Flowers Foods, Inc. — FY2017 Form 10-K
Period clarification: The request identifies “2016 Q4,” but the supplied filing is the annual report for the 52-week fiscal year ended December 30, 2017, with comparisons to fiscal 2016 and 2015. Unless noted, amounts below are in U.S. dollars.
Business context and reporting period
Flowers Foods produces and markets breads, buns, rolls, tortillas, snack cakes, and frozen bakery products. Its DSD segment accounted for 84.6% of fiscal 2017 sales; the Warehouse segment accounted for 15.4%. The company operated 47 bakeries and described itself as the second-largest U.S. packaged bakery producer.
Key financial results
| Metric | FY2017 | FY2016 |
|---|---|---|
| Sales | $3,920.7 million | $3,926.9 million |
| Operating income | $162.9 million; 4.2% of sales | $263.9 million; 6.7% of sales |
| Net income | $150.1 million | $163.8 million |
| Diluted EPS | $0.71 | $0.78 |
| Operating cash flow | $297.4 million | $356.6 million |
| Capital expenditures | $75.2 million | $101.7 million |
| Cash dividends paid | $141.0 million | $131.1 million |
| Long-term debt and capital leases | $820.1 million | $946.7 million |
Cash and cash equivalents were $5.1 million at year-end, and total debt and capital lease obligations, including current maturities, were $832.2 million. The company reported $670.6 million available under its receivables facility and revolving credit facility, and said it was in compliance with debt covenants. Current liabilities were $394.0 million and current assets were $507.2 million.
Production costs were 51.2% of sales, down from 51.6%; selling, distribution and administrative expenses rose to 38.4% from 37.3%. The company reported no separate gross-margin measure. Interest expense, net, was $13.6 million. The effective tax rate was negative 0.6%, reflecting a $48.2 million provisional benefit from U.S. tax reform.
Material changes versus prior year
- Sales declined 0.2%. DSD sales grew 1.0%, while Warehouse sales fell 6.3%; the latter reflected the mix-business divestiture, lower warehouse-delivered organic bread and snack cake sales, and unfavorable pricing/mix.
- Branded retail sales grew 0.7%, supported by Dave’s Killer Bread organic products and new breakfast items, but declines in other branded products and weaker category demand offset growth. The mix-business sale and fresh-bakery softness also weighed on overall sales.
- Operating income fell 38.3% and net income fell 8.3%. Project Centennial restructuring and impairment charges, higher consulting costs, and pension withdrawal costs were significant factors.
- Operating cash flow declined by $59.2 million. The company reduced debt by $124.0 million, compared with $55.6 million in fiscal 2016.
Outlook, unusual items and risks
- Project Centennial: Management’s stated long-term goals are sales growth of 2%–4% and EBITDA margins of 12%–14%. For fiscal 2019 and beyond, it expects sales growth of 3%–4% and EBITDA margins of 13%–14%, subject to execution. Full implementation of the new operating structure is targeted for early fiscal 2019; the broader initiative is expected to continue through fiscal 2021.
- Fiscal 2017 included $104.1 million of restructuring and related impairment charges, $37.3 million of Project Centennial consulting costs, $18.3 million of multi-employer pension withdrawal costs, and a $28.9 million gain on divestiture. About 325 employees accepted the voluntary separation plan; the Winston-Salem snack cake plant was closed.
- Management anticipated fiscal 2018 capital expenditures of $95–$105 million, consulting costs of $8–$10 million, and additional reorganization costs of $4–$5 million. It also expected a significant increase in ingredient costs, primarily due to flour prices.
- Tax accounting for the 2017 tax-law change remained provisional; the company expected to complete its analysis in the second half of 2018. It anticipated a $2.1–$2.3 million tax shortfall related to vesting performance awards in the first quarter of fiscal 2018.
- Customer concentration is substantial: Walmart/Sam’s Club represented 20% of fiscal 2017 sales, and the top 10 customers represented 48.5%. The company cited competitive pressure, consumer preference shifts, commodity and fuel volatility, and execution risks under Project Centennial.
- Distributor classification litigation remains material to monitor. The company was defending 33 distributor misclassification complaints, including 22 seeking class or collective treatment, and could not estimate potential losses for unresolved cases. A separate securities class action was also pending with no estimable loss range. The Department of Labor had initiated a Fair Labor Standards Act compliance review; the company said it was cooperating.
- The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting. Management also reported disclosure controls and internal controls were effective as of year-end.
Most important facts for investors to verify
- Whether Project Centennial delivers the targeted savings and sales/margin improvements, and how much further implementation will cost.
- Whether organic-brand growth can offset softness in other bakery categories and Warehouse segment declines.
- The final effect of tax reform accounting and the sustainability of reported earnings excluding the one-time tax benefit and restructuring-related items.
- Actual exposure and cash payments from distributor litigation, pension withdrawal obligations, and pension funding needs.
- Whether flour and other input-cost increases can be offset through hedging, pricing, or productivity without harming volume or margins.
- Ongoing dependence on Walmart/Sam’s Club and the financial capacity to fund dividends, investment, and debt obligations.