Good day, and thank you for standing by. Welcome to the Flowers Foods Fourth Quarter and Fiscal Year 2021 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand conference over to your speaker today, Mr. J.T. Rieck, Senior Vice President of Finance and Investor Relations. The floor is yours.

Thank you, and good morning. I hope everyone had the opportunity to review our earnings release and listen to our prepared remarks and view the slide presentation that were all posted yesterday evening on our Investor Relations website. After today's Q&A session, we will also post an audio replay of this call. Please note that in this Q&A session, we may make forward-looking statements about the company's performance. Although we believe these statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to what you hear in these remarks, important factors relating to Flowers Foods business are fully detailed in our SEC filings. We also provide non-GAAP financial measures for which disclosure and reconciliations are provided in the earnings release and at the end of the slide presentation on our website. Joining me today are Ryals McMullian, President and CEO; and Steve Kinsey, our CFO. Operator, we're ready to start the Q&A, please.

[Operator Instructions] Our first question comes from Ben Bienvenu of Stephens.

Jim Salera on for Ben. I wanted to ask a little bit about inflation moving into the new year. I guess, first of all, on the January 2022 price increase, how long do you think that will take to get fully implemented? And then maybe you can talk a little bit about the cadence expectations for inflation in the new year?

Sure. Thanks for the question. Well, the January price increases is in large measure. There's a few small pieces of it that's just due to contracts rotating over, but the lion's share of the pricing -- January price increases is already in for the year.

I think can you guys talk maybe a little bit about expectations kind of as the year progresses for inflation?

Sure. I mean when you look at the overall inflationary environment, obviously, we were building in Q4. So in 2022 -- I mean 2022, as we said, we expect it to ramp throughout the year and then obviously Q4 comps. While we still don't have inflation, we'll pull back slightly. So you should see a ramp and then Q2, Q3 would probably be the highest cost, and then it pulls back slightly in Q4.

Okay. And if I could sneak in one more question. In regards to freight, do you guys have a hedging position on freight cost? Or do you have any visibility into what freight costs might do into 2022?

Two things on freight, one, if you recall, our biggest transportation cost is around our DSD network. So we termed out a closed-loop network. We actually have 3 primary haulers who take product from the bakeries to the warehouses. So those contracts are usually on a couple of years in advance. But we are seeing elevated costs for those as well. And then from a kind of open market transaction on our warehouse business, we have to go to the market from time to time to provide delivery there, but we do not hedge any of that. So -- we try to buy it forward as much as we can. But the reality is, like most companies will be in the kind of the current market on the 3PL situation.

And next, we have Bill Chappel of Truist Securities.

This is Donald on for Bill. Just wanted to maybe ask a question on any color you could provide on your foodservice business versus 2019 levels. And also with regards to current inflation on the cost front, how much of that would you attribute towards labor? And do you believe there is a time where that could play so at some point?

Sure. The foodservice business, as you saw, did recover some in the fourth quarter, and we saw that sort of through the second half of the year last year. It's still below 2019 levels, but there has been some recovery there. As you know, we've been doing a lot of work on our foodservice business to improve the profitability of it as it does come back because obviously, we've been expecting at least some amount of reversion as we hopefully start to exit this pandemic situation. But it does still remain below 2019 levels. And conversely, our branded retail business continues to hold up really, really well, given the continued at-home eating trends, our investments in our premium brands, et cetera, have all helped that business to maintain its place as part of the mix. You want to address inflation?

When you look at -- I think your question was around labor inflation, I mean, we're really no different than other companies. I mean the labor market is really tight, as you know. So we're expecting kind of mid to -- low to mid-single-digit labor inflation throughout the year depending on which market you're in.

Up next, we have Rob Dickerson of Jefferies.

Great. Just a couple of questions. I guess, first one, I missed the probably first minute of the call, so sorry if you already spoke to this. Just in terms of the, I guess the gross margin EPS potential cadence for the year? I know in the prepared remarks, you're just kind of speaking to kind of first half, back half-ish with some moving pieces, obviously, in the back half. With kind of given what we saw in Q4, should the market kind of be expecting, let's say, similar year-over-year gross margin that kind of plays out in Q1 despite the higher pricing? And then just kind of in earnings, we kind of implied kind of flattish in Q1, just whatever you're willing to disclose, would be great.

