Flowers Foods, Inc.

Good morning, ladies and gentlemen, and welcome to the Flowers Foods third quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, J.T. Richt, Senior Vice President, Finance and Investor Relations.

Thank you, and good morning. 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 yesterday evening on our Investor Relations website. After today's Q&A session, we will 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 an 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. Operator, we're ready to start the Q&A, please.

Thank you. Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. One moment while we compile the Q&A roster. Your first question comes from the line of Bill Chappelle with Truist.

Hey, thanks. Good morning. Good morning, Bill. Three kind of quick questions. One, based on kind of your commentary and prepared remarks. One, you talk about you're not really, you know, it's too early to tell what kind of normal looks like in terms of people reverting back to work and to school and to stuff like that, kind of post-Delta variant. But you're pretty well exposed to states like Texas and Florida where they've kind of moved back to normal a little bit faster than the rest of the country. So maybe tell us what you're seeing there and kind of what that tells you for as we look to 22 in terms of kind of consumption.

Sure. I mean, Bill, you know, it's really interesting. you know, kind of broad-based across the country. We've been really pleased with how well things have held up, particularly on the branded retail side. So nothing, you know, really in particular to call out by region, except to say, you know, overall the brand investments that we continue to make, the innovation we continue to introduce has really helped us, you know, hold on to a lot of these consumers. And, you know, similarly, we're also seeing you know, further increases in household penetration, you know, velocities are up, repeat buyers are up. So, you know, all the signs point in a pretty optimistic direction, you know, when you think about what returns normal ultimately looks like.

Got it. And then in terms of costs, the comment of you may look to do additional pricing to cover the cost. Can you remind us, are you looking to kind of cover margin or cover profit dollars in terms of, you know, growth margin looking forward?

Sure. I mean, obviously, the ultimate goal would be to protect both. Now, at the end of the day, the consumer is going to drive, you know, the ultimate results, right? You know, consumers are experiencing very, very broad-based inflation. We've all read the headlines, you know, 30-year highs, you know, fifth straight month over 5%, that kind of thing. So, everything from gasoline to our products is going up. So we'll have to wait and see how the consumer at the end of the day reacts to that. If we find ourselves in a situation where there's a trade down the value or units drop off, it's certainly reasonable to assume that there could be some margin compression in the short term. But what I'd say overall about the inflationary environment is You know, whether you believe it's transitory or whether you think it'll last a little bit longer than that, ultimately these issues are temporary and, you know, and not completely within our control. So we're focused on what we can control. We will continue to make investments in our brands. We'll continue to make investments in our digital capabilities, et cetera, that over time will lead to expanded markets.

Got it. And then last one for me, you made the comment in the remarks of like you're seeing M&A activity kick up? And I guess the question is, why is that the case? I mean, I was under the impression that the same kind of 10 key targets you've been talking to for, you know, years, if not decades, and so didn't know why things would start picking up now or, you know, and, you know, maybe it's more color around that comment.

Sure. I mean, I think maybe a little bit earlier in the year, it may have been driven by some tax issues. Now, we'll ultimately see where that bill falls. It looks like some of that's going to not end up in the bill. So that could have been driving some of it. And you're right, we still continue to talk to some of the same targets that we have for a number of years. But that activity has really picked up, Bill, more in the adjacent product categories, so more in the smacking space, that kind of thing.

Okay, great. Thanks so much for the call.

Sure. Thanks, Bill.

Your next question comes from the line of Ben Benevue with Stevens.

Hey, thanks. Good morning, everybody. Hey, Ben. So I want to ask about just this continued strength in branded retail. Really good results still. I'm sure the mix is still supporting gross margins even in an environment where you're seeing some cost increases. I'm curious if you could talk about do you think we're – at this equilibrium now? Do you think this is an equilibrium that we can grow off of? And to what degree, as we continue to see maybe pricing increases, does that influence a shift from branded retail to store-branded retail products?

