Flowers Foods : Q4 2021 Prepared Remarks Transcript

FLOWERS FOODS - FOURTH QUARTER 2021 EARNINGS (PREPARED REMARKS) FEBRUARY 10, 2022

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' fourth-quarter and full year 2021 results. This is JT Rieck, SVP of finance and investor relations. As a reminder, we released our fourth-quarter and full year 2021 results on February 10, 2022. 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 flowersfoods.com. We will host a live Q&A session on Friday, February 11 at 8:30 a.m. Eastern. Further details are posted in the investor section of our website.

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 fourth-quarter call.

I'm very proud of our performance last year in what was a challenging and dynamic environment. The situation leading into the year was unprecedented-with inflation, supply shortages, labor challenges, and shifting demand-as the pandemic changed the way people live and work, creating new shopping and eating habits that continue to evolve.

In the face of this uncertainty, our team rose to the challenge and delivered another strong financial performance. We exceeded our initial 2021 guidance and, on each measure-sales, EBITDA, and EPS growth-remain ahead of our long-term financial targets with 2019 as the base year.

It's important to note that, excluding the impact of the extra week in the prior year, we overcame difficult comps and increased sales in both the fourth quarter and the full year. Our leading brands continue to gain market share, driven by investments in innovation and marketing.

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FLOWERS FOODS - FOURTH QUARTER 2021 EARNINGS (PREPARED REMARKS) FEBRUARY 10, 2022

Building off those results, we move into 2022 with confidence. To offset the higher-than-expected costs in the fourth quarter, we implemented an across-the board price increase in January, which, along with continued growth from our leading brands, is driving strong early performance in 2022.

Now I'd like to focus on our four strategic priorities, starting with our team….

2021 was an extraordinary year that challenged us all, and I'm grateful to our Flowers team, particularly our front- line workers, for all their efforts. A scarcity of labor, and quarantines related to Covid-19 outbreaks and exposures, contributed to staffing shortages, making production difficult at times. Through it all, our Flowers team pulled together to overcome these headwinds, getting our category-leading products on the shelves to meet consumer demand. It's impossible to thank our team enough for this effort, but to recognize their commitment and hard work, we awarded $5.2 million of appreciation bonuses to our front-line workers in the fourth quarter.

One of the key learnings from the pandemic has been our ability to adapt to remote working. Beyond our bakeries, we've capitalized on this new virtual work environment, using it to expand the talent pool from which we recruit. This flexibility has allowed us to supplement an already strong team with talent from across the country, which is particularly important considering the additional capabilities our digital transformation requires.

Our second strategic priority is focusing on our brands.

Prior to the pandemic, we pivoted to become a more brand-focused company. And our leading brands continue to perform very well. Our household penetration grew significantly over the last two years. Importantly, we have held on to many of those new customers and further increased penetration of our leading brands in 2021. Since 2019, our household penetration has increased 300 basis points, with Nature's Own up 460 basis points, Dave's Killer Bread up 350 basis points, and Canyon Bakehouse up 70 basis points. And consumers are also increasing the number of times they buy our products, with repeat rates up 270 basis points since 2019.

These improved metrics are driving sales and market share gains. Nature's Own, Dave's Killer Bread, and Canyon Bakehouse grew 2021 tracked channel sales by 0.3%, 11%, and 16% respectively, despite the difficult prior year comparison. Those top brands also gained a combined 60 basis points of market share.

Innovation has been a key growth driver for our top brands, so we are making significant investments to continue that growth by bringing new products to market. Products such as Nature's Own Perfectly Crafted Flatbreads, and Dave's Killer Bread and Nature's Own Perfectly Crafted Rye filled market segments where we were unrepresented previously.

I've spoken on past calls about our new agile innovation group, which is tasked with accelerating the development of truly innovative, new products that are outside of our core categories. And I'd like to highlight our first product that we've commercialized as part of that effort, our DKB Snack Bars. The bars, which come in three flavors, offer the same killer taste, texture, and nutrition that DKB fans have come to love, with the ease of a grab-and-go product. They will also offer access to the direct-to-consumer channel that many of our products do not. You can see a representation of the bars in the slide deck.

DKB's brand strength enables it to expand to different categories in ways that other brands can't. When our loyal DKB consumers, affectionately known as BreadHeads, expressed a desire for DKB products beyond loaf bread, we introduced bagels, English muffins, and burger buns, all of which have been met with strong demand. That success gave us the confidence to expand the product line beyond bread. The snack bars are being tested in several markets and have shown strong initial results that are exceeding our own expectations.

We are excited about the promise of these new products and the potential for additional developments from our agile innovation group. Our pipeline is full, and we plan to bring more innovation to market later this year.

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FLOWERS FOODS - FOURTH QUARTER 2021 EARNINGS (PREPARED REMARKS) FEBRUARY 10, 2022

Our third strategic priority is margins, an area that has taken on particular importance in this period of rising inflation. In part, earnings declined in 2021 due to continued labor challenges and inflationary pressures. Fourth- quarter margins, in particular, compressed as we transitioned to higher-priced hedges, and our pricing actions lagged cost increases. However, we have plans in place to offset these pressures through a combination of internal efficiencies, price increases, and steps to improve our hiring processes and working conditions, particularly in the bakeries.

In 2020 and 2021, our portfolio optimization programs saved a total of $60 million. For 2022, we've initiated additional cost savings measures, primarily across operational efficiencies and procurement. We expect these programs to deliver an incremental $25 to $35 million in savings for the year.

