Flowers Foods, Inc.

Good day, and thank you for standing by. Welcome to the Flowers Foods fourth quarter and fiscal year 2021 results conference call. At this time, all participants are in a listen-only mode. To ask a question during this session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded, and if you require any assistance during the call, please press star 0. I would now like to hand the conference over to your speaker today, Mr. J.T. Rick. Senior Vice President of Finance and Investor Relations. The floor is yours.

Thank you, and good morning. I hope everyone had the opportunity to review our earnings release and 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 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. Operator, we're ready to start the Q&A, please.

Thank you. And again, as a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the pound key. One moment as we compile the Q&A roster. Our first question comes from Ben Bienvenu of Stevens. Your line is open.

Hi, good morning, everyone. Jim Solera on for Ben. I want to talk a little bit about inflation moving into the new year. I guess, first of all, on the January 2022 price increase, how long do you think that'll take to get fully implemented? And then maybe you can talk a little bit about the cadence expectations for inflation in the year.

in large measure. There's a few small pieces of it that's just due to, you know, contracts rotating over, but the lion's share of the pricing, January price increases, is already in for the year.

I think you guys talked maybe a little about expectations kind of as the year progresses for inflation.

Sure. I mean, when you look at the overall inflationary environment, obviously we're rebuilding in Q4. So, In 2022, as we said, we expect it to ramp throughout the year, and then obviously Q4 costs. While we still will have inflation, we'll pull back slightly. So you should see a ramp, and then Q2, Q3 would probably be the highest cost, and then it pulls back slightly in Q4.

Okay. And if I could sneak in one more question, in regards to freight, Do you guys have a hedging position on freight costs, or do you have any visibility into what freight costs might do into 2022? Two things on freight.

We try to buy it forward as much as we can, but the reality is, like most companies, we'll be in kind of the current market on the 3PL situation.

Okay, great. Thanks, Ed. Thank you.

Thank you. And next we have Bill Chappell of Grice Securities. Your line is open.

Hi, morning. This is Donald on for Bells. I just wanted to ask a question on any color you could provide in your food service business versus 2019 levels. And also with regards to current inflation on the cost front, how much of that would you attribute towards labor? And do you believe there's a time where that could play toe at some point? Thank you.

Sure. The food service business, as you saw, did recover some. in the fourth quarter, and we saw that sort of through the second half of the year last year. It's still below 2019 levels, but there has been some recovery there. As you know, we've been doing a lot of work on our food service business to improve the profitability of it as it does come back, because obviously we've been expecting at least some amount of reversion as we hopefully start to exit this pandemic situation. But it does still, you know, remain below 2019 levels. And conversely, our branded retail business continues to hold up really, really well, you know, given the, you know, continued at-home eating trends, you know, our investments in our premium brands, et cetera, have all helped that business to maintain its place as part of the mix. You want to address the question?

Yeah, when you look at, I think your question was on round labor inflation. I mean, we're really no different than, Other companies, I mean, the labor market is really tight, as you know. So we're expecting kind of mid to low to mid single-digit labor inflation throughout the year, depending on which market you're in.

Okay. Thank you very much.

Thank you.

Thank you. Up next, we have Rob Dickerson of Jefferies. Your line is open.

Great. Thanks so much. Just a couple questions. I guess first one, I missed the first minute of the call, so sorry if you already spoke to this. Just in terms of the, I guess, the gross margin and, you know, EPS potential cadence for the year, I know in the prepared remarks you're kind of speaking to kind of first half, back half-ish with some moving pieces, obviously, you know, in the back half. But kind of given, you know, what we saw in Q4, should the market kind of be expecting, let's say, you know, similar year-over-year gross margin that kind of plays out in Q1, you know, despite the higher pricing? And then just kind of in earnings, you know, or we kind of, you know, implied kind of flattish in Q1? Just whatever you're willing to disclose would be great. Thanks.

Yeah, sure, Rob. I mean, obviously, we don't give guidance on gross margin specifically and definitely not by quarter, but I'd say overall, you know, we are expecting some pressure on the gross margin line, so it should be down on a year-over-year basis when we get through the full year. Mike Hayden, for about pricing, you may not have heard the comments, but we do have our January price increase that's pretty much in, and then we anticipate in certain categories or certain distribution segments more pricing coming, so that will fill through the first half as well. Then depending on the be potential that, you know, things don't moderate somewhat, you know, we would need to look again at some pricing initiatives as well. But, you know, we expect kind of, like we said in the release, the cadence thing will build. A lot of our savings initiatives start to come in Q3, so we do anticipate, you know, a build from that perspective with regard to overall margins for the year.

