Earnings Call Transcript - FLO Q3 2020

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

Thank you, operator, and good morning. I hope everyone had the opportunity to review our earnings release and presentation, and also listen to our prepared remarks, all of which are available on our Investor Relations website. Following the conclusion of 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. And with that, Deborah, can we begin the Q&A? Deborah, we're ready to start the Q&A please.

Operator, Operator

Thank you. Can you hear me now?

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

Yes.

Operator, Operator

Okay. I'm sorry. Your first question comes from Bill Chappell with Truist Securities.

Bill Chappell, Analyst

Thanks. Good morning.

Ryals McMullian, President and CEO

Good morning, Bill.

Bill Chappell, Analyst

Hey. I guess can you talk a little bit more about just what you're doing or what you're seeing on the price/mix in terms of the move of consumers more to branded? And I'm trying to understand, I guess first from a manufacturing standpoint, I mean, are you starting to change your mix? Where you're actually making less private label and making more branded just to reduce kind of sales? And then at the same point, is this really all just brand migration? Or is there any pricing in it?

Ryals McMullian, President and CEO

Yeah. So to start with the manufacturing concept, Bill, I mean as you know, we have pretty flexible manufacturing facilities. So the same plant that makes brand oftentimes makes private label too. So it's very easy for us to shift along with the consumer dynamics from private label to brand. But to layer on top of that, if you think about the Lynchburg bakery, it is probably a great example of moving up the mix chain, or up the margin chain, depending on how you want to look at it towards our higher-margin products, and adding production capacity to serve the market that way. From a pricing standpoint, not too much; we haven't seen too much pure pricing this year, but the promotional environment is certainly well beneath historical levels. So average base prices are, I guess, up some. We have seen that start to tick back up a little bit more recently, but still well off the historical levels.

Bill Chappell, Analyst

Got it. And I guess, just when I'm trying to understand the migration of the brands, I mean, there's one benefit from going from private label to Wonder. There's another one going up to Dave's Killer Bread. I mean, which is the bigger driver? Or is it kind of all of the above?

Ryals McMullian, President and CEO

Yeah, I mean, it's kind of in totality. You're right in what you say. I mean, the DKB margins and the Nature's Own margins together would be higher than Wonder and some of the other brands. But any shift out of that lower-margin business to higher-margin business in totality helps the bottom line. But DKB obviously is a tremendous growth driver. Canyon has been a big growth driver this year, and both those carry, yeah, very high margins.

Bill Chappell, Analyst

Got it. And then looking to next year, I realized you're not giving guidance, but two questions. One, what kind of impact on your business is the fact that 70% of U.S. school children are going to school at home or virtually or hybrid? And that might change and hopefully for a lot of us sometime in 2021? Does that – is it a positive or a negative impact? And then the same thing, I think Steve you had mentioned there was a variable comp component which understandably everyone is having a good year. What kind of switch does that turn into a tailwind as you kind of reset that to normal numbers for next year?

Ryals McMullian, President and CEO

Yes, sure Bill. Let me discuss the situation with school children and then I’ll hand it over to Steve for the incentive compensation details. There are certainly pros and cons to kids being at home. For instance, we missed the typical back-to-school boost in the fall with many children learning from home. On the flip side, we observed an increase in at-home eating since both kids and parents were mainly at home during that time. So, it’s somewhat of a balancing act, making it tricky to distinguish and measure these impacts. As we look ahead to 2021, I know many of you will have questions, so I'll share a few thoughts now. Planning for next year is quite challenging, especially considering how unusual 2020 has been. You can choose to speculate about what the demand will be in 2021 and later, or you can focus on the strategies you need to implement to shape that demand. That’s the approach we are taking with our portfolio strategy and the increased brand support we are using to grow our brands. You can either adapt to the circumstances or take control of what you can influence and enhance that brand environment through innovation, quality, and support. That’s our strategy moving forward. Steve, would you like to discuss the incentive compensation?

Steve Kinsey, CFO

Sure. As you review the year, it's clear that our performance has exceeded expectations, as indicated by our revised guidance and improved financials. This positive outcome is reflected in our profit and loss statement. Looking ahead to next year, we will establish targets and goals, taking into account our expectations for incentive compensation. While we anticipate a slight advantage from this year's performance, we expect the incentive compensation to return to more typical levels as we move into 2021.

Bill Chappell, Analyst

Thanks so much.

Steve Kinsey, CFO

Thank you, Bill.

