Flowers Foods, Inc.

Good day and welcome to the Flowers Foods second quarter 2022 results call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. As a reminder, this call may be recorded. I would like to turn the call over to J.T. Rick, Senior Vice President of Finance and IR. You may begin.

Thank you, Michelle, 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 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. Riles, I'll turn it over to you. Okay. Thanks, JT.

Good morning, everybody. Thanks for joining the second quarter call. We continue to execute well in the quarter, driving second quarter sales to record levels. Our performance in this challenging consumer environment demonstrates the resiliency of the category and the strength of our leading brands. Due to the outstanding efforts of our team, we successfully mitigated much of the supply chain pressure we discussed last quarter. As a result, we raised the bottom end of our 2022 EPS guidance by 5 cents to $1.25. I'd like to thank our exceptional Flowers team for their hard work and dedication, which has made this strong performance possible. The fundamentals of our business are strong, and I've never been more optimistic about our prospects. No matter the environment, our team is focused on delivering results in line with or better than our long-term financial targets. So with that, Michelle, we're ready to start the Q&A, please.

As a reminder, to ask a question, please press star 1-1.

Our first question comes from Bill Chappelle with Truist.

Your line is open.

Thanks. Good morning.

Good morning.

Hey, Ralph, you had mentioned in prepared remarks a little bit about, I guess, one competitor being a little bit slower to raise prices, and I don't know if that was just a timing issue. Maybe discuss any changes in terms of competitive landscape of pricing, or is everybody, for the most part, kind of moving up with commodities and input costs and what have you, and then I think you also had thought that inflation would start to peak by October in terms of what you're looking at, so maybe a little more color there would be great. Thanks.

Sure, happy to do that. I'll let Steve handle the inflation question. But with regard to pricing, it wasn't so much that other competitors were late raising prices. It's just that, Bill, we went in a little bit earlier than normal. So I would say that most of the rest of the industry was relatively on time as far as typical times to raise prices in the industry. But we went in June a little bit earlier. And so what you ended up with were price gaps that were a little bit larger than historical gaps. And I think we commented that that impacted our unit share a little bit in the quarter. But since then... you know, most of the industry has followed and raised prices as we have. Steve, you want to touch on inflation?

Sure. Yeah, Bill. So, you know, we have said that Q3, we will see our highest overall cost from an inflationary standpoint. It will moderate somewhat in Q4, but again, it still will be elevated in Q4. But the peak of that happens in Q3, and then it starts to pull back slightly.

Got it. And then separately, you know, just on acquisition slash innovation, you Can you give us a little more color, and I'm sorry, the name of the company is escaping me, of the investment you made in the quarter? I guess I would have expected normally you to buy outright those type of businesses, so kind of partnering with a small business and what that brings to the portfolio, and then I'll leave it at that and let others ask questions on other innovation.

Sure. Thanks, Bill. Yeah, the name of the company is Base Culture. Base Culture. They're a gluten-free and grain-free baked food company. So it's all keto and paleo certified, you know, certified very much on trend. The reason that we took more of a venture approach to this is that base culture is much, much earlier in their growth cycle than even like a Dave's killer bread was back in 2015. And, you know, we've been looking for some time to start doing venture type minority type investments. to bolster our own internal agile innovation efforts. And this one just fit very nicely with our portfolio and where we're trying to go as far as healthier eating, on-trend attributes like keto and paleo, which we don't really have much of an offering in right now. So we're quite excited about it. Small investment and small company, but we're quite excited about the prospects.

And when should we start to see, I guess, wider distribution of their products? And then is there an option to... own the company outright down the road?

Yeah, I mean, there is, and we'll be helping them not only with their production, because obviously we have that skill set, and they don't. They're a very small organization, but also sales and distribution opportunities. So we're already working in that regard.

So I would see the products in the next couple quarters everywhere? Or is that too quick?

