their broad retail rollout, a direct-to-consumer site has been introduced at creationsbyflowersfoods.com. Through that fresh channel, we can evaluate items with shoppers directly and gather input prior to official launches. A further piece of good news for one of our brands involves a fresh 3-year alliance with Wonder Bread tied to the Macy's Thanksgiving Day Parade. This is Wonder's debut appearance in the parade, and we are making the most of it through a set of social media and in-store display promotions. Media and consumers have responded warmly to these programs already, and we anticipate the alliance will further boost Wonder's national brand recognition. Margins rank as our third strategic priority, and in light of inflation they continue to receive special attention. The price hikes we started putting in place in June have done a lot to offset the effect of costlier inputs. Even though rising costs put pressure on margin percentages, I'd point out that adjusted EBITDA for the quarter grew in dollar terms, supported by those price increases. The pricing moves made a especially big difference in nonbranded products, where our emphasis was on lifting profitability. As we've said in the past, boosting what our balanced growth and maximized profitability portfolio roles contribute is central to how we strengthen margins. Still, pricing represents just one element of our strategy for expanding margins. Additional steps include a portfolio approach designed to move our blend toward a larger share of branded retail goods with better margins, plus initiatives for cost reduction and operational efficiency. For 2022, we still anticipate meaningful gains from procurement and operational efficiencies, but our cost savings goal is being adjusted to $20 million to $30 million from the prior $25 million to $35 million. As you may remember, some of those savings had been expected to arise from our digital initiatives. We think the money we're putting into digital will produce substantial gains in efficiency and will be a major factor in lifting margins. Still, as the ERP rollout moved forward, it grew evident that we had to commit more of our own internal resources so the effort would succeed. Even so, adoption of these new digital tools at several of our bakeries was a bit slower than expected, and continuing operational inefficiencies constrained our progress somewhat. Even so, we remain excited about digital's long-term potential. But some of the savings we expected during the back half of '22 are now moving into 2023, because our resources are being directed toward ERP implementation and improved operational performance. Meanwhile, the ERP program remains on track, and we're confident it can be deployed as planned. Smart M&A ranks as our fourth priority. We continue to monitor the deal market and are actively seeking acquisitions that could add capabilities, brands or products to our already strong lineup; we think our solid balance sheet positions us well to act once we have financial, commercial and operational conviction. As part of that effort, during the third quarter we took on $11.6 million in costs tied to chasing a potential acquisition that did not come together. While the outcome disappointed us, we stay committed to our disciplined approach as we evaluate further acquisition targets; at this point I'll hand things to Steve to go through the quarter's details, and then I'll return a bit later to talk about our outlook for the current business environment. Steve?

I want to thank Ryals, and good morning to all of you. I share your praise for our amazing team and want to offer my heartfelt appreciation for everything they have accomplished. As Ryals noted, we're quite happy with how the third quarter turned out. Sales overall rose 12.7% versus the same period a year ago. Better price/mix fueled the adjusted increase over last year, which came in at 17.8%, driven mainly by pricing actions taken to counter inflationary pressure. Volume fell 5.1%, largely reflecting deliberate sales rationalizations in cake and foodservice. Gross margin as a share of sales, excluding depreciation and amortization, fell 310 basis points to 46.8%. The comparison was affected by greater ingredient and packaging costs, partially offset by higher sales that leveraged labor expenses along with reduced production volumes and outside product purchases. Selling, distribution and administrative expenses as a percentage of sales declined 290 basis points to 38.6% in the third quarter. Results gained from price increases that leveraged workforce-related expenses, reduced employee fringe costs and distributor distribution fees measured as a percent of sales, and lower legal settlement and consulting costs, partially offset by acquisition-related costs. Excluding matters affecting comparability, adjusted SD&A expenses fell 200 basis points to 36.4%. GAAP diluted EPS for the quarter came to $0.19 per share versus $0.18 in the same period last year. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS this quarter was $0.30 per share, in line with the prior year period. Now moving to our balance sheet, liquidity and cash flow. Year-to-date through the third quarter of fiscal 2022, cash flow from operating activities dropped by $23.7 million to $291.5 million. Capital expenditures rose $41.6 million to $128.4 million, mainly because of the ongoing ERP upgrade, digital investments and additions to production capacity. Dividends paid grew $8.5 million to $140.1 million. During the second quarter, our Board of Directors raised the company's share repurchase authorization by 20 million shares. Year-to-date, we bought back $34.6 million of common stock, including $18.1 million in the third quarter, which leaves 24.4 million shares available for repurchase under the company's current share repurchase plan. Our financial position stayed strong. At the close of the third quarter of fiscal 2022, net debt-to-trailing 12-month adjusted EBITDA was roughly 1.5x. At quarter end, we had about $173 million in cash and cash equivalents and roughly $692 million of remaining availability on our credit facilities; now turning to our outlook for 2022. Our updated sales guidance calls for raising the bottom end of the range; we now expect sales of approximately $4.807 billion to $4.850 billion, representing growth of 11% to 12% versus prior guidance of 10% to 12%. Adjusted EPS is expected to land in the range of $1.25 to $1.30, implying a 9.9% compound annual growth rate off the 2019 base. The midpoint of this guidance exceeds our long-term financial targets of 1% to 2% sales growth and 7% to 9% EPS growth off the 2019 base. When the third quarter wrapped up, we had essentially all of our main commodities hedged for the rest of 2022. To keep volatility down and give ourselves enough advance notice so we can make price adjustments, we've stuck with our usual hedging approach, under which we try to raise the certainty of our key commodity costs 6 to 12 months ahead. Thank you. And with that, I'll hand it back to Ryals.

