Business context and reporting period
Flowers Foods, Inc. operates fresh-bakery businesses through direct-store-delivery (DSD) and warehouse-delivery segments. This Form 10-Q covers the 12 and 40 weeks ended October 8, 2016, compared with the corresponding 2015 periods. The request metadata says “2015 Q3,” but the filing itself is for fiscal 2016 Q3.
DSD represented about 84% of year-to-date sales; Warehouse represented about 16%. The filing is unaudited.
Financial results and key metrics
| Metric | 12 weeks ended Oct. 8, 2016 | 12 weeks ended Oct. 10, 2015 | 40 weeks ended Oct. 8, 2016 | 40 weeks ended Oct. 10, 2015 |
|---|---|---|---|---|
| Sales | $918.8 million | $885.3 million | $3,058.2 million | $2,920.1 million |
| Operating income | $66.1 million | $69.8 million | $242.7 million | $246.3 million |
| Net income | $40.2 million | $43.8 million | $150.7 million | $156.9 million |
| Diluted EPS | $0.19 | $0.21 | $0.72 | $0.74 |
| Operating margin | 7.2% | 7.9% | 7.9% | 8.4% |
| Net margin | 4.4% | 4.9% | 4.9% | 5.4% |
- Sales rose 3.8% for the quarter and 4.7% year to date, primarily from the DKB and Alpine acquisitions. The company’s sales bridge attributed 4.4 percentage points of quarterly growth and 5.1 points of year-to-date growth to acquisitions before cycling their anniversaries. Quarter pricing/mix contributed 0.3 points, while volume reduced growth by 0.9 points; year-to-date pricing/mix reduced growth by 0.4 points and volume was flat.
- Quarterly DSD operating income fell 10.1% to $66.3 million; Warehouse operating income rose 8.1% to $12.3 million. Year to date, DSD operating income declined 5.0% to $238.4 million, while Warehouse increased 12.2% to $46.8 million.
- Operating margin pressure reflected higher selling, distribution and administrative expense, including workforce, marketing, legal and consulting costs. Production costs improved slightly as a share of sales year to date, with lower ingredient costs partly offset by wage increases and organic-product costs.
- Operating cash flow was $285.0 million for the 40 weeks, versus $280.5 million. Capital expenditures were $67.4 million, implying operating cash flow less capital expenditures of approximately $217.6 million. Investing cash outflow was $57.3 million, compared with $333.1 million, which included prior-year acquisitions.
- Cash was $7.5 million at October 8, 2016, versus $14.4 million at January 2, 2016. Total debt and capital lease obligations were $991.8 million, versus $1,004.7 million at year-end; long-term debt and leases were $980.2 million. Available capacity was $473.2 million under the revolving credit facility and $54.2 million under the receivables facility. The company reported compliance with debt covenants.
- Dividends paid were $0.465 per share year to date, compared with $0.4225. The company repurchased 6.9 million shares for $126.3 million during the period, including a $120 million accelerated repurchase.
Material changes versus prior comparable periods
- Net income declined 8.2% for the quarter and 4.0% year to date despite higher sales. Higher net interest expense and lower DSD profitability contributed to the decline.
- Interest expense rose to $9.4 million for the quarter from $6.0 million, and to $26.2 million year to date from $20.3 million. The current period included $1.9 million of debt issuance costs expensed upon repayment of term loans and higher average borrowings.
- On September 28, the company issued $400 million of 3.50% senior notes due 2026 and used proceeds to repay its 2013 and 2016 term loans and part of the receivables facility. It also extended the receivables facility to September 28, 2018.
- Year-to-date pension settlement losses were $6.5 million; the comparable prior-year period had none. A further settlement charge in Q4 was possible. The noncurrent post-retirement benefit liability increased to $127.9 million from $76.5 million at fiscal year-end, primarily because of a lower discount rate.
- Quarterly sales benefited from the completed national rollout of Dave’s Killer Bread across the DSD footprint, reaching more than 16,000 stores. Management said non-acquisition branded-product volumes remained under pressure from competition and reduced promotions.
Outlook, commentary, risks and unusual items
- Management estimated fiscal 2016 capital expenditures of approximately $90 million to $100 million. No earnings or sales guidance is provided in the supplied filing text.
- Project Centennial, an enterprise-wide operational review, was underway; management anticipated consulting costs in subsequent quarters. The Tuscaloosa bakery conversion to organic production was completed, with approximately $2.5 million of start-up costs incurred year to date.
- Management expected no further qualified pension contributions in Q4, but noted a possible additional pension settlement charge. It stated that current cash flow and available credit should support foreseeable financial requirements.
- Key risks include litigation over independent distributors’ worker classification and potential disruption to the DSD model; commodity-price volatility; competition, changing consumer preferences and store-brand substitution; customer concentration; and execution and impairment risks for acquired brands. Walmart/Sam’s Club accounted for 19.8% of quarterly sales and 19.7% year to date.
- The company was defending 24 distributor misclassification complaints, including 18 seeking class or collective treatment, and cooperating with a Department of Labor compliance review. It also disclosed securities class-action complaints. The company said it could not reasonably estimate potential losses on unresolved cases. A $1.25 million distributor-litigation settlement was recorded in the period; the agreement reached November 8 was subject to court approval.
- Commodity hedges had a net fair-value liability of $7.3 million. A hypothetical 10% commodity-price move would change the portfolio’s fair value by $5.5 million; management expected changes to be substantially offset by movements in underlying input costs.
Important facts for investors to verify
- Confirm the reporting period: the filing is for Q3 2016, notwithstanding the request metadata’s “2015 Q3.”
- Assess how much sales growth persists after DKB and Alpine acquisition sales are fully included in comparable periods, and whether underlying DSD volumes stabilize.
- Track DSD expense ratios, margins, and results of Project Centennial against the company’s expected operating efficiencies.
- Review debt, interest costs, facility availability and covenant headroom, particularly as variable-rate borrowings expose the company to rising rates.
- Monitor distributor-classification litigation, the DOL review, securities claims, settlement approvals and any resulting costs or changes to the DSD model.
- Evaluate pension obligations and any additional settlement charges, alongside share repurchases, dividends and planned capital spending.