FLOWERS FOODS, INC. The following discussion of the financial condition and results of operations of the company as of and for the twelve and forty weeks endedOctober 8, 2022 should be read in conjunction with the Form 10-K and Part II., Item 1A., Risk Factors, of this Form 10-Q.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is segregated into four sections, including:
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Executive overview - provides a summary of our business, operating performance and cash flows, and strategic initiatives.
•
Critical accounting estimates - describes the accounting areas where management makes critical estimates to report our financial condition and results of operations. There have been no changes to this section from the Form 10-K.
•
Results of operations - an analysis of the company's consolidated results of operations for the two comparative periods presented in our Condensed Consolidated Financial Statements.
•
Liquidity and capital resources - an analysis of cash flow, contractual obligations, and certain other matters affecting the company's financial position.
Matters Affecting Comparability
Comparative results from quarter to quarter are impacted by the company's fiscal reporting calendar. Internal financial results and key performance indicators are reported on a weekly basis to ensure the same number of Saturdays and Sundays in comparable months to allow for consistent four-week progression analysis. This results in our first quarter consisting of sixteen weeks while the remaining three quarters have twelve weeks (except in cases where there is an extra week every five or six years). Accordingly, interim results may not be indicative of subsequent interim period results, or comparable to prior or subsequent interim period results, due to differences in the lengths of the interim periods.
Additionally, detailed below are expense items affecting comparability that will provide greater context while reading this discussion:
For the Twelve Weeks Ended For the Forty Weeks Ended Footnote
October 8, 2022 October 9, 2021
(Amounts in thousands) (Amounts in thousands)
Business process
improvement consulting
costs $ 8,144 $ 9,233 $ 28,866 $ 27,396 Note 1
Plant closure costs and
impairment of
assets 6,835 - 7,825 - Note 1
Severance and lease
termination costs - - 1,717 -
Legal settlements and
related costs 5,500 23,089 7,500 23,089 Note 13
Recovery on inferior
ingredients - (950 ) - (828 ) Note 1
Acquisition-related costs 11,582 - 11,582 - Note 1
Acquisition consideration
adjustment - - - 3,400 Note 9
Multi-employer pension
plan withdrawal
costs - 3,300 - 3,300 Note 16
Loss on extinguishment of
debt - - - 16,149 Note 11
$ 32,061 $ 34,672 $ 57,490 $ 72,506
•
Business process improvement consulting costs related to the transformation
strategy initiatives In the second half of Fiscal 2020, we launched initiatives
to transform our business operations, which include upgrading our information
system, as well as investments in e-commerce, autonomous planning, and our
"bakery of the future" initiative. In the first quarter of Fiscal 2022, we
launched the digital logistics and digital sales initiatives. These initiatives
are further discussed in the "Transformation Strategy Initiatives" section
below. The expensed portion of costs incurred related to these initiatives was
$8.1 million and $28.9 million during the twelve and forty weeks ended October
8, 2022 , respectively. We recognized $9.2 million and $27.4 million during the
prior year third quarter and year to date periods, respectively. These costs are
reflected in the selling, distribution, and administrative expenses line item of
the Condensed Consolidated Statements of Income. We currently expect consulting
costs (a portion of which may be expensed as incurred, capitalized, recognized
as a cloud computing arrangement, or recognized as a prepaid service contract)
related to the upgrade of our ERP system to be approximately $70.0 million to
$80.0 million for Fiscal 2022.
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Plant closure costs and impairment of assets OnJuly 19, 2022 , the company announced the closure of theHolsum Bakery inPhoenix, Arizona . The bakery produced bread and bun products and ceased production onOctober 31, 2022 . This closure is part of our strategy to optimize our sales portfolio and improve supply chain and manufacturing efficiency. The company recognized severance costs of$1.7 million , multi-employer pension plan withdrawal costs of$1.3 million , and asset impairment and equipment relocation charges for bakery equipment of$3.8 million in the third quarter of Fiscal 2022. As a result of the manufacturing line closures, the union participants of theIAM National Pension Fund (the "IAM Fund ") at thePhoenix, Arizona bakery will withdraw from theIAM Fund . While this is our best estimate of the ultimate cost of the withdrawal from this plan, additional withdrawal liability may be incurred based on the finalIAM Fund assessment or in the event of a mass withdrawal, as defined by statute, occurring anytime within the next three years. During the first quarter of Fiscal 2022, the company decided to sell two warehouses acquired at the end of Fiscal 2021 and recorded an impairment charge of$1.0 million . The company completed the sale of the impaired warehouse at the end of the first quarter of Fiscal 2022.
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Severance and lease termination costs In the second quarter of Fiscal 2022, the company committed to a plan to outsource its aviation services and recorded severance and lease termination charges totaling$1.7 million which are reflected in the selling, distribution, and administrative expenses line item of the Condensed Consolidated Statements of Income. The lease termination costs were paid in the second quarter of Fiscal 2022 and the severance payments are anticipated to be paid by the end of Fiscal 2022.
