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

Hi, everyone. I'm J.T. Rieck, EVP of Finance and Investor Relations. Thanks for joining us as we discuss Flowers Foods' 2024 First Quarter Results. Before we begin, please remember that what's presented here may contain forward-looking statements regarding the company's performance. While we believe those statements are reasonable, they carry risks and uncertainties that might make actual results differ materially. Beyond what you hear in these remarks, important factors concerning Flowers Foods' business are laid out 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. It's great to have everyone join us on this call. Our strong first-quarter results highlight how our portfolio strategy has been progressing—something we've talked about for a number of years now. In a market that's both challenging and dynamic, we increased branded retail units in tracked channels, beating the fresh package bread category. Our powerful brands also pushed dollar sales ahead of the category, rising 4% while the category grew just 1%. Importantly, momentum across total company volumes built as the quarter went on, turning positive during the last 4 weeks as our branded products keep picking up share and declines in our away-from-home business moderate. If you set aside the deliberate exits in our away-from-home business, company-wide volumes rose in the first quarter. What's even more encouraging is that early indicators suggest these gains have carried over into the second quarter. As I noted, the driver behind that performance was our portfolio strategy, which is designed to move a larger share of our sales toward higher-margin branded retail products while also lifting the profitability of our private label and away-from-home businesses. Our pandemic-era results showed what that strategy could deliver, since the mix shift toward branded retail products produced substantial margin expansion. In the years since, we've concentrated on pushing that strategy forward, strengthening our brands by investing in innovation and marketing. We've also reshaped the makeup of our away-from-home and private label businesses, prioritizing margins over volume. Near term, that process left us with stranded overhead that weighed on corporate margins. Yet underneath, profitability at those businesses improved sharply, and we're now seizing fresh opportunities to rebuild the volume we lost at better margins. Financial results picked up steam as the quarter progressed, with solid performance on both the top and bottom lines. Sales got a lift from pricing actions carried over from the prior year, along with improving volume trends. Margins benefited from moderating commodity costs, partly offset by investments in growth initiatives and higher labor expense. The bread category keeps outperforming, with unit sales flat against a 3% decline in overall food, as Slide 9 shows. Category trends matched the recent past. Even though the economic environment has pushed demand toward private label products, which picked up 30 basis points of unit share, Slide 10 shows that this shift has clearly eased. In fact, private label actually gave up share during the final 4 weeks of the quarter. In this changing environment, our brands keep flourishing, holding unit share for the quarter and adding 50 basis points of dollar share in tracked channels. We did especially well in specialty premium sandwich buns and rolls and in breakfast, where we gained 140, 40 and 40 basis points of unit share, respectively. This encouraging performance strengthens our confidence in our long-term prospects as consumer demand normalizes. Given these results, we're largely keeping our financial outlook for the year, though with higher expectations for capital spending tied to supply chain optimization initiatives. We feel good about ongoing volume gains and anticipate benefiting from fresh profitable business wins plus expanded savings efforts that should come through in the back half. We're still a bit cautious given the murky consumer picture and promotional activity. Steve will go into further detail when he speaks. Next, I'll walk through how we performed in quarter one relative to our 4 strategic priorities: building our team, concentrating on our brands, putting margins first and chasing smart M&A. After that, Steve will go over the financials and outlook, and then I'll wrap up by covering the key themes ahead. I can't overstate the enormous strides we've taken in a tough market. Those results stem directly from the dedication of our people, who represent our biggest edge over competitors. Whether it's creating new products, moving into additional markets, strengthening ties with retail partners, making our manufacturing more efficient, sharpening our route to market or countless other efforts too many to name, the Flowers team stays committed to making our company better every single day. Their passion and commitment leave me humbled, and I take enormous pride in what they've achieved. Priority two on our list is a focus on our brands, and those keep connecting with shoppers. Even though inflation is pushing people to prioritize value, they still look for something distinctive. Our brands provide a range of choices across different price points, and performance is coming through well across the portfolio. Dave's Killer Bread keeps delivering outstanding results even with softness in the premium segment. Dave's picked up 30 basis points of dollar share while unit growth reached 10%. Nature's Own and Wonder each added 20 basis points of dollar share, results just as strong as the other brands. Canyon Bakehouse, helped by capacity we recently brought online, is progressing toward restarting growth, lifting dollar share in gluten-free by 40 basis points. We credit these solid outcomes to the strength of our brands, how we execute in the market and our innovative products. As proof of how effective our innovation engine is, Flowers has launched the #1 new SKU in bread for each of the last 2 years — Nature's Own Hawaiian Loaf in 2022 and Keto Net One Loaf in 2023. Our pipeline of innovation keeps getting more productive, with 11 new products rolled out recently. To illustrate, we built on the success of the Keto Net One Loaf — the best-selling keto packaged bread across the country — by bringing out Keto Soft White Buns. Rounding out the lineup are Nature's Own Perfectly Crafted flatbreads, DKB Organic Rock 'N' Rolls, Wonder bagels and English Muffins and Canyon Cinnamon Raisin Bread; and naturally, the nationwide launch of DKB Amped-Up Protein Bars is underway, with DKB snack bites slated to follow across the country shortly. The original DKB snack bars keep drawing solid consumer backing, which is an encouraging signal as we roll out these follow-on items. The range and reach of what we've most recently introduced really show how we keep concentrating on innovation and on expanding our top brands. With shoppers looking more and more for items that stand apart, bringing fresh and compelling offerings to market matters a great deal. Our ambitions there are big, and the long-term growth potential that our innovation team makes possible leaves me optimistic. Margins form our third strategic priority, and that's an area where we keep moving forward. The pricing moves we made last year to counter inflationary pressure have worked well, recouping part of the margin we gave up in earlier years, and our plans to further streamline bakery operations—our digital initiatives included—are gaining traction and starting to deliver. Just as impressive is the better profitability we're seeing in away-from-home and private label, which I mentioned before. To signal the greater profit potential for away-from-home, we moved it up in our portfolio strategy matrix into the balance growth quadrant, as you can see on Slide 11. We're enthusiastic about what each of these areas offers. To make our leading brands even stronger, we're putting money into marketing and digital initiatives. Those investments do hold back near-term results, but they're nonnegotiable and essential if we're to hit or beat our long-term financial targets.

