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

Hi, everyone. I'm J.T. Rick, EVP of Finance and Investor Relations. Thanks for joining us as we discuss Flowers Foods' 2024 second quarter results. Before we begin, please remember that what's presented here may contain forward-looking statements regarding the company's performance. While we consider those statements reasonable, they carry risks and uncertainties that might make actual results differ materially; along with what you hear in these remarks, key factors about 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 with us today. The strong second-quarter results demonstrate that our strategic plan is working. Guided by our portfolio strategy, we're achieving growth and gaining share in higher-margin branded bread products, while also improving profitability in private label and away-from-home operations. That building momentum gives us greater confidence that we'll meet our 2024 guidance. Second-quarter financial performance was notable for growth in our retail businesses and a solid sequential margin improvement, helped by successful execution of our savings initiatives. Sales were modestly above what we had anticipated, aided by better volume trends in the fresh package spread category, which swung positive near the end of the quarter. We think this improvement came about as consumers redirected more of their spending toward at-home meeting in an effort to economize, and we're taking advantage of that shift by driving unit growth of 1.5% in the fresh package bread category; that growth fueled share gains as our branded bread products keep outperforming the overall category, picking up 40 and 20 basis points, respectively, of dollar and unit market share, more than any competitor. For a second quarter in a row, we increased both dollars and units in tracked channels, even as the bread category was largely flat. Momentum accumulated as the quarter progressed, with unit share gains reaching their peak in the final 4 weeks, up 40 basis points. Areas of particular strength include sandwich buns and rolls, breakfast and loaf, where we picked up 80, 30 and 20 basis points of unit share, respectively. Importantly, our performance got better in both the mass and grocery channels. Bread is a mature and stable category, but we're outperforming by concentrating on subcategories that hold notable growth potential for us, such as specialty premium, sandwich buns and rolls and breakfast. The changing composition of what we sell under our branded retail bread is benefiting margins. Looking at geography, results were particularly robust in areas where we have room to grow, including the Northeast, Mid-Atlantic and Upper Midwest, with fresh account wins and solid market execution driving ongoing growth. We're also seeing substantial gains in our away-from-home and private label segments. By lifting margins on existing accounts and swapping out business exits for newer accounts with better margins, profitability has improved significantly, and the gap versus branded retail has gotten smaller. Our confirmed wins on new business, plus the pipeline of potential additional wins, make us confident about further improvement in the back half of the year and beyond. On top of that, the headwinds from deliver exits are fading. Those departures hit hardest during the first quarter; their effect will shrink considerably over the back half of the year, and by the fourth quarter there will be essentially none. Next I'll walk through how we did in the second quarter against our four strategic priorities: building up our team, concentrating on our brands, putting margins first, and going after smart M&A. Following that, Steve will cover the financial results and guidance, and I'll close with the main themes going forward. Our strong second-quarter performance is a direct result of the team's hard work. I'm particularly pleased with the way they expanded our market share amid an environment that is both dynamic and demanding, and with how well they carried out our plan for lowering costs and achieving margin growth. As we reshape our team to fit the changing competitive landscape while aiming to become a best-in-class selling organization, we introduced exciting changes to the team that handles our retail customers. Under the new structure, we take a channel-focused approach, which allows us to align more effectively with our biggest customers and serve them better. Meredith Wiktorowski, who has come aboard at Flowers as Senior Vice President and Chief Customer Officer, leads our reorganized retail customer team. Retail customer strategy falls under her responsibility, and she is accountable for growing our revenue, market share, profitability and reputation. Meredith brings over 26 years of sales experience to the role, having most recently been Vice President of Retail Sales for the North division of PepsiCo Beverages North America. I'm enthusiastic about what Meredith and her team are expected to contribute, and I believe these adjustments will better position us to achieve sustainable, profitable growth. Our second strategic priority involves concentrating on our brands, and those brands played a vital part in our strong second quarter results. Results for our leading brands were outstanding: Wonder, DKB and Canyon each grew units by 10%, 7% and 5%, respectively, while Nature's Own held its unit sales steady. Those results gave us the biggest gain in dollar and unit share among every company in the category, and every one of our national bread brands either grew or held its dollar share. Dave's Killer Bread and Wonder both picked up 20 basis points of dollar share, and Nature's Own added 10 basis points. Nature's Own did especially well considering how inflation is squeezing consumers. The brand's emphasis on what shoppers want — both something different and good value — produced better results even in that climate. Our keto items are drawing consumers in a big way, with dollar share in that subcategory rising 710 basis points; we believe launching keto buns will keep that momentum going. Seeing how much shoppers want more value, we launched Nature's Own small loaves, and they're off to a great start. In 6 of the last 7 weeks, these new products have helped the brand grow units compared with the year-ago period. And thanks to recent capacity additions, Canyon Bakehouse is reigniting its growth, lifting dollar share in the gluten-free category by 260 basis points. Innovation is a key part of our growth strategy, and our new products are delivering strong results. The original DKB Snack Bars keep getting solid support from consumers. Moving brands into new segments is seldom simple, yet DKB has a strong history of successfully cracking adjacencies such as breakfast and sandwich buns and rolls, which makes us confident it can stretch further into snacking. Initial results at our largest accounts—where velocities run above the category average—demonstrate the upside potential as we bring those best practices to additional retailers. DKB Amped-Up Protein Bars are now rolling out nationwide, and we're conducting a soft launch of DKB Snack Bites, targeting over 2,000 points of distribution by the close of 2024. We anticipate widening distribution across the country in 2025, and I remain enthusiastic about what these new and innovative products can achieve. Margins rank as our third strategic priority, and we've achieved meaningful progress there. During the prior quarter, we discussed the importance of continuing to strengthen our cost structure, which would allow us to capitalize more effectively on our strong top-line performance and produce greater profitability. In pursuit of that goal, we intensified our efforts and lifted our targets for savings programs this year, moving from $30 million to $40 million and now to $40 million to $50 million. Among the specific steps taken were targeted workforce reductions, lower third-party spending, more effective marketing investments, gains in leased labor and indirect procurement spending, and efficiencies within our DSD network, along with other measures; those efforts drove a substantial sequential gain in SD&A costs measured as a percentage of sales. In addition to our savings programs, we're bettering the mix in our branded retail business. We're doing this by carrying out our portfolio strategy effectively, expanding premium labels such as DKB and Canyon, and introducing new items like Keto within flagship brands such as Nature's Own. We've likewise boosted the profitability of our away-from-home and private label operations via a purposeful effort to make sure every account hits the margin goals we set, something I mentioned earlier. Results from our second quarter demonstrate the ownership and accountability culture that is taking hold; we are effectively embedding a mindset of ongoing productivity gains tied to cost throughout the company. Smart M&A ranks as our fourth priority. Beyond reinforcing our standing in core categories through broader geographic reach and picking up share in underdeveloped markets, we're equally focused on uncovering new revenue streams throughout the baked foods category. We look for compelling brands that complement what we already offer and that lean toward a Better For You nutritional profile. With our strong balance sheet, we're well positioned to act once we have financial, commercial, and operational conviction. Now I'll hand things to Steve to walk through the quarter's details, and after that I'll wrap up with our outlook on the current business environment. Steve?

