Flowers Foods, Inc. — Form 10-Q Summary
Period: The filing covers the 12 weeks ended July 14, 2018, and year-to-date 28 weeks ended July 14, 2018, compared with the periods ended July 15, 2017. The request metadata says “2017 Q2,” but the filing itself is for fiscal 2018 Q2.
Business context
Flowers Foods produces packaged bakery foods through two segments: Direct-Store-Delivery (DSD), which represented about 84% of year-to-date sales, and Warehouse delivery, about 16%. Products include breads, buns, rolls, snack cakes and tortillas. Walmart/Sam’s Club accounted for 20.8% of quarterly sales and 20.3% year to date, creating significant customer concentration.
Key financial results
| Metric | 12 weeks ended July 14, 2018 | Comparable 2017 period | 28 weeks ended July 14, 2018 | Comparable 2017 period |
|---|---|---|---|---|
| Sales | $941.3 million | $926.6 million | $2,147.7 million | $2,114.3 million |
| Income from operations | $52.3 million | $68.7 million | $128.9 million | $166.9 million |
| Operating margin | 5.6% | 7.4% | 6.0% | 7.9% |
| Net income | $45.4 million | $44.7 million | $96.7 million | $105.2 million |
| Diluted EPS | $0.21 | $0.21 | $0.46 | $0.50 |
| Operating cash flow | Not separately presented for the 12-week period | $148.6 million | $173.0 million |
- Quarterly sales increased 1.6%; year-to-date sales also increased 1.6%. Growth in branded organic products, store-brand sales and selected foodservice and cake categories was partly offset by declines in other branded products.
- Quarterly net income rose 1.6%, principally because of lower income taxes and reduced Project Centennial consulting costs. Year-to-date net income fell 8.1%, reflecting weaker operating income and the prior-year divestiture gain, partly offset by lower taxes.
- Quarterly operating margin declined to 5.6% from 7.4%; year-to-date operating margin declined to 6.0% from 7.9%. Production costs were 51.9% of sales in both 2018 periods, versus 50.5% for the comparable quarter and 50.9% year to date.
- Effective tax rates were 8.7% for the quarter and 19.1% year to date, compared with 33.1% and 35.1%, respectively. The declines primarily reflect U.S. tax reform and related adjustments; the quarter also benefited from discrete tax credits and a $5.6 million tax benefit.
Cash, debt and liquidity
- Cash and cash equivalents were $29.6 million at July 14, 2018, up from $5.1 million at December 30, 2017.
- Year-to-date operating cash flow was $148.6 million, down from $173.0 million. The company made $40.0 million of voluntary pension contributions. Capital expenditures were $49.5 million, and dividends paid were $74.3 million.
- Total debt and capital lease obligations were $825.8 million, including $9.7 million of current maturities. Cash borrowings under the revolving credit facility and receivables securitization facility were zero at period-end.
- Available borrowing capacity was approximately $677.1 million: $491.6 million under the $500 million credit facility and $185.5 million under the receivables securitization facility. The company reported compliance with debt covenants.
- Current assets were $570.9 million and current liabilities were $411.3 million. The filing states management believes cash flow and available credit capacity can meet foreseeable requirements.
Material changes, outlook and risks
- Inferior yeast: Supplier shipments disrupted production and distribution for several days and affected product quality. The company recorded $3.9 million of identifiable costs, said further losses were possible but not estimable, and intends to seek recovery from the supplier.
- Project Centennial: The company is transitioning to a new organizational structure, with full implementation expected at the beginning of fiscal 2019 and the overall initiative expected to continue through fiscal 2021. It targets long-term sales growth of 2%–4% and EBITDA margins of 12%–14%; it also targeted cumulative gross cost savings of $70–$80 million by fiscal 2018 year-end, with about $32 million realized in fiscal 2017. These are targets, not reported results.
- Management expected ingredient costs to remain higher for the rest of fiscal 2018. It forecast fiscal 2018 capital expenditures of $95–$105 million and approximately $1 million of additional Project Centennial consulting costs. It did not anticipate further pension contributions in fiscal 2018.
- Pension settlement losses were $5.7 million year to date; management expected additional settlement charges in the third and fourth quarters, dependent on lump-sum payments and plan results.
- Year-to-date results included $9.7 million of distributor-litigation settlements, a $2.5 million impairment of a non-distributor note receivable, $2.3 million of multi-employer pension withdrawal costs, and $2.1 million of restructuring charges. The comparable 2017 period included a $28.9 million gain on divestiture.
- The company was defending 33 distributor misclassification complaints; some related settlements were reached or preliminarily approved, while potential losses for unresolved cases were not estimable. Securities and shareholder derivative litigation related to labor practices also remained unresolved, with potential loss not estimable.
- Other risks include commodity-cost volatility, supply-chain or product-quality disruptions, customer concentration, and legal challenges to the independent-distributor model. A 10% change in commodity prices would change the fair value of the hedge portfolio by an estimated $19.8 million; management expected underlying input-price effects to substantially offset that change.
- The filing reports an immaterial revision to prior-period cash-flow presentation to correct classification of certain territory and note-receivable transactions. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether yeast-related disruptions, additional losses, and any supplier recovery are resolved and fully reflected in subsequent results.
- Progress on sales growth, operating margins, ingredient-cost pressures, and Project Centennial savings against management’s targets.
- Cash conversion after pension contributions, capital spending, dividends, and other working-capital movements; also verify available borrowing capacity and covenant headroom.
- Developments, settlement costs, and potential exposure in distributor misclassification, securities, and derivative litigation.
- How much future earnings depend on tax-reform benefits and pension settlement accounting, and whether the unusually low quarterly tax rate is repeatable.