Flowers Foods Inc

NYSE:FLO

Earnings Call Transcript 2024-Q1

[J. Rieck, executive]

Hello, everyone. This is J.T. Rieck, EVP of Finance and Investor Relations. Welcome to the prerecorded discussion of Flowers Foods' 2024 First Quarter Results. We will host a live Q&A session this evening at 5:00 p.m. Eastern. Further details about the live call, along with our earnings release, a transcript of these recorded remarks and a related slide presentation are posted on the Investors section of flowersfoods.com.

Before we get started, keep in mind that the information presented here may include forward-looking statements about the company's performance. Although we believe these statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to what you hear in these remarks, important factors relating to Flowers Foods business are fully detailed in our SEC filings.

Providing remarks today are Ryals McMullian, Chairman and CEO; and Steve Kinsey, our CFO. Ryals, I'll turn it over to you.

[A. McMullian, executive]

Thanks, J.T. It's a pleasure to welcome everyone to the call. Our solid first quarter results underscore the progression of our portfolio strategy, which we've been discussing for several years now. In a challenging and dynamic market, we grew branded retail units in tracked channels, outperforming the fresh package bread category. Our strong brands also drove dollar sales outperformance, increasing 4% compared to category expansion of only 1%. Importantly, momentum built throughout the quarter in total company volumes, turned positive in the last 4 weeks as our branded products continue to gain share and away-from-home business exits moderate.

Excluding deliberate exits in our away-from-home business, company-wide volumes grew in the first quarter. Even more exciting is that early signs indicate that these positive results have continued into the second quarter. As I mentioned, the catalyst for that performance was our portfolio strategy, which aims to shift a greater portion of our sales to higher-margin branded retail products while improving the profitability of our private label and away-from-home businesses.

Our results during the pandemic demonstrated the potential benefits of that strategy as the mix shift to branded retail products drove significant margin expansion. In the years since, we've been focused on advancing that strategy, strengthening our brands through investments in innovation and marketing. We've also improved the composition of our away-from-home and private label businesses, emphasizing margins over volume. In the short term, that process resulted in stranded overhead that hampered corporate margins. However, beneath the surface, profitability in those businesses improved dramatically and we are capitalizing on new opportunities to rebuild that lost volume at more attractive margins.

Financial results gained momentum throughout the quarter with a solid top and bottom line performance. Sales benefited from the carryover of pricing actions in the prior year, as well as improving volume trends. Margins were aided by moderating commodity cost, partially offset by investments in growth initiatives and higher labor expense. The bread category continues to outperform with unit sales flat compared to a 3% decline in overall food as shown on Slide 9. Trends within the category were consistent with the recent past.

Although the economic environment has shifted demand toward private label products, which gained 30 basis points of unit share, Slide 10 shows that shift has clearly moderated. In fact, private label actually lost share in the last 4 weeks of the quarter. In this evolving environment, our brands continue to thrive, maintaining unit share in the quarter and gaining 50 basis points of dollar share in tracked channels. We performed particularly well in the specialty premium sandwich buns and rolls and breakfast channels where we added 140, 40 and 40 basis points of unit share, respectively. This encouraging performance bolsters our confidence in our long-term prospects as consumer demand normalizes.

Based on these results, we are largely maintaining our financial outlook for the year, though with increased expectations for capital spending related to supply chain optimization initiatives. We are optimistic about continued volume improvement and expect to benefit from new profitable business wins and increased savings initiatives that will flow through the second half. We remain somewhat cautious about the uncertain consumer and promotional environment. Steve will offer more detail in his remarks.

Now I'll provide an overview of our first quarter performance in the context of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. Following that, Steve will review our financial results and guidance and then I'll close with a discussion of key themes moving forward. I can't say enough about the tremendous progress we've made in a challenging market environment. That performance is the direct result of the hard work of our team who are our greatest competitive advantage. From innovating new products, expanding into new markets, deepening our relationship with retail partners, improving the efficiency of our manufacturing process, refining how we go to market and other areas that are too numerous to list, the Flowers team is focused on ensuring our company continues to improve each day.

