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

Get seated. We'll kick off our next fireside chat with Flowers Foods. So welcome back, everybody. And with me today are Chairman, CEO and President, Ryals McMullian; and CFO and Chief Accounting Officer, Steve Kinsey. Great to be here you both. Thanks for being here.

Thank you very much. I should note that I have been demoted, I'm not President anymore.

Okay. We'll lax in my research apparently. It's wonderful to have you all here. So thank you.

I think maybe a good place to start is this time last year, we're about trade down to private label, driven in part by consumer value-seeking behavior, slightly wider price gaps within the mass channel. Your business stabilized and improved to exit the first quarter of this year that continued through Q2 despite some incremental pricing around that time. Maybe you can provide us an update on the consumer backdrop right now through the lens of your business? And maybe talk to us about consumer demand trends for private label versus branded? How trends break down sort of across channels like mass and grocery and across your premium brands and differentiated products as well as opposed to really just the traditional segment of the fresh bread space?

Sure. I mean I think overall, it's no surprise that we still are dealing with a consumer that's under some pressure. The inflationary environment over the last year to 18 months or so has definitely had an effect. You have more recently, gas prices starting to go back up. You guys do a loan repayments coming back into play. And we have seen some trade down to private label. We've also seen some panel shifting from broader grocery to mass and dollar and things like that. So there's no question that some consumers are seeking margins. The good news is we actually remain fairly optimistic. As you said, we had a really good second quarter. Some of those trends have continued into the third quarter. We're really particularly pleased with the Dave's Killer Bread performance, and we've actually seen unit volume increases, which is of note because it is a super premium product. And we've even seen some of the lower income households start to come back today. So that -- there's a lot of competing data out there and conflicting data out there. So it's a little hard to prognosticate a definitive view, but there are some signs that perhaps the consumer is get more bit healthier.

Great. Great. And on your Q2 call, and just now you started Dave's Killer Bread had a strong quarter. I think unit sales were up about 7% in syndicated data, and that's partially a function of low-income shoppers, which previously comprised, I think 20% of the branch shoppers coming back, right, in addition to higher income household penetration gains. Maybe you can elaborate a bit more on that. You attribute the improvement entirely consumer health or was there anything you were able to sort of do from an advertising or merchandising standpoint to sort of reengage the consumer around that brand?

Yes. So we continue our marketing efforts. We're not cutting marketing spendings. So that continues to be a big thrust of our strategy. But I think at the end of the day, in our category, there's very little differentiation in private label. That's not true with other categories in the [indiscernible] ours, it's for all practical purposes, it's a very basic white bread and a very basic wheat bread. That's not true to [indiscernible] but it's a highly differentiated product, very high quality, yes, it's a premium price point, but it gives the consumer a point of difference with attributes that they want and, frankly, a brand that they value. So if I were to attribute it to anything, it is that differentiation, and that's frankly a main thrust of our branded strategy is to continue to innovate, continue to be sure that we're differentiated from the competition, doing our consumer research, making sure that we're bringing to consumers and our retail partners, the products that they want. And so I think that more than anything else when you think about super premium products like Dave's Killer Bread and Canyon as well. That's the main thrust of it.

That really leads into the next question with DKB and Canyon. There have been significant growth drivers in recent years. I guess, what gives you the confidence in the continued sort of growth opportunity, especially considered they're really lofting healthy market share already in that space?

Yes. So we still have geographies where we're less mature as a brand. Remember, Dave's started out Winston, Oregon, Northern California and Southern [indiscernible], and we have spread it across the country. So in places like the Northeast to a lesser extent, even in the Southeast, Mid-Atlantic area, just from a share standpoint, we still have room to grow. Furthermore, household penetration with Dave's Killer Bread is half of that of Nature's Own, and Nature's Own has been around since 1978. And so there's still a lot of consumers that either don't buy Dave's for one reason or other yet or don't even know about Dave's yet. Furthermore, we're moving into adjacencies with Dave's Killer Bread. We've got the snack bars coming out. We've got snack bites coming out. So moving into that healthier snacking arena. We still have a long runway for growth with Dave's.

