Earnings Call Transcript - FLO Q1 2023

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

Thank you, Shannon, 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 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; Steve Kinsey, our CFO. Ryals, I'll turn it over to you.

Ryals McMullian, President and CEO

Okay. Thanks, J.T. Good morning, everybody. Thanks for joining the call. Our results this quarter reflect the strength of our leading brands and the dedication of our Flowers team, and I want to thank them for their hard work. It was instrumental in helping us drive record quarterly sales. We did face difficult year-over-year comparisons in the quarter due to a strong impact from the Omicron surge early last year and by some storm activity during the same time period. The macroeconomic environment remains challenging with inflation pressure in consumer demand and input costs, and demand patterns continue to shift as the impact of the pandemic wanes. We adjusted our 2023 financial guidance to reflect those factors, but we believe the current environment is temporary, and we are focused on positioning ourselves for long-term success. Our investments in innovation, including the exciting nationwide launch of the DKB snack bars and digital and supply chain initiatives, are designed to enhance our competitive position. Some of these initiatives may impact near-term results, but they are crucial for enabling our growth plans. I'm excited about our prospects, and I've never been more confident in our ability to grow shareholder value over time. So, with that, Shannon, we are ready to take questions.

Operator, Operator

Thank you. Our first question comes from Steve Powers with Deutsche Bank. Your line is now open.

Steve Powers, Analyst

Hey, thanks and good morning, everybody. I guess picking up on those opening comments, just how much of the temporary transitory nature of the headwinds that you're seeing do you expect to improve within this year? I guess that wasn't clear from your prepared remarks last night? You know, in other words, are you assuming that things get better? Is it temporary within the year, or is it temporary over a longer period of time?

Ryals McMullian, President and CEO

Yes, Steve. I appreciate the question. Look, we are likely being a little bit conservative with the guidance just given the soft start to the year. We felt it was just most prudent to do that at this time. However, what we did see towards the end of the quarter was some pretty meaningful improvement. By that, I mean, our branded retail units turned flat to positive in several of the last weeks of the quarter. At the same time, private label share gains really started to come down. When we started off the year, I think in the first period of the year, we saw private label gain the most unit share that we've seen during this whole trade-down situation, gaining 120 basis points. By the end of the quarter, it was 50. So, we are starting to see that come down. It is still a tale of two channels in the sense that we're not seeing the same dynamics in grocery that we're seeing in mass. Most of the private label activity has been concentrated in mass. So, that's a continuation of what we've talked about in prior quarters. As to exactly when it's going to happen, it's a little difficult to predict, but I do have at least some hope at this point that things already look like they are beginning to get better, but for the time being, we've decided to be conservative.

Steve Powers, Analyst

Okay. So, I guess that's – so, you know, the soft start you called out, you know, in the year, I guess is evident in the data. And I guess what I'm trying to reconcile is, it seems like that would have been evident also to you when you've guided in early February. Things are getting better towards the end of the quarter. So, what got worse is my question?

Ryals McMullian, President and CEO

Well, yes, fair enough. The start to the year was softer than we expected out of the gate. It was significant enough to make us perhaps be a little bit more cautious about the health of the consumer than we were at the start of the year. I mean, we know it's going to be a challenging year, right? We said that, but given the really soft start, it turned out to be a little more challenging than we anticipated. Hopefully, that helps.

Steve Powers, Analyst

Okay. And I'll pass it on in a second, but just one more question if I could. Just you called out the temporary imbalance between capacity and production as a result of the softer start. I guess just could you elaborate a little bit on that in terms of what the implications are from a financial perspective? And then just the timeline you expect some resolution through the supply chain optimization work?

Ryals McMullian, President and CEO

Yes, sure. I mean, we're not going to quantify it. But I want to make it clear too that the imbalance was certainly a factor in the quarter. It is definitely not the factor. The factor is the consumer and the softness in the categories. I just want to be very clear about that, but we try to be transparent with you guys and give you as complete of a picture as we can as to what's going on, good, better, and different with the company. When we talk about our portfolio strategy and we've talked about not really so much the SKU rationales, I think that's kind of a common ongoing thing, but more of the business exits where we have elected to exit certain lines of business that were marginally profitable and really didn't have a chance to ever really meet our profitability thresholds through pricing or efficiencies or whatever. Those types of exits are what I'm referring to. Typically, those pieces of business do contribute at least a little something to the business, right? So, you're going to have a little bit of stranded cost when you add into those pieces of business. Now, over time as we've talked a lot about network optimization, that's where that comes into play. Once again, you've seen us do this; you've seen us exit the Phoenix bakery recently, but we've also converted facilities to organic production, all brand, that type of thing. That's what will take care of that. In addition to branded growth over time, we'll take care of that imbalance.

