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

Great. Good morning, everybody. I'm Pete Galbo from the beverage team here at BofA. We're delighted to join the conference this year by Flowers Foods. I believe, first time at the conference. Guys, thanks for being here. Flowers is a $5 billion revenue business, leader in packaged food bakery, including brands such as Nature's Own, Dave’s Killer Bread and of course, Tastykakes. So guys, thanks for being here. Steve Kinsey, CFO; J.T. Rieck, EVP of Finance and IR; and then we have Eric Jacobson from IR as well. I really appreciate you guys being here.

Well, thank you. Thank you for having us.

So Steve, maybe just to kick off from a very high level, if we can kind of get an update from your perspective on the consumer, how are they kind of holding up, particularly as inflation [ wins ]. I know in your probably biggest commodity, and maybe there's even been some deflation, so we can certainly talk about that, but would love to kind of get an update from you on where the consumer is.

Sure. Looking at the consumer kind of thinking about where we are today -- and we talked about this when we gave our guidance, we're still pretty -- are fairly cautious from an overall consumer perspective. When you look at the category and you think about what's happened over the last 12 to 18 months with pretty significant inflation, you saw the consumer may become more to value. We did see private label trends turn somewhat. If you go back pre-COVID, we were seeing private label down pretty sizable in this category. And what you saw probably in the last year or so is the consumer going -- maybe shifting back some into private label through value channels. We did see that begin to moderate some in the fourth quarter. So from that perspective, it seemed like maybe some improvement with the overall consumer. But the fact that private label did take a turn doesn't keep us a little more cautious from an overall consumer perspective. Now saying that, our brands have done, we believe, well throughout this. So we'll continue to watch from that perspective, traditional grocery brands have done really well. You have not necessarily seen kind of the private label impact that you've seen more in the mass channel. So again, as we said in our guidance, we're really watching the consumer in the first half and there are some size that many things could be potentially improving, but we're not really ready to call that yet.

And just being newer to your business, is there a private label impact more to any brand in particular that feel the pressure within the portfolio? Or is it kind of more broad-based?

I mean typically, private label impacts more your wheat or white bread offerings from an innovation standpoint or a premium standpoint, really, there's not typically a comparable product. So you'll see even in our data from a brand perspective, more to impact hit our private -- hit our wide offerings or [indiscernible] which is primarily our wheat offerings.

And you spoke a bit about the mass channel dynamics. Just any update on what you're seeing in grocery, more traditional grocery?

I mean, I'd say traditional grocery, again, it's probably more strategic on how the channels operate. You're just not seeing the private label impact in traditional grocery that you've seen necessarily in mass or kind of more the value channels. Some of that's consumer-driven based on probably demographics [ who shopping were ]. But we feel like across both channels, however, the brands continue to hold up well.

And maybe you can just give a state of the union across the brands, and particularly the major brands, just what changes you're seeing for at least for the key kind of 3 or 4?

Sure. I mean, obviously, Nature's Own is our kind of our staple, has been around since the late '70s. It's been a huge part of our growth when we made acquisitions. And it's been the brand that we took to market and we have had tremendous success with that brand. Again, we've had good innovation there. More recently, we've had products like Nature's Own Perfectly Crafted. I'd take the more -- a little more premium. And what you're seeing with that brand is where we've had innovation, things seem to be holding up well. Again, where you have products that compete more directly with private label or with a competitive brand that may be very similar, maybe a little more challenged. Then you move to more of a premium channel, like what Dave's Killer Bread or Canyon. We see really good brand performance there when you think about Dave's Killer Bread and what's happened with that brand. It's driving a lot of the category as well, the organic category is. While from a category perspective, you're down roughly 2.5%, 3% from a unit volume perspective. The reality for us is the premium channel has been up from a volume perspective. Q4, DKB was up almost 10% from a volume perspective. The category was down about 2.6%. So it appears that the consumer really is looking for innovation, Better For You attributes and products. And those products seem to be driving decent volume response. Same thing with Canyon, gluten-free, again, a premium product for us. We've seen things fairly stable, I guess, with that, I'm sure we'll get to it. We had -- back early in the year, we had an issue with production capacity, all that's behind us. So on the DSD side of the business beginning to see that ramp back up from a volume perspective. But on the warehouse side of that business, it's a little harder to push things through. So again, when you look kind of at the brand portfolio and you look across kind of traditional loaf and premium, good performance, I'd say, across the whole but definitely driven by innovation and Better For You to our products.

