Flowers Foods, Inc.

Good day and thank you for standing by. Welcome to the Flowers Food fourth quarter and fiscal year 2022 results conference 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. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, J.T. Rick, Executive Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Tanya, 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.

Thanks, JC. Good morning, everybody. Thanks for joining the fourth quarter call. I'm really proud of our accomplishments in 2022 and would once again like to thank our Flowers team for their hard work in making that performance possible. Despite the challenging macroeconomic environment, we generated record sales, we advanced our innovation pipeline, and we made important progress with our digital and supply chain initiatives. And we expect to build on that progress this year in 2023. We'll be making additional investments in digital and supply chain, as well as marketing support for the DKB bar launch. Although these investments alongside continued inflationary pressures will impact our near-term results, I'm confident by enhancing our already strong foundation we're positioning the company for future long-term success. So with that, Tonya, we're ready to take questions.

Certainly. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

Please wait while we compile the Q&A roster. One moment. Our first question will come from Bill Chappelle of Truist.

Your line is open.

Thanks. Good morning.

Good morning, Bill.

Hey, Ralph, give us a little more color on this kind of stepped-up marketing behind the snack bars. I guess it had been growing. It had been in test market. It had been doing well, but we didn't really have a kind of quantification of how big it is or how big it's expected to be this year. And maybe you could talk about what and when is being invested in Behind the brand, you know, what kind of impact that's having on gross margin or on earnings specifically versus just kind of overall brand spin or marketing step up? Thanks.

Sure. So, Bill, as you know, we're beginning the nationwide rollout as we speak. So it'll ramp up as production builds up and as we gain shelf space in retailers throughout the year. So it'll be a build throughout the year. And most of the support behind that is going to be marketing support, digital spin, display execution, all those kinds of things that you really need to activate a new product. DKB is a known quantity, but obviously this is a new space for DKB. And so we're being very intentional about the investments we put behind the introduction of the new snack line. So mostly marketing support. And again, it'll be a build throughout the year. As far as magnitude goes, we're not going to disclose that separately. But as we gain traction during the year, we can start to give you guys additional color on how the products are performing overall in the marketplace.

Got it. But I guess looking at the initial guidance, which is below kind of where we were, and granted you hadn't given guidance before, I mean, Is this kind of a $0.05 headwind to earnings? Is it a $0.10 headwind to earnings? Just trying to understand how much of that versus other market dynamics going into the guidance.

You mean the marketing support itself for the bars? What kind of headwind is it?

Correct.

I mean, maybe two or three cents probably.

Okay. Now that helps. Yeah. And then just second – Looking at the private label trends you talked about in your prepared remarks, is there an expectation now that pricing is normalized for private label at the one mass customer that it's stable as we move through this year, that it actually improves in terms of branded share improves? What's your outlook for share as we move over these next couple quarters?

Yeah, so the pricing dynamics have started. The retail pricing dynamics, I should say, for private label and mass have started to come up some, which is a good development. I think it's too early to call to play as to what the overall private label performance will be in 23. Towards the end of last year, as we saw private label kind of build the second half of the year, gaining share, it did sort of plateau at the end of the year. And, you know, sort of through our first period that we just completed this year, you know, that same dynamic is at play. So it's kind of a to-be-determined, and, of course, that's kind of factored into our guidance range. That's one of our, you know, that's one of our watchouts for the year is how those, you know, how is the consumer overall and how does that translate into private label performance? The divergence between mass and grocery does continue, though. You know, in the first period, private label was up you know, pretty significantly in line with what it had been, you know, the last couple periods of last year, but it was actually down from a unit share standpoint in the grocery segment. So that's, you know, if that continued, that's obviously, you know, an encouraging trend in and of itself.

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

Thank you. One moment.

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

Great. Thanks so much. I have a bunch of questions, but I'm going to try to keep it short. Riles, maybe also Steve, just, you know, I'm curious, in terms of the top-line guidance, the essentially 8% to 9% year-over-year, is, you know, is a lot of that coming from, it sounds like, some incremental pricing and food service and private label, and I'm Kind of just asking because obviously there's already been some pricing taken right on the branded side, which I would think would decelerate through the year. And, you know, volumes overall for the business were still down a little bit. So just seemed a little high to me. But maybe there's also some tailwind coming from the bar rollout. So just any additional color on that would be awesome.

