Flowers Foods, Inc. (FLO) CEO Allen Shiver on Q4 2018 Results - Earnings Call Transcript

Flowers Foods, Inc (NYSE:FLO) Q4 2018 Earnings Conference Call February 7, 2019 8:30 AM ET

Company Participants

J.T. Rieck - Vice President of Investor Relations and Treasurer

Allen Shiver - President and Chief Executive Officer

Steve Kinsey - Chief Financial Officer and Chief Administrative Officer

Conference Call Participants

Brian Holland - Consumer Edge Research

Bill Chappell - SunTrust Robinson Humphrey

Operator

Welcome to the Flowers Foods Fourth Quarter and Full Year 2018 Results Earnings Conference Call and Webcast. My name is Elin, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded.

I will now turn the call over to J.T. Rieck, Vice President, Investor Relations and Treasurer. Mr. Rieck, you may begin.

J.T. Rieck

Thank you, and good morning, everyone. Our fourth quarter results were released yesterday evening. The earnings release and our updated investor presentation is posted in the Investors section of the Flowers Foods website.

Before we begin, please be aware that our presentation today may include forward-looking statements about our Company's performance. Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters we will discuss during the call, important factors related to Flowers Foods business are fully detailed in our SEC filings.

With that, I will make some introductions. Participating on the call today, we have: Allen Shiver, Flowers Foods' CEO; and Steve Kinsey, Flowers' CFO.

Allen, I'll turn the call over to you.

Allen Shiver

Thank you, J.T., and good morning. Before we begin, I will review this past quarter and year, I want to take a moment command our Flowers’ team for their hard work. 2018 was year two in our five year journey to reposition Flowers Foods as a national consumer focused food. Substantial progress was made against our strategic priorities even as the team navigated unexpected disruptions.

I’m confident Flowers is well positioned to drive shareholder value. We have leading brands and a national footprint in a large and stable category. Our scale and relevancy with our retail partners enables us to leverage our distribution platform to strategically add differentiated products to our portfolio and drive profitable growth.

Now turning to the quarter. Overall, our fourth quarter performance was consistent with our expectations. Our brand portfolio is performing well. Once again, we achieved record market share for the quarter. We gained market share and buzz the loaf and breakfast segments. In each of our top three bread brands, Nature's Own, Dave's Killer Bread and Wonder increased their share of the category.

I want to point out that we have accomplished the share gains with less promotional activities this quarter compared with the year ago. I'm pleased with the top-line. However, earnings growth remains a major focus for our team.

Commodity and transportation cost have been still headwinds to margin over the past two years. We have been able to partially mitigate these headwinds to our savings initiatives which have offset more than $80 million of these costs since 2016.

In addition to attacking our cost, we have taken pricing where appropriate. We continue to review pricing market-by-market and we will adjust when necessary. We made progress on our strategic goals last year, and you will see us continue to execute on our sentential playbook.

In 2019, we will continue to drive focus on three main priorities. First, we are invigorating our core brands to profitably drive share, capitalizing on adjacencies and improving supply chain productivity to improve margins.

First, we have a focus on profitably growing share by continuing to reinvigorate our core brands through innovation and marketplace execution. The renewed focus we have put on our highest potential brand has led to additional space and improved shelf position.

This is helping us grow sales in expansion markets as well as gain share in core markets. We believe that has the retail landscape evolves and omnichannel shopping increases, the strength of our leading national brands and our reputation for serving the market will only become more important.

Today, Nature's Own is a number one lope bread brand in the category and strong consumer response to the recently introduced Nature's Own Perfectly Crafted is driving incremental market share for the brand.

DKD is the number one and the organic segment that is driving growth in the entire category. We have been pleased with the rollout of DKD's breakfast items and Wonder's powerful brand recognition continues to be a driver of market share growth.

We know our brands must continue to be market leaders, to help ensure that we have significantly increased our investment in innovation and in marketing. Our marketing team is focused on translating unique consumer insights into innovation and brand loyalty.

These efforts combined with our continued excellence in service to the market is how we intend to drive consumer demand and profitable growth. Our next strategic focus is capitalizing on adjacencies. The large size of the category over 30 billion will provide ample opportunities for substantial growth.

We continue to look for strategic M&A prospects in underdeveloped product segments and geographies that leverage our competitive advantages and align with our value creation strategies.

