Flowers Foods Inc
NYSE:FLO
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Flowers Foods Inc
Earnings Call Analysis
Q3-2024 Analysis
Flowers Foods Inc
In its third quarter, Flowers Foods demonstrated resilience despite external pressures impacting sales. The company managed to improve margins and achieve strong bottom-line growth, gaining market share in key product categories. Although overall category sales for fresh packaged breads encountered a downturn due to shifting consumer preferences, Flowers experienced a commendable growth in both unit and dollar sales, outperforming competitors and capturing a 20 basis point share increase.
The overall net sales for the quarter decreased by 0.7% compared to the prior year. This decline was attributed primarily to a 2.4% drop in volume, particularly in the cake and foodservice segments. However, a price/mix enhancement of 1.7%—bolstered by optimization efforts—partially offset this decline. While unit sales in the cake category experienced a 5% decrease, Flowers Foods is proactively addressing these challenges by extending its Wonder brand into sweet baked goods, anticipating a revival in this segment.
The company has outlined four strategic priorities to adapt to market conditions: developing team capabilities, honing brand focus, prioritizing margin enhancements, and pursuing smart mergers and acquisitions (M&A). Innovations in product offerings, notably within the keto product range, have produced significant share gains. For instance, Nature's Own Keto loaf reported gains of 730 basis points in unit share, establishing a robust momentum in its category.
Flowers Foods reported an adjusted gross margin improvement of 130 basis points year-over-year to 49.8%. This increase was driven by favorable sales prices, steady ingredient costs, and reduced product return rates. Operational efficiencies have led to selling, distribution, and administrative expenses decreasing by 1,170 basis points to 38.7% of sales compared to last year, marking a reduction due to lower legal settlements and related costs.
For fiscal year 2024, Flowers Foods has tailored its financial guidance to reflect realistic projections amid a fluctuating market environment. Sales are anticipated to increase between 0.5% and 1.1%, with adjusted EBITDA expected to range from $530 million to $542 million and adjusted EPS projected between $1.24 to $1.28. Capital expenditures have been revised downward to an estimated $130 million to $140 million, allowing for better cash flow management.
In the current landscape, consumers are increasingly seeking value, leading to a transition toward food purchased for at-home consumption. This has particularly benefited products such as tortillas and buns, although overall bread categories remain pressured. The company is leveraging these trends through innovation and improved promotional strategies, focusing on addressing the evolving preferences of consumers effectively.
Flowers Foods remains committed to both its workforce and community, evidenced by a seamless transition following recent natural disasters. The company’s shift from independent distributors to an internal sales model in California is on track, showcasing its operational resilience and dedication to long-term growth while navigating external challenges.
Despite increased promotional activity across the industry, Flowers Foods maintains a strong competitive position by effectively managing trade promotions and product differentiation. The company is adapting to pressures from private labels and emerging retail trends by reinforcing its brand strategy and expanding its product portfolio to meet diverse consumer needs.
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Hello, everyone. This is J.T. Rieck, EVP of Finance and Investor Relations. Welcome to the prerecorded discussion of Flowers Foods' 2024 Third Quarter Results. We will host a live Q&A session this morning at 8:30 a.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.
Thanks, J.T. It's a pleasure to welcome everyone to the call. Our third quarter performance was highlighted by a strong execution in a challenging environment. We achieved notable margin improvement and drove strong bottom line growth despite top line pressure that was largely due to external factors. Our leading brands continue to outperform the competition, and we're making significant progress in improving profitability in our other category.
Shifting consumer spending patterns have led to headwinds in fresh packaged breads. As a result, category sales declined in both units and dollars. The encouraging volume trends we noted last quarter did not persist. The results improved toward the end of the third quarter, partly due to the impact of Hurricane Helene.
In contrast to the category, Flowers grew both unit and dollar sales. That growth led to superior share performance, gaining 20 basis points of unit and dollar share, the largest increases in the category. We're investing in innovation and marketing to maintain that outperformance.
Our cake business has also been hampered by weak category trends. Although we maintained share in the quarter, unit sales in tracked channels declined 5%, in line with the category. We're taking action to overcome this pressure, including the extension of our Wonder brand into sweet baked goods, which I'll cover in more detail later on the call.
Strong execution of our portfolio strategy drove improved performance in our other category. Sales benefited from pricing, which more than offset lower volumes across the business. The impact from business exits diminished in the quarter and is now largely complete. Headwinds in certain end markets, particularly QSR, are expected to continue as consumers shift more of their consumption to at-home occasions.
Now I'll provide an overview of our third 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.
For more than 100 years, the willingness and ability of our team to rise to the occasion when called has been a hallmark of Flowers. Those attributes are evident across our business, and I'd like to highlight two examples, the recent hurricanes and the transition of our distribution model in California.
I'm grateful to inform you that no Flowers team members reported any serious injuries or loss of life from Hurricanes Helene or Milton. Though our bakeries emerged mostly unscathed, that was not the case for many of the communities we serve, some of which suffered unimaginable tragedies.
