Flowers Foods, Inc.

Thank you for standing by and welcome to the Flowers Foods third quarter question and answer session conference call. I would now like to hand the conference over to J.T. Rick, Senior Vice President, Finance and Investor Relations. Thank you. Please go ahead, sir.

Thank you, Operator, and good morning. I hope everyone had the opportunity to review our earnings release and presentation and also listen to our prepared remarks all of which are available on our investor relations website. Following the conclusion of 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 Riles McMullen, President and CEO, and Steve Kinsey, our CFO. And with that, Deborah, can we begin the Q&A?

Deborah, we're ready to start the Q&A, please.

Thank you. Can you hear me now?

Yes.

Okay. I'm sorry. It's all right. To ask a question, you may press star 1 on your telephone keypad. That is star 1. To withdraw your question, press the hound or hash key. Please stand by while we compile the Q&A roster. And your first question comes from Bill Chappell with Truist Securities.

Thanks. Good morning. Morning, Bill. Hey, I guess can you talk a little bit more about just what you're doing or what you're seeing on the price mix in terms of the move of consumers more to branded and trying to understand, you know, I guess first from a manufacturing standpoint, are you starting to change your mix where you're actually making less private label and making more branded just to reduce kind of sales? And then at the same point, you know, is this really all just brand migration or is there any pricing in it?

Yeah, so to start with the manufacturing concept, Bill, I mean, as you know, we have pretty flexible manufacturing facilities, so... You know, the same plant that makes brand oftentimes makes private label too, so it's very easy for us to shift, you know, along with the consumer dynamics from private label to brand. But to layer on top of that, you know, if you think about the Lynchburg Baker is probably a great example of, you know, moving up the mix chain or up the margin chain, depending on how you want to look at it, towards our higher margin products and, you know, adding production capacity to serve the market that way. From a pricing standpoint, you know, not too much – we haven't seen too much pure pricing this year, but the promotional environment is certainly, you know, well beneath historical levels. So, you know, average base prices are, I guess, up some. You know, we have seen that start to tick back up a little bit more recently, but, you know, still well off the historical levels.

Got it. And I guess when I'm trying to understand the migration to brands, I mean, There's one benefit from going from private label to Wonder. There's another one going up to Dave's Killer Bread. I mean, which is the bigger driver or is it kind of all the above?

Yeah, I mean, it's kind of in totality. You're right in what you say. I mean, the DKB margins and the Nature's Own margins together would be higher than Wonder and some of the other brands. But, you know, any shift out of that lower margin business to higher margin business in totality helps the bottom line. But DKB obviously is a tremendous growth driver. Canyon has been a big growth driver this year, and both of those carry very high margins.

Got it. And then looking to next year, I realize you're not giving guidance, but two questions. One, what kind of impact on your business is the fact that 70% of U.S. school children are going to school at home or virtually or hybrid schools? and that that might change, hopefully for a lot of us, sometime in 2021? Is it a positive or a negative impact? And then the same thing, I think, Steve, you had mentioned there was a variable comp component, which understandably everyone is having a good year. What kind of switch does that turn into a tailwind as you kind of reset that to normal numbers for next year?

Thanks. Yeah, sure. Bill, let me take the school children piece, and I'll pass it to Steve for the incentive comp. Yeah, I mean, it sort of puts and takes to the kids being at home, right? I mean, we sort of miss the back-to-school bump that we normally get in the fall with all the kids staying home or having gone and getting pulled back. But then again, on the other side of the equation, you have elevated in-home eating if the children are home all day, which is really what we saw at the outset of this, right? I mean, everybody's sitting around at home, kids at home, parents at home, so you get that. you get that increase in at-home eating. So, you know, there's a little bit of a balance in puts and takes there. It's a little hard to separate them and quantify them. But, you know, I guess at the end of the day, you know, I know there's probably going to be a lot of questions about 21 this morning, so might as well go ahead and make a few comments around that now. Obviously, as I'm sure you can appreciate, it's pretty tough to plan for next year just given the outsized year that 2020 has been. But there's two ways you can think about it. You can sit here and try to guess what the demand environment is going to be in 2021 and beyond, or you can sit here and figure out what strategies do you need to put in place to drive that demand environment. And that's what we're trying to do. through our portfolio strategy, through the brand support that we continue to increase and bring to bear to grow our brand. So you can either take what you're given or control what you can control and try to drive that brand environment with good innovation, great quality, and brand support. So that's kind of how we're approaching next year. Steve, do you want to address the incentive column?