Our recent focus has been extending our portfolio beyond traditional loaf breads. We have been very pleased with DKD's move into the breakfast segment. We are also growing share in this segment for the Sun-Maid license.

It's only been 8 week since the Canyon acquisition close and integration is going well. The rollout of the brand across our DSD network is already underway and we will continue to ramp up during 2019. As we increased capacity in the Canyon Bakery.

Canyon Bakehouse demonstrates execution against our strategic priority to capitalize on adjacencies. We believe Canyon provides incremental growth and allows us to leverage our banking expertise through our distribution network and retail partnerships to reach more consumers and increased brand equity.

And the final and important strategic focus is increasing supply chain productivity to improve margins and drive earnings. Over the past two years, our team has done a great job realizing significant savings from various initiatives under Project Centennial.

As part of this, we have developed better methods to identify savings opportunities and track our progress. This new processes are now a core capability that will help drive our ongoing productivity programs.

We are also working on a multi-year supply chain optimization project to address our fixed cost structure. This initiative is essential to achieving our long-term margin targets and enhancing returns on our capital investments.

One important aspect of this project is taking a sharper look at contribution margins across different channels and product lines. In many of our bakeries, a single production line can produce a variety of products for branded, store branded and non-retail segments.

Our objective is to take advantage of this flexibility and optimize for higher value production visions. One example of this, is a high-speed bun line, we installed in our Oxford, Pennsylvania bakery. This allowed us to better utilize the infrastructure at the Oxford bakery and to close the less efficient bakery in Brattleboro, Vermont.

Another example is we are adding organic production capabilities for one of our bakeries in the Northeast. When this project is completed, we can improve service to the Northeast market, while also lowering transportation costs.

In summary, our supply chain optimization project is a major opportunity for the Company and we believe the steps that we are taking, will drive significant productivity improvements. As we work towards our 2021 margin targets.

I do want to give you a brief update on our snack cake business. Improving this business will continue to be a major initiative in 2019. We are already making significant progress, streamlining the product assortment, improving price mix and exiting low margin business. Now it's about driving growth. We have a solid pipeline of new cake products and we look forward to improved results in 2019.

To recap, we have made important progress in 2018, we have reinvigorated the company and we are laying the foundation for sustainable, profitable growth. We have reduced cost and added new capabilities that have helped partially mitigate inflationary pressures.

Our team continues to work towards our long-term goals and deliver shareholder value. As we enter 2019, our 100th year, we have confidence in Flowers Foods’ continued growth. The bedrock of our business is our portfolio of leading fresh bakery brands headlined by Nature's Own, the number one loaf bread in the U.S.

By reducing fixed cost and improving productivity in our bakeries, we believe our team is taking the right steps to drive free cash flow from our business. With this cash flow, we can invest in growing segments and leverage our distribution capabilities, our manufacturing scale and retail relationships to grow earnings and shareholder value.

Now, I will ask Steve to review the financials and provide our outlook for the rest of the year. Steve.

Steve Kinsey

Thank you Allen and good morning everyone. As Allen stated, the quarter was in-line with our expectations. Good top-line performance was offset by continued margin pressure from cost inflation, primarily in commodity and transportation.

Lower volumes in core product line continues to pressure our manufacturing efficiencies. We did close the acquisition Canyon Bakehouse on December 14th. Due to immateriality Canyon's results for the last recent quarter were excluded from the fourth quarter and will be reported in our first quarter of fiscal 2019.

Turning to the details of our fourth quarter financial performance. Consolidated sales were up 80 basis points, volume was down 1.8% while price mix increased 2.6%. We continue to experience strong volume growth in DKB and growth in our expansion markets. Pricing actions across many product lines and growing sales of DKB primarily drove the increase in price mix.

We did experience lower volumes in the quarter in our food service, vending and cake businesses. As I mentioned last quarter, we are working to improve price realizations in these areas, and so we are taking a more selective approach with low margin high volume business.

Consolidated gross margins declined 70 basis points as a percentage of sales. This was primarily due to higher outside purchases and ingredient cost and lower manufacturing efficiencies. Excluding items affecting the variability detailed in the press release Adjusted SD&A expenses increased 50 basis points as a percentage of sales.

Overall workforce related cost were lower due to the organizational changes and lower incentive compensation. These decrease were more than offset by increased distributed discounts, marketing costs and shipping and holding cost. The higher distributor discount as a percent of sales is generally attributable to the sales of Company owned territories.

