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

Hi, everybody. I’m J.T. Rieck, EVP of Finance and Investor Relations. Thanks for joining us as we discuss Flowers Foods’ 2023 fourth quarter and full year results. Before we begin, please note that what’s presented here may contain forward-looking statements regarding the company’s performance. While we consider those statements reasonable, risks and uncertainties apply that could make actual results differ materially. Beyond what you hear in these remarks, key factors concerning Flowers Foods’ business are described in full in our SEC filings. Speaking today are Ryals McMullian, Chairman and CEO, and Steve Kinsey, our CFO. Ryals, over to you.

Thanks, J.T. We're glad to have everyone joining us today. For Flowers, 2023 turned out to be a productive year, and I take pride in everything our team has achieved. Of course, the economy and inflation are still challenging conditions, and those pressures have continued to steer shoppers toward private label products. Even so, that shift clearly moderated as the year progressed. Our brands performed well, gaining share and demonstrating how strongly consumers favor them. That encouraging result bolsters our confidence in the long-term prospects as consumer demand returns to normal. Our 2024 financial outlook incorporates an assumption of solid relative performance against those category headwinds. Our forecast assumes results will lean toward the first half, and we're being more careful about the back half—chiefly due to a consumer and promotional climate that's uncertain; in addition, we keep putting money into our team, operations and digital initiatives, which ought to support growth over the longer term. Steve will walk through the puts and takes surrounding these factors in greater detail. In the fourth quarter, unit share for our brands in tracked channels gained 10 basis points versus the same period a year earlier. And dollar share grew for the first time since the first quarter of 2022, climbing 20 basis points. In the grocery segment, our performance was even stronger—we gained 20 basis points in both unit and dollar share, which is called out on Slide 9 of the earnings presentation. On Slide 10, you can see volume trends getting better throughout 2023, helped by share gains and fewer business exits. That progress, especially pronounced in our branded retail category, shows just how well our portfolio strategy is working and how strong our brands are. Shifting more sales toward higher-margin branded products means our portfolio strategy is lifting both the top line and gross margin. We're applying that same approach in our other category too, and margins in cake, foodservice and private label are improving substantially. By putting profitability ahead of volume, we've widened margins on business we already have and trimmed accounts that don't clear our hurdle rates. Near term, that approach leaves some overhead costs temporarily stranded as volumes fall, which masks the real progress being made underneath. As time goes on, we anticipate our growth initiatives will bring in more volume and occupy that capacity with higher-margin business, lifting overall corporate profitability in the end. Next, I'll walk through how we performed in the fourth quarter and the full year against our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. Following that, Steve will return to walk through the financials, after which I'll wrap up by covering the main themes ahead. Turning to our team: 2023 brought substantial headway. We built fresh capabilities and brought in outside talent to address shifting business needs and make sure we're ideally set up to hit our long-range financial objectives. We further simplified the operating structure so those additions could have maximum effect and our people were positioned as well as possible to succeed. My confidence is high that the right team now exists to deliver on our strategic priorities, and I anticipate that will be reflected in stronger execution across 2024 and afterward. Priority two strategically is concentrating on our brands, and those brands are doing well despite a tough consumer backdrop. One standout was Dave's Killer Bread, which reached a record $1 billion in 2023 retail sales as tracked in measured channels. Although it carries premium positioning and sits in the softest section of the bread category, averaging above $6 per unit, DKB's appeal to consumers extended past what it costs. During the fourth quarter, the brand gained 30 basis points of both unit and dollar share. What's even more striking is that Dave's increased unit volumes by 10% in tracked channels, even as the bread category as a whole — at an average price of roughly $3.50 per unit — fell 3%. That performance demonstrates the brand's pull outside the organic and specialty premium segments. DKB also continues to show it can grow beyond core loaf products, with units up 15% and 28%, respectively, in the breakfast and sandwich buns and rolls subcategories. Given dollar share of just 7% and 1%, respectively, in those subcategories, we see considerable white space in adjacent areas, along with geographic expansion and extensions beyond the bread category. That opportunity is what led us to launch DKB bars, and they keep doing well — market share and velocities are right in line with the category. We got distribution in roughly 19,000 stores, well above our initial target of 13,000, and we're excited about what future growth could look like in small format locations such as convenience and drug stores. Riding that momentum, a national rollout of DKB protein bars — already sitting in 1,500 stores — is set for the first half of this year. In the end, those 3 new SKUs should double our shelf space in bars, boosting our shelf visibility and helping speed up sales. We've mentioned on earlier calls that Canyon Bakehouse had limited available capacity as the brand expanded; we have added capacity since then, and those additions are starting to pay off; we feel good about Canyon's growth prospects, and it still holds the top share position in gluten-free bread by a wide margin and has the strongest loyalty among all national bread brands. Nature's Own, our biggest brand, picked up 10 basis points of dollar share while unit share fell 10 basis points. The unit share decline was mostly in the traditional loaf segment, which private label trade down has hit hard. In sandwich buns and rolls—and particularly loaf—Nature's Own held its share, and in Keto it picked up 600 basis points of unit share, which shows how innovation is helping us serve consumers whose needs keep shifting. For 2023, our Nature's on Keto loaf ranked as the category's #1 new item. Margins are our third strategic priority. The team deserves credit for the admirable way it has cushioned our cost basket against commodity inflation. Those efforts show up in gross margins, which came in stronger in 2023 than they had the year before. EBITDA margins, though, have taken a hit from inflation in other areas—labor as well as repair and maintenance—and from spending meant to drive future growth, like marketing and our digital initiatives. Those investments do hold back near-term results, but they matter a great deal for reaching or beating our long-term financial targets. Our attention is on countering those elevated costs via efficiencies and cost savings programs, and we expect those to deliver roughly $30 million to $40 million of savings in 2024. Smart M&A is our fourth priority. For decades, M&A has contributed significantly to our growth, widening our geographic coverage and adding to our brand lineup. Looking ahead, in addition to strengthening where we stand in our main categories by expanding geographically and picking up share in underserved regions, we also want to discover fresh revenue opportunities across the entire baked foods space. Baked goods are found throughout the store—in the deli, the center aisles, and the freezer and refrigerator sections—as well as in numerous eating occasions outside the home. Our goal is to identify attractive brands that complement what we already own and that skew toward a healthier nutritional profile. The M&A environment is beginning to improve, and the development pipeline of possible deals has me feeling more optimistic than I have in years. We continue to monitor the transaction market. We’re working hard to build ties with owners and founders, and we’re looking closely at possible acquisitions and investments that might add capabilities, brands or products to the strong lineup we already have. Given our solid balance sheet, we’re in a good position to move once we’ve gained financial, commercial and operational confidence. I’ll now pass it to Steve to go through the quarter’s details, and after that I’ll close with our view of the current business environment. Steve?

