Good evening, and thank you for standing by. Welcome to the Flowers Foods First Quarter 2024 Results Conference Call. Please be advised that today's event is being recorded. I would now like to hand the conference over to your opening speaker today, J.T. Rieck, Executive Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Carmen, and good evening. 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 earlier 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 Ryals McMullian, Chairman and CEO; and Steve Kinsey, our CFO. Ryals, I'll turn it over to you.

Okay. Thanks, J.T. Good evening, everybody. Thanks for joining our first quarter call, and we also appreciate everybody's flexibility in accommodating the change in timing for our Q&A session today. Our solid first quarter results reflect the increasing effectiveness of our portfolio strategy, driven by investments in marketing and innovation, our brands gained share despite the challenging consumer environment. Significantly, we also grew branded retail volumes for the first time since 2020. Dave's Killer Bread led the way with its second consecutive quarter of 10% unit growth, but we saw encouraging signs across the brand portfolio. And we continue to expand our margins in our away-from-home and private label businesses. We are maintaining our financial outlook for the year, which incorporates continued volume improvement while acknowledging the ongoing economic uncertainty and its potential impact on consumer behavior and the promotional environment. As I mentioned in the prepared remarks, if there's one thing I'd like for you to take away from this call, it is that we're doing exactly what we said we would do. Although progress is not linear, we'll continue to execute our portfolio strategy with the expectation of achieving our long-term financial targets, and I'm extremely confident in our growth potential, and I look forward to continuing our progress throughout 2024. So with that, Carmen, we'll open it up for questions.

Our first question comes from Steve Powers from Deutsche Bank.

I was actually hoping we could start on just the operating expenses in the quarter and SG&A run rate spending. You called out a couple of things in the prepared remarks, higher labor costs, higher technology costs. You also separately called out stranded overheads. I was wondering if those two things are related, if those are separate? And really, what I'm focused on is just sort of how we think about the cadence of that SG&A and operating expense expenditures over the course of the year. Do we expect some relief on stranded overheads? Do you expect transition costs in California to replace that? Just some direction on the cadence of SG&A expenditures over the course of the year would be great.

Sure. Happy to. I'll start, and I'm sure Steve will want to chime in here too. But yes, it's a little bit of both. There's some labor expense in there. There's higher marketing expense in there, which we've talked about before, the rationale for that investment. And you've got the stranded overhead too, that we've talked about in the past. The good news is twofold: One, you may have noticed that we raised our savings range from $30 million to $40 million to $40 million to $50 million, and some of that will help us improve SG&A. As I noted in the prepared remarks, we do recognize our cost structure is a bit too high, and we're taking actions to pull some of that back and get more back in line. I mentioned the labor cost and marketing as well play a role in that. So I would expect over time for us to improve SG&A, particularly as a percentage of net sales and better leverage our cost structure going forward. Steve, do you want to add to that at all?

Yes. I mean, I think Ryals hit on that. Obviously, the first quarter is 16 weeks, we did see some elevated costs from that perspective. But we have good visibility to our cost takeout initiatives. And going forward, as a percent of sales, we do expect SG&A to pull back some and then kind of stabilize. So we do feel like we'll be able to get some of that under control as the year progresses.

Yes. I would like to add that regarding the stranded overhead, it ties into the volume story as well. We are bringing on new business at a quicker rate than we initially expected at the start of the year. This will help offset the stranded cost.

Okay. Very good. And then in terms of just use of cash, I noticed obviously, the capital expenditure outlook went up. Maybe a little bit more detail around what those supply chain investments are targeted at? And then you also sounded a little bit more front-footed with respect to an improved M&A environment. So maybe just some more color there as well.

Yes. I mean the capital investments really are just ongoing improvements, primarily at the bakeries, increasing automation, updating equipment. It's pretty normal course stuff, Steve, not out of the ordinary but just a little bit more spend than we originally thought beginning of the year. And then, yes, the M&A environment, I am a little bit more bullish on that now. Activity has really started to pick up that really started a couple of quarters ago and has continued. So the conversations that we're having out there with targets are increasing in frequency, which is a good sign. It's been a little slow in the last couple of years, and you're very familiar with our balance sheet so you know we're poised to do a transaction when we find the right one.

Very good. One last line, if I could. Just on the ERP pause in the bakeries, I thought that was on track to be lifted in the second half. Just I don't know if that's still the case or if that's been recalibrated?

Yes. No, we're still planning to go back to the bakery rollout starting sometime in the back half.

And it comes from the line of Bill Chappell with Truist Securities.

Can you provide a bit more information about the performance of private label versus branded products? I'm curious about whether there has been any significant weakness in the economy. It seems that private label has declined over the last few quarters, but I want to know if you're surprised by how well branded products are holding up, especially considering the strong 10% growth for Dave's Killer Bread. You mentioned that the growth is broader, so could you share your thoughts on how other brands are performing in comparison to private label and how the overall consumer environment is shaping up?