Thanks, Steve. You've just heard the specifics behind our robust quarterly financial performance. Now I want to walk through several of the major forces shaping the current landscape, among them inflationary strain on the American consumer. Inflation is still elevated, and the consumer price index indicates that food and energy costs rose 11% and 20%, respectively, across the 12 months that concluded in September. Those higher prices are squeezing shoppers and prompting some of them to trade down toward cheaper items and to move a larger portion of their food buying to value-focused retailers—mass, dollar and club stores. Consequently, within tracked channels that measure fresh packaged bread, total private label volume share climbed 100 basis points during the third quarter. Yet, as we mentioned during our previous earnings call, that private label momentum has come from concentrated activity within the mass merchandise channel, where certain private label shelf prices have yet to adjust for inflationary pressure. In retail segments where private label pricing generally mirrors the elevated cost—grocery especially—brands are faring better. Our branded retail products picked up unit share in tracked grocery channels in every quarter of this year. Meanwhile, inflation is squeezing the foodservice category as well. Compared with before the pandemic, consumers are eating a greater number of meals at home, and that pattern should persist given the cost benefits of eating in home rather than out-of-home. We anticipate gaining from these trends as we concentrate our efforts on expanding branded retail sales. On the whole, demand elasticity has matched our expectations and has stayed beneath historical levels. The bread category has demonstrated resilience over time, and that has held true even in today's environment. Because our lineup spans a broad range of products, we can capture consumer demand at every price point and across a variety of distribution outlets. We are watching inflation and demand elasticity carefully and stay confident that we will come out of this period even stronger. We expect that our relentless focus on creating new and innovative products for consumers, along with providing excellent service to our customers, will keep driving growth. Everyone at Flowers remains dedicated to enhancing shareholder value, and we expect to keep delivering results in line with or better than our long-term financial targets. Before we begin on this Veterans Day, we want to acknowledge the contributions of our servicemen and women, past and present; we thank you for your service to our country and the sacrifices you've made for our freedom. Turning to our results: we executed well during the quarter, lifting third quarter sales to record levels. Our performance amid this challenging consumer environment shows the resiliency of our business and the continued effectiveness of our strategy. Consumers keep showing a preference for the differentiated attributes of our leading brands, and we are focused on sustaining our momentum through investments in innovation and marketing, including our new agile innovation capability. My optimism regarding what lies ahead for us has never been stronger, and the steps we've put in motion to fuel upcoming expansion genuinely excite me. Our people remain, as they always have been, dedicated to producing outcomes that meet or exceed the long-term financial goals we've set. With that said, Gigi, let's go ahead and take questions, please.

I want to spend a bit more time on store branded, which you covered in your prepared remarks, and on the growth we saw this quarter. First, could you help us understand how that has continued to trend as we went into October and November — are you still seeing store branded accelerate relative to branded, or trade down more broadly? Second, I believe you said it was really one retailer that wasn't letting you — or wasn't letting pricing come up. I'm trying to understand why that is, in part, because I think you manufacture some of the store branded for that retailer, so I just want to understand the pricing dynamics there.

Sure, Bill. Broadly speaking, to begin with, as we've said throughout the year, in an economic environment as challenging as this one, you'd expect some trade down into private label. And across the market, that's proven true. Private label picked up 100 basis points of unit share during the quarter. But looking more closely, what you find — as we noted last quarter — is that this is heavily concentrated in the mass channel. Within mass, some retail prices on private label have been kept a little lower. If you switch over to grocery, the picture is quite different. In fact, we picked up 10 basis points of share in grocery in Q3, and later in the quarter it actually accelerated, and we picked up 60 basis points of unit share in grocery. And then, as we moved toward the end of the quarter — to address your question on trends — we actually saw private label's growth rate decelerate somewhat; it's too early to call that a trend, but we did see some slowing. As for our own results, you did see a big jump in private label sales. But keep in mind, we also raised prices significantly in private label, which, honestly, we needed to do regardless, going back to our portfolio strategy, where not only are we working to shift our mix toward more branded retail, but in other, lower-margin parts of the business, we've been working hard to improve the margin on those lower-margin items; so between SKU rationalization, price increases, strategic businesses, and so on, that's all part of our strategy. So overall, from a market standpoint, yes, private label has shown some strength, and certainly dollar strength in Flowers, but the unit story is more nuanced.