Thanks, Ryals, and good morning, everyone. Fourth-quarter total sales rose 4.3% versus the same period a year earlier. The year-over-year gain came from better price mix, which was up 5.6%, mainly as a result of pricing moves aimed at offsetting inflationary pressure. Volume fell 2.4%, in part because of deliberate sales rationalizations and food service, marking the smallest quarterly volume decline in 2 years. The Papa Pita acquisition contributed 1.1%. Gross margin as a percentage of sales, excluding depreciation and amortization, rose 110 basis points to 47.9% compared with the same quarter last year. Those comparisons benefited from moderating input cost inflation and fewer outside purchases stemming from the acquisition, partly offset by higher labor and maintenance costs. SG&A costs represented 39.7% of sales, up 180 basis points from the same period a year earlier. Increases in labor, insurance, marketing, technology costs and the prior-year asset sale gain were partially offset by reduced distributor distribution fees relative to sales along with lower bad debt expense. After stripping out items that affect comparability, adjusted SG&A stood at 39.4% of sales — a 150 basis point rise driven by the factors just listed, leaving aside last year's asset sale gain. Quarterly GAAP diluted EPS came to $0.17 per share, compared with $0.23 in the year-ago period. Leaving aside the comparability items spelled out in the release, adjusted diluted EPS for the quarter came in at $0.20 per share, a decrease of $0.03 versus the same period last year. Turning next to the balance sheet, liquidity and cash flow: operating cash flow for fiscal 2023 was $349 million, a decline of $12 million. Capital expenditures decreased $40 million to $129 million, which included $28 million tied to the ongoing ERP upgrade. Dividend payments increased $9 million, reaching $195 million. In our view, the company's financial position is still solid. Net debt to trailing 12-month adjusted EBITDA was roughly 2x at quarter end. Cash and cash equivalents totaled about $23 million, and roughly $537 million remained available under our credit facilities. Let's move on to what we expect for 2024. Our sales forecast ranges from flat to a 1.6% increase. That figure factors in positive pricing measures already implemented or agreed upon, partially counterbalanced by a modest volume decrease stemming from ongoing category declines and certain business exits. We anticipate 2024 will be the final year of significant business exits, with the bulk of that impact falling in the first half. For adjusted EBITDA, we're looking at $524 million to $553 million, and adjusted EPS should land between $1.20 and $1.30. As Ryals mentioned, this guidance reflects results weighted toward the first half, with greater caution applied to the second half, mainly because of uncertainty around the consumer and promotional landscape. Right now, those factors aren't showing material shifts, though we think some caution is appropriate given that consumers are still adapting to the post-pandemic landscape. For the first half, we expect to benefit from wraparound pricing in branded retail, fresh pricing at certain food service accounts, and commodity costs that are easing—partly offset by growth investments and other inflationary pressures. A big chunk of the branded retail price increases from 2023 won't be lapped until the middle of 2024. The consumer and promotional environment, the transition of our California distribution, and how well we execute our savings initiatives are among the main factors that could push results around within our guidance range. Overall, demand elasticity has come in as we expected, remaining below historical levels. Other factors we expect to influence the full-year results are an increased tax rate and higher net interest expense related to funding the payments for the California legal settlement and the ongoing ERP project, along with reduced interest income. As we have already disclosed, we agreed to a settlement of distributor-related class action litigation in California. The settlement still needs final court approval, which we do not expect before March 1, 2024. Once final court approval is obtained, we will proceed with buying back the California distribution rights, and that process should wrap up by the first quarter of fiscal 2025. For 2024, we're looking at depreciation and amortization of $160 million to $165 million, along with capital expenditures between $120 million and $130 million. About 70% of our key raw materials are covered for 2024. Given that coverage, our guidance factors in ingredient costs easing in 2024 compared with the year before. To keep volatility low and give us solid visibility on costs, we've kept our longstanding hedging approach, through which we try to lock in more certainty on key commodity costs 6 to 12 months ahead. The ERP system went live during Q2 2023, and we're still advancing that implementation, although we've put the bakery rollout on hold so we can focus resources on the California distribution transition. For fiscal 2024, we anticipate the ERP upgrade will cost roughly $25 million to $35 million, with $3 million to $6 million of that expected to be capitalized. By year-end, project costs incurred total about $214 million, and $112 million of that has been capitalized. Thank you. I'll now hand things back to Ryals.