Sure. Obviously, Dave's has been a standout in terms of volume growth. While I understand your questions about the overall portfolio, I want to point out that we saw an interesting trend this quarter with low-income shoppers returning to Dave's. Previously, we noted that about 20% of Dave's shoppers fell into the low-income category, defined as having an annual income of $30,000 or less. Due to inflation, that percentage dipped to about 16%, but we are now nearly back to 20%. This suggests that consumers might be feeling more financially secure, or they may be seeking better options as they become disenchanted with cheaper products. This is a positive indication that lower-income households are starting to return. Additionally, there is strength in other areas of our portfolio. For instance, Wonder, which is priced lower, has been performing well across sandwiches, buns, and rolls. Nature’s Own Perfectly Crafted is also showing positive unit growth. However, we still face challenges with the basic Nature's Own products, like Honey Wheat and 100% Whole Wheat, which have struggled in the face of private label competition. We're beginning to see some recovery as consumers shift back from private label to brands like Wonder. If this progress continues, I anticipate that brands like Nature's Own will also see improvement.

Got it. No, that helps. And then a question we haven't really talked about in a long time is just kind of DSD network expansion. Where does that stand? Are you still adding routes, be it in California or elsewhere today? Is it more about velocity and more products through the existing routes? Are you actually shrinking? Are there areas where it doesn't make as much sense as you're trying to be more efficient? Any kind of thoughts on kind of the DSD network as it stands today would be helpful.

It's a bit of a mixed situation. California is unique because we're converting to company routes there. In areas with higher growth, we're adding routes as they become full, which boosts sales and improves service to the stores. In some places, we're adding routes, while in others on the fringes, we're not. As we expand into new geographic regions, we're also adding routes. It really varies based on location, growth potential, and how new the territory is. The main goal is to make our Direct Store Delivery network as efficient as possible. For instance, in areas with lower household penetration or market share, we might switch independent routes to company routes temporarily until sales pick up. In growing regions, we will divide routes and add new ones. Ultimately, it boils down to efficiency. That’s our focus.

And it comes from Jim Salera with Stephens.

I wanted to ask on the volume side. In the prepared remarks, Ryals, you mentioned the planned business strategy that's obviously contributed some headwinds on the volume side. And absent that, total company volume would have been positive. If possible, can you tell us what it would have been like the actual volume number would have been absent that? And beyond that, is the weakness in the other category primarily coming from some of the restaurant customers because you called out some weakness in fast food? So any color around that would be helpful.

Yes, we mentioned that if we exclude the intentional strategic exits, our total company volumes would have been positive. We made this decision deliberately because we had low-margin business that wasn't going to significantly contribute. By removing that capacity, we can focus on higher-margin business. The positive takeaway is that we are starting to see the results of these strategic exits. As we progress through the year, you will notice those volumes decrease. By the third quarter, we've mostly completed these exits, with only minor ones left in the latter half of the year. We are replacing the lost volume with business that meets or exceeds our variable margin targets, regardless of whether it’s in the branded category or others. That’s really the important point to understand.

Okay. Great. And maybe if I could dig in on Dave's for a second. Continues to grow ahead of the category, which is great. Obviously, a very differentiated offering. Can you just give us a sense for where it continues to source volume from? I mean, is there other larger branded players? Is it bringing people from outside the category, just so we can kind of size up how long it can continue to run ahead of the broader category growth?

Yes. We have observed that it has gained market share from other players in the specialty premium segment. We compare Dave's to the specialty premium category, as we don’t have other comparable products. However, it stands out even among specialty premium products, especially since that segment is currently quite weak. Dave's is priced significantly higher than others in that category, making comparison challenging. Yet, it largely defines the organic brand category. To answer your question, yes, it attracts new customers due to its quality and unique appeal. However, it's important to note that household penetration for Dave's is about half of what Nature's Own achieves. With our marketing efforts and geographic expansion, we are increasing that household penetration, which is a significant factor as well.

And it's from Mitchell Pinheiro with Sturdivant & Company.

I'm interested in your strategy regarding the away-from-home segment of your business and how it fits into your overall growth plan. You mentioned that you're aiming for balanced growth that exceeds the category average. What factors are contributing to this growth? You've moved away from less productive accounts, so are the accounts you currently have performing better than the category average? Or is there potential to gain market share while maintaining strong margins? I would like to know your perspective on this approach.

Sure. Well, first of all, I'm glad you noticed that. It's an important point to make. Yes, so now that we freed our capacity up to pursue better business, we felt that it made sense to move it into that category because we're going to place more focus on it. Now, that does not mean that we're going to over allocate resources to it to the detriment of the branded business. The strategy remains the same. We're moving to be a consumer-focused, brand-oriented company. But when you look at the broader baked foods category, there is tremendous opportunity in away-from-home that we can capture with limited investment. We don't have to do a whole lot in terms of capacity or automation, et cetera, to capture some of that volume. And there are opportunities out there and customers who want us to serve them that are willing to deliver much fairer margins than we may have had in the past. So we've always talked about our away-from-home business being an important contributor to the company. And this makes sense because the more profitable that we can make that business, the more resources we're going to have to allocate towards innovation and marketing and all the fun stuff we like to talk to you guys about every quarter. So that's the rationale.