I mean I think a good example of that to add to it is the Nature’'s Own keto loaf, which was actually introduced a little bit -- maybe a little bit behind some of the others in the category, but it's now the best-selling keto loaf in the category. It's gained almost 600 basis points for the Nature's Own brand. So I think that's just a great example of how that differentiation is really resonating with the consumer.

And maybe if we just think about your brand performance within the category, how much of that is, I guess, driven by economic conditions for the consumer or the category versus kind of factors that you can control. So whether that's the innovation you talked about A&P spending...

Yes. I mean again, just kind of going back to the category, obviously, as I said, we've seen some challenges. The reality is if you look at like promotional activity, I'd say things have been pretty rational for the most part over the past few years. We're definitely below pre-pandemic levels within the category with regard to promotions. Coming out of Q4, we did say we started to see some increase from promotional activity. I think the good thing for us is overall promotional and effectiveness, I think was good in Q4. More recent track channel data would indicate that continues. So we'll continue to watch that. Hasn't necessarily had an overall impact on volumes from a brand perspective. Again, I think it goes back to innovation and what consumer expectations. The reality is, like I said, we're getting the most volume pull through on products where we've been focused on innovation over the past 12 months or so and products more at the premium level. So I think -- when I think about category impact, maybe what we can control internally, definitely staying focused on investing with innovation on our products.

Maybe we can switch gears a little bit. I'm looking back to your investor slides, you kind of have an updated portfolio strategy. I think the kind of 4 quadrants that you lay out. But maybe you could just give us an update there and expectations of kind of that portfolio strategy shift going forward?

Sure. I mean a few years back, we get shift. I'd say prior to 2019, we were brand-focused, but we were probably just as equally a volume-driven company. As we've shifted our focus more to branded products, shifted more to driving higher margin across the whole portfolio. I think we're seeing pretty good success. When you think about brand profitability and you think about overall profitability for the organization, we've seen the really, really good margin improvement more recently through the inflationary period. Obviously, there's been volume challenges. We've been working to drive more volume through there. But a lot of that volume improvement has been somewhat masked by the inflationary aspect of what's been happening in the last couple of years. And then also, when you think about kind of the [ non-rating ] side of the business, have been very focused on taking out a lot of the business maybe doesn't hit our profit profile. And if you think about the volume challenges over the last 12 to 15 months, a lot of that has been intentional as we've taken that business out. And as we said in our guidance, we expect complete the majority of that in the first half of 2024. So we'll be good to have that behind us and then just really focus on either bringing more branded business across the whole or either bringing back in more non-branded business in an appropriate margin profile.

I wanted to switch over to Dave's. Fascinating story, a fascinating brand history there that we've certainly had to do a little bit of reading on. But I guess, just given kind of Dave's very high share of the organic category, just how much more growth runway does that brand have? Is there an ACV metric that you think about or a [ GDP ] number that we should kind of be pegging to when we think about that brand?

Sure. I mean, if Dave's is -- I mean -- it's a phenomenal brand, but all measures, it's been a huge success. The acquisition was in 2015, became a $1 billion brand last year at retail. So I can't think of many brands that have had that much success in a short period of time. So definitely pleased with the growth and the impact that brand is having on the organization and the category as well. When you look at growth opportunities, obviously, when you look at kind of geographically, we're very focused on the Northeast and we're very focused on the West Coast with that brand, although it grew out of the West Coast. And I feel like there's still some white space with the brands not offer today. So while the growth has been pretty significant, by no means do we think the opportunities that started -- the things are coming to an end. I mean, we've taken that brand across category across segments. It's in breakfast now. We're getting good growth across breakfast with English muffins, bagels. As we've taken it out across the whole, we actually made an acquisition last year to give us more production capacity to allow us to focus on breakfast with the [ team JV ]. And then we've also taken across category, and I'm sure we'll get to this in a minute into bar. So the category seems -- I mean the brand seems to have relevance with the consumer. And it's just been amazing how we be able to take that brand and do things we haven't been able to do with maybe some of our more legacy brands like Nature's Own.