Thanks, Ryals, and good morning to all of you. I'd like to add my voice to Ryals's in congratulating the team on what was truly an outstanding quarter. We're pleased to report solid results for the second quarter. Overall sales were 0.2% lower than in the same period last year. Price/mix contributed a 1% increase, driven mainly by mix, but volume declines of 1.2% more than wiped out that gain. Those volume declines stemmed largely from deliberate sales rationalizations and weakness in the QSR market. Branded Retail volumes held steady, with ongoing growth in bread products canceled out by cake declines. Gross margin as a percentage of sales, excluding depreciation and amortization, climbed 90 basis points to 49.9% versus the prior-year quarter. Those comparisons got a boost from ingredient and packaging costs easing, improved price/mix, and a reduction in product returns. Working against that overall gain were lower production volumes, greater workforce-related and bakery maintenance expenses, and more outside purchases of product. Selling, distribution and administrative expenses came in at 38.5% of sales, a decrease of 30 basis points versus the prior-year period. Reduced distributor distribution fees, marketing expense and consulting costs, together with an insurance liability claim in the prior period, were partly offset by higher workforce-related costs, amortization of cloud-based applications, increased rent expense and less scrap-related income. When matters affecting comparability are excluded, adjusted SD&A expenses were 38.2% of sales, unchanged from the prior period. For the quarter, GAAP diluted EPS came in at $0.32 per share, which is $0.02 higher than the same period last year. When you set aside the items affecting comparability that we detailed in the release, adjusted diluted EPS for the quarter was $0.36, an increase of $0.03 over the prior-year period. Now let me move on to the balance sheet, liquidity and cash flow. Through the second quarter of fiscal 2024, on a year-to-date basis, cash flow from operating activities increased by $40 million, reaching $168 million. Capital expenditures declined $7 million to $61 million, and that figure included $3 million related to the ongoing ERP upgrade. Dividends paid were up $4 million, totaling $102 million. Our financial position, in our view, remains strong. At the close of the quarter, net debt to trailing 12-month adjusted EBITDA was roughly 2x. Our cash and cash equivalents stood at roughly $7 million, and we had about $517 million still available under our credit facilities. Now, moving to the 2024 outlook: as Ryals mentioned, we're keeping the guidance we issued earlier—sales flat to up 1.6%, adjusted EBITDA between $524 million and $553 million, and adjusted EPS ranging from $1.20 to $1.30. We are revising our assumptions for depreciation and amortization, interest expense, and share count, all of which are laid out in the earnings release and slide presentation. We're happy with how our cost reduction efforts have turned out, and we anticipate those gains—along with fresh business wins—will accumulate as we head into Q4. As Ryals mentioned, business exits are still acting as a drag during the third quarter and we'll have fully cycled past them by the time the quarter closes. Taking all of that into account, we feel good about landing in the middle of our guidance range. A number of factors could push results higher or lower within the range we've given—including how an uncertain economy shapes shopper behavior and the promotional environment, as well as the transition of our California distribution. As we mentioned earlier, in fiscal year 2023 we entered into an agreement that resolved class action litigation involving distributors in California; we are making progress on repurchasing the distribution rights, and according to that settlement agreement, the work ought to be finished in 2025. About 95% of the key raw materials we use are secured for 2024. With that coverage secured, our guidance incorporates a moderation in ingredient costs across 2024 relative to the prior year. To keep volatility down and give ourselves adequate visibility into costs, we have maintained our long-standing hedging practice, through which we seek to increase certainty regarding our key ingredient costs 6 to 12 months in advance. Our ERP implementation began during Q2 of 2023, and we're proceeding cautiously with it so we continue meeting market demand effectively at the high service levels we're known for. As noted earlier, we've paused the bakery rollout so we can concentrate resources on the California distribution transition. Looking at fiscal 2024, we expect the ERP system upgrade to run roughly $25 million to $35 million, including an anticipated $3 million to $6 million in capitalized costs. Project spending this year has reached $12.8 million thus far, with $3.4 million capitalized. Over the entire life of the project, total costs amount to $226 million, $115 million of which is capitalized. Thank you. And now I'll hand it back to Ryals.