Our digital transformation initiative is a crucial driver of improved data and efficiencies. When we launched this initiative, I highlighted some of the digital domains we were focusing on initially. These domains included bakery of the future, ecommerce, and autonomous planning.

The bakery of the future domain, among its many benefits, is expected to provide new business metrics, real-time performance management, and automate repetitive processes. We expect those changes to translate into meaningful benefits, such as reduced scrap and labor expenses, even-more-consistent product quality, and ultimately lower production cost-per-hour. We have already launched pilots at several bakeries, and we expect to deploy this program to half of our bakeries by the end of the year.

We expect the ecommerce domain to improve digital content and develop new partnerships to enhance the reach of our products. Our ultimate goal is to become the category leader, driving sales at traditional retailers' websites, online retailers, and last-mile delivery partners.

The goal of autonomous planning is to digitally connect the various pieces of our supply chain, allowing us to predict consumer demand with higher accuracy and integrate that insight from point-of-sale through the supply chain to ensure the right raw materials are on site at the right time, the right products are produced at the right bakery every day, and deliveries are optimized to achieve high on-shelf availability and customer service.

These digital domains, and others, are expected to drive greater sales and efficiencies, enabling us to meet or exceed our long-term financial targets. And of course, underpinning all of these digital initiatives is the upgrade of our ERP system. We have completed the design phase and moved into the build phase. This upgraded system will deliver better data, automate processes, and enable us to become a more digitally agile company with the ability to leverage data and technology to further improve efficiencies, operations, and service.

We've also talked about our focus on improving operations, particularly at our underperforming bakeries, including the Navy Yard. I'm pleased with the dramatic progress we've made in this regard, and, although we need to make further improvements, I'm confident that those results will continue to improve.

When internal initiatives are not sufficient to offset inflation, as in the current environment, we also turn to price increases. The first price increase in the current cycle came in July of 2021. However, as hedges transitioned to higher prices in the fourth quarter, the inflationary impact increased faster than expected.

To offset this cost pressure, we implemented a second price increase in January of this year. Input costs were volatile at the time we took that proposed pricing to the market, and since then our inflation expectations for 2022 have increased. Our early analysis of results so far in 2002 suggests that this price increase is covering much of the current inflationary pressure, though more pricing actions may be warranted in certain categories. We will continue to closely monitor the results and take any additional actions necessary.

Our fourth priority is smart M&A. We continue to monitor the deal market, which remains active. Valuations are high, but our steady free cash flow and strong balance sheet position us well to act when we have financial, commercial, and operational conviction. And as always, we will maintain our disciplined approach.

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FLOWERS FOODS - FOURTH QUARTER 2021 EARNINGS (PREPARED REMARKS) FEBRUARY 10, 2022

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.

As a reminder, 2021 was a 52-week year, one less week than in 2020, with the extra week falling in the fourth quarter. The impact of the extra week in 2020 was approximately 1.7% to the topline and 2 cents per share. Given the pandemic influence on year-over-year comparisons, in some circumstances we will also provide comparisons to the pre-pandemic results in the fourth quarter of 2019.

As Ryals mentioned, we are very pleased with our 2021 performance. In the fourth quarter, total sales decreased 3.9% from the prior-year period, but rose 3.8% excluding the extra week in 2020 and 7.2% compared to the fourth quarter of 2019. Improved price/mix drove the adjusted year-over-year increase, up 6.2%, 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 2.4% volume decrease mostly driven by declines in our retail business, particularly store branded retail.

Looking at sales by channel, branded retail sales decreased $26.9 million compared to the prior year, or 4.0%, to $649.9 million. This decrease was driven primarily by volume declines from the extra week in the prior year period and moderating at home food consumption, partially offset by favorable price/mix and improved promotional efficiency.

Despite the difficult prior-year comparisons, Flowers' fresh packaged bread gained 10 basis points of market share in tracked channels. Excluding the extra week in the prior-year period, sales of Nature's Own increased 4%, and Dave's Killer Bread and Canyon Bakehouse each rose 15%. Compared to the fourth quarter of 2019, branded retail sales increased 17.9% as our leading brands continued to benefit from pandemic-related demand increases and our initiatives to drive further growth.

Store branded retail sales decreased $20.0 million year over year, or 14.6% to $116.8 million, as consumers continued to express a preference for more-differentiated, branded products. The store branded category as a whole lost 120 basis points of market share in the fourth quarter compared to the prior-year period, declining to 18.8%, a downward trend that has endured for seven years. Compared to the 2019 fourth quarter, Flowers' store branded sales declined 17.0%.

Non-retail and other sales increased $7.4 million year over year, or 3.5%, to $216.8 million as we lapped pandemic- induced declines in the prior year period. Results benefitted from improved price/mix, partially offset by lower volume due to the extra week in the prior-year period. Non-retail and other sales overall remain below pre- pandemic levels, with sales down 4.0% compared to the 2019 fourth quarter. However, as non-retail sales continue their recovery, that business is coming back at higher margins due to the initiatives we've taken to improve the profitability of the business overall.

In the fourth quarter, gross margin as a percentage of sales, excluding depreciation and amortization, decreased 110 basis points to 47.9%. Gross margin comparisons were impacted by lower sales and higher ingredient and packaging costs, partially offset by lower incentive compensation expense and reduced outside purchases.

Selling distribution and administrative expenses increased 110 basis points as a percentage of sales in the fourth quarter. Excluding the items affecting comparability detailed in the press release, adjusted SD&A expenses

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