Flowers Foods: Reports Q2-2018 Financial Results

Thomasville / GA. (ff) Flowers Foods Inc., producer of Nature’s Own, Wonder, Tastykake, Dave’s Killer Bread, and other bakery foods, today reported financial results for the company’s 12-week second quarter ended July 14, 2018.

Highlights compared to Q2-2017 where applicable

• Sales grew 1.6 percent. Market share continued to increase, primarily driven by solid growth from Dave’s Killer Bread (DKB), Wonder, and Nature’s Own.
• Increased investments to drive consumer trial of new products, operational disruptions and additional costs due to inferior yeast, and elevated input and transportation costs negatively impacted adjusted Ebitda(1) margin.
• Diluted EPS was unchanged at USD 0.21.
• Adjusted diluted EPS increased USD 0.01 to USD 0.25.
• Revised earnings guidance for fiscal 2018: The company now expects adjusted diluted EPS in the range of USD 1.00 to USD 1.07. Previously the company expected adjusted diluted EPS in the range of USD 1.04 to USD 1.16.

(1) Earnings before Interest, Taxes, Depreciation and Amortization, adjusted for certain items affecting comparability.

Cief Executive’s Remarks

«In the second quarter, we achieved solid sales growth and continued to execute on our initiatives under Project Centennial,» said Allen Shiver, Flowers Foods president and CEO. «While we were pleased with our sales growth, several factors impacted our gross margins during the quarter, including promotional investments we made to support new products and inflationary cost pressures from commodities, labor, and transportation. In addition, we experienced widespread operational disruption caused by inferior yeast received from a supplier that impacted many of our bakeries. It took an extraordinary effort from our procurement, manufacturing, distribution, and sales teams to address the situation, and return operations to normal. We are continuing to assess the potential impact of the issue and our options with regard to being made whole by the supplier.

«As a result of these factors, we are revising our outlook for the year. Although I am proud of the team’s work to serve the market under difficult circumstances, we are not satisfied with our financial results so far this year. We have successfully navigated inflationary environments before, and we are working aggressively to address these cost headwinds using a variety of tools, including increased urgency with our supply chain optimization project.»

Shiver continued, «We are in the midst of a multi-year plan that is positioning Flowers for long-term success and value creation as a national branded baked foods company. We’ve been operating under our new organizational structure for seven months now and are fundamentally changing the way in which we work. The appointment of Ryals McMullian as chief operating officer is intended to enhance accountability as we optimize our supply chain, reduce costs, and drive profitable growth. Through our transformation, I am confident we can overcome the current challenges and successfully position Flowers Foods to drive enhanced value for shareholders.»

Revised Outlook for Fiscal 2018

• Expected sales in the range of approximately USD 3.921 billion to USD 3.982 billion, representing growth of approximately 0.0 percent to 1.6 percent.
• Expected adjusted diluted EPS in the range of approximately USD 1.00 to USD 1.07, representing growth of approximately 12.4 percent to 20.2 percent.
• Adjusted EPS guidance excludes consulting and restructuring costs associated with Project Centennial, which are expected to be in the range of USD 13 million to USD 15 million, and costs associated with matters affecting comparability that cannot be practicably estimated. See reconciliations of non-GAAP measures in the financial statements following this release.

Update on Project Centennial + Strategic Priorities

The company is executing on its strategic priorities under Project Centennial and implementing multiple initiatives designed to reinvigorate the core business, capitalize on product adjacencies, reduce costs to fuel growth, and develop leading capabilities. Launched in 2017, Project Centennial is an enterprise-wide, multi-year effort to streamline operations, drive efficiencies, and invest in strategic capabilities that strengthen Flowers’ competitive position, drive profitable revenue growth, and create shareholder value. As a result of a more efficient and productive organizational structure, reduced spending on purchased goods and services, continuous improvement, supply chain optimization, and improved ordering and stale reduction initiatives, the company is targeting total gross savings of USD 38 million to USD 48 million during fiscal 2018. Highlights of the company’s progress in 2018 include:

• Appointment of a chief operating officer and continued refinements to the organizational structure that better align operating functions and enhance execution and accountability.
• Acceleration of a wide-range of supply chain optimization initiatives for the third quarter that are expected to improve efficiencies, lower costs, and drive enhanced gross margins. Teams have been re-prioritized to focus on key areas of opportunity across the company to drive faster benefit realization.
• Substantial brand investments to support the launch of Nature’s Own Perfectly Crafted artisan-inspired, thick-sliced bakery breads and Dave’s Killer Bread Boomin’ Berry bagels.
• A significant decrease in selling, distribution, and administrative (SD+A) workforce-related expenses due to organizational restructuring.
• Implementation of enhanced working capital policies that improved the cash conversion cycle and generated incremental cash flow.

Consolidated Second Quarter 2018 Summary

Compared to the prior year second quarter where applicable

• Sales increased 1.6 percent to USD 941.3 million.
• Percentage point change in sales attributed to:
  • Pricing/mix: +0.4 percent
  • Volume: +1.2 percent
• Net income increased 1.6 percent to USD 45.4 million. Excluding matters affecting comparability, net income increased 3.0 percent to USD 52.0 million.
• Operating income decreased 23.9 percent to USD 52.3 million. Excluding matters affecting comparability, operating income decreased 13.6 percent to USD 67.5 million.
• Adjusted Ebitda decreased 9.5 percent to USD 102.9 million, or 10.9 percent of sales, a 140 basis point decline.
• Materials, supplies, labor and other production costs (exclusive of depreciation and amortization) were 51.9 percent of sales, a 140 basis point increase. This increase was primarily driven by significant promotional activity related to new product launches in the quarter, operational disruptions related to inferior yeast, increases in outside purchases of product due to strong demand for DKB breakfast items and replacement product related to inferior yeast, higher ingredient costs and decreases in manufacturing efficiencies, partially offset by favorable price/mix.
• SD+A expenses were 38.3 percent of sales, a 10 basis point decrease. Lower Project Centennial consulting costs and decreased workforce-related costs, as a percentage of sales, were partially offset by higher distributor distribution fees due to a larger portion of sales being sold via independent distributors and significantly higher marketing costs associated with the launch of Nature’s Own Perfectly Crafted bread. Additionally, higher legal settlements and transportation costs in the current quarter partially offset the decrease in SD+A expenses.
• Depreciation and Amortization (D+A) expenses were USD 35.1 million, 3.7 percent of sales, flat with the prior year second quarter.

