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

Hi, everyone. I'm J.T. Rieck, Executive Vice President of Finance and Investor Relations. Thanks for joining us to discuss Flowers Foods' results for the third quarter of 2024. Before we begin, please note that what we present today may contain forward-looking statements regarding how the company will perform. While we consider those statements reasonable, they carry risks and uncertainties that might make actual results come out materially different; beyond what you hear in these remarks, the important factors concerning Flowers Foods' business are laid out in full in our SEC filings. Speaking today are Ryals McMullian, our 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. Strong execution amid a difficult backdrop stood out in our third quarter results. We delivered meaningful margin gains and solid bottom-line growth, even though the top line faced pressure stemming largely from external forces. Our leading brands keep outdoing competitors, and we're making substantial headway on boosting profitability in our other category. Changing patterns in how consumers spend have created headwinds for fresh packaged breads. Consequently, category sales fell in both units and dollars. The encouraging volume trends we mentioned last quarter did not carry through. Results picked up near the end of the third quarter, thanks in part to the effects of Hurricane Helene. Unlike the category, Flowers posted growth in both unit and dollar sales; that gain produced superior share results, adding 20 basis points of unit and dollar share, the biggest increases within the category. We're putting money into innovation and marketing to sustain that outperformance. Weak category trends have also weighed on our cake business. Even though we held share during the quarter, unit sales in tracked channels fell 5%, matching the category. We're acting to counter this pressure, among other steps extending our Wonder brand into sweet baked goods, which I'll discuss in more detail later in the call. Disciplined execution of our portfolio strategy produced better results in our other category. Sales got a lift from pricing, which more than offset reduced volumes across the business. The effect of business exits shrank during the quarter and is now essentially finished. Headwinds in certain end markets, especially QSR, should persist as consumers move more of their consumption toward at-home occasions. Next I'll give an overview of our third quarter performance through the lens of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. After that, Steve will go through our financial results and guidance, and then I'll wrap up with a discussion of key themes ahead. For over 100 years, a hallmark of Flowers has been the willingness and ability of our team to rise to the occasion when called upon. Those qualities show throughout our business, and I'd like to highlight two examples, the recent hurricanes and the transition of our distribution model in California. I'm thankful to report that no Flowers team members suffered any serious injuries or loss of life from Hurricanes Helene or Milton. While our bakeries came through mostly unscathed, many of the communities we serve did not, and some endured unimaginable tragedies. True to our history and culture, we came together to make sure consumers had the products they needed both ahead of and after the storms. And we're working with nonprofit organizations and customers to keep delivering food to those in need. As always, our team's commitment leaves me in awe. The second example involves a change to how we operate in California—moving away from a model built on independent distributors toward a sales team housed within the company—and this effort demands a great deal of coordination and teamwork. Starting last year, a sizable cross-functional group of Flowers team members has collaborated to plan and establish the framework for what lies ahead in the state. Legal, sales, human resources, sales enablement, IT, procurement, finance and numerous others have been working together so that this transition goes as smoothly as possible for our team members and our customers. I'm pleased to say that substantial progress is being made, and we've successfully hit a major milestone by completing over half of the transition. That achievement wouldn't have been possible without the commitment of our Flowers team, and I want to recognize everyone involved for their efforts. Our second strategic priority centers on our brands, and they keep delivering solid results even in a difficult environment. In a category where both units and dollars fell, every one of our primary bread brands posted dollar and unit growth in tracked channels. To illustrate, Nature's Own units rose 2%, DKB 4%, Wonder 3% and Canyon an impressive 11%; that performance carried over into market share gains, with each of these brands increasing both unit and dollar share. Canyon's results deserve special mention, as it widened its lead in the gluten-free category by 360 and 340 basis points of unit and dollar share, respectively. A strong pipeline of innovative products is fueling our solid performance. Nature's Own keto loaf has kept up its remarkable momentum, picking up 730 and 770 basis points of unit and dollar share, respectively. Even though it launched just last year, it is quickly closing in on the #1 market share position in its subcategory; we're building on that momentum with a national launch of keto hamburger buns and a planned launch of keto hotdog buns next spring. Leveraging our innovation capabilities and our portfolio of strong brands, we're moving into adjacencies and even entirely new categories. Our DKB snack products offer one illustration of that strategy. Having already moved DKB successfully into breakfast buns and rolls, we took the brand further into snacking. Our snack bars are progressing nicely, with dollars and units growing as we apply best practices across our network. And we're increasing distribution of our snack bites as we get ready for the national launch in 2025. In the same way, we're leveraging Wonder's broad consumer brand awareness by moving into the sweet baked goods category; we're excited by the strong momentum gathering ahead of the upcoming launch. Retailers are reacting with enthusiasm, and even voted Wonder a Top 10 Cool New Products at the recent National Association of Convenience Stores Trade Show. These exciting new products will launch nationally in the spring of 2025. Needless to say, we see enormous potential in our innovation pipeline. Our third strategic priority is margins, an area where we continue to make significant progress. Adjusted EBITDA margins rose 110 basis points from the same quarter a year earlier, driven by solid execution of our portfolio strategy and our savings programs. We've made significant progress on boosting profitability in our away-from-home and private label operations by making sure every account hits our margin targets. That effort led to a temporary under absorption of overhead costs as we pruned low margin business. Even so, we're starting to realize the payoff from this strategy through better margins on existing business and new business wins. Innovation is another lever we're pulling to move a larger share of sales into higher margin products as we grow premium brands such as DKB and Canyon and introduce innovative items like keto along with core brands like Nature's Own. Our savings programs are contributing to the margin improvement as well, as we deliver against our $40 million to $50 million target for 2024. To support the operating leverage our long-term financial targets imply, we're running a rigorous process aimed at offsetting inflationary pressure in labor, shipping, commodities and other areas. Smart M&A is our fourth priority. The deal market is active, and we're carefully assessing potential acquisitions, with the aim of reinforcing our position in core categories and uncovering new revenue streams across the baked foods category. We look for compelling brands that fit alongside our existing portfolio and that lean toward a Better For You nutritional profile. Our strong balance sheet puts us in a good position to act when we have financial, commercial and operational conviction. As always, we'll stay disciplined in our approach and focused on growing shareholder value with an attractive risk/reward balance. While we may consider acquisitions that call for premium multiples, as we paid for DKB, such a premium would demand greater conviction in our ability to deliver strong growth and a compelling return on investment. Now I'll hand it over to Steve to review the details of the quarter, and then I'll close with our outlook for the current business environment. Steve?

