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

Welcome back, everybody to our fireside chat with Flowers Foods. With me today are Chairman, CEO and President, Ryals McMullian; and CFO and Chief Accounting Officer, Steve Kinsey. Good to be back with you both. Thanks for being here.

Thanks, Andrew.

Thank you.

Maybe a good way to kick it off with sort of a broader industry question first, Ryals. We've heard a lot about different perspectives throughout the week about state of the consumer. You obviously play in somewhat different categories than most others that we've talked to. So I'd be interested to hear your perspective about health of the consumer, maybe what assumptions around consumer behavior are currently incorporated into your guidance?

Sure. I mean, broadly speaking, consumer definitely still under some pressure. The good news for us is in a fairly steady category, just down slightly in the second quarter. We've been able to find ways to grow and primarily through innovation and differentiation in our category. There has been, over the last couple of years that the inflationary wave started, some trade down to private label, which we do have exposure to. And that typically happens when we get in these types of economic situations, you'll see some trade down in our category. But over the long term, private label's been on a downward trend. And we certainly expect that to continue. And as a matter of fact, private label lost share in our category in the second quarter. What we've been able to do with our more premium brands, Dave's Killer Bread, Canyon Bakehouse on the gluten-free side and Wonder kind of in that mainline segment, we've been able to find ways to grow even in this environment. We've been growing our share and frankly, our units as well. In Q2, our branded bread retail units were actually up 1.5%. The category was down just slightly. Dave's Killer Bread continues to be a shining star for us. We grew Dave's unit 7% in the second quarter, 10% in the first quarter, which is pretty remarkable considering the situation we find ourselves in. So in terms of the consumer in the category, what we're seeing is, you hear the word bifurcation a lot, we're not seeing anything different. The bottom end of the category is doing very well. The top end of the category, Dave's, Canyon, et cetera, is doing very well; the middle, Nature's Own, our largest brand is the area where it's getting squeezed a little bit. Arguably, that's a less differentiated segment of the category for us. But that's why we're looking at ways to even further differentiate that brand because we found that, that works and resonates with consumers. It's also important to note -- you hear a lot of competing data points out there. Walmart had a great quarter. The Dollar stores had an abysmal quarter. That doesn't really seem to add up, given that they -- they're value players. But even with Dave's Killer Bread, the fastest-growing income segment for Dave's Killer Bread is low-income households. So just another data point to show that innovation and differentiation matter, which is why we're so focused on those things.

Makes sense. You've got obviously a large presence in the bread category. Perhaps you can share some insight into how the bread category is performing maybe relative to sort of overall food and what you think has been driving that.

Yes. The bread category has actually been outperforming broader food for the last several quarters, frankly. And I think a lot of reason for that is just simply the fact that bread is generally a weekly purchase. The velocities are pretty high. It's a staple in the American diet despite some of the trends that might say otherwise. So I think that primarily is what has led it to be a bit more stable in broader food.

A lot of chatter this week, obviously, about the promotional environment picking up. And in certain categories, we certainly see the data sort of bearing that out. How is that impacting Flowers at this point? And what sort of an impact is that having on sales, if any?

Yes. So I mean we are seeing, just like a lot of others, we are seeing somewhat higher promotional levels. I do think it's important to note that we're still far below pre-pandemic levels when it comes to promotion. We tend to not lead in that regard. We tend to watch the category and react where we see fit. And in this particular case, we have seen fit to do a bit more promotion than we had last year. But we're also being a lot more efficient and effective with our promotions than we have in the past. And some of that's due to some new capabilities and technology that we brought in, in terms of our TPM systems. So while we may have more units on promotion, we're doing so with less trade spend. As an example, in the second quarter, despite the higher promotional levels, our average price was up a little less than 1%.

Yes. And despite sort of the more challenging operating environment, your brands, as you've mentioned, have actually held up quite well, particularly in the premium category. Maybe we can get into that a little bit more and to what do you sort of attribute that success on the premium side?

