Earnings Call Transcript - FLO Q2 2021

Operator, Operator

Good day and thank you for standing by. Welcome to the Flowers Foods Second Quarter 2021 Results Call. Please be advised that today's conference is being recorded. I would like to hand the conference over to your speaker today, Mr. J.T. Rieck, Senior Vice President of Finance and Investor Relations. Sir, please go ahead.

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

Thank you, operator, and good morning. I hope everyone has had the opportunity to review our earnings release, listen to our prepared remarks, and view the slide presentation. They 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 Ryals McMullian, President and CEO; and Steve Kinsey, our CFO. Operator, we are ready to start the Q&A, please.

Operator, Operator

We have our first question from the line of Bill Chappell from Truist Securities.

Bill Chappell, Analyst

Thanks. Good morning. Just one of the things we've heard from several food companies over the past month and a half is that there's been a meaningful, for whatever reason, trade up from private label to branded, due to stimulus checks or other issues, though no one can quite figure it out. And clearly, that had some impact or continues to have some positive impact on your business. So I guess the question is, do you see this as a sustainable shift? Or do you think that people will move back towards private label, which could put margin pressure as we move into the better back half of this year to next year?

Ryals McMullian, President and CEO

Yes, it's a good question, Bill. In our category, with private label being historically so overdeveloped, we were actually seeing these private label declines even prior to the pandemic. I think we've mentioned that in a couple of prior calls. We've done a fair bit of consumer insights research into why that trend is continuing and almost accelerating, really. It really comes down to in our category, there's a distinct lack of differentiation in private label. It's basic white and wheat bread and buns, whereas in our category, Flowers has participated in this, obviously. We have a lot of differentiation with the new perfectly crafted brioche rolls with things like Dave's Killer Bread and Canyon. And that's driven a bit of a premiumization process up to branded from private label. As to whether it's sustainable or not, I actually think it is. And that's why we're making all the investments we're making behind our brands, the marketing support, etc. If we get into a recessionary situation, you could see some move back to value. But even then, in the last recession that we saw in '08 and '09, we didn't see that much of a move back to private label.

Bill Chappell, Analyst

But did you see a step change in this current quarter? Or is it just more of a continuation of the trend?

Ryals McMullian, President and CEO

It's really more a continuation of the trend. Yes, private label just continues to fall, and branded retail continues to hold up very, very well.

Bill Chappell, Analyst

Great. And then turning to the cost front, same thing. I've heard a lot of your peers talk about especially more on freight and incremental costs. You seemed to raise EPS guidance for the full year in April. It seems like it's less of an impact. Is that largely due just to the way your supply chain distribution works? Or is there something else that's helping you offset these costs?

Ryals McMullian, President and CEO

Yes, partially. That's a bit more of a closed loop system, so we're not as exposed to the long-haul freight. The other thing I would say is with our hedging strategy being four to seven months out, sometimes a little bit longer, that gives us good visibility in advance of what our costs are going to be. We can be proactive about mitigating those costs. Steve, anything you'd add to that?

Steve Kinsey, CFO

No. I mean, I think, as we said earlier in the year, we had pretty good visibility into our overall cost structure for this year, obviously, looking in place in the back half and a little heavier. But we think we've taken the right steps to mitigate most of that. And as Ryals said, on transportation, we're not immune to the increases, but we feel like for 2021, our contracts have protected us the best they can.

Operator, Operator

Our next question is from the line of Mitchell Pinheiro from Sturdivant.

Mitchell Pinheiro, Analyst

Hi, good morning. Just following up on those questions regarding private label. Is the retailers' view of the other private label offerings changing as well, in terms of shelf space allocation? Are they looking to premiumize private label to a greater extent to keep private label? Or is that really not one of their strategies, and they're willing to let the market go where it goes and reallocate shelf space? Can you give us any color on that?