I'm humbled by their enthusiasm and dedication and I'm extremely proud of their accomplishments. Our second strategic priority is focusing on our brands, which continue to resonate with consumers. Although inflation is driving a greater focus on value, consumers continue to seek out differentiation. Our brands offer an assortment of options at various price points and we're seeing successful performance throughout the portfolio. Dave's Killer Bread continues to post exceptional results despite category weakness in premium products. Dave's gained 30 basis points of dollar share while growing units 10%. Other brands generated similarly impressive results with Nature's Own and Wonder each gaining 20 basis points of dollar share.

And with the benefit of recent capacity additions, Canyon Bakehouse is making progress in reigniting its growth, increasing dollar share in the gluten-free category by 40 basis points. We attribute these strong results to our brand strength, market execution and innovative products. Highlighting the effectiveness of our innovation capabilities, Flowers has had the #1 new SKU introduced in the bread category in each of the last 2 years with Nature's Own Hawaiian Loaf in 2022 and Keto Net One Loaf in 2023.

Our innovation pipeline has been increasingly productive with the recent introduction of 11 new products. For example, building on the success of the Keto Net One Loaf, the top-selling keto packaged bread nationwide, we introduced Keto Soft White Buns. Other products include Nature's Own Perfectly Crafted flatbreads, DKB Organic Rock 'N' Rolls, Wonder bagels and English Muffins and Canyon Cinnamon Raisin Bread.

And of course, we're in the midst of the nationwide launch of DKB Amped-Up Protein Bars with plans to launch DKB snack bites nationally soon after. The original DKB snack bars continue to receive strong support from consumers, an encouraging sign as we launch these follow-on products. The breadth and scope of our newest launches are a testament to our continued focus on innovation and the growth of our leading brands. As consumers increasingly seek more differentiated items, it's critical that we continue to bring new and exciting products to market. We have ambitious plans in that regard and I'm optimistic about the long-term growth potential enabled by our innovation team.

Our third strategic priority is margins, an area where we continue to make progress. Pricing actions taken last year to offset inflationary pressures have been effective in recovering some of the margin lost in prior years and plans to further optimize bakery operations, including our digital initiatives are taking hold and beginning to show progress. Equally impressive is the improved profitability in our away-from-home and private label businesses, which I touched on earlier. Signifying the increased profit potential for away-from-home, we elevated it in our portfolio strategy matrix to the balance growth quadrant as shown on Slide 11.

We're excited about the opportunities in each of these areas. To further strengthen our leading brands, we're investing in marketing and digital initiatives. Although those investments temper near-term results, they are nonnegotiable and crucial in enabling us to meet or exceed our long-term financial targets. Despite our solid performance, we recognize the need to further improve our cost structure to better leverage our strong top line results and deliver increased profitability. To help offset the near-term impact of those investments, we are redoubling our efforts and increasing our expectations for savings initiatives for the year from $30 million to $40 million to $40 million to $50 million.

The increase reflects our confidence in the effectiveness of our initial cost savings programs and the addition of new programs as we continue to optimize our operations. Specific's actions include select workforce reductions, reduced third-party spend, enhancing the effectiveness of marketing investments, improvements in leased labor and indirect procurement spend and efficiency in our DSD network, among others.

In addition to those savings initiatives, we have identified further areas of operational improvement in a couple of bakeries that we expect will result in a meaningful improvement to quarterly earnings going forward, though these initiatives will take time to implement. Had those bakeries been operating at their proper efficiency levels, our quarterly performance would have been even stronger. We're actively working to capture these efficiencies and view that process as a significant opportunity to drive further earnings growth.

Amid this challenging environment, it's more important than ever that we wisely control our cost and promote a culture of ownership and accountability. While this focus has always been ingrained in our DNA, we're increasing our emphasis going forward, instituting a mindset of continuous productivity improvement related to cost across the organization.

