FLOWERS FOODS, INC. The following discussion should be read in conjunction with Item 1., Business, and the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements included in this Form 10-K. The following information contains forward-looking statements which involve certain risks and uncertainties. See Forward-Looking Statements at the beginning of this Form 10-K.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is segregated into four sections, including:
• Executive overview - provides a summary of our operating performance and
cash flows, industry trends, and our strategic initiatives.
• Critical accounting estimates - describes the accounting areas where
management makes critical estimates to report our financial condition and
results of operations.
• Results of operations - an analysis of the company's consolidated results
of operations for the two comparative periods presented in the
Consolidated Financial Statements.
• Liquidity, capital resources and financial position - an analysis of cash
flow, contractual obligations, and certain other matters affecting the
company's financial position.
MATTERS AFFECTING COMPARABILITY
Detailed below are matters affecting comparability as well as other significant events that will provide additional context while reading this discussion:
Fiscal 2019 Fiscal 2018 Fiscal 2017 Footnote
52 weeks 52 weeks 52 weeks Disclosure
(Amounts in thousands)
Project Centennial consulting costs $ 784 $ 9,723 $ 37,306 Note 5
Gain on divestiture - - (28,875 ) Note 6
Restructuring and related impairment charges 23,524 9,767 104,130 Note 5
Impairment of assets - 5,999 - Note 2, 12
(Recovery) loss on inferior ingredients (37 ) 3,212 - Note 4
Pension plan settlement loss - 7,781 4,649 Note 22
Multi-employer pension plan withdrawal costs - 2,322 18,268 Note 22
Acquisition-related costs 22 4,476 - Note 10
Legal settlements (recovery) 28,014 21,452 5,978 Note 24
Lease termination costs - - 565
Executive retirement agreement 763 - -
$ 53,070 $ 64,732 $ 142,021
In fiscal 2017, we recognized an income tax benefit of $48.2 million related to
the estimated benefit of the Tax Cuts and Jobs Act of 2017 (the "Act"). In
fiscal 2018, we recognized an additional benefit of $5.6 million as an
adjustment to the fiscal 2017 amount. These tax benefits partially offset the
net expense amount of the pre-tax items in each respective fiscal year detailed
above.
Changes to segment reporting and reclassification of certain prior year
amounts. As of the beginning of fiscal 2019, we completed our transition to the
new organizational structure and began managing our business as one operating
segment. Additionally, we have reclassified certain prior year amounts for
comparability.
Project Centennial consulting costs. During the second quarter of fiscal 2016,
we launched Project Centennial, an enterprise-wide business and operational
review. Key initiatives of the project are outlined in Item 1., Business, of
this Form 10-K. As of the end of fiscal 2016, we had completed the diagnostic
phase and entered the implementation phase of the project. Consulting costs
associated with the project in fiscal 2019, 2018, and 2017 were $0.8 million ,
$9.7 million , and $37.3 million , respectively. Costs incurred in fiscal 2019
primarily related to the portfolio and supply chain network optimization
initiative of Project Centennial and we anticipate incurring additional
consulting costs between $7.0 million and $9.0 million in fiscal 2020 for this
initiative. In fiscal 2019, these costs were reflected in the selling,
distribution and administrative expenses line item of the Consolidated
Statements of Income.
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Gain on divestiture of the non-core mix manufacturing business. On January 14,
2017 , we completed the sale of our non-core mix manufacturing business located
in Cedar Rapids, Iowa and received proceeds, net of a working capital
adjustment, of $41.2 million and recognized a gain of $28.9 million in our
fiscal 2017 results of operations.
Restructuring and related impairment charges associated with Project Centennial. The following table details charges recorded in fiscal 2019, 2018, and 2017 (amounts in thousands):
Fiscal 2019 Fiscal 2018 Fiscal 2017
(Amounts in thousands)
Employee termination benefits and other
cash charges $ 3,295 $ 4,174 $ 34,529
Property, plant, equipment, and spare
parts impairments, net of
gain on sale 4,830 5,593 3,354
Trademark impairments 15,399 - 66,247
$ 23,524 $ 9,767 $ 104,130
In fiscal 2019, we closed our Opelika, Alabama bakery and recorded asset
impairment charges with respect to the property, plant, equipment, and spare
parts totaling $3.9 million and severance costs of $1.5 million . Additionally,
we recorded $1.8 million of asset impairment charges for a closed bakery
included in assets held for sale and for other manufacturing line closures, and
severance and relocation costs of $1.8 million related to transitioning to the
new organizational structure. Also, during fiscal 2019, we recorded a gain on
sale of $0.8 million related to a facility that had been previously impaired in
a prior year. In the fourth quarter of fiscal 2019, we completed a brand
rationalization study which resulted in $15.4 million of impairment charges for
certain trademarks that we either no longer intend to use or plan to use on a
more limited basis.
In fiscal 2018, employee termination benefits and other cash charges were
primarily for severance related to the plant closure discussed below and
relocation costs associated with the company reorganization that was completed
in fiscal 2018, net of an adjustment of $0.6 million to the VSIP charge
recognized in fiscal 2017. On November 7, 2018 , the company announced the
closure of a bakery in Brattleboro, Vermont as part of the supply chain
optimization initiative under Project Centennial. The facility ceased operating
at the end of fiscal 2018 and resulted in severance charges discussed above, as
well as property, plant and equipment impairments of $2.7 million . Additionally,
we completed a product rationalization project in fiscal 2018 that resulted in
the write-off of certain ingredient, packaging and advertising displays for
discontinued items, and decided to sell a closed manufacturing facility acquired
as part of the Acquired Hostess Bread Assets in fiscal 2013 and to close two
manufacturing lines in other bakeries resulting in asset impairments.
Employee termination benefits and other cash charges recorded in fiscal 2017
included the VSIP, severance related to other reorganizational initiatives,
severance related to the plant closure discussed below, and relocation costs due
to the company reorganization. The VSIP was made available to certain employees
who met the VSIP's age, length-of-service, and business function
criteria. Approximately 325 employees elected to participate in the VSIP, and
they accrued enhanced separation benefits totaling $29.7 million . We paid $4.6
million of these benefits in fiscal 2017 and $24.2 million in fiscal 2018. Other
reorganizational initiatives we completed during the fourth quarter of fiscal
2017 resulted in severance charges of $2.0 million . Additionally, on August 9,
2017 , the company announced the closure of a snack cake bakery in Winston-Salem,
North Carolina as part of its supply chain optimization initiative under Project
Centennial. The facility closed in November of fiscal 2017 and a portion of the
production was transitioned to other facilities. Closure costs included the
recognition of impairments related to property, plant and equipment of $3.4
million and severance costs of $1.0 million . We incurred reorganization costs,
primarily relocation costs, of $1.9 million during fiscal 2017. We substantially
completed the brand rationalization study in the third quarter of fiscal 2017,
which resulted in $66.2 million of impairment charges for certain trademarks
that we either no longer intend to use or plan to use on a more limited basis.
Impairment of assets. In fiscal 2018, we impaired a $2.5 million non-IDP notes
receivable because the counterparty defaulted on the note, and we recognized a
$3.5 million property, plant and equipment impairment for a construction in
progress asset that was ultimately not placed into service.
(Recovery) loss on inferior ingredients. In fiscal 2019, we incurred costs of
$1.8 million related to receiving inferior ingredients and co-manufactured
products, and received reimbursements totaling $1.8 million for a portion of
previously incurred costs. In fiscal 2018, we recognized $7.4 million of
currently identifiable and measurable costs associated with receiving inferior
yeast and whey ingredients and received a reimbursement of $4.2 million . The
shipments of yeast were from one supplier and reduced product quality and
disrupted production and distribution of foodservice and retail bread and buns
at a number of the company's bakeries during the second quarter of fiscal
2018. On July 18, 2018 , the company issued a voluntary recall due to the
potential of inferior whey shipments. The costs associated with inferior whey
were incurred during the third quarter of fiscal 2018. We continue to seek
recovery of all losses.
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Pension plan settlement loss. At the beginning of fiscal 2016, the company began
offering retired and terminated vested pension plan participants not yet
receiving their benefit payments the option to elect to receive their benefit as
a single lump sum payment. Settlement charges of $7.8 million and $4.6 million
for fiscal 2018 and 2017, respectively, were triggered as a result of lump sum
distributions paid in each fiscal year. There were no settlement charges
triggered in fiscal 2019. On September 28, 2018 , the Board of Directors approved
a resolution to terminate the Flowers Foods, Inc. Retirement Plan No. 1,
effective December 31, 2018 . The plan was closed to new participants on January
1, 1999 and benefit accruals were previously frozen on or before August 1,
2008 . The company has commenced the plan termination process and distributed a
portion of the pension plan assets as lump sum payments in January 2020 and the
remaining balance will be transferred to an insurance company in the form of a
nonparticipating group annuity contract during the first quarter of 2020. The
total payments distributed will depend on the lump sum offer participation rate
of eligible participants. Based on the estimated value of assets held in the
plan, the company currently estimates that a cash contribution of approximately
$17.0 million to $35.0 million will be required to fully fund the plan's
liabilities at termination. In addition, based on current assumptions of the
level of lump sum distributions elected by eligible plan participants, among
other assumptions, the company estimates a final non-cash settlement charge of
approximately $125.0 million to $143.0 million will be triggered in the first
quarter of fiscal 2020.
