Flowers Foods, Inc. (FLO) Q4 2021 Earnings Call Transcript

Flowers Foods, Inc. (NYSE: FLO) Q4 2021 earnings call dated Feb. 11, 2022

Corporate Participants:

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

A. Ryals McMullian — President and Chief Executive Officer

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Analysts:

Jim Salera — Stephens — Analyst

Donald — Truist Securities — Analyst

Rob Dickerson — Jefferies — Analyst

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Ryan Bell — Consumer Edge Research — Analyst

Presentation:

Operator

Good day, and thank you for standing by. Welcome to the Flowers Foods Fourth Quarter and Fiscal Year 2021 Results Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mr. J.T. Rieck, Senior Vice President of Finance and Investor Relations. The floor is yours.

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

Thank you, and good morning. I hope everyone had the opportunity to review our earnings release and 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; and Steve Kinsey, our CFO.

Operator, we’re ready to start the Q&A please.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Thank you. Our first question comes from Ben Bienvenu of Stephens. Your line is open.

Jim Salera — Stephens — Analyst

Hi. Good morning, everyone. Jim Salera on for Ben. I wanted to ask a little bit about inflation moving into the New Year. I guess, first of all, on the January 2022 price increase, how long do you think that will take to get fully implemented? And then maybe you can talk a little bit about the cadence expectations for inflation in the year.

A. Ryals McMullian — President and Chief Executive Officer

Sure, thanks — thanks for the question. The January price increase is, is in large measure — there is a few small pieces of it that’s just due to contracts rotating over, but the lion’s share of the pricing, genuine price increases is already in for the year.

Jim Salera — Stephens — Analyst

I think you guys talk maybe a little about expectations, kind of as the year progresses for inflation.

A. Ryals McMullian — President and Chief Executive Officer

Sure. When you look at the overall inflationary environment, obviously we’re building in Q4. So in 2022, yeah, 2022 as we said, we expect it to ramp throughout the year and then obviously Q4 costs. While we still have inflation here, we’ll pull back slightly. So you should see a ramp and then Q2, Q3, would probably be the highest cost and then it pulls back slightly.

Jim Salera — Stephens — Analyst

Okay. And if I could sneak in one more question. In regards to freight, you guys have a hedging position on freight costs or do you have any visibility into what freight costs might do into 2022?

A. Ryals McMullian — President and Chief Executive Officer

There are two things on freight. One, if you recall, our biggest transportation cost is around our DSD network, so we turn that into a closed loop network. We actually have three primary haulers who take products from the bakeries to the warehouses. So those contracts are yielding on a couple of years in advance. But we are seeing elevated cost for those as well.

And then from a kind of open market transaction on our warehouse business, we have to go to the market from time-to-time for product delivery there, but we do not hedge, so we try to buy a forward as much as we can. But the reality is, like most companies will be in the kind of the current market on the 3PL situation.

Jim Salera — Stephens — Analyst

Okay, great. Thanks, guys. I’ll pass it on.

A. Ryals McMullian — President and Chief Executive Officer

Thank you.

Operator

Thank you. And next we have Bill Chappell of Truist Securities. Your line is open.

Donald — Truist Securities — Analyst

Hi, good morning. This is Donald [Phonetic] on for Bill.

A. Ryals McMullian — President and Chief Executive Officer

Good morning.

Donald — Truist Securities — Analyst

I wanted to ask a question on any color you could provide an foodservice business versus 2019 levels? And also with regards to the current inflation on the cost front, how much of that would you attribute labor? And do you believe as the time where that could play to at some point? Thank you.

A. Ryals McMullian — President and Chief Executive Officer

Sure. The foodservice business as you saw did recover some in the fourth quarter and we saw that sort of through the second half of the year last year. It’s still below 2019 levels, but there has been some recovery there. As you know, we’ve been doing a lot of work on our foodservice business to improve the profitability of it as it does come back, because obviously we’ve been expecting at least some amount of reversion as we hopefully start to exit this pandemic situation. But it — it does still remain below 2019 levels. And conversely, our branded retail business continues to hold up really, really well given the continued at-home eating trends, our investments in our — in our premium brands, etc., have all helped that business to maintain its place as part of the mix. You want to address this question?