Our fourth priority is smart M&A. M&A has been a key contributor to our growth for decades, expanding our geographic coverage and supplementing our brand lineup. In addition to strengthening our position in core categories by expanding our geographic reach and gaining share in underdeveloped markets, we're also focused on finding new revenue streams across the baked foods category. We see compelling brands that complement our existing portfolio and SKU towards a better-for-you nutritional profile. The M&A market is showing signs of improvement and we remain encouraged by the developing pipeline of potential opportunities. Our strong balance sheet positions us well to act when we have financial, commercial and operational conviction.

Now I'll turn 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?

[R. Kinsey, executive]

Thank you, Ryals and hello, everyone. Total sales in the first quarter increased 2.8% from the prior year period. Improved price/mix drove the year-over-year increase, up 3.1%, primarily due to pricing actions taken in the prior year to mitigate inflationary pressures. Volume decreased 0.8%, largely due to targeted sales rationalizations and away from home. Notably, branded retail volumes increased 0.3%. The Papa Pita acquisition added 0.5%. Gross margin as a percentage of sales, excluding depreciation and amortization, increased 160 basis points to 49.4% over the same quarter last year.

Comparisons benefited from pricing actions taken in the prior year and lower ingredient and packaging cost, partially offset by volume declines related to business rationalizations. Selling, distribution and administrative expenses as a percentage of sales were 39.7%, a 110-basis point increase over the prior year period. Increased labor and technology expenses were partly offset by lower distributor distribution fees as a percentage of sales. Excluding matters affecting comparability, adjusted SD&A expenses were 39.3% of sales, a 130-basis point increase due to the factors listed above.

GAAP diluted EPS for the quarter was $0.34 per share compared to $0.33 in the prior year period. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter was $0.38 per share, consistent with the prior year period. Turning now to our balance sheet, liquidity and cash flow. Cash flow from operating activities in the first quarter increased by $47 million to $105 million. Capital expenditures decreased $1 million to $33 million and included $2 million for the ongoing ERP upgrade.

Dividends paid increased $2 million to $51 million. We believe our financial position remains strong. At quarter end, net debt-to-trailing 12-month adjusted EBITDA stood at approximately 2x. We held approximately $16 million in cash and cash equivalents and had approximately $541.6 million of remaining availability on our credit facilities.

Now turning to our outlook for 2024. As Ryals said, we are largely maintaining our previously issued guidance, which calls for sales to be flat to up 1.6%, EBITDA of $524 million to $553 million and adjusted EPS in the range of $1.20 to $1.30, The one change is an increase in capital spending related to supply chain optimization. Guidance reflects our expectation for continued volume improvement while acknowledging an uncertain economy and its potential impact on consumer behavior and the promotional environment.

Full year results are also expected to benefit from an expansion of our savings initiatives and new business wins. Key factors that could shift results within our guidance range include the consumer and promotional environment, the transition of our California distribution and implementation of our savings initiatives. Other factors expected to impact full year results include a higher tax rate and increased net interest expense associated with funding payments related to the California legal settlement, the ongoing ERP project and decreased interest income.

As previously disclosed, we reached an agreement to settle distributor-related class action litigation in California. The settlement received final court approval on March 18, 2024. We have started the process of repurchasing the California distribution rights, which is expected to be completed during the first quarter of fiscal 2025. Once completed, we plan to service the California market with an employment model.

Approximately 83% of our key raw materials are covered in 2024. Based on that coverage, our guidance incorporates a moderation in ingredient costs in 2024 relative to the prior year. To minimize volatility and provide adequate visibility into cost, we have maintained our historical hedging strategy in which we intend to increase the certainty of our key ingredient costs 6 to 12 months out.

Our ERP rollout went live in the second quarter of 2023 and we continue to make progress in that implementation, though we have paused the bakery rollout to concentrate resources on our California distribution transition. In fiscal 2024, we expect cost for the upgrade of our ERP system to be approximately $25 million to $35 million, including $3 million to $6 million expected to be capitalized. As of quarter end, we have incurred cost related to the project of approximately $223 million, of which $114 million has been capitalized.

