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

Hi, everyone. J.T. Rieck here, EVP of Finance and Investor Relations. Thanks for joining us to discuss Flowers Foods First Quarter 2020 Results, which we announced in a press release on May 18, 2023. Before we begin, please remember that what's presented here may contain forward-looking statements regarding the company's performance. While we consider these statements reasonable, they carry risks and uncertainties that might cause actual results to differ materially. Beyond what you hear in these remarks, important factors concerning Flowers Foods' business are fully detailed in our SEC filings. Speaking today are Ryals McMullian, President and CEO, and Steve Kinsey, our CFO. Ryals, I'll hand it over to you.

Thanks, J.T. It's great to have everyone join us on this call. The results we posted for the first quarter show how strong our leading brands are — they held up well even with the difficult environment out there, and that brand strength, together with price increases in our store-branded and nonretail businesses, pushed sales to a record level. We were up against very tough year-over-year comparisons, since the Omicron surge hit hard early last year and storm activity made it worse. That soft start, along with branded retail sales that came in below what we expected, led us to adjust our 2023 guidance. Even so, things got better as the quarter went on. We did lose 10 basis points of unit share in tracked channels, but that loss was mostly concentrated in the mass channel, while we grew share in grocery. Importantly, we started picking up share in the overall category near the end of the quarter, with branded retail bread units flat or higher in 5 of the last 6 weeks of the quarter. Inflation, together with an uncertain economic environment, is still a headwind for consumers. They keep trading down to private label products, although that growth slowed as the quarter progressed. Inflationary pressures also weighed on our margins, since the timing impact of our hedging strategy pushed commodity costs higher. It's important to note that we expect the current environment to be transitory. We believe the premiumization of the category will remain a long-term trend, and that once consumers get relief from the inflationary pressures they're facing now, they will come back to our #1 brands and differentiated products. While we address these short-term issues, we're also keeping our focus on longer-term opportunities. We're investing in future growth and exploring ways to maximize efficiency and productivity; those investments, which may affect near-term results, are crucial to ensuring that Flowers is well positioned to thrive in the years ahead; now I'll give an overview of our first quarter performance in the context of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. After that, Steve will review our financial results and updated 2023 guidance, and then I'll come back with a discussion on key themes moving forward and our plan to drive shareholder value in 2023 and beyond. I'd like to begin by recognizing the incredible contributions of our team, whose passion and commitment are the key ingredients in our success. One of our most important responsibilities as a company is making sure we have the right people in the right roles and giving them the resources they need to succeed. For example, we recently restructured operational responsibilities at our bakeries, shifting them from the sales function to the supply chain function. We expect this change to improve operational effectiveness, increase profitable sales and better meet customer requirements. Our supply chain team can now drive operating efficiencies and network optimization, and our sales team can focus on what they do best, bringing our leading products to as many customers as possible. I've likewise pushed every member of our team to take greater ownership of the results we deliver. Reaching our objectives and prospering in this tough climate makes embracing the culture we've built over the years more vital than it has ever been. What we report financially reflects everyone's combined work, and every one of us must own the push to get better, so that we come out of this stretch stronger still. Cindy Cox, our new Chief Human Resources Officer, brings deep experience running effective talent management programs, and she'll play a key role in building out our capabilities. Her main focus areas, among other things, will be growing the team we already have, rewarding strong performance and bringing in fresh talent. Priority two strategically is putting emphasis on our brands. The power of our top brands has rarely been clearer. Even as shoppers squeezed by inflation keep trading down to private label products, Nature's Own held unit share flat, and Dave's Killer Bread picked up 10 basis points. Canyon did lose 80 basis points of unit share during the quarter, but that drop was affected by a mix shift toward the growing club channel, whose sales are fully captured in tracked channels. Canyon branded unit sales rose according to our internal tracking, and we stay confident in its capacity to grow for many years ahead. Shoppers adore what makes our brands distinctive, and we're dedicated to launching additional products that serve their needs. Recent innovation covers Nature's Own Keto Net One loaf, Nature's Own Perfectly Crafted Everything buns and Wonder Hawaiian buns; and naturally, we're continuing the nationwide rollout of our DKB snack bars. Those bars currently sit on shelves in over 6,000 stores, and we anticipate that figure reaching beyond 10,000 by year-end; we're thrilled by how consumers have responded to the bar so far and upbeat about its potential to help widen our addressable market. As we've noted, the financial upside will be modest near term while we put money into a strong marketing strategy behind the launch. Though it's still early, the preliminary results encourage us and bolster our confidence that we can substantially grow sales beyond the bread category; alongside the snack bars, we have a deep pipeline of products built to leverage DKB's brand strength and take our business past the bread aisle. Those products include DKB Amped-Up Protein Bars and DKB Crunchy Snack Bites, and each one addresses distinct consumer needs while performing well in our test markets. You can try these products yourself by ordering from our innovation site: creationsbyflowersfoods.com. Priority three strategically is margins, an especially important focus given today's environment. We're tackling this area aggressively through multiple initiatives. To ease inflationary pressures, we raised prices on foodservice and private label products early this year, and selective price increases across our branded portfolio have been accepted and are scheduled to take effect this month. We keep advancing our portfolio strategy as well, through which we seek to shift a larger share of sales toward branded retail products that carry higher margins. Simultaneously, our attention is on squeezing out maximum efficiencies. Spending on digital and ERP generates near-term financial headwinds, yet those investments should unlock growth and efficiency for many years ahead. We are extending our bakery of the future program into more bakeries, and we're glad it is already producing gains in scrap and labor costs; cost savings initiatives also remain a focus, and we remain on track to hit our savings target of $20 million to $30 million for 2023. Smart M&A is our fourth priority. In February, we completed the Papa Pita Bakery acquisition. Papa Pita has served as an important co-manufacturer of Flowers products, and we anticipate the acquisition will generate manufacturing and distribution synergies. For decades, M&A has contributed significantly to our growth, broadening our geographic coverage and complementing our brand lineup. Looking ahead, we also expect M&A to assist us in entering faster-growing adjacent categories beyond bread; we keep watching the deal market, actively vetting potential acquisitions and investments that could bring capabilities, brands or products to our already robust lineup. Our strong balance sheet puts us in a good position to act when we have financial, commercial and operational conviction; now I'll hand it over to Steve to review the details of the quarter, and then I'll return a little bit later to discuss our outlook for the current business environment. Steve?