Multi-employer pension plan withdrawal costs ("MEPP" costs). On August 18, 2017 ,
the union participants of the MEPP Fund at our Lakeland, Florida plant voted to
withdraw from the MEPP Fund in the most recent collective bargaining
agreement. This resulted in the recognition of a $15.2 million pension plan
withdrawal liability in the third quarter of fiscal 2017, and the recognition of
$3.1 million of transition payments that were made on November 3, 2017 to, and
for the benefit of, union participants as part of the collective bargaining
agreement. During the first quarter of fiscal 2018, the pension plan withdrawal
liability was revised for the final settlement and we recorded an additional
$2.3 million of liability. All payments related to the withdrawal from the MEPP
Fund were completed by the end of the second quarter of fiscal 2018.
Legal settlements. In fiscal 2019, 2018, and 2017, we reached agreements to
settle distributor-related litigation in the aggregate amount of $29.3 million ,
$18.7 million and $6.0 million , respectively, including plaintiffs' attorney
fees. We recorded a benefit of $1.3 million in fiscal 2019 related to an
adjustment of a prior year settlement based on the final amount paid.
Additionally, in fiscal 2018, we reached agreements to settle other non-IDP
matters in the amount of $2.8 million . All amounts related to legal settlements
are recorded in the selling, distribution and administrative expenses line item
of the Consolidated Statements of Income.
Executive retirement agreement. On February 15, 2019 , Allen Shiver , president
and chief executive officer of the company and member of the Board of Directors,
notified the company he would be retiring from these positions effective May 23,
2019 . In connection with Mr. Shiver's retirement, the company and Mr. Shiver
entered into a retirement agreement and general release, as a part of the
agreement, Mr. Shiver was paid $1.3 million upon his retirement, which was
expensed in the first quarter of fiscal 2019. Additionally, upon his retirement
in the second quarter of fiscal 2019, we recognized a benefit of $0.6 million
related to the forfeiture of his unvested long-term incentive stock
awards. These amounts are reflected in the selling, distribution, and
administrative expenses line item of the Consolidated Statements of Income.
Income tax benefit related to the impact of the Tax Cuts and Jobs Act of
2017. In the fourth quarter of fiscal 2017, we recognized an income tax benefit
of $48.2 million related to the estimated benefit of the Act which was enacted
on December 22, 2017 . The benefit primarily resulted from the revaluation of the
company's net deferred tax liability as of a result of the decrease in the
corporate tax rate. In fiscal 2018, we recognized an additional benefit of $5.6
million as an adjustment to the fiscal 2017 amount.
Canyon Bakehouse LLC acquisition. On December 14, 2018 , we completed the
acquisition of Canyon, a privately held, gluten-free baking company in
Johnstown, Colorado , for $205.2 million total consideration. Canyon operates one
production facility in Johnstown, Colorado . The Canyon Bakehouse brand is the #1
gluten-free bread loaf brand in the U.S. We funded the purchase price of the
Canyon acquisition with cash on hand and borrowings under our accounts
receivable securitization facility (the "AR facility") and incurred
acquisition-related expenses of $4.5 million . Canyon's results of operations for
the period from December 14, 2018 through December 29, 2018 were excluded from
our consolidated results for fiscal 2018 due to immateriality and were reported
in our first quarter of fiscal 2019. Prior to the acquisition, Canyon's sales
were distributed frozen through natural, specialty, grocery, and mass retailers
around the country and this has and will continue. In addition to frozen
distribution, we began distributing Canyon branded products fresh via our DSD
distribution system during the first quarter of fiscal 2019. In January of
fiscal 2020, we paid $5.0 million to the prior owner related to the contingent
consideration recorded as part of the acquisition.
Reporting periods. The company operates on a 52-53 week fiscal year ending the
Saturday nearest
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Product recall. On July 9, 2019 , we issued a voluntary product recall for
certain hamburger and hot dog buns and other bakery products due to the
potential presence of small pieces of hard plastic that may have been introduced
during production. The products recalled were distributed to retail customers
under a variety of brand names in 18 states. We are not currently aware of any
confirmed injuries or illnesses. We incurred costs related to lost production
time, scrapped inventory, and product removal, among other costs, of
approximately $0.5 million and $0.3 million during the second and third quarters
of fiscal 2019, respectively, however, we cannot currently estimate the impact
of the recall on future periods.
Impact of adoption of lease accounting standard. We adopted the new lease accounting standard as of the beginning of fiscal 2019 using the modified retrospective method, as such, prior year amounts have not been restated.
EXECUTIVE OVERVIEW
We are the second-largest producer and marketer of packaged bakery foods in theU.S. with fiscal 2019 sales of$4.1 billion . We operate in the highly competitive fresh bakery market and our product offerings include fresh breads, buns, rolls, snack cakes and tortillas, as well as frozen breads and rolls. In the second quarter of fiscal 2017, the company announced an enhanced organizational structure designed to emphasize brand growth and innovation in line with a national branded food company, drive enhanced accountability, reduce costs, strengthen long-term strategy and provide greater focus on the strategic initiatives under Project Centennial. We completed our transition to the new structure and began managing our business as one operating segment as of the beginning of fiscal 2019. Prior to that time, the company managed its business and reported segment information in two operating segments, the DSD Segment and the Warehouse Segment. We operate 46 plants in 18 states that produce a wide range of breads, buns, rolls, snack cakes, and tortillas. See Item 1., Business, of this Form 10-K for information regarding our customers and brands, business strategies, strengths and core competencies, and competition and risks.
Summary of Operating Results, Cash Flows and Financial Condition:
Sales increased 4.4% in fiscal 2019 as compared to fiscal 2018 primarily due to the Canyon acquisition, continued sales growth of the DKB branded deli-style breads and traditional branded loaf breads, significant growth in branded breakfast items, growth in store branded breads and rolls, and positive price/mix. Partially offsetting these increases were softer sales for foodservice products. Since the first quarter of fiscal 2018, we have introduced Nature's Own Perfectly Crafted breads, Sun-Maid branded breakfast bread, DKB English muffins, and new varieties of DKB bagels, among other product launches, which contributed to the overall sales growth. Sales in fiscal 2018 increased 0.8% as compared to fiscal 2017 due to continued sales growth for our branded organic products and positive price/mix, partially offset by volume declines for other branded products and in the non-retail channel and the impact of inferior ingredients. Net income for fiscal 2019 increased 4.7% as compared to fiscal 2018 primarily due to increased sales and decreased Project Centennial consulting costs, loss on inferior ingredients, pension plan settlement losses, acquisition costs, and asset impairments. A lower effective tax rate in the prior year, as well as higher workforce-related costs, increased marketing investments, and higher legal settlements and restructuring charges in the current year partially offset the overall increase. Net income increased 4.7% in fiscal 2018 as compared to fiscal 2017 primarily due to significantly lower restructuring and related impairment charges, MEPP costs and Project Centennial consulting costs as compared to the prior year, partially offset by the income tax benefit recognized from passage of the Act and the gain on divestiture, both recognized in the prior year. Increased legal settlements, higher commodity prices, and the impact of inferior ingredients also negatively impacted fiscal 2018 earnings, net of the benefit of the VSIP, lower employee compensation costs and decreased tax rates. In fiscal 2019, we generated net cash flows from operations of$367.0 million and invested$103.7 million in capital expenditures. We decreased our total indebtedness by$114.3 million and extended the maturity date of the AR facility toSeptember 27, 2021 . We paid$160.0 million in dividends to our shareholders in fiscal 2019. In fiscal 2018, we generated net cash flows from operations of$295.9 million , made cash payments of$200.2 million for the Canyon acquisition, and invested$99.4 million in capital expenditures. We increased our total indebtedness by$173.3 million primarily as a result of borrowings under the AR facility to fund the Canyon acquisition and paid$150.2 million in dividends to our shareholders in fiscal 2018. 27 --------------------------------------------------------------------------------
Industry Trends
• We hold a
(Source: Flowers Custom Database - IRI Total US MultiOutlet + Convenience
Store for the 52 weeks ending 12/29/19)
• We hold a
Flowers Custom Database -
the 52 weeks ending 12/29/19)
• The Fresh Packaged Breads category is highly competitive.
• We anticipate our growth will be driven by our organic bread brands and
gluten-free bakery items, partially offset by softer demand for some of
our other product offerings.