•
Legal settlements and related costs During the second and third quarters of Fiscal 2022, we reached agreements to settle certain distributor-related litigation in the aggregate amount of$7.5 million , inclusive of attorney fees. We paid the settlement accrued for in the second quarter of Fiscal 2022 in the third quarter of Fiscal 2022. In the third quarter of Fiscal 2021, we reached an agreement to settle certain distributor-related litigation for a settlement payment, inclusive of plaintiffs' attorney fees, of$16.5 million . The payment was made in the second quarter of Fiscal 2022. The settlement also required a phased repurchase of approximately 75 distribution rights and the company estimated this cost to be approximately$6.6 million . The company commenced repurchasing the distribution rights during the second quarter of Fiscal 2022 and these repurchases are ongoing. All of these amounts are reflected in the selling, distribution, and administrative expenses line item of the Condensed Consolidated Statements of Income.
•
Recovery on inferior ingredients In the first quarter of Fiscal 2021, we incurred additional costs of$0.1 million related to receiving inferior ingredients used in the production of certain of our gluten-free products. In the third quarter of Fiscal 2021, we received reimbursements of approximately$1.0 million for these previously incurred costs.
•
Acquisition-related costs In the third quarter of Fiscal 2022, we incurred$11.6 million in costs from the pursuit of an acquisition that failed to materialize. Of this amount,$8.4 million related to realized foreign currency exchange losses. Although the majority of the target company's sales were made in theU.S. , the target company's foreign domicile required us to convert funds fromU.S. dollars to complete the transaction. Following that conversion, a significant strengthening of theU.S. dollar relative to the target company's currency resulted in the foreign currency exchange loss upon conversion back intoU.S. dollars following the failure of the deal.
•
Acquisition consideration adjustment In connection with an acquisition completed in Fiscal 2012, the company agreed to make the sellers whole for certain taxes incurred by the sellers on the sale. In the second quarter of Fiscal 2021, there was a tax determination that the sellers owed additional taxes, which we have appealed. If the appeal is unsuccessful, the company estimates that it will owe the sellers approximately$3.4 million , and the company recorded this cost in the selling, distribution, and administrative expenses line item of the Condensed Consolidated Statements of Income in the second quarter of Fiscal 2021.
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Multi-employer pension plan withdrawal costs OnSeptember 22, 2021 , the union participants of the Retail,Wholesale and Department Store Union Fund (the "RWDSU Fund ") at ourBirmingham, Alabama plant voted to withdraw from theRWDSU Fund in the most recent collective bargaining agreement. The union participants became eligible to participate in theFlowers Foods, Inc. 401(k) Retirement Savings Plan, beginning onDecember 1, 2021 . This resulted in the recognition of a pension plan withdrawal liability of$3.3 million (including transition payments) in our Condensed Consolidated Statements of Income. We made the transition payments in December of Fiscal 2021 and the withdrawal liability payment in the first quarter of Fiscal 2022.
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Loss on extinguishment of debt OnApril 8, 2021 , we completed the early redemption of the company's$400.0 million of 4.375% senior notes due 2022 (the "2022 notes") with proceeds received from the issuance of the company's$500.0 million of 2.400% senior notes due 2031 (the "2031 notes") onMarch 9, 2021 . We recognized a loss on extinguishment of debt of$16.1 million comprised of a make-whole cash payment of$15.4 million and the write-off of unamortized debt discount and debt issuance costs totaling$0.7 million . 35 --------------------------------------------------------------------------------
Executive Overview Business Flowers is the second-largest producer and marketer of packaged bakery foods inthe United States ("U.S."). Our principal products include breads, buns, rolls, snack cakes, and tortillas and are sold under a variety of brand names, including Nature's Own,Dave's Killer Bread ("DKB"), Wonder,Canyon Bakehouse , Tastykake, andMrs. Freshley's . Our brands are among the best known in theU.S. baking industry. Many of our brands have a major presence in the product categories in which they compete. We manage our business as one operating segment. Flowers' strategic priorities include developing our team, focusing on our brands, prioritizing our margins, and proactively seeking smart, disciplined acquisitions in the grain-based foods category. We believe executing on our strategic priorities will drive future growth and margin expansion and deliver meaningful shareholder value over time allowing us to achieve our long-term financial targets of 1% to 2% sales growth, 4% to 6% EBITDA growth, and 7% to 9% EPS growth. Highlights • Nature's Own is the best-selling loaf bread in theU.S. , DKB is the #1 selling organic brand in theU.S. , andCanyon Bakehouse is the #1 selling gluten-free bread brand in theU.S. (Source: IRI Total US MultiOutlet+C-Store 12 Weeks Ending 10/9/22)
•
Our retail sales comprised 78.8% of total sales for the forty weeks ended
•
As of
•
We utilize a direct-store-delivery distribution model for fresh bakery foods, whereby product is sold primarily by a network of independent distributor partners to retail and foodservice customers with access to more than 85% of theU.S. population.
•
We offer nationwide distribution of certain fresh snack cakes and frozen breads and rolls via contract carriers.
