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Flowers Foods Inc (FLO) Q3 2019 Earnings Call Transcript

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Flowers Foods Inc (NYSE: FLO)
Q3 2019 Earnings Call
Nov 7, 2019, 8:30 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Welcome to the Flowers Foods, Third Quarter 2019 Results Conference Call, and Webcast. My name is Paulette, and I will be your operator for today's call. [Operator Instructions].

I will now turn the call over to J.T. Rieck, Treasurer and Vice President of Investor Relations. You may begin.

J.T. Rieck -- Vice President of Investor Relations and Treasurer

Thank you, Paulette, and good morning everyone. Our third quarter results were released yesterday evening. The earnings release and our quarterly slide presentation is posted in the Investors section of the Flowers Foods website. Our 10-Q was filed with the SEC yesterday evening as well. Before we begin please be aware that our discussion today may include forward-looking statements about our company's performance. Although we believe those statements to be reasonable they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters, we will discuss during the call important factors relating to Flowers Foods' business are fully detailed in our SEC filings.

With that, I'll make some introductions. Participating on the call today we have Ryals McMullian, Flowers Foods' President and Chief Executive Officer; and Steve Kinsey, our Vice -- our Executive Vice President and Chief Financial Officer.

Ryals, I'll turn the call over to you.

A. Ryals McMullian -- President and Chief Executive Officer

Thanks, J.T. Good morning and welcome to our third quarter call. We are very happy today to report record sales ahead of our forecast and reiterate our outlook for fiscal 2019 adjusted EPS. Regarding our four strategic pillars: focusing on our brands prioritizing margin pursuing smart M&A and developing our team we are pleased to see good momentum in several of them. We continue to make nice progress growing our portfolio of top brands. The DKB and Canyon acquisitions have been resounding successes. And although it's harder to see from a quantitative standpoint we are doing some great things for the development of our team. But as we said in yesterday's release we are still facing some margin headwinds.

After five months as CEO, I've had the opportunity to assess where we are and what we need to do to improve our profitability while maintaining the great top line momentum we have enjoyed this year. And I'm looking forward to sharing that with you on the call today. However, before I do that like we did last quarter I want to call on Steve Kinsey first to review the financial results and give our outlook for the remainder of the year to set the context for what we will talk about in a few minutes. Then, of course, we will take your questions.


R. Steve Kinsey -- Chief Financial Officer and Chief Administrative Officer

Thank you, Ryals, and good morning everyone. In the third quarter, we continued to experience solid performance on the top line driven primarily by sales in the retail channel. Consolidated sales increased $43.1 million or 4.7% year-over-year. Canyon Bakehouse acquired in late 2018 contributed 2.2%. In the base business improved price mix drove 2.1% of the sales increase while higher volumes benefited the top line by 40 basis points. Price realization has improved across most of our channels and product classes which has helped to partially offset the commodity labor and transportation cost increases we have experienced in recent quarters. Overall volume performance in our key brands and store brands was strong. However, we did see lower volumes of foodservice and store-branded cake and breakfast items. Looking at sales by channel. Branded retail sales increased $36.7 million or 6.7%. Canyon Bakehouse-branded products accounted for slightly half -- less than half of these incremental sales dollars. The balance was largely driven by continued growth from Dave's Killer Bread and Nature's Own and Sun-Maid breakfast breads which were introduced in the third quarter of last year.

Branded retail cake was flat as compared to the prior year. Store-branded retail sales increased $12.1 million or 8.7%. Slightly less than half of the sales increase is attributed to the acquired Canyon Bakehouse store brand business. The balance of the growth was split between improved pricing mix and volume growth in store-brand bread buns and rolls due to increased distribution with existing customers offset by lower volumes at our store-branded breakfast business. Foodservice and other nonretail sales decreased by $5.7 million or 2.4%. Lower volumes drove most of the decline due in part to lost business from the inferior use disruption in 2018 and volume losses in the vending channel of our non-retail cake business. As we lap these prior year events we expect our foodservice and nonretail business to stabilize. In the quarter gross margin decreased 10 basis points to 47.3% of sales. Improved price realization did somewhat help to offset input cost inflation to some extent. However, the benefit of these pricing actions was offset by higher workforce costs and lower manufacturing efficiencies. Third quarter gross margins were also temporarily impacted by start-up costs related to the introduction of a new product line at one of our bakeries.