Thanks, Ryals, and good morning, everyone. I'm glad to take you through the results for our third quarter. Net sales fell 0.7% compared with the same period last year. Price/mix was up 1.7%, helped by optimization in our non-retail business, most notably foodservice, but volume declines of 2.4% more than offset that gain, largely in cake, foodservice and institutional sales. Gross margin as a percent of sales, excluding depreciation and amortization, increased 130 basis points to 49.8% versus the same quarter last year. The comparisons benefited from better sales price/mix, moderating ingredient and packaging costs and fewer product returns. Lower output levels, greater costs tied to our workforce, and more purchases of product from outside suppliers all weighed on results, though they were partly countered by the general upturn. As a share of sales, selling, distribution and administrative expenses came in at 38.7%, which is 1,170 basis points below the same period a year earlier. That drop stemmed from much smaller legal settlements and associated costs, along with reduced distributor distribution fees, marketing expense, logistics and freight costs and consulting costs. Those gains were partly countered by higher workforce-related costs, greater rent expense and less income from scrap dough. When matters affecting comparability are excluded, adjusted SD&A expenses represented 38.6% of sales, a rise of 20 basis points versus the prior period. For the quarter, GAAP diluted EPS came in at $0.31 per share, which is up $0.53 from the same period a year ago. If you set aside the items affecting comparability that we detailed in the release, adjusted diluted EPS for the quarter rose $0.04 versus the prior year period, reaching $0.33. Now let's move to the balance sheet, liquidity and cash flow. Through the third quarter of fiscal 2024 on a year-to-date basis, cash flow from operating activities grew by $25 million, hitting $282 million. Capital expenditures fell $10 million to $87 million, and that figure included $5 million tied to the ongoing ERP upgrade. Dividends paid were up $6 million, totaling $153 million. Our financial position, in our view, remains strong. As of quarter end, net debt to trailing 12-month adjusted EBITDA was roughly 2x. We finished with $15 million in cash and cash equivalents, and $531.6 million was still available to us under our credit facilities. Moving on to how we see 2024, we're tightening the range of the financial guidance we issued earlier. Our current projection has sales rising 0.5% to 1.1%, adjusted EBITDA between $530 million and $542 million, and adjusted EPS from $1.24 to $1.28. Because of how project timing has shifted, we're lowering our capital expenditures expectation to $130 million to $140 million. Several things could move results up or down inside the range we've given: how consumers behave and how much promotion is in the market, how quickly newly won business reaches full run rate, the shift in our California distribution setup, and the rollout of our cost-saving programs. In fiscal year 2023, as we've said before, we agreed to settle a class action lawsuit in California involving distributors. Per Ryals, we're moving forward on buying back the distribution rights, and under the settlement agreement that work should wrap up in 2025. For 2024, roughly 100% of our key raw materials are covered. Taking that coverage into account, our guidance assumes ingredient costs will moderate in 2024 compared with the year before. Looking ahead to Q4, the benefit we've been getting from lower raw material prices compared with a year earlier is likely to shrink quite a bit. To limit swings and keep enough sight lines into what costs will do, we've maintained our long-standing hedging practice, through which we aim to lock in more certainty on the prices of our main ingredients six to twelve months out. Our ERP implementation—which we expect to improve data management and efficiency and to automate a large share of our processes—went live during the second quarter of 2023. We're proceeding cautiously with that rollout so we continue serving market demand effectively at the high service levels customers expect from us. As we noted previously, we've put the bakery rollout on hold so we can direct resources toward our California distribution transition. For fiscal 2024, we anticipate the ERP system upgrade costing $25 million to $30 million, with $5 million to $7 million of that expected to be capitalized. Project costs so far this year stand at $18.1 million, $4.9 million of which has been capitalized. The project's