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

When you look at — and I think your question was on around labor inflation. I mean, we’re really no different than other companies. I mean, the labor market is really tied as you know, so we’re expecting kind of mid to — low-to-mid single digit labor inflation throughout the year depending on which market you are in.

Donald — Truist Securities — Analyst

Okay, thank you very much.

A. Ryals McMullian — President and Chief Executive Officer

Thank you.

Operator

Hank you. Up next we have Rob Dickerson of Jefferies. Your line is open.

Rob Dickerson — Jefferies — Analyst

Great, thanks so much. Just a couple of questions. I guess, first one, I missed by first minute of the call. So sorry if you already spoke to this. Just in terms of the, I guess the gross margin and EPS potential cadence for the year. I know in the prepared remarks you were kind of speaking to kind first half, back half-ish with some moving pieces, obviously in the back half where kind of given what we saw in Q4, should the market kind of be expecting, let’s say similar year-over-year gross margin that kind of plays out in Q1 despite the higher pricing and then just kind of an earnings kind of implied kind of flattish in Q1? Just whatever you’re willing to disclose would be great. Thanks.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, sure, Ralph, I mean, obviously we don’t give guidance on gross margin specifically and definitely not by quarter. But I’d say overall we are expecting some pressure on the gross margin line. So it should be down on a year-over-year basis when we get to the full year. From a cadence perspective, obviously our inflationary cost will build throughout the year and then because of the experience in Q4 we’ll see some of that pull back, if you will. And then, Ryals talked briefly about pricing, you may not have heard the comments. But we do have our January price increases pretty much in and then we anticipate in certain categories or certain distribution segments more pricing coming. So that will build through the first half as well, and then depending on the inflationary and what really happens for the inflationary environment, while we do have hedges on and we said we’re about 70% covered for the year, obviously we still have some open coverage in the back half. There could be potential that things don’t moderate somewhat. We would even look at again some pricing initiatives as well. But we expect, kind of just like we said in the release, the cadence I think will build a lot of our savings initiatives, starting to come in Q3. So we do anticipate a build from that perspective with regard to overall margin for the year.

Rob Dickerson — Jefferies — Analyst

Okay, perfect. That was helpful. And then kind of simplistically, again probably for you, Steve, and then one for Ryals. Just the topline guide for the year I’m assuming kind of what we’re seeing is maybe all that’s driven by pricing, maybe volumes you’ve kind of implied or maybe down low-single digit and I’m just kind of basing this off of kind of level of pricing, it’s all in Q4, but then also kind of what we already see in the January data set on the track side. So just kind of any kind of perspective on kind of that rate of pricing as of now excluding any additional pricing? Sounds like you’re kind of talking high single-digit-ish. Is that fair?

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, when you look at the track channel data, I mean, we’re still seeing some positive mix. So that’s also helping drive. But obviously as in Q4, pricing is a big driver of that. So, and we expect you would see that throughout most of the year.

Rob Dickerson — Jefferies — Analyst

Okay, fair enough.

A. Ryals McMullian — President and Chief Executive Officer

Rob, we’re pretty optimistic thus far on — on elasticities. Yeah, if you look at the — if you look at the syndicated data, this is from IRI for period one, which is essentially January of this year and this would have followed the significant price increase in January, were up 15.3% in dollars, but we’re also up 5.3% in units with both of which are ahead of the category. So, point is the early returns on the price increase is holding and those will almost, and particularly for branded retail those volumes holding up are pretty optimistic, so that gives us confidence going into the — going into the year. We want to continue to watch it and see what the consumer does, how much they’re able to absorb, but early returns are looking promising.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, I think your volumes are actually up year-over-year sequentially relative to December despite the price increase, so that — it’s a good sign. So just a lot to still play out.

Rob Dickerson — Jefferies — Analyst

All right, cool. And then just Ryals for you. You know, bakeries of the future. Ryals, you been speaking about this for some time. It sounds like given your prepared remarks that you’re have a number of pilots that will be in the market across a lot of your bakeries by the end of this year. You know, the savings are speaking to kind of so far and then through ’22 doesn’t seem like it’s really contingent on bakery of the future, but obviously bakery of the future would provide, I would think some material savings in the out years. So is that something that kind of starts to kind of go in to your network this year and that’s kind of more of a ’23 and forward optimization upside potential piece? Anything out there.