Yes, sure, Rob. I mean, obviously, we don't give guidance on gross margin, specifically and definitely not by quarter. But I'd say, overall, we are expecting some pressure on the gross margin line. So it should be down on a year-over-year basis when we get to the full year. From a cadence perspective, obviously, our inflationary costs will build throughout the year. And then because of the experience in Q4, we'll see some of that pull back, if you will. And then Ryals talked briefly about pricing you may not have heard the comments. But we do have our January price increase pretty much in and then we anticipate in certain categories or certain distribution segments, more pricing coming. So that will build through the first half as well. And then depending on the inflationary - what really happens with the inflationary environment because while we do have hedges on, and we said we're about 70% covered for the year, obviously we still have some open coverage in the back half. So there could be potential that things don't moderate somewhat. We would need to look again at some pricing initiatives as well. But we expect kind of like we said in the release, the cadence thing will build. A lot of our savings initiatives start to come in Q3, and we do anticipate a build from that perspective and with regard to overall margin for the year.

Okay. Perfect. That was helpful. And then kind of simplistically, again, probably for you, Steve, and then I have one for Ryals. Just on the top line guide for the year, I'm assuming kind of what we're seeing is maybe all of that's driven by pricing, maybe volumes you've kind of implied or maybe down low single digit. I'm just kind of basing this off of kind of the level of pricing we saw in Q4, but then also kind of what we already see in the January data set on the track side. So just kind of any kind of perspective on kind of that rate of pricing as of now, excluding any additional pricing? It sounds like you're kind of talking high single-digit-ish. Is that fair?

When you look at the tracked channel data, I mean, we're still seeing some positive mix. So that's also helping drive. But obviously, in Q4, pricing is a big driver of that. So I would expect you would see that development throughout most of the year.

Rob, let me to add to that a little bit. We're pretty optimistic thus far on elasticities. If you look at the syndicated data, this is from IRI for period one, which is essentially January of this year, and this would have followed the significant price increase in January. We're up 15.3% in dollars. But we're also up 5.3% units with both of which are ahead of the category. So point is the early returns on the price increases holding and those -- and particularly for branded retail, those volumes holding up are pretty optimistic. So that gives us confidence going into the year. We'll have to continue to watch it and see what the consumer does, how much they're able to absorb, but early returns are looking promising.

Yes, I think your volumes were actually up year-over-year sequentially relative to December despite the price increase. So it's a good sign, so there's a lot to still play out. All right, cool. And then just, Ryals for you, bakeries of the future, right? You've been speaking about this for some time. It sounds like given your prepared remarks that you have a number of pilots that will be in the market across a lot of your bakeries by the end of this year. The savings you're speaking to kind of so far and then through '22 doesn't seem like it's really contingent on bakery of the future, but obviously, bakery of the future would provide I would think, some material savings in the out year. So is that something that kind of starts to kind of go in to your network this year and that's kind of more of a '23 and forward optimization upside potential piece? Just anything you have there?

Yes. No, exactly. I mean we do start -- we do expect to start to see benefits from Bakery of the Future this year. And as you saw in the prepared remarks, we'll have it rolled out to half of the bakeries this year on the back of the 3 or 4 pilots that we've done over the last several months. So we do expect the cadence of savings to begin this year, but we also expect, as you indicate that, that will ramp up in '23 and '24.

Next, we have Mitch Pinheiro of Sturdivant & Company.

Just a follow-up there on Bakery of the future. Number one, how disruptive is it to change over a bakery into -- from current to the bakery of the future mode? Is it -- like what are we talking? What's happening? Is it just you're moving some servers around and have more computer screens out there? Or are you shutting down lines and things like that? Can you talk about that a little bit?

Yes. Sure. So from an operational standpoint, it's not disruptive. So we're not having to shut things down. It's mostly -- this is mostly data-driven type stuff at this point. I mean, obviously, we're doing some automation work, robotics and that type of thing, which is a little bit of a different story. As you know, we did that in Navy Yard, but the pure initial for us to bakery of the future is mostly around data, better data, more real-time data, driving out inefficiencies, lowering scrap costs, et cetera. So from an operational standpoint, Mitch, it's not disruptive hardly at all. The way that it is somewhat disruptive is it does require us to change the mindset of the bakeries. And that does take a little bit of time. These folks are -- have operated a certain way for a very long time, and you bring in all this fancy digital equipment and try to sell them on the prospects for improvement that it can provide. And that takes a little bit of time to educate them on how it can benefit them, make their daily lives easier and improve the performance of the bakery. So it's really -- it's as much of a change management exercise as it is anything else. But so far, we've been very pleased with the receptivity of the bakeries.