Sure. Obviously, Bill, you're right. As you look at the year and you can see through the through the comments and the financials and the fact we've raised guidance and brought up the lower end as the year progressed, that, you know, it has been an outperformance compared to where, you know, we thought coming into the year. So obviously that's flowing through the P&L this year. You know, as we plan for next year and we set targets and goals, you know, we don't give specifics around incentive cost, but we do expect things to, to normalize somewhat because obviously we'll set our goals in line with what we think expectations are. And while there'll be a bit of a tailwind from this year, you know, we expect the incentive comp to be somewhat more normal going into 2021.

Okay, great. Thanks so much. Thank you, Bill.

Your next question comes from Brian Holland of DA Davidson.

Yeah, thanks. Good morning and congrats on the continued strong results. I wanted to ask first about for Q, you know, you cleared what was, you know, at least in my model, a pretty high bar that I set for you in Q3. And if I look at the guidance revision, you know, the low end is above what my model applies for Q4. Now, certainly it's possible that I'm just not doing something like my model here for Q4. But assuming that there's no real issue there, I'll ask the question, You know, anything incrementally stronger building into year end? Because it does feel like a pretty marked improvement in guidance.

Yeah, I'll let Steve comment here as well. But nothing specific I would call out. I mean, you know, we, as I said earlier, you know, we continue to see pretty good trends from a branded retail standpoint. I mean, you see that data as well, you know, still pretty elevated. And, you know, we don't, As far as we can see, we don't see that dropping off substantially. You know, the headwinds in Q4 are always the holidays for us, which is a very strong roll season, which is not a huge part of our portfolio. So it kind of depends on how the holidays go, too. But, you know, on the upper end of the range, you're seeing, you know, continued elevated branded retail as we have been seeing. It's sort of, you know, in recent weeks kind of plateaued. and been pretty steady kind of week over week. So if we continue to see that, we feel good about the upper end. Obviously, the lower end of it will reflect some relatively meaningful drop-off in the branded retail mix. Steve, any other commentary you want to make?

Not specifically. I think Riles covered the majority of it. But just to remind folks, Q4 is typically our toughest quarter as you look at the year and as things progress. And Riles did call out. And we did call that in the pre-recorded content. Actually, there's three holidays in the fourth quarter this year, even with the extra week. And typically that business is role business, and our strength is more on the low side. So we are taking a little cautionary look kind of around the holidays. But as Ryle said, if this branded mix continues to perform well, things should shape up rather nicely for the quarter.

Yeah, and I should just clarify, I mean, I do have the extra week in, but I'm looking for mid-single digits in the branded retail segment. Q4, you are clearly outperforming that in the scanner data that we can see thus far. So, you know, anyway, just to clarify that on my end. Okay. Two dynamics that seem to be rearing its head, you know, based on some other food companies that we have reporting this earnings season that have weighed on you in the past. One, we're hearing about tight labor markets, you know, and costs related to that. And then also we have freight. You know, labor seems like that's a particularly acute issue for you guys given the manual intensive manufacturing. And then on the freight side, you know, 2017, 2018, you guys actually had a lag impact, as I recall, you know, kind of given the way you go about that. But just curious, obviously, any comments on the labor side, how we should be thinking about that going forward? And then on the freight side, just thinking about how you manage the, you know, what we saw 2017 into 2018 and how that impacted you, and maybe what changes did you make that might allow you to mitigate those factors in 2021 if this continues. Thanks.

Sure. Thanks, Brian. I'll take the labor market piece and maybe let Steve address the transportation side of it. Yeah, look, the labor markets continue to be a bit of a challenge depending on where you are. It's not, you know, it's not acute everywhere, but we certainly have some areas where, you know, we continue to struggle a bit just kind of keeping people, keeping turnover down, you know, Then you have the overlay of COVID, so you have folks calling out for one reason or another, and it does present some challenges in the plants. In fact, despite our excellent results, we still have a lot of opportunity in our plants. Our efficiencies are down a bit, even from last year. That may seem counterintuitive with the results that we've had, but You've got the volume drop-off, plus you have higher scrap rates and things like that that are directly attributable to the stability of your labor force. So a lot of effort to try to bed that down, particularly where it has been most acute, because there's some meaningful improvements that we can make there. I think beyond that, we've talked about before really working on our overall work environment. you know, making sure that our pay scales obviously are competitive. That's one element. But also working on things like scheduling because, you know, we find, as many other companies have found, that, you know, there's a huge quality of life component at play today that's oftentimes equally or more important than the compensation. So, you know, working on our scheduling to give more clarity to particularly our frontline employees on, you know, when they will have time off you know, trying to ensure that they have consecutive days off where possible, which is, you know, a significant departure from the norm in our industry. Those types of things really do make a difference. So we continue to work on that as well. Steve, on freight.

