Flowers Foods Q1 2023 Prepared Remarks Earnings Call Transcript

Quartr
Provided by Quartr
May 19, 2023

There are 3 speakers on the call.

Operator

Hello, everyone. This is J. T. Riek, EVP of Finance and Investor Relations. Welcome to the pre recorded discussion of Flowers Foods' Q1 2023 results, which we announced in a press release on May 18, 2023.

Operator

We will host a live Q and A session on Friday, May 19 at 8:30 am 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.

Operator

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

Speaker 1

Thanks, JT. It's a pleasure to welcome everyone to our call. Our first quarter results demonstrate the strength of our leading brands, which performed well despite the challenging environment. That brand strength combined with price increases in our store branded and non retail businesses drove record sales. We faced very difficult year over year comparisons due to a strong impact from the omicron surge early last year, accentuated by storm activity.

Speaker 1

The soft start and lower than expected branded retail sales resulted in an adjustment to our 2023 guidance. However, our performance improved throughout the quarter. Although we lost 10 basis points of unit share in tracked channels, that loss was largely concentrated in the mass channel as we expanded share in grocery. Importantly, we began gaining share in the overall category toward the end of the quarter with branded retail bread units flat or up in 5 of the last 6 weeks of the quarter. Inflation combined with an uncertain economic environment remains a headwind for consumers.

Speaker 1

They continue to trade down to private label products, though that growth declined throughout the quarter. Inflationary pressures also affected our margins as the timing impact of our hedging strategy drove higher commodity costs. It's important to note that we expect the current environment to be transitory. We believe that the premiumization of the category will remain a long term trend and that when consumers get relief from the current inflationary pressures, they will return to our number one brands and differentiated products. While we address these short term issues, we're also maintaining our focus on longer term opportunities.

Speaker 1

We're investing in future growth and exploring ways to maximize efficiency and productivity. Those investments, which may affect near term results, are crucial to ensuring that Flowers is well positioned to thrive in the years ahead. Now, I'll provide an overview of our Q1 performance in the context of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M and A. Following that, Steve will review our financial results and updated 2023 guidance, and then I'll come back with a discussion on key themes moving forward and our plan to drive shareholder value in 2023 and beyond. I'd like to start by recognizing the incredible contributions of our team, whose passion and commitment are the key ingredients in our success.

Speaker 1

One of our most important responsibilities as a company is ensuring that we have the right people in the right roles and providing them with the necessary resources to succeed. For example, we recently restructured operational responsibilities at our bakeries, shifting them from the sales function to the supply chain function. We expect this change to improve operational effectiveness, increase profitable sales and better meet customer requirements. Our supply chain team is now able to drive operating efficiencies and network optimization and our sales team is able to focus on what they do best, bringing our leading products to as many customers as possible. I've also challenged our entire team to heighten their overall sense of accountability for our results.

Speaker 1

To achieve our goals and succeed in this challenging environment, it's more important than ever to embrace our historical culture. Our financial results are the sum of our collective efforts and each of us needs to be responsible for driving improvement, so we emerge from this period even stronger. Our new Chief Human Resources Officer, Cindy Cox, has extensive experience driving successful talent management programs and she will be instrumental in furthering our capabilities. Among other things, our primary areas of focus will be on developing our existing team, incentivizing high performance and recruiting new talent. Our second strategic priority is focusing on our brands.

Speaker 1

The strength of our leading brands has never been more apparent. While consumers struggling with inflation continue trading down to private label products, Nature's Own held unit share flat and Dave's Killer Bread gained 10 basis points. Although Canyon lost 80 basis points of unit share in the quarter, That decline was impacted by a shift in mix to the growing club channel, the sales of which aren't comprehensively measured in tracked channels. Sales of Canyon branded units increased as measured by our internal tracking and we remain confident in its ability to grow for many years to come. Consumers love the unique attributes of our brands and we're committed to bringing forth more products to meet their needs.

Speaker 1

Recent innovation includes Nature's Own Keto Net 1 Loaf, Nature's Own Perfectly Crafted Everything Buns and Wonder Hawaiian Buns. And of course, we continued the nationwide rollout of our DKB snack bars. The bars are currently on the shelf in more than 6,000 stores and we expect that number to grow to more than 10,000 by year end. We're excited about the consumer response to the bar so far and optimistic about their potential to help expand our addressable market. As we've discussed, the financial benefit will be limited in the near term as we invest in a robust marketing strategy to support the launch.