Yeah, Ben, great question. And I think that's a key point. And, you know, as I was mentioning in response to Bill a minute ago, I mean, it's all going to be about the consumer. And, you know, so far, you know, even with the pricing actions that we took in July, you know, branded retail units have held up very, very well. I mean, we've seen little to no drop off at all in branded units. Now, you know, going forward, as you look into next year with all the inflation consumers face, you know, with stimulus payments coming off that kind of thing, I think it's yet to be seen just how much the consumer is willing to absorb. And that'll be a key topic for next year, right? You know, we've been through situations like this before. Most recently in kind of 07, 09 time period, the business held up relatively well. You know, we do offer products across a variety of price points, which certainly helps, you know, from the super premium Dave's Killer Breads all the way down to private label, you know, with some pricing in between, too, on Nature's Own and Wonder, that kind of thing. So we feel like we're very, very well-positioned. to do well in any environment. Obviously, we would be most pleased if the current trends that we're watching continue, but I think it's really all about the inflationary impacts on the consumer and what they'll be able to absorb. But that also makes it more important than ever that we continue to keep up with our pressing forward on innovation, that we keep developing our capabilities such that eventually this will subside. It always does, and when it does, we'll be positioned even stronger.

Yeah, perfect. Understood. On the cost side of the equation, how much visibility do you have into the balance this year and into early next year, and any thoughts that you have on what that looks like and kind of where we are in terms of the curve of cost inflation? How close do you think we are to maybe seeing a light at the end of the tunnel from your vantage point?

where we are in the year and the fact we do forward buy and hedge a lot of our commodity spend, we have full visibility for 2021. From that perspective, we've been talking about the cadence of inflation for this year. The majority of it is coming in in the fourth quarter. We'll begin to see some of that ramp up and all that is priced into the guidance we gave yesterday when we released Looking forward to 2022, we're not prepared to give guidance today, but obviously, you know, when you kind of look at it on a forward curve, it's pretty significant inflation. And if things stay at the market levels we see today, as we said in our, you know, in our prepared remarks, you know, we expect to see pretty meaningful inflation next year. But as Riles has commented, you know, we're looking at efforts to mitigate that through pricing as well as, you know, other cost initiatives. So we anticipate this to be at least, you know, another One year's back, as Ross just said, depending on whether it's truly transitory or not, it could go slightly beyond a year. But right now, all indications are that the inflation will hold through most of 2022 as well.

Okay, sounds good. Thanks so much for the thoughts and best of luck with the rest of the year. Thank you, Ben.

Your next question comes from the line of Steve Powers with Deutsche Bank.

Yeah, hey, thanks. And I guess picking up on what we've already been talking about, your prepared remarks and then some of the conversations this morning just really underscore the uncertainties around, you know, the pacing of demand migration back towards pre-pandemic levels potentially and just, you know, inflation rates headwinds and other variables. Plus, we know that you've got ongoing strategic investments around technology and branding otherwise. So I guess just in that context, I'm hoping you could elaborate on the drivers that, as I read your presentation, at least the presentation slides that accompany the prepared remarks, talk about confidence and expectation to get on to that long-term algorithm in fiscal 22. So maybe, you know, unless that was a misread on my part, just, you know, what are the drivers that despite all those uncertainties, you feel like you've got confidence and visibility to lock in those long-term growth targets next year?

Well, sure. I mean, I think we've already alluded to a few of them. But, you know, just to reiterate, one, you know, the momentum that we carry into 2022. I mean, we have gained a lot of consumers over the past two years at speed. We've invested a lot behind our brands. We're clearly growing our share nationally, but also in very important markets like the Northeast where we're underpenetrated. We have a lot of new innovation items, some of which we're testing right now, some of which will be forthcoming next year that we're quite excited about to continue to drive top-line growth. And you're right, we are making significant investments in our ERP platform. and other digital capabilities that over the long haul will enable us to stay on that long-term algorithm. And then, of course, Steve, we also have, you know, taking a look at the balance sheet, you know, we're obviously poised for acquisition activity should the right opportunity come along. So, you know, all those things put together, you know, give us confidence that we can stay on our long-term algorithm using 2019 as a base year. Okay.

Okay. Great.

And I guess maybe just sort of slightly different topic, just on your manufacturing footprint, obviously a diverse footprint of bakeries, and I'm assuming that gives you a pretty good amount of flexibility to help navigate different supply chain challenges. But maybe you can elaborate that on and just kind of talk about that generally. But I'm also hoping just for some visibility into how variable operating conditions are across your bakery footprint. Are things, you know, relatively similar across the board? Or are there, is there a lot of, you know, are there other, you know, kind of flashpoints where you're having more, you know, more challenges? I'm kind of thinking particularly from a labor perspective. But any color you have there would be great. Thanks.

