Welcome to the Flowers Foods First Quarter 2019 Earnings Conference Call and Webcast. My name is Paulette, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press star then one on your touch-tone phone. Please note that this conference is being recorded. I will now turn the call over to J.T. Rieck, Treasurer and Vice President of Investor Relations. You may begin.
Thank you. Good morning, everyone. Our first quarter results were released yesterday evening. The earnings release and our updated investor presentation is posted in the Investors section of the Flowers Foods website. Our 10-Q was filed with the SEC yesterday evening. Before we begin, please be aware 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'll discuss during the call, important factors relating to Flowers Foods business are fully detailed in our SEC filings. With that, I'll make some introductions. Participating on the call today, we have Allen L. Shiver, Flowers Foods President and Chief Executive Officer, Steve Kinsey, our Executive Vice President and Chief Financial Officer, and Ryals McMullian, our Chief Operating Officer.
Allen, I will turn the call over to you.
Thank you, J.T. Good morning. Before getting to the quarterly review, I want to comment about our CEO transition that is set to occur at our shareholder meeting next week. As announced in February, I'm retiring after 41 years with the company, and Ryals McMullian will become Flowers' next CEO. Over the past four decades, I've come to deeply appreciate the talent and the dedication of the Flowers team, and it has been a great honor to work with them. Our team has grown this company from a regional baker to a national powerhouse with leading brands, strong customer relationships, and a valuable partnership with our independent distributors. I believe Flowers has never been in a better position for the future.
Since launching Project Centennial in 2017, our company has restructured into a more brand and consumer-focused organization, and we continue to take actions to improve efficiencies and enhance profitability. With our transformation well underway and solid momentum in our business, it's the right time for this leadership transition. Ryals and I have worked closely together for many years, and I know that I'm leaving the company in very capable hands. Ryals has been a driving force behind the efforts to extend the company into growing segments within our category. As Chief Operating Officer, he has done an outstanding job aligning the team behind our strategic goals and in driving operational improvements. Ryals has been working closely with me to prepare for this transition. I am confident he is the right choice to take the helm at this exciting and important time in our company's history.
I will now turn the call over to Ryals so that he can share his thoughts and his observations. Ryals?
Thanks, Allen, and good morning, everybody. Appreciate you joining the call. First off, I just want to say that I am deeply honored to accept this new responsibility. I want to thank the board of directors, our team, and our customers for their support during this transition, which takes place next week. In particular, I want to thank Allen. I want to thank him for having the courage to set us on the course we find ourselves on today. It took a lot of conviction to embark on what ultimately became Project Centennial and to upend longstanding notions of what success looks like in our company and in our industry. He's created a really solid foundation for us to build on, and for that, we owe him a debt of gratitude.
The transformation underway here at Flowers is a major undertaking, but it's also absolutely necessary if we're going to compete effectively in a complex 21st century marketplace. Good progress has been made over the last two years. Our savings initiatives and our org restructuring have generated cost savings that, along with improved price realization, have helped us to offset some of the inflationary pressures we've seen more recently. These savings also enabled us to make brand investments to drive above-category growth and increase our market share, actually achieving record market share this quarter. Our realigned organization has clarified accountability and driven our team to be hyper-focused on building powerful brands, connecting meaningfully with our consumers, and improving our profitability. We're gaining new insights from enhanced analytical capabilities that help to provide heightened transparency into our business, but also inform better strategic decision-making.
Across the company and across functions, we're taking fresh approaches to solving business challenges. I'm really optimistic about what's ahead for us. We've set very simple, very clear priorities to achieve our goals. One, we're focused on profitably growing our brands. Our focus is on our brands. Two, we're aggressively managing costs to drive cash flow and improve our margins. Three, we're proactively exploring opportunities to grow in attractive adjacencies with smart M&A. Four, and most important of all, we're developing the capabilities of our team.
We're building upon and evolving the culture that carried us through the first 100 years by drawing forth greater accountability and achievement. I think it's important to call attention to the fact that since the beginning of the project a couple of years ago, there's been a clear shift of the collective mindset at Flowers, from one that was really more operationally and tactically focused, to one that's now deeply strategic, forward-looking, and accountable for executing with excellence. It's truly exciting and very satisfying to be a part of this shift and to see it start to generate meaningful results.