I think on Canyon, I know there have been some near-term headwinds. Is this a result really more of the competitive pressures or just really the capacity issues you referred to on the second quarter call?

Yes, it's almost exclusively capacity. Good problem to have, for sure, but we got really tight on capacity, just given Canyon's rapid growth. So we got that fixed now. And so some of the share slippage that we've seen for a little while now, we see that resolving itself.

And there you've seen some positive signs on the premium side right of your business. Overall, volume performance was down a little over 6% through the first half of '23. Can you remind us how much of that is related to like the impacts of pricing and declines in line with the market as opposed to some of the deliberate actions you've taken to rationalize some of the lower margin business? And how should investors think about volume performance across the sort of the near and intermediate term as we go forward?

Yes. So our elasticities continue to be better than our models suggested. So overall, that's sort of the base case. The lion share of the volume declines that the business has seen has been intentional. So we have a stated strategy of converting the business more to a branded retail consumer-focused business and deemphasizing some aspects of our private label and foodservice business. So between SKU rat and flat out business exits, that accounts for the lion's share of the volume declines. As we move through the rest of the year, you'll start to see that moderate as we lap the bulk of it. But I do want to emphasize that we're not done yet. We do have some additional retailers customers that we'll be exiting over the next 3 years or so, I would call it. By then, we should be much -- in much more of a steady state from a volume standpoint there.

Great. Maybe you can provide us a bit of an update on price gaps against both private label and your branded competition. It looks like they've been stable since your most recent action earlier in the year. Is that a fair characterization? Or are you still comfortable with where these levels are currently?

Yes. I mean they have normal lots. They got a little bit out of lack there early on in this inflationary cycle. But generally speaking, they've come more in line with historical norms.

When we think across food, we've seen levels of merchandising, including promotional activity, increases supply chains and costs normalize. So a lot of that is to be expected. It looks like that's the case in Wonder's bread as well. Where are we relative to sort of normalized or maybe pre-pandemic levels in terms of promotional and merchandising spend? And are those increases really prompted by retailer request? Or more due to getting back to more normal cadence really of merchandising?

It's still well below pre-pandemic levels, at least in our category. It has ticked up a little bit more recently, but nothing that I would point to as being terribly significant. I think another interesting note is that when we are promoting, we're not seeing a tremendous amount of lift. That somewhat indicates to me the consumer kind of buying just what they need right now being under pressure. But having said that, our business tends to be a pretty heavy base business.

And that kind of leads into my next question. You have stated on the most recent call that some of the incremental units on promotional increases that you put in, haven't been terribly attractive to your point, with the lift being sort of smaller than normal levels. And the implication being shoppers are on sort of buying what they need to your point. I guess to what really do you think those lower lifts could be a function of other bread manufacturers and indeed, other categories within the store increasing consumer levels at the same time and consumer budgets that might be somewhat sort of fixed near term?

Yes. I mean if you're on a budget, you're constrained and so there are certainly choices that have to be made. I will say that if you think about our core business, the bread business, it's a pretty economical choice still even with the increase in prices. There's a lot of servings in a loaf of bread. So I think that puts us in a good spot. Sandwiches are a very economical option for a family. So I mean that's insulating us today in this environment. It has insulated us in the past from that environment. We alluded to private label trade down earlier. Certainly, that is happening. But where we're seeing often oppose is #1 in the mass channel. And number two, the trade down is affecting our kind of mainline soft variety breads more than anything else because those are the least differentiated branded products that we have, so that's a little bit more successful. That's [indiscernible] for us to continue to innovate and find ways to further differentiate in those items from our competition and private level.

To the discussion earlier on premium brands and your differentiated products doing better of late, I guess, can you comment on whether there's an opportunity to scale back merchandising support in an environment where the consumer is a bit more distorted or whether a fair amount of support is necessarily to just to sort of stay relevant to the consumer?