In keeping with our history and culture, we banded together to ensure that consumers were supplied with necessary products both in preparation for and following the storms. And we're partnering with nonprofit organizations and customers to continue delivering food to those in need. As always, I'm awed by our team's commitment.
The second example is shifting our business model in California from a partnership with independent distributors to an internal sales team, an undertaking that requires significant coordination and collaboration. Since last year, a large cross-functional group of Flowers team members has worked together to plan and set the framework for our future in the state. Legal, sales, human resources, sales enablement, IT, procurement, finance and many others have been collaborating to make this transition as seamless as possible for our team members and our customers.
I'm happy to report that we're making great progress and have successfully reached a major milestone, completing more than half of our transition. That progress would not be possible without the dedication of our Flowers team, and I'd like to commend all of those involved for their efforts.
Our second strategic priority is focusing on our brands, and they continue to perform well despite the challenging environment. In a category where units and dollars declined, each of our primary bread brands grew dollars and units in tracked channels. For example, Nature's Own units increased 2%, DKB 4%, Wonder 3% and Canyon, a stunning 11%. That performance translated to market share gains as each of these brands grew unit and dollar share. Canyon's performance was particularly noteworthy, expanding its leadership position in the gluten-free category by 360 and 340 basis points of unit and dollar share, respectively.
A robust pipeline of innovative products is contributing to our strong performance. Nature's Own keto loaf maintained its tremendous momentum, gaining 730 and 770 basis points of unit and dollar share, respectively. Despite launching only last year, it's rapidly approaching #1 market share in its subcategory. We're building on that momentum as we execute a national launch of keto hamburger buns and planned for the upcoming launch of keto hotdog buns next spring.
Capitalizing on our innovation capabilities and our lineup of strong brands, we're extending into adjacencies and even new categories. Our DKB snack products are one example of that strategy. But having moved DKB successfully into breakfast buns and rolls, we further expanded into snacking. Our snack bars are making good progress, growing dollars and units as we apply best practices throughout our network. And we're ramping up distribution of our snack bites as we prepare for the national launch in 2025.
Similarly, we're capitalizing on Wonder's extensive brand awareness among consumers by expanding into the sweet baked goods category. We're excited about the strong momentum building around the upcoming launch. Retailers are responding enthusiastically, 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 tremendous potential for our innovation pipeline.
Our third strategic priority is margins, an area where we continue to make significant progress. Adjusted EBITDA margins expanded 110 basis points compared to the year ago quarter, benefiting from the successful execution of our portfolio strategy and our savings initiatives. We've made great strides in improving the profitability of our away-from-home and private label businesses by ensuring that each account meets our margin targets. That process has resulted in a temporary under absorption of overhead costs as we culled low margin business. However, we're beginning to see the benefit of the strategy with higher margins on existing business and new business wins.
We're also using innovation to shift more of our sales to higher margin products as we grow premium brands like DKB and Canyon and add innovative products like keto and core brands like Nature's Own.
Savings initiatives are also contributing to the improved margins as we execute on our $40 million to $50 million target for 2024. To enable the operating leverage implied by our long-term financial targets, we're undergoing a robust process focused on offsetting inflationary pressures in labor, shipping, commodities and other areas.
Our fourth priority is smart M&A. The deal market is active, and we are carefully evaluating potential acquisitions, with the goal of strengthening our position in core categories and finding new revenue streams across the baked foods category. We seek compelling brands that complement our existing portfolio and that skew towards a Better For You nutritional profile. Our strong balance sheet positions us well to act when we have financial, commercial and operational conviction.
As always, we will remain disciplined in our approach and focused on growing shareholder value with an attractive risk/reward balance. Although we may consider acquisitions that require premium multiples, as we paid for DKB, such a premium would require greater conviction in our ability to generate strong growth and a compelling return on investment.
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?
Thank you, Ryals, and hello, everyone. I'm pleased to present our third quarter results.
Net sales decreased 0.7% from the prior year period. Price/mix improved 1.7%, helped by optimization of our non-retail business, most notably foodservice, but was more than offset by volume declines of 2.4%, 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% over the same quarter last year. Comparisons benefited from improved sales price/mix, moderating ingredient and packaging costs and decreased product returns.
The impact of lower production volumes, higher workforce-related costs and increased outside purchases of product, partially offset the overall improvement.
Selling, distribution and administrative expenses as a percentage of sales were 38.7%, 1,170 basis point decrease over the prior year period. The decrease was due to significantly lower legal settlements and related costs as well as lower distributor distribution fees, marketing expense, logistics and freight costs and consulting costs. These items were partially offset by increased workforce-related costs, higher rent expense and lower scrap dough income. Excluding matters affecting comparability, adjusted SD&A expenses were 38.6% of sales, up 20 basis points compared to the prior period.