It'll probably take a little bit longer than that for it to be everywhere. Again, they're really small, but we'll grow them in a way that they can absorb with their production capacity, which eventually will need to be expanded.

Got it. I'll turn it over. Thanks so much.

Thank you, Bill.

Our next question comes from Robert Dickerson with Jefferies. Your line is open.

Great. Thanks so much. Maybe it's a question for you, Steve, first. I think you just said, I think costs may peak in Q2, still high Q3, Q4. The prepared remarks seem like you're essentially almost fully hedged for the year in ingredients, I'm assuming. So if we think about kind of that margin cadence, I guess inclusive of mix in the back half, you know, is there, there should be kind of this implied expectation for EBITDA to actually grow, I guess, in the second half, and then maybe just explain if that's what, you know, it sounds like it's a little bit more Q4 weighted. And I have a quick follow-up.

Yeah, I mean, just one quick correction there. We said Q3 would be our highest cost quarter. All right. Yeah, coming into Q3. It will pull back some in Q4, but for the most part, Q4 will be elevated as well, just not quite to the level as Q3. And you're right. In the back half, we have said a lot of our initiatives come into play. We have the pricing to mitigate a lot of the inflation, but we do have several cost savings initiatives as well as productivity initiatives that are in flight. And from a cadence perspective, we said those will come in Q3, Q4. So that will be a big driver of EBITDA in the back half.

And Rob, just to put a number on that, we're still in the range of that $25 to $35 million, all of which is back half.

Okay, great. Yeah, and I really just asked because I think there's a line in the prepared remarks that said as you got through the second quarter, you actually started to see EBITDA improve. So it sounds like maybe that was also a function of maybe some of the more of the pricing and some of the productivity coming through in the kind of latter part of the quarter. Is that fair?

Yeah, and remember, too, I don't know if this was clear from the prepared remarks, but there's still more pricing that will continue to come in, Steve, roughly through the third quarter. Right, yeah. Most of it's in, but there is still more rolling in, primarily in food service, so that will also help, too, Rob.

Okay, super. And then just quickly on DKB, Obviously, there sounds like there is a little bit of supply constraint in the quarter. Seems like that's essentially been fixed now. And then you also have the new West Coast facility. So kind of bigger picture, if we're thinking through kind of back half of this year, then really on the go forward from there, you view, I mean, well, let's say, you're not going to quantify what the opportunity is in the West Coast with EKB, but my assumption is that would still be kind of an ongoing driver of the business, maybe outside of what you see on the rest of the business. So any incremental color will be great.

Yeah, no question about it, Rob. I mean, we're still so confident in DKB and its growth prospects. We were hampered a bit by the packaging issues that we had in the second quarter for DKB, but also those capacities constraints, which are now resolved. Those capacity constraints You know, we don't promote DKB that much, but we were so constrained we weren't able to do much at all. And so that, you know, hurt the units a bit. Now that we have Henderson up and running, we can, you know, go back to what we have been doing historically driving the growth of DKB out west. You know, even still, though, I do want to point out, and I don't know if we mentioned this in the prepared remarks or not, but You know, even though DKB was slightly pressured in the quarter from a unit standpoint, the breakfast segment for DKB was outstanding in the quarter. And as you know, that's been a key area of focus for us since we're underpenetrated there. So that was one highlight for DKB in the quarter that I wanted to call out.

All right. Super. Thanks so much.

I'll pass it on.

Thank you, Rob. Appreciate it.

Our next question comes from Ben Bienvenue with Stevens. Your line is open.

Hey, guys. Jim Sparrow on for Ben. Good morning. I wanted to ask Riles in your prepared comments, you had mentioned you were seeing, you know, lower income consumers trade down to less expensive, which is kind of, you know, on par with the expectations. But then for higher income consumers, they had actually been increasing their purchases with the premium products. Can you maybe just drill down on that a little bit and see or talk about what's driving that? Because we would think that, you know, everyone just kind of shifts, parallel shifts down. So the fact that they're increasing is, I would say, counter-cyclical to what you would expect.