We are continuing to focus on optimization initiatives in our procurement,
distribution, operations, and administrative functions and the company is
projecting savings in the range of
Impact of the Inflationary Economic Environment, Other Macroeconomic Factors, and COVID-19 on Our Business
We continue to monitor the impact of the inflationary economic environment, supply chain disruptions, labor shortages, the conflict betweenRussia andUkraine , and the COVID-19 pandemic on our business. Our results through the third quarter of Fiscal 2022 have continued to benefit from a more optimized sales mix of branded retail products as compared to pre-pandemic periods. Remote and hybrid-work arrangements spurred by the pandemic have endured in Fiscal 2022 resulting in greater at-home food consumption than in pre-pandemic periods. We have experienced significant input cost inflation for commodities and transportation, and, to a lesser extent, for labor in the current year period which has partially offset the more optimized sales mix. We expect these inflationary pressures to continue throughout the remainder of Fiscal 2022. To mitigate the ongoing cost pressures, we have implemented multiple price increases in Fiscal 2022. Additionally, in the latter half of the first quarter and into the second quarter of Fiscal 2022, we experienced heightened supply chain disruptions which impacted our ability to procure adequate quantities of certain raw materials and particularly packaging items, resulting in lower production volumes. Although we were able to mitigate these packaging shortages earlier than originally anticipated, our operating results were negatively impacted. These and other supply chain disruptions could continue to negatively impact production volumes due to uncertainty in the global andU.S. supply chain. Although the conflict betweenRussia andUkraine has not impacted us directly, we are closely monitoring its effects on the broader economy, including on the availability and price of commodities used in or for the production of our products. Disruptions in our operations, related to factors including, but not limited to, the procurement of raw materials and packaging items, transport of our products, and available workforce, have negatively impacted, and could continue to negatively impact, our operations, results of operations, cash flows, and liquidity. 36 -------------------------------------------------------------------------------- Labor shortages and turnover at some of our bakeries in Fiscal 2021 and during the forty weeks endedOctober 8, 2022 hampered production levels. These and other factors, including, but not limited to, high employment rates and additional government regulations, may continue to adversely affect labor availability and labor costs. These challenges may negatively affect our ability to operate our production lines efficiently or run at full capacity which could lead to increased labor costs, including additional overtime to meet demand and higher wage rates to attract and retain workers. An overall labor shortage, lack of skilled labor, or increased turnover could have a material adverse impact on the company's operations, results of operations, liquidity, or cash flows. Our operations may continue to experience disruption due to the continued uncertainty caused by the pandemic, including but not limited to additional variants of the COVID-19 virus, new geographic hotspots, changes in the number of COVID-19 cases, the rate of vaccination within theU.S. population, the efficacy, or lack thereof, of the vaccines, changes in the global andU.S. economic environment, supply chain disruptions and labor shortages, and changes in pandemic safety policies. Our main focus throughout the pandemic has been and continues to be the health and safety of our team members and independent distributor partners. We continue to follow the pandemic guidance of theU.S. Centers for Disease Control and Prevention (CDC ).
We believe we have sufficient liquidity to satisfy our cash needs and we continue to execute on our strategic priorities, including our transformation strategy initiatives, as further discussed in the "Liquidity and Capital Resources" sections below.
Summary of Operating Results, Cash Flows and Financial Condition
Sales increased 12.7% for the twelve weeks endedOctober 8, 2022 compared to the same quarter in the prior year due to price/mix contributing 17.8%, partially offset by volume declines of 5.1%. Inflation-driven pricing actions were partially offset by net volume losses. Targeted sales rationalization contributed to the softer volumes. Sales increased 11.2% for the forty weeks endedOctober 8, 2022 compared to the same period in the prior year primarily due to inflation-driven pricing actions. This increase was partially offset by volume declines of 3.8%. Targeted sales rationalization and production constraints from supply chain disruptions contributed to the lower volumes. For the forty weeks endedOctober 8, 2022 , our leading brands, Nature's Own, DKB, andCanyon Bakehouse , continued to perform well as these brands all experienced double-digit sales growth from positive price/mix. Income from operations for the twelve weeks endedOctober 8, 2022 was$55.5 million compared to$52.1 million in the prior year quarter. Price increases and decreases in legal settlement and consulting costs drove the increase. These items were partially offset by significantly higher input and transportation costs, higher distributor distribution fees, lower production volumes, and the current year acquisition-related costs and plant closure costs. Income from operations for the forty weeks endedOctober 8, 2022 was$239.1 million compared to$241.1 million in the prior year period. Sales increases from positive pricing actions and decreases in legal settlement costs were more than offset by considerable input and transportation cost increases, increased distributor distribution fees, and lower production volumes year over year. Net income for the twelve weeks endedOctober 8, 2022 was$40.5 million compared to$38.9 million in the prior year period. The increase resulted primarily from greater income from operations, as described above, partially offset by a higher effective