Flowers Foods Inc
NYSE:FLO
Earnings Call Analysis
Q4-2023 Analysis
Flowers Foods Inc
In 2023, Flowers Foods navigated a tough economic landscape characterized by inflation and a consumer shift toward private label products. Despite these headwinds, the company's strategic execution led to a solid performance, with notable achievements like Dave's Killer Bread reaching $1 billion in retail sales and significant brand share gains in key categories.
Flowers Foods achieved a 4.3% increase in sales year-over-year, with improved price mix countering inflationary pressures and targeted rationalizations. Gross margins rose by 110 basis points to 47.9%, displaying effective management of rising costs. However, adjusted diluted EPS saw a slight decline to $0.20, a $0.03 decrease from the previous year, pointing to investments geared towards future growth and heightened operating expenses.
The organization's commitment to infrastructure transformation was evident through the $28 million allocated to the ERP upgrade, signifying a proactive approach to improve operational efficiency. Additionally, about 70% of key raw materials for 2024 are covered, reflecting a strategy to mitigate commodity cost volatility and preserve steady financial performance going forward.
In response to evolving consumer behavior and competitive dynamics, Flowers Foods successfully adjusted to the market. The company's strong brands surpassed private labels in performance and continued to focus on innovative and differentiated products, predicting a resurgence in the trend toward premiumization as consumers reconcile with pricing normalities.
Looking ahead, 2024 is anticipated to see flat to 1.6% growth in sales, backed by pricing actions and an adjusted EBITDA forecast between $524 million and $553 million. Flowers Foods expects to phase out business exits by the year's end while employing caution in an unpredictable consumer and promotional landscape. The company's financial position remains robust, with a stable net debt to adjusted EBITDA ratio and a strong balance sheet that positions it well for potential mergers and acquisitions moving forward.
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Hello, everyone. This is J.T. Rieck, EVP of Finance and Investor Relations. Welcome to the prerecorded discussion of Flowers Foods 2023 Fourth Quarter and Full Year Results. We will host a live Q&A session on Friday, February 9 at 8:30 a.m. Eastern. Further details about the live call, along with our earnings release, a transcript of these recorded remarks and a related slide presentation are posted on the Investors 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, Chairman and CEO; and Steve Kinsey, our CFO. Ryals, I'll turn it over to you.
Thanks, J.T. It's a pleasure to welcome everybody to the call. 2023 was a productive year for Flowers, and I'm proud of everything our team has accomplished. To be sure, the economic and inflationary environment remain challenging, resulting in a continued shift toward private label products. However, that shift clearly moderated throughout the year. Our brands performed well, gaining share and demonstrating their strong preference with consumers. This encouraging performance bolsters our confidence in our long-term prospects as consumer demand normalizes.
Our 2024 financial outlook incorporates an expectation for solid relative performance within the context of those category headwinds. We expect results to be first-half weighted with more caution on the back half, largely due to the uncertain consumer and promotional environment. We're also making continued investments in our team, operations and digital initiatives that are expected to enable longer-term growth. Steve will provide more detail on the puts and takes related to these factors.
In the fourth quarter, our brands gained 10 basis points of unit share in tracked channels versus the prior year period. And for the first time since the first quarter of 2022 grew dollar share, which was up 20 basis points. In grocery, we performed even better, gaining 20 basis points of unit and dollar share as highlighted on Slide 9 in our earnings presentation. Slide 10 illustrates the improving volume trends throughout 2023, driven by share gains and moderating business exits. This improvement, which was particularly strong in our branded retail category, underscores the effectiveness of our portfolio strategy and the strength of our brands. Our portfolio strategy is driving top line and gross margin expansion as we focus on shifting more sales to higher-margin branded products. That strategy extends to our other category as well, and we're improving cake, foodservice and private label margins significantly.
With a focus on profitability over volume, we have expanded the margins of existing business while rationalizing accounts that fail to meet our hurdle rates. In the short term, that process results in some temporarily stranded overhead costs as volumes decline, obscuring the underlying progress we're making. Over time, we expect our growth initiatives to drive additional volume and fill that capacity with higher-margin business, ultimately improving overall corporate profitability.