Yeah, there's a lot to talk about there, really. And I know there's going to be a lot of questions about elasticity, so this is as good a time as any to talk about it. There's quite a few sort of competing data points out there that we're looking at. On the one hand, we saw private label gain a little bit of unit share, 10 basis points of unit share. But if you look at the overall private label units, they were down almost 8 million units in the quarter. So a lot of that private label share growth was being driven in mass. And what we've seen in mass is retail prices being held down, which kind of creates a bit more of a gap than you might have historically seen. If you look at the grocery channel, sort of X mass, private label lost share again in the quarter. And in that channel, the price gaps were much more in line with historical averages than what we're seeing in mass. Turning to DKB specifically, DKB's unit declines were primarily in California and the mass channel. And they were, as you pointed out, they were concentrated more among lower income households. but DKB grew units and share in the Northeast and nationwide among higher income households, which you might expect. And product trips also increased nationwide among both middle and higher income households. But then a caveat to that is we are seeing even those higher income households seek a bit more value from the mass and club channels. So you can see there's you know, there's a little bit of yin and yang there when we're looking at the data, because I think it's still early days. But the takeaway is that, you know, given the environment, and everybody saw the news yesterday, you know, grocery prices up 13.1%, the highest since 1979. And yet, you know, we still perform very, very well in that environment. Nature zone units were up, canyon units were up. Yes, our volumes were down, but quite a bit of that is our own portfolio optimization and skew rationalization we're doing, and our volume declines were right in line with our expectations. So overall, when you look at the total picture, even though there's some sort of conflicting data points out there, we were very, very pleased with how our brands and the company performed in the quarter.

If I can follow up on that, do you think it's because the price point is still so accessible just in dollar terms that If everything's up, a 13% change on a $2 item is obviously a lot lower than a 13% change on a $20 item. Is it just that there's nowhere else for the consumer to go, and so it's easy to make a $3 indulgent purchase than a $30 one?

Yeah, certainly I think it's part of it. We've said many, many times, I mean, when you think about an inflationary environment, bread is still a very, very economical choice just given the number of servings. in a loaf, right? And furthermore, you know, we, even though prices have increased, we play across all the price points from super premium, Dave's Killer Bread and Canyon, you know, all the way down to private label. So, you know, simply put, there's something for everybody there. There's something for, you know, every household income, every household budget.

Okay, great. And then if you guys could give us, you mentioned real briefly in the prepared remarks, the AB bars test. Maybe you could just give us a little more commentary on consumer reception of that, maybe channels that it worked in better or worse, and just how we're thinking about the rollout of that.

Yes.

So it's still early days for that. We're still in test market, but we're working towards national distribution on the first three SKUs. as we said in the prepared remarks we're wildly excited about the results that we've seen so far it just it's just further testament to the dkb brand and what it stands for and the quality and the story behind it etc so we're very excited about it in in further news not in the prepared remarks we've recently launched three additional SKUs that are high protein which the original three were not to add to that that we're also putting in the test markets and and quite excited about as well so Not resting on our laurels, we continue to innovate with DKB, and one of the reasons we continue to be excited about its growth prospects going forward.

Okay, great. When should we expect to see the first handful of SKUs out in stores across the country? Yeah, early next year. Okay, perfect. Thanks, guys. I'll pass it on. Thank you.

Again, to ask a question, please press star 1-1. Our next question comes from Connor Radigan with Consumer Edge Research. Your line is open.

Good morning, guys. Thanks for the question. Good morning. Good morning. Thanks. I guess just on the mix shift more towards private label and the quarter, I was wondering if you could address the margin implications of that shift. Just, I guess, how much of the 240 basis points decline was attributable to that mixed shift? And I guess also sort of just following up on Ben's question, would it be a reasonable assumption that maybe in the next few quarters the portfolio remains slightly more oriented towards private label versus 2021?