tax rate in the current year quarter. Net income for the forty weeks endedOctober 8, 2022 was$179.8 million compared to$166.9 million in the prior year period. The increase resulted primarily from the loss on extinguishment of debt in the prior year period. During the forty weeks endedOctober 8, 2022 , we generated net cash flows from operations of$291.5 million and invested$128.4 million in capital expenditures and made a$9.0 million cost-method investment in Base Culture, as further discussed below. Additionally, we made stock repurchases of$34.6 million and paid$140.1 million in dividends to our shareholders. During the forty weeks endedOctober 9, 2021 , we generated net cash flows from operations of$315.2 million , invested$86.7 million in capital expenditures, paid$131.5 million in dividends to our shareholders and decreased our total indebtedness by$81.9 million . OnMarch 9, 2021 , we issued the 2031 notes and used the net proceeds from the offering to complete the early redemption of our outstanding 2022 notes and for other debt repayments. AtOctober 8, 2022 , all of our outstanding debt obligations had fixed interest rates. Late in the first quarter of Fiscal 2022, we increased production capacity for our organic products by adding a production line at ourHenderson, Nevada bakery. We anticipate this added capacity will allow us to better serve theWest Coast market. In the third quarter of Fiscal 2022, we announced the closure of theHolsum Bakery inPhoenix, Arizona , as discussed above. 37 --------------------------------------------------------------------------------
During the second quarter of Fiscal 2022, we invested
Transformation Strategy Initiatives
In the second half of Fiscal 2020, we launched initiatives to transform our business operations. The primary goals of these initiatives are: (1) enable a more agile business model, empowering the organization by fundamentally redesigning core business processes; (2) embed digital capabilities and transform the way we engage with our consumers, customers and employees; and (3) modernize and simplify our application and technology infrastructure landscape, inclusive of the upgrade of our ERP system. We completed the initial planning and road mapping phase of the ERP upgrade at the end of Fiscal 2020 and transitioned into the design phase in early Fiscal 2021 and the build phase at the beginning of Fiscal 2022. Digital Strategy Initiatives Our digital strategy initiatives include investments in digital domains of e-commerce, autonomous planning, bakery of the future, digital logistics, and digital sales. In e-commerce, we strive to become a category and market share leader, engage with the consumer through digital platforms and marketplaces, and support our retail partners' omnichannel strategies. The autonomous planning domain encompasses predictive ordering, cost-to-serve modeling, integrated business planning, and supply and demand forecasting, among other areas. Bakery of the future involves transforming our current manufacturing processes and operational visibility to apply industry-leading digital manufacturing tools, such as real-time performance management and visibility, automation of repetitive processes, standardization of processes and procedures, and sensor-based quality monitoring tools to improve consistency and quality. Digital logistics includes real-time operational visibility, improving our routing efficiency, and automating the freight bill pay audit process. Finally, digital sales will focus on improving our sales execution through improved visibility to in-store activities, streamlined reporting, and improved collaboration tools across our sales ecosystem. These digital domains are expected to improve data visibility and efficiencies while automating many of our processes. When fully implemented, we expect this work will further our brand efforts, bring us ever closer to the consumer, increase operational efficiencies, and deliver higher-quality, real-time insights, which will in turn enable more predictive business decision-making. We transitioned into the implementation phase for the e-commerce, autonomous planning, and bakery of the future domains and selected two bakeries for the pilot program for bakery of the future and autonomous planning in Fiscal 2021. To date, we have rolled out these programs to more than twelve bakeries and will continue to invest in these new ways of working.
ERP Upgrade
This initiative includes upgrading our information system platform and is expected to improve data management and efficiencies while automating many of our processes. During the first quarter of Fiscal 2021, we engaged a leading, global consulting firm to assist us in planning and implementing the upgrade of our ERP platform and serve as the system integrator for the project. We transitioned into the build phase of the project in the beginning of Fiscal 2022. We expect the transformation strategy initiatives to require significant capital investment and expense over the next several years. We currently anticipate the upgrade of our ERP system will cost approximately$275 million (of which approximately 40% is anticipated to be capitalized) and anticipate the upgrade to be completed in 2026. As ofOctober 8, 2022 , we have incurred costs related to the project of approximately$125 million . Costs related to the digital initiatives are more fluid and cannot be estimated.
CRITICAL ACCOUNTING POLICIES:
Our financial statements are prepared in accordance with GAAP. These principles
are numerous and complex. Our significant accounting policies are summarized in
the Form 10-K. In many instances, the application of GAAP requires management to
make estimates or to apply subjective principles to particular facts and
circumstances. A variance in the estimates used or a variance in the application
or interpretation of GAAP could yield a materially different accounting result.
Refer to the Form 10-K for a discussion of the areas where we believe that the
estimates, judgments or interpretations that we have made, if different, could
yield the most significant differences in our financial statements. There have
been no significant changes to our critical accounting policies from those
disclosed in the Form 10-K.