total cost to date is $232 million, with $117 million of that capitalized. Thank you. I'll now 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 both current and upcoming opportunities are fully captured. First I'll cover consumer trends, and after that I'll turn to the competitive environment. Our initial 2024 financial outlook came with a cautionary note about an uncertain consumer and promotional backdrop. Trends in those areas are still fairly in line with what we've seen recently, but we have picked up on certain changes in how consumers behave, and promotional activity has kept climbing versus a year earlier. As we said last quarter, shoppers looking to get the most from what they spend have moved a larger portion of their buying toward food at home, and in particular toward value channels such as mass and club stores. That at-home movement is especially pronounced among those at the lower end of the income spectrum. Even with that favorable swing toward eating at home, the bread category as measured in tracked channels has come under pressure as shoppers lean more toward the store perimeter, with meal preparation ingredients such as protein, spices and oils showing particular strength. In line with that pattern, notable growth pockets within bread include tortillas as well as buns and rolls. Since the pandemic, we've watched perimeter bread share gains revert slowly, though they have not returned to prior levels; we view this move toward meal preparation items as temporary, but we are using consumer trends to help the overall category grow through innovation, giving shoppers appealing new choices such as our keto products; those efforts produced continued outperformance, with bread unit and dollar sales in tracked channels rising for the third consecutive quarter, as Slide 13 shows. Slide 9 shows private label kept losing unit share, down 40 basis points in the quarter. Sales took a hit from narrowing price gaps as branded retail products stepped up promotions and private label prices climbed 2.7%. Private label sales in traditional grocery have been especially pressured, perhaps because those shoppers hunting for value are moving more of their spend to mass and club stores. Turning now to the competitive environment, which remains rational, with promotions below pre-pandemic levels. As I noted, we have observed a notable pickup in promotional activity during the second half of the year; even so, despite the higher promotional levels, the average category price was flat against the year ago period. One reason for that pattern is a mix shift toward premium products, but some is also likely because a greater percentage of products sold on promotion, albeit with less promotional intensity. Consumers are responding well to promotions, and we keep effectively leveraging our enhanced trade promotion management capabilities; for instance, instead of focusing only on price, we've been emphasizing display execution so our brands stand out better for consumers. Likewise, since consumers respond well to differentiation, we keep investing in innovation to meet their evolving needs. To close, I'm pleased with our strong relative performance in this challenging environment. We're making the most of the chances we have in the areas we control — going after pockets of growth in branded retail, improving margins in our private label and away-from-home businesses, and delivering on our cost savings plan. Thanks to these initiatives, I have a lot of confidence that we are positioning Flowers for growth consistent with our long-term financial targets; we're very pleased with how strongly our leading brands performed in what is still a pretty challenging environment. Even with consumers seeking value and pressured category sales, we did grow dollars and units in fresh packaged breads. And that growth drove the biggest share gains in the category, which confirms that our investments in differentiation are paying off. In our Other segment, carrying out our portfolio strategy made sales growth possible, as strong pricing initiatives more than offset volume losses. As we get ready to close out the year and look toward 2025, we stay focused, of course, on enhancing shareholder value and on delivering results consistent with our long-term financial targets. That process includes making the most of the chances we have in areas we can control — going after pockets of growth in branded retail, improving margins in our private label and away-from-home businesses, and delivering on our cost savings plan. So, Josh, with that, we'll open up the floor for questions.