Thanks, Ryals. Hello, everyone. Now let's turn to our results. In the first quarter, total sales rose 6.9% versus the same period a year earlier. Better price/mix pushed the adjusted year-over-year gain to 13.6%, driven mainly by price hikes aimed at offsetting inflationary pressure. Volume fell 7.3%, in part because of deliberate sales rationalizations in cake and foodservice, along with tough comparisons against the prior-year period tied to storms during the pandemic. The Papa Pita acquisition contributed 0.6% to the top line. Gross margin as a percentage of sales, excluding depreciation and amortization, fell 170 basis points to 47.8%. Input cost inflation had an impact on the comparisons, and that was partially balanced out by pricing moves driven by inflation, decreased employee compensation expense, and fewer outside product purchases. Selling, distribution and administrative expenses represented 38.6% of sales, in line with the prior year period. The results got a boost from sales growth outpacing wage inflation, lower incentive compensation, and reduced distributor distribution fees as a percentage of sales; those gains were counterbalanced by higher marketing expenses, greater amortization of cloud-based applications, and acquisition-related costs. On an adjusted basis, excluding items affecting comparability, SG&A expenses were 38%, consistent with the prior year period. GAAP diluted EPS for the quarter came to $0.33 per share, versus $0.40 in the prior year period. If you set aside the comparability items spelled out in the release, adjusted diluted EPS for the quarter came in at $0.38 a share, which is $0.06 lower than the same period a year ago. Moving on to the balance sheet, liquidity and cash flow: in the first quarter, operating cash flow fell by $66.2 million to $58 million, and that figure included $6.2 million of business process improvement costs tied to the transformation strategy initiatives now underway. Working capital grew by $76 million, mostly because of inflation, and that weighed on operating cash flow. Capital expenditures were down $16.5 million to $34 million, including $10 million for the ERP upgrade in progress. Dividends paid rose $2.4 million to $49.1 million. Our financial position remains strong. When the quarter closed, our net debt was roughly 2.1x trailing 12-month adjusted EBITDA. We finished the period with about $28 million in cash and cash equivalents, plus approximately $521 million still available under our credit facilities. As Ryals noted, we're revising our 2023 guidance because the year got off to a slower start than we anticipated. Our updated outlook calls for sales growth of 5.8% to 7%, EBITDA between $494 million and $528 million, and EPS of $1.15 to $1.25. Several factors could move results within that guidance range: demand reversion, price elasticities, consumer resilience, and ongoing inflationary pressure. On the whole, demand elasticities have matched what we expected and continue to run below historical levels. Just to remind everyone, our adjusted EBITDA outlook includes roughly $26 million—about $0.09 per share—in added ERP project expenses. In Q1 those added costs came to $5.7 million, or $0.02 per share, and we expect them to ease considerably by the time the project wraps up in 2026. Looking further out, for 2023 we see a per-share impact of $0.08 to $0.10 from increased interest, depreciation and amortization tied to the ERP rollout and the Papa Pita deal. The ERP effort remains on track, and we're confident about beginning implementation in 2023 and completing it within the financial guidance. Looking ahead to fiscal 2023, we expect the ERP upgrade to cost somewhere in the range of $95 million to $105 million, and we anticipate that $30 million to $40 million of that total will be capitalized. Through April 22, 2023, we've spent approximately $172 million on this project, with $97 million of that amount capitalized. For 2023, we have about 80% of our key raw materials covered. We've retained our longstanding hedging approach so we can cut down on swings and get a clear enough read on expenses—with it, we aim to lock in more predictability for our main commodity costs looking six to twelve months out. We continue to monitor commodity markets closely and are looking into opportunities to lengthen our coverage and bring down prices, which might benefit our results in the second half. Thanks—I'll now turn things back over to Ryals.