Yes. I mean I think, again, it shows that consumers are still willing to pay for quality, for differentiation, certainly. And we've got brands and products that certainly fit that bill. So as I said earlier, even though you have this pressured consumer, we're still seeing the top end of our portfolio perform extremely well. We're very, very focused on bringing innovation in the category and helping our retail partners grow this category. There's no running away from the fact that it is a slow growth category, but we've demonstrated an ability to grow our share, grow our units, grow our sales through innovation. The last 2 years running, we've had the #1 new item in the category. We've introduced some Keto products under the Nature's Own Label that have done extraordinary well. In that segment of the category, we grew our share of 710 basis points. Despite having just introduced the product last year, we're very close to being #1 in that subsegment. So once we achieve that, you're #1 in keto, you're #1 in gluten-free, and you're far and away #1 in organic breads.

Great. Thank you for that. Much like a bunch of other companies in the space, right, gross margin has been benefiting from moderating input costs. How do we think about that going forward? And should we expect that tailwind to accelerate or moderate?

Sure. I mean, obviously, you've seen the underlying commodities for us pull back fairly significantly. I'd say, there's still a little bit of volatility there. We did see margins improve very nicely in the first half of the year. It is really our easier comp period because last year, we began to see some of this moderation. So for the back half, while we expect to see some benefit, probably not to the magnitude that you saw in the first half, and then when you think about the overall input basket in total, obviously, things like flour, our oils, the underlying commodities have pulled back, but then there's other areas like cocoa, sugar, resin, that we continue to see some inflation and higher cost. So it's balanced out pretty well. But overall, it has moderated some, and we've seen a nice read-through on the gross margin line.

And you made some progress on SG&A as well in the second quarter. How do we think about the cadence and magnitude of SG&A moving forward?

Yes. I mean when you look at SG&A costs, actually, you've seen, obviously, over the past year or 2, we've experienced some increase there. Coming into the year, we realized we needed to really kind of get the back-end check. So we came out with guidance around a $30 million to $40 million savings initiative coming out of Q1. After doing some deeper dive, we were able to raise that guidance from $40 million to $50 million. We've been very pleased with the fact we've been able to hit on that. It is driving some significant cost out of the business. It's kind of a multitude of different areas. There's some selected labor decreases in there. There are some cost buckets like T&E. We did something around more efficiency around our marketing spend. So we do think for the back half, we should stay on target there. Everything is in place as far as the key actions to make sure it happens. So we're very confident that for the rest of the year, that will play out, and we will be on target for that. And then actually, since most of that started kind of late Q1, there will be some of that rolls into Q1 of 2025.

And along with that, EBITDA margin improved really nicely on a sequential basis as well in the most recent quarter. What drove that increase?

From an EBITDA perspective, basically, with kind of the gross margin things we just talked about, the input cost bucket kind of moderating very nicely. And then the projects that we just talked about around our key cost takeouts. It's definitely pushing to the bottom line. So It's good to see that.

I think the other thing worth mentioning, too, Andrew, it's one thing to take out costs. It's another thing to keep them out. They have a sneaky way of coming back in. So we're also working on some new controls and budgeting processes for next year to make sure that we preserve those savings and find annual productivity targets because, again, slow growth category, it's incumbent that we continue to manage our costs well going forward, not just on a onetime basis.

And despite the company having sort of vested consensus EPS by about $0.03 in the second quarter, you opted to essentially reaffirm full year guidance. What was the logic behind the decision to reaffirm rather than flow that through?

Yes. I think it's just a little bit of caution. We get asked -- everybody gets asked about the state of consumer, the promotional environment. And as I said earlier, we've seen in the past, the category get a little bit too promotional. That hasn't happened yet, but we've kind of called that caution out throughout the year. And so far, the year has turned out basically as we anticipated. But we still think it's prudent to remain cautious given the environment they're in. So we're very comfortable with the middle of the guidance range as we said on the second quarter call. We think that given the fact that we're going to be lapping a lot of those strategic exits that we've done over the last year or so to help margin up and bring in new business, we'll lap that at the end of the third quarter. And then the new business will come on in the fourth quarter. So we expect year-over-year in the fourth quarter to be a bit stronger than the third. And that -- all that adds up to being comfortable with the middle of the range.