Speaker 1

While still early, we are encouraged by the preliminary results, which increase our confidence that we can meaningfully grow sales outside the bread category. In addition to the snack bars, we have a deep pipeline of products designed to capitalize on DKB's brand strength and expand our business beyond the bread aisle. Products include DKB Amped Up Protein Bars and DKB Crunchy Snack Bites, each of which meet distinct consumer needs and are performing well in our test markets. You can sample these products for yourself by ordering them from our innovation site creationsbyflowersfoods.com. Our 3rd strategic priority is margins, a particular focus given the current environment.

Speaker 1

We are addressing this area aggressively with multiple initiatives. To mitigate inflationary pressures, we implemented price increases on foodservice and private label products early this year and selective price increases in our branded portfolio have been accepted and are Price increases in our branded portfolio have been accepted and are set to go live this month. We also continue to execute our portfolio strategy, whereby we aim to transition a greater portion of our sales to higher margin branded retail products. At the same time, we are focused on maximizing efficiencies. Investments in digital and ERP create near term financial headwinds, but are expected to enable growth and efficiency for years to come.

Speaker 1

We continue to expand our Bakery of the Future program to additional bakeries and we're pleased that it's already driving improvements in scrap and labor costs. We're also focused on cost savings initiatives and we are on track to meet our savings goal of $20,000,000 to $30,000,000 for 2023. Our 4th priority is smart M and A. In February, we closed on the Pappapita Bakery acquisition. Pappapita has been an important co manufacturer of Flowers products, and we expect the acquisition to drive and Distribution Synergies.

Speaker 1

M and A has been a key contributor to our growth for decades, expanding our geographic coverage and supplementing our brand lineup. Moving forward, we also expect M and A to help us move into faster growing adjacent categories beyond bread. We continue to monitor the deal market, actively vetting potential acquisitions and investments that could add capabilities, brands or products to our robust existing lineup. 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 come back a little bit later to discuss our outlook for the current business environment.

Speaker 2

Steve? Thank you, Ryals, and hello, everyone. Moving on to our results. Total sales in the Q1 increased 6.9% from the prior year period. Improved price mix drove the adjusted year over year increase, up 13.6%, primarily due to price increases to mitigate inflationary pressures.

Speaker 2

Volume decreased 7.3%, partly due to targeted sales rationalizations in cake and foodservice and difficult comparisons in the prior year period related to storms in the pandemic. The Pompapita acquisition added 0.6% to the top line. Gross margin as a percentage of sales, excluding depreciation and amortization, decreased 170 basis points to 47.8%. Comparisons were impacted by input cost inflation, partially offset by inflation driven pricing actions, lower employee compensation expense and reduced outside purchases of product. Selling, distribution and administrative expenses as a percentage of sales were 38.6%, consistent with the prior year period.

Speaker 2

Results benefited from sales increases in excess of wage inflation, lower incentive compensation and lower distributor distribution fees as a percentage of sales. Those benefits were offset by greater marketing expenses, increased amortization of cloud based applications and acquisition related costs. Excluding matters affecting comparability, adjusted SG and A expenses were 38%, consistent with the prior year period. GAAP diluted EPS for the quarter was $0.33 per share compared to $0.40 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, down $0.06 from the prior year period.

Speaker 2

Turning now to our balance sheet liquidity and cash flow. For the Q1, cash flow from operating activities decreased by $66,200,000 to $58,000,000 which included business process improvement costs of $6,200,000 related to the ongoing transformation strategy initiatives. Cash flow from operating activities was affected by working capital increases of $76,000,000 largely due to the impact of inflation. Capital expenditures decreased $16,500,000 to $34,000,000 and included $10,000,000 for the ongoing ERP upgrade. Dividends paid increased $2,400,000 to $49,100,000 Our financial position remains strong.

Speaker 2

At quarter end, net debt to trailing 12 month adjusted EBITDA stood at approximately 2.1 times. At quarter end, we held approximately $28,000,000 in cash and cash equivalents and had approximately $521,000,000 of remaining availability on our credit facilities. As Ryals mentioned, we are adjusting our 2023 guidance to reflect the slower than expected start to the year. We are now forecasting sales to increase 5.8% to 7%, EBITDA in the range of $494,000,000 to $528,000,000 and EPS in the range of 1.15 to $1.25 Key factors that could shift results within our guidance range include demand reversion, price elasticities, consumer resilience and continued inflationary pressure. Overall, demand elasticities have been in line with our expectations, remaining below historical levels.