Excluding the items affecting comparability detailed in the press release adjusted SD&A expenses increased 60 basis points as a percent of sales primarily due to the timing of employee incentives and increased marketing costs. These items were partially offset by lower distribution -- lower distributor distribution fees which decreased 30 basis points as a percentage of sales and stabilizing logistics cost as a percentage of sales. GAAP diluted EPS for the quarter was $0.20 per share. Excluding the items affecting comparability detailed in the release adjusted diluted EPS in the quarter was $0.22 per share down $0.01 compared to the prior year. Higher sales were largely offset by elevated labor costs higher marketing expenses and reduced manufacturing efficiencies. Canyon Bakehouse was accretive to both EBITDA and EPS in the quarter. Shifting to leveraging cash flow just a few comments. Looking year-to-date we have generated operating cash flows of $278.1 million and made capital expenditures of $70.6 million. Accordingly, cash flows year-to-date have been solid and we paid $119.8 million in dividends to shareholders and reduced our total indebtedness by $102.5 million. At quarter end our net debt-to-trailing 12-month adjusted EBITDA stood at approximately 2.1x.

Now turning to guidance. For the remainder of fiscal 2019, we expect good top line momentum so we are increasing our outlook for full year sales growth to be in the range of 4% to 4.5%. This includes sales from the acquisition of Canyon Bakehouse which now is anticipated to be in the range of $75 million to $80 million accounting for approximately 2% of the total 2019 sales growth. We expect base business growth to be driven by improvements in price mix partially offset by a conservative view of volumes due to broader category softness. We continue to expect adjusted EPS in the range of $0.94 to $0.99 per share. The pricing actions we have taken now help to mitigate input cost inflation but we expect the margins will continue to be pressured as we work through manufacturing inefficiencies and higher workforce costs because of the tight labor market. We are pleased that Canyon Bakehouse is performing at the upper end of our plan and we now see it being slightly accretive to full year EPS.

Now I'll turn the call back to Ryals.

A. Ryals McMullian -- President and Chief Executive Officer

Thank you, Steve, so look although there were some issues that affected the quarter the underlying fundamentals of the business are strong. We have got a solid foundation to build upon. And while there are certainly areas for improvement I believe the trajectory of the business is quite positive. Our branded retail business is thriving and we believe this is largely attributable to the org changes put in place a couple of years ago and the resulting focus and higher marketing support for our high-potential national brands: Nature's Own Dave's Killer Bread Wonder all are significantly driving our top line and all three gained unit and dollar share in the quarter as they have each quarter this year. Also in the third quarter, DKB became the #2 specialty loaf in retail dollars and Canyon Bakehouse became the #1 gluten-free bread brand in the country and it continues to grow in distribution and velocity. Furthermore, our focus on omnichannel is starting to pay off. In fact, syndicated data shows us that e-commerce sales of fresh-packaged bread buns and rolls have almost doubled in the last year.

And, our branded sales have increased by 55%. That's still a relatively small base but establishing a presence for our brands on the digital shelf is critical for growth in the future as more households buy groceries online and home delivery expands. Having said that we recognize there's room for improvement and we still have work to do to improve our margin performance. So over the past several months, I've taken the time to evaluate our current situation and challenge our senior leadership team. Working collaboratively we have honed our focus around the issues we face. We have better framed the questions we need to be asking ourselves and focused on the development of a solid plan of action all within the context of our four strategic pillars. So we have identified the three primary areas that we believe will drive the most meaningful margin improvement. One is portfolio and supply chain optimization. Look we need to identify the optimal mix of products for Flowers so we can drive out complexity and determine the most efficient bakery and logistics footprint. Now the other two areas I'll talk about in a minute. Certainly, have independent scopes of opportunity but they too will be informed by the halo of this portfolio and supply chain initiative. Secondly, it's no secret we have been challenged in the cake business.