Thanks, Steve. I'd now like to go over a few of the trends shaping how we're performing at present, along with the actions we're taking so we can make the most of our opportunities in this climate and going forward. First I'll cover how the consumer is holding up, and after that I'll talk about the competitive landscape. In the fourth quarter, consumer behavior stayed in line with what we saw through most of 2023. Store-brand items keep picking up share within bread as shoppers react to higher prices, although that pattern is easing, as we point out on Slide 11. In Q4, private label's unit share rose just 10 basis points. Price gaps are also narrowing, because private-label prices are rising faster than the branded ones. Then, with store-brand unit growth decelerating, our branded retail business showed improved volume trends. In the fourth quarter those volumes, as I mentioned earlier, declined just 30 basis points — a significant improvement compared with the first 3 quarters of the year. That encouraging volume trend contrasts with the bread category as a whole, where units leveled off after the first quarter, as Slide 12 illustrates — which signals that our brands are outperforming. Bear in mind that branded products have a long record of gaining share, driven by considerable innovation and differentiation. The premiumization trend shown on Slide 13 was thrown off course by inflation during the past two years, though we anticipate it will resume once shoppers adjust to the new conditions. The divergence between mass and grocery channels also continued, as private label lost 60 basis points of unit share in grocery for the quarter, compared with a 30 basis point drop in Q3. With that private-label picture in mind, Flowers gained unit share in grocery across all four quarters of 2023, including 20 basis points in Q4. Store-brand products remained most dominant in loaf categories offering the least differentiation. In areas with more product differentiation, store-brand share fell; we keep gaining share in specialty premium, breakfast, and sandwich buns and rolls subcategories, up 170, 100 and 40 basis points, respectively, as our leading brands show they can extend further into those adjacencies. We see a substantial opportunity to grow through these brand extensions. Now to the competitive environment, which stayed fairly steady through 2023 and remains rational. From the start of the pandemic onward, promotions had less effect on consumer demand, with incremental programs producing minimal lift. Even though promotional levels for Flowers and our category stay well under where they were before the pandemic, the share of our products sold on promotion went up in the fourth quarter, as we ran slightly more promotional activity and consumer response to promotions shifted somewhat back toward more historic levels. That gain in effectiveness came mostly from better consumer response, which our strong brands made possible, along with improved display execution and new capabilities we built in trade promotion management systems; thanks to those factors, we improved promotional effectiveness by a wide margin, well past the rise in our trade spend. Improving promo performance is just one piece of how we're striving to get the most out of the present market. In closing, let me reiterate that our attention remains on the substantial long-term opportunities we see in front of us — filling white space along with geographic and product adjacencies, and leveraging innovation to move into new categories. As we see it, the strongest route to seizing those opportunities is continuing to build our brands both organically and via M&A, serving more consumer needs by creating new, differentiated products that broaden our addressable market. My confidence in our long-term potential has never been higher, and I'm eager to build on our solid foundation through 2024. We feel good about how our team has done amid the tough consumer conditions we're up against. Our brands turned in a strong performance, picking up both unit and dollar share for the first time since the first quarter of 2022. Dave's Killer Bread really stood out, hitting $1 billion in retail sales and posting 10% unit volume growth, even as the bread category as a whole fell 2.6%; we see plenty of future growth opportunities ahead for Dave's and our other brands, and we're putting money into marketing and innovation to seize that potential. Our 2024 forecast anticipates continued solid results in spite of these category headwinds. We anticipate a first-half weighting for these results, driven by wraparound pricing, branded retail, fresh pricing across certain food service accounts, and easing commodity costs. Our forecast for the second half builds in added caution given the unclear consumer and promotional landscape. We stay concentrated on the substantial longer-term opportunities in front of us—filling white space across geographic and product adjacencies while using innovation to move into new categories. My confidence in our long-term potential has never been stronger, and I'm eager to build on our solid foundation through 2024. With that, Norma, let's open the line for questions.