Speaker 2

As a reminder, our adjusted EBITDA guidance incorporates approximately $26,000,000 or $0.09 per share of incremental costs related to the ERP project. Those incremental costs were $5,700,000 or $0.02 per share in the Q1. We anticipate these costs to moderate substantially by project completion in 2026. Additionally, we expect A 2023 impact of $0.08 to $0.10 per share from an increase in interest, depreciation and amortization expense associated with the ERP implementation and Papa Pita acquisition. Our ERP program remains on track and we are confident in our ability begin implementation in 2023 and complete the project within the financial guidance.

Speaker 2

In fiscal 2023, we expect cost for the upgrade of our ERP system to to be approximately $95,000,000 to $105,000,000 including $30,000,000 to $40,000,000 expected to be capitalized. As of April 22, 2023, we have incurred costs related to the project of approximately $172,000,000 of which $97,000,000 has been capitalized. Approximately 80% of our key raw materials are covered in 2023. To minimize volatility and provide adequate visibility into cost, we have maintained our historical hedging strategy in which we attempt to increase the certainty of our key commodity cost 6 months to 12 months out. We continue to monitor the commodity markets, exploring opportunities to extend coverage and lower values that could benefit our second half results.

Speaker 2

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

Speaker 1

Thank you, Steve. Now I'd like to discuss some key areas impacting our current performance, including consumer behavior and our initiatives to maximize long term results. In response to inflationary pressures, consumers are trading down to lower priced products, responding more to promotions and shifting more of their shopping trips to value focused retailers. Private label has reversed a multiyear trend of share losses, though its volumes are still well below pre pandemic levels and the gains have largely occurred in the mass channel. In the Q1, private label gained 70 basis points of unit share in tracked channels, driven by large gains in the mass channel.

Speaker 1

In the grocery channel, however, private label lost 20 basis points of unit share. From a cadence perspective, private label share gains moderated significantly throughout the quarter. As I mentioned, we saw a similar dynamic in our own performance between the grocery and mass channels. Our strong performance in grocery continued, gaining 20 basis points of unit share with consistent growth throughout the quarter. At the same time, we lost unit share in mass largely due to private label strength.

Speaker 1

Overall, our sales improved toward the end of the quarter as we move past difficult prior year comparisons with particular improvement in branded bread. In addition to the impact of consumer trade down on mix, we've also seen volume revert toward pre pandemic levels in the category overall. During the pandemic, the category enjoyed a large increase in demand as consumers ate more meals at home, but that benefit is dissipated as consumers have reverted to eating more meals out of the home. The resulting unit volume pressure, which began in 2021, continued into the Q1, but lessened considerably towards the end of the period. What has endured is the trend toward premiumization.

Speaker 1

Consumers recognize the superior taste, share and quality of more premium branded products and have shifted a greater portion of their purchases towards those products. Although private label has gained some share recently, Branded retail products have outperformed private label since 2019, accounting for 81.4 percent of tracked channel category sales in 2022, up 3 70 basis points from 2019. The near term mix trends combined with our portfolio strategy of transitioning more of our sales to higher margin branded retail products have impacted volumes. Importantly, most of our volume declines have been in cake and foodservice, where we have been implementing price increases and rationalizing business that fails to meet our profitability hurdles. However, that volume effect has led to a temporary imbalance between capacity and production.

Speaker 1

Now we recognize the possibility of this imbalance when we initiated our portfolio strategy, but inflationary pressures have exacerbated the impact. Our supply chain optimization work is intended to address this imbalance and we remain confident that our strategy is the right one for Flowers over the long term. As I mentioned earlier, it is important to understand, however, that we believe many of these headwinds are temporary. We expect premiumization to be a long term driver of branded retail sales. When inflationary pressures lessen, we believe consumers will return to their prior purchasing habits.

Speaker 1

While at home eating may never return to peak COVID levels, the work from home trend appears to be sustainable. We are taking the necessary steps to thrive in this new environment. Although that process may be uneven and results in some near term headwinds, we believe it is the best path toward growing long term shareholder value. As we align our product portfolio and network to this future, We're excited about the potential for our company. We see a portfolio shifted to more profitable branded products being produced and distributed by a more modern and efficient bakery network.

Speaker 1

We expect to supplement that existing business by moving into faster growing adjacent categories, both organically and via M and A. We have the right team with the right structure to make that shift possible and I've never been more excited about our long term prospects. So with that, thank you very much for your time and this concludes our prepared remarks.

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