Even with the strong results we posted, we know there is more work to do on our cost structure so we can build on our robust top line and drive greater profitability. To help counter the near-term effect of those investments, we are stepping up our efforts and raising our targets for savings this year, from $30 million to $40 million, and from $40 million to $50 million. That increase shows our confidence in how well our initial cost savings programs are working and reflects the addition of new programs as we keep optimizing operations. The steps Specific is taking include cutting certain jobs, spending less with outside vendors, getting more out of marketing dollars, improving how we buy leased labor and indirect goods and services, and running our DSD network more efficiently, among other things. On top of those cost-saving efforts, we've identified further chances to improve operations at a couple of bakeries, which we believe will give quarterly earnings a meaningful lift down the road, though putting these changes in place will take time. Had those bakeries been operating at the efficiency levels they should, our quarterly results would have been even better. We're working hard to realize these efficiencies and view that effort as a major opportunity to fuel additional earnings growth. Given the tough conditions we're facing, it's now more crucial than ever to manage expenses carefully and foster a culture where people take ownership and responsibility. This focus has long been part of who we are, but moving forward we're putting even more weight on it, building a mindset of ongoing productivity gains tied to cost across the whole company. Smart M&A is our fourth priority. For many decades, M&A has played a major role in driving our growth, widening our geographic footprint and adding to our portfolio of brands. Beyond reinforcing where we stand in core categories by extending our geographic reach and picking up share in underdeveloped markets, we're also concentrating on uncovering fresh revenue streams throughout the baked foods category. There are appealing brands out there that fit well with what we already offer and move our SKU range toward a healthier nutritional profile. Conditions in the M&A market are getting somewhat better, and we continue to feel positive about the pipeline of possible deals taking shape. With our solid balance sheet, we're in a good position to move when we have conviction on the financial, commercial and operational fronts. At this point I'll hand things to Steve, who will walk through the quarter's details, and after that I'll wrap up with how we see the current business environment. Steve?