You talked a bit about some of the differences you're seeing within the bread portfolio, but perhaps you can talk a little bit broadly across the broader portfolio, some of the differences you're seeing in performance, right, whether it be in bread versus sweet, bakery piece?

Yes. Yes. So we've already really touched on the branded retail piece, which is kind of a highlight for us. Away from home, as you've heard from a lot of the big QSR people is under a bit of pressure just given all the inflation. That's somewhat benefiting branded retail because it's kind of shifted some back into in-home meeting. But we have a pretty large QSR business within our broader foodservice business. So that's been a bit soft. And of course, the sweet side of the business, really kind of all of snacking really has been under some pressure, and we're no different on the sweet baked side of things.

With the bread category, as you mentioned, experiencing a little bit of growth, but it's pretty stable. Where can Flowers kind of -- what can Flowers do to continue to outpace what you've been doing, but outpace the growth of the category?

Yes. So we have been doing that. Our plan to continue to do that is obviously our marketing efforts, we've increased our marketing budget substantially over the last several years. We have a lot of geographic expansion ahead of us. We were born in the South. And that's where we're most penetrated. But in places like the Northeast, we've only got a $10 share in the Northeast, $18 nationally. So just getting that 8 points at 35 million or so at retail per share point is substantial. And then in the Upper Midwest, some major metro markets there like Chicago, Detroit, Minneapolis, et cetera, we only have roughly a 5 share. And we're just now starting to move up in other area. So we don't -- there is no fresh Dave's Killer Bread in Chicago. There is no fresh Nature's Own in Chicago. So we think it's a nice part of our growth story that not only are we being able to show organic growth across the portfolio in our core territories but also being able to grow in those underpenetrated markets and underpenetrated segments of the category like sandwich buns and rolls and breakfast. So we've been really chipping away and growing our share in breakfast under the Dave's Killer Bread label, which has been huge for us. And Wonder, as a national brand, has been really a smashing success in the bun segment where we were never very strong before.

And how do we think about growth in your other business? I mean I presume private label should be fairly strong in this sort of environment, while obviously away-from-home segment facing some headwinds as consumers shift a bit more. Is that sort of the right way to think about it?

Yes. I mean private label certainly has been growing, though I mentioned that is slowing down now. Another reason you will see it grow a little bit more because some of the new business that we're taking on is private label. Some of you that are familiar with our portfolio strategy may initially find that kind of odd that we're growing in private label. But it's important to remember that in order to build in this category, strategic relationships with our key retail partners, it's important, private label is important to them. And I'm fine with that so long as we get a fair margin and our internal thresholds and that we get brand concessions along with it. If it's strategic in nature, we're fine doing it, and that's part of some of the new businesses coming on in the fourth quarter.

Yes. You mentioned you've been -- you recently made some progress in winning some new business. Can you give us a little more color on what that could ultimately amount to? And maybe what categories those wins have come in?

Yes. We haven't quantified it, but it's -- one, it's not insignificant. The other important thing to remember from a strategic standpoint is we exited a lot of capacity that was very, very low and sometimes even negative variable margin. So to the extent we weren't able to margin that up, in some cases, we were up to our internal thresholds, but where we weren't able to do it we were very intent and very serious about exiting, which we have now done. And we're replacing that volume with new volume that meets our margin threshold. So not only is there a good growth component to it because we'll grow brand on top of that new business. But even the private label business that we're taking on is at much higher margins than what we had before.

And you mentioned some of the business exits. As those slowly start to wind down, I guess, how much of those business exits expected to impact the remainder of the year?

All of the exits themselves have already been done. We were pretty much done with that at the end of last year. All we're doing now is just lapping it. And so we're almost fully lapped at the end of the third quarter. There's just a de minimis amount left in the fourth quarter, and then you'll have that new business come on top of it. So that's why kind of sequentially, we see the fourth quarter stronger year-over-year.

Perfect. You recently ventured into the more competitive snacking category with the Dave's Killer Bread snack products. Can you share a bit of an update around those, how those products are doing? And maybe what gives you confidence you can capture share in what's clearly a crowded category?