On a consolidated basis, branded retail sales increased 1.5 percent to USD 557.7 million, store branded retail sales increased 3.5 percent to USD 149.6 million, while non-retail and other sales increased 0.6 percent to USD 234.0 million. Continued sales growth from branded organic products and in our expansion markets, as well as more favorable price/mix resulted in the increase in branded retail sales, partially offset by increased promotional activity primarily related to new product launches, decreased production capacity as a result of inferior yeast, and volume declines in other branded products. Sales of DKBbranded products continued to increase, partly due to the introduction of breakfast products during the second quarter of fiscal 2017. Store branded retail sales increased from both positive price/mix and volume increases. Volume growth in vending drove the increase in non-retail and other sales, partially offset by softer bakery outlet store sales and declines in price/mix.

DSD Segment Summary

Compared to the prior year second quarter where applicable

• Sales increased 0.5 percent to USD 796.6 million.
• Percentage point change in sales attributed to:
  • Pricing/mix: 2.0 percent
  • Volume: -1.5 percent
• Operating income decreased 31.4 percent to USD 54.5 million. In the quarter, the company recognized legal settlements, costs related to inferior yeast, and restructuring charges totaling USD 12.9 million.
• Adjusted Ebitda decreased 10.4 percent to USD 97.6 million.

DSD Segment branded retail sales increased 1.4 percent to USD 521.9 million, store branded retail sales increased 1.3 percent to USD 121.5 million, while non-retail and other sales decreased 3.2 percent to USD 153.2 million. Branded retail sales increased due to significant sales growth for branded organic products, growth in our expansion markets, the launch of Nature’s Own Perfectly Crafted bread, and improved price/mix. This increase was partially offset by costs related to increased promotional activity, decreased production capacity as a result of inferior yeast, and softer volume for other branded items. Sales of DKB branded products continue to increase, driven by volume gains and the addition of DKB branded breakfast products during the second quarter of fiscal 2017. Store branded retail sales increased quarter over quarter due to positive price/mix, partially offset by volume declines. Volume losses in foodservice, partly due to the inferior yeast issue and the shift of certain foodservice business from the DSD Segment to the Warehouse Segment, and decreased sales of products in our bakery outlet stores resulted in decreased non-retail and other sales.

The decrease in the DSD Segment operating income as a percent of sales primarily resulted from USD 8.3 million of legal settlements, USD 3.9 million of currently identifiable and measurable costs related to shipments of inferior yeast, and USD 0.7 million of restructuring charges incurred during the second quarter of fiscal 2018, as well as costs related to increased promotional activity, and new product launches, as well as increased production costs partially due to shipments of inferior yeast. The benefit of the voluntary separation incentive plan and other restructuring initiatives and lower employee fringes partially offset these items.

Warehouse Segment Summary

Compared to the prior year second quarter where applicable

• Sales increased 8.2 percent to USD 144.7 million.
• Percentage point change in sales attributed to:
  • Pricing/mix: -2.0 percent
  • Volume: 10.2 percent
• Operating income decreased 3.9 percent to USD 11.1 million.
• Adjusted Ebitda decreased 1.6 percent to USD 16.1 million.

Warehouse Segment branded retail sales increased 2.3 percent to USD 35.8 million, store branded retail sales increased 14.7 percent to USD 28.1 million, while non-retail and other sales increased 8.8 percent to USD 80.8 million. Branded retail sales increased mostly due to growth in branded cake, partially offset by volume declines in warehouse-delivered branded organic bread and negative pricing/mix. Sales of store branded retail items increased primarily due to volume increases in store branded cake. Non-retail and other sales, which include contract manufacturing, vending and foodservice, increased primarily from significant volume growth in foodservice and vending sales, and to a lesser extent the shift of certain foodservice business from the DSD Segment to the Warehouse Segment in the current year, partially offset by declines in contract manufacturing.

The decrease in the Warehouse Segment operating income as a percent of sales was primarily due to a shift in mix from higher margin branded bread items to lower margin cake and foodservice items, increased product purchases from the DSD Segment, increased outside purchases of product, declines in manufacturing efficiencies, and higher distribution costs, partially offset by lower workforce-related costs.

Unallocated Corporate Expense Summary

Note: Comparisons are to consolidated sales

• Unallocated corporate expenses decreased 100 basis points to 1.4 percent of consolidated sales, primarily due to the USD 7.2 million decrease in Project Centennial consulting costs, and to a lesser extent, reduced legal expense.

Cash Flow, Dividends, Share Repurchases, and Capital Allocation

In the second quarter of fiscal 2018, cash flow from operating activities was USD 51.5 million (including a tax-advantaged voluntary pension contribution of USD 30 million), capital expenditures were USD 23.0 million, and dividends paid were USD 38.0 million.

There are 6.5 million shares remaining on the company’s current share repurchase authorization. As in the past, the company expects to continue to make opportunistic share repurchases under this authorization.