Critical Accounting Estimates
The company's discussion and analysis of its results of operations and financial condition are based upon the Consolidated Financial Statements of the company, which have been prepared in accordance with generally accepted accounting principles in theU.S. ("GAAP"). The preparation of these financial statements requires the company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of the revenues, expenses, and cash flows during the reporting period. On an ongoing basis, the company evaluates its estimates, including those related to customer programs and incentives, bad debts, raw materials, inventories, long-lived assets, leased assets, intangible assets, income taxes, restructuring, pensions and other post-retirement benefits, and contingencies and litigation. The company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The selection and disclosure of the company's critical accounting estimates have been discussed with the company's audit committee. Note 2, Summary of Significant Accounting Policies, of Notes to Consolidated Financial Statements of this Form 10-K includes a summary of the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. The following table lists, in no particular order of importance, areas of critical assumptions and estimates used in the preparation of the Consolidated Financial Statements. Additional detail can be found in the following notes: Critical Accounting Estimate Note Revenue recognition - Derivative financial instruments 11 Long-lived assets -Goodwill and other intangible assets 9 Leases 14 Self-insurance reserves 24 Income tax expense (benefit) and accruals 23 Postretirement plans 22 Stock-based compensation 19 Commitments and contingencies 24 Revenue Recognition. Revenue is recognized when obligations under the terms of a contract with our customers are satisfied. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. The company records both direct and estimated reductions to gross revenue for customer programs and incentive offerings at the time the incentive is offered or at the time of revenue recognition for the underlying transaction that results in progress by the customer towards earning the incentive. These allowances include price promotion discounts, coupons, customer rebates, cooperative advertising, and product returns. Consideration payable to a customer is recognized at the time control transfers and is a reduction to revenue. The recognition of costs for promotion programs involves the use of judgment related to performance and redemption estimates. Estimates are made based on historical experience and other factors. Price promotion discount expense is recorded as a reduction to gross sales when the discounted product is sold to the customer. 28
-------------------------------------------------------------------------------- Derivative Financial Instruments. The company's cost of primary raw materials is highly correlated to certain commodities markets. Raw materials, such as our baking ingredients, experience price fluctuations. If actual market conditions become significantly different than those anticipated, raw material prices could increase significantly, adversely affecting our results of operations. We enter into forward purchase agreements and other derivative financial instruments qualifying for hedge accounting to manage the impact of volatility in raw material prices. The company measures the fair value of its derivative portfolio using fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal market for that asset or liability. When quoted market prices for identical assets or liabilities are not available, the company bases fair value on internally developed models that use current market observable inputs, such as exchange-quoted futures prices and yield curves. Valuation of Long-Lived Assets,Goodwill and Other Intangible Assets. The company records an impairment charge to property, plant and equipment, goodwill and intangible assets in accordance with applicable accounting standards when, based on certain indicators of impairment, it believes such assets have experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of these underlying assets could result in losses or an inability to recover the carrying value of the asset that may not be reflected in the asset's current carrying value, thereby possibly requiring impairment charges in the future. Impairment charges recorded in fiscal years 2019, 2018, and 2017 are discussed above in the "Matters Affecting Comparability" section. Flowers has concluded that under its new organizational structure the company has one operating segment based on the nature of products that Flowers sells, an intertwined production and distribution model, the internal management structure and information that is regularly reviewed by the CEO, who is the chief operating decision maker, for the purpose of assessing performance and allocating resources. This change to one operating segment aligns with the company's internal structure and investors' desire to have consistent external reporting. We completed our transition to the new structure and began managing our business as one operating segment as of the beginning of fiscal 2019 and we have also determined we have one reporting unit. Prior to that time, the company managed the business and reported segment information in two operating segments, the DSD Segment and the Warehouse Segment, which were also its reporting units. The company evaluates the recoverability of the carrying value of its goodwill on an annual basis or at a time when events occur that indicate the carrying value of the goodwill may be impaired using a two-step process. As discussed above, beginning in fiscal 2019, we changed to a single reporting unit and reassessed the recoverability of goodwill at that time and determined there was no impairment. We have elected not to perform the qualitative approach. The first step of this evaluation is performed by calculating the fair value of the business segment, or reporting unit, with which the goodwill is associated. This fair value is compared to the carrying value of the reporting unit, and if less than the carrying value, the goodwill is evaluated for potential impairment under step two. Under step two of this calculation, goodwill is measured for potential impairment by comparing the implied fair value of the reporting unit's goodwill, determined in the same manner as a business combination, with the carrying amount of the goodwill. Our annual evaluation of goodwill impairment requires management judgment and the use of estimates and assumptions to determine the fair value of our reporting unit. Fair value is estimated using standard valuation methodologies incorporating market participant considerations and management's assumptions on revenue, revenue growth rates, operating margins, discount rates, and EBITDA (defined as earnings before interest, taxes, depreciation and amortization). Our estimates can significantly affect the outcome of the test. We perform the fair value assessment using the income and market approach. Changes in our forecasted operating results and other assumptions could materially affect these estimates. This test is performed in the fourth quarter of each fiscal year unless circumstances require this analysis to be completed sooner. The income approach is tested using a sensitivity analysis to changes in the discount rate and yield a sufficient buffer to significant variances in our estimates. The estimated fair value of our reporting unit exceeded its carrying value in excess of$3.3 billion in fiscal 2019. Based on management's evaluation, no impairment charges relating to goodwill were recorded for the fiscal years 2019, 2018, or 2017. In connection with acquisitions, the company has acquired trademarks, customer lists, and non-compete agreements, a portion of which are amortizable. The company evaluates these assets whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The undiscounted future cash flows of each intangible asset are compared to the carrying amount, and if less than the carrying value, the intangible asset is written down to the extent the carrying amount exceeds the fair value. The fair value is computed using the same approach described above for goodwill and includes the same risks and estimates. The fair value of the trademarks could be less than our carrying value if any of our four material assumptions in our fair value analysis: (a) weighted average cost of capital; (b) long-term sales growth rates; (c) forecasted operating margins; and (d) market multiples do not meet our expectations, thereby requiring us to record an asset impairment. We use the multi-period excess earnings and relief from royalty methods to value these intangibles. The method used for impairment testing purposes is consistent with the valuation method employed at acquisition of the intangible asset. Impairment charges recorded in fiscal 2019 and 2017 related to amortizable intangible assets totaled$15.4 million and$47.7 million , respectively, and are discussed above in the "Matters Affecting Comparability" section. There were no impairment charges related to amortizable intangible assets for fiscal 2018. 29 -------------------------------------------------------------------------------- As ofDecember 28, 2019 , the company also owns a trademark acquired through an acquisition with a carrying value of$127.1 million that is an indefinite-lived intangible asset not subject to amortization. The company evaluates the recoverability of intangible assets not subject to amortization by comparing the fair value to the carrying value on an annual basis or at a time when events occur that indicate the carrying value may be impaired. In addition, the assets are evaluated to determine whether events and circumstances continue to support an indefinite life. The fair value is compared to the carrying value of the intangible asset, and if less than the carrying value, the intangible asset is written down to fair value. There are certain inherent risks included in our expectations about the performance of acquired trademarks and brands. If we are unable to implement our growth strategies for these acquired intangible assets as expected, it could adversely impact the carrying value of the brands. The fair value of the trademarks could be less than our carrying value if any of our four material assumptions in our fair value analysis: (a) weighted average cost of capital; (b) long-term sales growth rates; (c) forecasted operating margins; and (d) market multiples do not meet our expectations, thereby requiring us to record an asset impairment. As of the end of fiscal 2019, the company has determined a trademark with a carrying value of$79.5 million no longer is deemed to have an indefinite life and we will begin amortizing this trademark in fiscal 2020 over its remaining useful life of 33 years. As discussed above, during fiscal 2017, we recorded asset impairment charges of$18.5 million on certain indefinite-lived trademarks and determined these trademarks were no longer deemed to have an indefinite life. Leases. The company's leases consist of the following types of assets: two bakeries, corporate office space, warehouses, bakery equipment, transportation and IT equipment. The company uses the applicable incremental borrowing rate at lease commencement to perform the lease classification tests on lease components and to measure the lease liabilities and right-of-use assets in situations when discount rates implicit in leases cannot be readily determined. Self-Insurance Reserves. We are self-insured for various levels of general liability, auto liability, workers' compensation, and employee medical and dental coverage. Insurance reserves are calculated on an undiscounted basis and are based on actual claim data and estimates of incurred but not reported claims developed utilizing historical claim trends. Projected settlements and incurred but not reported claims are estimated based on pending claims and historical trends and data. Though the company does not expect them to do so, actual settlements and claims could differ materially from those estimated. Material differences in actual settlements and claims could have an adverse effect on our financial condition and results of operations. Income Tax Expense (Benefit) and Accruals. The annual tax rate is based on our income, statutory tax rates, and tax planning opportunities available to us in the various jurisdictions in which we operate. Changes in statutory rates and tax laws in jurisdictions in which we operate may have a material effect on the annual tax rate. The effect of these changes, if any, would be recognized as a discrete item upon enactment. Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenues and expenses. Deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. As such, inDecember 2017 , the company revalued its deferred tax assets and liabilities as a result of passage of the Act. Additional information on the tax impacts of the Act is presented in Note 23, Income Taxes, of Notes to Consolidated Financial Statements of this Form 10-K. Our income tax expense, deferred tax assets and liabilities, and reserve for uncertain tax benefits reflect our best assessment of future taxes to be paid in the jurisdictions in which we operate. The company records a valuation allowance to reduce its deferred tax assets if we believe it is more likely than not that some or all of the deferred assets will not be realized. While the company considers future taxable income and ongoing prudent and feasible tax strategies in assessing the need for a valuation allowance, if these estimates and assumptions change in the future, the company may be required to adjust its valuation allowance, which could result in a charge to, or an increase in, income in the period such determination is made. Periodically, we face audits from federal and state tax authorities, which can result in challenges regarding the timing and amount of income or deductions. We provide reserves for potential exposures when we consider it more likely than not that a taxing authority may take a sustainable position on a matter contrary to our position. We evaluate these reserves on a quarterly basis to ensure that they have been appropriately adjusted for events, including audit settlements that may impact the ultimate payment of such potential exposures. While the ultimate outcome of audits cannot be predicted with certainty, we do not currently believe that current or future audits will have a material adverse effect on our consolidated financial condition or results of operations. The company is no longer subject to federal examination for years prior to fiscal 2016. Postretirement Plans. The company records pension costs and benefit obligations related to its defined benefit plans based on actuarial valuations. These valuations reflect key assumptions determined by management, including the discount rate, expected long-term rate of return on plan assets and mortality. Material changes in pension costs and in benefit obligations may occur in the future due to experience that is different than assumed and changes in these assumptions. 30
-------------------------------------------------------------------------------- EffectiveJanuary 1, 2006 , the company curtailed its largest defined benefit plan ("Plan No. 1") that covered the majority of its workforce. Benefits under this plan are frozen, and no future benefits will accrue under this plan. In addition to Plan No. 1, the company sponsors an ongoing defined benefit pension plan for union employees ("Plan No. 2") and a frozen nonqualified plan covering former Tasty executives. OnJanuary 1, 2016 , the company began providing retired and terminated vested pension plan participants who have not yet started their payments the option to receive their benefit as a single lump sum payment. Participants can elect this option when they retire or when they leave the company. This change supports our long-term pension risk management strategy. Lump sum payments made in 2017 triggered settlement charges as detailed in the table below (amounts in thousands). Based on activity in 2018, primarily related to the VSIP, the company recorded settlement charges in each of the quarters of fiscal 2018. The company recorded pension cost (income) on our qualified defined benefit plans and nonqualified plan in fiscal 2019, 2018, and 2017 as detailed in the table below (amounts in thousands). We expect pension cost of approximately$2.0 million on our qualified defined benefit plans and nonqualified plan for fiscal 2020 excluding any potential settlement losses. Fiscal 2019 Fiscal 2018 Fiscal 2017 52 weeks 52 weeks 52 weeks
Pension cost (income)
- 7,781 4,649
Net pension cost (income)
For all but Plan No. 1, we use a spot rate approach ("granular method") to estimate the service cost and interest cost components of benefit cost by applying the specific spot rates along the yield curve to the relevant projected cash flows, as we believe this provides the best estimate of service and interest costs.
