Earnings Call Transcript - FLO Q3 2021

Operator, Operator

Good morning, ladies and gentlemen. And welcome to the Flowers Foods Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host J.T. Rieck, Senior Vice President, Finance and Investor Relations.

J.T. Rieck, Senior Vice President, Finance and Investor Relations

Thank you 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 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'll also provide non-GAAP financial measures for which disclosure reconciliations are provided in the earnings release and at the end of the slide presentation on our website. Joining me today are Ryals McMullian, President and CEO; Steve Kinsey, our CFO. Operator, we're ready to start the Q&A, please.

Operator, Operator

Thank you. Your first question comes from the line of Bill Chappell with Truist.

Bill Chappell, Analyst

Hey, thanks. Good morning.

Ryals McMullian, President and CEO

Good morning, Bill.

Bill Chappell, Analyst

Guys, quick questions. One, based on your commentary in prepared remarks. One you talked about, you're not really, it's too early to tell what kind of normal looks like in terms of people reverting back to work and to school and stuff like that post Delta variant. But you are pretty well exposed to states like Texas and Florida where they've moved back to normal a little bit faster than the rest of the country. So, maybe tell us what you're seeing there and kind of what that tells you for as we look to '22 in terms of consumption.

Ryals McMullian, President and CEO

Sure. Bill, it's really broad-based across the country. We've been really pleased with how well things have held up, particularly on the branded and retail side. Nothing really in particular to call out by region except to say, overall, the brand investments that we continue to make, the innovation we continue to introduce has really helped us hold on to a lot of these consumers. And similarly, we're also seeing further increases in household penetration, velocities are up, repeat buyers are up. So, all the signs point in a pretty optimistic direction when you think about what return to normal ultimately looks like.

Bill Chappell, Analyst

Got it. In terms of costs, could you remind us if you're planning to make additional pricing adjustments to cover costs, and whether you aim to maintain margin or profit dollars in regards to gross margin moving forward?

Ryals McMullian, President and CEO

Obviously, the ultimate goal would be to protect both. Now, at the end of the day, the consumer is going to drive the ultimate results, right? Yeah, consumers were experiencing very, very broad-based inflation. We've all read the headlines, 30-year highs, fifth straight month, over 5%, that kind of thing. So, everything from gasoline to our products is going up. So, we will have to wait and see how the consumer at the end of the day reacts to that. If we find ourselves in a situation where there is a trade down in value or units drop-off, it’s certainly reasonable to assume that there could be some margin compression in the short term. But what I would say overall about the inflationary environment is whether you believe it's transitory or whether you think it lasts a little bit longer than that, ultimately these issues are temporary and not completely within our control. So, we're focused on what we can control. We will continue to make investments in our brands, we will continue to make investments in our digital capabilities, etc. that over time will lead to expanded margins.

Bill Chappell, Analyst

Got it. For my last question, you mentioned that M&A activity is increasing. I'm curious about why that's happening now. I thought you were pursuing the same key targets for years, if not decades, so I'm wondering what has changed to drive this uptick or if you could provide more details on that comment.

Ryals McMullian, President and CEO

Sure. I think maybe a little bit earlier in the year, it may have been driven by some tax issues. Now, we'll ultimately see where that bill falls. It looks like some of that’s going to knock down the bill. So that could have been driving some of it. And you're right, we still continue to talk to some of the same targets that we have for a number of years, but that activity has really picked up, Bill, more in the adjacent product categories, some more in the snacking space, that kind of thing.

Bill Chappell, Analyst

Okay, great, thanks so much for the color.

Ryals McMullian, President and CEO

Sure. Thanks, Bill.

Operator, Operator

Your next question comes from the line of Ben Bienvenu with Stephens.

Ben Bienvenu, Analyst

Hey, thanks. Good morning, everybody.

Ryals McMullian, President and CEO

Hey, Ben.

Ben Bienvenu, Analyst

I would like to ask about the ongoing strength in branded retail. The results are impressive, and I assume the mix is still helping to maintain gross margins even with rising costs. I'm interested in your thoughts on whether we have reached an equilibrium at this point. Can we grow from this equilibrium? To what extent are we likely to see continued price increases, and how might that affect the shift from branded retail to store branded products?