No, it is competitive, but we're in a competitive category right now. So we're used to crowded and competitive categories and we're just -- we're very confident in the brand equity that Dave's carries. I mean we've moved it across different products in the bread aisle, which with our other brands we have not been able to do, that gave us confidence to take one step further and actually step outside of the category. As I say often, we're treating this like a new business, like a startup, basically starting from scratch. It's going very well. But we're barely a year into full distribution on the first 3 SKUs. So we're really just getting started. Our retail partners are excited about it. Great feedback from consumers. Our velocities with many of our retail partners is in excess of the category average, already even though we're brand new. And I think most importantly, we're bringing new consumers to Dave's Killer Bread. Obviously, DKB -- current DKB bread buyers are natural consumers for this product. But as we all know, there's plenty of people out there that don't eat bread at all, and so bringing a whole new population of consumers to the brand is pretty exciting.

Taking a bit of a step back, your long-term revenue growth target is 1% to 2%. Is your expectation that will be price volume or mix driven or a combination. And as you -- as a follow-up, I guess, how much of a contribution would you expect from a branded retail versus other to that 1% to 2%?

Well, I mean, given the environment that we're just coming out of, you can expect it to be mostly mix and volume. On the branded retail side of things, for the time being, probably not much more price. We're at some pretty important -- right at some pretty important price thresholds kind of across the portfolio. Any price that we would take opportunistically as needed would primarily be in the private label and away-from-home side of the business.

I think on a recent call, you mentioned that you're looking at restructuring your retail team. Maybe you can expand on some of the motivations behind that change? And maybe what some of the expected benefits are that this could ultimately yield?

Yes, absolutely. I mean it's really just a part -- really a continuation of what we've been doing over the last several years in terms of adding new capabilities and upgrading not only our team but our Board of Directors as well. We recognize the need not only to develop talent internally, but given where we want to go to make sure that we've got capabilities that match our strategic priorities. And in some cases, we did not have those internally that we could promote. And so we went outside, which is somewhat new for us. We've been primarily a company that promotes from within, but circumstances change and your approach needs to change with it. So over the last several years, we've brought in some really highly experienced and capable folks from some very large CPG companies. And that's true on the Board of Directors as well, and I personally think that's a testament to the buy-in of the strategy, if you will, because I'm not sure we could have attracted that kind of talent 5 or 6 years ago. I'll also say that in some sense, the pandemic really helped us because we've always been a very Thomasville, Georgia centric, particularly if you're in the senior ranks, you got to live in Thomasville. If you don't know, Thomasville, it's a very, very small town of about 25,000 people, lovely place, but it's not for everybody. So it's really the openness to hybrid or remote work has really expanded our talent pool because we're not located in Atlanta or New York or Nashville, places like that. So it's really expanding our talent pool, and we've been able to attract some really, really high-quality candidates.

Another thing we've been tracking more recently has been your ongoing California distribution transition. How is that progressing? And have you experienced any disruptions as a result? And when do you expect the transition to be completed?

So first of all, no disruptions. The unfortunate situation for those of you who are not familiar with it, California passed a law a few years ago, that imposed a very, very strict test for what it takes to constitute an independent contractor. And most of our routes are run by independent business owners. And so in California, it made it virtually -- well, it made it virtually impossible for us to pass that test. So as part of a settlement, we agreed to buy all of those routes back. So we're in the process of converting them from independently owned businesses to routes that we own. So we'll own the trucks, we'll own the route, the people who runs them will be company employees. That may sound daunting, but it's also important to remember that we run company routes all over the country. We're primarily independent contractors, but we're very accustomed to running company routes. So from that standpoint, it's not that big of a deal. And when will it be done? The settlement gives us 12 months. That's roughly late April, early May of next year. And so far, everything has gone as expected.

Given that the ERP rollout has been paused to focus on the California transition, how does that impact your scheduled completion date and total cost estimate, if at all?