A. Ryals McMullian — President and Chief Executive Officer

Yeah, no, exactly. I mean, we do start — we do expect to start to see benefits from bakery of the future of this year and as you saw in the prepared remarks we’ll — we’ll have it rolled out to half of the bakeries this year on the back of three or four pilots that we’ve done over the last several months. So we do expect the cadence of savings to begin this year, but we also expect as you indicate that that will ramp up in ’23 and ’24.

Rob Dickerson — Jefferies — Analyst

All right, cool. Thank you. Pass it on.

A. Ryals McMullian — President and Chief Executive Officer

Thanks, Rob.

Operator

Thank you. Next we have Mitchell Pinheiro of Sturdivant & Co. Your line is open.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Hey, good morning.

A. Ryals McMullian — President and Chief Executive Officer

Hey, Mitch.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Hey, just a follow-up there on bakery of the future. So number one, you know, how disruptive is to, to change over a bakery into — from current to a — to the bakery of the future mode? Is it, is it, like what are we talking? What’s happening? Is it just you’re moving some servers around and they have more computer screens out there or are you shutting down lines and, and things like that? Can you talk about that a little bit?

A. Ryals McMullian — President and Chief Executive Officer

Yeah, sure. So from an operational standpoint it’s not disruptive. So, we’re not having to shut things down. It’s mostly — this is mostly data driven type stuff at this point. I mean, obviously we’re doing some automation work, robotics and that type of thing which is little bit of a different story. As you know, we did that Navy Yard, but the pure initial for us for bakery of the future is mostly around data, better data, more real-time data, driving out inefficiencies, lowering scrap costs, etc. So from an operational standpoint, Mitch, it’s not disruptive hardly at all.

The way that it is somewhat disruptive is it does require us to change the mindset of the bakeries. And that does take a little bit of time. These folks have operated in a certain way for a very long time and you bring it all this fancy digital equipment and try to sell them on the prospects for improvement it can provide, and that takes a little bit of time to educate them on how it can benefit them, make their — make their daily lives easier and improve the performance of the bakery. So it’s really — it is much of a change management exercise as it is anything else. But so far we’ve been very pleased with the receptivity of the bakeries.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

And then a lot of that is — so, so how does that dovetail with the new ERP program? I mean, I haven’t been shopping for any on ERP program personally, but I was sort of stunned to see $275 million the cost for five — over five years. What, where, like where is that being spent? Is that just all software costs with a little bit of hardware? I mean, what — that’s a big number or maybe is it not a big number.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, I mean, when you look at these, these projects and you look kind of across kind of our peers as well, these are not — these are not cheap projects that’s built. As we’ve said in the release, about 40%, 50% of the cost will be capitalized and the rest will — will be cost of primarily implementing and rolling out the project itself. But when you look at the ERP itself, a lot of that is technology driven and will be kind of a foundational enabler for bakery of the future. The majority of the cost runs through ERP are not necessarily through kind of the digital work around bakery of the future. But to your point, it’s not an insignificant cash flow item and a large part of ERP cost from a capital standpoint will come this year. So you should begin to see that tell also over the next four years or so.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Okay. Okay, and then when you go back and just look at some of the balance sheet numbers, like if you look at your fixed asset turns and things like that, it was kind of stuck and like I was sort of expecting as we sort of roll through bakery of the future and as you like sort of — sort of adjust your your, your capacity and things like that, are we going to see, I mean, are we gong to see better fixed asset turns going forward? I mean, I realize that baking is a regional business when it comes to manufacturing, you need to be near your markets. But are we going to see some leverage here where you can go several years without adding capacity because you’re — you’re finding it through your efficiencies or is what your fixed asset turns, is it going to be sort of set for a while? We’re really not going to see much improvement there. Can you talk a little bit about that please.