Operator, Operator

Your next question comes from Brian Holland of D.A. Davidson.

Brian Holland, Analyst

Thanks. Good morning and congrats on the continued strong results. I just wanted to ask first about 4Q. You cleared what was at least in my model a pretty high bar that I set for you in Q3. Then if I look at the guidance revision, the low end is above what my model implies for Q4. Now certainly it's possible that I'm just doing something like in my model that's different here for Q4. But assuming that there's no real issue there, I'll ask the question. Anything incrementally stronger building into year-end because it does feel like a pretty marked improvement in guidance?

Ryals McMullian, President and CEO

Yes. I'll let Steve comment as well. However, I don't have anything specific to highlight. As I mentioned earlier, we are seeing good trends in branded retail. The data reflects that it remains elevated, and we don’t anticipate a significant drop-off. The challenges in the fourth quarter usually come from the holiday season, which is a strong period but isn't a major part of our portfolio. So, it’s somewhat dependent on how the holidays perform. On the upper end of our expectations, we’re still seeing strong branded retail as we have recently. In the last few weeks, it has steadied, showing consistent performance week over week. If this trend continues, we feel optimistic about the upper end, but the lower end would indicate a significant decline in the branded retail mix. Steve, do you have any additional comments?

Steve Kinsey, CFO

Not specifically; I think Ryals covered most of it. Just to remind everyone, Q4 is usually our most challenging quarter as the year progresses. Ryals pointed out, and we noted in the release and the prerecorded conference, that there are three holidays in the fourth quarter this year, even with the additional week. Typically, this business has been more roll-focused, while our strength is in loaf products. Therefore, we are being a bit cautious around the holidays. However, as Ryals mentioned, if the branded mix continues to perform well, things should shape up quite nicely for the quarter.

Brian Holland, Analyst

Yes. And I should just clarify, I mean, I do have the extra week in. But I'm looking for mid-single-digits in the branded retail segment in Q4. You are clearly outperforming that in the scanner data we can see thus far. So right anyway just to clarify that on my end. Two dynamics that seem to be rearing their heads based on some other food companies that we have reporting this earnings season that have weighed on you in the past. One, we're hearing about tight labor markets and costs related to that. And then also we have freight. Labor seems like that's a particularly acute issue for you guys given the manual intensive manufacturing. And then on the freight side, in 2017, 2018, you guys actually had a lag impact as I recall kind of given the way you go about that. But just curious, obviously any comments on the labor side? How we should be thinking about that going forward? And then on the freight side just thinking about how you manage what we saw in 2017 into 2018 and how that impacted you? And maybe what changes did you make that might allow you to mitigate those factors in 2021 if this continues? Thanks.

Ryals McMullian, President and CEO

Sure. Thanks, Brian. I'll take the labor market piece and maybe let Steve address the transportation side of it. Yeah, look, the labor markets continue to be a bit of a challenge depending on where you are. It's not acute everywhere, but we certainly have some areas where we continue to struggle a bit just kind of keeping people, keeping turnover down. Then you have the overlay of COVID. So you have folks calling out for one reason or another and it does present some challenges in the plants. In fact, despite our excellent results, we still have a lot of opportunity in our plants. Our efficiencies are down a bit even from last year. That may seem counterintuitive with the results that we've had, but you've got the volume drop-off plus you have higher scrap rates and things like that that are directly attributable to the stability of your labor force. So, a lot of effort to try to bed that down and particularly where it has been most acute, because there's some meaningful improvements that we can make there. I think beyond that we've talked about before really working on our overall work environment making sure that our pay scales obviously are competitive. That's one element, but also working on things like scheduling, because we find, as many other companies have found, that there's a huge quality of life component at play today that's oftentimes equally or more important than the compensation. So working on our scheduling to give more clarity to particularly our frontline employees on when they will have time off, trying to ensure that they have consecutive days off where possible, which is a significant departure from the norm in our industry. Those types of things really do make a difference. So we continue to work on that as well. Steve, on freight?

Steve Kinsey, CFO

Sure. We have benefited this year from our increased reliance on direct store delivery. We refer to this as a closed-loop system, and we work with three to four main carriers for our DSD products sent to our distribution centers. These contracts are typically negotiated over 12 to 24 months, so we aren't as affected by the fluctuating market rates for freight as we are in our warehouse operations. If this mix holds into 2021, we expect the benefits to continue until we start to compare against higher numbers later in the first quarter. Additionally, we've become more efficient in production and transportation. We're dispatching fuller trucks to our distribution centers instead of half loads, which has also contributed to our efficiency. If this trend persists through 2021, we expect to maintain relatively stable transportation costs going into next year. Of course, fuel prices will also affect this, and those are the main factors that influence our transportation costs.