So that's a good transition to bars. Just maybe an update on bar's performance. And I guess within that will be helpful. Bars have been a relatively challenged as a category as a whole. So I guess the a, just the decision to kind of enter bars and then Dave’'s just performance kind of within that as well.

Sure. The bars came out of internal innovation. We're very pleased so far with what we're seeing. Last year, we launched 3 flavors, kind of across our whole. We had good sell-through. We had a good acceptance. A lot of it -- we're investing heavily. But from a velocity standpoint, very pleased with what we're seeing. It's a little different from a bar perspective. It's more of a baked bar, great taste, great texture. When you look at the ingredient panel, like less sugar content than what you traditionally see in the bar. So I think it's something different and it's something the consumer seems to be pull towards, so we feel good about that. The back half of last year, we did test 3 additional flavors and we added protein content. We are rolling that out across the whole this year. So far, we've been pleased with velocities with that particular item as well. And the good thing is we're not seeing significant cannibalization. It appears that there's a consumer set who's pleased with the base bar and then there's a consumer set looking for the protein additive. So we believe that based on what we're seeing that we can continue to see good growth as we get more shelf space and get more relevance within the bar category.

And I believe there's a snack bite launch for this year as well. Talk on that.

Yes. So we also have Dave's into like a snack bite category. It's kind of a cross between a [indiscernible] product and maybe like a crunchy cracker. Again, we're testing that in the first half of 2024. And then based on the test markets, our plans are to roll that out across the back half. Very excited with that product as well. It seems to be doing well from a test perspective. Again, a couple of SKUs, a couple of flavors and it will be merchandised probably near the [ granola ] section of the store. But again, it has that DKB packaging that kind of pops and we feel like in the brand resonates well with the consumer in that segment of the store. So very excited about that launch and really looking forward to seeing what that product does as well. Because I think it's just -- it just shows how well that brand can go across many different categories within consumer and food. And it's exciting to continue to invest in that brand and see what we can come -- what can come from it from an innovation perspective.

We switch over maybe to Canyon. I think you've had some capacity issues there. You touched on a little bit, hindering some of the near-term growth. Just an update there in terms of resolution and then maybe to go along with that. Maybe when we might start to see that kind of flow through some of the scan channel data?

Sure. I mean last year, we did have some capacity challenges in our facility in Colorado. Those are now fixed. They're behind us. And as I said, we're beginning to see the DSD side of the business is kind of the fresh velocities pick back up. Things are getting back on track. It's a little bit easier to push things from a DSD network perspective because that's kind of within our control to manage the inventory and drive distribution. On the frozen Canyon actually distributed frozen when we made the acquisition. So on the frozen side of the business is a little more -- takes a little more time to get product through the kind of through the distribution cycle. But we're seeing -- but we believe that will [ prove ] itself in the near term. So we're excited about having kind of that issue beside us. And now we have the ability to go back and focus on growth of that brand as well as innovating in that brand as well, whereas we were having the capacity issues. I think we were more focused on just getting that fixed. But again, we believe it's a brand that within that category and segment it resonates really well with the consumer. If you never tried it, has some very great taste. And from a gluten-free perspective, believe that, that brand could also bode well from an innovation standpoint.

And maybe what we might start to see that kind of come through in the data, some of the takeaway trends start to improve.

I mean I just think some of it on the DSD side. I think probably -- we're near probably more back half with regards to kind of the warehouse business which we're pushing probably back through the network.

And maybe zooming back out to the category, you spoke a little bit about promotional cadence and what you've seen, I think there's been kind of an increase in products sold on promo. I guess how should we think about over the next 6 to 12 months pace of promotional cadence? Are there, again, being newer to the category? Are there key promotional windows didn't matter as Memorial Day particularly important for the July? Like what should we kind of be honing in on as some of the key windows?