OnSeptember 28, 2018 , the Board approved the termination of theFlowers Foods, Inc. Retirement Plan No. 1. Therefore, the benefit obligations as ofDecember 31, 2018 for Plan No. 1 were valued reflecting the plan termination cost to settle the obligations. The single effective discount rate used to derive the estimated plan termination obligation was used to develop interest cost. This approach does not use the mechanics of the granular calculation that was used for measurements prior toSeptember 30, 2018 . The movement away from the granular approach for Plan No. 1 is considered a more precise estimation approach given the fact that assets are expected to be distributed within the next three months. OnDecember 31, 2017 , the company adopted a de-risking investment strategy for its pension assets. As the funded status of the plans increases, over time the targeted allocation to return seeking assets will be reduced and the targeted allocation to fixed-income assets will be increased to better manage the company's pension liability and reduce funded status volatility. After the Board approved the termination of Plan No. 1, the plan administrator separated the assets of Plan No. 1 and Plan No. 2 onDecember 31, 2018 . Based on the funded status of the plans as ofDecember 31, 2019 , the asset allocation for each of theFlowers Foods' pension plans has been adjusted as follows:
Plan No. 1: to 90 to 100% fixed-income securities, and 0-10% short-term investments and cash.
Plan No. 2: to 0 to 80% equity securities, 20-100% fixed-income securities, and 0-10% short-term investments and cash.
For the details of our pension plan assets, see Note 22, Postretirement Plans, of Notes to Consolidated Financial Statements of this Form 10-K.
In developing the expected long-term rate of return on plan assets at each
measurement date, the company considers the plan assets' historical actual
returns, targeted asset allocations, and the anticipated future economic
environment and long-term performance of the individual asset classes, based on
the company's investment strategy. While appropriate consideration is given to
recent and historical investment performance, the assumption represents
management's best estimate of the long-term prospective return. Further, pension
costs do not include an explicit expense assumption, and therefore the return on
assets rate reflects the long-term expected return, net of expenses. Based on
these factors, the long-term rate of return assumption for the plans was set at
5.2% (Plan No. 1) and 7.4% (Plan No. 2) for fiscal 2019 and 4.8% (Plan No. 1)
and 7.1% (Plan No. 2) for fiscal 2020.
31
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The company utilizes the Society of Actuaries' ("SOA") published mortality
tables and improvement scales in developing their best estimates of mortality.
In October 2019 , the SOA published its final report on their "standard"
mortality table ("Pri-2012") and released its annual update to the mortality
improvement scale ("MP-2019"). For purposes of measuring pension benefit
obligations of Plan No. 1 at year-end 2019, the company used mortality rates
based on the RP-2018 and MP-2018 mortality table and scale, with a 30% upward
adjustment to mortality rates (i.e., the same basis that was used at year end
2018). At year-end 2019, for all plans except Plan No. 1, the company updated
all mortality assumptions to reflect the most recent base mortality tables and
mortality improvement projection scale released by the SOA in 2019, Pri-2012 and
MP-2019, respectively. For Plan No. 2, the company will use a blue collar
adjustment to the base table. No other collar adjustments are applied for any
other plans. In addition, contingent annuitant mortality rates are applied for
surviving spouses after the death of the original retiree.
The company determines the fair value of substantially all of its plans' assets
utilizing market quotes rather than developing "smoothed" values, "market
related" values, or other modeling techniques. Plan asset gains or losses in a
given year are included with other actuarial gains and losses due to
remeasurement of the plans' projected benefit obligations ("PBO"). If the total
unrecognized gain or loss exceeds 10% of the larger of (i) the PBO or (ii) the
market value of plan assets, the excess of the total unrecognized gain or loss
is amortized over the expected average future lifetime of participants in the
frozen pension plans. Prior service cost or credit, which represents the effect
on plan liabilities due to plan amendments, is amortized over the average
remaining service period of active covered employees. The total unrecognized
loss and prior service cost in accumulated other comprehensive income ("AOCI")
as of December 28, 2019 for the pension plans the company sponsors was
$146.7 million . Amortization of this unrecognized loss and prior service cost
during fiscal 2020 is expected to be approximately $7.8 million . To the extent
that this unrecognized loss and prior service cost is subsequently recognized,
the loss will increase the company's pension costs in the future.
A sensitivity analysis of fiscal 2019 pension costs on a pre-tax basis and year-end benefit obligations for our qualified plans is presented in the table below (amounts in thousands) to changes in the discount rate and expected long-term rate of return on plan assets ("EROA"):
0.25% (0.25%) 0.25% (0.25%)
Percentage increase (decrease) Discount Rate Discount Rate EROA EROA
Estimated change in FY 2019 pension
costs $ (66 ) $ 67 $ (803 ) $ 803
Estimated change in FY 2019 year-end
benefit obligations $ (9,991 ) $ 10,483 N/A N/A
In fiscal 2020, the company expects to make a cash contribution to Plan No. 1
ranging from $17.0 million to $35.0 million and a $2.5 million cash contribution
to Plan No. 2, and expects to pay $0.3 million in nonqualified pension benefits
from corporate assets during fiscal 2020.
Stock-based compensation. Stock-based compensation expense for all share-based
payment awards granted is determined based on the grant date fair value. The
company recognizes these compensation costs net of an estimated forfeiture rate,
and recognizes compensation cost only for those shares expected to vest on a
straight-line basis over the requisite service period of the award, which is
generally the vesting term of the share-based payment award.
We grant performance stock awards that separately have a market and performance
condition. The expense computed for the total shareholder return shares ("TSR")
is fixed and recognized on a straight-line basis over the vesting period. The
expense computed for the return on invested capital ("ROIC") shares can change
depending on the attainment of performance condition goals. The expense for the
ROIC shares can be within a range of 0% to 125% of the target. There is a
possibility that this expense component will change in subsequent quarters
depending on how the company performs relative to the ROIC target. Additionally,
there are timed-based stock awards that vest over a period of three years. See
Note 19, Stock-Based Compensation, of Notes to Consolidated Financial Statements
of this Form 10-K for additional information. No awards were granted to
employees by our Board of Directors in fiscal 2018. In early fiscal 2020, the
company granted stock awards to certain employees and stock-based compensation
expense is expected to increase approximately $6.0 million to $8.0 million as
compared to fiscal 2019.
Commitments and contingencies. The company and its subsidiaries from time to
time are parties to, or targets of, lawsuits, claims, investigations and
proceedings, including personal injury, commercial, contract, environmental,
antitrust, product liability, health and safety and employment matters,
including lawsuits related to the independent distributors, which are being
handled and defended in the ordinary course of business. Loss contingencies are
recorded at the time it is probable an asset is impaired or a liability has been
incurred and the amount can be reasonably estimated. For litigation claims, the
company considers the degree of probability of an unfavorable outcome and the
ability to make a reasonable estimate of the loss. Losses are recorded in
selling, distribution and administrative expense in the Consolidated Statements
of Income.
