PHILADELPHIA — In a flat market for baked foods, bountiful opportunities for growth at Flowers Foods, Inc. have been identified and are being pursued and captured, executives at the company said. Speaking to investment analysts March 20 in Philadelphia, the executives took a highly upbeat tone even in the wake of recent difficulties that have been faced by Flowers and the entire baking industry.

“When you compare us to other categories, we’ve really weathered the storm,” said Allen L. Shiver, president of Flowers. “This isn’t about doom and gloom. We’re excited about the opportunity to grow the company and grow our share in the category we call fresh bakery.”

As has been the case in recent years, the annual analyst meeting was held in a location where Flowers recently completed an expansion. The meeting this year was followed with a tour of a Tasty Baking plant located in Philadelphia’s Navy Yard. Flowers acquired Tasty Baking in May 2011.

Even as they offered an optimistic view of Flowers’ future, Mr. Shiver and the other executives did not sugarcoat the tough sales trends facing the baking industry. Mr. Shiver said the overall fresh bakery market, including bread, sweet goods and tortillas, has been flat to down slightly in recent years.

“In the South market we are seeing the same overall flat trends we are seeing in other markets,” Mr. Shiver said.

Offering an overview of the market based on SymphonyIRI data, Mr. Shiver estimated the overall category at retail at $20.5 billion, including $13.8 billion for bread, $4.3 billion for cake and $2.4 billion for tortillas/wraps.
“What’s really important with regard to category share is the absolute size of the fresh bakery category — about $27 billion when you add retail and food service together,” he said.

The breadth of the opportunity for growth was emphasized by Robert B. Hysell, president of the Flowers food service group. Like Mr. Shiver, Mr. Hysell was quick to note the market he covers was not enjoying good growth.

“The (food service) industry as a whole has been trending downward since 2007 and has basically flatlined since 2009,” he said.

While acknowledging some improvement in recent months, he attributed this uptick to better weather rather than a sustained turnaround.

“It’s clearly a challenging environment,” he said. “In this environment, growth in food service means greater, deeper and broader penetration into the top 100 restaurant chains and broadline food service distributors.”

Explaining the distributor opportunity, Mr. Hysell said the 10 largest food service distributors account for 44% of the overall food service business. He suggested Flowers has not maximized its presence in this category.

“These are very important customers,” he said. “Flowers has a major presence with the top three and has a working relationship with the others.”

In recent years, Flowers has developed new products offering the customers product differentiation in the market.

At the restaurant level, the top 100 national chains account for 57% of the industry volume, and Flowers has opportunity for much more business in the sector, he said.

As an example, he mentioned a successful partnering in 2011 with a longtime quick-service restaurant customer, expanding the relationship. As a result, Flowers’ business with the customer will double in 2012, to more than $50 million, he said.

Central to growth in this arena is new product innovation, an area Mr. Hysell said is one of strength for Flowers. New products for various chains include specialty buns, tortillas and challah bread introduced in recent months.

Also making an observation about food service opportunities was Bradley K. Alexander, president of Flowers Bakeries Group.

He said the company was able to gain a new large food service customer because of supply interruption issues with other bakers.

Mr. Alexander said the customer called during Flowers stormy winter conditions in 2010 “because one of our competitors couldn’t serve the restaurant because of weather.”

Flowers was able to serve them during the supply interruption. Another weather incident occurred two weeks later with the same chain in another state, and again Flowers was able to successfully step in.

“Today, we are their supplier,” Mr. Alexander said of an account he said gives Flowers $11 million in new business.

He said the episode was a reminder of the adage, “If you don’t take care of your customers, somebody else will.”

New products remain an important source of sales growth at Flowers, Mr. Alexander said. He and Mr. Shiver said the company’s Nature’s Own brand has been an excellent vehicle for tapping into consumer interest in health and wellness.

Still, the company’s most recent new product introductions were in other segments, including the recent introduction of Nature’s Own Butterbread.

“We are rolling out this spring unique items we are very excited about,” he said. “Nature’s Own Butter Buns and a unique, Butterbread Pull-A-Part dinner bread. Other exciting new products are planned for roll out later this year.”