Higher production cost and higher adjusted SD&A as a percentage of sales resulted in adjusted EBITDA margin decreasing 150 basis points for the quarter to 8.9%. Earnings per share for the quarter was $0.10 per share.

Excluding the items affecting comparability detailed in the press release adjusted diluted EPS in the quarter was $0.16 per share. Few items below the operating lines did influence adjusted EPS relative to our forecast.

First, our effective tax rate was lower than we forecasted. This added approximately $0.01 to EPS. Second, as part of our pension de-risking process, we had started a more conservative asset allocation in-line with our past to plan and termination. This reduced adjusted EPS by approximately $0.01 in the quarter offsetting the benefit from the lower effective tax rate.

Now turning to segment level financial results. DSD segment revenue was up 1.2% in the fourth quarter. Price mix increased 2%, while volume decreased 0.8%. Our price mix this quarter was driven by the growth of DKB and the pricing actions we implemented during the year to address input costs inflation.

Volumes were impacted by lower food service volumes. Adjusted operator margin in our DSD segment was down 170 basis points as a percent of sales versus the prior year. We continue to experience lower manufacturing efficiencies, as well as higher input costs and distribution costs.

Warehouse segment revenue was down 1.5% in the quarter, price mix increased 3.1%, while volume decreased 4.6%. Price mix was driven by pricing actions. Volume declines occurred primarily in our cake and vending businesses. Adjusted warehouse operating margin improved 20 basis points as a percent of sales, primarily due to improved price mix.

Turning to cash flow for the year. Cash flow continues to be strong. Operating cash flow for the year was 296 million, as compared to 297 million in the prior year. Keep in mind, in 2018 there were several discrete cash uses, the totals over 100 million. These investments allow us to streamline our workforce, reduce risk associated with our pension liabilities and position the Company were continued growth.

These cash uses were mostly offset by the cash generated from our payment terms extension initiatives. A lower effective tax rate and bonus depreciation. Capital expenditures were 99.4 million in 2018 as compared to 75.2 million in 2017.

Dividends paid during the year, totaled a record a 150.2 million, a 6.5% increased year-over-year. We ended the year with 976.2 million in debt. At quarter end, our net debt for trailing 12 months adjusted EBITDA was 2.4 times. Our financial position remain solid. As of quarter end, we had approximately 492.9 million of liquidity available on our credit facilities.

Now turning the guidance. For 2019, we expect sales growth in the range of 3% to 4%. This includes Canyon’s sales expected to be in the range of 70 million to 80 million, accounting for approximately 1.8% to 2% of the total sales growth.

The balance of our top-line outlook is driven by price mix, partially offset by conservative yield volumes. For 2019, we are targeting adjusted EPS in the range of $0.94 to $1.02 per share. In 2019, we expect continue in inflationary pressures in commodities, transportation and labor of approximately 150 basis points as a percentage of sales.

We intend to mitigate these costs through comprehensive cost savings and productivity initiatives. These initiatives are being supported by new capability that enable improved tracking and enhanced accountability.

As Allen mentioned, improving price will also be used to offset cost pressures from inflation. We continue to expect Canyon to be accretive to EBITDA in 2019, but it will be slightly dilutive to overall EPS.

As stated in the release, we expect depreciation and amortization of $150 million to $155 million. Other official expense of $2.5 million to $3 million, net interest expense was approximately $12 million. We expect our effective tax rate to be in the range of 24% to 25% before discrete items and we are also forecasting weighted average shares outstanding of approximately $212 million.

Capital expenditures are expected to be between $110 million and $120 million. We expect robust free cash flow generation in 2019. Our long-term capital allocation priorities remains consistent with our focus on maximizing return on invested capital and growing shareholders value.

We will continue to invest in our brands and bakeries as well on the way that strengthen the capabilities of our team. Strategic acquisitions to diversify and enhance the profitability of our portfolio will also be our priority. We will do this while maintaining an investment grade financial position and continue to return values to shareholders through dividends and opportunistic share repurchases.

Now let's open the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. Our first question is from Amit Sharma from BMO. Please go ahead.

Unidentified Analyst

Hi there. This is [indiscernible] for Amit. Thanks for taking the questions. I just want to first start out with the incremental pricing from commodity inflation. Can you talk about you know as this is - that you have seen those hard from the incremental pricing and that is within your expectations.