32
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Results of Operations
The company's results of operations, expressed as a percentage of sales, are set forth below for fiscal 2019 and fiscal 2018:
Percentage of Sales Increase (Decrease)
Fiscal 2019 Fiscal 2018 Fiscal 2019 Fiscal 2018 Dollars %
52 weeks 52 weeks 52 weeks 52 weeks
(Amounts in thousands, except percentages)
Sales $ 4,123,974 $ 3,951,852 100.0 100.0 $ 172,122 4.4
Materials, supplies, labor
and other production
costs (exclusive of
depreciation and
amortization shown
separately below) 2,155,709 2,066,828 52.3 52.3 88,881 4.3
Selling, distribution and
administrative
expenses 1,575,122 1,507,256 38.2 38.1 67,866 4.5
Multi-employer pension plan
withdrawal costs - 2,322 - 0.1 (2,322 ) NM
(Recovery) loss on inferior
ingredients (37 ) 3,212 (0.0 ) 0.1 (3,249 ) NM
Restructuring and related
impairment charges 23,524 9,767 0.6 0.2 13,757 NM
Impairment of assets - 5,999 - 0.2 (5,999 ) NM
Depreciation and
amortization 144,228 144,124 3.5 3.6 104 0.1
Income from operations 225,428 212,344 5.5 5.4 13,084 6.2
Other components of net
periodic pension and
postretirement benefits
expense (credit) 2,248 (529 ) 0.1 (0.0 ) 2,777 NM
Pension plan settlement
loss - 7,781 - 0.2 (7,781 ) NM
Interest expense, net 11,097 7,931 0.3 0.2 3,166 39.9
Income tax expense 47,545 40,001 1.2 1.0 7,544 18.9
Net income $ 164,538 $ 157,160 4.0 4.0 $ 7,378 4.7
Comprehensive income $ 167,689 $ 151,354 4.1 3.8 $ 16,335 10.8
The company's results of operations, expressed as a percentage of sales, are set forth below for fiscal 2018 and fiscal 2017:
Percentage of Sales Increase (Decrease)
Fiscal 2018 Fiscal 2017 Fiscal 2018 Fiscal 2017 Dollars %
52 weeks 52 weeks 52 weeks 52 weeks
(Amounts in thousands, except percentages)
Sales $ 3,951,852 $ 3,920,733 100.0 100.0 $ 31,119 0.8
Materials, supplies, labor
and other production
costs (exclusive of
depreciation and
amortization shown
separately below) 2,066,828 2,009,473 52.3 51.3 57,355 2.9
Selling, distribution and
administrative
expenses 1,507,256 1,510,015 38.1 38.5 (2,759 ) (0.2 )
Gain on divestiture - (28,875 ) - (0.7 ) 28,875 NM
Multi-employer pension plan
withdrawal costs 2,322 18,268 0.1 0.5 (15,946 ) NM
Loss (recovery) on inferior
ingredients 3,212 - 0.1 - 3,212 NM
Restructuring and related
impairment charges 9,767 104,130 0.2 2.7 (94,363 ) NM
Impairment of assets 5,999 - 0.2 - 5,999 NM
Depreciation and
amortization 144,124 146,719 3.6 3.7 (2,595 ) (1.8 )
Income from operations 212,344 161,003 5.4 4.1 51,341 31.9
Other components of net
periodic pension and
postretirement benefits
credit (529 ) (6,558 ) (0.0 ) (0.2 ) 6,029 NM
Pension plan settlement
loss 7,781 4,649 0.2 0.1 3,132 NM
Interest expense, net 7,931 13,619 0.2 0.3 (5,688 ) (41.8 )
Income tax expense
(benefit) 40,001 (827 ) 1.0 (0.0 ) 40,828 NM
Net income $ 157,160 $ 150,120 4.0 3.8 $ 7,040 4.7
Comprehensive income $ 151,354 $ 148,844 3.8 3.8 $ 2,510 1.7
NM - the computation is not meaningful
Percentages may not add due to rounding.
33
--------------------------------------------------------------------------------Consolidated Results - Fiscal 2019 compared to Fiscal 2018
Sales (dollars in thousands)
Fiscal 2019 Fiscal 2018
52 weeks 52 weeks
$ % $ % % Change
(Amounts in (Amounts in
thousands) thousands)
Branded retail $ 2,481,835 60.2 $ 2,346,944 59.4 5.7
Store branded retail 645,091 15.6 586,661 14.8 10.0
Non-retail and other 997,048 24.2 1,018,247 25.8 (2.1 )
Total $ 4,123,974 100.0 $ 3,951,852 100.0 4.4
The change in sales was attributable to the following:
Favorable
Percentage point change in sales attributed to: (Unfavorable) Pricing/mix
2.4
Volume (0.2 )
Acquisition 2.2
Total percentage change in sales 4.4
Sales increased primarily due to the Canyon acquisition contribution, continued
sales growth of DKB branded organic deli-style breads, and significant growth in
branded breakfast items. Growth in both store branded breads and buns and
traditional branded loaf breads and overall positive price/mix also contributed
to the sales increase. These increases were partially offset by declines in
foodservice sales. Additionally, in the prior year, we incurred higher
promotional activity associated with the launch of Nature's Own Perfectly
Crafted breads.
The Canyon acquisition has extended our product offerings to include gluten-free
items, both in the branded retail and store branded retail categories. Prior to
the acquisition, Canyon's products were solely distributed by warehouse
distribution. During the first quarter of fiscal 2019, we began the rollout of
Canyon's branded products across our DSD distribution system as well, which we
are continuing to implement.
Branded retail sales increased due to the acquisition, growth in DKB branded
products, more favorable price/mix, and branded product introductions. We
introduced Nature's Own Perfectly Crafted breads in the second quarter of fiscal
2018, Sun-Maid breakfast bread late in the third quarter of fiscal 2018, and DKB
English muffins in the first quarter of fiscal 2019. We have continued to expand
upon these product introductions with new varieties such as Nature's Own
Perfectly Crafted brioche bread. Store branded retail sales increased due
primarily to volume growth from increased distribution of store branded breads
and buns, positive price/mix, and the Canyon acquisition. Significant volume
declines and negative price/mix for foodservice, and softer volume for vending
and institutional items resulted in the decrease in non-retail and other
sales. Foodservice sales were negatively impacted by lost business related to
the receipt of inferior ingredients beginning in the second quarter of fiscal
2018.
Materials, Supplies, Labor, and Other Production Costs (exclusive of depreciation and amortization shown separately; as a percent of sales)
Fiscal 2019 Fiscal 2018 Change as a
Line item component % of sales % of sales % of sales
Ingredients and packaging 29.3 29.6 (0.3 )
Workforce-related costs 15.2 14.9 0.3
Other 7.8 7.8 -
Total 52.3 52.3 -
34
-------------------------------------------------------------------------------- Costs were consistent with prior year as a percent of sales. Improved sales and decreased ingredient costs as a percent of sales were offset by higher workforce-related costs and lower manufacturing efficiencies. Favorable shifts in product mix largely resulted in lower ingredients and packaging costs as a percent of sales. Workforce-related costs increased due to a competitive labor market and higher employee incentive costs year over year. Sales and production costs were negatively impacted by the effects from inferior ingredients, although we cannot currently quantify these amounts. Raw materials, such as our baking ingredients, periodically experience price fluctuations. The cost of these inputs may fluctuate significantly due to government policy and regulation, weather conditions, domestic and international demand, or other unforeseen circumstances. We enter into forward purchase agreements and other derivative financial instruments in an effort to manage the impact of such volatility in raw material prices, but some organic and specialty ingredients do not offer the same hedging opportunities to reduce the impact of price volatility. Any decrease in the availability of these agreements could increase the effective price of these raw materials to us and significantly affect our earnings. We currently anticipate ingredient costs to be stable to moderately lower in fiscal 2020 relative to fiscal 2019.
Selling, Distribution and Administrative Expenses (as a percent of sales)
Fiscal 2019 Fiscal 2018 Change as a
Line item component % of sales % of sales % of sales
Workforce-related costs 11.0 10.6 0.4
Distributor distribution fees 14.7 14.9 (0.2 )
Other 12.5 12.6 (0.1 )
Total 38.2 38.1 0.1
Workforce-related costs were higher as a percent of sales as a result of
increased employee incentive costs year over year and a competitive labor
market. Distributor distribution fees decreased primarily due to the Canyon
acquisition as Canyon's sales are largely warehouse-delivered. The slight
decrease in the Other line item in the table above primarily resulted from
decreased consulting costs related to Project Centennial and prior year
acquisition costs, mostly offset by increased legal settlements and greater
investments in marketing in the current year. As discussed in the "Matters
Affecting Comparability" section above, in fiscal 2019, we recorded legal
settlements of $28.0 million (inclusive of a $1.3 million benefit related to an
adjustment of a prior year settlement based on the final amount paid). In fiscal
2018, we recorded legal settlements of $21.5 million . We incurred consulting
costs associated with Project Centennial of $0.8 million in the current year
compared to $9.7 million in the prior year, and anticipate additional consulting
costs related to the project in the range of $7.0 million to $9.0 million in
fiscal 2020. We incurred acquisition costs of $4.5 million related to the Canyon
acquisition in fiscal 2018.
