Flowers Foods snacks - Tastykake and Mrs. Freshley's
Executives of Flowers Foods say long-term success will depend on innovation.

THOMASVILLE, GA. — While near-term restructuring activities will focus on technology upgrades, stock-keeping unit (s.k.u.) rationalization and creating a more streamlined operating model, executives of Flowers Foods, Inc. say long-term success will depend on innovation that may take the baked foods company into the snack and specialty baked foods markets.

In a Feb. 14 call with investment analysts, Allen L. Shiver, president and chief executive officer, and R. Steve Kinsey, executive vice-president and chief financial officer, spoke at length about Project Centennial, a business and operational review conducted in collaboration with Accenture and first announced in August.

If successfully implemented, Project Centennial will transform Flowers Foods into a growing, national branded food company, Mr. Shiver said. Steps toward this objective began in the fourth quarter of 2016.

Mr. Shiver and Mr. Kinsey said cost cutting over the next several years will fuel this transformation.

Allen Shiver, Flowers Foods
Allen L. Shiver, president and c.e.o. of Flowers Foods

During the fourth quarter, Flowers “reduced costs through improved planning to trim overtime hours, spent less on supplies and travel, and increased bakery throughput,” Mr. Shiver said. “We are just getting started.”

Project Centennial-related costs in the fourth quarter were approximately $3.8 million, or 1c per share. In 2017, program costs are projected to balloon to $25 million to $30 million.

Offering a brief backgrounder on Project Centennial, Mr. Shiver said dissatisfaction with the company’s financial results over several quarters culminated in a decision to make changes that would “take Flowers Foods to the next level and do so quickly.” He said the six-month diagnostic phase of the project conducted in 2016 “revealed exciting opportunities for us to build on our key strengths.”

Every aspect of the business was scrutinized, and “nothing was off the table or out of scope,” he said.

“We asked questions, we listened carefully, and we didn’t shy away from difficult discussions or decisions,” he said. “This phase is now over and we have a clear understanding of what factors have slowed our growth and what we need to do to dramatically improve our performance.”

The process led Flowers to the conclusion its growth has been impeded by the persistently competitive market environment, evolving consumer preferences (weighing down the category) and operational complexity that has pressured margins.

“Through Project Centennial we have a road map to address each of these issues,” Mr. Shiver said. “Our Centennial growth plan is based on two key takeaways from our comprehensive diagnostics. First, we must pivot Flowers toward the consumer. This means shifting our focus from growth by geographic expansion to grow through brands. We have an incredible portfolio of strong, trusted brands that will form the core of our growth platform: Nature’s Own, Wonder, Dave’s Killer Bread and Tastykake. The consumer is now our primary focus. While we have always paid close attention to consumer trends, we often did not capitalize on them. That will change. We will be investing in greater product innovation and marketing to keep our brands fresh and relevant to consumers.

“Second, we must transition to a simpler operating model that is not only an improved margin structure, but also the resources to support profitable growth of our brands. So how will we unleash the potential of our brands and deliver value? Our plan follows four strategic initiatives: No. 1, reinvigorate our core business; No. 2, grow product adjacencies; No. 3, reduce cost to fuel our growth; and No. 4, invest in and develop leading capabilities.”

Fleshing out the four initiatives, Mr. Shiver said Flowers will reinvigorate its core business by supporting the company’s brands and its distributors. To boost its brands, he said the company will improve the selection of brands offered to better align with the company’s targeted consumer base and strengthen trade promotion capabilities. Pruning the company’s portfolio of s.k.u.s will be part of this effort.

“A more focused brand strategy will drive effective and relevant product innovation and realize a greater return on our investment in trade promotion and advertising dollars,” Mr. Shiver said. “Decades of bolt-on acquisitions have left us with a complicated portfolio of brands and s.k.u.s.”

While he did not discuss which brands would be affected by the s.k.u. rationalization, Mr. Shiver said the effort already has begun, helping Flowers focus on its strongest and most promising brands.

“As an added bonus, this action also increases runtimes and improves manufacturing efficiencies,” he said.

To better support Flowers’ independent distributors, Flowers will improve distributors’ ordering platforms, providing data and analytics and promoting a “free exchange of insights and best practices.”

With these efforts, Mr. Shiver said Flowers will be able to achieve its long-term goal of 2% to 4% compounded annual sales growth in the company’s current geographic footprint in three to five years.

The company’s second initiative, capitalizing on product adjacencies, is aimed at adapting to changes in consumer behavior, including where they eat and how they shop, Mr. Shiver said.

“As a result of changing consumer needs and wants there are growing bakery segments that Flowers can capitalize on such as food service, in-store bakery, impulse items and healthy snacking,” Mr. Shiver said. “Targeting food service just makes sense, especially since today’s consumer is eating out more. Our company already is the No. 1 provider of food service bakery products. We believe we can leverage our food service experience toward higher-margin products with a point of difference. Unique specialty items are just as popular with consumers in the grocery aisle, and we will translate our food service innovation to the retail sector.”