Yes. I think, again, I think a fair amount of it is fine. The advantage that we have is that we compete with 3 #1 brands in the category. And so I think from an overall promotional cadence standpoint, we're a little bit more insulated from that just because we have those #1 brands that resonate with consumers.

Switching gears maybe a little bit. One of your strategic initiatives this year has been the national rollout of the DKB sort of snack bars. I guess how is retailer and consumer acceptance been so far? You mentioned that in the most recent call, you expect to be in greater than 13,000 stores by year end, above the current level and the original projection, I think, 12,000. The velocity has been in line with some of the leading competitors. So after that strong start, I guess, what have been some of the key insights from the launch thus far? How have you sort of evolved launch plans if at all?

Well, I'll tell you, first of all, overall, we're really pleased about it, and we're really excited about this. What is essentially a new business for us? I was telling some people earlier. I mean we're literally treating this as a start-up. These probably are all warehouse delivered. They're all co-manufactured. Some of this is a little bit of new territory for us and during the rollout, we have certainly taken some learnings that will help us for future rollouts. But overall, we're really pleased with the trajectory. As you said, we've got velocities that are already in the top 10, and that's even taking into account that we dilute that so much because we're still increasing [ ACV ]. So retailer excitement about it is really good. Every -- I don't know if how many people in the room have tried it, but I think there's some around [indiscernible] outside maybe given the try -- everybody that tries them loves them. I think it speaks volumes about DKB as a brand and the quality that stands for. So we think we've got a really, really bright future in the snacking world.

Great. Maybe longer term, you can talk about the market opportunity for the DKB bars. I mean is this -- is it a lifestyle brand play? I know DKB fans are willing to try sort of lots of products you put out under that banner? Your core customer, do they have an unmet need? Bars are just a big category, and this is sort of a logical extension. I guess how far can this brand travel basically?

Yes. Well, what we're seeing are 2 things. Number one, DKB fans are pretty rapid. We did some market research recently. And what came out of that, and I just love this line is that people don't buy Dave's Killer Bread, they're enjoying Dave's Killer Bread, almost like joining a club, right?

You're going to say club, but we went with the club...

But DKB bread buyers are highly likely to gravitate to this product. It's incremental and it's something that's probably already in their household pantry. But there, as we said earlier, given the household penetration for Dave's today, there's a lot of people that don't know about Dave's Killer Bread, they might not even eat bread. But I bet they eat the nutrition bars, right? And so we're doing a lot cross [ SKUs ] product. We're doing DKB combination bread and bar displays. So we're bringing those days -- current days, consumers over to the bars and then we're bringing new people to the brand.

Great. And as you build off of the success of the snacks innovation, maybe you can tell us a little bit more about the amped-up protein bars. I mean, how are they doing in test -- how should we think about a national launch of crunchy snack bites at some point in the future?

So there are 3 original SKUs in the DKB bars, those are the ones that are in 13,000-plus stores by the end of the year. Those are more of a whole grain attribute next spring, launching of the -- that the high-protein bars in the test markets. They're doing extremely well. And what's even more exciting is that they are proving to be incremental to the current set of bars. So we're clearly tapping into different consumer segments with these varied attributes. The country snack bite, I think, are particularly exciting. There are 6 SKUs of that, 3 are [indiscernible], 3 are [indiscernible]. And I would argue that we've had even more retailer excitement about those than DKB bars...

I think your guidance incorporates a moderate decline in commodity costs in the second half of '23 relative to your initial expectations. Does that mean you expect commodities to decline at a moderate rate or inflation is on a lot below what you would have assumed before. I just want to clarify on that.

