Flowers Foods - Earnings Call - Q3 2019

Transcript

Speaker 0

note that this conference is being recorded.

I will now turn the call over to J. T. Rick, Treasurer and Vice President of Investor Relations. You may begin.

Speaker 1

Thank you, Paulette, and good morning, everyone. Our third quarter results were released yesterday evening. The earnings release and our quarterly slide presentation is posted in the Investors section of the Flowers Foods website. Our 10 Q was filed with the SEC yesterday evening as well. Before we begin, please be aware that our discussion today may include forward looking statements about our company's performance.

Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters we'll discuss during the call, important factors relating to Flowers Foods business are fully detailed in our SEC filings. With that, I'll make some introductions. Participating on the call today, we have Ryals McMullen, Flowers Foods' President and Chief Executive Officer and Steve Kinsey, our Executive Vice President and Chief Financial Officer. Ryals, I'll turn the call over to you.

Speaker 2

Thanks, JT. Good morning, and welcome to our third quarter call. We're very happy today to report record sales ahead of our forecast and reiterate our outlook for fiscal twenty nineteen adjusted EPS. Regarding our four strategic pillars, focusing on our brands, prioritizing margin, pursuing smart M and A and developing our team, we're pleased to see good momentum in several of them. We continue to make nice progress growing our portfolio of top brands.

The DKB and Canyon acquisitions have been resounding successes. And although it's harder to see from a quantitative standpoint, we are doing some great things for the development of our team. But as we said in yesterday's release, we are still facing some margin headwinds. And after five months as CEO, I've had the opportunity to assess where we are and what we need to do to improve our profitability while maintaining the great top line momentum we've enjoyed this year. And I'm looking forward to sharing that with you on the call today.

However, before I do that, like we did last quarter, I wanna call on Steve Kinsey first to review the financial results and give our outlook for the remainder of the year to set the context for what we'll talk about in a few minutes.

Speaker 1

Then of course, we'll take your questions. Steve? Thank you, Rob, and good morning, everyone. In the third quarter, we continued to experience solid performance on the top line, driven primarily by sales in the retail channel. Consolidated sales increased $43,100,000 or 4.7% year over year.

Canyon Bakehouse acquired in late twenty eighteen contributed 2.2%. In the base business, improved price mix drove 2.1% of the sales increase, while higher volumes benefited the top line by 40 basis points. Price realizations improved across most of our channels and product classes, which has helped to partially offset the commodity labor and transportation cost increases we've experienced in recent quarters. Overall, performance in our key brands and store brands was strong. However, we did see lower volumes of foodservice and store branded cake and breakfast items.

Looking at sales by channel, branded retail sales increased 36,700,000 or 6.7%. Canyon Bakehouse's branded products accounted for slightly half less than half of these incremental sales dollars. The balance was largely driven by continued growth from Dave's Killer Bread and Nature's Own and Sun Maid breakfast breads, were introduced in the third quarter of last year. Branded retail cake was flat as compared to the prior year. Store branded retail sales increased $12,100,000 or 8.7%.

Slightly less than half of the sales increase is attributed to the acquired Canyon Bakehouse store brand business. The balance of the growth was split between improved pricing mix and volume growth in store brand bread, buns, and rolls due to increased distribution with existing customers, offset by lower volumes in our store branded breakfast business. Foodservice and other non recent retail sales decreased by $5,700,000 or 2.4%. Lower volumes drove most of the decline due in part to lost business from the inferior yeast disruption in 2018 and volume losses in the vending channel of our non retail cake business. As we lap these prior year events, we expect our food service and non retail business to stabilize.

In the quarter, gross margin decreased 10 basis points to 47.3% of sales. Improved price realizations did somewhat help to offset input cost inflation to some extent. However, the benefit of these pricing actions was offset by higher workforce costs and lower manufacturing efficiencies. Third quarter gross margins were also temporarily impacted by start up costs related to the introduction of a new product line at one of our bakeries. Excluding the items affecting comparability detailed in the press release, adjusted SD and A expenses increased 60 basis points as a percent of sales, primarily due to the timing of employee incentives and increased marketing costs.