Just a few quick questions here. I suppose — maybe the first item is really more directed at Steve. When we look at the year, particularly the first half versus the second half, what's your view on how gross margin will trend, given that some of your input costs have come down, but also perhaps there's potential for continued promotional reinvestment?

Sure, Rob, I'll begin, and Steve can certainly add to it. From a gross margin perspective, we're anticipating stronger results. We had a good gross margin gain in the fourth quarter, and we anticipate that carrying forward. There are a couple of other things, though, to consider that will affect bottom line performance. First, we're putting money into the business. So whether that's ERP or our marketing spend, and so on, supporting Dave's and Nature's Own and the new bar launches and all of that, we're putting more marketing dollars into the business. So that will put some pressure on margins from an EBITDA or bottom line perspective. But clearly, those are meant to drive future growth and are investments we're glad to make; still, we would anticipate some gross margin improvement. But another thing worth noting, partly offsetting that, we discussed in the prepared remarks the stranded overhead from the strategic exits. That does, especially on the labor side, impact those margins somewhat. However, what's exciting about that for us is the chance ahead to refill that capacity with higher margin volume, which was the plan from the start. Now clearly, that won't happen all at once. It will require a bit of patience; but we have a really substantial opportunity in front of us to refill that extremely low margin business we've exited with far more profitable business. Steve, would you like to add?

Yes. As Ryals said, and as you noticed in the script, we're taking a somewhat more careful view of the consumer for the second half. So if you look at the overall cadence right now—roughly in line with the guidance range—we do expect better results in the first half. A lot of that, as Ryals noted, stems from a mix of positives and negatives—in particular, I'd say, the easing pressure from commodities. If you think back to last year, the first half was harder than the second. So from an overall comparison standpoint, that's what will drive part of the first-half improvement, since we've seen things soften a bit. For overall commodity inputs, our expectation is that the benefit will be greater in the first half of 2024 than in the back half.

