Flowers Foods - Q1 2024 (Q&A)

Transcript

Operator (participant)

Good evening, and thank you for standing by. Welcome to the Flowers Foods First Quarter 2024 Results Conference Call. Please be advised that today's event is being recorded. I would now like to hand the conference over to your opening speaker today, J.T. Rieck, Executive Vice President of Finance and Investor Relations. Please go ahead.

J.T. Rieck (EVP of Finance and Investor Relations)

Thank you, Carmen, and good evening. I hope everyone had the opportunity to review our earnings release, listen to our prepared remarks, and view the slide presentation that were all posted earlier on our investor relations website. After today's Q&A session, we will also post an audio replay of this call. Please note that in this Q&A session, we may make 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. We also provide non-GAAP financial measures for which disclosure and reconciliations are provided in the earnings release and at the end of the slide presentation on our website.

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

Ryals McMullian (Chairman and CEO)

Okay, thanks, J.T., and good evening, everybody. Thanks for joining our first quarter call, and we also appreciate everybody's flexibility in accommodating the change in timing for our Q&A session today. Our solid first quarter results reflect the increasing effectiveness of our portfolio strategy, driven by investments in marketing and innovation. Our brands gain share despite the challenging consumer environment. Significantly, we also grew branded retail volumes for the first time since 2020. Dave's Killer Bread led the way with its second consecutive quarter of 10% unit growth, but we saw encouraging signs across the brand portfolio, and we continue to expand our margins in our away-from-home and private label businesses. We are maintaining our financial outlook for the year, which incorporates continued volume improvement, while acknowledging the ongoing economic uncertainty and its potential impact on consumer behavior and the promotional environment.

As I mentioned in the prepared remarks, if there's one thing I'd like for you to take away from this call, is that we're doing exactly what we said we would do. Although progress is not linear, we'll continue to execute our portfolio strategy with the expectation of achieving our long-term financial targets, and I'm extremely confident in our growth potential, and I look forward to continuing our progress throughout 2024. So with that, Carmen, we'll open it up for questions.

Operator (participant)

Thank you so much. As a reminder, if you do have a question, press star one one to get in the queue and wait for your name to be announced. Please stand by while we compile our first question, and it comes from Steve Powers from Deutsche Bank. Please proceed.

Steve Powers (Equity Research Analyst)

Hey, guys. Good evening. Thanks for the question. I was actually hoping we could talk, start on just the operating expenses in the quarter and SD&A run rate spending. You call it a couple of things in the prepared remarks, you know, higher labor costs, higher technology costs. You also separately call out stranded overheads. I was wondering if those two things are related or if that's separate. And really, what I'm focused on is just how we think about the cadence of that SD, the operating expense expenditures over the course of the year. You know, do we expect some relief on stranded overheads? Do we expect, you know, transition costs in California to replace that?

Just some direction on the cadence of SD&A expenditures over the course of the year would be great. Thank you.

Ryals McMullian (Chairman and CEO)

Sure, happy to do that. I'll start, and I'm sure Steve will wanna chime in here, too. But yeah, it's a little bit of both. You know, there's some labor expense in there. There's, you know, higher marketing expense in there, which we've, you know, we've talked about before the rationale for that investment. And, you know, you, you've got the stranded overhead, too, that we've, we've talked about in the, in the past. The good news is twofold. One, you may have noticed that we raised our savings range from $30 million-$40 million to $40 million-$50 million, and some of that will help us improve SD&A.

As I, as I noted in the prepared remarks, you know, we do recognize our, our cost structure is a bit too high, and we're taking actions to pull some of that back and get, get more back, back in, in line. You know, I mentioned the, the labor cost and, and, and marketing as well, play a, play a role in that. So, you know, I would expect over time for us to improve, SD&A, particularly as a, as a percentage of net sales, and better leverage our, our cost structure going forward. Steve, do you want to add to that at all?

J.T. Rieck (EVP of Finance and Investor Relations)

Yeah, I mean, I think Ryals hit on it. Obviously, the first quarter is 16 weeks. You know, we did see some elevated costs from that perspective, but, you know, we have good visibility into our cost takeout initiatives. And going forward, as a percent of, you know, sales, we do expect SD&A to pull back some and then kind of stabilize. So we do feel like we'll be able to get some of that under control as the year progresses.

Ryals McMullian (Chairman and CEO)

Yeah, the only other thing I'd add, Steve, relative to the stranded overhead is that, you know, this actually goes to the volume story as well, is that we are adding new business back at a bit of a faster clip than we originally anticipated at the beginning of the year. Of course, that'll help cover that, that stranded cost.