These items were partially offset by lower distribution lower distributor distribution fees, which decreased 30 basis points as a percentage of sales and stabilizing logistic costs as a percentage of sales. GAAP diluted EPS for the quarter was $0.20 per share. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter was $0.22 per share, down $01 compared to the prior year. Higher sales were largely offset by elevated labor costs, higher marketing expenses, and reduced manufacturing efficiencies. Canyon Bakehouse was accretive to both EBITDA and EPS in the quarter.

Shifting to, leveraging cash flow, just a few comments. Looking year to date, we've generated operating cash flows of 278,100,000.0 and made capital expenditures of 70,600,000.0. Accordingly, cash flows year to date have been solid and we paid 119,800,000.0 in dividends to shareholders and reduced our total indebtedness by 102,500,000.0. At quarter end, our net debt to trailing twelve month adjusted EBITDA stood at approximately 2.1 times. Now turning to guidance.

For the remainder of fiscal twenty nineteen, we expect good top line momentum. So we are increasing our outlook for full year sales growth to be in the range of 4% to 4.5%. This includes sales from the acquisition of Canyon Bakehouse, which now anticipated to be in the range of 75,000,000 to 80,000,000 accounting for approximately 2% of the total 2019 sales growth. We expect base business growth to be driven by improvements in price mix, partially offset by conservative view of volumes due to broader category softness. We continue to expect adjusted EPS in the range of 94¢ to 99¢ per share.

The pricing actions we've taken have helped to mitigate input cost inflation, but we expect the margins will continue to be pressured as we work through manufacturing inefficiencies and higher workforce costs because of the tight labor market. We are pleased that Canyon Bakehouse is performing at the upper end of our plan, and we now see it being slightly accretive to full year EPS. Now I'll turn the call back

Speaker 2

to Ryals. Thank you, Steve. So look, although there were some issues that affected the quarter, the underlying fundamentals of the business are strong. We've got a solid foundation to build upon and while there are certainly areas for improvement, I believe the trajectory of the business is quite positive. Our branded retail business is thriving and we believe this is largely attributable to the org changes put in place a couple of years ago and the resulting focus and higher marketing support for our high potential national brands.

Nature's Own, Dave's Killer Bread, Wonder, all are significantly driving our top line and all three gained unit and dollar share in the quarter as they have each quarter this year. Also in the third quarter, DKB became the number two specialty loaf in retail dollars and Canyon Bakehouse became the number one gluten free bread brand in the country. And it continues to grow in distribution and velocity. Furthermore, our focus on omni channel is starting to pay off. In fact, syndicated data shows us that e commerce sales of fresh packaged breads, buns, and rolls have almost doubled in the last year, and our branded sales have increased by 55%.

That's still a relatively small base, but establishing a presence for our brands on the digital shelf is critical for growth in the future as more households buy groceries online and home delivery expands. Now having said that, we recognize there's room for improvement and we still have work to do to improve our margin performance. So over the past several months, I've taken the time to evaluate our current situation and challenge our senior leadership team. Working collaboratively, we've honed our focus around the issues we face. We better frame the questions we need to be asking ourselves and focus on the development of a solid plan of action, all within the context of our four strategic pillars.

So we've identified the three primary areas that we believe will drive the most meaningful margin improvement. One is portfolio and supply chain optimization. Look, we need to identify the optimal mix of products for flours so we can drive out complexity and determine the most efficient bakery and logistics footprint. Now the other two areas I'll talk about in a minute certainly have independent scopes of opportunity, but they too will be informed by the halo of this portfolio and supply chain initiative. Secondly, it's no secret we've been challenged in the cake business, but I believe that with the right level of focus on our cake brands plus investments in automation, we can turn this business and bring it to more attractive levels of margin contribution.

And third, stabilizing and growing our food service business. We're one of the largest suppliers of food service bakery products in The US and we need to better leverage that scale. Rebuild our lost business and focus on our highest margin opportunities. So with regard to portfolio and supply chain optimization, we've told you for a while now that the first stage of Centennial will focus primarily on indirect costs and org structure and that we'd be turning our attention to supply chain in the second stage. Well, we're now at that point and so we're asking ourselves two fundamental strategic questions.