The reality is when you look at our largest input cost which is we're driven by wheat. We have remained pretty volatile. It has pulled back, but on a relative basis, it's still pretty high when you go back a couple of years. So while we're looking at -- when we look at the wheat and the pull back, also thinking about other ingredients like sugar, packaging, gluten, those were actually maybe higher than expected. So in the overall perspective, we don't really expect inflation to pull back significantly. We play pretty moderate. So a lot of that guidance has driven really kind of the amount of inflation.

Even if commodity pressure is somewhat less acute the broader cost bucket, labor, as you talked about, some of the things should remain inflationary. I guess based on where we are today, how are you thinking about future price increases that might be necessary to cover sort of the lingering cost inflation.

Yes. I mean it's -- there's probably a lot of price fatigue out there, just given the cadence and inflation that we've seen. Obviously, we will do what's necessary for the business. If we see material cost increases, then we may have to do that too early to speculate. But by the same token, we -- there are plenty of things we can do on our side of the table from increased efficiency thing to bring us more in line. So there's more than one way to handle it. Certainly, my hope is, is that we're through the worst of it, and we get back to more normal cadence. But we'll set to it.

You've earmarked, I think about $26 million in ERP expenses for the current fiscal year. To date, you recognized a little over $8 million. Is this a reflection of sort of how you're tracking with the implementation as well? How should we think about the progress on sort of digital initiative benefits as the ERP rolls out?

Yes. I mean, look, overall, the ERP implementation has gone fine. I mean as with any of these things, there's been some a few stumbling blocks along the way, but nothing -- it's a life or death situation. So we feel pretty good about where we are. We certainly hope to be through the rollout by the end of next year, which we're really looking forward to because if you're familiar with these implementations, it does take a tremendous amount of out of the business that could otherwise [indiscernible] on the business. However, the implementation of ERP will open up a lot of other opportunities from a digital standpoint for us. We've already started taking to manage up. We talk a lot about Baker in the future, which is essentially the digitization of our bakeries and that's already providing some really nice accretive benefits for us. And we're only having about half of the bakers so far.

I know that over time, you've been pretty acquisitive. Maybe you can talk a little bit about the M&A environment at a high level and maybe your strategic areas of interest on this front?

Sure. So it's been a little slow because the last -- the last few years, just coming out of the pandemic, I think a lot of that just had to do with so much noise in everybody's numbers. I mean, I recall, we looked at several during the pandemic, it was so difficult to parse out what was permanent and what was it while we were asking that on about our own business. How much of this was going to actually stick around, but I think that we've now gotten through that period. We're seeing more things start to come to market or in anticipation of the market over the next 12 to 18 months or so. So I think this next period should be -- I'm certainly hoping that it's a bit more active for us because we're well poised with our balance sheet to take advantage of it when it does. You asked about areas of opportunity? You'll see most of our acquisitions be outside of our core category going forward. The consolidation of the bread industry is more or less done a few limited exceptions to that. So we're focused on areas of baked foods outside of our core category. But I would say, generally speaking, with more of a health and wellness halo around them unlike what we're doing with Dave's and Canyon.

If we broaden out the discussion a little bit, just you're certainly seeing and hearing about a lot of the discussion in the industry just about volume recovery maybe being a little bit weaker than some might have expected as sort of pricing has lapped. And people are trying to figure out this puzzle over like where is the volume going. It doesn't seem like there's this mass trade down to private label is a little, but it's not dramatic. Not a huge shift to away from meeting necessarily. If we accept the the premise that consumers are needing fewer calories, they need some summer travel. I mean there's lots of potential sort of reasons for it, but I'm just curious on your thesis, if you've got one around where this volume has gone? And I guess, more importantly, with most food companies looking for sequential improvements in volume as we go through the year, get back to merchandising, service levels are better, easier comps in '24. What's your thought around some of this as it relates to the industry?