To be sure, we still have a lot of work to do to fully realize our goals, and in particular, we've got to continue to work aggressively to optimize our cost structure, and we've got a variety of initiatives underway to achieve that goal that we'll update you on as we go through the year. Furthermore, we're still not finished installing new capabilities to support our business. These things will take some time to fully achieve, but for now, I'm very pleased with the overall trajectory and the building momentum we're experiencing in the business. Thanks for allowing me to take a few minutes to speak with you, and I look forward to updating you in the coming quarters. Allen?
Good. Thank you, Ryals. Turning to the quarter. Our first quarter results are encouraging, especially on the top line, which increased 4.8% overall. In the base business, excluding Canyon Bakehouse sales, our base business increased 3%. Our brands performed very well, with base business volumes down only slightly, even as we took pricing to address the inflationary cost pressures we mentioned on prior calls. For comparison, the fresh packaged bread category, as measured by IRI, was down approximately 3% in units and was flat in dollars. Store brands continue to be the biggest driver of category decline on both a dollar and unit basis. Flowers' market share increased from 16.1% to a record 17% share. Approximately one-third of our share gains in the quarter came from newly added Canyon Bakehouse and Sun-Maid products.
The balance was driven by innovation and growth in our core national brands, Dave's Killer Bread, Nature's Own, and Wonder. New marketing capabilities and a more brand-focused organization have generated a robust innovation pipeline, and we're excited about the recent introduction of new bread and snack cake items. These include a brioche-style variety of Nature's Own Perfectly Crafted, Wonder Hamburger Buns with a Touch of Honey, and Tastykake Scoop Shop ice cream-inspired sweet snacks. We believe that our brand portfolio has never been stronger, especially with the addition of Canyon Bakehouse. The category segments posting the strongest growth in dollars and units are organic and gluten-free specialty loaf breads. With DKB and now Canyon Bakehouse, Flowers has top brands in both of these attractive segments.
With Nature's Own and Wonder, we have a strong and growing position in the traditional loaf segment, which is the category's largest in both dollars and units. For our snack cake team, the priority is improving profitability. We are seeing the top line stabilize. Cake sales in the quarter were flat compared to a year ago. We also have made considerable progress streamlining our product assortment and improving pricing. In addition, the team is bringing new products to market, as well as continuing to lower product cost and improve efficiencies. Food service sales declines did negatively impact the top line this quarter by approximately 50 basis points. These results were driven by exiting lower-margin accounts, as well as business loss because of inferior yeast that we received last year.
As pleased as we are with our first quarter sales performance, margins continue to be impacted by inflationary pressures from commodities, labor, and transportation. While pricing is an important tool to address these pressures, we're also very focused on manufacturing efficiencies. Recently, we clarified roles and adjusted incentive programs. This additional level of accountability is designed to drive execution and accelerate the impact of our cost savings initiatives. Reducing fixed operating costs through our multi-year supply chain optimization initiative remains a top priority, and we are making good progress in several areas. For example, we recently started production of DKB at one of our bakeries in Lewiston, Maine. This will not only significantly reduce transportation cost, but will also enable additional sales through better service, fresher product, and improved availability to the important Northeast market. Overall, we are pleased with the solid start to the year.
We delivered strong earnings growth in line with our plan and continue to grow market share. We're also encouraged that our revenue management and cost savings initiatives are starting to mitigate inflationary headwinds. I'll ask Steve to review the financials and provide our outlook for the rest of the year. Steve?
Thank you, Allen, and good morning, everyone. Before I turn to the quarter results, as you may have seen in our press release in 10-Q, effective this quarter, Flowers reorganized our segments to include our results under one operating segment on a go-forward basis. As always, our goal is to provide meaningful and relevant information that allows investors to make an informed decision about Flowers Foods. We believe this reporting structure is a better and more accurate reflection of our operations and our business following our organizational restructuring and other internal changes over the past several quarters. The shift from a distribution focus to a brand-centric company and the interrelated nature of our manufacturing and distribution capabilities leads us to one consolidated segment. Turning to the results. As Allen detailed, the top-line performance was solid, and we delivered adjusted EPS in line with our plan.