Yeah, so, yeah, definitely a little bit of tailwind expected from the bar launch, but, you know, more impactful. You know, remember, Rob, we've got, you know, roughly five months of wraparound pricing from last year, so that may be something you're missing there. Plus, you know, we have gone back with additional pricing on top of that this year. So, you know, a lot of that top-line guidance range is additional price, you know, as we continue to experience higher costs.

Okay, got it. And then in terms of the gross margin, you know, it sounds like, you know, Q1 is a tough comp. You do have some pricing. Sounds like maybe, you know, there could be some easing costs as you get through the year just in terms of the hedging strategy. You know, kind of how would you paraphrase the year in terms of the gross margin side? Is it like Probably flattish. Maybe it's down a little bit. Maybe it's a little second half, you know, better than first half. Again, any other color would be great.

I mean, when you look at the full year, Rob, I think you're going to see probably pretty much flattish. You know, as we said, we're expecting, you know, some significant inflation to continue through 2023. And even with the additional pricing that Rob just discussed, From an overall margin perspective, I would say pretty flattish and pretty even throughout the year with some pressure coming in Q1, obviously, because if you go back and look, Q1 was a very strong start in the last year.

Okay, perfect. That's good enough. And then lastly for me is just, you know, Riles and the prepared remarks, a lot of discussion, commentary. on the spending side, you know, kind of for future benefits and then also some commentary around kind of what those benefits could mean longer term. I think the line was, you know, meaningful margin expansion potential. Obviously, you're spending to make the business stronger and hopefully with that strength and some mixed benefits longer term, there would be margin expansion potential. You know, so I'm just thinking, I'm just curious, like, if we're thinking about timing that, you know, some of that spending will continue you know, through 23 and then assuming 24, then maybe it starts to decelerate 25, 26, but still some there, you know, if we just kind of hold, let's say commodities constant or everything else being equal, right, which is tough to do, but just conceptually, you know, how do you think of kind of, you know, that flow through on the benefit? Is it, you know, again, this is more broad based, is it, more like, yeah, we need to really, we're spending more, right, in 23, and then we'll still be spending in 24. But as we get through these benefits, then we would expect to see, right, that margin expansion maybe play out in year three or four or what have you. So that's all. Thanks.

Well, first of all, I would certainly hope that, you know, that this is not, you know, the new normal as far as commodities go. So, you know, hopefully there's some know release coming as we get through this year and into next year but no you good question rob and and i think you've largely got it um you know obviously you know investment has to come before benefit right and you know i think we've we've laid out that you know due to inflation and the consumer and other things it's going to be a pretty challenging year for us and others in the in the food space um but you know we remain steadfast about continuing to invest in this business for the future. And so we're not slowing down. We see no reason to slow down. So we will continue to roll out the bars. We'll put marketing support behind that. We're investing in supply chain this year. We've talked a lot about the efficiency improvements that we need in the bakeries. We think that these investments are going to unlock that as well. And then obviously you have the digital ERP spending. And I think that's where you'll see kind of a peak spending this year with that beginning to moderate. in the years to come. And then, of course, you have the expected benefits that we'll be rolling in as well. So, you know, investments going down and benefits coming up, all of which we think will contribute to substantial margin improvement.

Got it. All right. Thanks, guys.

One moment. And our next question will come from Ben Bienvenu of Stevens. Your line is open.

Hey, good morning, guys. Jim Soler on for Ben. Morning, Beth. I wanted to ask some questions around demand elasticity. I know in the prepared remarks you guys called out a significant portion of the volume decline was due to skew rat. Can you just give us an idea for maybe what the branded volume could have looked like, X, the cake skew rat? I assume in the other, the whole volume decline is probably all eliminated skews, but on the branded side, is that like half skew rat, half demand elasticity?

We don't have that to disclose for you today, that breakout. I mean, what I can tell you is you're right that the lion's share of the volume declines are in cake and food service, and a lot of that is strategic and intentional. So we pull back on a lot of underperforming SKUs in cake. We pull back on a lot of underperforming business in food service, and we'll continue to attempt to optimize that business, if you will. So when you think about volume declines, and certainly there has been some softness on the branded side. As we've seen this mixed shift to private label, I don't think that's a surprise to anybody. But as you think about the overall business, it's heavily weighted towards cake and food service. Okay.

And then on the pricing for 2023, is that kind of evenly spread out? across the portfolio, or is that more targeted on food service and private label? Because my thought is as the value gap at mass is narrowing, if you guys put pricing, does that kind of reopen that gap back up, or is it still going to kind of trend to a narrower gap?