I was hoping we might begin by looking at the growth areas for next year — both Dave's snack bites and Wonder. Could you give us a sense of how big those expansions are and what ramp you expect? And maybe a bit more detail on the Wonder side about your confidence in sweet baked goods, which has clearly been under some pressure lately. And on Dave's, a little more on where you expect to land placement for those snack bites, plus some signs of confidence that we aren't at risk of stretching that brand too far — that's my question, I suppose?

Yes, absolutely. Let me begin with Wonder. We'll likely have more specifics for you in February. We're really early in getting it out to customers. What I can say is the early returns have been pretty strong. Retailers have shown a lot of enthusiasm. We noted the top 10 item at The NAC Show only a few weeks ago. So the items are unique. Quality is fantastic. Packaging looks great; and frankly, we all know some help is needed in sweet baked goods. The category has been down; we performed roughly in line with it, but that isn't a good story. So I think the key takeaway is that we're taking proactive steps to bring some growth into that category, and we're quite excited to do it with the Wonder brand given very high unaided awareness for Wonder. On the DKB snack line, the borrowers keep doing well — the original 3, the protein bars — we have more SKU innovation in the pipeline to deliver as early as next year; and then, of course, as you said, the snack bites too. Steve, I don't think overextension is a danger. If anything — take the bars, for example — shelf space and visibility matter so much; and we came out of the gate with 3 SKUs and did quite well, but now we're expanding to 6 and then beyond. And then, of course, the snack bites are entirely differentiated from that, in a different category and quite unique for the category. There's really nothing quite like them out there. The closest analogy, I'd say, is probably some of the granola products you see on the shelf. But with 3 savory items, 3 suite items; we're very excited about the prospects. Retailer acceptance has been great. But I always like to remind you guys that these things take time. I mean, this really functions a lot like a startup, and building that consumer base takes some time to ramp up. Some of these consumers aren't currently DKB shoppers, which is great since we're growing consumption of the brand, but accomplishing that does take time. That said, we're still very bullish on this emerging snack business we have for DKB.