Commenting on health and wellness, Mr. Shiver noted that between 2006 and 2011, 75% of 2,500 new product introductions in bread had a health claim.

“The majority of consumers are interested in products with whole wheat, whole grain or high fiber,” he said. “When you think of the Nature’s Own brand, we are positioned perfectly to capitalize on health and wellness trends.”

Great emphasis was placed by the company’s executives on the importance of geographic expansion, through acquisition and organic growth into new markets.

Updating the analysts on progress made in geographic expansion, George E. Deese, chairman and chief executive officer, said Flowers today serves customers in 61% of the United States.

“In 2004, we were serving 37% of the U.S. population, which at the time was about 110 million consumers,” he said. “We felt like we needed to be 50%, and we did achieve that, serving about 230 million six years later by 2011. Now we expect in the next five years 240 million or 75% by organic growth or acquisitions.”

Commenting on organic moves into new areas, Mr. Alexander said the company plans a launch into a new market in April.

While geographic expansion is important to the Flowers strategic plan, acquisitions will remain very important, Mr. Shiver said. Over the past three years, acquisitions accounted for the largest proportion of the company’s growth.

Looking forward, “the majority of our anticipated growth will be through acquisitions,” he said.

Noting that the company’s history of successful acquisitions dates back half a century, Mr. Shiver provided extensive data indicating the dramatic shrinkage in the number of baking companies over the past generation and showed the growing market share of the largest bakers. This trend has been working toward a climax in recent years.

“I am very, very confident our company will successfully participate in the final stage of consolidation in the baking industry,” Mr. Shiver said.

Presentations in the two-hour meeting also included discussions of progress toward cost controls, capital projects and how the company is dealing with volatile ingredient markets.

Michael A. Beaty, executive vice-president, supply chain, updated analysts on the considerable progress the company has made against two key performance indicators: efficiency and scrap.

In both instances, significant improvements over the last five years were demonstrated.

In productivity, the gains made by Flowers equate to the addition of adding two new bakeries, saving $120 million in capital resources Flowers is able to put into other areas, Mr. Beaty said.

He offered an extensive list of new plants built as well as smaller capital projects at existing plants.

“These additions allow for capacity rationalization and helps the company maximize efficiency,” Mr. Beaty said.
He also described smaller steps taken by the company in response to a challenge by Mr. Deese to find additional opportunities to enhance efficiency. He offered an example of a suggestion provided at one plant to reduce pre-light time by 30 minutes for three lines and 15 minutes for one line. The plant now pre-lights ovens 30 minutes before the product enters instead of 1 hour.

“This will save us 8.75 hours of natural gas per week,” Mr. Beaty said. “This should save us approximately $7,700 per year.”

Cost controls also were very much on the mind of Steven Kinsey, executive vice-president and chief financial officer.

Against a backdrop of growth in sales and EBITDA, the company has experienced gross margin pressure since 2006.

“Over the past five years, we have not been able to fully price to offset the dilutive impact higher input costs have on our margins,” Mr. Kinsey said.

Putting the issue into perspective, he showed that ingredients represent by far the largest part of cost of goods sold.

“I don’t think, I know the one thing that can really driver our margin is buying input costs right,” he said. “Ingredients are 50% of costs of goods sold. Commodity risk management is the key to our success.”

With that in mind, Flowers has evaluated and adjusted its approach to ingredient purchasing, Mr. Kinsey said.

“The last couple of years markets have been very volatile, and we found ourselves upside down on some purchases compared with near-term prices and flat pricing,” he said. “Sometimes that puts you at a competitive disadvantage. Knowing this, we have re-concentrated our efforts in the procurement process. Through an independent review we came to the conclusion that during periods of high volatility we would be better served to take a shorter view of the market.

“Philosophically we believe we should manage risk through hedging of forward contracts no different than we have in the past, but strategically we have now concluded that shortening our average 6-to 9-month horizon in periods of extreme volatility is really prudent. So going forward on average, when the market is very volatile, we will be looking at more of a 4- to 7-month time horizon and that will allow us to make better buying decisions. That said, we will maintain the flexibility to move opportunistically when we believe prices are attractive. This means we could be longer and also means we could be shorter during that period.”