Now I'll provide an overview of our fourth quarter and full year performance in the context of our 4 strategic priorities: developing our team, focusing on our brands, prioritizing margins and pursuing smart M&A. Following that, Steve will come back and review our financial results, and then I'll close with a discussion of key themes moving forward.
With regard to our team, we made considerable progress in 2023. We developed new skill sets and added external talent to meet the evolving demands of our business and ensure we are best positioned to meet our long-term financial targets. We also streamlined our operating structure to maximize the impact of these additions and put our team in the best position to succeed. I'm confident that we have the right team in place to successfully implement our strategic priorities and expect that to manifest itself in improved execution in 2024 and beyond.
Our second strategic priority is focusing on our brands, which are thriving, despite the difficult consumer environment. Dave's Killer Bread was a particular standout, achieving a record $1 billion in 2023 retail sales as measured in tracked channels. Despite its premium status, the weakest part of the bread category, at an average price of more than $6 a unit, DKB's consumer appeal transcended its price point. The brand gained 30 basis points of unit and dollar share in the fourth quarter.
Even more impressively, Dave's grew unit volumes in tracked channels by 10%, while the overall bread category with an average price of approximately $3.50 per unit declined 3%. This strong performance illustrates the brand's appeal beyond the organic and specialty premium categories. And DKB continues to demonstrate an ability to grow outside of core loaf products, increasing units 15% and 28%, respectively, in the breakfast and sandwich buns and rolls subcategories. With dollar share of only 7% and 1%, respectively, in these subcategories, we see significant white space in adjacencies in addition to geographic expansion and extensions beyond the bread category.
That potential spurred our decision to launch DKB bars, which continue to perform well with market share and velocities in line with the category. We achieved distribution in approximately 19,000 stores, significantly exceeding our original goal of 13,000, and we're excited about the potential for future growth in small format locations like convenience and drug stores.
Building off that momentum, the national rollout of DKB protein bars, which are already in 1,500 stores is scheduled for the first half of this year. Ultimately, those 3 new SKUs are expected to double our shelf space in bars, increasing our shelf visibility and helping to accelerate sales.
On past calls, we've talked about the shortage of available capacity at Canyon Bakehouse as the brand has grown. We've since added new capacity and are beginning to see the benefits of those additions. We're optimistic about the growth potential of Canyon, which remains solidly in the #1 share position in gluten-free bread and enjoys the highest loyalty of all national bread brands.
Our largest brand, Nature's Own, gained 10 basis points of dollar share with a 10 basis point reduction in unit share. That unit share loss was concentrated in the traditional loaf category, which has been significantly impacted by private label trade down. Nature's Own maintained share in sandwich buns and rolls and especially loaf and gained 600 basis points of unit share in Keto, an example of how we're using innovation to meet the changing needs of consumers. Our Nature's on Keto loaf was the #1 new item in the category for 2023.
Our third strategic priority is margins. Our team has done an admirable job of mitigating the effects of commodity inflation on our cost basket. Those efforts are reflected in our gross margins, which improved in 2023 versus the prior year. However, EBITDA margins have been impacted by inflationary pressures in other areas, including labor and repair and maintenance, along with investments to drive future growth, such as marketing and our digital initiatives.
Though these investments temper near-term results, they are crucial in enabling us to meet or exceed our long-term financial targets. We're focused on offsetting those higher costs through efficiencies and cost savings initiatives, which we expect to save approximately $30 million to $40 million in 2024.
Our fourth priority is smart M&A. M&A has been a key contributor to our growth for decades, expanding our geographic coverage and supplementing our brand lineup. Moving forward, in addition to strengthening our position in core categories by expanding our geographic reach and gaining share in underdeveloped markets, we're also focused on finding new revenue streams across the baked foods category. Baked foods are sold throughout the store, including the deli, center store, and freezer and refrigerator cases in addition to the many out-of-home eating occasions. Our goal is to identify compelling brands that complement our existing portfolio and skew towards a better-for-you nutritional profile.