Yeah, I think the gap should stay pretty stable throughout the year. I mean, overall, there's going to be more you know, sort of total dollar in private label and food service overall, but, you know, the pricing is across the entire business, but probably a little bit more heavily weighted towards private label and food service. But I would expect the gaps to, you know, assuming, you know, this is us talking, you know, depending on, you know, the retailers can always do something different, but I would expect the gaps to maintain where they are.

Okay. And then maybe one more question on that. From the consumer perspective, do you think once – if they have traded down, whether it's from a high premium to just a normal branded or from normal branded to private label, do you think that there needs to be promo in the channel to get them to make the switch back up the value chain? Or as the gaps narrow, do you think they'll just kind of naturally go back to buying the more premium skewers?

Yeah, I mean, certainly my hope is that it's the latter. That's just something we'll have to wait and see what happens. So far, the competitive environment has continued to be stable, haven't seen any meaningful uptick. And I would certainly hope that any consumers that might have left a nature zone or a DKB to trade down to something else will come back. But that's also, remember, the reason that we're continuing with our marketing spend. We're not We're not slashing that for the year because it's going to be a difficult year. We're continuing to invest in our brands. And, you know, when the time comes and some of this pressure, you know, is relieved on the consumer, I think that they, you know, they recognize the differentiated aspects of our top brands. And I think that alone, in addition to the marketing support, will drive them back to us.

Okay, great. One moment. And I'm going to remove Mitchell from the platform. One moment.

Our next question will come from Connor Radigan, Consumer Edge. Your line's open.

Hey, guys. Good morning. Thanks for the question.

Good morning.

Yeah, so it sounds like you guys have a really exciting innovation pipeline coming from Dave's Bars and Snack Bites to Nature's Own Breakfast Pastries. So clearly the snacking occasion is totally incremental to the existing portfolio. But I guess on the breakfast pastry, you know, in your research, do you guys see this as a substitute to your current breakfast products like bagels or English muffins? Or, you know, is this really bringing in a new customer or a new occasion?

Yeah, we actually think it will be incremental, Connor, which is a pretty exciting prospect. Now, remember, you know, those breakfast pastries are still just in test. But, you know, the thesis is, you know, bringing something additionally differentiated. And what's interesting about these breakfast pastries is that we would intend actually to market those in the bread aisle. So I see it as an incremental item to a bagel or an English muffin, something like that, that distinguishes those from the DKB bars, which of course are, you know, warehouse distributed and they're in the kind of the traditional bar aisle.

Okay, no, that's great. That's really interesting. And then also, too, just a little bit on the basis of the future initiative, you know, if possible, could you guys maybe share some of the data points you're collecting or maybe some of the insights you've gleaned thus far and, you know, maybe any cost savings initiatives those have led you to pursue?

Yeah, I mean, a big one for us is scrap or waste reduction. And so, you know, having greater data insights into how the bakeries are running allows us to be smarter about how we run the lines. and reduce that waste. Waste is a big cost for us, so it's not immaterial at all. The other thing it helps us do is it helps us with preventive maintenance, understanding when breakdowns may occur so that we can plan for downtime instead of having unplanned downtime, which is costly. And then there's the whole notion of microstops on the line. You have your normal downtime for cleaning or whatever, or if you have a mechanical problem, but it's the tiny stops the 10, 15, 20, 30-second, one-minute stops that build up day by day, week by week, month by month, throughout the year that become a big expense as well. So all this data that we're able to gather is going to help us alongside leadership capabilities and process improvements, things like that, help us gain those efficiencies in the bakeries that we've needed for some time now.

All right, thanks.

That was great. Appreciate it. I'll pass it on. Thanks, Connor.

One moment.

And our next question will come from Mitchell Pinero of CertiVent. Your line is open, Mitchell.

Hey, good morning. So of your sales guidance, is any Papapita included in that? Yes. Okay. Have you, I have, you know, so what, what should we assume is that small, but what percentage of the sales guidance comes from Papa Pita?

Yeah, we can't, we can't break that out specifically, Mitch. I mean, it's not, it's not tremendous. Remember they were a, they were a co-manufacturer for us. So the overall top, yeah, the overall top line sales impact is not that, not that huge.

Okay. But it is included in there, right? So whatever incremental you expect to get out of that would be included? It's in the sales guidance, yes. Okay. And then of the sales guidance, what's the breakdown of volume and mix, pricing and mix in the year?