Ryals McMullian, President and CEO

Yes, I mean, we've had some isolated discussions about that but nothing broadly in the market. We're not hearing much about wanting to premiumize private label or anything like that, to this point. Probably the one exception for us, and one area of private label that continues to do well is Canyon's private label gluten-free; that's probably the one call out in private label that's actually showing some growth in our portfolio.

Mitchell Pinheiro, Analyst

Are they looking to reduce shelf space for private label? I mean, clearly the dollar value and the gross margin contribution of the brands versus private label would suggest more allocation to the branded shelf space, but is that happening at all?

Ryals McMullian, President and CEO

Again, I would say that it has happened to some extent, but we haven't seen any broad market-wide moves to take shelf space out, but there have been some isolated customers where that's been reduced. You also have the labor situation that limits somewhat the ability to provide all the SKUs. I mean, throughout this pandemic, we've had to limit some of our SKUs, and that's had some effect on the shelf space allocation. But as far as the overall private label allocation, there's been no meaningful change really.

Mitchell Pinheiro, Analyst

Are there any pricing changes with private labels? Is it a volume decline? Or is there pricing going up? Can you talk about that a little bit?

Ryals McMullian, President and CEO

Yes. I mean, we have taken some pricing over the last several years in private label, yes.

Mitchell Pinheiro, Analyst

In terms of part of the whole strategy or some of the benefits that Flowers gets is from gaining share in lower-penetrated newer markets. Is there anything you could call out geographically, strengths or weaknesses among your territories?

Ryals McMullian, President and CEO

Yes, I mean, we've been calling out the Northeast for the last several quarters as a focus market for us. We continue to make investments up there. The good news is we're seeing share gains there. Yes, we had a good quarter in the Northeast, and we continue to gain share on the West Coast, another really strong market for us. Obviously, we're super strong in the south. I mean, Mitch as you know, the big opportunity for us is that whole upper Midwest quadrant.

Mitchell Pinheiro, Analyst

Okay. And then just a couple more in terms of what's happening with that snack cake and Tasty Cake in particular. Are you making progress on your profitability?

Ryals McMullian, President and CEO

Yes, thanks for asking. Really good progress at Navy Yard. Again, I'll say we're still not where we want to be, but the trajectory is really good. The team's done a great job up there; our automation investments are paying off, and scrap rates are coming down. Labor in the cake markets, in the cake plants rather, continues to be a bit of a challenge. It's just the nature of the cake bakeries with more people in there. But overall, we've been able to manage through it really well. We've also done some things on the commercial side, Mitch, from a price promotion standpoint to make us more competitive there. So all sides are pointing in the right direction; in fact, relative to our internal goals, we're actually ahead of plan there.

Mitchell Pinheiro, Analyst

And I guess the final question, when you look longer term and you look at your margin profile, I think you mentioned in either this quarter, while mix is certainly a powerful help for you, you have productivity and your whole network optimization to support further margin improvement. However, it seems that the branded versus the non-branded mix is still going to be the most important part of the change. I'm curious whether you agree with that, and what you're doing specifically to create the positive mix going forward?

Ryals McMullian, President and CEO

No, absolutely. I agree with you. The whole notion of shifting more around mix to branded retail is the most powerful tool we have to improve our overall margin profile. But all the other things you mentioned, whether it's network optimization, our marketing investments, or our digital transformation are all intended to support that mix shift to branded retail. So you had all rolls up to the same strategy of over time shifting more of our mix to brands, both the brands we have today and hopefully the brands we will have tomorrow with future M&A.

Mitchell Pinheiro, Analyst

Okay. And just one more question, speaking of M&A, can you talk about your pipeline or maybe the environment in M&A right now?

Ryals McMullian, President and CEO

Yes, sure. Really no change from last quarter. Deal activity continues to pick up. We're looking at quite a few things right now, which is a welcome change from last year when it really kind of dried up. So we're happy with the pipeline, and Mitch it's nice to be in the position that we've got the balance sheet to act when the timing is right.

Operator, Operator

Our next question is from Ryan Bell with Consumer Edge Research.