Thank you, 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 that today's and tomorrow's opportunities are fully captured. First I'll cover consumer trends, and after that I'll turn to the competitive environment. In the second quarter, consumer trends stayed in line with what we've seen recently. To get the most from what they spend, shoppers have moved a greater portion of their buying toward food eaten at home and, in particular, toward value channels such as mass and club stores—areas in which we hold a strong position. Within our stores, bread—a category that draws shoppers hunting for value—is outperforming food overall: its unit volume slipped only 0.2%, versus a 0.7% drop for food, as you can see on slide 9. We continue to observe positive momentum in bread. Premium items are performing well as buyers seek out something distinct, and DKB's impressive numbers illustrate this better than anything else. Subsegments with greater differentiation—dinner bread and rolls, sandwich buns and rolls, and specialty premium—did better than the traditional loaf, which is less differentiated. Down at the value end, slide 10 makes clear that private label gave up unit share this quarter, since the price gaps between store brands and branded goods got smaller. Store-brand pricing continued climbing faster than the overall category, and shoppers reacted favorably when we stepped up promotions on our branded items. With private label volumes losing momentum, slide 14 shows our branded retail bread volume in tracked channels expanding for a second quarter in a row, gaining 1.5%; that performance far exceeded the category, which was down 0.2%, as reflected on slide 9. Consistent with our portfolio strategy, this gain lifted our branded retail category to 64.5% of sales for the quarter, a 40 basis point increase versus the same period a year ago. Moving to the competitive landscape, conditions remain rational, with promotional activity still trailing prepandemic levels. With economic strain prompting lots of shoppers to hunt for better value, they've responded more to promotions—albeit starting from a modest baseline because of the pandemic's effects. Given that backdrop, we've dialed up our promotional activity somewhat, which means a bigger share of product moves on promotion. Still, we're using trade promotion management tools to accomplish this more efficiently and with appealing returns on investment; beyond wanting better value, shoppers also seek products that stand apart; that appetite shows up in how strongly our top brands are performing. Shoppers plainly see what sets our brands apart, which is producing the biggest gain in dollar and unit share of any player in the category. We're putting money behind strengthening that point of difference and bringing our brands even more closely in line with what the consumer wants. To wrap up, I'm happy about the gains our second quarter results show, though we recognize that a shaky economy might affect how consumers behave and what happens with promotions. We kept carrying out our portfolio strategy, putting investment into our brands and enhancing our mix. To get a clearer read on how our top line is doing, we improved the structure of our costs, and that gave our margins a substantial lift; and we're leveraging technology for sharper insight into data and to back up better strategic decisions, while channeling investment into our team so that overall execution keeps moving ahead. This quarter's results reflected progress on our long-term goals, and we'll continue striving to deliver further gains. I'm looking forward to extending the momentum we built throughout 2024. I'm genuinely pleased with the solid performance we reported this quarter on both revenue and earnings. Our top brands are outpacing the category, with volumes growing and share gaining, while our portfolio approach is boosting profitability in private label and away-from-home. At the same time, our cost-saving initiatives have strengthened our cost structure, lifting margins significantly compared with the first quarter and positioning us to capture more value from our sales performance going forward. With inflation where it is, some shoppers are hunting for value, but a growing number are chasing products that stand apart, and that demand is reflected in the strength of our leading brands. People clearly recognize what makes our brand different, and that delivered the largest gain in dollar and unit share of any player in the category; we're putting money behind deepening that distinction by aligning our brand portfolio more closely with what consumers want. The quarter's numbers bolster our confidence that we'll hit our annual guidance. We're focused on finding further gains, and I'm excited to continue building on the progress made through 2024. With that, Shannon, let's open it up for questions.