Steve Powers (Equity Research Analyst)

Okay, very good. And then in terms of just use of cash, you know, I noticed that obviously the capital expenditure outlook went up, maybe a little bit more detail around what those supply chain investments are targeted at. And then you also sounded a little bit more front-footed with respect to an improved M&A environment, so maybe just some more color there as well.

Ryals McMullian (Chairman and CEO)

Yeah, I mean, the capital investments really are just, you know, ongoing improvements, primarily at the bakeries. You know, increasing automation, updating equipment. It's pretty normal course stuff, Steve, not out of the ordinary, but just a little bit more spend than we, than we originally thought at the beginning, at the beginning of the year. And then, yeah, the M&A environment, I am a little bit more bullish on that now. Activity has really started to pick up. It really started a couple of quarters ago, and has continued. So, you know, the conversations that we're having out there with targets are increasing in frequency, which is a good sign.

It's been a little slow the last couple of years, and you're very familiar with our balance sheet, so you know we're poised to do a transaction when we find the right one.

Steve Powers (Equity Research Analyst)

Yep, very good. Very good. One last thing, if I could, just the, on the, the ERP pause in the bakeries. I thought that was on track to be lifted in the second half. Just don't know if that's still the case or if, if that's been recalibrated.

Ryals McMullian (Chairman and CEO)

Yes. No, we're still planning, you know, to go back to the bakery rollouts, starting sometime in the back half.

Steve Powers (Equity Research Analyst)

Great. All right. Thanks, all. Thank you.

Ryals McMullian (Chairman and CEO)

Thank you, Steve.

Operator (participant)

Thank you. One moment for our next question, and it comes from the line of Bill Chappell with Truist Securities. Please proceed.

Bill Chappell (Managing Director and Equity Research Analyst)

Thanks. Good afternoon.

Ryals McMullian (Chairman and CEO)

Hey, Bill.

Bill Chappell (Managing Director and Equity Research Analyst)

Just maybe a little bit more about private label and the branded growth and just trying to a little more color there. You know, I guess, if anything, if there's any real weakness in the economy, we hear it at the lower end. Obviously, private label has kind of receded over the past few quarters, but didn't know if you're surprised by brands holding up, if it's really Dave's Killer Bread accelerating. I mean, you said it was broader, but 10% growth for Dave's Killer Bread sounds pretty strong. So just maybe you could give us some more color thoughts around beyond Dave's Killer Bread, kind of how brands are doing versus private label and kind of how the consumer environment is working out.

Ryals McMullian (Chairman and CEO)

Sure. Yeah, I mean, obviously, you know, Dave's has been sort of the star of the show from a volume growth standpoint. But, and I know you're asking, you know, questions about the broader portfolio, but I, I will say, just to start, one of the interesting things that we saw in the quarter was low-income shoppers coming back to Dave's. So we had mentioned to you all quite a while back that around 20% of Dave's shoppers, and we're defining that as $30,000 or less in annual income, 20% of Dave's shoppers were low-income shoppers. With the, you know, with the inflationary environment, that dropped off a little bit to about 16%, and we've recovered almost back to 20% again. So, you know, that tells me that perhaps the consumer is getting a bit healthier.

Either that or they're tired of lack of differentiation in cheaper products and are coming back to Dave's. I see that as a good macro sign, that lower income households are starting to come back. Beyond that, you know, we are seeing some strength in other parts of the portfolio. You know, Wonder is a good example. That is a lower price point item for us, but Wonder across sandwich buns and rolls and loaf has been doing quite well. Nature's Own Perfectly Crafted continues to do well with positive unit growth in the quarter. I think, you know, the one weak spot that we still have that we've talked about in prior quarters is sort of the broader basic Nature's Own product, whether that's honey wheat or 100% whole wheat.

You know, that, that is the area of the category that has experienced the most weakness during this era of private label trade down. I think some of that is starting to come back up out of private label into brands like Wonder, and if, if things continue to improve, you know, I'd expect it to continue to come back to brands like Nature's Own as well.

Bill Chappell (Managing Director and Equity Research Analyst)

Got it. Now, that helps. And then, you know, a question we haven't really talked about in a long time is just kind of DSD network expansion. Where does that stand? Do you, are you still adding routes, be it in California or elsewhere today? Is it more about velocity and more products through the existing routes? Are you actually shrinking? Are there areas where it doesn't make as much sense as you're trying to be more efficient? You know, any kind of thoughts on kind of the DSD network as it stands today would be helpful.

