Flowers Foods Inc (FLO) 2015 Q2 法說會逐字稿

Welcome to the Flowers Foods second-quarter 2015 earnings conference call. My name is Ellen and I will be your operator for today's call.

(Operator Instructions)

Please note that this conference is being recorded. I will now turn the call over to JT Rieck. You may begin.

Thank you, Ellen. And good morning, everyone. Marta Jones Turner, Executive Vice President of Corporate Relations and I welcome you all to Flowers Foods' second-quarter earnings call. Our second-quarter results were released yesterday after the market closed. Also, we announced the acquisition of Dave's Killer Bread. And you can find copies of both releases posted on our website, along with a set of slides supporting our discussion this morning. Finally, the 10-Q was filed earlier this morning with the SEC.

Before we begin, I must remind you that our presentation today may include forward-looking statements about our Company's performance. Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters we will discuss during the call, important factors relating to Flowers Foods business are detailed fully in our SEC filings.

Participating on our call today are Allen Shiver, Flowers Foods President and Chief Executive Officer, and Steve Kinsey, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we'll open the call to your questions. Now, it's my pleasure to introduce our President and CEO, Allen Shiver.

Thank you, JT. Good morning, everyone. Thank you for joining our call. Yesterday afternoon we released outstanding results. Our reported EPS and EBITDA was a record for the Company's second quarter. I want to thank everyone on the Flowers team for their hard work to make that possible.

Later last night we announced entering an agreement to acquire Dave's Killer Bread, the leading brand in the organic fresh bread category. With Dave's, we not only efficiently gain scale in the fast-growing organic category, but we also welcome to Flowers an experienced team with a culture of innovation. We believe Flowers is uniquely positioned to create value in the organic bread category. Our DSD and warehouse distribution networks have a proven track record of excellent customer service. When our fresh bakery production and distribution capabilities are combined with Dave's organic baking expertise, the resulting opportunities for growth are significant.

All in all, the organic category is growing. And with Dave's Flowers is competitively positioned to grow share and we could not be more excited about the opportunities to come. As mentioned in the release, the acquisition is subject to regulatory review. We expect a favorable outcome but it is premature to comment further on the Dave's acquisition. Once the review process is complete, we look forward to more discussion about the opportunities we see with Dave's and the organic category. While the acquisition of Dave's Killer Bread is certainly big news, I am also excited to share with you the details of our record second-quarter results.

Our consolidated sales were up 1.8%, with price/mix and volume each contributing 0.9% to the sales growth. Looking at the IRI data, overall category growth of fresh packaged breads was up 0.9%. For the category, price/mix was up 2.3% while unit volume was down 1.4%. Looking deeper into the category data, we see that large volume losses were suffered by store brands with volumes being down 2.9% while price/mix gained 1.1%. Our brands performed well, driving our overall top-line growth. IRI data shows our Flowers share of fresh packaged breads increased to 14.2%, up 0.3 share points, outperforming the category. Unit volume growth and favorable price/mix drove sales of branded breads, buns and rolls.

In particular we saw strong performance of branded white and soft variety breads led by Wonder and Nature's Own. Flowers store brand sales declined primarily due to the loss of certain store brand business in the back half of last year. We have largely cycled those losses and we anticipate more favorable comparisons through the remainder of the year. Our sales of snack cakes increased, primarily driven by price/mix. But we were also seeing unit volume growth, reversing recent trends. Our sales of store-brand cake turned positive, contributing to the improved results in our warehouse segment. On a consolidated basis, our non-retail sales, which primarily consist of sales to foodservice establishments, grew 1.2% with price/mix and volume both contributing. The sales loss by the warehouse segment as a result of exiting the foodservice tortilla business during the third quarter of last year were more than offset by new foodservice wins in the DSD segment.

If I step back and consider our top-line performance, a few things in particular stand out. First, in this category consumers recognize the quality that our brands represent so it's critical that we continue to support and innovate our branded product offerings. Nature's Own, which generates over $1 billion in retail sales annually, continues to keep pace with consumers' desire for transparency and simpler ingredients. As we've streamlined the ingredient label for select Nature's Own items, consumer interest has increased not only within our existing retail channels but also with those consumers shopping at specialty food stores.

In response to changing demographics and consumer requests for a smaller loaf, this summer our Cobblestone Bread Company brand introduced in select markets a new line of right-sized specialty breads. The reduced size better meets the needs of consumers who may have a smaller household or who want to have a variety of breads in their pantry. While still early, the response so far has been encouraging. The Cobblestone brand continues to come into its own, further developing the premium specialty bread and roll categories where Flowers has so much growth opportunity. Our Tastykake brand continues to grow. And with the recent launch of our new mini cupcakes, consumers can enjoy their favorite snack cakes in a new way. The seasonal Tastykake items continue to do well. And with fall just around the corner, the new flavors of the season will be on shelves very soon.