Ryals McMullian, President and CEO

Yeah Ben. Great question. I think that's a key point. And as I was mentioning in response to Bill a minute ago, I mean, it's all going to be about the consumer. And so far, even with the pricing actions that we took in July, branded retail units have held up very well. I mean, we've seen a little to no drop-off at all in branded units now. Going forward and as you look into next year with all the inflation consumers face with the stimulus payments coming off that kind of thing, I think it’s yet to be seen just how much the consumer is willing to absorb. And that will be a key topic for next year, right? We've been through situations like this before most recently around the 07 or 09 time period; business held up relatively well. Yeah, we do offer products across a variety of price points which certainly helps from the super premium Dave's Killer Bread all the way down to private labels with some pricing in between two on Nature's Own and Wonder, that kind of thing. So, we feel like we're very well-positioned to do well in any environment. Obviously, we would be most pleased if the current trends that we're watching continue, but I think it's really all about the inflationary impact on the consumer and what they'll be able to absorb. But that also makes it more important than ever that we continue to keep up with our pressing forward on innovation, that we keep developing our capabilities such that eventually this will subside. It always does; and when it does, we will be positioned even stronger.

Ben Bienvenu, Analyst

Perfect. Understood. On the cost side of the equation, how much visibility do you have into the balance of this year, and into early next year? Any thoughts that you have on what that looks like and where we are in terms of the curve of cost inflation? How close do you think we are to maybe seeing a light at the end of the tunnel from your vantage point?

Ryals McMullian, President and CEO

Sure. Given where we are in the year and our forward buying strategy, we have complete visibility into our commodity expenses for 2021.

Steve Kinsey, CFO

From that perspective, we've been talking about the cadence of inflation for this year. Majority of it is coming in the fourth quarter. We will begin to see some of that ramp up, but all that is priced into the guidance we gave yesterday when we released. Looking forward to 2022, we're not prepared to give guidance today, but obviously you can look out on the forward curve, and it is pretty significant inflation. And if things stay in the market levels we see today, as we said in our prepared remarks, we expect to see pretty meaningful inflation next year. But as Ryals has commented, we're looking at efforts to mitigate that through pricing as well as other cost initiatives. So, we anticipate this to be at least probably another one-year cycle and as Ralph just said, depending on whether it's truly transitory or not, it could extend slightly beyond a year. But right now, all indications are that the inflation will hold through most of 2022 as well and hit the cost side.

Ben Bienvenu, Analyst

Okay. Sounds good. Thanks so much for the thoughts and best of luck with the rest of the year.

Ryals McMullian, President and CEO

Thank you, Ben.

Operator, Operator

Your next question comes from the line of Steve Powers with Deutsche Bank.

Steve Powers, Analyst

Hey, thanks. Picking up on what we've already been talking about, in your prepared remarks and then some of the conversations this morning just really underscores the uncertainties around the pacing of demand migration back towards pre-pandemic levels potentially and just inflation headwinds and other variables. Plus, we know that you've got ongoing strategic investments around technology and branding otherwise. So, just in that context, I'm hoping you could elaborate on the drivers that, as I read your presentation, at least the presentation slides and the accompanying prepared remarks talk about confidence and expectation to get onto those long-term growth targets in fiscal '22. So maybe, unless that was a misread on my part, just what are the drivers that despite all these uncertainties, you feel like you've got confidence and visibility to lock in those long-term growth targets next year?

Ryals McMullian, President and CEO

Sir, I mean, I think we've already alluded to a few of them, but just to reiterate one, the momentum that we carry into 2022. I mean, we have gained a lot of consumers over the past two years, Steve. We've invested a lot behind our brands. We're clearly growing our share nationally, but also in very important markets like the Northeast where we're underpenetrated. We have a lot of new innovation items, some of which we're testing right now, some of which will be forthcoming next year that we're quite excited about to continue to drive top-line growth. And you're right, we are making significant investments in our ERP platform and other digital capabilities that over the long haul will enable us to stay on that long-term algorithm. And then of course, Steve, we also have, taking a look at the balance sheet, we're obviously poised for acquisition activity should the right opportunity come along. All those things put together give us confidence that we can stay on our long-term algorithm using 2019 as the base year.

Steve Powers, Analyst

Thank you. I want to touch on a different topic regarding your manufacturing footprint. You have a diverse network of bakeries, which likely provides considerable flexibility in managing various supply chain challenges. Could you discuss this further and give an overview? Additionally, I would appreciate some insight into the variability of operating conditions across your bakery network. Are the conditions fairly consistent, or are there specific areas where you're facing more difficulties, particularly relating to labor? Any details you can provide would be appreciated. Thank you.

Ryals McMullian, President and CEO

Sure. The labor challenges we face are fairly uniform across the Company, although there are a few areas where the issues are somewhat less pronounced. Overall, the situation is consistent nationwide. We've managed these challenges relatively well, considering the obstacles we're all dealing with, but it remains a difficulty that affects our efficiency. We often find ourselves either shorthanded or training many new employees, particularly in bakeries, which increases waste and reduces efficiency. Cake bakeries have experienced more intense issues since they require more labor and have a higher number of staff, especially in packaging. While the challenges are somewhat more severe in that area, we have still managed to handle it quite effectively.