While Flowers has been aware for some time of the potential to participate in adjacent product categories such as healthy snacks, the company now has developed strategies to devote the resources necessary to allow these products to contribute to Flowers success, Mr. Shiver said.

Asked by an analyst for elaboration, Mr. Shiver wouldn’t offer details but said changing eating patterns point to opportunities in snacking.

“Today’s consumer continues to change their eating habits with snacking becoming really a round-the-clock activity,” he said. “I don’t want to really share any of our strategic plans, but we are interested in that particular segment of better-for-you snacking. And at the appropriate time we will be happy to share our plans.”

Considerable discussion during the call revolved around a target Flowers has established to improve its EBITDA net margin at least 250 basis points by fiscal 2021. Mr. Kinsey elaborated on areas of potential savings, beyond the $45 million expected annually by 2017.

R. Steve Kinsey, Flowers Foods
R. Steve Kinsey, executive vice-president and c.f.o. of Flowers Foods

“We need to enhance our capabilities and become a more centralized and analytics-focused company,” he said. “Doing so requires strategic investment or redirecting resources to upgrade our technology, enhance our financial planning and analysis capabilities, and redesign our performance management system for greater accountability and responsibility”.

In 2017 and 2018, Flowers will focus on optimizing its brands reducing costs and “creating a more streamlined operating model,” Mr. Kinsey said. He said top-line growth during this period will be flat to up 2%, and Flowers expects to generate EBITDA margins of 12% to 13%.

In 2019 and beyond, Flowers will begin investing to “reinvigorate the core and grow project adjacencies” that will boost sales, Mr. Kinsey said, generating sales growth of 3% to 4% and EBITDA margins of 13% to 14%.

“We believe that by achieving these financial goals we can become a company that is capable of delivering high single-digit e.p.s., cash to shareholders through dividends and opportunistic share repurchases, and solid total returns to the shareholder over the long term,” Mr. Kinsey said.

Many of the changes needed to reduce complexity and “strengthen capabilities” will be done in the first half of 2017. Benefits will become apparent in 2018. Neither Mr. Kinsey nor Mr. Shiver offered specific details or examples of what kind of cost-cutting moves would be made.

Costs associated with these efforts are anticipated to be weighted to the first half of 2017, while the majority of benefits are expected to be realized beginning in fiscal 2018.

Asked by a couple analysts about s.k.u. rationalization, Mr. Shiver emphasized the importance of a thoughtful approach to deciding which brands to preserve and how to go about rationalization.

“As we look at certain regions of the country, there are specific brands that have unique regional demand that we will be very careful in making any changes there,” he said. “So as far as our brand focus, it is the brands that we mentioned earlier, but also we will be evaluating very carefully strong regional brands before we make any quick decisions.”

In addition to taking care in determining which brands are eliminated, Flowers must work diligently to preserve shelf space during this process, Mr. Shiver said.

“It’s very easy to see what brands and what products are contributing to sales,” he said. “As we move forward, we will eliminate certain brands, but we will do that by replacing them with a brand that is going to turn more dollars and at a greater rate in hopefully the same space. Making sure that you maintain shelf space with the retail environment is very important.”

Ultimately, Flowers expects gross savings from Project Centennial to be considerably greater than 250 basis points (though the executives declined to offer a specific target). Gross savings above 250 basis points will allow Flowers to significantly step up its marketing and innovating spending, Mr. Shiver said.

“What I am excited about is the savings that we are going to be generating with Project Centennial will allow us to reinvest a significant portion of those savings back into building our brands at a much higher level than what we have done in the past,” he said.

Commenting on the $45 million in savings the company is on track to generate in 2017, Mr. Kinsey said Flowers historically has done well at direct spend (inputs into the company’s products) but less well on indirect spend (ranging from computers and office supplies to safety goggles, equipment and furniture).

“Through the project now we will take a more centralized philosophy on how we bid that spend out,” he said. Some of those savings may be reinvested in the company as early as 2018, while some will drop to the bottom line.

One analyst noted that the company even in the later years of Project Centennial is not projecting earnings growth greater than its existing long-term goal of 8% to 10% per year. Mr. Kinsey conceded that the company is taking a “cautious approach” in what it is promising. Similarly, Mr. Shiver described exceeding 250 basis points in EBITDA margin improvement as a “personal goal” he would like to see Flowers achieve.

Asked whether Flowers, with its well-regarded management team, is adaptable to major change, Mr. Shiver said the company’s track record of major pivots justifies confidence that Project Centennial will be a success.

“If you look at our company in the rearview mirror, we’ve been through a lot of change through the years, going back to the Keebler days, Mrs. Smith’s,” he said. “We can go on and on. I think one of the real strengths of the unique culture that we have in place is that our team is all about winning, and they understand in order to win you have to make adjustments at the appropriate time.”