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--------------------------------------------------------------------------------RESULTS OF OPERATIONS:
Results of operations, expressed as a percentage of sales and the dollar and percentage change from period to period, for the twelve and forty weeks endedOctober 8, 2022 andOctober 9, 2021 , respectively, are set forth in the tables below (dollars in thousands): For the Twelve Weeks Ended Percentage of Sales Increase (Decrease) October 9, October 8, 2022 October 9, 2021 October 8, 2022 2021 Dollars % Sales$ 1,158,169 $ 1,027,800 100.0 100.0$ 130,369 12.7
Materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately below) 615,621 515,078 53.2 50.1 100,543 19.5 Selling, distribution and administrative expenses 447,363 426,575 38.6 41.5 20,788 4.9 Plant closure costs and impairment of assets 6,835 - 0.6 - 6,835 NM Recovery on inferior ingredients - (950 ) - (0.1 ) 950 NM Multi-employer pension plan withdrawal costs - 3,300 - 0.3 (3,300 ) NM Depreciation and amortization 32,899 31,680 2.8 3.1 1,219 3.8 Income from operations 55,451 52,117 4.8 5.1 3,334 6.4 Other components of net periodic pension and postretirement benefit plans credit (178 ) (94 ) (0.0 ) (0.0 ) (84 ) NM Interest expense, net 1,342 1,311 0.1 0.1 31 2.4 Income before income taxes 54,287 50,900 4.7 5.0 3,387 6.7 Income tax expense 13,759 12,048 1.2 1.2 1711 14.2 Net income $ 40,528 $ 38,852 3.5 3.8$ 1,676 4.3 Comprehensive income $ 46,489 $ 34,909 4.0 3.4$ 11,580 33.2 For the Forty Weeks Ended Percentage of Sales Increase (Decrease) October 9, October 8, 2022 October 9, 2021 October 8, 2022 2021 Dollars % Sales$ 3,723,152 $ 3,347,277 100.0 100.0$ 375,875 11.2 Materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately below) 1,926,297 1,662,716 51.7 49.7 263,581 15.9 Selling, distribution and administrative expenses 1,440,665 1,336,255 38.7 39.9 104,410 7.8 Plant closure costs and impairment of assets 7,825 - 0.2 - 7,825 NM Recovery on inferior ingredients - (828 ) - (0.0 ) 828 NM Multi-employer pension plan withdrawal costs - 3,300 - 0.1 (3,300 ) NM Depreciation and amortization 109,244 104,685 2.9 3.1 4,559 4.4 Income from operations 239,121 241,149 6.4 7.2 (2,028 ) (0.8 ) Other components of net periodic pension and postretirement benefit plans credit (594 ) (312 ) (0.0 ) (0.0 ) (282 ) NM Interest expense, net 4,947 6,582 0.1 0.2 (1,635 ) (24.8 ) Loss on extinguishment of debt - 16,149 - 0.5 (16,149 ) NM Income before income taxes 234,768 218,730 6.3 6.5 16,038 7.3 Income tax expense 54,971 51,865 1.5 1.5 3,106 6.0 Net income $ 179,797 $ 166,865 4.8 5.0$ 12,932 7.7 Comprehensive income $ 178,005 $ 163,188 4.8 4.9$ 14,817 9.1
NM - the computation is not meaningful.
Percentages may not add due to rounding.
39
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TWELVE WEEKS ENDED
Sales (dollars in thousands)
For the Twelve Weeks Ended
Percentage of Sales Increase (Decrease)
October 8, 2022 October 9, 2021 October 8, 2022 October 9, 2021 Dollars %
Branded retail $ 748,401 $ 688,995 64.6 67.0 $ 59,406 8.6
Store branded retail 163,937 124,639 14.2 12.1 39,298 31.5
Non-retail and other 245,831 214,166 21.2 20.9 31,665 14.8
Total $ 1,158,169 $ 1,027,800 100.0 100.0 $ 130,369 12.7
(The table above presents certain sales by category that have been reclassified from amounts previously reported to conform to the current period presentation.)
The change in sales was generally attributable to the following:
Percentage Point Change in Sales Attributed to: Pricing/mix 17.8 Volume (5.1 ) Total percentage change in sales 12.7 Sales increased significantly quarter over quarter due to positive pricing actions implemented in the latter half of Fiscal 2021 and during the first three quarters of Fiscal 2022 to mitigate considerable cost inflation, partially offset by volume losses. Year over year sales comparisons for store branded and non-retail and other sales benefitted from price increases that took place primarily in the current year, whereas branded retail sales were lapping prior year price increases. Volume decreases in branded retail and non-retail and other sales were partially offset by volume growth in store branded retail products. We continued to execute on our portfolio strategy of shifting more of our sales to higher margin, value-added branded retail products. This shift, combined with supply chain disruptions and labor shortages, contributed to the volume decreases. The promotional environment has remained relatively stable in the third quarter of Fiscal 2022 as compared to the same quarter in the prior year, however, this trend may not continue in future periods. Branded retail sales increased 8.6% quarter over quarter due to favorable price/mix resulting from inflation-driven pricing actions and improved promotional efficiency, partially offset by volume declines. The largest volume declines occurred in branded cake, branded traditional loaf breads, and branded buns and rolls. Branded cake volumes declined due to targeted sales rationalization and the impact of supply chain disruptions and labor shortages during the current year quarter. Sales of our leading brands, Nature's Own, DKB, andCanyon Bakehouse , continued to perform well benefiting from inflation-driven price increases, however, inflationary impacts on consumer spending and, to a lesser extent, supply chain constraints, pressured volumes. Store branded retail sales were significantly higher quarter over quarter due to price increases implemented to mitigate inflationary pressures and volume growth resulting from trade down from branded retail to store branded retail products, net of targeted sales rationalization. Sales of our store branded retail products had been declining prior to the pandemic and we experienced an acceleration of this trend during the last two fiscal years. This trend started to reverse in the second quarter of Fiscal 2022 and continued to expand in the third quarter of Fiscal 2022 partly due to the inflation-driven price increases and, to a much lesser extent, consumers shifting from branded retail to store branded retail products. However, store branded retail sales continue to comprise a smaller portion of our total sales mix as compared to pre-pandemic levels. Non-retail sales increased quarter over quarter from positive price/mix due to inflation-driven pricing actions, partially offset by volume declines. Foodservice drove most of the volume decrease. Targeted sales rationalization, including exiting certain low margin business, and production constraints from supply chain disruptions contributed to the lower volumes. 40 --------------------------------------------------------------------------------