And then a lot of that is -- so how does that dovetail with the new ERP program. I mean, I haven't been shopping for an ERP program personally, but I was sort of stunned to see $275 million of cost for -- over 5 years. Like where -- like where is that being spent? Is that just all software costs with a little bit of hardware? I mean what -- that's a big number? Or maybe is it not a big number?

Yes. I mean when you look at these projects and you can look kind of across kind of our peer set as well. I mean these are not cheap projects, if you will. As we said in the release, about 40%, 50% of the costs will be capitalized. And the rest will be the cost of primarily implementing and rolling out the project itself. But when you look at the ERP itself, a lot of that is technology-driven and will be kind of a foundation or an enabler for Bakery of the Future. The majority of the cost runs through ERP are not necessarily through kind of the digital work around Bakery of the Future. But to your point, it's not an insignificant cash flow item. And a large part of the ERP costs from a capital standpoint will come this year. So you'll begin to see that tail off some over the next 4 years or so.

Okay. And then -- when you go back and just look at some of the balance sheet numbers, like if you look at your fixed asset turns and things like that, it'd been kind of stuck. And I was sort of expecting as we sort of roll through Bakery of the Future, and as you like sort of adjust your capacity and things like that, are we going to see I mean, are we going to see better fixed asset turns going forward? I mean, I realize that baking is a regional business when it comes to manufacturing. You need to be near your markets. But are we going to see some leverage here where you can go several years without adding capacity because you're finding it through your efficiencies or is -- what your fixed asset turns? Is it going to be sort of set for a while? We're really not going to see much improvement there. Can you talk a little bit about that, please?

Well, a couple of things there, Mitch. One, obviously, our aim is to significantly improve the efficiency of the bakery. So that in and of itself will help us create some capacity. But also remember, we are doing some work via our customer strategy to over time, as we shift more of the mix to branded retail to convert some of that lower-margin business into our branded business. And you've seen examples of that in Tuscaloosa and Lynchburg with the organic conversions, and we'll continue to do that. But those customer strategies also open up opportunities for us to further optimize the network. You point out that, in a fresh business, we do need to be relatively close to the market, but we don't have to be as close as we used to be. With some of the [enzyme] technology that's out there now that we're already utilizing, that old 250-mile radius is not as relevant as it once was. So that opens up additional opportunities for us as well.

Moving on. As far as foodservice, what type of initiatives are you taking to improve profitability there? Can you give us some examples?

Yes, sure. I mean, look, price is the most obvious one. And we've said many times that we do have some accounts that are underperforming. So we continue to work on those. Some of those are under contracts, so they do take some time. But price is certainly one lever. Our own efficiencies are another. This is not all about the customer. It's incumbent upon us to be as efficient as possible. So those are 2 things. But also method of delivery, too. Because some of these accounts are still DSD, which is a pretty expensive route to market, as you know. And converting them to a more optimized distribution model can help as well. So those are just a few of the levers we're pulling.

Okay. And then a final question on M&A. Your balance sheet is in terrific shape. You have some great low-cost fixed debt now. You have ample room on your revolvers. You'll still generate plenty ample free cash flow next year based on my estimates. So I know that you're going to stay disciplined. You're going to find the right thing, but I mean, how close are we? Should we expect to see some M&A this coming year? And I know you can't predict timing, but are we -- I mean, is it still like -- what is really on the radar right now? Or is there things that are working that we shouldn't be surprised to see something in 2022?

Yes, Mitch. I mean, we've been saying for some time now, our appetite rather for M&A is certainly high. It's been a while since we've done one. We have a good pipeline of opportunities that we continue to look at. Just for one reason or another, we haven't pulled the trigger on one because of fit or price or a combination of the two. But we continue to be active in the space. And I don't -- I can't predict what's going to happen this year. And I wouldn't want to sort of prognosticate there, but just know that we're -- we continue to be active in that market.

[Operator Instructions] Our next question comes from Ryan Bell of Consumer Edge Research.

I just had a quick question about the ERP upgrade and sort of the efficiencies that would be provided by it. Is there sort of any savings number that you could talk to? We saw something on the cost side. Just to kind of understand exactly what you get out of that program.