Allen Shiver

The pricing that we have taken again it is in the market and we are encouraged with the overall consumer reaction. If pricing varies by market, it varies by brand and product line, but overall the pricing that has been taken its encouraging.

I think the real key here is having product that have a meaningful point of difference and the consumer understands that the costs are going up and the pricing that we have taken. It's encouraging to see the reaction so far.

As we look forward, again pricing will continue to be an opportunity for us to address issues as a cost continue run up. So pricing will - as in the past it will continue to be a very much of a priority for us.

Unidentified Analyst

Thanks. And then kind of transitioning to the guidance. Can you talk about anything differently that you have done this year in regards to the plan. We had two guidance calls last year, wanted to hear before that. So can you just talk about maybe any different controls that are in place for this year?

Allen Shiver

You know I think as we have implemented kind of the early phases of Project Centennial, the organizational structure changes that we have made are really selling down from an overall leadership standpoint. I'm very encouraged with the progress that is being made and organizational structure, Steve may have other comments.

Steve Kinsey

Sure. I mean, when you look at the guidance for 2019, we did do a couple of things I would say a little differently. When you look at the top-line guidance as Alan mentioned price mix is a big driver of that. I would say we also are taking somewhat conservative view on four volumes, we are looking at your flat to down low-single-digits, the category has been down slightly.

And coming out of Q4 in 2018. Even though, we did take pricing actions, you could see, some impact on overall volume. So on the top-line, I feel like we have taken a conservative approach, while still being able to hit within our long-term guidance target of the 2% to 4% coming out of Project Centennial.

You may recall from a cadence perspective, 2019 was when we thought we would begin to see things here from a top-line perspective and we are still on that cadence with respect to growth. When you look at overall cost initiative and from an overall earnings perspective, we did enhance capabilities throughout 2018 from an accountability and tracking perspective.

And I believe those went along the way as we pull together the 2019 guidance and from an accountability perspective, the granularity is pushed back down all the way through our bakeries, I would say was strengthened by the capabilities that we put in place in 2019. So we feel fairly confident with the range that we have put for it.

Unidentified Analyst

Great thanks and just last one from me. You talked about 150 bps inflation from commodity transportation labor. Can you just kind of maybe bucket those for us or any kind of relative commentary on which is the bigger buckets of those? Thanks.

Allen Shiver

Sure. When you look at the commodity basket, again 2018 was the first inflationary year we had seen in sometimes although it’s fairly significant high-single-digit commodity inflation or input costs inflation for 2018. We do expect inflation to continue and we don't really see that turning in the near-term.

So in 2019 we are looking more at low-single-digit inflation from a commodity perspective or input cost perspective. You know transportation continues to be a challenge, when you look at the broader buckets that would include SD&A, again its overall low-single-digits and that would encompass transportation as well as labor.

Operator

Our next question is from Brian Holland with Consumer Edge. Please go ahead.

Brian Holland

Yes thanks good morning. Forgive me, if you guys touched on this and I missed it. But had you laid out any gross savings targets specific to Centennial for 2019?

Allen Shiver

So when you look at what we said in the press release, coming out of 2018 we did achieve and actually slightly exceed the targets we had laid out for the two year period of $70 million to $80 million and in the $38 million to $48 million for 2018. We will continue to focus on those cost savings.

The next kind of leg of the stool will be network optimization and as Alan mentioned, we have several projects going on from that perspective. We didn't quantify an absolute dollar amount. But again, we still have inside the targets of the 13% to 14% EBITDA margin and we still feel like currently based on the 2019 plan that those are still within the reach.

Brian Holland

Okay, thanks. And so it looks like the guidance would imply some margin expansion in 2019. So maybe Steve this for you I'm curious if you can help us understand maybe how that is balanced between gross margin and SD&A. We do some gross margin expansion off of a tough year last year or does the majority of the cost savings still flow through SD&A, it sounds like based on Allen's comments a little more gross margin base. And then maybe just tack on to that, you had some headwinds in 2018 labor, capacity constraints on days Dave’s Killer Bread which you addressed earlier in the call. Freight sounds like it probably an issue for you through maybe the first half at least of this year. I’m just wondering if we think about the cadence as we go through the year maybe some of the puts and takes as you lapse some of these external factors.

Steve Kinsey

Sure, when you look at the kind of the cost initiatives, the majority of them are gross margin driven. There are a lot of initiatives around operating efficiency. We did see our efficiency ratios fall off in the quarter by about 100 basis points. And for the full-year we were down about 150 basis points.

