Business context and reporting period
Flowers Foods, Inc. is a U.S. packaged bakery company operating direct-store-delivery (DSD) and warehouse-delivery segments. This filing is a Form 10-Q for the 12 and 40 weeks ended October 6, 2018, compared with periods ended October 7, 2017. The request metadata says “2017 Q3,” but the filing itself reports fiscal 2018 third-quarter results.
Financial results
Amounts below are in millions of dollars except per-share data; figures may not sum due to rounding.
| Metric | 12 weeks ended Oct. 6, 2018 | 12 weeks ended Oct. 7, 2017 | 40 weeks ended Oct. 6, 2018 | 40 weeks ended Oct. 7, 2017 |
|---|---|---|---|---|
| Sales | $923.4 | $932.8 | $3,071.2 | $3,047.1 |
| Operating income (loss) | $53.5 | $(52.1) | $182.3 | $114.9 |
| Net income (loss) | $39.6 | $(33.6) | $136.3 | $71.6 |
| Diluted EPS | $0.19 | $(0.16) | $0.64 | $0.34 |
| Operating margin | 5.8% | (5.6)% | 5.9% | 3.8% |
Third-quarter sales declined 1.0%, as volume weakness outweighed favorable price/mix. Year-to-date sales increased 0.8%. The effective tax rate was 22.5% for the quarter and 20.1% year to date, down from 40.6% and 32.1%, respectively, primarily reflecting the lower federal corporate tax rate following tax reform.
For the 40 weeks, operating cash flow was $232.1 million (prior year: $224.0 million); capital expenditures were $75.0 million (prior year: $51.2 million); and dividends paid were $112.2 million (prior year: $105.2 million). Cash at October 6, 2018 was $49.7 million, versus $5.1 million at fiscal year-end 2017.
Total debt and capital lease obligations were $825.4 million, including $11.3 million current and $814.1 million long term. The company reported $491.7 million available under its revolving credit facility and $194.2 million under its receivables facility, or $685.9 million combined, and said it was in compliance with debt covenants. Current assets were $569.6 million and current liabilities $401.4 million.
Material changes versus the comparable period
- Quarterly net income improved from a loss to profit, principally because prior-year restructuring and multi-employer pension withdrawal charges were substantially lower and the current-year tax rate was lower. These benefits were partly offset by weaker sales, higher product costs, and increased legal settlements.
- Year-to-date net income rose $64.7 million. Lower restructuring, pension-withdrawal, consulting, and employee-compensation costs and lower taxes were partly offset by the prior-year $28.9 million divestiture gain, higher production costs, legal settlements, and marketing spending.
- Year-to-date production costs increased to 52.1% of sales from 51.0%, with higher ingredient costs, softer production volumes, outside product purchases, and manufacturing inefficiencies contributing. Selling, distribution and administrative expense declined to 38.0% of sales from 38.6%.
- DSD year-to-date sales rose 0.5%; warehouse sales rose 2.5%. In the quarter, both segments recorded lower sales. DSD operating income improved year over year, while warehouse year-to-date operating income fell, including comparison against the prior-year divestiture gain.
- Operating cash flow increased modestly, but capital spending rose and the company made $40.7 million of voluntary pension contributions. The prior-year period included $41.2 million of divestiture proceeds and $101.3 million of debt reduction.
Outlook, commentary, risks and unusual items
- Management’s stated long-term goals under Project Centennial are sales growth of 2%–4% and EBITDA margins of 12%–14%. It targets cumulative gross savings of $70–$80 million by the end of fiscal 2018 from specified cost programs; approximately $32 million was realized in fiscal 2017. Management expects the reorganization to be fully implemented at the beginning of fiscal 2019 and Project Centennial to continue through fiscal 2021.
- Management expected ingredient costs to remain higher through the rest of fiscal 2018 and into fiscal 2019. Fiscal 2018 capital expenditures were forecast at $95–$105 million. Additional fourth-quarter Project Centennial consulting costs of $0.5–$1.0 million and relocation costs of $0.5–$1.0 million were anticipated.
- Inferior yeast and whey disrupted production and distribution; a voluntary recall was issued July 18, 2018 over potentially tainted whey. The company recorded $2.0 million net loss on inferior ingredients year to date after a $4.2 million supplier recovery, and said further losses were possible but not estimable.
- The board approved termination of Retirement Plan No. 1, effective December 31, 2018. The company estimated a $5–$35 million cash contribution to fully fund the plan and an approximately $125 million final non-cash settlement charge, subject to assumptions and market conditions. An additional pension settlement charge was expected in the fourth quarter.
- Distributor misclassification litigation remains a significant contingency. The company agreed in principle to a $9.0 million settlement covering 12 collective actions, pending final court approval; other unresolved cases’ possible losses could not be reasonably estimated. Securities and derivative shareholder lawsuits also remained unresolved, with potential losses not estimable.
- After quarter-end, Flowers announced a Vermont bakery closure, expecting $5–$6 million of costs, and a definitive agreement to acquire Canyon Bakehouse for approximately $205 million, including a contingent payment. The acquisition was subject to approval and customary closing conditions and was expected to be funded with cash and existing facilities.
- Key risks include commodity cost and supply variability, product quality and recalls, customer concentration (Walmart/Sam’s Club represented 20.3% of year-to-date sales), independent distributor classification litigation, execution of restructuring and acquisitions, and consumer demand and competitive pricing.
Important facts for investors to verify
- Whether sales volumes and margins recover as management addresses elevated ingredient costs, production inefficiencies, and distribution expenses.
- The timing, final funding requirement, and non-cash accounting charge for the pension plan termination.
- Final court approval and payment of the proposed distributor settlement, plus developments and potential costs in remaining distributor and securities litigation.
- Actual supplier recoveries and total costs related to inferior ingredients and the recall.
- Completion, funding, and performance of the Canyon Bakehouse acquisition, and the cost and financial impact of the announced bakery closure.
- Progress against Project Centennial savings, growth and margin goals, and the forecast capital expenditure range.
- The filing revised prior-year cash-flow line items for a non-material classification error; verify comparisons use the revised figures. Management reported disclosure controls effective and no material quarter-specific changes to internal control over financial reporting.