Sure. You know, Bill, I would say we've benefited somewhat this year from the fact that, you know, our mix is more DSD driven. So as you recall, we term it as a closed loop system. We actually have, you know, three to four primary carriers for that. for our DSD products that deliver to our DCs. So those contracts are usually negotiated on a 12, 24-month cycle. So we're not in the true market buying so much freight as we do typically on our warehouse business. So we have seen some benefit for that. So if this mix continues into 2021, we would expect some of that to continue until we begin to lap some of it late in Q1. Also, I would say, as Riles alluded to, on the labor side and being more efficient, I think we've gotten more efficient from a production standpoint. And our runs, we have better transportation run efficiency as well because we're sending four trucks to these DCs versus sending half loads. So that's impacted us as well. And again, that's mixed driven. So if that continues through 2021, I would expect to continue to see somewhat stable transportation going into next year as well. And then obviously fuel costs will will impact that as well. And so I would say those were probably the three or four factors that really influenced transportation for us.

So thanks. Appreciate all the color. I'll leave it there. Best of luck going forward. Thanks again. Thanks, Brian.

Your next question comes from Mitch Pinero's certified and company.

Hey, good morning. Hey, Mitch. Hey, so this... Looking at current trends, I mean, how has food service been ramping for you? If you could break that out, sort of QSR and casual.

Sure. You know, the QSR business, I think we mentioned this on the last quarter, so it's kind of a continuation of the trend. The food services, the fast food, excuse me, QSR business has been ramping A bit quicker to recover just by its nature, drive-thrus, that sort of thing, you know, Chick-fil-A's, you know, the ones I see. The lines are double-wrapped around the store, so they're doing pretty well. You know, the sit-down, fast-casual type stuff is, you know, still lagging. It mitches off the bottom but still well down. You can see that in the non-retail numbers that we put out, you know, down roughly, you know, 14.5% or so. but off the lows, you know, that we saw, you know, early in the year. So slow recovery there, I think it's going to be a long time. That's my personal opinion. And you kind of have to factor into that, well, you know, what happens with COVID? You have another surge, it's really going to get hurt. You're seeing that, you know, start to happen in Europe, you know, with new lockdowns and, you know, does that, you know, migrate its way over here as we move into flu season? We'll have to see. So, you know, it's trying to come back, but it is slow, and I think it will be protracted.

And is that, you know, so is it off the bottom, you know, in the third quarter, you know, as we're hearing in the fourth quarter, is it just sort of stabilized? Is that what you're saying?

Yeah, in the second quarter, non-retail for us was down 15.8%. And in the third quarter, it was down 14.7%. So better, but not by a whole lot.

Okay. And then as you're looking at the 21, just broadly speaking, in broad terms, what type of cost savings, supply chain savings, you know, part of that $20 million that you had this year – I mean, are we talking about the same type of level of cost savings next year, or does it drop off? Any color around that?

For obvious reasons, I'd rather stop short of actually quantifying it, but it is a continuation of many of the same initiatives we had in place this year. So it'll be largely first half weighted until we lap it in the second half, Mitch. But it's across those same categories, right, the overhead frame line that we did, procurement, you know, depot consolidation, all the things that we've talked about. That is not to say that we're not working on additional incremental things, but that's, you know, some of those are still in the planning stages. But, you know, it will be meaningful, but it will also be mostly first half weighted.

Okay. And then just a couple more. So has the current environment affected your ability – to gain new distribution or, you know, getting new products on the shelf in your newer territories? Has this been good for you? Has this been neutral? Any color around that?

You know, it really hasn't. I mean, we've continued to, you know, to introduce new products, the DKB buns, the perfectly crafted line extensions that we talked about in the prepared remarks. All that's happened in the midst of all this, and we're not the only ones. Our competitors have put new products forth. We've gained new shelf space during this period. Mitch, no really meaningful geographic expansion during this, but by the same token, we weren't trying to. We're really focused, as we've talked about before, on places like the Northeast where we're still relatively low share. So we're there, but really trying to gain deeper penetration there. you know, by gaining incremental shelf space and putting forth our brand support, those types of things. So from that standpoint, it really hasn't, Steve, unless I'm missing something, it really hasn't impacted us negatively.

And then this last question on tasty baking.

So, hey, Mitch, let me cut you off there because I do want to add one more thing to your question as I sit here thinking about it. I do think in some ways that, you know, the COVID circumstance has been a positive relative to new product introductions because what we have seen in the mix shift is somewhat of a shift away from traditional loaf to buns and rolls and to breakfast items, right? And so as we've introduced new items, you know, in those categories, from that standpoint, it's actually been a positive rather than a neutral.

Okay.

Gotcha.