The second item that stands out is the impact that we have by executing well in our core markets. Market by market, we have carefully refined our brand strategy, reducing promotions and tailoring product assortments to better appeal to consumers. These improvements, combined with our distributors providing excellent service to their retailers, drove strong performance in our core markets. Another important factor contributing to our sales growth was our expansion markets. Our acquired brands have been instrumental as we enter new markets and grow sales not only with the brands we acquired, such as Wonder, but also with our proven Nature's Own and Tastykake brands, and our growing Cobblestone Bread Company brand.

To support growth in our Midwest expansion markets, during the quarter we opened our newest bakery in Lenexa, Kansas, just outside of Kansas City. The start-up went smoothly. The team in Lenexa did a great job and I look forward to accelerated growth in the Midwest. We have three advantages supporting our geographic expansion. First, we have strong brands which, when combined with our existing retailer relationships, provides us with access to new markets. Second, with our acquired facilities, we have access to well-located incremental capacity at a fraction of new construction cost. Third, and the most important advantage, is our people. We have a deep bench of experienced team members ready to step into new roles created as we grow.

As many of you are aware, several industries including packaged foods have seen an increased number of independent contractor misclassification disputes. In our Form 10-Q, we note that we currently have seven misclassification complaints filed against us. It is our policy not to comment specifically regarding ongoing litigation. That being said, the distributors that sell our product are talented entrepreneurs who take the initiative to maximize opportunities within their exclusive geographic territories. We value our relationship with these individuals and we are committed to helping them grow their sales.

Shortly, Steve Kinsey, Flowers' CFO, will provide a review of the factors driving our strong profitability. But before I turn it over I want to call out the improvements in the past year made by the team at Lepage. While the integration process was not without challenges, we gained valuable experience that we can leverage in future integrations. Today I am pleased to report that Lepage is realizing its potential as EBITDA margins move back in line with our original expectations. The Northeast is an important expansion market for Flowers and the Lepage team is well positioned for continued growth.

Now let's have Steve give us a review of the financials.

Thank you, Allen. And good morning, everyone. As Allen mentioned, we had a very good quarter. We were very pleased with the overall margin improvement.

On a consolidated basis, our gross margin as a percent of sales increased 110 basis points, while our selling, distribution and administrative costs fell as a percent of sales by 20 basis points, resulting in our adjusted EBITDA margin increasing 130 basis points to 12.7% for the quarter. The EBITDA margin expansion was driven by a favorable shift in sales mix, better sales, higher manufacturing efficiencies, lower ingredient costs, and improvements at Lepage, as Allen mentioned. The combination of these factors resulted in lower overall costs as a percent of sales. As was the case in the first quarter, corporate costs remained elevated due to higher consulting and legal costs and lower pension income. You may recall, as I mentioned on the first-quarter call, pension income will be down approximately $4 million on an annual basis for 2015, primarily the result of the new mortality tables. We expect consulting costs to abate as we complete some key initiatives while legal costs will remain variable quarter to quarter.

A quick update on our closed facility carrying costs. You'll remember that in 2013 we acquired from the former Hostess brand 20 closed manufacturing plants and 36 depots. Since then we have renovated and opened three bakeries -- Lenexa, Kansas; Henderson, Nevada; and Knoxville, Tennessee -- and disposed of eight closed bakeries and 18 depots that we had determined did not support our sales growth objectives. Net proceeds from the sale of these facilities have been approximately $33 million. Currently we have listed for sale three of these closed bakeries and three depots, which leaves six bakeries that remain under valuation to be opened or sold, as necessary, to meet our strategic objectives.

After the acquisition in 2013, carrying costs associated with the acquired facilities had an annualized run rate of roughly $23 million. During the second quarter these costs were $2.7 million. And for the full year we continue to expect carrying costs to be approximately $15 million. During the quarter we recognized asset impairment charges totaling $2.3 million or approximately $0.01 per share related to the adjusted fair value estimates for properties held for sale and a production line we'll be closing in the third quarter. Net interest expense was down just under $1 million driven by lower interest expense due to reduced debt outstanding and increased interest income related to increases in our notes receivable from the sale of Ralph's. Since the second quarter of 2014, we had reduced our debt approximately $133 million, of which $68 million was paid down during the first and second quarters this year.