Thank you, Ryals, and good morning, everyone. First-quarter total sales rose 2.8% versus the same period a year earlier. That year-over-year gain came from better price/mix, which was up 3.1%, mainly reflecting pricing moves we made last year to offset inflationary pressure. Volume fell 0.8%, driven largely by targeted sales rationalizations and away from home. Of note, branded retail volumes were up 0.3%. The Papa Pita acquisition contributed 0.5%. Gross margin as a percentage of sales, excluding depreciation and amortization, rose 160 basis points to 49.4% compared with the same quarter last year. The comparison benefited from prior-year pricing actions and lower ingredient and packaging costs, partly offset by volume declines tied to business rationalizations. SD&A costs represented 39.7% of sales, which is 110 basis points higher than the same period last year. Increased spending on labor and technology was partially offset by reduced distributor distribution fees measured as a share of sales. When you set aside items that impact comparability, adjusted SD&A stood at 39.3% of sales — a 130-basis point rise attributable to the factors I just mentioned. On a GAAP basis, diluted EPS for the quarter was $0.34 per share, compared with $0.33 during the prior year period. After excluding the comparability-affected items laid out in the release, adjusted diluted EPS for the quarter came to $0.38 per share, matching the prior year period. Let me now move on to our balance sheet, liquidity and cash flow. Operating cash flow for Q1 rose $47 million, reaching $105 million. Capex was down $1 million at $33 million, which included $2 million tied to the ERP upgrade that's still underway. Dividend payments went up $2 million, totaling $51 million; in our view, the company's financial position is still solid. When the quarter closed, net debt to trailing 12-month adjusted EBITDA was roughly 2x. Cash and cash equivalents came to about $16 million, and we had around $541.6 million left available under our credit facilities; let's now discuss what we expect for 2024. As Ryals mentioned, we're mostly keeping the guidance we issued before: sales flat to up 1.6%, EBITDA between $524 million and $553 million, and adjusted EPS of $1.20 to $1.30. The sole adjustment is higher capital spending tied to supply chain optimization. This outlook assumes volumes keep improving, though it also accounts for an uncertain economy and how that might affect consumer behavior and the promotional environment. We also expect full year results to gain from broader savings initiatives and new business wins. Several things could move our results around inside the guidance range: how consumers behave and the promotional climate, the shift of our California distribution, and the rollout of our cost-saving programs. Full-year results should also feel the effect of a higher tax rate and greater net interest expense tied to funding the payments for the California legal settlement, plus the continuing ERP project and lower interest income. As we said before, we agreed to settle the distributor-related class action litigation in California, and that settlement got final court approval on March 18, 2024. We've started the work of buying back the California distribution rights, and we expect that to finish in the first quarter of fiscal 2025. Once that's finished, we intend to serve California via an employment model. For 2024, about 83% of our essential raw materials are secured. Given this coverage, our guidance factors in modest relief in ingredient costs next year versus the previous one. To curb volatility and ensure sufficient visibility into costs, we've maintained our longstanding hedging approach, through which we seek to increase certainty on key ingredient expenses 6 to 12 months in advance. Our ERP deployment launched in Q2 2023, and implementation work continues, though we've halted the bakery rollout in order to direct resources toward the California distribution transition. Looking ahead to fiscal 2024, our estimate for the ERP upgrade is a cost of roughly $25 million to $35 million, with $3 million to $6 million of that amount anticipated to be capitalized. By the close of the quarter, costs tied to this project totaled approximately $223 million, and capitalized costs make up $114 million of that figure. Thanks — I’ll now hand things back to Ryals.