Steve Powers, Analyst

Okay. That's great color. Thank you very much.

Ryals McMullian, President and CEO

Sure. Thank you.

Operator, Operator

Your next question comes from the line of Mitch Pinheiro with Sturdivant & Company.

Mitch Pinheiro, Analyst

Good morning.

Ryals McMullian, President and CEO

Morning, Mitch.

Mitch Pinheiro, Analyst

Have you defined what your inflation rate has been on the cost of goods for 2021?

Ryals McMullian, President and CEO

We have not provided a specific measure due to the way we hedge; it wouldn't be appropriate to disclose that. As we move into 2021, you will start to see inflation trends increase. The impact will be more pronounced in the second half of the year, but we haven't specified a percentage for competitive reasons.

Mitch Pinheiro, Analyst

Okay.

Ryals McMullian, President and CEO

You could do the math with acute input costs, that would be pretty much in line, but beyond that, we haven't disclosed that.

Mitch Pinheiro, Analyst

Okay. With brand and growth rapidly increasing, I would like to hear more about your brand-building efforts. It seems that consumer demand for branded products, particularly higher-quality and more diverse baked goods, is driving some of this growth. Are you focusing on marketing more aggressively than before to capitalize on this trend? I would be interested to know how your spending is allocated. Are you shifting more towards television advertising like what I've seen with Dave's Killer Bread, or are you pursuing more digital eCommerce initiatives? I would love to hear more details on that.

Ryals McMullian, President and CEO

Sure, Mitch, happy to. You can just take a look at our marketing spend and see over the last several years how much we've ramped up to support the portfolio strategy, growing our branded business at a faster rate. You touched on a lot of 'em already. I mean, a lot of it is being allocated towards our aggressive growth brands whether that be Canyon, Nature's Own, DKB. It's been more intense in parts of the country where we're underpenetrated like in the Northeast, that's why you're seeing some of the commercials up your way. And you're also correct on digital. E-commerce is about 8% of our sales right now, which is roughly in line with the category. We want to continue to grow that. I think e-commerce is going to continue to be a bigger and bigger part of the picture, and we need to have that digital presence. But on the other side, we're also investing in consumer insights. We have to understand our consumers such that we can continue to deliver the innovation that they want in a category. Some of that spend is going into that and continued investments in R&D. And I think you'll start to see some of that as we go forward with some of the newer innovation items that we're coming out with that are not in the bread category, put it that way.

Mitch Pinheiro, Analyst

What is driving the growth of Dave's Killer Bread? Clearly, you have new products. I would be interested to hear more about specific channels, products, and the distribution gains that are happening. I'd like to understand more about what is contributing to the growth of DKB beyond just strong demand for organic products.

Ryals McMullian, President and CEO

Yes. Sure. I think at the end of the day, first of all, it all starts with quality. There are other organics that are out there. Dave's has a commanding 70% share for reasons because it's the best tasting, the best quality, best consistency. We're continuing to grow in the Northeast, which is a big part of the puzzle there. Bringing on Lynchburg last year to support that growth has been a huge thing for us in Dave's evolution. We continue to come out with new products with Dave's. We're testing some new products right now with them. There will be more coming next year. So, increasing awareness is a big one. I've talked about this before. When you look at the great success of Dave's that we are all very proud of, of course, but then you compare it to household penetration to that of Nature's Own, it's roughly half that of Nature's Own. Even with the great growth we've experienced, we feel like that brand still has a ton of runway ahead of it, both within its current categories and in other categories because I think the brand is strong enough now to begin playing across different categories, which we're obviously very excited about.

Mitch Pinheiro, Analyst

And then just a final question. Do you have any update on your cake business regarding the manufacturing side? Is a lot of that resolved, or is it still a work in progress in 2022?

Ryals McMullian, President and CEO

Yes. Mitch, this is not solved yet, but great progress this year. They're ahead of pace, actually, which we're very pleased about. But as I've said on the past several calls, though we're pleased with the progress, we still have some way to go, but the improvement this year has been material.

Mitch Pinheiro, Analyst

Okay. Thank you very much.

Ryals McMullian, President and CEO

Thank you, Mitch.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn the conference back to Ryals McMullian.

Ryals McMullian, President and CEO

Thank you very much, everybody. Appreciate your interest in the Company and we'll look forward to speaking with you again next quarter. Everybody take care.

Operator, Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may now disconnect.