That's useful. So Steve, perhaps a little on — when I look at gross margin. I realize you aren't providing guidance right now for '23, but what's your thinking there? My guess is that with your hedging program, some of those higher or lower cost hedges are going to roll off, and you've offset part of that with pricing. You've also got the cost savings program, which definitely helps. But then there's maybe private label, which you do produce, which carries a lower margin and is growing more quickly at the moment. So does a strong opportunity for gross margin expansion still exist next year? Or will it be more of a challenge?

Well, like you mentioned, we aren't ready to offer guidance for next year. But what we're seeing matches what you're hearing from other companies. We keep expecting inflation to be strong. And we're looking particularly at certain input costs — there's still plenty of volatility in wheat, though we'll stay fairly true to our hedge strategies — and labor, transportation, all of those keep showing significant inflation and really no signs of any of that reverting at this point. So without getting into a specific set for 2023, I'd say you can keep expecting some of the same pressures on those margins that you're seeing this year.

So now that we're starting to lap inflation and pricing has mostly caught up, could you offer any perspective on the balancing act of restoring gross margin while safeguarding market share? I suppose if share trends begin to decelerate while some retailers aren't willing to pass along pricing—would you be open to more promotions, even if that means a longer horizon to recover that lost margin over 2022?

Yes. Look, I mean, clearly there's always a delicate balance, as you said, between covering these inflationary costs and keeping your market share; and I think so far, we've done pretty well on that. Our share levels have held fairly stable despite the current conditions. Competition has remained sensible up to now, though we do have certain promotional offers running. Since DKB is a super premium item, as you'd probably anticipate, we've seen a modest decline in unit share for DKB. So we've launched a few focused promotions, right, aimed at retaining those buyers. Yet for some people, that's clearly going to be unaffordable over the near term. That's also why keeping up our media and advertising—digital and social campaigns—matters, so these brands stay front and center before those consumers. Therefore, when relief does arrive—and fortunately, we at least received a more favorable inflation report yesterday, which we hope continues—as that relief arrives, they return to the brand; we closely monitor the count of households we've added since 2019. We definitely intend to retain those households. But, as you noted, there's a balance we handle every day.

That's useful, thanks. I also wanted to check whether Hurricane Ian had any effect during the quarter. I believe a handful of your bakeries are in Florida. Did you see any out-of-stocks or empty shelves for a stretch while those bakeries were down? Or was there perhaps some pantry-loading ahead of the storm?

Yeah. Typically we actually do very well when hurricanes hit. And honestly, I'm glad you raised it, because when you look at how our share performed this quarter, keep in mind that in last year's third quarter there were 4 named storms, and we usually beat the competition during those storms. This year, we had just one. So there is some impact. I don't want to make too much of it, but it does affect our share. Thankfully, though, we had no bakery shutdowns at all. All of our people were safe. And as always, the team did an outstanding job keeping the market served.

Morning. I'm wondering about geography — did any regions come in unexpectedly strong, or fall short of what you'd anticipated this quarter?

Not really. On the whole, Mitch, things were fairly consistent. A few things stand out: the Northeast keeps delivering strong results for us. As you're aware, that's a region where we're growing. From a share perspective, we did quite well there once again this quarter. Out West, Mitch, it's been somewhat more difficult, California especially. We've run some background research to pin down precisely what's happening in that market. And really, what you have is a state where costs are already extremely high. Nationwide, gas prices have improved for the majority of the U.S. in recent months, yet they remain quite steep in California. Add in rising rents and similar costs. My sense is that Californians may be feeling somewhat more squeezed than consumers elsewhere across the nation; accordingly, when we examine our share, we're noticing somewhat greater softness on the West Coast at present.

All right, and then as you consider the capacity you have for bakery and possibly what you'll need down the road — I mean, do you still have plenty of room in the system you've got now? Or will we need to put some money toward new bakery capacity in 2023, or begin thinking about that at that point?

Yes. That's a good question, Mitch. So on the whole, we feel good about where we stand. There are a few spots with needs that I'd flag for you, one of which we already addressed with the new organic line in Henderson. That handles the days when things were really tight out there for a while, and we're in good shape there now. The other one I'd point to is Canyon. It's a good news story. Demand for Canyon remains very, very high, and we're very pleased with how that business is progressing, but capacity at Canyon is extremely tight. So we're actively working to resolve that with both a short-term solution and a long-term solution.

What sort of CapEx figure should we expect? I realize 2023 isn’t on the table yet, but does anything stand out as unusual on the capital spending side for 2023?