Ryan Bell, Analyst

Hi, how are you guys? Touching on the inflationary environment and the impacts of rising costs, can you talk about your ability to take pricing as we get to the end of the year in 2022?

Steve Kinsey, CFO

Yes, I mean, obviously we're not going to talk about 2022 today. We're not prepared at this point to give guidance, although it is on our mind, given the inflationary environment we're in. We've seen pretty substantial runs, like most other companies, regardless of which industry or segment you're operating in. We're all experiencing pretty tremendous inflation. What I would say for 2021, and I think we talked about in our prepared comments in the back half, is we're pretty confident in our overall cost structure. We're also confident in the measures we've taken to mitigate inflation the way we have, whether that was pricing. I think you'll see promotional efficiency, which we saw in Q2. A lot of our projects are on track with regard to efficiencies and productivity. We expect to use the same tools going into 2022, but beyond that, no, I can't really comment about beyond this year.

Ryals McMullian, President and CEO

One thing that I would add is if you think back to the last significant inflationary period that we saw, sort of '07 to '08, we were a much different company back then. Our market share was a lot lower. We really only had one sort of quasi-national brand then, Nature's Own. Fast forward today, and we've got roughly an 18 share. We've got Nature's Own, expanded Nature's Own now with perfectly crafted as well, we've got Dave's, we've got Canyon, we've got Wonder. The brand portfolio is quite a bit stronger than it was, which also gives us greater confidence that we can pull that lever to the extent necessary to help mitigate any rises in cost.

Ryan Bell, Analyst

Thank you. That's helpful. Could you talk about how you're thinking of the back-to-school season in terms of your guidance, what you're assuming about the season and what could change potentially to your base case, given some of the variability with the Delta variant and other types of getting back to normal?

Ryals McMullian, President and CEO

Yes, our perspective on that has changed markedly since the first of the year, when we first issued guidance, and then with the vaccine rollout, we were kind of planning for what that was going to look like and how that was going to affect market dynamics. Now here we find ourselves at the beginning of back-to-school season with the Delta variant surging significantly across the country. So our perspective has changed as the dynamics out there have changed. It’s hard to say. We originally expected that the back-to-school season would give us a really good indication of what the new normal might look like in a more steady state going forward. I think the rise of the Delta variant has brought that into question and pushed that timeline out a bit. In our results through Q2, and even the beginning of Q3, we're continuing to see very strong branded retail performance in line with what we've been witnessing for the first part of the year. It's going to be a little bit of a wait and see. I thought that back to school and people returning to the office would give us a better indication, but I think that's gotten pushed out a bit.

Ryan Bell, Analyst

Thanks, that's helpful. Would you be able to try a little more detail about some of the shifts in your CapEx guidance this year? I know you took it down a little bit, and you mentioned that it was largely due to delays from the pandemic. Was the expectation for that just to shift out to next year?

Steve Kinsey, CFO

Yes, I mean, the majority of that will just roll into 2022. The reality is, there's no one specific or large project that was impacted. It's kind of across the whole, just some delay in timing and getting equipment in for some of the projects.

Ryan Bell, Analyst

Thanks. Just the last question for me, how do you feel about the general longer-term impacts of incremental add-on demand? I mean, it's pretty evident at this point that there will be incremental work-from-home relative to 2019. Could you potentially share some of your thoughts about this expense or the potential for this to impact your business over the next few years?

Ryals McMullian, President and CEO

Yes, I'd be happy to. Frankly, Ryan, I'm quite optimistic about it. I think there have been fundamental shifts, both good and not so good. The good parts are I think that the future of work is going to be a lot different. Here at Flowers, we're going to be doing it differently, permanently. Many other companies are, as you've read, are doing the same thing. I think that shift or that change in mindset really only benefits our business with more people eating at home, more sandwiches consumed, or whatever it might be. I think we're very well positioned. Coupled with that, our commitment to innovation and continuing to bring new and exciting offerings to the consumer will continue to be really important for us to drive future growth. So I'm frankly really optimistic. On the negative side, the labor situation continues to be difficult, as we read across every industry, whether service, manufacturing, or otherwise, it's a challenging situation, and it's tough to attract and retain people right now. So far, we've done a really good job of managing through it; it has not been easy. But we've continued to serve the market effectively throughout this period. But it is a challenge and we have to relook at how we approach labor in both short-term and long-term changes.