All right, that's great, and I'll make sure to share it. But Steve, I wanted to ask you, if I may, about the CapEx reduction for the year. It really does appear to be on the ERP side, since that actually rose a bit. Could you perhaps explain what caused the reduction? And is that, sort of — is that genuine efficiency? Or is that something we ought to factor in as we think about capital planning in '25?

Sure. Steve here, this is Steve. I mean, the primary driver behind that change is really just the pace of spend for the year. I mean, you're correct, it isn't necessarily ERP, it's other projects, mainly bakery. And a lot of those got delayed, so we simply weren't able to get to them. So they'll carry over into 2025. So you should factor that in as you think about next year.

I'd like to spend a moment on the sweet baked goods, or the snackie business. And regarding those declines, is there anything different you're noticing this year now that Smucker's owns Hostess — more competition, more promotion, or even pressure pushing down into the store brand type stuff? Or is this simply the category's continued ups and downs as far as you're concerned?

Yes. For us, I think it's more generally — Bill, can you hear me?

Yes.

All right. We had a bit of audio disruption there. Yeah, it really comes down to the category's fluctuations. I'd say that's mostly because shoppers are cutting back on discretionary spending or on treats. You've noticed a bit of softness even in salty snacks, which has usually held up quite well. I believe that's short-lived. Still, I do think it has more to do with consumers' wallets than anything else.

Understood. And just following up on that — since you've witnessed this before, what's your sense of how long it goes on? This really isn't some dire financial crisis. It's simply a pullback. So do you figure you can return to growth as we head into '25? Or is it simply too soon to say?

Well, I don't own a crystal ball, but my sense is — it would be fair to expect that sometime next year, things begin to normalize and the category becomes somewhat healthier. You'll remember that before this inflationary cycle hit us. Sweet baked goods stood as the strongest among snacking categories, despite all the health stuff, the health and wellness trends happening out there. So my expectation is that it comes back. We're aimed at delivering super high-quality items to the consumer under great brands. That's why this Wonder brand excites us, or Tastykake, a great iconic Philadelphia brand, but speaking just for us, it doesn't perform quite as well beyond that category. And I believe you've witnessed that across the last several years, especially as Hostess emerged stronger from bankruptcy. So shifting somewhat toward the Wonder brand, we believe it can make us more competitive against some of those stronger brands in the category, particularly if we fulfill the quality promise.

Understood. And apologies, just one more; regarding the promotional level in the bread line roll business, is it mainly coming from the biggest competitor? Or are you also seeing it among the smaller regional players?

Yeah. I mean, it's pretty broad-based. And look, I mean, we've ramped up our promotional activity as well. Now the intensity of that isn't as high, and we're still quite a bit under pre-pandemic levels. But we've also increased our promotions. So it's across the category. However, since we're number one in differentiated brands, we're seeing fairly good lift from those promotions. And I think that might be a little different from what some others may have said.

Great. Let's do a bit of quick housekeeping first. In the prepared remarks, I believe you mentioned that some trends carry over into Q3 from Q2, but then they got somewhat better toward the end of the quarter—it sounds like a hurricane may have given a little assist. So I'm just wondering—I'm not sure whether you want to or can quantify how much that possibly contributed to the quarter. And then maybe how you saw those trends shaping up after the hurricane, even though it's only been a couple of weeks?

Yes. So a number of the stronger category trends we called out in Q2 did not carry on. It did weaken somewhat as we progressed through the third quarter. The hurricanes did have an effect, Rob, but honestly not especially material. I mean, it helped. It was positive, of course, but not really all that significant in the quarter. I think, again, the key point to stress, specifically on flowers in the quarter, is that although the category remains somewhat soft, we are outperforming the category. And our—if you look at fresh packaged breads, our units rose about 70 basis points. We picked up 20 basis points of dollar share, 20 basis points in share, both of those, the largest among competitors in the category; so our innovation, our brands, our differentiated items keep making a difference even with a somewhat soft category at the moment.