Steve Powers, Analyst

Okay. Okay. Thanks, Ryals. Appreciate everybody. Thank you.

Ryals McMullian, President and CEO

Sure. My pleasure.

Operator, Operator

Thank you. Our next question comes from the line of Bill Chappell with Truist Securities. Your line is now open.

Unidentified Analyst, Analyst

Good morning. This is [indiscernible] filling in for Bill Chappell. I appreciate the opportunity to ask a question. Could you provide more details about the price gap dynamics after the recent pricing adjustments? How have the major retailers responded to the new prices? Is it reasonable to think that the gaps might be closing, and will you need some time to address this? Any insights would be greatly appreciated.

Ryals McMullian, President and CEO

Yes. So, if you recall last year when we implemented pricing, the gaps between brand and private label did widen. Some retailers were holding their retail prices down. I believe it was late in the year or early this year those gaps started to narrow as the private label retails came back up. We have recently taken some additional branded pricing that goes into effect this month. So, there could be a much smaller increase in the gap because our branded price increases this round were quite a bit smaller than what we've done the last few rounds. So, that could widen the gap temporarily at least for a while, but it's too early to say because the pricing just went into effect, and we haven't seen the data yet.

Unidentified Analyst, Analyst

Got it. Understood. Thank you. And thank you for some of the color on the DKB launch. It seems like you guys are making some real progress there. Can you share some high-level thoughts on how you're performing versus maybe your internal expectations?

Ryals McMullian, President and CEO

Yes, we're still really excited about it. We’re in about 6,000 stores now, so roughly halfway to where we want to be by the end of the year. As far as us entering the retailers that we expected to, we're largely on track there. In terms of performance, where the bars have been in the market the longest, we’re doing really well. Where we're newer, it's a little bit lower. Yes, you expect that. We had just one retailer, in particular, where we had a few executional issues just on the front-end. We're getting all that taken care of, so those numbers are already starting to track better. All in all, we're in a really good position, and I'm super excited about where we're headed with the bars.

Unidentified Analyst, Analyst

Awesome. Thank you very much, and I'll pass it on.

Ryals McMullian, President and CEO

Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Robert Dickerson with Jefferies LLC. Your line is now open.

Robert Dickerson, Analyst

Great. Thanks so much. A couple of questions. I guess the first question is just with respect to that incremental pricing that's coming through. I know that was already discussed previously, just kind of where you're seeing the share trends as you're entering or exiting the quarter. Is there a scenario that plays out such that maybe you do need to promote a little bit more because I know, Ryals, you've said historically, right, it's not a very heavily promoted category, but at the same time, at some point, volume growth should matter. So, I'm just kind of curious how you think about that right now?

Ryals McMullian, President and CEO

Yes, absolutely. So, Rob, the branded pricing just went in. So, we can't really see any impacts from that just yet. I will tell you, we promoted a little bit more in the quarter. It wasn't terribly significant, but we did pick up a little bit as far as our activity went to your direct point. I know that particularly with – if you think about elasticities in our business, set the category, softness aside for a second, we're still performing very well against our elasticity models. We're outperforming virtually everything. Now, when you look at something like Tastykake, for example, where we don't have a stronger brand, we've had more elasticities there and have had to promote a little bit more from that standpoint, but that probably wouldn't be a surprise to anybody. Overall, we've seen some pockets of competitive activity from our competitors in the category, and our promotional level did tick up just a little bit in the category. But as of yet, Rob, I wouldn't call out anything terribly meaningful. I think we've got to continue to your point, watch the volume trends. Once again, they did start to get better, and we actually saw unit increases towards the end of the quarter, so that gives me a little bit of confidence. I just don't have enough of a trend line yet because it happened right at the end of the quarter to call it a long-term trend just yet. So, once again, that's why we're a little bit conservative with the guidance.