Excluding the 1.8% top-line contribution for the acquisition, price mix contributed 3.2% of sales of $38.6 million. Most of this increase came from pricing actions taken to mitigate the inflationary headwind we've experienced the past few quarters. In addition, mix was positive, driven by growth from DKB, the Nature's Own Perfectly Crafted product line launched last year, as well as sales from Sun-Maid products we began selling at the end of last year's third quarter. Volume decline slightly impacted the top line by 20 basis points, primarily because of declines in the food service and vending channels. We continue to focus on improving margin in these channels and being more selective about taking on low margin, high volume business. In addition, food service volumes were impacted by lost business because of the inferior yeast we received last year.
Volumes in our core national brands were better than expected, given the pricing actions implemented during the quarter. Turning to gross margin. Consolidated gross margin improved 20 basis points as a percentage of sales. This was primarily due to increased production volume and pricing that mostly offset inflation in commodities and labor. Excluding the items affecting comparability detailed in the press release, adjusted SG&A expenses increased 50 basis points as a percentage of sales. This was primarily due to a high percentage of sales to independent distributors, as well as higher selling and marketing costs. GAAP diluted EPS for the quarter was $0.31 per share. Excluding the items affecting comparability detailed in the release, adjusted diluted EPS in the quarter increased by $0.02 to $0.32 per share, driven primarily by higher sales. Canyon Bakehouse was accretive to EBITDA and neutral to EPS in the quarter.
A few comments on leverage and cash flow for the quarter. Discretionary cash flow remains solid, and as a result, we made debt repayments of approximately $41 million in the quarter. A quarter in, our net debt to trailing 12-month adjusted EBITDA stood at approximately 2.2 times. Looking ahead to 2019 guidance and forecast. For 2019, we continue to target sales growth in the range of 2%-4%. This includes Canyon Bakehouse sales, which are anticipated to be in the range of $70 million-$80 million, accounting for approximately 1.8%-2% of the total sales growth. We expect base business growth to be driven by improvements in price mix, partially offset by a conservative view on volumes due to the broader category softness that Allen mentioned in his remarks. We continue to target adjusted EPS in the range of $0.94-$1.02 per share.
Inflationary pressures from commodities, labor, and transportation are expected to be approximately 150 basis points as a percentage of sales. To mitigate these costs, we are working on a broad set of cost saving and productivity initiatives, as well as continuing to evaluate pricing and promotional strategies market by market. We continue to expect Canyon Bakehouse to be accretive to EBITDA and neutral to slightly dilutive to full year EPS. I do want to call your attention to a couple of items that bear keeping in mind when thinking about the cadence of earnings through the remainder of 2019 and comparability to last year. First, in the second quarter of 2018, we did a major promotional event to launch Nature's Own Perfectly Crafted. As we noted at the time, this event did pressure price realizations and overall profitability.
Additionally, in the second and third quarter of 2018, we experienced significant disruption due to the receipt of inferior yeast from a supplier. This impacted many of our bakeries and resulted not only in reduced sales, but also higher costs and inefficiencies while corrective actions were being taken. It's also important to note that this came in the height of our traditional bun season throughout the summer. While we are not able to quantify the financial impact of these items for you today, our forecast does anticipate more favorable comparisons in the second and third quarters of 2019 as a result of these events. Thank you. Now let me turn the call back to Allen before we open up for questions.
Thank you, Steve. Here are the three most important things that you should take away from today's call. First, our strong brands are driving growth. They're outperforming our category. Second, we're taking actions to mitigate the impact of inflationary headwinds on our profitability. Third, Flowers is stronger than it has ever been. Ryals is the right choice to be the next CEO, and I am confident he and the team will capitalize on opportunities and build value for shareholders. Finally, this is of course my last earnings call. It's been a privilege to host these calls and work with the investment community throughout the years. With that, let's open the floor for Q&As.