Ryals McMullian (Chairman and CEO)

Sure. Yeah, it's a little bit of a mixed bag. Now, California is its own thing because, you know, we're converting to company routes there. But, you know, in some areas, where we have higher growth, we're adding routes because routes are starting to get full. When that happens, it's usually quite a nice lift to sales to break up those routes, and better service the stores in that area. So in some places, we're adding, in some places on the fringe, we're not. And in other areas, you know, as we move into new geographic territories, we're adding routes as well. So it kind of depends on where you are, what the growth trajectory is, how new the territory is.

I think the key takeaway is that we are what we're really trying to do is make our DSD network as efficient as it possibly can be. So, for example, if you're in an area where you've got you know lower household penetration, lower market share, and you know those independent routes may be struggling, we might convert them to company routes for a while until we get you know enough sales. In other areas where we're growing, we'll split them up and actually add routes. So it really just kind of depends. The keyword is efficiency, though. That's what we're looking for.

Bill Chappell (Managing Director and Equity Research Analyst)

Got it. Thanks so much.

Ryals McMullian (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. One moment for our next question, please. It comes from Jim Salera with Stephens. Please proceed.

Jim Salera (Equity Research Analyst)

Hi, guys. Good afternoon. Thanks for taking our question.

Ryals McMullian (Chairman and CEO)

Yep, sure.

Jim Salera (Equity Research Analyst)

I wanted to add on, on the volume side, in the prepared remarks, you mentioned the planned business that, that's obviously contributed some headwinds on the volume side, and absent that, total company volume would have been positive. If possible, can you tell us what it would have been, like, what the actual volume number would have been absent that? And beyond that, is the weakness in the other category primarily coming from some of the restaurant customers? Because you called out some weakness in fast food, so any color around that would be helpful.

Ryals McMullian (Chairman and CEO)

Yeah, sure. So yeah, we did say, Jim, if you, if you took the intentional strategic exits, and we didn't quantify it, but if you took the intentional strategic exits out, total company volumes would have been positive. The reason we're saying it that way is because we did this on purpose, as we, as we talked about. We had low margin business that was never gonna be a big contributor, and we made the strategic decision to free that capacity up to move into higher margin business. The good news, and I think one of the larger stories of the quarter, is that's exactly what we're doing. We're beginning to lap all those strategic exits. So you'll see those, continue to go down as we move through the year.

We pretty much lap all of them in the third quarter, there'll be very minor strategic exits in the back half, and we're replacing that volume with business that meets or exceeds our variable margin targets, depending on what category of business we're talking about, whether it's branded or whether it's other. So that's really the key takeaway there.

Jim Salera (Equity Research Analyst)

Okay, great. And maybe if I could dig in on Dave's for a second. You know, continues to grow ahead of the category, which is great. Obviously, a very differentiated offering. Can you just give us a sense for where it continues to source volume from? I mean, is it other larger branded players? Is it bringing people from outside of the category? Just so we can kind of size up how long it can continue to run ahead of, you know, the broader category growth.

Ryals McMullian (Chairman and CEO)

Yeah. As we've looked at that, it's, you know, it has—it's taken some share from other players and specialty premium, and it's—Jim, we look at Dave's against the specialty premium category because we really don't have anything else to compare it to. But it kind of stands apart even from specialty premium because the specialty premium segment of the category is really, really weak right now. And, you know, Dave's is at a price point quite a bit higher than the rest of the specialty premium category, so it's really kind of hard to compare it to that. And it drives the, you know—it pretty much is the organic brand category. But to answer your question, yes, it brings new people back into the category just because of its quality and differentiation.

But Jim, also remember, it's also household penetration. The household penetration for Dave's is roughly half of what Nature's Own does. And so through our marketing investments, as we grow geographically, et cetera, we're growing that household penetration, so that's a big contributor as well.

Jim Salera (Equity Research Analyst)

Okay, great. Thanks, guys. I'll hop back in the queue.

Operator (participant)

Thanks.

Ryals McMullian (Chairman and CEO)

Thanks, Jim.

Operator (participant)

One moment for our next question. It's from Mitchell Pinheiro with Sturdivant & Co. Please proceed.