Thank you, Steve. I want to turn now to several critical factors shaping how we're performing at present, among them how shoppers are behaving and what we're doing to drive the best results over the long haul. Facing inflationary pressure, buyers are moving toward cheaper items, reacting more strongly to promotional offers, and doing a greater share of their shopping at retailers that emphasize value. Store brands had been losing share for several years, and that pattern has now flipped—although their volumes remain far under where they stood before the pandemic—and most of those gains have come in the mass channel. During the first quarter, private label picked up 70 basis points of unit share in tracked channels, powered by substantial increases in mass. In grocery, by contrast, store brands gave up 20 basis points of unit share. Looking at how things unfolded across the quarter, the share gains for private label slowed markedly as the period went on. As I noted, our own results showed a comparable pattern when comparing grocery with mass. Our solid results in grocery carried on, adding 20 basis points of unit share with steady improvement throughout the quarter. Meanwhile, we gave up unit share in mass, mainly because of the strength of private label. On the whole, our sales got better as the quarter drew to a close, once we lapped tough comparisons from the prior year, with branded bread showing especially notable improvement. Beyond the mix effect caused by shoppers trading down, we've also watched volume return toward where it was before the pandemic across the category as a whole. While the pandemic was underway, the category saw a big jump in demand because people were eating at home more often; that tailwind, however, has faded now that consumers have gone back to eating more meals away from home. The unit volume pressure that followed, which started in 2021, carried over into the first quarter but eased substantially by the end of that period. What has stuck around is the move toward premiumization. Shoppers appreciate the better taste, texture, and quality that come with more premium branded items, and they've directed a larger share of what they buy toward those products. Even though private label has picked up some share of late, branded retail products have beaten private label since 2019, making up 81.4% of tracked channel category sales in 2022, which is 370 basis points higher than in 2019. The mix changes we're seeing in the near term, along with our portfolio approach of shifting a larger share of sales toward branded retail products with better margins, have put pressure on volumes. The key point is that most of the volume loss has occurred in cake and food service, segments where we've been increasing prices and cutting back on business that fails to meet our profitability thresholds. Even so, that volume impact has produced a short-term gap between our capacity and our production; we expected this gap when we began our portfolio strategy, but inflationary pressure has intensified the effect. Our supply chain optimization efforts are designed to close this gap, and we remain confident that our strategy is the correct one for Flowers over the long term. Like I mentioned before, though, one key point is our view that a lot of these headwinds won't last. Over the long run, we expect premiumization to help drive branded retail sales. We think shoppers will return to their pre-existing buying patterns once inflationary pressure lets up. At-home eating may never return to the highs seen during COVID, but working from home appears here to stay. We're doing what's necessary to succeed in this new landscape. That effort might be uneven and could generate some short-term headwinds, yet we see it as the strongest route to building long-term shareholder value. In getting our product lineup and network ready for what's ahead, we're genuinely enthusiastic about what this company can achieve; we envision a portfolio that has moved toward higher-margin branded items, turned out and delivered through a bakery network that's both more up-to-date and more efficient. On top of that current business, we plan to add faster-expanding neighboring segments, doing so through our own efforts as well as through acquisitions; the people and organizational setup we have are suited to enabling that transition, and my excitement about what's possible for us over the long run has never been greater; so, thank you so much for spending time with us, and that wraps up what we had prepared to say. The numbers for this quarter demonstrate how strong our top brands are and how committed the Flowers team is. I want to express my appreciation for their dedication. Their efforts played a key role in achieving record sales for the quarter. During the quarter, we encountered tough comparisons against last year, driven by a significant effect from the Omicron surge in early 2022 as well as some storm activity in that same period. The macro backdrop is still difficult, with inflationary pressure affecting consumer demand and input costs, and buying patterns keep changing as pandemic effects fade. We revised our 2023 financial guidance to account for these factors; however, we view the present situation as temporary, and our focus is on setting ourselves up for success over the long term. We've put money into innovation—like the nationwide rollout of DKB snack bars, plus digital and supply chain efforts—and these moves are meant to strengthen how we compete. A few of them could affect results in the near term, yet they matter a great deal for making our growth plans possible. Our prospects excite me, and honestly my confidence in our capacity to build shareholder value over time has never been higher. With that, Shannon, let's open it up for questions.

