Flowers Foods : Q3 Results Q&A Transcript

Third Quarter 2021 Prepared Remarks

November 11, 2021

Q3-2021-RESULTS-PREPARED-REMARKS-TRANSCRIPT

CORPORATE PARTICIPANTS

J.T. Rieck, SVP of Finance and Investor Relations

Ryals McMullian, President and CEO

Steve Kinsey, CFO and CAO

PRESENTATION

J.T. Rieck, SVP of Finance and Investor Relations

Hello everyone and welcome to the pre-recorded discussion of Flowers Foods' third quarter 2021 results. This is JT Rieck, SVP of finance and investor relations. As a reminder, we released our third quarter results on November 11, 2021. Along with a transcript of these recorded remarks from our CEO and CFO, you can find the earnings release and related slide presentation in the investor section of our website. We will host a live Q&A session on Friday, November 12 at 8:30 a.m. Eastern. The details are posted in the investor section of flowersfoods.com.

Before we get started, keep in mind that the information presented here may include forward-looking statements about the company's performance. Although we believe these statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to what you hear in these remarks, important factors relating to Flowers Foods' business are fully detailed in our SEC filings.

Providing remarks today are Ryals McMullian, president and CEO, and Steve Kinsey, our CFO. Ryals, I'll turn it over to you…

Ryals McMullian, President and CEO

Thanks JT.

It's a pleasure to welcome everyone to our third quarter call. And I'm happy to share our record third quarter results with you today.

Flowers continues to perform exceptionally well in a dynamic and challenging environment. In fact, our performance has been so strong that we are increasing our 2021 guidance for the third consecutive quarter.

When we provided our initial guidance back in February, we thought it reasonable to assume that a portion of the pandemic impact would wane throughout the year. However, we've been very pleased to see how well demand for our branded retail products has held up. In fact, sales of our top brands have continued to grow, even surpassing last year's record third quarter numbers. I'll address these trends in more detail a little bit later on the call.

As always, to provide some context to our results, I'll discuss the current business environment and the steps we're taking to succeed in it through the lens of our four strategic priorities: developing our team, focusing on our brands, prioritizing margins, and pursuing smart M&A.

Starting with the team….

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Q3-2021-RESULTS-PREPARED-REMARKS-TRANSCRIPT

I'd like to begin by once again expressing my appreciation to the entire Flowers team for their dedication to producing quality products for our consumers and faithfully serving our markets. The labor market remains challenging. Unemployment claims are declining, and job openings are at record levels. Despite this difficult environment, our bakery teams are working tirelessly, and I'd like to commend them for their perseverance.

Everyone on the production lines and in the shipping departments are pitching in wherever needed to get the job done. And we as a company are doing everything in our power to fill open positions and keep our bakeries running efficiently. To recognize the efforts of our frontline workers, I'm pleased to announce that we will be awarding them with appreciation bonuses in the fourth quarter of this year.

Our second strategic priority is focusing on our brands.

We are increasing demand for our leading products by investing in marketing and advertising, innovation, and expanding penetration. These initiatives drove our market share to 18%, up 50 basis points year over year and up 100 basis points compared to the third quarter of 2019. Our top brands are leading the way, with Dave's Killer Bread gaining 50 basis points of market share, the most of any bread brand in the category, and Nature's Own and Canyon Bakehouse up 20 and 10 basis points, respectively.

Consumers continue to express their preference for differentiated branded products. That premiumization trend, which we've discussed previously, is not a recent phenomenon. According to IRI, market share of branded fresh packaged bread is up 480 basis points since 2017, and now stands at 80.6%. Over that same period, Flowers' share has expanded 210 basis points, substantially more than any competitor. The rate of branded share gains has increased during the pandemic, but we believe the underlying drivers of the gains, innovation and differentiation, appear sustainable. The impact of potential sustained inflation on this premiumization trend is unclear, but our aim is to continue growing our brands by introducing unique and delicious products and then marketing and distributing those products to reach a variety of consumers.