But, I believe that with the right level of focus on our cake brands plus investments in automation we can turn this business and bring it to more attractive levels of margin contribution. And third, stabilizing and growing our foodservice business. We are one of the largest suppliers of foodservice bakery products in the U.S. and we need to better leverage that scale rebuilds our lost business and focus on our highest margin opportunities. So with regard to portfolio and supply chain optimization. We have told you for a while now that the first stage of Centennial focus primarily on indirect costs and org structure and that we will be turning our attention to the supply chain in the second stage. Well, we are now at that point. And so we are asking ourselves two fundamental strategic questions: one what's the optimal portfolio for Flowers that can promote margin accretive growth?; and two what's the correct network and resources required to support and grow that portfolio going forward? The answer to these questions we are undertaking a complete portfolio profitability review along with the development of tools and capabilities that will allow us to make more informed strategic choices around things like assortment pricing distribution innovation.

It will also help us more efficiently weed out unprofitable products or unprofitable accounts that contribute nothing but added cost and complexity. And it will generate opportunities for supply chain and overhead optimization. So the true crux of this effort is to drive out valueless complexity and improve our operational efficiencies. Now we have certainly taken advantage of the immediate opportunities to optimize our network. We have added organic capacity in the Northeast this year we announced the closing of our Opelika Alabama bakery at the end of this year and we installed a new high-speed bun line in Suwanee Georgia. We also have plans in place to convert another existing Flowers bakery to organic production to support the growth of DKB and that will happen next year. But I believe that a holistic approach that's centered around the optimization of the portfolio will generate more meaningful improvements over time. Before we formally launched this initiative we did complete an internal review that began when I was COO. I wanted to be sure that we challenge and hone the questions we are trying to answer. So that when work began in earnest we had a very tight focused scope of activities with clearly understood desired outcomes.

The initial phase of this work has already begun. It will take several weeks to complete. It's being directed by a dedicated internal team and we have support from outside resources. And it's our intention to have an update for you on where we are by our earnings call next February. With regard to the second area of focus reinvigorating and investing in our cake business. Look it's become clear to me that we have under-invested in our cake brands and operations for several years now. And the recent production difficulties we experienced with that new product launch only serve to shine a brighter light on it. We believe in the potential of the iconic Tastykake brand and we will be seeking to make smart investments to drive the brand forward. That means a renewed focus on consistent quality service distribution and innovation. It also means investing in robotics and other automation tools to drive efficiencies and improve our quality. The work on that initiative is already under way. Foodservice is our third area of focus. As you know our foodservice business was challenged last year by the yeast disruption. We are now cycling that but more importantly, we need to get our foodservice business growing again.

It's an important and scalable part of our business and I think that working to grow it smartly by winning a good margin business and seeking out attractive M&A candidates that offer margin accretive premium or artisan product lines will be beneficial. So within our four strategic pillars, we will focus on these three areas with intensity and I believe that over time execution against all three will improve our bottom line performance. So moving on M&A. M&A remains a key strategic priority where we have had some recent success. As we mentioned earlier since we closed the deal last September Canyon has grown from #3 all the way to #1. On the top line, it's performing at the upper end of our expectations and it's beating our bottom line targets. But as the Canyon integration winds down we are continuing to proactively seek strategic opportunities in areas of the store outside the traditional bread aisle as well as different product segments where we believe we have the right to win. As you know we play in a large category so M&A is expected to be a key driver to grow our business and pivot to higher-margin and faster-growing categories within baked foods.

And finally, I firmly believe our most important strategic priority is developing our team members and making sure that our organization possesses the capabilities and tools to successfully execute on all the other priorities we have talked about today. So at all levels of the organization we are increasing communication we are increasing engagement we are aligning work schedules to better fit today's modern lifestyles and we are clarifying career paths to attract the best candidates and improve retention. Also, we are increasing accountability and better aligning incentives to job responsibilities. Today almost 30% of our employees have incentives that are directly tied to their role. two years ago that number was 0. So I firmly believe that as we continue to link incentives with responsibilities at the functional level execution against our priorities will improve.

So in summary, despite some continuing margin headwinds in a few discrete areas the fundamentals of the business are strong the branded business continues to enjoy good growth our recent M&A successes continue to bring meaningful returns our cash flow and our balance sheet are strong and we have got a talented loyal and dedicated team that executes with excellence. It will take some patience and some time for us to realize the full benefits of our initiatives. But if we can deliver against the three areas of focus I summarized for you today we believe that we can not only continue to drive the top line but also deliver the improved margin performance of which we are capable and that our shareholders expect.

So, now we will turn to your questions.

Questions and Answers:


Thank you. [Operator Instructions] And we have a question from Mitch Pinheiro from Sturdivant & Co. Please go ahead, Mitch.