Yes. I think we've already hit on some of it. I mean, obviously, a pressure consumer is 1 thing, right? So making economies where they need to potentially buying less, we talked about the kind of the lack of lift from a promotional context. By the same token, while business travel hasn't completely recovered, personal travel certainly seems to have if you've been in an airport lately or been on an airplane lately. So I think if you talk about annual meeting, which is the -- that's all of our -- that's our branded business, essentially, certainly, I'm sure that's impacted a bit and certainly more so than we were in the middle of the pandemic by the same token. They're half empty. People are still eating a lot at home, which benefits our business through that. It's kind of what I was saying earlier, I mean, there's a lot of puts and takes and completing data. But having said all that, we're actually really happy with our positioning and relatively optimistic. Again, lot of our volume declines are intentional, and they are part of our strategy going forward as we move more moving the business more to a concentration and bring the retail and away from foodservice and private label.

Yes. You've announced a few recent management and Board appointments. We've got Keith [indiscernible] the President title as you mentioned. In addition to continuing on as COO, Terry Thomas will come off the board, join as Chief Growth Officer. You have Richard King, Chief Digital Officer; Joanne Smith, Chief People Officer. How do you see these changes impacting the company and just the rationale more broadly for some of these shifts?

Absolutely. We couldn't be more excited about it. In fact, if you were to ask me what my proudest personal achievement is since I've been a CEO and the team that we've been able to put together. We brought in a tremendous amount of new talent to the company in areas where we needed capabilities that we did not have before. Yes, Terry is the most recent addition. Chief Growth Officer is a new role of Flowers. It essentially combines sales and marketing, just to put it some point. There's a few other things there, innovation will be under Terry as well. But to be able to attract an executive of Terry's background and experience from Unilever, P&G, Pepsi, Coke, that's not something we probably could have done 6 or 7 years ago. And then similarly on the Board, Brigitte King as Chief Digital Officer at Colgate-Palmollive and Joanne Smith is the CHRO at Delta. And those are 2 capabilities that I saw on [indiscernible] Board both from a digital marketing standpoint and from a people standpoint. None of these things that we've talked about today could be done if we don't have the talent to do it. And we've also hired in the last new CHRO ourselves from Carrier, a new Supply Chain Officer a couple of years ago from Pepsi, I mean he just kind of goes on and off. Yes. I would know too for us being a smaller company from Southwest Georgia, the pandemic, in some ways, was quite [indiscernible] for us because we had this traditional mantra of everybody, particularly in the C-Suite, that work for Flowers [indiscernible] and Thomasville. If you don't know, Thomasville has about 25,000 people in Southwest Georgia, it's not for everybody. And this whole hybrid work-from-home arrangement essentially for us has allowed us to increase our talent pool tremendously virtually nationwide. So some of these folks that I've just mentioned are remote. They're not headquartered in Thomasville. So that sets really helped our ability to attract top-tier talent.

You're underselling in Thomasville a little bit, but...

That was wonderful but it's not [indiscernible] about it.

Yes. Maybe to round out the discussion would be -- I'm sure you've got a long list right of things that you sort of worry about, keep track of new sleep over with respect to the business. But if you had to sort of say top 1 or 2 things right now that you're sort of keeping a really sort of eye on, sort of what would those be?

Florida States Football season is the first thing you go.

Want to know...

Look, for us, I mean, like everybody else, getting through this cycle, you're certainly hoping to see a healthier consumer and top of mind for me because we do have the management team in place that I trust to get the job, the day-to-day job done. My attention is now turning much more back to growth, back to M&A, which is the world that I grew up in. Steve, right there alongside helping me with resource and capital allocation. Those kinds of things are a big focus for us. As we said earlier, we've got a very healthy balance sheet. So we're poised to do some things to both in terms of investing in our business, the current business that we have and growing our business via M&A, which, as you know, was a large part, about half of our historical growth was the M&A. So it's nice now that we really have a solid team firmly in place, it's nice to be able to turn my attention back to those things.

Great. Okay. I think that's a really good place to sort of cut it off here. Take it through the breakout, have you guys all get your questions out there as well. So please join me in thanking Ryals and Steve for being here, and see you in the breakout.

Thank you.