Our third strategic priority is margins, and third quarter results continue to demonstrate our success in that area. Our portfolio strategy has increased the percentage of higher-margin branded retail sales and our portfolio optimization work remains on track to reach our target savings of $30-40 million this year, making the full value of this program over the last two years close to $60 million. We believe those initiatives have enabled us to minimize the pressure on EBITDA margins. Although margins are down slightly compared to last year's tough comparison, they are up 170 basis points over pre-pandemic levels.

Many of our digital transformation initiatives, which are intended to improve data visibility and efficiencies while automating processes, are progressing from the design to the build phase. And some of our key domains, such as ecommerce, autonomous planning, and bakery of the future, have progressed to the implementation phase and we are excited about the benefits we expect these investments will bring.

Our fourth priority is smart M&A. Deal flow is picking up and as always, we are proactively exploring our options. Our steady free cash flow and strong balance sheet provide the flexibility to act when we have financial, commercial, and operational conviction. And, as always, we will maintain our disciplined approach.

Now, I'll turn it over to Steve to review the details of the quarter, and then I'll come back a little bit later to discuss our outlook for the current business environment. Steve?

Steve Kinsey, CFO and CAO

Thank you, Ryals - and hello everyone. I'd like to echo your comments on our incredible team and express my sincere thanks for their outstanding efforts. Now, turning to the quarterly results…

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Q3-2021-RESULTS-PREPARED-REMARKS-TRANSCRIPT

Because of the uniqueness of the year over year comparison due to the pandemic, in some circumstances we will also provide comparisons to the pre-pandemic results in the third quarter of 2019.

As Ryals mentioned, we are very pleased with our third quarter performance. Total sales increased 3.9% from the prior year period and 6.3% compared to the third quarter of 2019. Improved price/mix drove the year over year increase, up 6.4%, more heavily weighted to price than mix. The primary factors were price increases to mitigate inflationary pressures and growth in our more-profitable branded retail products. Partially offsetting the sales increase was a 2.5% volume decrease driven by declines in our retail volumes offset somewhat by increases in non- retail volume.

Looking at sales by channel, branded retail sales increased $31.6 million compared to the prior year, or 4.8%, to $689.1 million. This increase was driven by price/mix. Despite the difficult comparisons, Flowers' fresh packaged bread sales gained 50 basis points of market share in tracked channels, with sales of Nature's Own up 4%, Dave's Killer Bread up 14%, and Canyon Bakehouse up 17%.

Compared to the third quarter of 2019, branded retail sales increased 17.6%, higher than comparable second quarter 2021 growth of 15.2%, as our leading brands continue to benefit from pandemic-related demand increases and our initiatives to drive further growth. And, as Ryals mentioned, our total market share increased 100 basis points over pre-pandemic levels to 18%.

Store branded retail sales decreased $11.5 million year over year, or 8.5%, to $124.6 million, as consumers continued to express a preference for more-differentiated, branded products. The store branded category as a whole lost 160 basis points of market share, declining to 18.8%, a downward trend that has endured for more than five years.

Our consumer research clearly shows that the bread category is undergoing a premiumization process, shifting away from store brand, which Ryals spoke about earlier. The ability to manage that shift in demand highlights the flexibility of our bakery network.

In addition to the store brand category trends, initiatives such as our portfolio strategy, which aims to shift more of our sales to higher margin branded products, and our initiative to increase the profitability of some of our underperforming accounts, have also impacted sales. In situations where we are unable to attain satisfactory margins, we have walked away from some accounts. Compared to the 2019 third quarter, Flowers' store branded sales declined 17.5%.

Non-retail and other sales increased $18.1 million, or 9.2%, year over year to $214.2 million as we lapped significant pandemic-induced declines in the prior year period. Non-retail results benefitted from improved price/mix and volume increases. Non-retail and other sales overall remain below pre-pandemic levels, with sales down 6.8% compared to the 2019 third quarter. However, as non-retail sales continue their recovery, that business is coming back at higher margins than before due to the initiatives we've taken to improve the profitability of the business.