Mitchell Pinheiro (SVP and Director of Research)

Yeah, hey, good afternoon. I'm curious. You said, you know, you elevated the away-from-home part of the business to the balanced growth as part of your strategy mix and your portfolio mix. And I thought that was interesting. Does that—you know, and that balanced growth means you're gonna grow above the category. So what's driving that? I mean, you've exited from some unproductive accounts. Are the accounts that you're in now growing in excess of the category, and that's sort of why? Or is there ability to gain share, but at a strong margin? I'd love to hear your thoughts on that move.

Ryals McMullian (Chairman and CEO)

Sure. Well, first of all, I'm glad you noticed that. It's an important point to make. Yeah, so now that we've freed our capacity up to pursue better business, you know, we felt that it made sense to move it into that category because we're gonna place more focus on it. Now, that does not mean that we're going to over-allocate resources to it to the detriment of the branded business. The strategy remains the same. We're moving to be a consumer-focused, brand-oriented company. But, you know, when you look at the broader baked foods category, there is tremendous opportunity in away from home that we can capture with limited investment. We don't have to do a whole lot in terms of capacity or automation, et cetera, to capture some of that volume.

There are opportunities out there and customers who want us to serve them that are willing to deliver much fairer margins than we may have had in the past. So, you know, we've always talked about our away-from-home business being an important contributor to the company. And this makes sense, because the more profitable that we can make that business, the more resources we're gonna have to allocate towards innovation and marketing and all the fun stuff we like to talk to you guys about every quarter. So that's the rationale.

Mitchell Pinheiro (SVP and Director of Research)

Okay, thank you. And then, you know, you're launching, you know, a lot of new products. You know, I thought I read 11 new products and, like, how do you think about that, like, first of all, in terms of priority of those new products, which ones are gonna be the at the top? And as you know, these new products obviously would complicate, certainly, you know, in the bakeries as you're transitioning, you know, to things. How do you think about, like, the new products? Is it going to be positive out of the gate as a margin contributor, in addition to sales? And I'd love to hear your comments on that.

Ryals McMullian (Chairman and CEO)

Sure. Great question. I mean, we go through a very rigorous process that covers every single one of the points you just made. We start with the consumer, number one. Does the consumer even want this, right? If the answer to that is yes, then we start looking at commercialization and financials, and how does this fit operationally? Is it going to create complexity in the plan? If so, how much? And we don't launch anything that doesn't make sense for the consumer or doesn't make sense from a financial standpoint, or doesn't make sense from an operational standpoint. We have to check all of those boxes before we'll launch anything. But it's a great question because we, you know, we go through that entire sort of funneling process, if you will, before we launch any of these new items.

Mitchell Pinheiro (SVP and Director of Research)

Are these soft launches?

Ryals McMullian (Chairman and CEO)

Go ahead.

Mitchell Pinheiro (SVP and Director of Research)

I'm sorry. Are these soft launches, or are they going to be more substantial rollouts?

Ryals McMullian (Chairman and CEO)

Yeah, there are some of them that are more regional, but, you know, a lot of times, you know, because we can make this stuff in so many bakeries, Mitch, most of them will be throughout the network.

Mitchell Pinheiro (SVP and Director of Research)

I have one more question on gross margin. It was a sizable expansion in the quarter. And, you know, you talked about pricing contributing, but pricing's been contributing about that rate for the last several quarters. So it seems like, you know, it's more than just that, and you called out some other things. But if you had to, you know, order them, I mean, I'd love to know which were the largest contributors. And then, you know, is it price—is the mix really helping there at all or not? And then, do you see, I know it's a large, long quarter, you generally get some nice, you know, you get some volume, you know, some leverage there.

Are we going to see a drop-off in gross margin in the second quarter?

Steve Kinsey (CFO)

Yeah, Mitch, this is Steve. I mean, obviously, you know, we've had to, you know, we've taken considerable pricing to help mitigate some of the inflationary pressures, so that continues to really help from a top line and gross margin perspective. And the mix, you know, talking about Dave and the growth there, continue to see really nice contribution overall from price mix. So I would say that, you know, I'd rate that number one. And then, obviously, we had some nice commodity tailwinds coming into the year, and those continue primarily through the first half, some into the third quarter, and they start to wane some, you know, Q3 and Q4. So that's something, that would be the, the second, I'd say, primary driver, outside of the top line from an overall gross margin perspective.