MEPP Costs, (Recovery) Loss on Inferior Ingredients, Restructuring and Related Impairment Charges and Impairment of Assets
Refer to the discussion in the "Matters Affecting Comparability" section above regarding these items.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased slightly as a percent of sales due to accelerated depreciation of certain right-of-use assets in the prior year and certain other property, plant and equipment becoming fully depreciated, partially offset by increased amortization expense from amortizing the Canyon intangible assets acquired at the end of fiscal 2018.
Income from Operations
Income from operations increased modestly year over year as a percent of sales largely due to sales increases, the prior year loss on inferior ingredients and impairment of assets, somewhat offset by increased restructuring charges year over year.
Other Components of Net Periodic Pension and Postretirement Benefits Expense (Credit) and Pension Plan Settlement Loss
Other components of net periodic pension and postretirement benefits expense (credit) changed primarily due to a decrease in pension income resulting from the company changing its pension plan asset allocation to include a larger percentage of fixed-income assets as part of the plan termination process as discussed in the "Matter Affecting Comparability" section above. Additionally, in fiscal 2018, we recorded$7.8 million of pension plan settlement losses. We anticipate settlement charges of approximately$125.0 million to$143.0 million in the first quarter of fiscal 2020. 35 --------------------------------------------------------------------------------
Net Interest Expense
Net interest expense increased year over year due to higher average amounts outstanding under the company's debt arrangements primarily due to funding the Canyon acquisition at the end of fiscal 2018, net of repayments we have made through fiscal 2019. Income Tax Expense The effective tax rate for fiscal 2019 was 22.4% compared to 20.3% in the prior year. The rate in the prior year was lower primarily due to recognizing an income tax benefit of$5.6 million to adjust the estimated provisional benefit recorded in fiscal 2017 related to tax reform enacted inDecember 2017 . The provisional amount was adjusted in the second quarter of fiscal 2018 to reflect timing differences reported on the 2017 federal tax return. The adjustment resulted in a discrete tax benefit of$5.6 million , a reduction to federal income tax payable of$16.4 million and increase to federal deferred tax liabilities of$10.8 million . The adjustment primarily relates to pension contributions and bonus depreciation on certain assets placed in service during fiscal 2017. This benefit was partially offset by stock-based compensation shortfalls in 2018 compared to windfalls in the current year. In 2019, the most significant difference in the effective rate and the statutory rate was for state income taxes. The primary differences in the effective rate and the statutory rate for the prior year were for adjustments to provisional taxes related to tax reform and state income taxes.
Comprehensive Income
The increase in comprehensive income year over year resulted primarily from the increase in net income and the prior year pension plan actuarial loss, net of the prior year pension plan settlement loss.
Consolidated Results - Fiscal 2018 compared to Fiscal 2017
Sales (dollars in thousands)
Fiscal 2018 Fiscal 2017
52 weeks 52 weeks
$ % $ % % Change
(Amounts in (Amounts in
thousands) thousands)
Branded retail $ 2,346,944 59.4 $ 2,307,836 58.9 1.7
Store branded retail 586,661 14.8 579,006 14.7 1.3
Non-retail and other 1,018,247 25.8 1,033,891 26.4 (1.5 )
Total $ 3,951,852 100.0 $ 3,920,733 100.0 0.8
The change in sales was attributable to the following:
Favorable
Percentage point change in sales attributed to: (Unfavorable) Pricing/mix
1.8
Volume (1.0 )
Total percentage change in sales 0.8
Significant sales growth for our DKB branded organic products, positive
price/mix and growth in our expansion markets drove the increase in branded
retail sales, partially offset by softer demand for other branded items, most
significantly buns and rolls and traditional loaf breads. Sales of DKB branded
products grew due to volume and price increases as well as the introduction of
DKB branded breakfast items in the second quarter of fiscal 2017. Store branded
retail sales increased primarily due to positive price/mix. Non-retail and other
sales, which include contract manufacturing, vending and foodservice, decreased
largely due to declines in price/mix and softer sales in our thrift stores, as
well as the impact from inferior yeast.
36
--------------------------------------------------------------------------------Materials, Supplies, Labor, and Other Production Costs (exclusive of depreciation and amortization shown separately; as a percent of sales)
Fiscal 2018 Fiscal 2017 Change as a
Line item component % of sales % of sales % of sales
Ingredients and packaging 29.6 29.0 0.6
Workforce-related costs 14.9 15.0 (0.1 )
Other 7.8 7.3 0.5
Total 52.3 51.3 1.0
Ingredients increased as percent of sales mainly due to a significant increase
in non-organic flour prices and to a lesser extent sweetener prices, somewhat
offset by increases in outside purchases of product (sales with no ingredient
costs) and lower prices for certain organic ingredients. The increase in outside
product purchases primarily was for DKB branded breakfast products and pita
breads and is reflected in the Other line item in the table above. Production
disruptions related to inferior ingredients and declines in manufacturing
efficiency also contributed to the rise in production costs.
Raw materials, such as our baking ingredients, periodically experience price
fluctuations. The cost of these inputs may fluctuate significantly due to
government policy and regulation, weather conditions, domestic and international
demand, or other unforeseen circumstances. We enter into forward purchase
agreements and other derivative financial instruments in an effort to manage the
impact of such volatility in raw material prices. Any decrease in the
availability of these agreements could increase the effective price of these raw
materials to us and significantly affect our earnings.
Selling, Distribution and Administrative Expenses (as a percent of sales)
Fiscal 2018 Fiscal 2017 Change as a
Line item component % of sales % of sales % of sales
Workforce-related costs 10.6 12.7 (2.1 )
Distributor distribution fees 14.9 13.5 1.4
Other 12.6 12.3 0.3
Total 38.1 38.5 (0.4 )
During fiscal 2018, a larger portion of our sales were made through IDPs
resulting in increased distributor distribution fees and decreased
workforce-related costs. Additionally, workforce reductions from the VSIP and
other restructuring initiatives, lower employee fringes and reduced stock-based
compensation expense (no stock awards were granted to employees in the current
year) reduced workforce-related costs. As discussed in the "Matters Affecting
Comparability" section above, legal settlements increased $15.5 million over
fiscal 2017 and acquisition costs in fiscal 2018 were $4.5 million , however,
consulting costs associated with Project Centennial decreased $27.6 million as
compared to fiscal 2017, all of which are reflected in the Other line item in
the table above. Higher transportation costs and increased investments in
marketing initiatives in fiscal 2018 also negatively impacted overall costs,
somewhat offset by reduced legal fees.
Gain on Divestiture, MEPP Costs, (Recovery) Loss on Inferior Ingredients, Restructuring and Related Impairment Charges and Impairment of Assets
Refer to the discussion in the "Matters Affecting Comparability" section above regarding these items.
Depreciation and Amortization Expense
Depreciation and amortization expense was relatively consistent as a percent of sales year over year.
Income from Operations Income from operations increased significantly as a percent of sales year over year largely due to sales increases and decreases in selling, distribution and administrative expenses, both discussed above, and decreased restructuring charges of$94.3 million and decreased MEPP costs of$15.9 million . The$28.9 million gain on divestiture in fiscal 2017 and increased ingredient costs in fiscal 2018 partially offset the overall increase. 37 --------------------------------------------------------------------------------
Other Components of Net Periodic Pension and Postretirement Benefits Credit and Pension Plan Settlement Loss
The change in other components of net periodic pension and postretirement benefits credit resulted primarily from a decrease in pension plan income as a result of the company changing its pension plan asset allocation to include a larger percentage of fixed-income assets as measured onDecember 31, 2018 compared toDecember 31, 2017 . Refer to the discussion in the "Matters Affecting Comparability" section above regarding pension plan settlement loss.
Net Interest Expense
Net interest expense decreased primarily due to a significant increase in interest income resulting from increases in distributor notes receivable outstanding year over year.
Income Tax Expense (Benefit)
The effective tax rate for fiscal 2018 and fiscal 2017 was 20.3% and -0.6%, respectively. The rates reflect federal tax reform effective for the company starting in the fourth quarter of 2017. The Act reduced our current year corporate rate from 35% to 21%. The increase in the rate in fiscal 2018 compared to fiscal 2017 was primarily due to provisional tax benefits recorded in the fourth quarter of 2017 to revalue ourU.S. deferred tax liabilities to the lower rate under the Act. Fluctuations in the tax rate for fiscal 2018 compared to fiscal 2017 were also significantly impacted by improved earnings before tax. The company's fiscal 2017 financial results included the income tax effects of the Act for which the accounting was complete, and provisional amounts for effects of the Act for which the accounting was incomplete, but a reasonable estimate could be determined. The effective tax rate for fiscal 2017 included an estimated tax benefit of$48.2 million due to the Act. The provisional amount was adjusted in the second quarter of fiscal 2018 to reflect the actual timing differences reported on the federal tax 2017 return. The adjustment resulted in a discrete tax benefit of$5.6 million , a reduction to federal income tax payable of$16.4 million and an increase to federal deferred tax liabilities of$10.8 million . The adjustment primarily related to pension contributions and bonus depreciation on certain assets placed in service during fiscal 2017. Our accounting for the income tax effects of the Act was complete as ofDecember 29, 2018 . In 2018, the most significant differences in the effective rate and the statutory rate were for adjustments to provisional taxes related to tax reform and state income taxes. In 2017, other than the substantial benefit associated with the enactment of the tax reform, the most significant differences in the effective rate and the statutory rate were the benefit from Section 199 qualifying domestic production activities deduction and state income tax expense.