Mitch Pinheiro -- Sturdivant & Co -- Analyst

Good morning.

A. Ryals McMullian -- President and Chief Executive Officer

Hi Mitch.

Mitch Pinheiro -- Sturdivant & Co -- Analyst

So the first question is regarding Phase two here of Project Centennial and the supply chain optimization, I mean -- I know you said something but I missed it in your remarks. But how long is this review going to take? I would have thunk that Phase two would have been planned out as Phase one is going along. But now that it seems like it's a discrete stop and then start and then you have this Phase two analysis and then Phase two implementation like what's the timeline on that?

A. Ryals McMullian -- President and Chief Executive Officer

Yes. So Mitch I mean it's -- the whole thing is kind of the next step in the evolution under Centennial right? I mean, we had a we had a lot of org changes that came about in the first phase that we want to make sure we got bedded down and all in place. And all that frankly is settled out now. But I think more importantly Mitch, we have been thinking about this for a long time. I mean you know this industry pretty well and this is something you got to be pretty careful and deliberate about. And so we took quite a bit of time to do our internal reviews, and frankly learn quite a bit. And I mentioned in my prepared remarks that one of the reasons we did that is we wanted to come out on the other side of that internal review with a very very detailed and tight scope of work. Obviously, for economies, we went through a lot of spend with Centennial that won't be repeated here. This is much -- a much smaller scale. But we wanted both our internal and our outside resources to be fully prepared going in on the front end so we could keep that scope really tight clearly understand what outcomes we were after and then perform the formal work.

Mitch Pinheiro -- Sturdivant & Co -- Analyst

And when you look at this is there -- are you looking at your portfolio profitability optimization? I mean, is there any -- are we going to see sales being cold in a material way? Or I mean would it be a drag on revenue growth in a material way I guess is the question?

A. Ryals McMullian -- President and Chief Executive Officer

Yes. I mean look I mean, there's an element of SKU rationalization involved here. Obviously, I can't quantify that for you today. That will come later on but it's much more than that. I mean this is a much more holistic approach that is rooted in portfolio optimization but it's also about the network right and making sure that we are operating as efficiently as possible. I mean we will have more details on it as we go through the process and not ready to answer that today. But there will be some element of SKU rationalization involved. I mean that's probably pretty obvious.

Mitch Pinheiro -- Sturdivant & Co -- Analyst

Okay. And then when it comes to the tight labor as it affects efficiency is that the inability to fill second shifts? Or can you talk about that a little bit?

A. Ryals McMullian -- President and Chief Executive Officer

Yes, Mitch, it's really turnover. The turnover has been the biggest problem. And to address that we are doing some short-term things. And then obviously the portfolio and supply chain network stuff is a little longer term. But we are trying to do some creative things with scheduling. As a fresh perishable DSD business, we basically run every day and so we don't have the luxury of building inventories and sort of having more predictable scheduling. So we are doing some things with shifts to try to give people more certainty as to their schedule more instances of consecutive days off which is historically a rarity in our industry and just overall trying to make it a more attractive place to work. And furthermore, we are moving back away in some of our plants from outsourced labor back to permit labor to create that more of that one team atmosphere. We have done that in a couple of bakeries so far. And I can't say that we have seen significant financial returns from that yet but we have seen the turnover start to fall. Once that happens and takes hold one would expect once those folks are trained up for those manufacturing efficiencies to start coming back up to historical levels.

Mitch Pinheiro -- Sturdivant & Co -- Analyst

Okay, I will. Thank you. I'll get back in the queue.

A. Ryals McMullian -- President and Chief Executive Officer

Thank you Mitch.


We have no further questions, at this time. That concludes the Q&A session. And I will now, turn the call over to Ryals McMullian for closing comments.

A. Ryals McMullian -- President and Chief Executive Officer

Well, we appreciate you joining our call today. Thanks for your interest in Flowers and we look forward to speaking again in February. Thank you.


[Operator Closing Remarks].

Duration: 22 minutes

Call participants:

J.T. Rieck -- Vice President of Investor Relations and Treasurer

A. Ryals McMullian -- President and Chief Executive Officer

R. Steve Kinsey -- Chief Financial Officer and Chief Administrative Officer

Mitch Pinheiro -- Sturdivant & Co -- Analyst

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