Thank you. We will now begin the question and answer session. If you have a question, please press star then one on your touch tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your touch tone phone. Our first question comes from Amit Sharma from BMO Capital Markets. Please go ahead.
Hi, good morning, everyone. This is Drew Levine on for Amit. Thanks for taking the questions. I wanted to start off on the strong price mix in the quarter. Obviously, a really nice outcome with pretty minimal volume declines there. Just curious, as that relates to Project Centennial, as we're thinking about gross margins and inflation, maybe if the Project Centennial costs are coming through as expected, because I think we probably would've expected to see a little bit more gross margin expansion with that strong price mix.
Yeah, Drew, this is Steve. When you look at the overall gross margin for the quarter, I would say it is in line with our expectations as we continue to build off of a decline last year. We continue to see inflationary pressures within the marketplace, obviously the pricing actions we have taken have helped somewhat mitigate those, but they've not fully offset 100% of the cost inflation. We're also focused on other areas around efficiencies and cost reduction as we continue to rebuild the overall gross margin. There's also a mix component of that. When you look at the new products that are really driving sales, their gross margin has been slightly lower as we've been ramping up those brands. You may recall DKB we rolled out a couple of years ago. We're still continuing to see good improvement in overall margins from that brand.
As we ramp Canyon up and take it across the whole network, we should begin to see improvements from that perspective. I'd say we're not surprised where we ended up. We feel like we're in line, we're focused on rebuilding, I'd say from a cadence perspective, it's what we anticipated.
Thanks. Just on that point from an inflation perspective, still targeting 150 basis points of sales is the expectation. Is that really front-half loaded? Any sort of other comments on commodity inflation?
Overall, I'd say from a coverage perspective, the market's well aware that we try to cover well in advance of our actual cost of usage. That way we know how we need to react in the marketplace. When you look at the full year, I'd say it's fairly evenly spread. Overall, I'd say I wouldn't say anything significant stands out quarter to quarter from a cost perspective.
Thanks. Just last one for me. It looks like on your slides, you took down the low end of the longer-term sales guidance to 2%-4% from 3%-4% previously. Just any comments on what's driving that would be helpful. Thank you.
The 2%-4% is 2019, and the longer-term sales growth through 2021, it would be within our five-year Project Centennial plan. Really nothing out of line or unexpected there as well.
Great. Thank you.
Our next question comes from William Chappell from SunTrust. Please go ahead.
Thanks. Good morning.
Good morning, Bill.
Yeah, Allen, congratulations. I enjoyed working with you.
Great. Thanks.
A couple questions. I guess first, I think you said on the Project Centennial margin goals there is no real question internally that you can get to them. It's just more this year was going to be a pivotal year of when you can get to them. Is that still the case? Do you feel like you still can get the pricing needed this year to hit those goals, or is it too early in the year to really figure that out? I guess more of a question of, is there more layers of pricing to come this year, and is that kind of necessary as if we're looking towards those 2021 goals?
Bill, as I mentioned, a lot of pricing is already in place. We're really focused looking at the remainder of the year on cost savings initiatives, and all those will all combine to help us to achieve the margin targets that we've laid out. Really, we're very confident in the numbers that we've presented today to you for the remainder of the year.
Bill, this is Steve. Again, I think you said it. We have said 2019 is going to be a pivotal year to hitting the targets within the timeframe we've set. Coming out of the first quarter, I'd say we're still early in the year, but we're pleased with what we've seen in the first quarter. We don't want to forecast on forward pricing, but what I'd like to say is we're pleased with what's happened in Q1. Overall, our volumes held up, and we'll continue to watch that as the year progresses.
Did first quarter reflect the full pricing effect, or was there some pricing within the quarter where you maybe got a half or two-thirds of the effect and you'll get the full effect in the second quarter?
For competitive reasons obviously we can't answer that directly, but I'd say, as Allen said, we took significant pricing in the first quarter.
Just going to DKB and Canyon. On DKB, is there any way to break out how much of it now is just velocity versus distribution gains? Are there still meaningful areas where you can get distribution for DKB, or is it really just backfilling with more products and driving that velocity?