Comprehensive Income
The increase in comprehensive income year over year resulted primarily from the increase in net income and changes in the fair value of derivatives, net of changes in the pension plan as a result of the remeasurement.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION
Strategy
We believe our ability to consistently generate cash flows from operating
activities to meet our liquidity needs is one of our key financial strengths and
we do not anticipate significant risks to these cash flows in the foreseeable
future. Additionally, we strive to maintain a conservative financial position
aiming to achieve this through prudent debt reduction and opportunistic share
repurchases. We believe having a conservative financial position allows us
flexibility to make investments and acquisitions and is a strategic competitive
advantage. Currently, our liquidity needs arise primarily from working capital
requirements, capital expenditures, pension contributions and obligated debt
repayments. We believe we currently have access to available funds and financing
sources to meet our short and long-term capital requirements. The company's
strategy for use of its excess cash flows includes:
• implementing our strategies under Project Centennial;
• paying dividends to our shareholders;
• maintaining a conservative financial position;
• making strategic acquisitions;
• repurchasing shares of our common stock; and
• making discretionary contributions to our qualified pension plans.
38
-------------------------------------------------------------------------------- The company leases certain property and equipment under various financing and operating lease arrangements. Most of the operating leases provide the company with the option, after the initial lease term, to purchase the property at the then fair value, renew the lease at the then fair value, or return the property. The financing leases provide the company with the option to purchase the property at a fixed price at the end of the lease term. The company believes the use of leases as a financing alternative places the company in a more favorable position to fulfill its long-term strategy for the use of its cash flow. See Note 14, Leases, of Notes to Consolidated Financial Statements of this Form 10-K for detailed financial information regarding the company's lease arrangements.
Key items impacting our liquidity, capital resources and financial position in fiscal 2019 and 2018:
Fiscal 2019: • We generated$367.0 million of net cash from operating activities. • We paid dividends to our shareholders of$160.0 million . • We decreased our total debt outstanding$114.3 million .
• We invested in our business through capital expenditures of
• We incurred Project Centennial implementation costs, including
restructuring cash charges of $3.3 million and non-restructuring
consulting costs of $0.8 million .
Fiscal 2018:
• We generated
• We acquired Canyon, a gluten-free bakery, for cash payments of
million.
• We increased our total debt outstanding by
result of borrowings under the AR facility to fund the Canyon acquisition.
• We paid dividends to our shareholders of$150.2 million .
• We invested in our business through capital expenditures of
• We incurred Project Centennial implementation costs, including
restructuring cash charges of $4.2 million and non-restructuring
consulting costs of $9.7 million .
Liquidity Discussion
Flowers Foods' cash and cash equivalents were$11.0 million atDecember 28, 2019 ,$25.3 million atDecember 29, 2018 , and$5.1 million atDecember 30, 2017 . The cash and cash equivalents were derived from the activities presented in the table below (amounts in thousands): Cash flow component Fiscal 2019 Fiscal 2018 Fiscal 2017 Cash flows provided by operating activities$ 366,952 $ 295,893 $ 297,389 Cash disbursed for investing activities (97,093 ) (301,805 ) (35,395 ) Cash provided by (disbursed for) financing activities (284,121 ) 26,089 (263,275 ) Total change in cash$ (14,262 ) $ 20,177 $ (1,281 ) 39
--------------------------------------------------------------------------------
Cash Flows Provided by Operating Activities. Net cash provided by operating
activities included the following items for non-cash adjustments to net income
(amounts in thousands):
Fiscal 2019 Fiscal 2018 Fiscal 2017
Depreciation and amortization $ 144,228 $ 144,124 $ 146,719
Gain on divestiture - - (28,875 )
Restructuring and related impairment
charges 21,062 5,593 69,601
Stock-based compensation 7,430 8,148 16,093
Impairment of assets - 5,999 -
Deferred income taxes 18,609 21,657 (61,306 )
Pension and postretirement plans (benefit)
expense
(including settlement losses) 3,234 8,474 (897 )
Other non-cash 9,243 4,165 1,776
Net non-cash adjustment to net income
• Refer to the Restructuring and related impairment charges associated with
Project Centennial, Gain on divestiture of the non-core mix manufacturing
business, and the Impairment of assets discussions in the "Matters
Affecting Comparability" section above regarding these items.
• The change in stock-based compensation from fiscal 2017 to fiscal 2018 was
due to no stock awards being granted to employees in fiscal 2018.• For fiscal 2017, deferred income taxes changed due to revaluing the net
deferred tax liability due to tax reform and changes in temporary
differences year over year. For fiscal 2019 and fiscal 2018, the changes
resulted from changes in temporary differences year over year.
• Changes in pension and postretirement plan (benefit) expense were
primarily due to settlement losses of $7.8 million and $4.6 million infiscal 2018 and fiscal 2017, respectively, and changes to the pension plan
asset allocations as part of the de-risking strategy.
• Other non-cash items include non-cash interest expense for theamortization of debt discounts and deferred financing costs and gains or
losses on the sale of assets.
Net cash for working capital requirements and pension contributions included the following items (amounts in thousands):
Fiscal 2019 Fiscal 2018 Fiscal 2017
Changes in accounts receivable, net $ (7,809 ) $ (8,278 ) $ (11,762 )
Changes in inventories, net (4,774 ) (8,424 ) (7,801 )
Changes in hedging activities, net 10,289 2,725 (15,727 )
Changes in other assets and accrued
liabilities, net 17,557 (65,613 ) 30,213
Changes in accounts payable (14,155 ) 60,863 10,840
Qualified pension plan contributions (2,500 ) (40,700 ) (1,605 )
Net changes in working capital and pension
contributions $ (1,392 ) $ (59,427 ) $ 4,158 •Hedging activities change from market movements that affect the fair value and required collateral of positions and the timing and recognition of deferred gains or losses. These changes will occur as part of our hedging program.
•The change in other assets and accrued liabilities primarily resulted from changes in income tax receivable balances, deferred gains recorded in conjunction with the sale of distribution rights to IDPs, hedge margin, employee compensation accruals (including restructuring-related employee termination benefits), accrued MEPP costs, and legal accruals. As a result of the change in lease accounting in fiscal 2019, prepaid rent amounts that were previously included in other assets are included in right-of-use assets and deferred credits that were previously included in accrued liabilities are included in lease obligations. In fiscal 2019 and 2018, we paid$2.1 million and$29.3 million , respectively, of restructuring-related cash charges. In fiscal 2018, we also paid$17.5 million of MEPP costs. We paid$7.9 million of legal settlements in fiscal 2019, all of which had been accrued for in prior years, and paid$16.4 million in fiscal 2018, of which$5.2 million had been accrued for in prior years. We anticipate making payments of approximately$19.4 million , including our share of employment taxes, in performance-based cash awards under our bonus plans in the first quarter of fiscal 2020. During fiscal 2019 and 2018, the company paid$7.9 million and$28.1 million , respectively, including our share of employment taxes, in performance-based cash awards under the company's bonus plan. An additional$1.2 million and$0.4 million was paid during fiscal 2019 and 2018, respectively, for our share of employment taxes on the vesting of the performance-contingent restricted stock awards in each respective year. 40 --------------------------------------------------------------------------------
• The significant change in accounts payable in fiscal 2018 resulted from
extending our payment terms with certain of our suppliers as well as
increases in ingredient costs.
• During fiscal 2019, 2018, and 2017, we made voluntary contributions to our
defined benefit pension plans of
million, respectively. In the first quarter of fiscal 2020, we expect to
make a final cash contribution to Plan No. 1 in the range of
to
contribution to Plan No. 2 and expect to pay
pension benefits from corporate assets. The company believes its cash flow
and balance sheet will allow it to fund future pension needs without
adversely affecting the business strategy of the company.
Cash Flows Disbursed for Investing Activities. The table below presents net
cash disbursed for investing activities for fiscal 2019, 2018, and 2017 (amounts
in thousands):
Fiscal 2019 Fiscal 2018 Fiscal 2017
Purchase of property, plant, and equipment $ (103,685 ) $ (99,422 ) $ (75,232 )
Principal payments from notes receivable,
net of
repurchases of independent distributor
territories 3,824 (4,699 ) (7,151 )
Acquisition of businesses, net of cash
acquired - (200,174 ) -
Proceeds from divestiture - - 41,230
Proceeds from sale of property, plant and
equipment 2,649 1,913 3,935
Other 119 577 1,823
Net cash disbursed for investing activities
• The company currently estimates capital expenditures of approximately
• Cash payments for the Canyon acquisition of
quarter of fiscal 2018 were funded from cash on hand and borrowings under
the AR facility.
• We received proceeds, net of a working capital adjustment, of
million from the divestiture of our
business in the first quarter of fiscal 2017.