Materials, Supplies, Labor and Other Production Costs (exclusive of depreciation and amortization shown separately; as a percent of sales)
For the Twelve Weeks Ended Increase
October 8, 2022 October 9, 2021 (Decrease) as a
Line Item Component % of Sales % of Sales % of SalesIngredients and packaging 32.9 28.1 4.8 Workforce-related costs 13.5 14.9 (1.4 ) Other 6.8 7.1 (0.3 ) Total 53.2 50.1 3.1 Materials, supplies, labor and other production costs as a percent of sales rose sharply quarter over quarter due to considerable input cost inflation, partially mitigated by inflation-driven pricing actions. In the current year quarter, ingredient and packaging costs continued to be impacted by the decades-high inflationary environment and these cost increases outpaced the sales price increases. Additionally, reduced outside purchases of product (sales with no associated ingredient costs) and sharp increases in egg prices as a result of the avian influenza outbreak earlier this year contributed to the higher ingredient and packaging costs. We anticipate ingredient and packaging costs to remain volatile and egg prices to remain a headwind for the remainder of Fiscal 2022. Although workforce-related costs did not increase at the same rate as the sales price increases, the competitive labor market combined with lower production volumes continued to impact our operations and we expect this trend to continue. Lower employee fringe costs also contributed to the decrease in workforce-related costs as a percent of sales. The decrease in the Other line item mostly reflects lower outside purchases of product, partially offset by reduced manufacturing efficiencies. We expect similar challenges could occur as a result of uncertainty in the global andU.S. supply chain. Prices of ingredients and packaging materials fluctuate and we continually monitor these markets. Ingredient and packaging costs are currently experiencing significant volatility and are expected to remain volatile for the remainder of Fiscal 2022. The cost of these inputs has fluctuated widely, and may continue to so, due to government policy and regulation, weather conditions, domestic and international demand, or other unforeseen circumstances. We enter into forward purchase agreements and other financial instruments to manage the impact of volatility in certain raw material prices. Any decrease in the availability of these agreements and instruments could increase the price of these raw materials and significantly affect our earnings.
Selling, Distribution and Administrative Expenses (as a percent of sales)
For the Twelve Weeks Ended Increase
October 8, 2022 October 9, 2021 (Decrease) as a
Line Item Component % of Sales % of Sales % of SalesWorkforce-related costs 10.3 11.1 (0.8 ) Distributor distribution fees 14.5 14.9 (0.4 ) Other 13.8 15.5 (1.7 ) Total 38.6 41.5 (2.9 ) Price increases in excess of wage inflation and lower employee fringe benefit costs in the current year quarter resulted in lower workforce-related costs as a percent of sales. Distributor distribution fees decreased as a percent of sales primarily due to a smaller portion of our sales being made through IDPs. The decrease in the Other line item reflects the$17.6 million reduction in legal settlement and related costs and reduced consulting costs, net of the$11.6 million acquisition-related costs in the current year period. Transportation cost increases were mostly offset by sales price increases. See the "Matters Affecting Comparability" section above for a discussion of the project-related consulting costs, legal settlements and related costs, and the current year acquisition-related costs.
Plant Closure Costs and Impairment of Assets, Recovery on Inferior Ingredients, and Multi-Employer Pension Plan Withdrawal Costs
Refer to the discussion in the "Matters Affecting Comparability" section above regarding these items.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased as a percent of sales due to
price increases implemented during Fiscal 2022, but increased in dollars mainly
due to assets we have placed in service and increased depreciation related to
twenty-seven leased warehouses purchased at the end of Fiscal 2021, two of which
were moved to held for sale in the first quarter of Fiscal 2022.
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--------------------------------------------------------------------------------Income from Operations
Income from operations decreased as a percent of sales for the twelve weeks endedOctober 8, 2022 compared to the twelve weeks endedOctober 9, 2021 mostly due to substantial input cost inflation, partially offset by inflation-driven sales price increases and lower selling, distribution, and administrative expenses as a percent of sales.
Net Interest Expense
Net interest expense was relatively consistent with the prior year quarter as a percent of sales and in dollars.
Income Tax Expense
The effective tax rate for the twelve weeks endedOctober 8, 2022 was 25.3% compared to 23.7% in the prior year quarter. The increase in the rate quarter over quarter was primarily due to larger net favorable discrete items related to tax credits in the prior year quarter. For both periods presented, the primary differences in the effective rate and the statutory rate were state income taxes which includes the recognition of a discrete benefit related to state tax credits.
Comprehensive Income
The increase in comprehensive income quarter over quarter resulted primarily from changes in the fair value of derivatives and higher net income period over period. FORTY WEEKS ENDEDOCTOBER 8, 2022 COMPARED TO FORTY WEEKS ENDEDOCTOBER 9, 2021 Sales (dollars in thousands) Forty Weeks Ended Percentage of Sales Increase (Decrease) October 8, 2022 October 9, 2021 October 8, 2022 October 9, 2021 Dollars % Branded retail$ 2,440,500 $ 2,225,224 65.5 66.5$ 215,276 9.7 Store branded retail 494,749 418,161 13.3 12.5 76,588 18.3 Non-retail and other 787,903 703,892 21.2 21.0 84,011 11.9 Total$ 3,723,152 $ 3,347,277 100.0 100.0$ 375,875 11.2
(The table above presents certain sales by category that have been reclassified from amounts previously reported to conform to the current period presentation.)