Sure. I mean, as you may recall, we went live last May on our new S/4HANA platform, primarily the back-office functions, we actually went to 2 bakeries. I think the back office functions, things went pretty much as planned, and we're able to stabilize most of that within the next 4 or 5 months. Both bakeries, one was a DSD bakery; one was a warehouse bakery. We had a few complications. So we decided to pause it, go back and clean some things up, understand a little better about what we needed to do with regard to the ERP system to make the next bakeries go smoother. During that time, the California situation came up. So the same folks working on both projects. So it was critical to hit the time -- the deadlines with regard to California. So we did pause the bakery rollouts for the California situation as well as to give us the opportunity to go back and reassess. Most of that is now behind us. We're getting close to having a finalized plan to start back up the implementation of the bakery. So my guess is it will be late this year or early next year. Depending on how the first couple of those go, I think we'll have a better picture about time line. But right now, we feel like if we -- if we're successful, we may do more bakeries at a given point in time, but we should still be able to hit the overall time line from that perspective. From an overall cost perspective, I think we're pretty comfortable that we should stay within the cost guidance we've given, which is to me, is critical. The time line, making sure we don't do things to impede the business or bring a location down is very critical. So we're being very measured about how we approach this.

You've also sounded pretty excited about the M&A environment on recent calls. I guess, where is your focus and what makes you optimistic on that front? And are you looking more so at bolt-ons or potentially more transformational deals or both?

Yes. So nothing transformational. Some smaller things can become transformational over time, but we don't really have our eye on anything massive at this point. I mean look, we're really focused on expanding our branded portfolio. And there are a few core acquisitions that would help. I mentioned the geographic expansion earlier that could certainly help you get a faster toehold in some of those geographic areas. And the good news there is that typically, first of all, we know all of them. These are relationships that go back sometimes 50 or 60 years in this industry. And we're typically the buyer of choice because, one, typically private equity doesn't do fresh packaged bread just because of perishable and DSD and all that sort of stuff, the network you have to have. And the other major player in the category is so penetrated -- from a regulatory standpoint, they're kind of done at this point. So we're typically the buyer of choice there. So that's the core. But what you'll see us do more of over the next several years is outside of our core business. So we're typically focused on branded products that, that really resonate with consumers that would be both growth and margin accretive for us, but they also have healthier attributes to them or at least a better-for-you health halo over them. We are pretty bullish on the M&A market. We believe that there are some things that could be coming to market over the next 12 to 18 months that would be a great fit for us and really help to advance our business. We are very proactive about developing relationships with these primarily founder-led businesses, sometimes private equity, too. But a lot of times, founder-led businesses. And these are relationships we've been cultivating for 5, 6, 7, 8 years. And we think that, that does give us an advantage. Obviously, valuation matters but so do these relationships because the founders are typically very passionate about these businesses, and they're passionate about the go-forward stewardship of the business, and we bring a lot to the table on that regard.

Maybe in the final couple of minutes, what does success look like if we're thinking out over the course of the next year, right? What does success look like for Flowers Foods as everyone here tries to sort of assess the progress against that.

Yes. I mean, obviously, there's the long-term algorithm that we have published. I mean so that's one marker of success. But to be a little bit more granular, we've touched on all of it. Continuing to innovate, continuing to find ways to grow in the category, continuing to find ways to grow organically in adjacent categories like we are with the snack bars and the bites that will be coming out next year. We have very heady aspirations for what we want to do from an innovation standpoint in terms of dollar sales contribution per year. It's not something that we specifically disclosed yet. But we continue -- each year, we get better. We learn more, we learn how to become more effective and efficient, and we continue to kind of raise the bar on how much innovation is going to contribute to the total over time. Obviously, executing well on M&A when those opportunities come up. Look, valuations are high. That's just a fact. Those of you who know us well also know that we're very disciplined with how we approach M&A. We do very rigorous work, and we are happy to pay a premium. But we've got to have significant conviction commercially, operationally, financially before we'll pull the trigger. But the fact of the matter is some of the assets we're looking at, we won't have the luxury being tepid about price, but we will be reasonable, and we'll be very diligent in that regard. And then finally, I would mention just ongoing cost management that we covered earlier, did a good job this year, very proud of the team. difficult task to remove as much cost as we did. The key now is to keep it out with those new governance controls.

Great. Good. Well, I think that's a great place to cut it off here and take it over to the breakout. Thank you very much, Ryals and Steve, and Kraft Heinz up here next. Thank you.

Thanks for having us.