One, what's the optimal portfolio for flowers that can promote margin accretive growth? And two, what's the correct network and resources required to support and grow that portfolio going forward? To answer these questions, we're undertaking a complete portfolio profitability review along with the development of tools and capabilities that will allow us to make more informed strategic choices around things like assortment, pricing, distribution, innovation. It'll also help us more efficiently weed out unprofitable products or unprofitable accounts that contribute nothing but added cost and complexity. And it will generate opportunities for supply chain and overhead optimization.

So the true crux of this effort is to drive out valueless complexity and improve our operational efficiencies. Now, we've certainly taken advantage of immediate opportunities to optimize our network. We've added organic capacity in the Northeast this year. We announced the closing of our Opelika, Alabama bakery at the end of this year. And we installed a new high speed bun line in Suwanee, Georgia.

We also have plans in place to convert another existing Flowers bakery to organic production to support the growth of DKD and that'll happen next year. But I believe that a holistic approach that's centered around the optimization of the portfolio will generate more meaningful improvements over time. Before we formally launched this initiative, we did complete an internal review that began when I was COO. I wanted to be sure that we challenged and honed the questions we were trying to answer so that when work began in earnest we had a very tight, focused scope of activities with clearly understood desired outcomes. The initial phase of this work has already begun and it will take several weeks to complete.

It's being directed by a dedicated internal team and we have support from outside resources. And it's our intention to have an update for you on where we are by our earnings call next February. With regard to the second area of focus, reinvigorating and investing in our cake business. Look, it's become clear to me that we have underinvested in our cake brands and operations for several years now. And the recent production difficulties we experienced with that new product launch only serve to shine a brighter light on it.

We believe in the potential of the iconic Tastykake brand and we'll be seeking to make smart investments to drive the brand forward. That means a renewed focus on consistent quality, service, distribution, and innovation. It also means investing in robotics and other automation tools to drive efficiencies and improve our quality. And work on that initiative is already underway. Food service is our third area of focus.

As you know, food service business was challenged last year by by the yeast disruption. We're now cycling that, but more importantly, we need to get our food service business growing again. It's an important and scaled part of our business, and I think that working to grow it smartly by winning good margin business and seeking out attractive M and A candidates that offer margin accretive, premium, or artisan product lines will be beneficial. So within our four strategic pillars, we'll focus on these three areas with intensity and I believe that over time execution against all three will improve our bottom line performance. So moving on, M and A.

M and A remains a key strategic priority where we've had some recent success. As we mentioned earlier, since we closed the deal last September, Canyon's grown from number three all the way to number one. On the top line, it's performing at the upper end of our expectations and it's beating our bottom line targets. But as the Canyon integration winds down, we're continuing to proactively seek strategic opportunities in areas of the store outside the traditional bread aisle as well as different product segments where we believe we have the right to win. As you know, we play in a large category, so M and A is expected to be a key driver to grow our business and pivot to higher margin and faster growing categories within baked foods.

And finally, I firmly believe our most important strategic priority is developing our team members and making sure that our organization possesses the capabilities and tools to successfully execute on all the other priorities we've talked about today. So at all levels of the organization, we're increasing communication, we're increasing engagement, we're aligning work schedules to better fit today's modern lifestyles, and we're clarifying career paths to attract the best candidates and improve retention. Also, we're increasing accountability and better aligning incentives to job responsibilities. Today almost 30% of our employees have incentives that are directly tied to their role. Two years ago that number was zero.

So I firmly believe that as we continue to link incentives with responsibilities at the functional level, execution against our priorities will improve. So in summary, despite some continuing margin headwinds in a few discrete areas, the fundamentals of the business are strong. The branded business continues to enjoy good growth. Our recent M and A successes continue to bring meaningful returns. Our cash flow and our balance sheet are strong, and we've got a talented, loyal, and dedicated team that executes with excellence.