The change in sales was generally attributable to the following:
Percentage Point Change in Sales Attributed to: Pricing/mix 15.0 Volume (3.8 ) Total percentage change in sales 11.2 Sales increased significantly year over year mainly due to inflation-driven pricing actions implemented to mitigate rising operating costs, partially offset by volume declines across all three sales categories. We continue to execute on our portfolio strategy to shift more of our sales to higher margin, value-added branded retail products and this shift, combined with supply chain disruptions and labor shortages, contributed to the lower volumes. The promotional environment has remained relatively stable in the first three quarters of Fiscal 2022 as compared to the same period in the prior year, however, this trend may not continue in future periods. Branded retail sales increased year over year due to favorable price/mix resulting from price increases and improved promotional efficiency, partially offset by volume declines, most notably in branded cake items and branded traditional loaf bread products. Branded cake volumes were negatively impacted by targeted sales rationalization, supply chain disruptions, and labor shortages during the current year period. Sales of our leading brands, Nature's Own, DKB, andCanyon Bakehouse , all experienced double-digit sales growth driven by inflation-driven price increases and, to a much lesser extent, volume growth, although volumes were pressured by the impact of supply chain disruptions. 42 -------------------------------------------------------------------------------- Store branded retail sales increased considerably year over year due to price increases implemented to mitigate inflationary pressures. Volumes declined slightly due to targeted sales rationalization and supply chain disruptions, partially offset by the impact of consumers shifting more of their purchases from branded retail products to store branded products, particularly in white loaf breads. Non-retail sales increased year over year from positive price/mix due to inflation-driven pricing actions, partially offset by volume declines. Volume declines in foodservice, fast food, and co-manufactured items drove the decrease and were partially offset by volume increases in vending products. Targeted sales rationalization as well as production constraints from supply chain disruptions contributed to the lower volumes. We anticipate our Fiscal 2022 sales will be higher than Fiscal 2021 sales due to pricing actions taken at the beginning of the first quarter of Fiscal 2022 and additional price increases implemented through the second and third quarters of Fiscal 2022.
Materials, Supplies, Labor and Other Production Costs (exclusive of depreciation and amortization shown separately; as a percent of sales)
For the Forty Weeks Ended Increase
October 8, 2022 October 9, 2021 (Decrease) as a
Line item component % of sales % of sales % of sales
Ingredients and packaging 31.6 27.7 3.9
Workforce-related costs 13.7 14.8 (1.1 )
Other 6.4 7.2 (0.8 )
Total 51.7 49.7 2.0
Materials, supplies, labor and other production costs as a percent of sales
increased significantly year over year due to considerable input cost inflation.
In Fiscal 2022, inflation impacted all ingredient and packaging items, and most
significantly for flour costs, which outpaced the sales price increases.
Additionally, increases in finished goods inventory period over period resulted
in higher ingredient and packaging costs. We anticipate input costs to remain
volatile for the remainder of Fiscal 2022. Although workforce-related costs did
not increase at the same rate as the sales price increases, the competitive
labor market continues to impact our operations and we expect this trend to
continue. The Other line item reflects the impact of timing differences of the
sell-through of product inventories and reduced outside purchases of product,
net of reduced manufacturing efficiencies and lower production volumes. Similar
to workforce-related costs, other costs did not increase at the same rate as the
sales price increases. In the latter half of the first quarter of Fiscal 2022,
we experienced heightened supply chain disruptions which impacted our ability to
procure adequate quantities of certain raw materials and packaging items
contributing to lower production volumes. We effectively navigated these
challenges faster than originally anticipated, although with more costly inputs,
partially mitigating the negative impact to our operating results. We expect
these challenges to continue as a result of uncertainty in the global and U.S.
supply chain.
Prices of ingredients and packaging materials fluctuate and we continually
monitor these markets. Ingredient and packaging costs are currently experiencing
significant volatility and are expected to remain volatile for the remainder of
Fiscal 2022. The cost of these inputs has fluctuated widely during the current
year, and may continue to so, due to government policy and regulation, weather
conditions, domestic and international demand, or other unforeseen
circumstances. We enter into forward purchase agreements and other financial
instruments to manage the impact of volatility in certain raw material prices.
Any decrease in the availability of these agreements and instruments could
increase the price of these raw materials and significantly affect our earnings.
Selling, Distribution and Administrative Expenses (as a percent of sales)
For the Forty Weeks Ended Increase
October 8, 2022 October 9, 2021 (Decrease) as a
Line item component % of sales % of sales % of sales
Workforce-related costs 10.8 11.3 (0.5 )
Distributor distribution fees 14.7 15.0 (0.3 )
Other 13.2 13.6 (0.4 )
Total 38.7 39.9 (1.2 )
Price increases we have implemented and lower employee fringe benefit costs in
the current year period more than offset wage inflation rates resulting in lower
workforce-related costs as a percent of sales. Distributor distribution fees
decreased as a percent of sales primarily due to a smaller portion of our sales
being made through IDPs. However, this decrease was more than offset by the rise
in transportation costs which is reflected in the Other line item. The decrease
in the Other line item reflects the $15.6 million decrease in legal settlements
and related costs, the $3.4 million prior year acquisition consideration
adjustment, and reduced marketing
43
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investments period over period. Partially offsetting these items were $11.6
million of acquisition-related costs incurred in the current year period and
higher transportation costs. See the "Matters Affecting Comparability" section
above for a discussion of legal settlements and related costs, the prior year
acquisition consideration adjustment, and acquisition-related costs.