Okay. Perfect. All right. So my second question: I think the guidance kind of inherently allows for continued volume declines. Obviously I get there's a bit of pressure on the consumer backdrop, and clearly a fair amount of pricing is flowing through. Dave's is doing well, though I'd say that's a bit of a different situation. So I'm just curious — when we hear from many other companies all facing some form of volume pressure, there's kind of an expectation that as we go through the back half of '24, the chances should increase that volumes actually get back to growth, partly just because of the lower base and the easier comp in the back half of '23. So it sounds like you're being somewhat more cautious and perhaps a bit more rational than others. So the direct question is just: why not forecast a bit more on the positive volume side as you move through the year? That might occur, sure — it's simply that you can't really tell if it will, and that's probably a realistic view.

Yeah. Look, that's a reasonable observation. And it's quite clear the category remains under pressure, and private label trade down is part of that too. But when you look at our market share results, what we've been able to achieve even in this environment is fairly impressive. Of course, we recognize that share gains in a shrinking category don't automatically convert into bottom line profitability, but they do demonstrate that the investments we're putting behind our brands allow us to keep posting comparatively strong results in a category that's under pressure. Regarding this year's volume forecast, your view is not one I'd argue against. As the market settles into a post-pandemic reality, there's definitely a chance the category reaches its equilibrium — which seems to be what it's attempting. We might witness stronger volume results during the back half; however, one reason we remain cautious is the potential counterweight of a more promotional climate in such a scenario. In other words, should the category choose to lean more heavily on promotions in order to move units, that could work against us. One additional point worth mentioning is that our volume results got better and better as 2023 went on. By year's end, branded retail volume was lower by just 30 basis points — a meaningful gain — and volume overall rose. In Q4, if memory serves, the decline was 2.4%, versus 4.1% back in Q3. That progression looks solid, and it gives us reason to feel optimistic — something we believe is reflected in the top end of our guidance. Still, in light of the uncertainty and the category's comparative softness, we felt prudence was wise for the time being.

All right. And then forgive me for a third question, quickly. Just on the California legal decision, you said during prepared remarks that no decision should come before March 1. Could you perhaps give a bit more detail about what that ruling might mean — for instance, if it goes one way, would we likely take on punitive damages or something like that? I'm not certain, or maybe there wouldn't be much material effect. I'm only trying to grasp what that might mean against the current guidance.

Yes. So we've already disclosed what the settlement will cost the company. I think the more pertinent answer to your question is what happens after March 1 should the settlement be approved. And if that's the case, what will happen is we'll then begin converting every distributor in California to an employee-based model. At least initially, that is likely to be somewhat dilutive to our results there in California, at least near term, until we can get everyone trained up, et cetera, and bring all the employees on. The good news, though, is that it will be a phased-in approach, Rob. So we have 12 months from the settlement date to get that done. So we'd expect — and I think we said during prepared remarks — probably first quarter of '25, that conversion should be complete.

Could you give us a little more detail on foodservice and the cake business — what your thinking is there, and in particular which initiatives you're looking at to make things better on the Tastykake side, or cake overall, and how you see those trends playing out compared with the core?

Sure. I think we've mentioned this during a few prior quarterly calls, but it's a good question. I'd like to expand on it a bit; so obviously, pricing has been a factor in both of those areas — in all of those areas, private label foodservice and the cake business. You're aware we've finished some pretty big SKU rationalization plus strategic exits from certain businesses—mostly in foodservice and cake, with a small amount in private label too. Even so, profitability has risen noticeably across all three of those units. From that angle, the strategy is delivering. Naturally, there are offsets in other parts of the business—the soft variety and white bread segment, Bill, as you know, is the most vulnerable to private label trade down, so that's clearly a negative, and then the DKB unit volume performance offsets it. But honestly, even DKB's profitability dropped quite a lot last year, since our organic wheat cost was substantially higher that year. Dave's margins remain quite appealing—specific figures aren't disclosed, yet they still rank among the strongest in the portfolio. Those margins, however, fell by about 500 basis points in the past year, purely as a result of higher organic wheat expenses. This year those costs will ease to some degree, so we will win back a portion of that. Overall, there's genuinely solid improvement in those areas of the business, partly counterbalanced by softness in the category, commodity cost pressures, and the impact of those factors on other segments.