It will take some patience and some time for us to realize the full benefits of our initiatives. But if we can deliver against the three areas of focus I summarized for you today, we believe that we can not only continue to drive the top line, but also deliver the improved margin performance of which we're capable and that our shareholders expect. So now we'll turn to your questions.

Speaker 0

Thank you. We will now begin the question and answer session. And we have a question from Mitch Pinheiro from Sturtevant and Company. Please go ahead,

Speaker 3

Hi, good morning. Hey, Mitch. So first question is regarding Phase two here of Project Centennial and the and the supply chain optimization. I mean, I I know you said something, but I missed it, in your in your in your remarks. But how long is this review going to take?

I would have thought that, you know, phase two would have been planned out as phase one's going along, but now it seems like it's a discrete stop and then start. And then you have, you know, this phase two analysis and then phase two implementation. Like, what's the timeline on that?

Speaker 2

Yeah. So, Mitch, I mean, it's the whole thing is kind of the next next step in the evolution under Centennial. Right? I mean, we had a we had a lot of org changes that came about in the first phase that we wanted to make sure we got bedded down and all in place. All that frankly is settled out now.

But I think more importantly, Mitch, we've been thinking about this for a long time. I mean, know this industry pretty well. This is something you gotta be pretty careful and deliberate about. And so we took quite a bit of time to do our internal reviews and frankly learned quite a bit. And I mentioned in my prepared remarks that one of the reasons we did that is we wanted to come out on the other side of that internal review with a very, very detailed and tight scope of work, obviously for economies.

You know, through a lot of lot of spent with Centennial that won't be repeated here. This is a much smaller scale. But we wanted both our internal and our outside resources to be fully prepared going in on the front end so we could keep that scope really tight, clearly understand what outcomes we were after, and then perform the, the formal work. And and when you look at

Speaker 3

this, is there and you look at, you know, your portfolio profitability optimization. I mean, is there is there any you know, are we gonna see sales being cold in a material way? Or, I mean, would it be a drag on revenue growth in a material way, I guess, is the question.

Speaker 2

Yeah. I mean, you know, look. I mean, there's an element of of SKU rationalization involved here. Obviously, I I can't quantify that for you today. That that'll come, later on, but it's much more than that.

I mean, this is a much more holistic approach that is, you know, is rooted in portfolio optimization. But it's also about the network, right? And making sure that we're operating as efficiently as possible. I mean, we'll have more details on it as we go through the process. I'm not ready to answer that today.

But, you know, there there there will be some element of SKU rationalization involved. I mean, that's probably pretty obvious.

Speaker 3

Okay. And then when when it comes to, you know, the tight labor as it affects efficiency, is that is that the inability to fill, you know, second shifts? Or what what can you talk about that a little bit?

Speaker 2

Yeah. Mitch Mitch, it's really turnover. I the turnover has been the been the biggest problem. And, you know, to address that, we're doing some short term things. And then, obviously, the portfolio and supply chain network stuff is a little longer term.

But we're trying to do some creative things with scheduling. You know, as a as a fresh perishable DSD business, we basically run every day. And so, you know, we don't have the luxury of building inventories and and sort of having more predictable, predictable scheduling. So we're doing some things with shifts, to try to give people more certainty as to their schedule, more instances of consecutive days off, which is historically a rarity in our industry. Just overall trying to make it a more attractive place to work.

And furthermore, we're moving back away, in some of our plants from outsource labor back to permanent labor to create that more of that one team, atmosphere. We've done that in a couple of bakeries so far. And, I can't say that we've seen, you know, significant, financial returns from that yet, but we have seen the turnover start to fall. Once that happens and takes hold, one would expect, you know, once those folks are trained up for those manufacturing efficiencies to start coming back up to historical levels.

Speaker 3

Okay. Alright. Well, thank you.

Speaker 2

I'll get

Speaker 3

back in the queue.

Speaker 2

Thank you, Mitch.

Speaker 0

We have no further questions at this time. That concludes the Q and A session. And I will now turn the call over to Ryals McMullen for closing comments.

Speaker 2

Well, we appreciate you joining our call today. Thanks for your interest in Flowers, and we look forward to speaking again in February. Thank you.

Speaker 0

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect. Hi.