Bill hey, it's, Ryals. Coming on that, we still feel like we've got a lot of runway for growth with DKB. If you look around the country, particularly outside of the West Coast and the South, where we're most heavily penetrated, the Northeast and the Upper Midwest still represent a really big opportunity for distribution gains along with that. Obviously, the organic category continues to grow, the brand continues to grow, but there's still also ample runway for growth from a distribution standpoint as well.
Got it. Then on Canyon, any learnings now that you've owned it for a full quarter in terms of should we expect a similar trajectory in terms of distribution and growth that we saw at DKB?
This is Ryals again. It's probably a little bit different with Canyon, just the nature of the products. As you know, we go to shelf with Canyon in a modified atmosphere packaging, which is a little different from a shelf life standpoint. We don't have as many facings with Canyon, a smaller category than organic. It's a little bit different. The rollout, it looks very similar, but the cadence of the sales ramp-up and growth will be a little bit different just because it's a smaller category.
Got it. All right, thanks so much.
Yeah. Thank you, Bill.
Our next question comes from Robert Dickerson from Deutsche Bank. Please go ahead.
Hey, good morning. It's Matt on for Rob. Thanks for the question and congratulations, Allen.
Great. Thank you, Matt.
Given we don't have a DSD or a branded volume price breakdown this time around, can you elaborate on the drivers behind the volume outperformance? I think you said it was relative to your expectations. I think this quarter was a bit better than we were expecting given the price increase. The comps get easier throughout the year two-year stacked organic growth accelerated significantly this quarter from the end of last year. I know you guys have got a ton of work improving velocities at retail, and that's apparent no matter how we cut the data, so you deserve a ton of credit for that. In short, is organic growth in Q1 sustainable? Is there any one-off factor supporting Q1 that maybe I'm not thinking about correctly, like Easter shipment timing or the longer Easter selling period?
I don't think that should affect you, but the EPS cadence commentary was helpful. Just trying to reconcile Q1 to your full-year organic sales guide. Thanks.
Yes. This is Steve, Matt. When you look at the overall volume in the quarter, we were pleased to see that our retail business had nice volume gains. You continue to see, as Ryals said, nice growth from Dave's Killer Bread. Our private label business was up, as you can see in Q2, and that is driven primarily by some new business wins and some new regions of the country, as well as Canyon does have some private label business. From an overall volume perspective, I'd say those were the big drivers. As I said in my comments, there are a couple of factors affecting the quarter. As Ryals said, we do expect continued good organic growth from a distribution standpoint, but we will be lapping a couple of product introductions in Q2. Just from a cautionary standpoint, I'd want to point that out.
Again, we still feel like we're going to fall well within line with the guidance we have for 2019.
Cool. Okay. Thank you for that. On Project Centennial, just wanted to know if there's maybe any other updates you can share on the supply chain optimization piece. Definitely appreciate the Dave's Killer Bread example in Maine. I know there hasn't really been much you can say from a quantitative perspective over the last few quarters, that's perfectly fair. Given a lot of the margin expansion opportunity hinges on it, are there any ideas or tracking its milestones you can point to that give us a little bit more confidence in the timeline and magnitude you've laid out? Because I have to, I feel like when should we expect the DKB production in Maine to have any type of impact on the P&L? Thanks.
Matt, this is Ryals. Thanks for the question. The DKB production in Maine has started, so we'll start to see the benefits from that fairly soon. The broader supply chain initiatives, we're still internally in the data gathering and modeling phase right now. We'll have some more details on that hopefully a little bit later this year. Not a lot to share yet, except to say that it's a major initiative here to help us get our fixed costs more in line and to raise our margin profile. We've got the team highly focused on it. It is one of the key initiatives as we go through the CEO transition. It's a primary initiative for me. Unfortunately, not a lot to share today, but certainly will be as we go towards the back half of the year.
Okay. Just as a follow-up, this could be helpful too. If we think about the margin expansion opportunity of Flowers over the next few years, the supply chain optimization piece sounds like it's the bulk of the gap between where you are now and where you want to be. Am I thinking about that wrong? Maybe there's now more weight given to profitable growth through higher ROI brand investments and product mix. Can you give us any color on that?