Okay, perfect. That was helpful. And then kind of simplistically, again, probably for you, Steve, and then I have one for Riles. Just, you know, the top line guide for the year, you know, I'm assuming kind of what we're seeing is maybe, you know, all of that's driven by pricing, maybe volumes you've kind of implied or maybe down low single digit. And I'm just kind of basing this off of kind of the level of pricing. I saw a key for it, but then also kind of what we already see in the January data set on the track side. So just kind of any kind of perspective on kind of that rate of pricing as of now, excluding any additional pricing. Sounds like you're kind of talking high single-digit-ish. Is that fair?

Yeah, when you look at the track channel data, I mean, we're still seeing some positive mix, so that's also helping drive. But obviously, as in Q4, pricing is a big driver of that. So I would expect you would see that throughout most of the year.

Okay, fair enough. Rob, we're –

Rob, to add to that a little bit, we're pretty optimistic thus far on elasticities. If you look at the syndicated data, this is from IRI for period one, which is essentially January of this year, and this would have followed the significant price increase in January. We're up 15.3% in dollars, but we're also up 5.3% in units, both of which are ahead of the category. So, point is the early returns on the, on the price increases holding and those moments, and particularly for branded retail, those volumes holding up are, um, are, are pretty optimistic. So that gives us confidence going into the, going into the year. We'll have to continue to watch it and, and see what the consumer does, how much they're able to absorb, but early returns are, are looking promising.

Yeah. I think your volumes are actually up year over year, sequentially relative to December, despite the price increase. So that it's good sign. So there's still a lot to still play out. Um, All right, cool. And then just, Riles, for you, you know, bakeries of the future, right? You've been speaking about this for some time. It sounds like, you know, given your prepared remarks that you're, you know, have a number of pilots that'll be in the market across a lot of your bakeries by the end of this year. You know, the savings you're speaking to kind of you know, so far and through 22 doesn't seem like it's really, you know, contingent on bakery of the future, but obviously bakery of the future would provide, I would think some material savings, you know, in the out year. So, you know, is that something that kind of starts to kind of, you know, go in to your network this year and that's kind of more of a 23 and forward, you know, optimization upside potential piece, you know, anything you have there.

Yeah, no, exactly. I mean, we do expect to start to see benefits from Bakery of the Future this year, and as you saw in the prepared remarks, we'll have it rolled out to half of the bakeries this year on the back of three or four pilots that we've done over the last several months. So we do expect the cadence of savings to begin this year, but we also expect, as you indicate, that that will ramp up in 23 and 24.

All right, cool. Thank you. Pass it on.

Thanks, Rob.

Thank you. Up next, we have Mitch Pinheiro of Sturdivant and Company. Your line is open.

Hey, good morning. Hey, just to follow up there on Bakery of the Future. So, number one, you know, how disruptive is it to change over a bakery, you know, into a from current to the bakery of the future mode? What are we talking? What's happening? Is it just you're moving some servers around and have more computer screens out there, or are you shutting down lines and things like that? Can you talk about that a little bit?

Yeah, sure. So from an operational standpoint, it's not disruptive. So we're not having to shut things down. It's mostly... This is mostly data-driven type stuff at this point. I mean, obviously, we're doing some automation work, robotics, and that type of thing, which is a little bit of a different story. As you know, we did that in Navy Yard. But the pure initial thrust of Baker to the Future is mostly around data, better data, more real-time data, driving out inefficiencies, lowering scrap costs, et cetera. So from an operational standpoint, Mitch, it's not disruptive hardly at all. The way that it is somewhat disruptive is – it does require us to change the mindset of the bakeries. And that does take a little bit of time. These folks have operated a certain way for a very long time, and you bring in all this fancy digital equipment and try to sell them on the prospects for improvement that it can provide. And that takes a little bit of time to educate them on how it can benefit them, make their daily lives easier. and improve the performance of the bakery. So it's really, it's as much of a change management exercise as it is anything else. But so far, we've been very pleased with the receptivity at the bakeries.