Sure. I mean as we said, we did see Q4 an indication that the promotions are starting had increased, and that continues through some of the more recent track channel data. Obviously, most of our promotions are planned well in advance of the year with our retailers. And to your point, they do -- a lot of those come around key holidays like Memorial Day, July 4, Labor Day, especially with regard to our bun business. On the low side of the business, typically, those are more evenly spread throughout the year and just how they fit with the retailer promotion strategy. But again, good visibility in all of that. So we've -- that's all in our guidance for the year. But I'd say, for particular product segments like buns, the holiday seasons are very key and very critical, and you'll see that. You've seen that in the past and as we talk about kind of the summer bun months and some are bun for those -- is very key for us. One thing we've done to kind of enhance that as we've partnered with the USO. So you'll see in most of the major retailers, you'll see nice displays around certain holidays, especially Memorial Day, driving overall bun -- kind of try to drive bun volume. And that's been a very successful partnership for us. We're in our the third or fourth year of that now. And we've really seen that work well. So excited to have that in front of us for this year and looking forward to see to that season, in particular with regard to buns.

And maybe just 2 follow-ups on that. One, have you kind of disclosed what buns are as a percent of the portfolio? Is it 5%, 10%?

No, we haven't given life. We don't give specifics, but necessarily by category. But buns are pretty significant for us with regard to brands. And obviously, it drives a lot of the foodservice, QSR business.

And I think maybe a second follow-up there. If I'm just thinking back to the fall, the retailers were very focused on having baskets available for consumers that were at a certain price point, we could get an entire Thanksgiving dinner for $50. I mean is that conversation happening or has already happened with the retailers, they're very focused on having a basket of -- it's not just buns, but hamburgers and [ catch-up ] for a certain dollar amount as we go into Memorial Day as we go into the 4th July? And what's that conversation like?

I mean we have -- we're always having conversations with our retail partners, obviously. I wouldn't say there's like a tremendous focus on necessarily baskets of affordability within our segment per category. But you want to make sure from our perspective, the promotions aligned really well when the consumers are kind of "shopping" and makes the most sense. So again, we try to strategically align things like the USO promotion with major holidays. And then there'll be good price points as you promote and you drive volume through the holiday season. But I feel good about where we are strategically from that perspective. And like I said, most of our promotion cadence is set well in advance with our retailers, and I feel like we have a strong promotion calendar, and that's an opportunity to drive volume growth.

Maybe an update just on your ERP rollout. ERP seems like a 4-letter word to a lot of investors and a lot of companies, but where things stand today and kind of how you see the go forward?

No. It's not a small task. It seems like less companies go through this every 20 or 30 years. So we're not immune, and we're in the midst of it. We've been in it now for a couple of years. A lot of the development, a lot of the -- that is behind us. And we did start to roll out last year. As we disclosed, it's about a $350 million project for us across 4- or 5-year period. We're scheduled to be fully live in 2026. To date, we've spent about $215 million of the $350 million. Really, what we have left is primarily the rollout to our bakery production floor. Through the end of last year, we hit a lot of our administrative functions, a lot of our sales, a lot of our trade promotion spend programs. And most of that now is behind us. We're still running 2 systems in a lot of cases. So as we continue to roll out over the next 12 to 18 months, hopefully, we can consolidate down to one and that will reduce a lot of complexity. But for now, we're on track. We did roll out to 2 bakeries last year. And as we called out, we had a couple of bumps or challenges. So we kind of paused the bakery rollout. We've gone back now and we feel like we've gotten all those identified, everything are corrected. And the goal is to start back with bakery rollouts in the back half of 2024. So again, a major project, we feel like -- we've done a good job mitigating any kind of missteps that typically come with these projects. We didn't miss any days on the market, so that's a good thing. And we look forward to getting behind us in a couple of years.

And maybe just another update. I think you had a California legal settlement. Just any update there and impact maybe on how you distribute in California?