Robert Dickerson, Analyst

Got it. Got it. Okay. And then I guess just questions around input costs, kind of where the grain markets have gone, how that could potentially benefit you? I think in the prepared remarks you said there could be some kind of back-half benefit, but not really stating that there will be. It looks like you're 80% covered for the year. And then previously, it's probably about flat gross margin. So, just kind of wrapping all that in, gross margin was down, kind of as expected, maybe a little bit more in Q1. The guide comes down a little bit on EBITDA, which I'm assuming is gross margin-driven, while at the same time costs have deflated. So, I would assume at some point that does become a benefit. But I don't know if you're being conservative because maybe you need to reinvest some of that back in. So, a lot in there, but just trying to gauge how the gross margins could play out, right?

Ryals McMullian, President and CEO

I mean, the reality is, overall, we expect inflation throughout the whole year. The first half is definitely our toughest comp because we had pretty favorable hedges coming into the year last year. The inflationary environment around we really didn't begin to ramp until kind of early first half, and we would have been covered for most of that period last year. Looking into the full year and kind of thinking about cadence, obviously, the first half is the toughest back half. Like I said, we still expect inflation, a lot of it is driven by other buckets other than flour across the input bucket. You know, sugar is up, gluten is up pretty significantly, and we use quite a bit of gluten because of protein quality within the wheat. We're also seeing the yeast is up, honey, and several other smaller amounts of ingredients. While we do expect better and easier comparisons in the back half, we are expecting an inflationary environment throughout the whole year.

Robert Dickerson, Analyst

Okay. Got it. Fair enough. It's helpful. Look, I know you're not – it's not really your style to kind of speak to the next quarter, right, a quarterly guide, but I am kind of curious maybe in more general terms, we saw this EBITDA step down in Q1. Is there any way you can frame it? So, we kind of understand a little bit of the cadence as we get through the year? Like we'll probably again see more of a step down in Q2 relative to what we would expect in the back half? Just thinking about the midpoint of the updated guide?

Steve Kinsey, CFO

Obviously, I mean, you're right, we don't give quarterly guidance. So, when you think about the annual guidance that we've given from an EBITDA perspective, again, we do think it will get easier in the back half. Overall, from a cadence perspective, hopefully, Ryals said too, we're seeing improvement across markets coming out of the first quarter. So, not speaking specifically to any quarter, I think we should come in kind of in-line with some of the comments you've made and expectations.

Robert Dickerson, Analyst

Alright, great. Thank you, guys. Appreciate it.

Ryals McMullian, President and CEO

Thanks, Robert.

Operator, Operator

Thank you. Our next question comes from the line of Mitchell Pinheiro with Sturdivant & Co. Your line is now open.

Mitchell Pinheiro, Analyst

Hey, good morning. So, why do you think the environment is transitory and not – I don't know what transitory means, like is it a quarter, two quarters versus transitory, it's shorter than that? But the environment looks pressured and looks pressured for longer at least in our view. So, why do you see it as transitory?

Ryals McMullian, President and CEO

Yes. Mitch, I think the transitory to me means temporary, right? So, I don't think that this is a permanent situation that we're in. There are a variety of competing factors out there. I mean, you read the same stuff that we do: inflation continues to tick down. The job market looks pretty strong. I can't say with any assurance exactly when things are going to turn, but I do believe that they will. The reason I believe that is because eventually, we're going to come out of this inflationary cycle. Presumably, at some point, you have a recovering consumer. When you think about our business in particular and the trade down to private label, I firmly believe that the premiumization of the category is a long-term trend. I do believe that people will come back to differentiation. I do believe that people will come back to our top brands. That's why I believe that it's temporary now: is it two months? Is it six months? Is it nine months? Is it a year? I don't know that. But I do believe it will come back, and I think we'll be well-positioned to take advantage of it when it does. Once again, we're keeping up our brand investments; we're keeping up our market activity. We're investing in the business. We're investing in our team. We wouldn't be doing that if we believe that this was a permanent circumstance.

Mitchell Pinheiro, Analyst

You also talked about taking specific steps in the short term to mitigate some of these pressures. And I heard you said that you did step up promotion a little bit in the quarter, at the end of the quarter. What else are you doing in the short term?