GAAP diluted EPS for the quarter was $0.31 per share, a $0.53 increase over the prior year period. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter increased $0.04 over the prior year period to $0.33.
Turning now to our balance sheet, liquidity and cash flow. Year-to-date through the third quarter of fiscal 2024, cash flow from operating activities increased by $25 million to $282 million. Capital expenditures decreased $10 million to $87 million and included $5 million for the ongoing ERP upgrade. Dividends paid increased $6 million to $153 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 $15 million in cash and cash equivalents and had $531.6 million of remaining availability on our credit facilities.
Now turning to our outlook for 2024. We are narrowing the range of our previously issued financial guidance. Our forecast now calls for sales to be up 0.5% to 1.1%, adjusted EBITDA of $530 million to $542 million and adjusted EPS in the range of $1.24 to $1.28. We are reducing our expectations for capital expenditures to $130 million to $140 million due to the timing of projects.
Key factors that could shift results within our guidance range include the consumer and promotional environment, the speed at which new business wins ramp up, the transition of our California distribution and implementation of our savings initiatives.
As previously disclosed, in fiscal year 2023, we reached an agreement to settle distributor-related class action litigation in California. As Ryals noted, we are making progress with the process of repurchasing the distribution rights, which is expected to be completed in 2025 in accordance with the settlement agreement.
Approximately 100% of our key raw materials are covered in 2024. Based on that coverage, our guidance incorporates a moderation and ingredient costs in 2024 relative to the prior year. The year-over-year benefit from lower raw material cost is expected to moderate significantly as we progress through the fourth quarter. To minimize volatility and provide adequate visibility in the cost, we have maintained our historical hedging strategy in which we attempt to increase the certainty of our key ingredient costs 6 to 12 months out.
Our ERP rollout, which is expected to improve data management and efficiencies while automating many of our processes, went live in the second quarter of 2023. We are proceeding deliberately in that implementation to ensure we continue to effectively meet market demand with our traditional high service levels. As noted previously, we have paused the bakery rollout to concentrate resources on our California distribution transition.
In fiscal 2024, we expect costs for the upgrade of our ERP system to be $25 million to $30 million, including $5 million to $7 million expected to be capitalized. Costs related to the project year-to-date are $18.1 million, of which $4.9 million has been capitalized. Total cost for the project to date are $232 million, of which $117 million has been capitalized.
Thank you. And now I'll turn it back to Ryals.
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 present and future opportunities. I'll first touch on consumer trends and then address the competitive environment.
When we provided our initial 2024 financial outlook, it included a cautionary note regarding the uncertain consumer and promotional environment. While trends in those areas remain relatively consistent with the recent past, we have detected some shifts in consumer behavior, and year-over-year increases in promotional activity have continued.
As we discussed last quarter, to maximize the value of their spending, consumers have shifted more of their purchases to food at home and specifically to value channels like mass and club stores. The at-home shift is particularly strong at the lower end of the income spectrum.
Despite that positive shift to at-home eating, the bread category is measured in tracked channels has been pressured as consumers gravitate more to the store perimeter, meal preparation ingredients like protein, spices and oils have shown particular strength. Consistent with this theme, notable pockets of growth within bread include tortillas and buns and rolls. Since the pandemic, we've seen a slow reversion of share gains in perimeter bread, though not back to prior levels.
We expect this shift to meal preparation items to be temporary, but we're leveraging consumer trends to help grow the overall category through innovation, providing consumers appealing new options such as our keto products. Those actions drove continued outperformance, growing bread unit and dollar sales in tracked channels for the third consecutive quarter as shown on Slide 13.
Slide 9 shows that private label continued to lose unit share, down 40 basis points in the quarter. Sales were hurt by narrowing price gaps as branded retail products increased promotions and private label prices rose 2.7%. Private label sales in traditional grocery have been particularly pressured, perhaps as those consumers seeking value shift more of the spend to mass and club stores.
Turning now to the competitive environment, which remains rational with promotions below pre-pandemic levels. As I mentioned, in the second half of the year, we have seen a notable increase in promotional activity. However, despite the greater promotional levels, the average category price was flat versus the year ago period. Part of the explanation for that trend is a mix shift to premium products, but some is also likely due to a greater percentage of products sold on promotion, though with less promotional intensity.
Consumers are responding well to promotions, and we continue to effectively leverage our enhanced trade promotion management capabilities. For example, rather than simply focus on price, we've been emphasizing display execution to better highlight our brands for consumers. Similarly, because consumers are responding well to differentiation, we continue to invest in innovation to meet their evolving needs.
In closing, I'm pleased with our strong relative performance in this challenging environment. We're maximizing our opportunities in areas that we control by targeting pockets of growth in branded retail, margining up our private label and away-from-home businesses and executing on our cost savings plan. These initiatives give me great confidence that we're positioning Flowers for growth in line with our long-term financial targets.
Thank you very much for your time, and that concludes our prepared remarks.