A. Ryals McMullian — President and Chief Executive Officer

Well, a couple of things there, Mitch. One, obviously our aim is to significantly improve the efficiency of the bakery, so that in itself will help us create some capacity. But also remember we are doing some some work via our customer strategy to over time as we shift more of the mix branded retail to convert some of that lower margin business into our branded business and you’ve seen examples of that in Tuscaloosa and much for with the — with the organic conversions and we’ll continue — we’ll continue to do that.

But those — those those customer strategy has also opened up opportunities for us to further optimize the network. You point out that in our fresh business we do need to be relatively close to the market, but we don’t have to be as close as we used be, with some of the enzyme [Phonetic] technology that’s out there now that we’re already utilizing, that 250-mile radius is not as relevant as it once was. So that opens up additional opportunities for us as well.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Okay. Just moving on, as far as foodservice. What type of initiatives are you taking to improve profitability there? Can you give us some examples?

A. Ryals McMullian — President and Chief Executive Officer

Yeah, sure. I mean, look, price is the most obvious one and we’ve — we’ve said many times that we do have some accounts that are — that are underperforming, so we continue to work on those. Some of those are under contracts, they do — they do take some time, but price is certainly one lever, our own efficiencies or another. This is not — this is not all about the customers incumbent upon us to be as efficient as possible. So those are — those are two things. But also our method of delivery too, because some of these — some of these accounts are still DSD, which is a pretty expensive route to market as you know and converting them to a more optimized distribution model can help as well. So those are just a few of the levers we’re pulling.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Okay. And then final question on M&A. Your balance sheet is in terrific shape, you have some great low cost fixed debt. Now you have ample room on your revolvers. You still generate plenty ample free cash flow next year based on my estimates. So I know that you’re going to stay disciplined, you’re going to find the right thing, but I mean, how — how close are we — should we expect to see some M&A this coming year? And I know you can’t predict timing, but are we, I mean, is it – is it still like market is really on the radar right now or are there things that are working that, that we shouldn’t be surprised to see something in 2022?

A. Ryals McMullian — President and Chief Executive Officer

Yeah, Mitch, I mean, we’ve been saying for some time now in our app — our appetite rather for M&A is certainly, certainly high. It’s been a while since we’ve done one. We have a good pipeline of opportunities that we continue to look at. Just for one reason or another we have a — we haven’t pulled the trigger on one because of — because of fit or price or price or a combination of the two, but we continue to be active in the space and I don’t — I can’t predict what’s going to going to happen this year and wouldn’t want to sort of prognosticate there, but done just know that we’re — we continue to be active in that market.

Mitchell Pinheiro — Sturdivant & Co. — Analyst

Okay, all right, thanks for, thanks for the time.

A. Ryals McMullian — President and Chief Executive Officer

Thanks, Mitch.

Operator

Thank you. [Operator Instructions] Our next question comes from Ryan Bell of consumer and Research. Your line is open.

Ryan Bell — Consumer Edge Research — Analyst

Good morning. I just had a quick question about the ERP upgrade and sort of the efficiencies that would be provided by it. Is there sort of any savings number that you could talk to be softening on the cost side? Just trying to understand exactly what you get out of that program.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, I think a couple of things on the ERP upgrade. One, SAP is our enterprise-wide ERP system. The reality is, one would say we’re forced, but we had to make a move because SAP has been to their S/4HANA platform across the whole platform across the whole. So at some point, service for our ECC platform will drop off, so that’s driving a portion of the move — the move in the cost. Secondly, because we have to make that move because of the digital initiatives, they were looking at things that will enable the productivity needs or hopefully drive long-term efficiency across the bakeries. So there will be efficiency gains that have come out of this initiative. But we are not disclosing those at this point.

Ryan Bell — Consumer Edge Research — Analyst

Okay, thanks. And then just a broader question about the evolution of your portfolio as we’re seeing a bit more normalization of the environment. Obviously, the branded part of your business has been doing really well and just trying to understand how you think about the shift in the migration towards branded, how much of that can continue? And then in terms of the private label trends, why — why do you think they’re actually so soft despite some of the pricing up coming through from the — from the industry standpoint?