So, following up on those opening remarks, how much would you say these headwinds are of a temporary, transitory kind? Do you think things will pick up before this year is out? That part wasn't really clear from what you said in your prepared remarks last night. Put another way, are you working on the assumption that conditions improve? Is it temporary within the year, or temporary across a longer stretch of time?

Yes. Steve, thanks for asking. Look, we're probably being a bit conservative with the guidance, given how soft the start of the year was. We just felt it was most prudent to take that approach right now. That said, what we did observe toward the end of the quarter was some fairly meaningful improvement. What I mean by that is our branded retail units went flat to positive in several of the final weeks of the quarter, and at the same time, private label share gains really began to decline. When we began the year, I think in the first period of the year, we saw private label pick up the largest unit share that we've seen throughout this entire trade down situation. It gained 120 basis points. By the quarter's end, it was 50%. So we're starting to see that come down. It's still a tale of 2 channels, in the sense that the dynamics in grocery aren't the same as what we're seeing in mass. Most of the private label activity has been concentrated in mass. So that's a continuation of what we've discussed in prior quarters; so as to exactly when it's going to happen, that's a little bit difficult to predict. But I do have at least some hope at this point that things already look like they're beginning to get better; but for the time being, we've decided to be conservative.

All right. So I suppose that's — the soft start you mentioned for the year, I mean, it shows up clearly in the data; and what I'm trying to square is that it seems like that would've been clear to you as well back when you gave guidance in early February. Things improved toward the end of the quarter; so what deteriorated? That's my question...

Well, yes, that's fair. The beginning of the year came in weaker than we had expected right out of the gate; and that was significant enough that it made us maybe a bit more cautious regarding the consumer's health than we had been at the start here. I mean, we know it's going to be a challenging year, right? We said that. But with such a really soft start, it proved a little more challenging than we anticipated. Hopefully, that helps.

All right. I'll hand that over in a moment, but if I may, just one more question. You mentioned the temporary mismatch between capacity and production stemming from the softer start. Could you expand on that a bit — what does it mean financially? And then the timeline for when you'd expect some resolution from the supply chain optimization efforts.

Yes, of course. We won't put a number on it. But I also want to be clear that this imbalance was — it certainly played a role this quarter; it is definitely not the main factor. The main factor is the consumer and the softness in the category. So I want to be very clear on that; but we're aiming to be transparent with you and give as complete a picture as possible of what's going on that's good, better and different at the company; and when we discuss our portfolio strategy, we've spoken about — not so much SKU rationalization, which is kind of a routine ongoing matter — but more the business exits, where we've chosen to leave certain lines of business that were marginally profitable and really never had a chance to meet our profitability thresholds through pricing or efficiencies or whatever. Those kinds of exits are what I mean. And usually, those pieces of business do contribute at least a little something, right? So you'll have a little bit — you'll have some stranded cost when you fold in those pieces of business. Now over time, as we — and we've discussed network optimization a lot over time, that's where it comes into play. And again, you've watched us do this. You've watched us — we exited the Phoenix bakery recently, but we've also converted facilities to organic production, all brand, that sort of thing. That's what will handle that; along with branded growth over time, we'll handle that imbalance.

This is Stephen Lengel here on behalf of Bill Chappell. Could you fellows provide a bit more detail about how the price gap is behaving and about the other pricing round? In what way have the mass retailers responded to the extra pricing? Is it reasonably fair to think the gaps may have begun to widen again and that you could need a while to make some touch-ups? Any color on that would be really helpful.

Yes. So as you'll remember, when we put pricing in last year, the gaps separating brand and private label did become wider. A number of retailers were keeping their retail prices low. And I think it was late in the year or early this year that the gap began to shrink as the private label retailers came back. We've recently made some additional branded pricing that takes effect this month. So the gap could increase by a much smaller amount, because our branded price increases this round were quite a bit smaller than those in the last few rounds. So that might widen the gap temporarily, at least for a while, but it's too early to say, since the pricing just went in, so we haven't seen the data yet.