In the quarter, gross margin as a percentage of sales, excluding depreciation and amortization, increased 20 basis points to 49.9%. Gross margin comparisons benefitted from higher sales and $1.9 million of start-up costs in the year-ago period related to the conversion of our Lynchburg, Virginia facility to an organic bakery. More favorable price/mix mitigated rising commodity costs, partially offset by reduced outside purchases.

Selling distribution and administrative expenses increased 240 basis points as a percentage of sales in the third quarter. Excluding the items affecting comparability detailed in the press release, adjusted SD&A expenses increased 40 basis points to 38.4% as higher logistics costs and increased marketing investment were partly offset by lower distributor distribution fees.

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Q3-2021-RESULTS-PREPARED-REMARKS-TRANSCRIPT

GAAP diluted EPS for the quarter was 18 cents per share compared to 21 cents in the prior year period. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter was 30 cents per share, up 1 cent from the prior year period.

Turning now to our balance sheet, liquidity, and cash flow.

Year-to-date, through the third quarter of fiscal 2021, cash flow from operating activities decreased by $49.2 million to $315.2 million largely due to higher bonus payments in the first quarter this year and other changes in working capital. Capital expenditures increased $18.5 million to $86.7 million, and dividends paid increased $6.6 million to $131.5 million.

Our financial position remains strong. At quarter-end, net debt to trailing twelve month adjusted EBITDA stood at approximately 1.1-times, down from 1.2-times at the end of the second quarter. At quarter-end, we held approximately $308 million in cash and cash equivalents and had approximately $679 million of remaining availability on our credit facilities.

Now, turning to our adjusted outlook for 2021.

We are forecasting sales to decline between 1% to 2% versus 2020, an increase from prior guidance of down 2% to 3%. Relative to 2019 results, our guidance implies growth of 4.3% to 5.3%. For earnings, we are raising our guidance range to adjusted EPS of $1.22 to $1.26, compared to our prior guidance of $1.17 to $1.22 and 2019 adjusted EPS of $0.96. EPS guidance includes a 1 cent impact in the fourth quarter for appreciation bonuses to be paid to our frontline workers that Ryals mentioned earlier.

Our updated guidance range is above our long-term financial targets of 1% to 2% sales growth and 7% to 9% EPS growth off the 2019 base, even with the five-cent headwind from our digital/ERP initiatives and no benefit from M&A. As a reminder, 2021 shifts back to 52 weeks, one fewer week than 2020. The additional week in 2020 contributed 1.8% to full-year sales and approximately 2 cents to EPS. We continue to expect strong free cash flow generation, and our capital allocation priorities and philosophy remain consistent with our focus on maximizing return on invested capital and growing shareholder value.

Some of the factors we considered when setting guidance included the timing and magnitude of demand reversion, as well as inflationary pressures. The operating environment remains stronger than our initial forecasts. Our most profitable segment, branded retail, has largely maintained its increased percentage of total sales despite the partial recovery in our non-retail and other business. The back-to-school season, which we are monitoring closely, thus far has not driven significant changes in demand.

Regarding inflation, there are three general buckets on which we are focused: commodities, logistics and freight, and labor. We are doing everything in our power to offset higher commodity costs, looking ahead so we can proactively navigate through this period successfully. Our hedging strategy, in which we attempt to lock in commodity prices 6 to 12 months out, provides visibility into future inflation and enables us to be proactive in offsetting potential cost increases.

We've noted that should commodity prices remain at current market levels, we would expect more meaningful inflation in 2022. So far, we've been successful in obtaining the higher prices necessary to offset inflation in the current year and we remain optimistic that, combined with other internal actions, we should be able to use pricing to mitigate the impact of inflation into 2022 if necessary.

Logistics and freight costs have increased as our contract carrier rates repriced. Our closed loop system stabilizes costs over the short-term, but pricing over longer periods will adjust to market levels. On the bright side, the strong relationships we've developed with our carriers has allowed us to maintain adequate capacity despite driver shortages and other challenges.

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