And then a lot of that is, so how does that dovetail with the new ERP program? I mean, I haven't been shopping for an ERP program personally, but I was sort of stunned to see, you know, $275 million that cost for over five years. Where is that being spent? Is that just all software costs with a little bit of hardware? I mean, that's a big number, or maybe is it not a big number?

Yeah, I mean, you know, when you look at these, As we said in the release, about 40-50% of the cost will be capitalized and the rest will be the cost of primarily implementing and rolling out the project itself. But when you look at the ERP itself, a lot of that is technology driven and will be a it'll work around bankruptcy in the future. But to your point, you know, it's not an insignificant cash flow item, and a large part of the ERP costs from a capital standpoint will come this year. So you'll begin to see that tell also over the next four years or so.

Okay, and then, you know... You know, when you go back and just look at some of the balance sheet numbers, like if you look at your fixed asset turns and things like that, it kind of stuck. And I was sort of expecting as we sort of roll through Bakery of the Future and, you know, as you like sort of adjust your capacity and things like that, are we going to see – I mean, are we going to see better fixed asset turns going forward? I mean, I realize that baking is a regional business when it comes to manufacturing. You need to be near your markets. But are we going to see some leverage here where you can go several years without adding capacity because you're, you know, finding it through your efficiencies or – you know, or is what your fixed asset turns, is it going to be sort of set for a while? We're really not going to see much improvement there. Can you talk a little bit about that, please?

Well, a couple of things there, Mitch. One, you know, obviously our aim is to significantly improve the efficiency of the bakery. So that, you know, that in and of itself will help us create some capacity. But also remember, you know, we are doing some work, you know, as we shift more of the mix to branded retail, to convert some of that lower margin business into our branded business. And you've seen examples of that in Tuscaloosa and Lunchburg with the organic conversions, and we'll continue to do that. But those customer strategies also open up opportunities for us to further optimize the network. You point out that in a fresh business, we do need to be relatively close to the market, but we don't have to be as close. that we're already utilizing, you know, that old 250-mile radius is not as relevant as it once was. So that opens up additional opportunities for us as well.

Okay. Moving on, as far as food service, what type of initiatives are you taking to improve profitability there? Can you give us some examples?

Yeah, sure. I mean, look, price is the most obvious one. And we've said many times that we do have some accounts that are underperforming, so we continue to work on those. Some of those are under contract, so they do take some time. But price is certainly one lever. Our own efficiencies are another. This is not all about the customer. It's incumbent upon us to be as efficient as possible. So those are two things. But also, you know, method of delivery, too, because, you know, some of these accounts are still BSD, which is a pretty expensive route to market, as you know. And, you know, converting them to a more optimized distribution model can help as well. So those are just a few of the levers we're pulling.

Okay. And then a final question on M&A. You know, your balance sheet is in terrific shape. You have some great low-cost fixed debt accounts. You know, now you have ample room on your revolvers. You'll still generate plenty, ample free cash flow next year based on my estimates. So I know that you're going to stay disciplined. You're going to find the right thing. But, I mean, how close are we? You know, should we expect to see some M&A this coming year? I know you can't predict timing, but are we – You know, I mean, is it still like nothing's really on the radar right now, or is there things that are working that we shouldn't be surprised to see something in 2022?

Yeah, Mitch, I mean, we've been saying for some time now that, you know, our appetite for M&A is certainly high. It's been a while since we've done one. We have a good pipeline of opportunities that we continue to look at. Just for one reason or another, we haven't pulled the trigger on one because of fit or price or a combination of the two. But we continue to be active in the space, and I can't predict what's going to happen this year. I wouldn't want to sort of prognosticate there, but just know that we continue to be active in that market.

Okay. All right. Thanks for the time. Thanks, Mitch.

Thank you. And again, to ask a question, please press star 1 on your telephone. To withdraw your question, please press the pound key. Our next question comes from Ryan Bell of Consumer and Research. Your line is open.

Morning. I just had a quick question about the ERP upgrade and sort of the efficiencies that would be provided by it. Is there sort of any savings number that you could talk to? We saw something on the cost side, just kind of a understand exactly what you get out of that program.