Yes, sure. I mean -- as we disclosed last year, and as we've been working through some of the challenges with our independent operator model, we did in California reach a settlement with regard to the model in that market. The market -- that market is a little more challenging. I think when you look kind of at the regulatory environment around independent operators, as we move to that lawsuit, we realized that it was probably best to move back to company-operated territories. So that's the goal. We did reach an agreement with the [indiscernible] in that case. We're still waiting on the judge to get final approval. We went back early March, and we're just a few weeks away hopefully from getting the final order. And once we get that, then we can begin to move forward with that transition to avoid as much market disruption as possible. We do have a 12-month period. It's been approved from that perspective. And that will allow us to kind of take it in bites and roll out convert to company-owned territories versus the independent operator model. We operate company-owned rounds today in other markets. This will just be a bigger scale. So we're pretty confident from that perspective. The one thing that we get asked about a lot is kind of the financial impact versus independent operators through the rollout and the fact we're having to ramp up staffing and make sure we don't have a misstep. It will be slightly dilutive, but we've built that into our guidance. And then as it ramps up and then we're fully operational, we believe there will be a lot of advantages and opportunities on the top line perspective. And more longer term, we believe that kind of offsets the near-term cost challenges from the conversion.

Is there a view internally or in the markets where you have company-operated DSD routes, do you see a material difference in performance relative to -- I know when we speak to the salty snack guys, right? There's I guess, very strong views on both sides, some live and die by company-owned because they think the execution and in-store display is better, but I'm just curious kind of how you view?

Yes. The reality is, it depends. We did this on a smaller scale in the Northeast about 18 months ago. But you do have more control over a company-owned route as far as dictating what has to happen in the store. But the reality is a lot of the IOs are entrepreneurial and they're driven to drive execution because that controls their income. So I mean it's balanced. I wouldn't say necessarily that one is significantly advantaged over the other, especially given the scale we have right now with IOs. So we'll see how California shapes up and again, a lot of it is driven by the regulatory environment and [ it works ] in a particular geography.

Okay. I wanted to switch to the M&A environment. Obviously, it's been very topical. In fact, package food in particular, and we've certainly written a lot about it and I would have thought we probably would have seen more by now this year. But just kind of curious what you're looking for maybe in terms of acquisition size, category-wide spaces that you'd be interested in?

Yes. I mean, obviously, if you look at Flowers, if you look at our history, we've gone through M&A. I mean this industry years ago had local baker in every main geography and that there was kind of a roll-up story. So when we talk about M&A, we look at that as more traditional, a lot of that was bolt-on. There's still opportunities left with kind of traditional bakery especially when you think about our white space Midwest, Northern Midwest. There are probably a couple of family-owned bakeries that would sit well with Flowers. It gives us great production capacity. The regional brands are important as well. When you look at some of the regional brands we have today and what they do, do for the portfolio, so we still see opportunities there. And then obviously, we've talked about being more in adjacent categories, some of the things you've seen us do with the Dave's brand is what we mean when we talk about adjacencies. There's still truly kind of baking maybe grain-based focus, but not traditional bakery in the sense that we've grown over the years. We feel like there's a good pipeline of opportunities there. If you look at Flowers and the way we've managed that has all been relationship driven over the years, and we continue to focus on some of the opportunities that we see making sure that we maintain those relationships. So when they do come to market, hopefully, we have the opportunity to be the kind of the bar of choice, if you will. And feel like that's boded well for us for several decades now. So again, it's kind of like you in the market, it would be nice to have the opportunity. But you also know we're very disciplined from that perspective. And I would say we probably missed opportunities on valuation. And -- but it does seem like valuations have maybe come in slightly. But when you get -- again, it depends on legacy versus kind of more adjacency or niche-type products because usually there's more growth opportunity from a brand perspective with a niche type of acquisition. So excited about kind of what's in the pipeline or what we see and just hoping that we have the opportunity to participate.

And where would you kind of be willing to take leverage in to -- in the...

Yes. So when we think about a leverage perspective, if you look at Flowers historically, again, I think we've done a good job managing our balance sheet. We're very focused on keeping our investment-grade credit rating, which takes you to 3x maybe slightly north of that, which fits well with the type of acquisitions that we consider they're more bolt-on kind of tuck-in type acquisitions. And we typically will lever up and then have a pretty clear path to delevering over the next 12 to 18 months. So again, we're going to stay very focused on investment grade. And we don't mind going up to 3 or over, but our comfort zone is probably more where we are today, maybe 2 or less.