All right, thank you, Steve. Next I want to go over a few of the trends shaping how we're performing right now, along with what we're doing to make the most of our opportunities in this environment and going forward. I'll start with consumer trends, then move on to the competitive environment. Shopper buying patterns during the first quarter stayed in line with what we've seen recently. The market is somewhat split, with premium items doing well because some shoppers are looking for something different, while cheaper items appeal to people hunting for more value. Store-brand products keep picking up share, even if that trend is easing, as I mentioned earlier. As a matter of fact, store brands lost unit share toward the end of the quarter; and with private-label unit growth decelerating, our branded retail volume swung to positive, delivering growth in the quarter for the first time since 2020. This development carries forward the encouraging trend we highlighted last quarter, which is visible on Slide 12. Consistent with our portfolio strategy, that gain pushed our branded retail mix up to 64.4% of sales in the quarter, 50 basis points higher than the same period a year ago and 440 basis points above the first quarter of 2019. Consumer spending remains somewhat uneven. The data shows fast food traffic falling, while total at-home food and beverage units also moved lower toward the end of the quarter. Meanwhile, trends in the bread category have been getting better, with unit performance in the quarter notably improved on a sequential basis, as Slide 9 shows; we're watching these trends closely. Now to the competitive environment, which is still rational and in line with recent periods. Even though economic pressure is pushing many shoppers to look for more value, lifts from promotion are still under prepandemic levels. Research from Circana points to a few possible reasons for this apparent anomaly. To start, once prices rose sharply to counter inflation, customers perceive markdowns applied to those elevated prices as a smaller saving than they would have against the lower prices that existed before inflation. Next, budget-constrained shoppers from lower income brackets, who previously might have used promotions to stock up on product, may now lack the means to do so. Also, a growing number of shoppers decide what to purchase before walking into the store and then adhere to that list while inside, which reduces impulse buying. Given all this, to extract greater efficiency from our promotions, we are leaning even more heavily on our enhanced in-house digital tools. During the prior quarter, we noted that an increased portion of our goods moved through promotional channels, driven by a modest uptick in promotional efforts and shoppers responding to deals in a way that moved somewhat closer to longer-term norms. In Q1, a comparable trend emerged: a larger percentage of items were sold via promotion than in the same period twelve months earlier, although that gain was less pronounced when measured in percentage terms. Even with that, our promotional levels continue to sit significantly below where they stood before the pandemic. One more thing to highlight: our average selling price rose compared with the same quarter a year ago, which confirms that using promotions selectively—together with better display execution and new trade promotion management capabilities—was the right approach. We'll keep applying promotions in a targeted manner where they make sense—to encourage trial of new and innovative products, for instance—but only when we expect the return on investment to be net positive. Beyond promotions, we remain focused on delivering greater perceived value to consumers through innovation and on communicating that value in our marketing. Take a look at the new small loaves from Nature's Own: you get the same excellent taste, texture and quality as with our traditional loaves, but the price is lower, and smaller households deal with less wasted product. Our innovation team, we expect, will continue creating distinctive items that widen the potential market for our leading brands. As a final point, I feel good about the improvement in our Q1 results; keeping our attention on long-term opportunities calls for patience, since putting change into practice takes time and progress might not come steadily. Quick fixes delivering fast wins can look attractive, but often they do not secure the greatest long-term value. What I want everyone listening to this call to walk away with is this: we're doing exactly what we said we would—running our portfolio strategy by getting out of low-margin business and filling that freed-up capacity with new business that adds to margin, strengthening how we manage costs, putting money behind our brands to grow volume and share and enhance our mix, using technology to give us better visibility into data and support smarter strategic choices, and investing in our people so we execute better across the board. We aren't where we want to be yet, but the progress is showing up more and more clearly. We'll keep at it, staying focused on hitting our long-term financial targets. My confidence in our growth potential is very high, and I'm eager to keep building on our progress through 2024. The strength we saw in the first quarter shows that our approach across the portfolio is working better and better. Because we put money into marketing and innovation, our brands picked up share even though consumers faced a tough backdrop. Notably, branded retail volumes rose for the first time since 2020. Dave's Killer Bread paved the way, posting 10% unit growth for a second quarter in a row, and we observed promising signals throughout the brand lineup, even as margins keep widening in our away-from-home and private label operations. Our financial outlook for the year stays as it was, and it factors in further volume gains while recognizing that economic uncertainty persists and could affect how consumers behave and the promotional landscape. To repeat my earlier point, the single message I hope you carry away from today is that our actions match our stated commitments. While advancement doesn't follow a straight line, we will keep carrying out our portfolio strategy, anticipating that we hit our long-term financial targets. My confidence in our capacity to grow is very high, and I'm eager to keep building on our momentum through 2024. Having said that, Carmen, please open it up for questions.