Brian Holland, Analyst

Thanks. appreciate all the color. I’ll leave it there. That’s all I come for. Thank you.

Ryals McMullian, President and CEO

Thanks, Brian.

Operator, Operator

Your next question comes from Mitch Pinheiro, Sturdivant & Co.

Mitch Pinheiro, Analyst

Good morning.

Ryals McMullian, President and CEO

Hey, Mitch.

Mitch Pinheiro, Analyst

So just looking at current trends, I mean, how has foodservice been ramping for you? If you could break that out sort of QSR and casual?

Ryals McMullian, President and CEO

Sure. The QSR business I think we mentioned this on the last quarter, so it's kind of a continuation of the trend. The foodservices – the fast food, excuse me, QSR business has been a bit quicker to recover just by its nature: drive-throughs, that sort of thing. Yes, Chick-fil-As – the ones I see the lines are double wrapped around the store. So they're doing pretty well. The sit-down fast-casual type stuff is still lagging. It Mitch hits off the bottom but still well down. You can see that in the non-retail numbers that we put out, down roughly 14.5% or so. But off the lows that we saw early in the year. So slow recovery there. I think it's going to be a long time; that's my personal opinion. And you kind of have to factor into that well what happens with COVID. If you have another surge, it's really going to get hurt. You're seeing that start to happen in Europe with new lockdowns. And does that migrate its way over here as we move into the flu season? We'll have to see. So it's trying to come back but it is slow. And I think it will be protracted.

Mitch Pinheiro, Analyst

And is that – so is it off the bottom like in the third quarter? As you're here in the fourth quarter, is it just sort of stabilized? Is that what you're saying?

Ryals McMullian, President and CEO

Yes. If you – in the second quarter, non-retail for us was down 15.8%. And in the third quarter it was down 14.7%. So better but not by a whole lot.

Mitch Pinheiro, Analyst

Okay. And then as you're looking into 2021, just broadly speaking in broad terms, what type of cost savings, supply chain savings, you all – part of that $20 million that you had this year. I mean, are we talking about the same type of level of cost savings next year? Or does it drop off? Any color around that?

Ryals McMullian, President and CEO

For obvious reasons, I'd rather stop short of actually quantifying it. But it is a continuation of many of the same initiatives we had in place this year. So it will be largely first half weighted until we lap it in the second half, Mitch. But it's across those same categories, right? The overhead streamlining that we did: procurement, depot consolidation, all the things that we've talked about. That is not to say that we're not working on additional incremental things, but some of those are still in the planning stages. But it will be meaningful. But it will also be mostly first half weighted.

Mitch Pinheiro, Analyst

Okay. And then just a couple more. So has the current environment affected your ability to gain new distribution or new – getting new products on the shelf in your newer territories? Have you ever – are there – is this – has this been good for you? Has this been neutral? Any color around that.

Ryals McMullian, President and CEO

It really hasn't affected us. We've continued to introduce new products, such as the DKB buns and the new line extensions mentioned earlier. This has occurred alongside our competitors launching their own new products. We've also gained new shelf space during this time. While there hasn't been significant geographic expansion, that wasn't our goal. We're focusing on areas like the Northeast where our market share is still relatively low. Our aim is to deepen our presence by increasing shelf space and enhancing our brand support. Overall, this situation hasn't negatively impacted us, unless I've overlooked something.

Mitch Pinheiro, Analyst

And then just last question on Tasty Baking. So...

Ryals McMullian, President and CEO

Hey, Mitch, let me cut you off there, because I do want to add one more thing to your question. As I sit here thinking about it. I do think in some ways that the COVID circumstance has been a positive relative to new product introductions. Because what we have seen in the mix shift is somewhat of a shift away from traditional loaf to buns and rolls and to breakfast items, right? And so as we've introduced new items in those categories from that standpoint, it's actually been a positive rather than a neutral.

Mitch Pinheiro, Analyst

Thank you. I have one more question about Tastykake Tasty Baking. Where do we currently stand in the fourth quarter with Tasty Baking? Are the operations optimized to your satisfaction? Will we see gradual improvements in the first half of next year? Also, how did Tastykake's sales perform in the third quarter?