And I'd be remised if I didn't ask you this, Steve. So obviously, we had one of your competitors in the sweet baked goods category that was recently bought. I noticed when I looked at the back, Tastykake seems to be in the maximize profitability quadrant. So just -- how do I think about it? It's placing your portfolio. Obviously, this other asset had a lot of bidder for it, seemingly maybe somebody might come knock on your door, but I'd be curious, just how you think about that, particularly where it's positioned in the portfolio?

Well, we get a lot of questions about that, obviously, and that's kind of a loaded question. So I need to be very careful not to take the [indiscernible] No. I mean, Cakes been an important part of our portfolio for my career at Flowers. I mean, we've got other brands besides Tastykake. Tastykake is our DSD brand. We made that acquisition in 2011. Probably a little more challenging than some of the other brands in the category. It was very well known in the Mid-Atlantic. We've taken it across our -- for the most part, our whole DSD network. And it's kind of held us on #3 -- well #4 brand in the category. So it does make it a little more challenging from a shelf space perspective than an add-on as to see. We've talked about the operational challenges we've had with the bakeries and stuff from that perspective. So the last 12 months or so, we've been focused pretty heavily on correcting that. We've made good improvement. We're not where we want to be. So we continue to look for margin opportunities on the operations and cost side of the business. And they continue to look to -- look for opportunities to make that brand more relevant in the market as well. And then we have our warehouse cake brand, which is Frestillas, which is kind of more of an economic brand. It also goes through [indiscernible]. Again, that brand has kind of held us on from a positioning perspective. So while I would say there was a nice transaction in that space, we still think cake has its place in our portfolio, and we'll continue to operate in and drive the margin improvement that we think we need. And then I guess, things go from there.

The -- Frestillas is a nice throwback.

Yes.

Yes. All right. Cool. Maybe just in the last few minutes, we can touch on guidance that you gave for the year. And I think it was unique in a good way. You're probably the only packaged food CPG company that gave a front half weighted year. So maybe you could talk about the dynamics there, the inverse hockey stick, I guess, as people would call it, given that most of the packaging companies that we cover are very focused on a back half '24 recovery. Just what kind of drives your confidence in the first half?

I mean I think a couple of things there. When you think about our business more historically, we have a longer first quarter and then the first half captures some events like we talked about Memorial Day. So that does drive a lot of the performance in the first half. When you look at some of the key factors impacting our guidance for the year. We know we have -- still have some pricing to come in the first half based on what we took in the back half of last year. We also know our cost structure is a little more certain than the first half, although we said coming out of 2023, we're about 70% covered with regard to our input cost. There's a lot more certainty in the first half of the year than obviously the back half with regard to that. And then we said we're very cautious on the consumer still. Starting to see, as we said in Q4, some movement in promotional activity in the category. And now that has continued somewhat in the data. This year, we just felt like it was more prudent to kind of take a wait and see. What the consumer does, what competition does from an overall promotional cadence. And then as the year builds, obviously, we'll be able to think more about the back half and where things go.

And do you have a view on kind of wheat cost? I mean, I know you said you're probably 70% covered on that, but just kind of the...

Yes. I mean, obviously, there's been a nice pullback. We use primarily [indiscernible] winter wheat, which is Kansas City Exchange. Even though things have come back from the kind of the inflationary higher, we're still at elevated historical levels from a wheat production -- from a wheat cost perspective. So yes, I mean, it does seem like the crop is going to be a decent crop. It's not necessarily you need export pressure currently with regard to So we do feel like that it's in kind of a range where it lands on that range. Who does, but we do -- we don't see anything right now that would indicate it would take a turn and then be run back door. So we feel pretty good about that, and that actually bodes well for maybe the lower term as well. So we'll continue to watch that.

Great. I think we have a minute or 2. Are any questions in the room or anybody? All right. If not, Steve, J.T., guys, thanks very much for being here.

Thanks a lot.

Enjoy the rest of the day.

Well, thank you.

Thanks.