Sure. Not so much by region of the country. I mean, the labor challenges are pretty consistent. pretty consistent across the company. And we do have a few areas where we've had, you know, somewhat less issue than other areas. But generally speaking, it's pretty consistent across the country. Now, you know, we have been able to manage through that, you know, I think pretty well just given the challenges that we're all facing. But it's still a challenge. And, you know, it does impact our efficiency. You know, you've got a – you're either shorthanded or you have a lot of new people in a bakery, for example – You know, that increases your scrap, lowers your efficiency, that kind of thing. The one call-out I would make, it has been a bit more intense in the cake bakeries, but those are more labor-intensive operations to begin with. So you just have more people, you know, particularly in packaging there. So it's been a little bit more acute there, but by the same token, you know, we've been able to manage through it pretty well. Okay. That's great, Keller. Thank you very much. Sure. Thank you.

Your next question comes from the line of Mitch Penhiro with Sturdivant and Company.

Good morning. Good morning, Mitch. So have you defined what your inflation rate has been on cost of goods for 2021?

We have not given that a specific measure. I mean, Because of the way we hedge, you know, obviously coming into 2021 is really when you begin to see the inflation ramp. So it's more back half driven, but we haven't given a specific percentage, just maybe for competitive reasons. Okay. You could do the math with the Q input cost. It would be pretty much in line, but beyond that, we haven't disclosed it.

Okay. When you – with the brand and growth surging, I'd love to hear more about your brand building efforts. I mean, in particular, you know, obviously some of this is driven by – You know, the consumer looking for, you know, the branded growth looking, you know, looking for premium products, looking for, you know, higher quality and more diverse set of baked goods. But I was wondering whether, you know, you're looking to capitalize and market your weighted growth more so than in the past. And I'd love to hear what you're doing and how your spending is allocated there. Is it being shifted more to TV like I've seen in the days killing bread? Or, you know, is it a digital e-commerce initiative? I'd love to hear a little more on that.

Sure, Mitch. Happy to. And, you know, you can just take a look at our marketing spend and see over the last several years how much we've ramped it up to support, you know, the portfolio strategy of growing our branded business at a faster rate. You touched on a lot of them already. I mean, a lot of it is being allocated towards our aggressive growth brands. You know, whether that be Canyon, Nature's Own, DKB, it's been more intense in parts of the country where we're underpenetrated, like the Northeast. That's why you're seeing some of the commercials up your way. And you're also correct on digital. You know, e-commerce is about 8%. of our sales right now, which is roughly in line with the category. We want to continue to grow that. I think e-commerce is going to continue to be a bigger and bigger part of the picture, and we need to have that digital presence. But on the other side, we're also investing in consumer insights. We have to understand our consumers such that we can continue to deliver the innovation that they want in the category. Some of that stems going into that and continued investments in R&D. I think you'll You'll start to see some of that as we go forward with some of the newer innovation items that we're coming out with that are not in the bread category, put it that way.

When it comes to Dave's Killer Bread, what's driving the growth there? Obviously, you have new products. I'd be curious to hear a little bit more about either any particular channels you'd like to call out, products, is there distribution gains happening? I'd love to understand more what's driving DKB rather, you know, more than just, you know, there's just, you know, strong demand for organic product.

Yeah, sure. I think at the end of the day, you know, first of all, it all starts with quality. You know, there are other organics that are out there. But Dave's has a commanding 70 share for a reason because it's the best tasting, the best quality, best consistency. We're continuing to grow in the Northeast, Mitch, which is a big part of the puzzle there. Bringing on Lynchburg last year to support that growth has been a huge thing for us in Dave's evolution. We continue to come out with new products with Dave's. We're testing some new products right now with them. There'll be more coming next year. So increasing awareness is a big one. I've talked about this before. When you look at the great success of Dave's that we're all very proud of, of course, but then you compare its household penetration to that of Nature's Own, it's roughly half that of Nature's Own. So even with the great growth we've experienced, we feel like that brand still has a ton of runway ahead of it. both within its current categories and in other categories, because I think the brand is strong enough now to begin playing across different categories, which we're obviously very excited about.

And then this final question, any update on your Cape business as far as the manufacturing side? Is a lot of that solved, or is it still work in progress in 2022?

Yeah, Mitch, not solved yet, but great progress this year. They're ahead of pace, actually, which we're very pleased about. But as I've said on the past several calls, though we are pleased with the progress, we still have some ways to go. But the improvement this year has been material. Okay.

Okay, thank you very much. Thank you, Mitch. Thank you.

I'm showing no further questions at this time. I would now like to turn the conference back to Riles McMullen.

Thank you very much, everybody. I appreciate your interest in the company, and we'll look forward to speaking with you again next quarter. Everybody take care.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may now disconnect.