Ryals McMullian, President and CEO

Well, obviously, cost-saving activities. I think we said in the prepared remarks, we're on track for our $20 million to $30 million for this year. All the investments that we're making in the bakeries from a digital standpoint, bakery in the future, in particular, which I'm excited to say, is really starting to show some nice returns. It took a while to gain some momentum, but once we got through the first period or so of this year, it's really starting to come on strong. That's going to be particularly meaningful this summer during the height of the summer bun season because we did not operate well last year. Our financial results were good last year; we really struggled in the bakeries last year. That's going to be a good comp for us coming up this year. You may also recall, we had some of the packaging issues in the second quarter last year that we'll be comping as well. We don't have those issues this year. We're in great shape from a supply chain standpoint. All those factors together help to mitigate not only inflation but just the overall macro environment that we're facing today.

Mitchell Pinheiro, Analyst

Okay. Thank you much.

Ryals McMullian, President and CEO

Thanks, Mitch.

Operator, Operator

Thank you. Our next question comes from the line of Connor Rattigan with Consumer Edge. Your line is now open.

Connor Rattigan, Analyst

Good morning, guys. Thanks for the question.

Ryals McMullian, President and CEO

Hi, Connor.

Connor Rattigan, Analyst

It appears that you are performing very well in the grocery sector. The main pressure is coming from the mass channel. I am trying to gain a clearer understanding of the situation. It seems reasonable to assume that budget-conscious shoppers are likely to switch from national brands to private labels. Have you typically observed consumers transitioning directly from a specific growth rate to private label and mass brands, or has this been a gradual decline? Also, for those consumers who have already made the switch, how can we work on bringing them back to branded products?

Ryals McMullian, President and CEO

Yes, exactly. Well, I think to the last part of your question, it goes back to the brand investments, frankly, no matter where they shop, whether they're shopping in mass, whether they're shopping at club, dollar, grocery; we have an omnichannel strategy. We look at all those different channels. The dynamics are interesting, though, because you're right, our grocery performance has far exceeded our performance in mass for a couple of reasons. One, there's been a channel shift. People across the income spectrum, quite interestingly, including your higher-income shoppers, are looking for bargains. Given the environment that we face, there's been a bit of that channel shift in the mass, in the club, in the dollar stores and away from grocery. That does play into it. However, for those shoppers that are still in grocery, outperformance has been really good. I mean, we were up in the unit share in grocery, and we were up across the board in every category. It is an interesting dynamic, but I think, to your point about how do you bring them back to brands if they trade down to private label? I think you've got to keep them front and center. We've got to be spot on with our display execution. We have to put our marketing dollars in the right places, whether that's digital or TV or whatever to keep these brands in front of people. It's also still about innovation; we're not slowing down our innovation just because of the environment we're facing. I think it's more important than ever now. Whether that's in our core category in terms of our keto or our Hawaiian products or whether it's outside of our core category in terms of the bars, keeping these brands front and center for consumers is more important than ever today.

Connor Rattigan, Analyst

That was great, Ryals. Really helpful. And then also just a quick follow-up too. On Canyon, I think in the prepared remarks, you guys commented that the track data was kind of skewed just given the sort of mix shift in sub-channel? I believe you guys quantified about 80 bps of share losses, but flat unit sales. How are shares looking when accounting for the club channel mix shift?

Ryals McMullian, President and CEO

So, the ultimate question is what is the share trend for Canyon when considering the mix shift in the club channel? I understand that in track channels, your share was down about 80 basis points, but I assume it might be better in the club channel when you factor that in. It is. It is. Yes. Our internal data indicates we're still up. We've got every confidence in Canyon. It's proven to be one of the most inelastic brands we have, which makes sense given some of the dietary issues with folks and gluten allergies. We’re still really excited about Canyon and frankly, from an innovation standpoint, we're really excited as well. We've just started with DKB from an innovation standpoint just because it's a bigger category. We've got some really nice opportunities to innovate both inside and outside the core with Canyon as well.

Connor Rattigan, Analyst

Alright. That was great. Thank you, Ryals.

Ryals McMullian, President and CEO

Okay. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Jim Salera with Stephens. Your line is now open.