Yes, Ryan. I think a couple of things on the ERP upgrade. One, SAP is our enterprise-wide ERP system. The reality is, one would say we're forced, but we had to make a move because SAP has been to their S/4HANA platform across the whole. So at some point, service for our ECC platform will drop off. So that's driving a portion of the move in the cost. Secondly, because we have to make that move and because of the digital initiatives, they were looking at things that will enable productivity needs or hopefully drive long-term efficiencies across the bakeries. So there will be efficiency gains that have come out of this initiative, but we're not disclosing those at this point.

Okay. And then just a broader question about the evolution of your portfolio as we're seeing a bit more normalization of the environment. Obviously, the branded part of your business has been doing really well. And just trying to understand, how do you think about the shift in the migration towards branded? How much of that can continue? And then in terms of the private label trends, why do you think that they're actually so soft despite some of the pricing that's coming through from the industry standpoint?

Sure. Yes. This is Ryals. So on the private label side, I mean, we're really seeing the continuation of a trend that's been going on for over 5 years now. And it certainly seemed to accelerate during the pandemic. But even as we kind of get towards the end of that, we're seeing similar trends. I mean, it was down rather significantly again in the fourth quarter. We're seeing it down in units. It's up a little bit in dollars so far this year. But in terms of units, it's down even as we start this year. And what we would point to through our research is you're seeing a premiumization trend in the category, where people are really gravitating towards more differentiated items. And obviously, we benefited significantly from that with the branded portfolio that we have today, particularly when you think about the Dave's Killer Bread and Canyon. And then on the Nature's Own side, particularly the Perfectly Crafted subline for Nature's Own have done extremely well. Canyon and Dave's were both up double digits in the fourth quarter. We're seeing that trend continue even after the -- those are already premium items. And after the price increase in January, we're seeing that trend continue. So it really demonstrates the consumers' preference for a premium quality differentiated item. And typically, with private label in our category, you don't see a lot of that. And so that's kind of -- that's the primary driver. And then as we think about the prospects for our brands going forward, with the innovation we're bringing to market, we mentioned the DKB snack bars that we're really excited about. And early returns on those have been fantastic, really shows you that these strong brands can play across categories, which obviously gives us opportunity outside of our core space, if you will.

Ryan, this is Steve. Just one quick follow-up on your benefit question around ERP plus. When we started this project, the discussion there was, and Ryals have said it many times as well, part of this initiative really is going to be an enabler to drive productivity that helps us hit the long-term targets we have out there. So we really expect, in those target ranges, to see the benefit from the digital and ERP initiative. And that, hopefully, will drive us somewhere to the upper end of our range. But that's the -- that's really how we're looking at it more internally.

And then just one last one for me in terms of what you're seeing from a pricing standpoint. I know you're talking about the premiumization trend across the category. Just -- is there a sense as to how much of the pricing is actually being driven by mix shift and stronger demand for products like Canyon's and Dave's versus sort of pricing on an individual product basis?

I mean, with the pricing we took, and I think Ryals talked about it briefly with the current IRI data for period one, we're seeing it really across the whole branded portfolio. Obviously, your premium products are going to drive more -- any increases. But so far, we've taken pricing across, I would say, the whole, not specifically one brand.

[Operator Instructions] And we have a follow-up from Robert Dickerson of Jefferies.

Great. Just a clarification question, Steve, on cash flow in Q4. It was a little light. I'm assuming there were probably some working cap headwinds on the inventory side. So maybe just explain if that's right. And then the only other question I have was just on the purchase of the lease portfolio. I've rarely seen that line item pop up. I'm not sure if that's part of the bakery of the future optimization plans. Maybe just those 2 quick questions.

Yes. I mean when you look at kind of the fourth quarter on the lease portfolio, there was an opportunity that came to us kind of mid-quarter with regard to that. It was a collection of several warehouses and it fits in with our warehouse optimization strategy. So it did give us the ability to take out some leases and now we have some flexibility to look at how we're going to utilize these warehouses or potentially combine some warehouses. So that does fit in with that long-term strategy. And then the remainder of the elevated CapEx in Q4 was primarily driven around some of the project work, if you will, the transformation [Indiscernible] you've alluded to in the kind of working capital.

And I'm seeing no further questions in the queue. I'll turn it back over to the speakers for closing comments.

Well, thank you for your interest in Flowers Foods. Appreciate your time today. Goodbye, everybody. Have a good weekend. Thank you.

This concludes today's conference call. Thank you all for participating. You may now disconnect. Have a pleasant day, and enjoy your weekend.