The M&A market is beginning to show signs of improvement, and I'm more encouraged than I've been in several years by the developing pipeline of potential opportunities. We continue to monitor the deal market. We're actively building relationships with owners and founders and actively vetting potential acquisitions and investments that could add capabilities, brands or products to our robust existing lineup. Our strong balance sheet positions us well to act when we have financial, commercial and operational conviction.
Now I'll turn it over to Steve to review the details of the quarter, and then I'll close with our outlook for the current business environment. Steve?
Thank you, Ryals, and hello, everyone. Total sales in the fourth quarter increased 4.3% from the prior year period. Improved price mix drove the year-over-year increase, up 5.6%, primarily due to pricing actions to mitigate inflationary pressures. Volume decreased 2.4%, partly due to targeted sales rationalizations and food service, reflecting the lowest quarterly volume decline in 2 years. The Papa Pita acquisition added 1.1%.
Gross margin as a percentage of sales, excluding depreciation and amortization, increased 110 basis points to 47.9% over the same quarter last year. Comparisons benefited from moderating input cost inflation and reduced outside purchases resulting from the acquisition, partially offset by higher labor and maintenance costs. Selling, distribution and administrative expenses as a percentage of sales were 39.7%, a 180 basis point increase over the prior year period. Higher labor, insurance, marketing, prior year gain on sale of assets and technology expenses were partly offset by lower distributor distribution fees as a percentage of sales and bad debt expense.
Excluding matters affecting comparability, adjusted SG&A expenses were 39.4% of sales, 150 basis point increase due to the factors listed excluding the prior year gain on sale of assets.
GAAP diluted EPS for the quarter was $0.17 per share compared to $0.23 in the prior year period. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter was $0.20 per share, down $0.03 from the prior year period.
Turning now to our balance sheet, liquidity and cash flow. Cash flow from operating activities in fiscal 2023 decreased by $12 million to $349 million. Capital expenditures decreased $40 million to $129 million and included $28 million for the ongoing ERP upgrade. Dividends paid increased $9 million to $195 million.
We believe our financial position remains strong. At quarter end, net debt to trailing 12-month adjusted EBITDA stood at approximately 2x. We held approximately $23 million in cash and cash equivalents and had approximately $537 million of remaining availability on our credit facilities.
Now turning to our outlook for 2024. We are forecasting sales to be flat to up 1.6%, which assumes positive pricing actions that are already in place or agreed to, partly offset by slight volume degradation from continuing category declines and selected business exits. We expect 2024 to be the last year of meaningful business exits with most of the impact concentrated in the first half of the year. Adjusted EBITDA is expected to be $524 million to $553 million, with adjusted EPS in the range of $1.20 to $1.30.
As Ryals said, the guidance reflects results that are first half weighted with more caution on the back half, largely due to the uncertain consumer and promotional environment. At this time, we are not seeing material changes in those factors, but we believe caution is warranted as consumers continue to adjust to the post-pandemic environment.
The first half is expected to benefit from wraparound pricing in branded retail, new pricing in selected food service accounts and moderating commodity costs, partly offset by growth investments and other inflationary pressures. Much of the 2023 branded retail price increases will not be lapped until midyear 2024.
Key factors that could shift results within our guidance range includes the consumer and promotional environment, the transition of our California distribution and implementation of our savings initiatives. Overall, demand elasticity has been in line with our expectations, remaining below historical levels. Other factors expected to impact full year results include a higher tax rate and increased net interest expense associated with funding payments related to the California legal settlement, the ongoing ERP project and decreased interest income.
As previously disclosed, we reached an agreement to settle distributor-related class action litigation in California. The settlement is awaiting final court approval, which we anticipate will occur no sooner than March 1, 2024. Once the settlement receives final court approval, we will proceed with the repurchase of the California distribution rights, a process expected to be completed by the first quarter of fiscal 2025.