Cash Flows Provided by (Disbursed for) Financing Activities. The table below
presents net cash provided by (disbursed for) financing activities for fiscal
2019, 2018, and 2017 (amounts in thousands):
Fiscal 2019 Fiscal 2018 Fiscal 2017
Dividends paid, including dividends on
share-based
payment awards $ (159,987 ) $ (150,214 ) $ (140,982 )
Exercise of stock options - 791 19,313
Payment of financing fees (110 ) (100 ) (729 )
Stock repurchases (7,054 ) (2,489 ) (2,671 )
Change in bank overdrafts 3,217 4,851 (14,206 )
Net change in debt obligations (114,250 ) 173,250 (124,000 )
Payments on financing leases (5,937 ) - -
Net cash provided by (disbursed for)
financing activities $ (284,121 ) $ 26,089 $ (263,275 ) • Our dividend payout rate increased 5.6% from fiscal 2018 to fiscal 2019
and 6.0% from fiscal 2017 to fiscal 2018. While there are no requirements
to increase the dividend payout we have shown a recent historical trend to
do so. Should this continue in the future, we will have additional cash
needs to meet these expected dividend payouts.
• Stock option exercises decreased due to fewer exercises in fiscal 2018
compared to fiscal 2017. As of December 28, 2019 , there were no
nonqualified stock options outstanding.
• Stock repurchase decisions are made based on our stock price, our belief
of relative value, and our cash projections at any given time. See Note
18, Stockholders' Equity, of Notes to Consolidated Financial Statements of
this Form 10-K for additional information.
• Net debt obligations increased in fiscal 2018 primarily due to funding the
Canyon acquisition, net of repayments we made during the year.
41
--------------------------------------------------------------------------------
Capital Structure
Long-term debt and right-of-use lease obligations and stockholders' equity were as follows atDecember 28, 2019 andDecember 29, 2018 . For a detailed description of our debt and right-of-use lease obligations and information regarding our credit ratings, distributor arrangements, deferred compensation, and guarantees and indemnification obligations, see Note 14, Leases, and Note 15, Debt and Other Commitments, of Notes to Consolidated Financial Statements of this Form 10-K: Interest Rate at Final Balance at Fixed or December 28, December 29, December 28, 2019 Maturity 2019 2018 Variable Rate (Amounts in thousands) 2026 senior notes 3.50% 2026$ 396,122 $ 395,550 Fixed Rate 2022 senior notes 4.38% 2022 398,906 398,423 Fixed Rate Credit facility 3.30% 2022 41,750 - Variable Rate AR facility 2.94% 2021 26,000 177,000 Variable Rate
Right-of-use lease
obligations 2036 404,503 21,942
Other notes payable 2.10% 2020 3,730 8,621
1,271,011 1,001,536
Current maturities of
long-term debt
and right-of-use lease
obligations 64,712 10,896
Long-term debt and
right-of-use lease
obligations $ 1,206,299 $ 990,640
Total stockholders' equity was as follows at December 28, 2019 and December 29,
2018 :
Balance at
December 28, 2019 December 29, 2018
(Amounts in thousands)
Total stockholders' equity $ 1,263,430 $ 1,258,267
The AR facility and credit facility are generally used for short term liquidity
needs. The company has historically entered into amendments and extensions
approximately one year prior to the maturity of the AR facility and the credit
facility. The following table details the amounts available under the AR
facility and credit facility and the highest and lowest balances outstanding
under these arrangements during fiscal 2019:
Amount Available Highest Lowest
for Withdrawal at Balance in Balance in
Facility December 28, 2019 Fiscal 2019 Fiscal 2019
(Amounts in thousands)
AR facility $ 163,400 $ 177,000 $ -
Credit facility (1) 449,850 $ 122,200 $ -
$ 613,250
(1) Amount excludes a provision in the agreement which allows the company to
request an additional
Amounts outstanding under the credit facility can vary daily. Changes in the gross borrowings and repayments can be caused by cash flow activity from operations, capital expenditures, acquisitions, dividends, share repurchases, and tax payments, as well as derivative transactions which are part of the company's overall risk management strategy as discussed in Note 11, Derivative Financial Instruments, of Notes to Consolidated Financial Statements of this Form 10-K. During fiscal 2019, the company borrowed$297.3 million in revolving borrowings under the credit facility and repaid$255.5 million in revolving borrowings. The amount available under the credit facility is reduced by$8.4 million for letters of credit. The AR facility and the credit facility are variable rate debt. In periods of rising interest rates, the cost of using the facility and the credit facility will become more expensive and increase our interest expense. Therefore, borrowings under these facilities provide us the greatest direct exposure to rising rates. In addition, if interest rates do increase it will make the cost of funds more expensive. 42
-------------------------------------------------------------------------------- Restrictive financial covenants for our borrowings include such ratios as a minimum interest coverage ratio and a maximum leverage ratio. Our debt may also contain certain customary representations and warranties, affirmative and negative covenants, and events of default. The company believes that, given its current cash position, its cash flow from operating activities and its available credit capacity, it can comply with the current terms of the debt agreements and can meet its presently foreseeable financial requirements. As ofDecember 28, 2019 andDecember 29, 2018 , the company was in compliance with all restrictive covenants under our debt agreements. Special Purpose Entities. AtDecember 28, 2019 andDecember 29, 2018 , the company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes. Contractual Obligations and Commitments. The following table summarizes the company's contractual obligations and commitments atDecember 28, 2019 and the effect such obligations are expected to have on its liquidity and cash flow in the indicated future periods: Payments Due by Fiscal Year (Amounts in thousands) 2025 and Total 2020 2021-2022 2023-2024 Beyond Contractual Obligations: Long-term debt$ 871,500 $ 3,750 $ 467,750 $ -$ 400,000 Interest payments (1) 134,750 31,500 54,250 28,000 21,000 Financing right-of-use leases (2) 29,625 9,032 12,077 7,827 689 Operating right-of-use leases (2) 466,309 67,885 108,313 79,882 210,229 Pension and postretirement contributions and payments (3) 38,966 33,175 1,291 1,260 3,240 Deferred compensation plan obligations (4) 17,308 1,750 2,134 1,753 11,671 Purchase obligations (5) 330,526 330,526 - - - Total contractual cash obligations$ 1,888,984 $ 477,618 $ 645,815 $ 118,722 $ 646,829 Amounts Expiring by Fiscal Year (Amounts in thousands) Less than More than Total 1 Year 1-3 Years 4-5 Years 5 Years Commitments: Standby letters of credit (6)$ 19,064 $ 19,064 $ - $ - $ - Truck lease guarantees 4,644 1,118 1,279 1,957 290 Total commitments$ 23,708 $ 20,182 $ 1,279 $ 1,957 $ 290
(1) Amounts outstanding under our credit facility at
included since payments into and out of the credit facility change daily. The
facility interest rate is based on the actual rate at
Interest on the senior notes and other notes payable is based on the stated
rate and excludes the amortization of debt discount and debt issuance costs.
(2) Includes the computed interest portion of the payments based on the
incremental borrowing rate.
(3) Includes the expected benefit payments for postretirement plans from fiscal
2020 through fiscal 2029. These future postretirement plan payments are not
recorded on the Consolidated Balance Sheets but will be recorded as these
payments are incurred in the Consolidated Statements of Income. The company
expects to complete the termination of Plan No. 1 and anticipates making a
final required cash contribution ranging from
in the first quarter of fiscal 2020. Additionally, the company expects to
make a
(4) These are unsecured general obligations to pay the deferred compensation of,
and our contributions to, participants in the executive deferred compensation
plan. This liability is recorded on the Consolidated Balance Sheets as either
a current or long-term liability.
(5) Represents the company's various ingredient and packaging purchasing
commitments. This item is not recorded on the Consolidated Balance Sheets.
(6) These letters of credit are for the benefit of certain insurance companies
related to workers' compensation liabilities recorded by the company as of
not recorded on the Consolidated Balance Sheets, but
total reduces the availability of funds under the credit facility.
43
-------------------------------------------------------------------------------- Because we are uncertain as to if or when settlements may occur, these tables do not reflect the company's net liability of$0.2 million related to uncertain tax positions as ofDecember 28, 2019 . Details regarding this liability are presented in Note 23, Income Taxes, of Notes to Consolidated Financial Statements of this Form 10-K. In the event the company ceases to utilize the independent distribution form of doing business or exits a geographic market, the company is contractually required to purchase the distribution rights from the independent distributor. These potential commitments are excluded from the table above because they cannot be known at this time. Stock Repurchase Plan. The Board has approved a plan that currently authorizes share repurchases of up to 74.6 million shares of the company's common stock. At the close of the company's fourth quarter onDecember 28, 2019 , 6.2 million shares remained under the existing authorization. Under the plan, the company may repurchase its common stock in open market or privately negotiated transactions or under an accelerated repurchase program at such times and at such prices as determined to be in the company's best interest. These purchases may be commenced or suspended without prior notice depending on then-existing business or market conditions and other factors. During fiscal 2019, 0.3 million shares of the company's common stock were repurchased under the plan at a cost of$7.1 million and during fiscal 2018, 0.1 million shares were repurchased under the plan at a cost of$2.5 million . From the inception of the plan throughDecember 28, 2019 , 68.4 million shares, at a cost of$642.6 million , have been repurchased. There were no repurchases of the company's common stock during the fourth quarter of fiscal 2019.
New Accounting Pronouncements Not Yet Adopted
See Note 3, Recent Accounting Pronouncements, of Notes to Consolidated Financial Statements of this Form 10-K regarding this information.
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