A. Ryals McMullian — President and Chief Executive Officer

Sure, yeah. This Ryals. So on the private label side, I mean, we’re really seeing the continuation of a trend that’s been — that’s been going on for over five years now, and it certainly seem to accelerate during the pandemic. But even as we kind of get towards the end of that we’re seeing — we’re seeing similar trends, I mean it was — it was down rather significantly again in the fourth quarter. We’re seeing it — we’re seeing it down in units, is up a little bit in dollars so far this year. But in terms of units its down even as we start this year. And what we would point to through our research is you’re — you’re seeing a premiumization trend in the category, where people are really gravitating towards more differentiated items, and obviously we’ve benefited significantly from that with the branded portfolio that we have today, particularly when you think about Dave’s Killer Bread and Canyon and then on the Nature’s Own side, particularly the Perfectly Crafted subline for Nature’s Own have done extremely well. Canyon and Dave’s were both up double digits in the fourth quarter. We’re seeing that trend continue even after the — those are already premium items and after the price increase in January we’re seeing that trend continue. So it, it really demonstrates the consumers’ preference for a premium quality differentiated item and typically with private label in our category you don’t see a lot of that. And so that’s kind of, that’s the primary driver.

And then as we think about the prospects for our brands going forward, with the innovation we’re bringing to market. We mentioned the DKB snack bars that we’re really excited about and early returns on those have been fantastic. Really shows you that these strong brands can play across categories, which obviously gives us opportunity outside of our our core space, if you will.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Hey, Ryan, this is Steve. Just one quick follow-up on your benefit question around the ERP plus. When we stared this project, the discussion there was and Ryals has said it many times as well. Part of — part of this initiative really is going to be the enabler to drive productivity that helps us hit the long-term targets we have out there. So we, we really expect in those target ranges to see the benefit from the digital and ERP initiatives and that hopefully will drive us somewhere to the upper end of our range, but that’s the — that’s really how we’re looking at it more internally.

Ryan Bell — Consumer Edge Research — Analyst

Thanks. And then just one last one for me. In terms of what you’re seeing from a pricing standpoint, I know you’re talking about the premiumization trend across the category. Just, is there a sense as to how much of the pricing is actually being driven by mix shift and stronger demand for products like Canyon’s and Dave’s versus sort of pricing on an individual product basis?

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

With the pricing that we talking about, I think Ryals talked briefly with the current IRI data from period one. We’re seeing it really across the — across the whole branded portfolio. Obviously, your premium products are going to drive more — any increases, but so far we’ve taken pricing across, I would say the whole, not specifically ne brand.

Ryan Bell — Consumer Edge Research — Analyst

Thanks, that’s it from me.

A. Ryals McMullian — President and Chief Executive Officer

Thank you.

Operator

Thank you. [Operator Instructions] We have a follow-up from Rob Dickerson of Jefferies.

Rob Dickerson — Jefferies — Analyst

Great. Just a clarification question, Steve, on cash flow in Q4. It was a little light. I’m assuming there were probably some working cap headwinds on the inventory side. So maybe just explain if that’s right. And then the only other question I have is just on the purchase of the lease portfolio. I’ve rarely seen that line item pop up and I’m not sure if that’s part of the bakery of the future optimization plans. Maybe just those two quick — two quick questions.

R. Steve Kinsey — Chief Financial Officer and Chief Accounting Officer

Yeah, I mean, when you look at kind of the fourth quarter on the lease portfolio, there was an opportunity that came to us kind of mid-quarter with regard to that. It was a collection of several warehouses and it fits in with our warehouse optimization strategy. So it did give us the ability to take out some leases and now we have some flexibility to look at how we’re going to utilize these warehouses or potentially combine some warehouses. So that does fit in with that long-term strategy. And then the remainder of the elevated capex in Q4 was primarily driven around some of the project work, if you will, the transformation and then obviously [Phonetic] you’ve alluded to in the kind of working capital.

Rob Dickerson — Jefferies — Analyst

Got it. Very cool. Thank you.

A. Ryals McMullian — President and Chief Executive Officer

So, Rob, thank you.

Operator

Thank you. And I’m seeing no further questions in the queue. I’ll turn it back over to the speakers for closing comments.

A. Ryals McMullian — President and Chief Executive Officer

Well, thank you for your interest in Flowers Foods. Appreciate your time today. Goodbye, everybody. Have a good weekend. Thank you.

Operator

[Operator Closing Remarks]