Yeah. Certainly supply chain will be a major piece of it, actually you said it all. It's everything put together. It's execution in the marketplace. It's investing in our brands. It's investing in our people. Hopefully, it's additional good M&A as we go down the road. It's not just one thing that's going to be the keystone to this. It's all of it put together. Okay. Thank you.
Sure.
Our next question comes from Tim Ramey from Pivotal Research. Please go ahead.
Thanks so much. Just trying to think through your new presentation of sales, since we haven't seen it in exactly this way before. I'm assuming that there was maybe a market-like decline in volume in branded retail, given the significant increase in store-branded retail. These rate of change numbers year-over-year, is this going to be similar to what we should expect for the full year, or any commentary on how we ought to model this now?
Yes, Tim, I think when you look at the Q, I think we're breaking out sales the way we have historically between branded retail, non-branded retail, and food service. Within the branded retail line, again, we had strong performance across primarily the bread category driven by DKB and then also with the acquisition of Canyon from a brand perspective. The private label business is both pricing volume gains from new business and also Canyon. I'd say it would be pretty similar, provided things hold across the year from a quarter-to-quarter perspective.
Good. Steve, I think you mentioned in response to another question that perhaps pricing didn't offset all of the input cost inflation. You were up 20 basis points at the gross margin line. Should we think about that as being Project Centennial savings? Will there be a similar mix moving forward where pricing maybe isn't everything, but you're getting some cost saves on the overheads?
A big part of the quarter was reduced promotional activity. We talked about coming out of the fourth quarter, promotional activity had been down as well. There was some benefit there. A lot of the Project Centennial savings are down in SG&A currently. As Ryals talked about, as we focus on network optimization over the next 12 to 18 months, you should see more running through the gross margin line. We're always focused on efficiency. Efficiency, we're slightly down for the quarter. It wasn't a significant impact. We have been down year-over-year from an efficiency perspective. There is a focus to ramp back up efficiencies.
Okay. It looks like uses of cash were mainly about debt reduction in the quarter. Is there anything we should take away from that? I didn't see if you actually bought any shares back, but it didn't look like you did. If you did, it wasn't much.
Yeah. Generally, our capital allocation strategy is pretty consistent, and we'll continue to focus on investing in the business and also long-term shareholder returns and balance that.
Yep. Okay, thank you.
Thank you.
Our next question comes from Chase West from Consumer Edge Research. Please go ahead.
Hey, thanks for the question. Allen, congrats on retirement. I definitely enjoyed covering the story under your leadership.
Right. Thanks, Chase.
Yep. Most of my questions have been answered here, but I wanted to touch on an answer that you just gave previously on the net revenue management initiatives that you also called out in your prepared remarks and pruning the kind of promotional activity in Q4 and Q1. How should we expect that going forward?
It's hard to speculate on a go-forward basis. One thing we always watch when you take pricing actions or promotional actions is the volume impact. We were pleased in Q1 with the overall volume implications. We'll just continue to watch that as the year progresses and hopefully things continue to hold and there's no pricing or promotional impact. It's hard to speculate on that.
Okay, that's helpful. Thanks. Just changing gears to snack cakes, it looks like scanner sales still appear to be a little under pressure. Just wondering when we can start to see some progress on the initiatives you've talked about in the past with respect to maybe SKU optimization, and maybe when you think there could be an inflection in that segment.
Yeah, Chase, it's Ryals. On the cake side of the portfolio, it is steady progress, slow but steady progress. The environment kind of still remains challenging there. We're on the right track. Internally, we're seeing some things improve. I think sales were relatively flat for the quarter. We're focused on the profitability of that piece of the portfolio. Efficiency in the plants, new product introductions, which some have already come out and more to come there for sure. It's a slow ramp, but we're pleased with the progress that we're seeing so far.
Got it. Thanks for the questions. I'll pass it on.
That concludes the Q&A session. I will now turn the call over to Allen Shiver for closing comments.
Thank you very much. Thank you for joining the call today. We appreciate your interest in Flowers Foods. This concludes our call.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.