The tax rate was up slightly, 34.6% in the current quarter, as compared to 33.9% quarter year ago. Backing out the asset impairment charge, adjusted net income was up 18%. Adjusted earnings per share for the quarter was up 19% to $0.25 per share as compared to $0.21 during the prior second year -- second quarter. Turning to the guidance, as mentioned in the press release we expect sales for the fiscal year to remain in the range of $3.786 billion to $3.861 billion, or a 1% to 3% growth over FY14. Adjusted EPS is expected to fall in the range of $0.96 to $1.01, while capital expenditures are anticipated to be in the range of $85 million to $95 million.

We feel good about the overall input cost outlook for the back half. Obviously at this point the majority of our contracts are in place and we don't see anything that we believe could materially impact that. Please keep in mind our comments today on guidance and the outlook do not include any impact of the pending acquisition of Dave's Killer Bread. We expect the transaction to close late in the third quarter or early fourth quarter and at that time we'll provide more color on the financial and strategic aspects of the transaction. We continue to see momentum as we move into the back half. As Allen mentioned, our brands are performing well, growing both in our core and expansion markets. We believe our initiatives to reduce cost and improve efficiencies are bearing fruit. Overall, the business is performing well and we believe we remain on track to hit our long-term goals.

Now I'll turn the call back to Allen.

Thank you, Steve. Once again I want to recognize the hard work of our teams to generate record second-quarter earnings. Our sales force executed in the market, winning new business and driving our branded sales, all the while providing great service and reducing sales. And I congratulate our manufacturing team. Not only did they increase production volumes but also improved efficiencies and maintained product quality. And to top it all off, the team opened our bakery in Lenexa without a hitch, lowering costs and setting the stage for future growth.

At this time two years ago, we had a lot on our plate. We had just acquired the former Hostess brands and facilities, we had acquired the Sara Lee brand in California, and were in the midst of integrating the acquisition of Lepage Bakeries. During the past two years we've worked diligently to realize the potential made possible by those strategic acquisitions. The acquisition of Dave's Killer Bread could not have happened at a better time. Today, our business is strong. We have a solid foundation and an experienced team eager to continue Flowers' growth in creating value for our shareholders.

Thank you. Now we'll open the line for your questions.

(Operator Instructions)

Our first question is from Farha Aslam with Stephens.

Hi. Good morning. Your margins in the quarter were exceptional. So, could you just share with us a little bit more color on sales and plant addition fees, how much they improved year over year and where they could go over time?

Sure, Farha. When you look at the margin, you're right, the sales mix was the big contributor to overall margin improvement. And then also from a top-line perspective we did see good improvement in our sale rate. It was roughly 100 basis points on the quarter year over year, so that's pretty strong from that perspective.

Efficiencies were up about 50 or 60 basis points year over year. And, again, we were right around that 92%. The summer sometimes puts a little stress because of the heat, and our goal is to get to a sustainable 93% or 94% efficiency. So, you can, however, that efficiencies and sales and mix on the top line really drove a big part of the margin improvement.

That's helpful. And then your recent IRI trends, the ones that came out this week, were quite good. Could you just share with us what you're seeing in terms of promotional cadence in the marketplace?

Farha, if you look at the IRI data, you can see price/mix was up 2.3%. So, overall category, the promotional environment appears to be improving and that's the case with what we're seeing internally, as well.

That's helpful. And then my final question is on Dave's Killer Bread, could you share with you us a little bit about the Company's profitability and what synergies you expect to realize from combining Flowers and Dave's?

Farha, we're really excited about Dave's Killer Bread. As I mentioned earlier, once we have regulatory approval we'll have a separate call and provide all those details. But it would probably be premature to get into that right now.

Understood. Thank you very much.

The next question is from Amit Sharma with BMO Capital Markets.

Hi. Good morning, everyone. Allen, a quick question on, you talked about new channel strategy and also you talked about the opportunities in Midwest. Could you just frame that opportunity for us in terms of channel, national specialty, and the size of the opportunity as you expand in Midwest.

The Midwest expansion is really tied to the opening of our Lenexa bakery. As we've said in the past, our target is to have a production facility within, say, 300 miles of all of our markets. Lenexa really just gives us the ability to expand our geographical footprint.

As far as channels, we continue to work to develop our business in all channels. But we're encouraged this past quarter both from a DSD standpoint and from a warehouse standpoint, both distribution systems seem to be working very well as we move into all channels.

Okay. I will probably follow up after the call on some of these. And then thinking about Dave's Killer Bread -- and I understand that you'll provide more details later -- but if we think conceptually, could you compare this business from a margin profile to the Lepage business in terms of the potential for those margins to get to those levels, or is there something fundamentally different between these two?