So this is fairly significant from an overall margin perspective. Some of the same initiatives we have talked about in 2018 that are continuing in 2018 and into 2019 you know we are looking at sales, we are looking overall efficiency - volume impact efficiency pretty significantly. So we are looking at that and that kind of rolls into the network optimization projects that are going on.

And then from a top-line perspective, the initiatives that roll into the gross margin as well. So SD&A I would say in 2018 we have done a great job, we are not planning any efforts in SD&A. We are looking at building on the $70 million to $80 million that was saved over the last two years. But the most significant savings is now or the most significant improvement can be made in the gross margin-line.

From an overall cadence perspective, the big external factor I would say in 2018 was transportation. We did expect to see the increases that we experienced with all we were a little more protected with somewhat with our kind of our close loop system.

So they did begin to pick up in the back half. So you will see probably stronger transportation changes in the first half of the year with kind of flattish in the back half of the year, but we are still forecasting transportation cost for 2019.

Brian Holland

Okay thanks that is helpful. And then last one for me. Sort of thing in the scanner some inflection in the cake segment for you guys less negative sales. Obviously part of that is just lapping some sharp decline. I was just wondering if we are starting to see some progress there on some of the initiatives you talked about with respect to skew optimization et cetera. Maybe just an update on how that is progressing and maybe to the extent you think about when we could see an inflection - a sharper inflection in that segment.

Allen Shiver

I think we look at our cake business today, I think you're exactly right. We are seeing some encouraging trends with the new products that we have introduced. We all know the cake is an impulse category and our new products and bringing news to that the retail environment with our Tastykake brand as well as Freshley’s is something that the retailers are looking for as well.

So, we have gone through some significant SKU rationalization in our cake business. And now as I mentioned earlier, the focus is on introducing new items that bring excitement back into the category. And I'm making sure that our retailers are working with us, with all practice close and other items to push sales. So we are focused on growing our cake business.

Steve Kinsey

Okay thanks, best of luck.

Brian Holland

Thank you.

Operator

The next question is from Bill Chappell with SunTrust Robinson. Please go ahead.

Bill Chappell

Thanks good morning. Two questions, one on pricing. So are you done with the pricing actions for this year? Or does your forecasts assume there are additional pricing actions throughout the year?

Allen Shiver

Our forecasts assumes additional pricing throughout the year. Again, we did take pricing last quarter. But again pricing really is a constant opportunity. And again as I mentioned earlier, it varies by market, it varies by brands and the pricing will continue to be very much top priority something that we evaluate week-in, week-out.

Bill Chappell

And in terms of the modest expectations for volumes with pricing being favorable. Is that - are you assuming total volumes are actually down for this year?

Allen Shiver

The guidance is flat to down, mid to low-single-digit.

William Chappell

Okay. And then back to the cake business. And then just kind of your outlook. Do you believe, you can grow the business this year? And the reason I ask that is, I guess historically or past four, five years, that have been kind of hostess with a different model taking share and really pushing back. But right now, it seems like bimbo with almost an identical distribution model and business and brands really having an outstanding past few quarters and momentum. Can you replicate that with Tastykake or in the Freshley’s and can you drive the growth of the overall category with your system?

Allen Shiver

We are confident that we can. If you look at our history, our Tastykake brand is obviously very much high unaided awareness with consumers. As I mentioned earlier, I mean, our focus is on developing new items that have a exciting point of difference, making sure that our retailers understand that outright displays are the key to growing in this segments.

Our independent distributors are focused on growing their cake segment. And again, there is an opportunity there, because of the impulse nature of the category. And I'm really excited about some of the new items that we have got in the pipeline that will be introduced. So we are focused on building our cake business.

Bill Chappell

And the thought it can grow this year?

Allen Shiver

Net sales maybe depending on the SKU rationalization that we have taken offsetting some of the new items that we are introducing. We are not projecting tremendous growth in our cake business. But I want to make sure you understand it remains an important part of overall product mix.

Bill Chappell

Got it. Thank you.

Operator

And we have no further questions at this time. I would like to turn the call back to Allen Shiver for closing remarks.

Allen Shiver

Thank you for your time this morning. Thanks for joining the call. We will look forward to our next update in May and we will share our first quarter results at that time. Thank you for your time and that concludes our call.

Operator

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