Plant Closure Costs and Impairment of Assets, Recovery on Inferior Ingredients, and Multi-Employer Pension Plan Withdrawal Costs
Refer to the discussion in the "Matters Affecting Comparability" section above regarding these items.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased as a percent of sales due to price increases implemented during the forty weeks endedOctober 8, 2022 , but increased in dollars mainly due to assets placed in service and increased depreciation related to twenty-seven leased warehouses purchased at the end of Fiscal 2021, two of which were moved to held for sale in the first quarter of Fiscal 2022. Income from Operations Income from operations decreased as a percent of sales for the forty weeks endedOctober 8, 2022 compared to the forty weeks endedOctober 9, 2021 mostly due to substantial input cost inflation, partially offset by sales increases and lower selling, distribution, and administrative expenses as a percent of sales, as discussed above. Net Interest Expense Net interest expense (exclusive of the portion related to the loss on extinguishment of debt in the prior year period discussed below) decreased in dollars and as a percent of sales year over year due to lower average amounts outstanding under our borrowing arrangements and the lower interest rate on the 2031 notes as compared to the 2022 notes which were redeemed in the first quarter of Fiscal 2021. Lower interest income year over year partially offset the decrease in net interest expense.
Loss on Extinguishment of Debt
In the first quarter of Fiscal 2021, we completed the redemption of the
outstanding 2022 notes and incurred a loss of
Income Tax Expense
The effective tax rate for the forty weeks endedOctober 8, 2022 was 23.4% compared to 23.7% in the prior year period. The decrease in the rate was primarily due to favorable windfalls on stock-based compensation recorded discretely in the current year period. For the current year period, the primary differences in the effective rate and the statutory rate were state income taxes including the recognition of discrete tax credits and windfalls on stock-based compensation. The primary differences in the effective rate and statutory rate for the prior year period were state income taxes including the recognition of discrete tax credits. Comprehensive Income
The increase in comprehensive income year over year resulted primarily from increased net income and changes in the fair value of derivatives.
LIQUIDITY AND CAPITAL RESOURCES:
Strategy and Update on Impact of the Inflationary Economic Environment, Other Macroeconomic Factors, and COVID-19 on Our Business
We believe our ability to consistently generate cash flows from operating activities to meet our liquidity needs is one of our key financial strengths. Furthermore, we strive to maintain a conservative financial position as we believe it 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, 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 strategic priorities, including our transformation strategy initiatives;
•
paying dividends to our shareholders;
44
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maintaining a conservative financial position;
•
making strategic acquisitions; and
•
repurchasing shares of our common stock.
Although there has been no material adverse impact on the company's results of operations, liquidity or cash flows for the forty weeks endedOctober 8, 2022 , volatility in global andU.S. economic environments, including as a result of, among other things, the inflationary economic environment, supply chain disruptions, labor shortages, the conflict betweenRussia andUkraine , and the COVID-19 pandemic on our business, could significantly impact our ability to generate future cash flows and we continue to evaluate these various potential business risks. Those potential risks include the possibility of future economic downturns that could result in a significant shift away from our branded retail products to store branded products, supply chain disruptions that have impacted, and could continue to impact, the procurement of raw materials and packaging items, the workforce available to us, and our ability to implement additional pricing actions to offset rising inflation. In light of the potential risks detailed above, the company has taken actions to safeguard its capital position. We continue to maintain higher levels of cash on hand compared to pre-pandemic levels and in the first quarter of Fiscal 2021 issued the 2031 notes and used the net proceeds from the offering to redeem in full the outstanding 2022 notes, extending the earliest maturity date of our non-revolving debt to 2026. Additionally, we repaid the outstanding balances on both the accounts receivable securitization facility (the "facility") and the credit facility (the "credit facility") with proceeds from the issuance of the 2031 notes and from cash flows from operations. The macroeconomic-related factors discussed above remain fluid and the future impact on the company's business, results of operations, liquidity or capital resources cannot be reasonably estimated with any degree of certainty. If the company experienced a significant reduction in revenues, the company would have additional alternatives to maintain liquidity, including amounts available on our debt facilities, capital expenditure reductions, adjustments to its capital allocation policy, and cost reductions. Although we do not currently anticipate a need, we also believe that we could access the capital markets to raise additional funds. We believe that we have sufficient liquidity on hand to continue business operations during the pandemic and the volatile global andU.S. economic environments. The company had total available liquidity of$864.3 million as ofOctober 8, 2022 , consisting of cash on hand and the available balances under the credit facility and the facility.
Liquidity Discussion for the Forty Weeks Ended
Cash and cash equivalents were$172.7 million atOctober 8, 2022 and$185.9 million atJanuary 1, 2022 , significantly higher than historical pre-pandemic levels. The cash and cash equivalents were derived from the activities presented in the tables below (amounts in thousands):
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