All right, great. And then perhaps more generally, you'd also made remarks about the store's permit performing slightly better, and maybe that's benefiting certain subcategories of overall bread such as buns or tortillas, and I'm just curious, perhaps you could share your view on that a bit — like someone's picking up chicken around the perimeter of the store. I mean, I suppose with a burger, you're using a bond chicken, maybe you'll put it into tortillas; so maybe there's just a bit of a shift when it comes to traditional sandwich bread versus some of those other subcategories. And then, I guess, just as a follow-on to that, you always tend to comment on M&A when you mention the deal activity out there, right? Are any of those areas ones where you'd actually like to be bigger, just to diversify that portfolio somewhat?

By perimeter, you mean?

Yeah. Same as picking up a major tortillas brand. We've got tortillas now. We have lunch bread, keto, and buns.

Yeah. I mean, look, as we've mentioned previously, we're examining baked goods broadly. That covers the perimeter, it covers the freezer case, it covers center-store, it reaches away from home and convenience, those kinds of areas; so we're examining the full breadth of Baked Foods, which in total is an enormous category. On the trends, if you think back, Rob, the store perimeter was kind of a major topic before the pandemic, correct? And I believe as we came out of the pandemic, one question we'd hear each and every quarter was when do you think the reversion will occur? When do you think the reversion will occur? We really haven't heard that question for many quarters, but I think that's partly what you're observing now regarding shopping patterns and also the shift now toward in-home eating given inflationary pressures and consumers attempting to stretch their food budget. I do believe that trend tends to hit the traditional segment of our business harder than the other parts. We've discussed previously how that's arguably the least differentiated piece of our portfolio and that we have plans to raise that level of differentiation there to sort of fight back, but clearly, far less impact on the buns and rolls, as you said, on the Dave's Killer Bread of the world, on the Canyons of the world. So we keep repeating this message that innovation and differentiation matter, and that's what's driving our business overall.

All right, that's clear. Perhaps just one brief final question, then. It concerns the EBITDA guidance. When we consider what that suggests for Q4, at the midpoint at least, it appears there might still be a bit of margin expansion versus a year ago; so a few things I'd like to ask. Just what — and the range, I suppose, for the quarters still seems somewhat broad, right, which is understandable, given a complicated backdrop. But I'm rather curious about what could push you toward the upper end of that implied margin guidance for Q4, and perhaps what would bring you to the lower end? So is part of that just being cautious, given the promotional climate in general and how you're weighing the pricing side of things?

Yeah. I'd say it's really just an ongoing conservative stance. Look, I understand we're already in Q4, and on one hand you'd ask why visibility isn't better. I believe we do have that visibility, Rob, but we're simply choosing to stay careful given the outlook. When we put out guidance at the start of the year, we flagged the factors that could affect the year, among them heavier promotional activity, and several of those have indeed come to pass. What has countered that, though, is truly superb performance on our cost-savings initiative, along with excellent marketplace results as we keep expanding units of bread, butter and rolls. What's weighing on the business is the away-from-home segment, mainly the QSR portion, which honestly came in somewhat softer than we expected, simply because elevated pricing has pushed consumers toward in-home eating. And the softness in the cake business we've already addressed. Fresh-packaged bread is performing very well. I mean, there's simply — there's really no problem whatsoever in that area of the business. It's those other segments that are the issue. Regarding your question about reaching the top of that range — stronger results from cake and QSR, combined with the core business continuing to perform well, could take you to the upper end.

Ryals, I'd like to drill into the other category a bit. You mentioned some headwinds in food service, and the softness in QSR is pretty well known, I think. Could you break out how big a headwind foodservice was for other volume versus the business exits? Because I believe we still had some of those in the third quarter. So if we strip those out, how much would other volume have been down? And any detail on the private label piece within that category would also be helpful.