Thank you and now I'll turn it back to Ryals.

[A. McMullian, executive]

Okay. Thank you, Steve. Now I'd like to discuss some of the trends impacting our current performance and the steps we're taking to maximize our opportunities in this environment and beyond. I'll first touch on consumer trends and then address the competitive environment. Consumer purchasing behavior in the first quarter remained consistent with the recent past. The market is somewhat bifurcated with premium products performing well as some consumers seek differentiation and less expensive products appealing to those looking for greater value.

Private label products continue to gain share, though that trend is moderating, as I noted earlier. In fact, private label actually lost unit share toward the end of the quarter. And as private label unit growth moderated, our branded retail volume inflected positively, growing in the quarter for the first time since 2020. That shift continues the positive trend that we highlighted last quarter, as shown on Slide 12. Consistent with our portfolio strategy, the result of that growth is that our branded retail mix increased to 64.4% of sales in the quarter, up 50 basis points from the year earlier period and up 440 basis points from the first quarter of 2019.

Consumer spending remains somewhat inconsistent. Data shows that fast food traffic is declining, while overall at-home food and beverage units also trended negatively towards the end of the quarter. At the same time, bread category trends have been improving, with notably better sequential unit performance in the quarter, as highlighted on Slide 9. We continue to monitor these trends closely.

Turning now to the competitive environment, which remains rational and consistent with recent periods. Although economic pressure is driving many consumers to seek greater value, lifts from promotion remain below prepandemic levels. Research from Circana offers several possible explanations for this seeming anomaly. First, following significant price increases to offset inflation, consumers perceive discounts off those higher prices as less of a value compared to lower preinflationary prices. Second, lower income consumers with stretched budgets, who previously may have capitalized on promotions by stocking up on product may not be able to afford to do so now.

And third, more consumers are planning their purchases ahead of store visits and not straying from their list while in store, minimizing the number of impulse purchases. Given that environment, to drive greater efficiencies in our promotions, we are leaning even further on our enhanced internal digital tools. Last quarter, we noted that the percentage of our products sold on promotion grew as our promotional activity increased slightly and consumer response to promotions reverted somewhat to more historical levels.

In the first quarter, we saw a similar trend with higher levels of products sold on promotion compared to the prior year, though at a smaller percentage increase. That said, our promotions remain significantly below prepandemic levels. It's also important to note that our average selling price rose versus the prior year quarter, validating our selective use of promotions in combination with enhanced display execution and new trade promotion management capabilities. We will continue to selectively use promotions where warranted, including to drive trial of new and innovative products but only where we expect a net positive return on investment.

Beyond promotions, we remain focused on bringing greater perceived value to consumers through innovation and highlighting that value in our marketing. For example, our new Nature's Own small loaves offer the same great taste, texture and quality of our traditional loaves but at a lower price point with less product waste for smaller households. We expect our innovation team to continue their work of developing unique products that expand the potential market for our leading brands.

So in closing, I'm pleased with the improvement demonstrated by our first quarter results, maintaining a focus on long-term opportunities requires patience, as change takes time to implement and progress can be uneven. Short-term fixes that generate quick wins can be tempting but often don't go far enough to maximize long-term value. If there's one thing that I hope everyone will take away from this call is that we're doing exactly what we said we would do, executing our portfolio strategy by exiting low-margin business and refilling that capacity with margin-accretive new business, improving our cost structure, investing in our brands to drive volume and share gains and improve our mix, leveraging technology to improve data visibility and drive better strategic decisions and investing in our team to improve overall execution.

While we're not yet where we want to be, our progress is becoming increasingly apparent. We will continue to push forward with a focus on achieving our long-term financial targets. I'm extremely confident in our growth potential, and I look forward to continuing our progress throughout 2024.

Thank you very much for your time. That concludes our prepared remarks.