Actually, what I'd hoped we could discuss is beginning with the operating expenses for the quarter and the SG&A run rate spending. During the prepared remarks you mentioned a few items — greater labor costs, greater technology costs. You also mentioned stranded overheads as a separate item. I'm wondering whether those two are connected or whether they're distinct? And really, my focus is simply on how we should think about the cadence of that SG&A and operating expense spending across the year. Should we expect some relief on stranded overheads? Do you expect transition costs in California to replace that? Could you give us some sense of how SG&A spending will trend across the year?

Absolutely, glad to. I'll take the first pass, and I'm certain Steve will have something to add as well. But to answer: it's partly one thing and partly another. Labor costs account for some of it. Marketing spend is higher, and we've previously explained why that investment makes sense. On top of that, there's the stranded overhead we've discussed before. The encouraging part comes in two pieces: first, you might have picked up that our savings target went up from $30 million to $40 million, now $40 million to $50 million, and a portion of that will help us bring SG&A down. We acknowledge that our cost structure is somewhat elevated, as I mentioned in the prepared remarks, and we're acting to rein in a portion of it and bring things closer to where they should be. Labor expense and marketing, I noted, are factors there too. So my expectation is that SG&A will improve as time goes on, especially as a share of net sales, and that we'll achieve better leverage on our cost base moving forward. Steve, would you like to chime in on that?

Yeah, I think Ryals really nailed that point. Obviously, that first quarter runs 16 weeks, and from that standpoint we did experience some higher costs. Still, we've got solid visibility into the initiatives we're using to take out cost. And as we move forward, we expect SG&A as a percent of sales to come down somewhat and then more or less level off. So we do believe we'll be able to bring some of that under control as the year goes on.

Yes. And one more point on that, Steve, regarding the stranded overhead: it does tie into the volume picture too, because we're bringing on new business at a somewhat quicker pace than we had expected at the start of the year. Naturally, that helps offset that stranded cost.

Alright, sounds good. Turning to cash usage, I saw that the capex forecast was raised, as expected. Could you give a bit more detail on exactly what those supply chain investments are aimed at? And you also came across as somewhat more confident regarding a better M&A backdrop, so perhaps a little more insight on that too.

Sure. What I'd say is those capital investments are really just continuous upgrades, mainly at the bakeries — more automation, refreshed equipment. It's fairly routine, Steve, nothing unusual, just somewhat higher spending than we initially anticipated at the start of the year. Then on M&A, yes, I'm feeling a bit more optimistic about it at this point. Things have genuinely begun to accelerate; that kicked off a couple of quarters back and has carried on. So the discussions we're holding with targets are happening more often, which is an encouraging signal. It was rather sluggish over the last couple of years, and you know our balance sheet well, so you're aware we're ready to move on a deal once the right one comes along.

Great. If I may, one final point. Regarding that ERP hold in the bakeries, my understanding was it would be removed during the second half — I just don't know whether that remains true or whether it has been adjusted.

Right. No, our plan is still to resume the bakery rollouts at some point in the back half.