Ryals McMullian (Chairman and CEO)

Mitch, also, you know, as we talk about the savings initiatives, some of those are going to benefit gross margin, not just SD&A, but gross margin as well. And we also pointed to, in the quarter, you know, we had a couple of discrete operational issues that we were working on that definitely impacted gross margin, that if we had, you know, hit closer to plan, we would have, we would have outperformed even the number we turned out on the bottom line. So, you know, as we get those things squared away, it's just at 2, 2 bakeries, it's not the end of the world, but it did have a bit of an impact on the quarter. As we bring that more back in line, that's also going to benefit gross margin. It'll benefit the whole P&L, but particularly gross margin.

Steve Kinsey (CFO)

I mean, the forecast and expectation is to increase gross margin year-over-year, but obviously, you know, we're expecting a gross margin quarter by quarter, just different magnitudes.

Mitchell Pinheiro (SVP and Director of Research)

Okay. All right. That's all for me. Thank you.

Operator (participant)

Thank you. And as a reminder to our teleaudience, if you do have a question, simply press star one one to get in the queue. One moment for our next question. And it comes from the line of Connor Rattigan with Consumer Edge. Please proceed.

Connor Rattigan (Senior Equity Research Analyst)

Good afternoon. Thanks for taking our question.

Ryals McMullian (Chairman and CEO)

Hey, Conor.

Connor Rattigan (Senior Equity Research Analyst)

So, in the prepared remarks, Ryals, you noted that you guys remain well below pre-pandemic promo levels, and that it doesn't really seem like there's a, you know, a real, real big notable lift on promo. But it does sound like your digital initiatives are really impacting your promo strategy. So I guess, what learnings have you guys gleaned so far on the promo front from those initiatives? And also, if you're not seeing as strong of a lift as you'd, as you would like, should we maybe interpret that that may inform your, I guess, your spending decisions as you kind of debate the balance between using more promo versus marketing spend?

Ryals McMullian (Chairman and CEO)

Yes, absolutely. And, you know, I will say, you know, it seems like the lifts have gotten a little bit better, but certainly not, you know, where we were, you know, pre-inflationary period, let's say. We did promote a little bit more in the quarter, pretty targeted, but we did. And but we're spending a whole lot less trade spend in order to do it. And, you know, the digital tools that you mentioned are really helping us achieve that. You know, we get better insights, we get better sort of postmortems, if you will, on promotions, so that when we do them, we're generally doing them with a good positive return.

It's been tremendously helpful because, I mean, you can see how much our trade spend has come down over the last three or four years, and a lot of that has been enabled by these digital tools we have now via TPM.

Connor Rattigan (Senior Equity Research Analyst)

Got it. Very helpful. And then just one quick follow-up for me. So, you guys also called out the expectation for profitable business wins and increased cost savings initiatives to flow through in the second half. Is this a change from any prior expectations, or was there maybe some sort of a shift of expected cost savings out of one Q into the back half, or just no change there?

Ryals McMullian (Chairman and CEO)

So no, we were able to identify. When we came out of the year, we had a target of $30 million-$40 million, and as we really got into that, we uncovered further opportunities, and we've been able to raise that pretty confidently, actually, to $40 million-$50 million. And we're already enjoying some of those savings now. And in the prepared remarks, I listed out a few categories where we were looking to bring our costs back in line.

Connor Rattigan (Senior Equity Research Analyst)

Got it. Thank you so much.

Ryals McMullian (Chairman and CEO)

But yes, sorry, the new business, Connor. Let me touch on that, too. So again, similarly, when we started out the year, we had expectations for certain new business wins that we had really good line of sight to. And as we moved through the year and moved through the quarter, rather, and continued to work on, you know, refilling this strategically exited capacity, we ended up finding more than we thought we were going to, and so our expectations for that have increased somewhat. Nobody's asked us yet sort of about, you know, how the cadence of the quarter went, so this is a good time, if any, as any to address it. The quarter did start off a little weaker than we anticipated that it would.

I know originally we had kind of signaled a first half weighted cadence to the year. That sort of unexpected weakness early in the quarter got us a little off, a little off cadence. However, now that we have these increased savings targets and we have line of sight to higher new business wins, we think that that's gonna be able to offset that early weakness, thus maintaining guidance for the year. So that's how all that sort of shook out.

Operator (participant)

Thank you. As I see no further questions in the queue, I will hand it back to Ryals McMullian for final remarks.

Ryals McMullian (Chairman and CEO)

Okay. Thank you, Carmen. Just like to thank everybody for taking the time today and joining us for questions. We very much appreciate your interest in our company, and as always, we look forward to seeing you again, seeing you again next quarter. Everybody, take care. Thank you.

Operator (participant)

Thank you, everyone. This concludes the conference, and you may now disconnect.