You're launching a lot of new products, and I believe there are 11 new ones. How do you prioritize these new products? Which ones are the highest priority? As you transition in the bakeries, how do you view the impact of these new products? Will they positively contribute to margins along with sales from the start? I'd appreciate your thoughts on this.

Sure. Great question. I mean, we go through a very rigorous process that covers every single one of the points you just made. We start with the consumer, number one. Does the consumer even want this, right? If the answer to that is yes, then we start looking at commercialization and financials and how does this fit operationally? Is it going to create complexity in place? If so, how much? And we don't launch anything that doesn't make sense for the consumer or does it make sense from a financial standpoint or does it make sense from an operational standpoint. We have to check all of those boxes before we'll launch anything. But it's a great question because we go through that entire sort of funneling process, if you will, before we launch any of these new items.

Are these soft launches? Or are there going to be more substantial rollouts?

Yes. There are some of them that are more reasonable. But a lot of times, because we can make this stuff in so many bakeries, most of them will be throughout the network.

I have a question about gross margin. There was a significant increase this quarter, and while you've mentioned that pricing has been a factor, it seems like there's more to it since pricing has been consistent over the last few quarters. You've highlighted some other aspects, but I would like to know which ones had the biggest impact if you had to rank them. Is pricing alone responsible for this, or is the mix making a difference as well? Additionally, since it's a lengthy quarter, usually resulting in increased volume and leverage, should we expect a decline in gross margin in the second quarter?

Yes, this is Steve. We have taken significant pricing steps to address some of the inflationary pressures, which has been beneficial for our top line and gross margin. Additionally, the growth from the mix, as Dave mentioned, has been a significant contributor overall. I would rate that as the number one factor. We also experienced favorable commodity conditions at the start of the year, which continued mainly through the first half and into part of the third quarter, but those effects have begun to diminish in the latter half of the year. This is the second main factor affecting our gross margin outside of the top line.

Mitch, also, as we talk about the savings initiatives, some of those are going to benefit gross margin, not just SG&A but gross margin as well. And we also pointed to, in the quarter, we had a couple of discrete operational issues that we were working on that definitely impacted gross margin, that if we had hit closer to plan, we would have outperformed even the number we turned that on the bottom line. So as we get those things away, it's just two bakeries. It's not the end of the world but it did have a bit of an impact on the quarter as we bring that more back in line, that's also going to benefit gross margin. It will benefit the whole P&L but particularly gross margin.

I mean the forecast had some expectations to increase gross margin year-over-year. But obviously, we're expecting up gross margin quarter-by-quarter, just different magnitudes.

And it comes from the line of Connor Rattigan with Consumer Edge.

So in the prepared remarks, Ryals, you noted that you guys remain well below pre-pandemic promo levels and that it doesn't really seem like there's a real big notable lift on promo. But it does sound like your digital initiatives are really impacting your promo strategy. So I guess, what learnings have you guys seen so far on the promo front from those initiatives? And also, if you're not seeing as strong of a lift as you would like, should we maybe interpret that, that may inform your, I guess, you're spending decisions as you kind of debate the balance between using more promo versus marketing spend?

Yes, I agree. It appears that the lifts have improved somewhat, but they're still not at the levels we experienced before the inflationary period. We did increase our promotions a bit this quarter, in a targeted manner, but we're engaging in significantly fewer promotional strikes to achieve that. The digital tools you referred to are truly enhancing our efforts. They provide us with better insights and allow for more effective evaluations of our promotions, which generally leads to positive returns when we implement them. This has been extremely beneficial, especially as we've seen a substantial decrease in our trade spending over the past three or four years, largely thanks to the digital tools we now have through TPM.

Got it. Very helpful. And then just one quick follow-up for me. So you guys also called out the expectation for profitable business wins and increased cost savings initiatives to flow through in the second half. Is it a change from any prior expectations? Or was there maybe some sort of a shift of expected cost savings out of 1Q into the back half? Or just no change there?

We were able to identify, when we came out of the year, that we had a target of $30 million to $40 million. As we delved deeper, we discovered further opportunities and confidently raised that target to $40 million to $50 million. We're already experiencing some of those savings now. I listed several categories in the prepared remarks where we aim to align our costs better. Regarding new business, at the beginning of the year, we had certain expectations for new business wins that we anticipated. As we progressed through the quarter and worked on refilling strategically exited capacity, we found more opportunities than we initially expected. Consequently, our expectations for new business have increased somewhat. Nobody has asked about the cadence of the quarter, so now is a good time to address it. The quarter began a bit weaker than we anticipated. We had initially indicated a first-half weighted cadence to the year, but that unexpected weakness early on threw us off. However, with our increased savings targets and visibility to higher new business wins, we believe we can offset that early weakness and maintain our guidance for the year. That's how everything unfolded.

And as I see no further questions in the queue, I will hand it back to Ryals McMullian for final remarks.

Okay. Thank you, Carmen. I'd just like to thank everybody for taking the time today and joining us for questions. We very much appreciate your interest in our company. And as always, we look forward to seeing you again next quarter. Everybody take care. Thank you.

And thank you, everyone. This concludes the conference, and you may now disconnect.