All right. And now a bit about commodities. I suppose in the past you've basically said, look, we hedge 6 to 9 months ahead. I realize it's largely the same point, but this time you're telling us, look, we're 70% locked in on input costs. So has anything changed in how you approach this? Or are we simply talking percentages instead of months?

No, not truly, Bill. Our strategy remains looking 6 to roughly 12 months ahead; so in some cases probably toward the shorter end of that. But the fact is, I think last year, as we entered the year, we had about 60% — 65% coverage. So we remain quite committed to our overall strategy. We have — we've added a few items to the toolkit, so to speak, to better manage the volatility, the trading there. But nothing has changed in how we view coverage and how far ahead we plan, how far ahead we're prepared to go.

Understood; and no — and actually, a quick follow-up about the DKB bars: is there — and apologies if — if this has already been addressed, but is there anything you can — are you seeing repeat rates or anything that gives you — the pushback we sometimes hear is that it's a crowded category; and I know DKB has a strong brand, but how do you differentiate or secure incremental shelf space against the 20 other bars sitting there? And what gives you that confidence based on what you've seen over the past 3, 4 months as you expand this year?

Yes. As we noted in our prepared comments, we're quite happy with how '23 performed. We ended up in significantly more stores than our goal. To start, the product is excellent. We see that as our point of difference. What distinguishes the loaf items and the breakfast items is really just the higher quality. It's a baked bar with excellent flavor and texture, plus a strong nutritional panel. A lot of bars in that segment are cold-pressed. So we deliver more of that freshly baked taste, which — if you've had them, you can definitely attest to. But you're correct regarding shelf space. We only have 3 SKUs on the shelf, so positioning is truly important. What we're observing is that in spots where our shelf placement is solid — roughly at eye level, mid-shelf — even with just those 3 SKUs, the striking colors we offer genuinely draw shoppers in, whether they already buy DKB or are discovering the brand for the first time, and that adds net new consumers to the DKB base. I really believe this will be a big help to us as we launch the 3 additional protein SKUs this year, which will give us greater shelf visibility. And as we've mentioned previously, those protein bars in test market are demonstrating incrementality relative to the first 3 SKUs. So through that higher protein offering, we're effectively extending our reach to a wider consumer base. The velocities align with the categories, so we're in good shape there; there's always room for improvement and we'll improve. As we've stated repeatedly, we're running this like a start-up. We're also picking things up as we go, Bill. But thus far, things are going well. And naturally, behind that sits a solid innovation pipeline, with 4 days launching with the snack bites in the back half and even more to come beyond that in '25. So we've gotten off to a strong start. We have good momentum. The team is enthusiastic. Consumers and retailers are both enthusiastic about it. So we feel really positive about where we stand at this point. It's early, but we're in good shape.

During your prepared remarks, you noted there’s some uncertainty in 2024—clearly, around the consumer and promotions. I think we all understand the consumer part of that; but to dig deeper into the promotion side, is the worry that some of the bigger competitors in the category might go back to how they acted previously, when they chased volume really aggressively? Or is it more that retailers will approach you expecting price deflation and use promotion as a way to get there?

Yes. Jim, it’s definitely the former. We’ve witnessed this in our category previously. We haven’t witnessed it in quite a while. And although, as we noted in our remarks, we actually promoted somewhat more in the fourth quarter simply because, as you know, there is seasonality in our business—since we aren’t a big dinner roll supplier, the fourth quarter can be a little volatile. So we promoted somewhat more to drive additional unit volume, got solid effectiveness from those promotions, but we also spent nowhere near as much in trade to achieve it and kept one of the highest average price points in the category. But yes, the concern is far more about the other competitors in the space than about pressure from retailers, which we truly have not experienced so far.

All right, that's helpful. And it feels like — we've discussed this before — but one piece of the difficulty is that you've got this channel shift happening, and from where the branded retailers sit — or actually from the branded food company's side — if you're spending promo dollars in one channel while the consumer is in a different one, then really you're just handing out price, at least that's roughly how we've been looking at it. So would we need to wait for the consumer to move back toward traditional grocery before we start to see those promotional increases actually go in? Or could it happen that, even with consumers still in these value-oriented channels, competitors simply put promo into the channel regardless, just to find out what happens on the other side?