Amit, this is Steve. Because the deal hasn't closed, we're still in our confidentiality agreement. So, beyond what we said, is what we've agreed to disclose publicly since that's a privately held business. When you look at their product profile and you look in the organic business, again, it's a nice business, it does drive nice margin. It competes in that premium segment which you can see typically carries a nice margin. I think the exciting thing about that is geographically it's primarily a West Coast business. So, now we'll have a lot of opportunity to expand that business throughout Flowers' geography and on our routes. So, that's what gives us excitement from that perspective.

Amit, just a comment on the organic category. We're excited about -- if you look at the growth rate for Dave's Killer Bread, it's one of the fastest growing, if not the fastest growing brand in the category. And if you look at organics in general, in every food category they continue to do exceptionally well. We feel like Dave's is well positioned. It is excellent product quality. It's a very unique brand name. And when we combine where Dave's is today from a positioning standpoint with our distribution systems, that's why we're excited about the growth.

And then a quick follow-up on that. You said Lepage is coming back to what you expected the margins should be. Could you remind us -- they are much better than your consolidated margins -- are they in the 20%s from a margin profile for Lepage?

Amit, this is Steve. As you recall, when we made the acquisition we did disclose that they were roughly a 20% to 25% EBITDA business. So it's great to see them get back on track and now we want to make sure that's all sustainable. But we're very pleased with the progress we've made there and the fact we're moving back in line with where they were when we made the acquisition.

Got it. Final one from me about the legal issues and I understand that you can't talk much about it, but the fact that only two more cases were added between 1Q and 2Q, does that temper some risk that this is going to blow up into a full-bore crisis?

Amit, again, we can't really comment about ongoing litigation or speculation there.

Got it. Thank you very much.

The next question is from Brett Hundley with BB&T Capital Markets.

Hey, good morning, guys. Let me offer my congratulations on striking this deal. I have a question for you guys. You mentioned that organic segment margins are better than conventional, that category is more premium. I assume that there's some good margin in that industry from the way that certain product gets shipped. I'm just curious if, as premium bread gets put on DSD routes or something like that, if an inherent margin profile falls or if that inherent margin profile can be sustained, if that makes sense.

Brett, we're confident that from a margin standpoint the Dave's Killer Bread brand will play at the top of the ladder in terms of the pricing scale. Again, we'll get into more detail once we get approval, but we're very confident that the margins that will come along with the brand and also our growing participation in the organic category, the margins are going to be very good.

Okay. And then, Allen, I wanted to ask you about private label for a minute and just get a sense of your outlook for that category and maybe the conversations that you're having across branded and private label with some of your customers. It seems like bread buying today has definitely taken on this cult-like following by brand for consumers where brands are becoming incrementally more important. So, I just wanted to get a sense of those conversations that you're having with customers, given such.

I think with category management all of our retail customers are really looking at the profitability within their bakery department, taking brand and private label into consideration. You said it well -- in many cases the smaller brands are winning. That's why we're so excited about our entry into this organic category. But, really, the private label programs continue to be -- retailers will bid that business out periodically, but just in general there's pressure to grow their entire category but there's not dramatic pressure to increase their private label.

Okay. And, Steve, can you give me a sense either quantitatively or qualitatively what your bun/roll performance looked like in Q2 relative to Q2 2014?

Overall we were pleased with the buns and rolls. We had nice improvement from a unit volume perspective and we were up in dollars. So, generally we feel like we had a good bun and roll season. We had really good weather across most of the country for the two major holidays for us coming out of Memorial Day, as well as July 4th. So, we're very pleased with our overall performance there.

Okay. And then just last question from me, Steve, I wanted to go back to a question on just margins. Your margins were very good during the quarter. Clearly you're seeing some of the true benefits of some of your operational initiatives, pricing, volume improvement for certain items. And I'm trying to get a sense of how margins go forward here and whether we can build from here on further improvement related to those efficiencies, stale rates, et cetera. Are there things in the future that negate some of those future increases? Can you give us some comments on the margin outlook in the next year?

I'm not sure we're ready to talk about 2016 at this point. We're 2015 right now, we're holding to our current guidance. Obviously margins were up very strong in the second quarter. The back half impact from an input cost perspective, we won't have quite the benefit we saw in the first half but we do expect some benefit from that perspective.

Overall, as Allen said, we're very pleased with the market and the promotional effectiveness that we've seen. So, hopefully that will continue as the year progresses. And, again, we saw strong mix. The mix component was a big contributor to the margin improvement as well as the stale improvement. So, if those two items remain consistent for the back half of the year, we should come in from a margin perspective right at or slightly above the 50 or so basis point margin that we talked about improvement on gross margin.