It's primarily price mix, Mitch.

Yeah. Okay, and or maybe another, let me ask you this. What would be the SKU RAT this year? Is it the same 3%-ish of sales? Is that included in there?

We should see the effect of SKU RAT decline as we get throughout the year. Now, again, that will continue to do SKU RAT, But, you know, the volume losses that you've been seeing, you know, over the last year or so, that should start to moderate as we move through the year.

Okay. When I look in terms of, you know, you're going to try to take some pricing and food service and private label. But I'm looking at slide eight of your fourth quarter presentation. You have some of your store brands in the priority and some of your store brands tactical. What percentage of your store brands are in each of those categories and where are you going to be taking the price?

We're taking price across the portfolio, Mitch. And the price has already been taken.

Okay. Okay. And is that, I mean, and what percentage is your store brand, you know, the breakout between priority and tactical? Is it 50-50? Is it mostly priority? Can you describe that?

I'll have to get back to you on that. I'll have that in front of me.

Okay. And then another question, you know, just sort of on interest expense, you expected to go up this year, but Most of your debt's fixed, and when I look at your cash flow, just based on the preliminary guidance, you're going to have three cash flows, so I wouldn't anticipate debt to rise. Am I wrong?

I mean, you'll have the financing of the Papapita acquisition, so you will see it rise for a moment in time until we're able to delever and pay back down. you know, from an investment perspective, you know, we're still investing in ERP this year. So although last year was the highest cash flow year, you know, it's still pretty significant in 2023 as well.

Okay. And then I finally, so as you look at the, your guidance range, let's say your EBITDA guidance range, EPS, if you were down, if you're down at the bottom, What's that saying about what would cause that to be down at the very low end? Is there going to be more private label pressure, commodity cost spikes? What gets you to the low end?

Yeah, it's not really going to be on the commodity side just because of our hedging program. So we pretty much know what our costs are going to be for the year, Mitch. But I think you're spot on. It's mostly going to be the overall health of the consumer, you know, how does this private label, you know, uptick trend play out throughout the year? You know, what happens with the competitive environment to an earlier question? Does it start getting, you know, do we start seeing much higher promotions as perhaps, you know, we move into the back of the year and some of this inflation subsides, do people start trying to, you know, win consumers back with promotions? And then finally, it's, you know, it's our ability to execute on our savings programs. I mean, you saw in the prepared remarks, and we have additional savings of $20 to $30 million in the plan for this year. And, you know, it's up to us to execute on that. So, you know, those are the biggest swing factors that we can see during the year that could move you, you know, higher or lower on the guidance spectrum. And, you know, then I would also note that, you know, once again, in addition to those items pressuring EPS this year are the investments that we're making behind the bars, behind our supply chain capabilities. additional investment in digital, you know, that's pretty much a nine-set headwind on the digital ERP side alone this year, plus you have the additional DNA from the Papapita acquisition and the ERP Plus program that are pressuring EPS as opposed to EVBA.

That's helpful. Have you made any or included in your guidance would be continued growth margin improvement, I guess, in the cake business, or is that not in your – do you anticipate that in your guidance, I should ask?

Yeah. I mean, every year we're making improvements with the cake business. I mean, you know, last year, despite some of the syndicated data that you all see that doesn't pick up nearly all of our cake business, the profitability in our cake business improved substantially last year.

Okay. And that should continue? I mean, I thought earlier in the year it was still struggling a little bit. So is there incremental growth there?

Remember that a lot of times, Mitch, when we're talking about the CAPE business, some of the struggles that we focus on are the struggles at the Navy Yard specifically, and the Navy Yard is not all of the CAPE business, right? So significant improvements have been made at the Navy Yard, but alongside that, we've done really well with our SKU RAT program, getting rid of all the unprofitables. Well, not all of them, but a lot of the unprofitable SKUs. taking pricing to improve profitability, innovation, et cetera, has done a lot to improve the profitability overall of the cake business. Okay.

All right. That's all I have. Thank you.

Thank you, Mitch.

I would now like to turn the conference back to Riles McMullen for closing remarks.

Okay, thank you, Tanya, and thanks, everybody, for your interest in Flowers Foods, and we certainly look forward to speaking with you again next quarter. Everybody take care.

This concludes today's conference call. Thank you for participating. You may now disconnect.

The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 11. The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1. The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1.