Good morning — or should I say, happy Friday. Ryals, what I really want to ask about is how much we're putting into promotions. In your prepared remarks, you said you'd promoted a little bit more. "A little bit more" doesn't sound like much, but it is more. And clearly at the same time, it looks like you're gaining both unit and dollar share in bread. So I'm just curious — it feels like since the start of the year, the guidance has built in some promotional risk, right? And maybe some pickup in that promotional activity as you move through the back half of the year, you promoted a little bit more. You're gaining share too, so I'm just wondering — sitting here right now, does it feel like there might be a bit more risk, because typically, yeah — when you're gaining share, others may take notice and could begin promoting more heavily.

Yes, absolutely, Rob. Appreciate the question. Yeah, look, I guess that's a possibility; and as we said in our prepared remarks and even built into the guidance, we're factoring in that risk throughout the year. We flagged it at the start of the year, and I believe it remains wise to flag it again now. As we mentioned, shoppers are now reacting somewhat more strongly to promotional offers, which wasn't the case not so long ago. And it's common knowledge that, along with wanting differentiation, the consumer is looking for value. I believe a major retailer's report this week illustrated that point. We're observing a shift in where people shop, and we've highlighted this for multiple quarters now — moving from grocery toward mass, club, and dollar channels; and this trend appears across income levels as well. So in summary, I think the sensible approach is for us to keep monitoring this and to remain somewhat cautious regarding our outlook. With that said, although promotional activity has increased, the environment is still fairly rational and remains significantly under pre-pandemic levels. You'd therefore need to cover considerable ground before reaching the sort of promotional intensity seen in 2019.