Okay. I'm just curious if there's something else on your radar that you see in the back half. Just given the strength that you saw during the quarter I'd be curious why maybe guidance wasn't even raised for the full year.

We left our ranges in place. We feel like we're going to hit within our range. It's a pretty wide range. We thought it was best to leave that in place given the fact that we did have strong improvement. So, in that respect we feel good about the guidance that's out there.

Okay. Thanks for your time.

The next question is from Bill Chappell with SunTrust.

Good morning. Thanks. Just going back to Dave's bread, two questions. One, would this be one of the ones that was in the handful of $250 million type deals that you looked on the horizon or did this come up separately? Because it doesn't seem like this is a traditional regional player. This seems more of a slightly different category. Was this always in the plans in terms of possibilities or is this something new?

Bill, we've observed the success of Dave's for the last several years. This did not happen overnight. We've developed a relationship with the team at Dave's over a period of time and really just feel like that it's -- if you look at our existing product categories where we're strong, the products that are sold within Dave's product line, it's a real opportunity for us. Specialty breads and certainly organic breads, we don't currently play in a big way. And Dave's does a great job here and we think it will be very much of a complementary addition to our product line.

And with that, is there anything ingredient, production-wise why you can't produce this type of bread in other bakeries around the country?

Again, we'll talk more about that as we get further down the road, but we are very excited about the product quality that we see associated with the Dave's brand. And, again, our mission will be to expand that brand system-wide and we'll address the production decisions as we go down the road.

Okay. And then switching to the right size on Cobblestone, I assume that gives you -- I don't know if this is the right way to look at it -- a higher price per ounce. If that's the case, or even if it's not the case, is it something you're looking to maybe do for other parts of your business on the Nature's Own side?

Bill, we're encouraged about Cobblestone Bread Company, the right-size loaf, let's say a 18-ounce loaf with 11 slices. The market test that we've been conducting has been very successful. The margins on this product, again they're good margins. As we look at the roll-out, we're optimistic it's going to be a source of new business. We don't see this particular product line converting from other brands. But at this point this will only be introduced in the Cobblestone Bread Company brand. We don't have plans to move the smaller loaf into other brands at this point.

Okay. And then last one, Steve, just making sure I understand for modeling, is the current run rate for carrying costs around $10 million to $12 million for the acquired facilities? And can you give us an idea what you're now expecting for legal costs for this year?

On the run rate for the carrying costs, the projection is to be about $15 million for the year.

I meant just -- you said, I think, $3 million for the quarter, so is the run rate going forward now about $12 million?

Yes, correct. Slightly below that. We did sell a few more facilities and we have some listed. So, if those sell before year end or the third quarter closes, then it could drop slightly.

On the legal cost, it's just hard to predict that. Those will be variable from quarter to quarter. We were up slightly this quarter, not quite the magnitude as the first quarter. So again, I can't really predict how those costs will hit.

And year-to-date your legal costs have been $5 million?

We haven't disclosed the absolute dollar value, but It's been up relatively, significantly so.

Got it. Thanks so much.

(Operator Instructions)

The next question is from Tim Ramey with Pivotal Research Group.

Good morning. Thanks. First, as somebody who lives in Oregon, I can tell what you a great brand that is. And for those analysts who don't know it, it's like $4.50 a loaf. So, I'm guessing the margin structure is wonderful and it's a great product.

I do have one or two questions about Dave's. You mentioned FY16 sales. What month is their fiscal year, so I can understand? Is that a projection or is that the current year or what is that?

It's a calendar year.

Yes, that's a projection, Tim, an estimate.

So, calendar 2016 sales.

Right.

Okay. And I don't think they have a DSD system. Are they going to market through warehouse or do they piggyback on other people's DSD or how does that work?

Tim, they have a few DSD routes but primarily they're a warehouse distribution today.

Okay. And, Allen, earlier I think you made the statement -- our sales force executed well driving sales in the market. When you say that, do you mean your independent operators or do you mean something else by sales force?

Our independent operators are our sales -- our independent operators did a great job this past quarter generating sales and the Company did a good job supporting the efforts of our independent operators.

Okay. Great. Thanks so much.

And we have no further questions at this time. I'd like to turn the call back over to Allen Shiver for closing remarks.

Ellen, thank you. Again, we appreciate all of the support that we received. And before we close, one last appreciation to our Flowers team. It was a great quarter and we're very optimistic about finishing this year strong. Thank you very much and have a good day.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.