Ryals McMullian, President and CEO

I'll answer your question directly to begin and then provide some additional details. We are not where we want to be, but we are making improvements. I am very pleased with David Roach's performance. He is one of our more experienced operational executives, and he is doing an excellent job with a challenging task. We have completed most of our new automation installations and made some management upgrades. We have also sought outside assistance to enhance our operational processes. We have resolved our union contract negotiations, which is now settled. So, things are improving, Mitch. I appreciate your wording, as I expect to see gradual and steady progress as we advance into next year. If we are successful, I believe that this slow and steady progress will lead to significant improvements for the company next year.

Mitch Pinheiro, Analyst

Okay.

Ryals McMullian, President and CEO

Yes, Tasty remained flat for the quarter, but I want to highlight an issue. The operational inefficiencies we've encountered at Navy Yard have affected their revenue as we've had to reduce production due to these inefficiencies and waste. This has obviously impacted our top line. Therefore, making these improvements will not only benefit the bottom line but will also enhance the top line.

Mitch Pinheiro, Analyst

Okay. And one more thing. I really like the new conference call format.

Ryals McMullian, President and CEO

Thanks.

Mitch Pinheiro, Analyst

So, I appreciate you doing that.

Ryals McMullian, President and CEO

Sure. You bet.

Operator, Operator

Your next question comes from Ryan Bell of Consumer Edge Research.

Ryan Bell, Analyst

Hui everyone. Morning. Is there any way you could provide some detail about the direction of store brands given the non-retail parts of your business throughout the quarter? Kind of talking about where they were to start the quarter? And where they came at the end just to see where the momentum is being pushed?

Ryals McMullian, President and CEO

So, the intra-quarter trajectory of private label, is that what you're asking?

Ryan Bell, Analyst

Yes. For the private label and then also the nonretail portion of the business. I know that's still down and improved a little bit, but it's harder to get the magnitude of sort of the month-to-month to figure out where that might be going.

Ryals McMullian, President and CEO

I'm with you, Ryan. I don't have that in front of me. I have the totals which you already have from the release. We can look into that and come back to you though. I want to say it was fairly steady for the quarter, but let me check that.

Ryan Bell, Analyst

Okay. Thank you. And then when we're talking a little bit more about private label at the industry level, we've been seeing that down pretty significantly in scanner. Would you be able to share some of your perspective about the drivers of the industry decline? Obviously, producers such as yourself have the ability to favor branded over store brand. That's for the margin advantage and other reasons. But is there any commentary you could have about that on the industry level?

Ryals McMullian, President and CEO

I’ve mentioned this before, but it’s an important question. The shift to branded products began at the start of the pandemic due to capacity constraints, causing everyone to focus on producing as many branded items as possible within a limited selection. Now that we may have found a new normal, what’s influencing this shift? E-commerce is one factor; brands are more visible on e-commerce platforms, which is playing a significant role today. Additionally, people are spending less time in-store and making fewer trips. They prefer to quickly get what they need, and in this scenario, brands offer more of what they want compared to private labels. There’s greater differentiation and innovation among brands, some of which we’ve contributed to in the category. I believe these factors are the main drivers behind this trend.

Ryan Bell, Analyst

Okay. And that kind of seems like as you're looking out to 2021 that private label probably is not going to be picking up quite as much given what you're talking about overall?

Ryals McMullian, President and CEO

I believe that's the case. If we execute our strategy well and present a compelling brand to consumers, we should expect them to remain loyal to our branded products. In a more challenging economic environment, where government support is diminishing, there might be some shifts towards lower-cost options. However, we are well-positioned as we offer a range of products at different price points. We have premium offerings like Dave's and Canyon, the mid-tier brand Nature's Own, and more affordable options like Wonder. This variety helps us weather potential economic downturns. Looking back at the last recession in 2008-2009, we managed to navigate that period successfully, as we have in previous recessions.

Ryan Bell, Analyst

Thanks. Thank you. That’s it for me.

Ryals McMullian, President and CEO

Okay. Thanks.

Operator, Operator

Thank you, gentlemen. Do you have any closing remarks?

Ryals McMullian, President and CEO

No, not except to thank everybody for their time and for your interest in the company. I certainly hope you like the new format. We certainly like it better, able to dedicate a little more time to your questions. So we appreciate you joining the call this morning.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.