We expect 2024 depreciation and amortization in the range of $160 million to $165 million and capital expenditures of $120 million to $130 million. Approximately 70% of our key raw materials are covered in 2024. Based on that coverage, our guidance incorporates a moderation in ingredient costs in 2024 relative to the prior year. To minimize volatility and provide adequate visibility into cost, we have maintained our historical hedging strategy, in which we attempt to increase the certainty of our key commodity costs 6 to 12 months out.
Our ERP rollout went live in the second quarter of 2023, and we continue to make progress in that implementation, though we have paused the bakery rollout to concentrate resources on our California distribution transition. In fiscal 2024, we expect cost for the upgrade of our ERP system to be approximately $25 million to $35 million, including $3 million to $6 million expected to be capitalized. As of year-end, we have incurred costs related to the project of approximately $214 million, of which $112 million has been capitalized. Thank you. And now I'll turn it back to Ryals.
Thank you, Steve. Now I'd like to discuss some of the trends impacting our current performance and the steps we're taking to maximize our opportunities in this environment and beyond. I'll first touch on the health of the consumer and then address the competitive environment.
Consumer behavior in the fourth quarter remained consistent with what we've seen for most of 2023. Private label products continue to gain share in the bread category as consumers respond to higher prices, though that trend is moderating as highlighted in Slide 11. Unit share of private label products increased only 10 basis points in the fourth quarter.
Price gaps are also narrowing as private label prices continue to increase faster than branded counterparts. And as private label unit growth moderated, our branded retail volume trends improved. As I mentioned earlier, those volumes declined only 30 basis points in the fourth quarter, a significant improvement compared to the first 3 quarters of the year. This favorable volume trend contrasts with the overall bread category, where Slide 12 shows units leveled off after the first quarter, indicating that our brands are outperforming.
As a reminder, branded products have a long track record of share gains, which has been driven by significant innovation and differentiation. The effect of that premiumization trend, which is shown on Slide 13, was interrupted by inflationary pressures over the last 2 years, but we expect it to resume as consumers adjust to the new environment.
The disparity between the mass and grocery channels also continued, with private label losing 60 basis points of unit share in grocery in the quarter compared to a loss of 30 basis points in the third quarter. In contrast to that private label performance, Flowers gained unit share in grocery in each quarter of 2023, including 20 basis points in the fourth quarter. Private label products remained strongest in the loaf categories with the least differentiation. Areas with greater product differentiation showed declines in private label share. We continue to grow share in the specialty premium, breakfast, and sandwich buns and rolls subcategories, gaining 170, 100 and 40 basis points, respectively, as our leading brands demonstrate their ability to further extend into those adjacencies. We see significant opportunity for growth in these brand extensions.
Turning now to the competitive environment, which was relatively consistent throughout 2023 and remains rational. Beginning with the onset of the pandemic, the impact of promotions on consumer demand waned, with minimal lift from incremental programs. Although promotional levels for Flowers and our category remains significantly below pre-pandemic levels, the percentage of our products sold on promotion increased in the fourth quarter, as our promotional activity increased slightly and consumer response to promotions reverted somewhat towards more historic levels.
That increase in effectiveness was largely due to the improved consumer response enabled by our strong brands, enhanced display execution and new capabilities we built in trade promotion management systems. Those factors allowed us to greatly improve the effectiveness of our promotions far beyond the increase in our trade spend. Our improved promotional effectiveness is just one way in which we're working hard to maximize our performance in the current market.
In closing, I'd like to reiterate that we remain focused on the significant longer-term opportunities we see ahead of us, filling in white space and geographic and product adjacencies, while leveraging innovation to push into new categories. We think the best way to capitalize on those opportunities is by continuing to strengthen our brands organically and through M&A, meeting additional consumer needs by developing new and differentiated products that expand our addressable market.
I've never been more confident in our long-term potential, and I look forward to building on our strong base throughout 2024. Thank you very much for your time, and that concludes our prepared remarks.