Jim Salera, Analyst

Hi everyone, good morning. Thank you for answering our questions. Can you provide some follow-up on the Canyon situation? In your prepared remarks, you mentioned some challenges as you're rationalizing SKUs and managing product availability. Should we understand that your supply of Canyon products is limited, and that you've redirected some distribution towards club? As production capacity improves in the future, will there be an opportunity to replenish the SKUs in the track channels, or should we consider those as permanently reduced?

Ryals McMullian, President and CEO

No, no. It's a good news, bad news situation, right? Because we are a little bit strained with Canyon, but we're strained because it's grown so much. Once we get our capacity situation resolved, which we're obviously actively working on, we expect to refill in that space.

Jim Salera, Analyst

Okay. And then maybe more broadly, just across the branded portfolio, you talked about kind of the press gaps narrowing. Obviously, consumers are strained right now. But as things hopefully ease as the year progresses, do you think that the consumer will just gradually come back to branded or are you going to need to have some additional push to pull that consumer back into the branded portfolio if they've shifted towards private label?

Ryals McMullian, President and CEO

Yes, that's a really good question. I'll answer it in two parts. Frankly, it depends on what brand you're talking about? If you're talking about a brand like DKB, it has tremendous consumer pull. You don't have to do as much to draw people back to DKB because they want to come back to it naturally because it is so differentiated and high quality. Frankly, when you're talking about a brand like Nature's Own, yes, you're probably going to need a little bit more push there, hence the marketing investment. That's why we're not stopping that. We're not waiting for the consumer to get healthy before we start that marketing. We want to keep it front and center now, so that they want to come back to us. It depends on which brand you're talking about. Some will take a little bit more pushing than others, if that makes sense.

Jim Salera, Analyst

Yes, yes, absolutely. Should we think about from the levers that you guys have to pull to bring them back? Is it more traditional marketing, just making the consumer more aware or kind of highlighting the positives of the brand or is it promotion getting them to come back with an initial lower price point and then hoping that with the immersion as you pull the promotion as they kind of stay in the branded portfolio?

Ryals McMullian, President and CEO

Well, we certainly hope it's not in the latter. Sometimes you have to pull that lever, but I go back to execution as well. Display execution in our category, off-shelf display execution is so important in our category. Sometimes that does come with a promotion to bring people back to the brand. We've got to be best-in-class in that regard. If we can do that, and I believe we can when the consumer is ready, I think we're well-positioned to win. It's really – you've got a toolbox of things, right? You have marketing, you've got some hopefully limited promotions, you've got display execution, you've got minimal out-of-stocks, minimizing your e-commerce picks. All these things are important. It's not just one thing. You've got to have a mix of tools to be successful. Fortunately, from a promotional standpoint, as we've said before, we're so much better positioned now with the data that we have. When we do run promotions, we're getting a good ROI on that promotion and not just doing it for the sake of driving a week of unit volume.

Jim Salera, Analyst

Got it. And then maybe if I could sneak in one more question. Just looking at the DKB bar launch, I know we've still got a lot of opportunity to ramp that. The initial results that you guys are seeing, are there existing DKB buyers that are just expanding their buy rate and taking it into new categories? Or have you seen incremental buyers that maybe aren't DKB bread buyers that will buy the bar and then the hope that you kind of cross-pollinate that into the traditional brand category?

Ryals McMullian, President and CEO

Yes, it's both. This is why the opportunity for DKB is so interesting and fun to think about going forward. I've talked about the household penetration for DKB many times in the past, and it's actually still quite low. As a matter of fact, I was speaking with a recently retired Chief Marketing Officer from a major CPG company who had never heard of DKB before. This is a person who's in the business of marketing. It just goes to show you that as well as that brand is done, we still have a tremendous runway ahead of us, both with the core items and with new consumers. The answer to your question is it’s both. There are people discovering bars that may not even know that the bread exists and vice versa. We're also doing things from a shopper marketing standpoint to cross-pollinate that and encourage it more.

Jim Salera, Analyst

Okay. Great. Thanks, guys. I’ll pass it along.

Ryals McMullian, President and CEO

Thank you.

Operator, Operator

Thank you. I'm showing no further questions at this time. I'd like to hand the call back over to Ryals McMullian for closing remarks.

Ryals McMullian, President and CEO

Okay. I want to thank everybody for taking the time today and joining us for questions. Thank you very much for your interest in our company. As always, we look forward to speaking with you again next quarter. Take care.

Operator, Operator

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