Yeah. Thank you. I just wanted one more question about Tasty Baking. So where are we right now here in the fourth quarter with Tasty Baking? Are the operations sort of optimized, you know, where you want them to be? Is this something that we're going to see, you know, slowly build into the first half of next year? And were Tasty Cake sales up or can you talk about, you know, up, down in the third quarter?

I'll answer your question bluntly to start and then provide some color. We are not where we want to be, period. We are making improvements. I'm extremely pleased with the job that David Roach is doing. As you know, he's one of our more seasoned operational executives. He's doing a great job up there with a very difficult task. We have installed new automation. Most of that is complete. We have made some management upgrades. We have even brought in some outside help to improve our operational processes. We've been through union contract negotiation, and that has all settled down now. So things are getting better, Mitch. I forget the exact phrasing you used, but I think it's spot on that I expect to see slow, steady progress as we move through next year. But if we're successful, I believe that that slow, steady progress will culminate in a meaningful improvement for the company next year. Okay. Oh, yeah. By the way, Tasty was flat for the quarter, but let me point something out there. Okay. The operational inefficiency that we've been experiencing at Navy Yard has impacted their top line, too, because we've had to cut. Because of those inefficiencies in scrap, we've had to cut product, which obviously impacts your top line. Okay. You know, making these improvements will not only help the bottom line, but it will improve the top line as well.

Okay. And one more thing, I do like the new conference call format. Good, thanks. So I appreciate you doing that. Sure. You bet.

Your next question comes from Ryan Bell of Consumer Edge Research.

Hi, everyone. Morning. Is there any way you could provide some details about the direction of store brands and the market retail parts of your business throughout the quarter, kind of talking about where they were to start the quarter and where they came at the end, just to see where the momentum is being pushed?

So the intra-quarter trajectory of private label, is that what you're asking?

Yes, for the private label and then also the non-retail portion of the business. I know that's still down and improved a little bit, but it's harder to get the magnitude and sort of the month-to-month to figure out where that might be going.

I'm with you. Ryan, I don't have that in front of me. I have the totals, which you already have from the release. We can look into that and come back to you, though. I want to say it was fairly steady for the quarter, but let me check that.

Okay, thank you. And then when we're talking a little bit more about private label at the industry level, we've been seeing that down pretty significantly in scanner. Would you be able to share some of your perspective about the drivers of the industry decline? Obviously, producers such as yourself have the ability to favor branded over store brands for the margin advantage and other reasons. But is there any commentary you could have about that on the industry level?

Yeah, you know, I've talked a little bit about this before, but it's, you know, it's a kind of a key question, right? I think it all started at the outset of the pandemic because you had this massive shift to brand because of capacity constraints, right? So, you know, everybody was pumping out as much, you know, branded product as they could, you know, in a limited SKU assortment. But now, you know, as we've, you know, maybe found, you know, something akin to a new normal, now what's driving it? Well, I think e-commerce is one. You know, the brands are a bit more prominent on the e-commerce platform, and obviously that's playing a much larger role today. I think it's, you know, time spent in store is a lot shorter now. You know, number of trips are shorter. People don't want to, you know, spend a lot of time wandering around the grocery store. So, you know, they go for what they want, and in this particular case, brand delivers more of what they want than, you know, perhaps the private label does. There's more differentiation there. There's more innovation there, some of which we're happy to have brought, you know, to the category. So, yeah, I think those are probably the primary drivers.

Okay, and that kind of seems like as you're looking out to 2021 that the private label probably is not going to be picking up quite as much given what you're talking about overall.

Yeah, I mean, I would certainly think so. I mean, if we do, you know, if we do our job correctly and, you know, we bring a compelling, you know, brand proposition to the consumer, then, you know, naturally that should lead them to stay with our branded products. You know, if you think about, you know, a deeper recessionary environment and, you know, stimulus money running out and that sort of thing, Yeah, you could see some trade down, but the good news for us is that we play across, you know, a variety of different price points. So, you know, you've got your super premiums up in the Dave's and Canyon areas. You've got the premium in Nature Zone, and you've got, you know, a little bit more value, you know, in the Wonder area. So, you know, we're kind of able to address all those price points with the brands that we have, which we believe provides us some, you know, some insulation, you know, should you encounter a recession. And if you think back to 08, 09, you know, the last one we had, we fared pretty well through that environment, as we have through prior recessions.

Thank you. That's good for me.

Okay, thanks.

Thank you, gentlemen. Do you have any closing remarks?

No, except to thank everybody for their time and for your interest in the company. I certainly hope you like the new format. We certainly like it better. able to dedicate a little more time to your questions. So we appreciate you joining the call this morning.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.