Got it, that makes sense. Thanks for sharing a bit of detail on the DKB launch. It sounds as though you need to make genuine headway there, and could you give us some big-picture thinking on how things are going relative to what you expected internally?

Yeah. No, we remain genuinely enthusiastic about it. We're currently in roughly 6,000 stores, so that puts us at about halfway toward the goal for year-end. And in terms of getting into the retailers we planned to, we're pretty much where we should be. On performance, in places where the bars have been on shelves the longest, results are extremely strong. In newer markets it's somewhat softer, but yes, that's expected; at just one retailer in particular, we ran into a handful of execution problems at the front end. All of that is being addressed now. So those figures are already beginning to look better. Overall, we're sitting in a strong spot and very excited about the direction we're taking with the bars.

Great. A few questions. I suppose the first one concerns the incremental pricing that's flowing through, which I know was covered earlier. Basically, what are you seeing in terms of share trends as you come out of — sorry, as you exit the quarter, and could a scenario unfold where perhaps you need to promote a bit more? Because I know, Ryals, you've said in the past, right? It's not a — it isn't a category with heavy promotion, but even so, at some stage, volume growth ought to count for something. So I'm just curious how you're thinking about that at the moment?

Yes, absolutely. So Rob, the branded pricing has only just gone in; so we're not really — we can't really observe any effects from it as of now. I'll tell you, we did promote somewhat more during the quarter; it wasn't terribly significant, but our activity did tick up a little, to your direct point. I know that especially with — if you consider elasticities in our business, putting category softness to one side for a second, we're still doing very, very well relative to our elasticity model; so it hasn't — we're outperforming just about everything; now when you look at something like Tastykake, for instance, where our brand isn't stronger. We've experienced more elasticity there and have needed to promote somewhat more on that front, but that probably wouldn't surprise anybody; but overall, we've seen — again, we've seen some pockets of competitive activity from our competitors in the category, and our promotional level did tick up just a little within the category. But as of yet, Rob, I wouldn't point to anything terribly meaningful. I think we're going to keep — to your point, keep watching the volume trends. Again, they did begin to improve, and we actually saw unit increases toward the end of the quarter. So that gives me a bit of confidence. I just don't have enough of a trend line yet. Because it came right at the end of the quarter to call it a long-term trend just yet. So again, that's why we're somewhat conservative with the guidance.

Understood. Understood. All right. Then, I suppose, just things about input costs — sort of where grain markets have moved, and how that might end up helping you? In the prepared remarks, I believe you mentioned there could be some sort of second-half benefit, but you didn't really say there would be one; it looks like you're 80% covered for the year. And before, it was probably roughly flat gross margin. So just pulling all of that together, gross margin came down roughly as expected, maybe a touch more in Q1, and the EBITDA guide comes down a little, which I'm assuming is gross margin driven, while at the same time grains have deflated. So I'd figure that eventually it starts working in our favor, though I'm not sure if you're being cautious since you might have to put some of it back into the business. So there's a lot going on there, but I'm just trying to get a sense of how the year might unfold, right, when it comes to gross margin?

The reality is that, on the whole, we're anticipating inflation across the entire year. I mean, the first half is certainly our hardest comparison because we came into last year with fairly advantageous hedges. Then, clearly, the inflation around us starts climbing sharply until roughly the first half, and we would have been protected through most of that stretch last year. So when we look at the full year and think about the cadence, clearly the first half is stronger and the back half weaker. As I said, we still anticipate inflation. Much of it comes from buckets other than Flower within the input bucket. Sugar has risen. Gluten has risen quite substantially, and we use a fair amount of gluten since — usually since of protein quality within the wheat. We are also seeing yeast higher, honey, and several other smaller or minor ingredients higher. Although we anticipate improved and more favorable comparisons during the second half, we still expect inflation to persist across the entire year.

Okay, I understand. That's reasonable. That helps. And then, look, I realize that's not really how you typically operate, so to speak, when it comes to discussing the upcoming quarter, right, a quarterly guide, but I am somewhat curious, perhaps in broader terms, we saw EBITDA step down in Q1. Could you frame that somehow? So we can grasp a bit of the cadence as we move through the year, like we will likely again see a larger step down in Q2 compared with what we'd anticipate in the back half? Just considering the midpoint of the revised guide.

Obviously, I mean, you're correct, we don't provide quarterly guidance. So in terms of the annual guidance we've provided from an EBITDA standpoint, again, we do believe it gets easier in the back half. Overall, from a cadence standpoint, hopefully, as Ryals mentioned as well, we're observing improvement across markets coming out of the first quarter. So without addressing any particular quarter, I think we should land roughly in line with some of the remarks you've made and expectations.