Yeah, Ron, I think a couple of things on the ERP upgrade. One, SAP is our enterprise-wide ERP system. The reality is, let's say we're Then we're looking at things that will enable productivity needs or hopefully drive long-term efficiencies across the bakeries. So there will be efficiency gains that come out of this initiative, but we're not disclosing those at this point.

Okay, thanks. And then just a broader question about the evolution of your portfolio as we're seeing a bit more normalization of the environment. Obviously the branded part of your business has been doing really well. And just trying to understand how you think about the shift in the migration towards branded, how much of that can continue. And then in terms of the private label trends, why do you think that they're actually so soft despite some of the pricing that's coming through from the industry standpoint?

Sure, yeah. This is Riles. So on the private label side, I mean, we're really seeing the continuation of a trend that's been going on for over five years now. And, you know, it certainly seemed to accelerate during the pandemic. But, you know, even as we kind of, you know, get towards the end of that, we're seeing, you know, we're seeing similar trends. I mean, it was down rather significantly again in the fourth quarter. You know, we're seeing it down in units. It's up a little bit in dollars so far this year, but in terms of units, it's down even as we start this year. And, you know, what we would point to through, you know, our research is, you know, you're seeing a premiumization trend in the category where people are really gravitating towards more differentiated items. And, obviously, we've benefited significantly from that with the branded portfolio that we have today, particularly when you think about Dave's Gilded Bread and Canyon and then on the Nature's Own side, particularly the Perfectly Crafted saw. for Nature's Own have done extremely well. Canyon and Dave's were both up double digits in the fourth quarter. We're seeing that trend continue even after those are already premium items. And after the price increase in January, we're seeing that trend continue. So it really demonstrates the consumer's preference for a premium quality differentiated item. And typically with private label in our category, you don't see a lot of that. And so that's the primary driver. And then as we think about the prospects for our brands going forward, with the innovation we're bringing to market, we mentioned the DKB snack bars that we're really excited about, and early returns on those have been fantastic. It really shows you that these strong brands can play across categories, which obviously gives us opportunity outside of our core space, if you will.

When we started this project, the discussion there was, and Rob has said it many times as well, part of this initiative really is going to be an enabler to drive productivity that helps us hit the long-term targets we have out there. So we truly expect in those target ranges to see the benefit from the digital and ERP initiatives, and that hopefully will drive us somewhere to the upper end of our range. But that's really how we're looking at it more internally.

Thanks. And then just one last one for me. In terms of what you're seeing from a pricing standpoint, I know you're talking about the premiumization trend across the category. Is there a sense as to how much of the pricing is actually being driven by mixed shift and stronger demand for products like Canyon and St. Dave's versus pricing on an individual product basis?

I mean, period one. We're seeing it really across the whole branded portfolio. Obviously, your premium products are going to drive more penny increases, but so far, we've taken pricing across, I would say, the whole, not specifically one brand.

Thanks. That's it for me. Thank you.

Thank you. And again, to ask a question, please press star 1 on your telephone. We have a follow-up from Rob Dickerson of Jefferies. Your line is open.

Great. Just a clarification question, Steve. On cash flow in Q4, it was a little light. I'm assuming there were probably some working cap headwinds on the inventory side, so maybe just explain if that's right. And then the only other question I had was just the purchase of the lease portfolio. I haven't really seen that line item pop up, and I'm not sure if that's part of the Baker of the Future optimization plans. Maybe just those two quick questions.

Yeah, I mean, when you look at kind of the fourth quarter on the lease portfolio, there was an opportunity that came to ask kind of mid-quarter with regard to that. It was a collection of several warehouses, and it fits in with our warehouse optimization strategy. So it did give us the ability to take out some leases, and now we have some flexibility to look at how we're going to utilize these warehouses or potentially combine some warehouses. So that does fit with that long-term strategy. And then the remainder of the elevated CapEx You know, in Q4, it was primarily driven around, you know, some of the project work, if you will, transformation. And you alluded to the kind of working capital.

Got it. All right, cool. Thank you. Thank you.

Thank you. And I'm seeing no further questions in the queue. I'll turn it back over to the speakers for closing comments.

Well, thank you for your interest in Flowers Foods. Appreciate your time today. Hope everybody has a good weekend. Thank you.

This concludes today's conference call. Thank you all for participating. You may now disconnect. Have a pleasant day and enjoy your weekend.