So, private label definitely went up in the quarter, but remember, that's virtually all price. I've already mentioned that the units were down in the category 8 million units, and that's a good thing. As we've mentioned on prior calls, we've been working diligently to improve the margin profile of our lower margin business, which is, generally speaking, the private label and food service businesses, and we've taken significant price to mitigate these inflationary headwinds in both those businesses. Now, certainly there's still lower margin than branded retail, and the pressures we're feeling on gross margin from You know, ingredients, packaging, freight, eggs, you know, you name it. You know, it's certainly impacting us on the gross margin line. But, you know, Steve can comment further. We have done a good job, I think, leveraging SD&A, and that's come down as a process of sales.

Right. I mean, I would say overall the inflationary pressures probably drive more the margin pressure than the mixed shift because it's Even though it's happening, we've said it's still not meaningful at this point. We continue to monitor that. So a lot of the margin pressure really is coming from the inflation on input cost, transportation, labor, more than the mix itself.

One other thing I would add to that, Connor, that's exactly why it's more important than ever for us to maintain our marketing and brand support investments. Because as we said, we said it last quarter, in this kind of environment, you've got to expect some amount of trade-down particularly among lower-income households. But lower-income households, believe it or not, are 20% of Dave's Killer Bread units. Kind of surprising even to me when I first heard that. But continuing to support the brands, continuing to be out there from a marketing standpoint, keeping those brands front and center, we will get through this eventually. And when we do, we want those consumers, obviously, to come back to the brands they love.

Thanks. That was helpful. And I guess just a follow-up to that, too. Just a question about the Phoenix bakery closure. So in the prepared remarks, you guys commented that it's, you know, I guess it's an older, lower margin bakery that services more private label products. I guess just why the decision to close it now? I mean, was this like a long-running plan or, I mean, just I guess given the increased private label demand you saw in the quarter?

So, yeah, Phoenix is an older, much less efficient bakery. This is all part of our network optimization plans that we've been talking about for several years now. And alongside that, we did exit some lower margin private label and food service business out there. And we have plenty of capacity to take over what remains and ample capacity to fund future growth. So we can take care of all of our remaining business. But as we execute our portfolio strategy, it can have network optimization implications as well. And that's what you saw with Phoenix.

Okay, great. Thank you. I'll pass it on.

Thank you.

Our next question comes from Steve Powers with Deutsche Bank. Your line is open. Hey, guys. Good morning.

Morning. I wanted to go back to what you were seeing or what you have been seeing in terms of the different tactics in terms of private label pricing masks versus grocery. And how do you think that evolves? Do ultimately mass prices move higher because the cost picture demands it? Or, you know, does this risk creating some kind of competitive dynamic where grocery prices, you know, move lower to compete with mass and then we have sort of this downward pressure on the category? How are you thinking about that evolution?

Well, we certainly haven't seen that yet, and I can't speak to why certain retailers are doing what they're doing. All we can do is execute on our plans. Obviously, we hope that they'll come up and some of those gaps will close a bit, but it's certainly hard for me to predict what they're going to do. But, again, as we mentioned, so far we haven't seen this in grocery and, again, private label loss share in grocery.

Yeah, yeah. And as you say, you still have some pricing set to come in. Nothing that you're seeing has really altered your own strategy from a pricing standpoint or your own expectations in terms of price realization.

It has not.

Okay. Okay.

Very good.

Thank you. Thank you very much. Thanks, Dave.

Our next question comes from Mitchell DeNiro. Hello. Ten Hero with Sturdivant and Company. Your line is open.

Yeah, hey, good morning. Hey, I had a question. You talked about price increases ahead of competition, which seemed to trim a little bit of volume in the quarter. And, you know, is pricing, I mean, it seems to suggest that it's, you know, that Maybe, you know, this is certainly a commodity type product. If, you know, merely, you know, a price increase a couple weeks or a month ahead of the competition is going to affect buying that much. Why is it that, is it, you know, was it a very large price increase relative to the competition? Or, you know, why would it be that dramatic?