All right, that's fair. So it sounds like toward the end of the quarter you began noticing some easing in those trends, and you mentioned a growing shift perhaps back toward at-home dining in search of value around mid-August. What we saw in the data through July was that this was continuing, and actually even picked up slightly. I'm not sure whether there's a way to give any color on what you've observed, say, across the summer months and how you're viewing that momentum heading into back-to-school?

Yeah. So we have — as you're aware, we have a big foodservice operation, and a major piece of that is quick serve, fast food chains. And it's been covered in the news. People have watched results at some of those QSR-focused restaurants come in somewhat soft. And I believe much of that is inflation, clearly, but it likewise impacts our food service volumes because that's a fairly substantial portion of the portfolio; yet conversely, that generally works in favor of the retail side. And so I do believe that's something of a tailwind for our branded retail business as we go through the next — at minimum, the coming 2 quarters, and we'll just see how the economy performs.

Davis Holcombe here, sitting in for Bill Chappell. I was hoping you might help us unpack how the business exits have affected volume. Is there any way to quantify that, given volume is roughly flat? Directionally, what does it look like from here, I guess?

Yes, sure. We don't disclose that at such a granular level. But looking at volumes in the quarter, they were quite positive overall on the branded retail side, and especially on the branded bread side. Now that was somewhat weighed down by softness in the cake business. You've seen that across the sweet baked goods category. And then for the rest of the business, as we said, foodservice volumes have been somewhat weak because of that QSR weakness, plus the strategic exits we've discussed for several quarters now. However, it's important to remember that those strategic exits roll off in Q4. So they have virtually no impact on us in Q4; we're almost through them, as we mentioned last quarter. And so going forward, you'll see much less impact from that.

Great. I was also hoping you might give us a sense of how distribution is shaping up for DKB — the protein bar launch and all of that. Just a bit more detail would help.

Yes, absolutely. On the whole, we're very happy with our progress. As I've mentioned a number of times, this is a start-up business for us. It's completely new. It's a different merchandising format. It isn't distributed DSD on the bread trucks. It goes through the warehouse. At present, our SKU count is limited, and we're working to grow our shelf presence; we have the 3 snack bars. We have the 3 protein bars that are launching. So our shelf presence keeps improving. At our top accounts, the large retailers where we perform well, we're performing really well. And our velocities sit comfortably within the top 10 in the category. That said, a couple of places saw us stub our toe on execution, which is part of the learning curve, and we're fixing that. But taking the broad view, we believe we have a great product beneath a great brand umbrella, and we're highly confident in where this is headed. Add to that the further innovation pipeline, with the snack bites arriving later this year and then full distribution next year; so on balance, we're pleased.

Ryals, I'd like to see whether you could walk us through the puts and takes — if we look at what the exits did to the business, you mentioned pressure on the QSR business, but then if we net those against the strong results at DKB and Canyon plus, which seems like a benefit from the shift toward food at home and...

Sorry for cutting you off. Could you begin your question again, since the audio was really bad at the start of it?

Yeah, no problem at all. Does that come through better?

Yeah. Looks that way to me.

All right. Great. Yeah, I was simply wondering whether we might be able to offset the hit from exiting the business with a portion of the pressure you referenced in QSR. And then, considering that alongside DKB's strong results, Canyon gaining from a shift toward food at-home — if we put all of that together, might we see positive volumes in 3Q and then, of course, carrying into 4Q?

Yeah. For 4Q, I'd say that's certainly a fair assumption, especially given all the new business, Jim, that's coming on. We discussed that last quarter. So that's going to have a — a bigger effect in Q4; and then as the strategic exits roll off, if we can keep enjoying solid momentum across all the brands you mentioned, then yes, I'd say that's a real possibility. Honestly, we were nearly there in Q1. Branded retail was actually fairly positive in Q1. So yeah, I'd call that a reasonable possibility.