Let me dig a bit deeper on private label versus branded growth — just looking for some additional detail there. If there's any genuine softness in the economy, it shows up at the lower end. Private label has clearly pulled back somewhat over the last few quarters, but I'm wondering whether the resilience of brands surprises you, or whether it's really Dave's Killer Bread speeding up? You did say it was broader, but 10% growth for Dave's Killer Bread sounds pretty strong. So maybe you could share a bit more color, your thinking on, apart from Dave's Killer Bread, how brands are performing relative to private label and how the consumer environment is shaping up?

Sure. Yes. Obviously, from a volume growth standpoint, Dave's has been the standout. But — and I realize your questions are about the wider portfolio, but let me say right off the bat that one interesting thing we observed this quarter was low-income shoppers returning to Dave's. So we told you all some time ago that roughly 20% of Dave's shoppers — which we define as $30,000 or less in annual income — 20% of Dave's shoppers were low-income. Given the inflationary environment, that fell a bit to around 16%, and we've climbed almost all the way back to 20% again. So that suggests to me the consumer may be getting somewhat healthier; or else they're fed up with the lack of differentiation in cheaper products and are coming back to Dave's. I view that as a favorable macro signal that lower-income households are beginning to return. On top of that, we're seeing some strength elsewhere in the portfolio. Wonder is a good example. It's a lower price point item for us, but Wonder, across sandwich, buns and rolls, and loaf, has performed quite well. Nature’s Own Perfectly Crafted keeps performing well, with positive unit growth in the quarter. I think the one soft spot that remains, which we've discussed in earlier quarters, is the broader basic Nature's Own product, whether that's Honey Wheat or 100% Whole Wheat. That's the part of the category that has felt the most weakness during this period of private label trade down. I think some of that is beginning to come back up out of private label into brands like Wonder. And should things keep improving, I'd expect it to keep coming back to brands like Nature's Own as well.

Understood. No, that's helpful. Then here's something we haven't discussed in quite a while: DSD network expansion. What's the current status? Are you continuing to add routes, whether in California or other places right now? Is the focus more on speed and pushing more products through the routes you already have? Or are you actually shrinking? Are there regions where it makes less sense, as you aim for greater efficiency? Any thoughts at all on the DSD network as it stands today would be useful.

Certainly. Yes; it's somewhat of a mixed picture. California is a separate case since we're converting to company routes there. But in certain areas with higher growth, we're adding routes, because routes are beginning to fill up. When that occurs, splitting those routes and serving the stores in the area better usually gives sales a nice lift. So in certain places we're adding, in certain places on the fringe we're not; and elsewhere, as we enter new geographic territories, we're adding routes too. So it depends somewhat on where you are, what the growth trajectory looks like, how new the territory is. I think the main point is that we are — what we're really attempting to do is make our DSD network as efficient as it can possibly be. So for instance, if you're in an area with lower household penetration, lower market share, and those independent routes may be struggling, we might convert them to company routes for a while until we get enough sales. In other areas where we're growing, we'll split them up and actually add routes; so it really just depends. Efficiency is the key word, though. That's what we're after.

I'd like to ask about volume. Ryals, in the prepared remarks you noted that the planned business exits have clearly created some headwinds where volume is concerned, and that without them, total company volume would have been positive. If you can, could you tell us what that figure would have been — what the actual volume number would have looked like, absent those exits? And beyond that, does the softness in the other category mainly stem from some of the restaurant customers? You did flag some weakness in fast food. So any detail on that would be helpful.

Yes, sure. So yes, Jim, we did say that if you removed the intentional strategic exits — and we didn't quantify it — total company volumes would have been positive. The reason we're framing it that way is that we did this on purpose, as we discussed; we had low margin business that was never going to contribute much, and we made the strategic decision to free up that capacity so we could move into higher-margin business. The good news, and I think one of the bigger stories of the quarter, is that's exactly what we're doing. We're starting to lap all of those strategic exits. So you'll see them keep declining as we move through the year; we pretty much lap all of them in the third quarter — there'll be very minor strategic exits in the back half — and we're replacing that volume with business that meets or exceeds our variable margin targets depending on which category of business we're talking about, whether it's branded or whether it's other; so that's really the key takeaway there.