Yeah, so it's not in terms of magnitude of our price increases versus competitors' price increases. It was just that in this environment, when you start getting gaps that much larger, that can affect behavior somewhat. That's not the only thing that affected units in the quarter. Again, we talked about supply chain issues, et cetera. But it certainly was a factor. You know, we also copped a hurricane, which we haven't mentioned yet, and we typically performed very well. So there were other things other than that, but it certainly had, you know, at least some effect in the quarter. But that's, you know, that's all much more normalized at this point.

Okay. And how did food service do in the quarter?

From a top line standpoint, really, really well. So if you look at it from a pre-pandemic standpoint year to date, you know, in terms of sales dollars, the food service business has recovered, but the units are still below pre-pandemic.

And are units below across the board or in one particular segment like QSR or, you know, fast casuals?

I'd have to look. I want to say it was a little bit lower in quick serve.

QSR was the more challenged. Yeah.

Okay. And is there a reason for that? Is it just traffic in the QSR customers or is there anything going on underneath that?

No, I think it's just, Mitch, I think it's just a bit more normalization coming out of the pandemic. Remember, quick serve actually did pretty well. during the pandemic just because of less contact, but now that people are more comfortable going back to restaurants, I think that's why you're seeing that shift. But that's also good for us because our margins are higher in those other segments.

Right. And then you've had, I don't know, it seems like about six quarters of lower volume growth. When does that start? When are we going to see SKU rationalization slow down as an impact on your results? And if you could talk about that a little bit, it would be helpful.

Yeah. So I think, generally speaking, we've done the bulk of what we want to do for now. I mean, obviously, SKU RAT is kind of a continual process. But I think in large measure, we've cleaned out most of the underperforming items that we wanted to to simplify operations. simplify our sales execution for that matter, and get to the business of growing volumes. I think innovation remains key for that. And so obviously our goal over time is to not only grow dollars, but continue growing our units and our unit share as well. So we're focused on that.

So if we look at the third quarter, I mean, are we going to still see some year-over-year volume declines in the overall business?

Yeah, so, Mitch, embedded in the EPS guidance is the assumption around mainly elasticities. And as I've said, so far year to date, we're running right about where we thought we would be. So, I think it's reasonable to assume, you know, that trend to continue through the year.

Okay. And then, could you talk about some, specifically about some of the cost savings programs that you are, you're currently, you know, initiating and how they're going to flow through the second half?

Yeah, so that's that $25 to $35 million, and it's a mix of benefits from our digital investments that we've made, which we expect in the back half. We talked a little bit about bakery in the future. And then, so that's bakery improvement in the digital sense. There are also separate bakery improvement projects, initiatives that are underway, and also procurements. So those are sort of the three big areas that the savings will come from.

And as you look next year, does any of that carry through into 23?

Yes, it does. We have not quantified that yet, but yes, it does.

And then I guess finally, just when it comes to regional variations in your business, is there any, which were the best performing regions and Which were the worst-performing regions geographically?

So the Northeast continues to be a call-out for us. As you know, we put a lot of focus up there, and it continues to pay dividends for us. We did have a couple of regions that underperformed by our standards, but I would submit to you that was more operational performance-driven than it was top-line sales performance-driven.

Okay, that's all I have. Thank you for your time.

Great, thank you, Mitch. There are no further questions. I'd like to turn the call back over to Ralph McMullen for any closing remarks.

Okay, Michelle, thank you very much, everybody, for your interest in flowers. We look forward to speaking with you again next quarter. Everybody take care.

Thank you. This concludes the program. You may now disconnect. Everyone, have a great day.

To raise your hand during Q&A, you can dial star 1 1.