Operator, Operator

Our next question is from the line of Ben Bienvenu with Stephens.

Ben Bienvenu, Analyst

Thanks. Good morning. Ryals, I wanted to follow up on the compensation side of things. You talked about you are reviewing compensation. I'm wondering where you are today in that process? What's considered in your guidance with respect to compensation and benefits for the balance of the year and fiscal '21? You talked about a combination of short and long term. Sounds like you're taking a holistic approach and being more surgical. Can you talk about your mindset and what you're seeing today relative to normal? How do you feel about your ability to ameliorate those dynamics?

Ryals McMullian, President and CEO

Sure. For '21, I wouldn't worry too much about it from a wage standpoint because, for one thing, I think it's more than just wages that are the issue. Certainly, we'll look at that; we periodically assess that to ensure that our bakeries are competitive in each of our markets, but again, the dynamics have changed. What you used to look at as your peer set in manufacturing has changed. We used to look at other food companies or warehouses, now you're competing against Amazon, you're competing against Tesla. With all the government payments coming in, you're even competing with the government. It makes it pretty difficult. So you're right; we're taking a holistic look because I don't believe it's solely about compensation. To some extent, we want to remain competitive. The quality of life factors are even more important. By that, I mean, bakeries can be hot and uncomfortable during the summertime. What can we do to improve the overall working environment inside the bakeries? We're looking at different uniforms, different cooling systems, and those types of things. But one of the biggest issues for us, I've mentioned this before, is scheduling in the bakeries. Working in a bakery is a tough job. We're running the bakeries hard, particularly right now with the labor shortage. We've had increases in overtime because our people are working really hard. That's not a situation we want to sustain for too long. So what can we do from a scheduling standpoint to give more consecutive days off and more predictable schedules so that people can plan their childcare, doctor visits, or whatever it might be in daily life? We're looking at a myriad of different approaches to help mitigate this, and I'm glad we are because I don't think this is a temporary situation.

Ben Bienvenu, Analyst

Okay, makes sense. Promotional efficiency contributes to a better price mix. Can you talk about what's happening there? Is it returning to a normal or new dynamic around consumer behavior? Are volumes sustaining at new levels? Or are there initiatives that you have in place? Maybe just help us understand what's going on there and the glide path associated with that, and how repeatable is that dynamic?

Ryals McMullian, President and CEO

Yes, sure. I'll start, and Steve can chip in if he has something else. The overall promotional environment has been pretty steady for a while now. In our category, I would call it at least five-year lows. That's been pretty steady with the demand for branded retail. I don't see that changing anytime soon. We also internally do a much better job with our trade promotion management system than we did historically at managing promotions and only pursuing those that have a high return associated with them. So both the macro environment supports this, but also our internal efforts of being more efficient with our promotions are helping.

Steve Kinsey, CFO

No. I mean, I think Ryals' point about systems really can't be emphasized enough. In the last couple of years, we've worked really hard on implementing new technology that gives us great visibility. As we talked about in Q1, promotional activity has pulled back quite a bit. It's really about net pricing now. A lot of our inflation comes in the back half of the year, so that's when more true pricing will show up. We've been really pleased with the promotional environment and the levels we've seen, and that's been a big part of the margin equation.

Ryals McMullian, President and CEO

Yes, Ben. The only thing I would add is we did implement a price increase right at the beginning of Q3. While it's early days, we've been really pleased with how volume has held up with that price increase. So that's encouraging, certainly.

Operator, Operator

There are no further questions at this time. Mr. Ryals McMullian, please continue.

Ryals McMullian, President and CEO

Thank you very much, everybody, for your interest in the company. We look forward to speaking with you again next quarter. Take care, everybody.

Operator, Operator

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