THOMASVILLE, GA. — Quarterly sales and earnings were higher at Flowers Foods, Inc. in the three months ended July 13, but the company cut the high side of its earnings guidance for the full year.

Net income of Thomasville-based Flowers Foods in the second quarter was $53,095,000, or 25c per share on the common stock, up 17% from $45,442,000, or 21c per share, in the second quarter last year. Sales were $975,759,000, up 3.6% from $941,283,000.

Flowers affirmed its sales guidance for the year in a range of $4,030 million to $4,109 million, but tightened its earnings-per-share guidance to 94c to 99c, versus guidance of 94c to $1.02 at the end of the first quarter.

The results and revised guidance disappointed investors. Shares of Flowers Foods fell 11% in early trading Aug. 8 on the New York Stock Exchange, dipping as low as $21.64 per share, down $2.60.

Excluding the contribution of Canyon Bakehouse, Flowers sales in the quarter were up 1.8%. Accounting for the organic sales growth were 1.9% price/mix and -0.1% volume.

Ingredient, labor and transportation costs are expected to add 150 basis points to costs as a percentage of sales, said R. Steve Kinsey, chief financial officer and chief administrative officer.

“To mitigate these costs, we are working on a broad set of cost savings productivity initiatives as well as continuing to evaluate pricing and promotional strategies market by market,” he said. “We expect Canyon Bakehouse to be accretive to EBITDA and neutral to slightly dilutive to full-year e.p.s.”

Atop Flowers’ list of cost concerns is labor, said A. Ryals McMullian, president and chief executive officer.

“Certainly, there’s some transportation cost in there, too, but let’s primarily talk about labor here,” Mr. McMullian said. “Not only is the cost of labor up, but with a tight labor market that, frankly, everyone’s experiencing, that manifests itself into higher turnover, which in turn manifests itself into lower efficiencies. You’re constantly turning over people at the bakeries. You tend to have higher staff costs at the company. So getting control of that and doing it both from a quantitative standpoint but also from a qualitative standpoint. That’s why I talked a lot about the workforce and how can we improve scheduling and working conditions.”

Branded retail sales rise

Branded retail sales during the quarter were $586 million, up 4.6%, while store brand retail sales jumped 11% to $162.9 million. Non-retail and other sales slipped 2.9%, to $226.9 million.

“Branded retail sales increased due to the Canyon acquisition, continued growth of Dave’s Killer Bread branded products, as well as the introduction of Sun-Maid breakfast bread late in the third quarter of fiscal 2018, and more favorable price/mix,” the company said. “Sales of branded cake decreased quarter over quarter mainly due to softer volume resulting from product rationalization and a competitive environment. Store branded retail sales increased primarily due to gluten-free store-branded items produced by Canyon, volume growth from additional distribution, other store branded bread and buns, and positive price/mix, partially offset by volume declines in store branded cake. Food service and vending volume declines drove the decrease in non-retail and other sales, partly because of lost business due to the yeast disruption in fiscal 2018.”

Canyon meeting expectations

Overall, the Canyon Bakehouse business is falling in line with management expectations so far, Mr. McMullian said.

“The frozen side of the business is actually exceeding our expectations,” he said. “The stay fresh piece is slightly behind our expectations. Most of that has to do with consumer awareness. A lot of gluten-free shoppers aren’t necessarily accustomed to shopping gluten-free bread in the bread aisle, and so it’s taking us a little bit longer than we expected to draw them in.”

Adjusted EBITDA rose 3.2% to $105.9 million. EBITDA margins of 10.8% were 10 basis points narrower than in the second quarter last year. Higher workforce-related costs, lower production volumes and decreased manufacturing efficiencies weighed on margins.

Searching for profitability

While pleased with the execution of Project Centennial and the savings the program has generated, Mr. McMullian expressed frustration that the efficiencies have not translated into anticipated heightened profitability.

“Many of you will remember originally the plan was to reinvest a portion of our Centennial savings back into the business and then let the remainder fall to the bottom line,” he said. “However, greater-than-anticipated cost increases have offset some of those remaining savings, and so we’ve not yet been able to fully realize our earnings potential. So in short, one could argue that we’re a little heavy on cost due to those investments. Now the easy course of action would be to cut costs in those areas, but that would amount to cutting capabilities, which, in turn, would come at the expense of future growth. We believe firmly this is a temporary imbalance and that it will right itself over time as we grow our top-performing brands and achieve greater efficiency.

“But in the meantime, we are working the current opportunities we’ve identified to drive down costs in other areas. Specifically, we’re focused on improving workforce productivity and manufacturing efficiencies, which has been impacted by a tight labor market and increased turnover. Now for this sort of situation, there’s no quick fix, but we know the steps that need to be taken to address the root causes and enable our team to reach their full potential.”

Challenges ahead in 2020?

Asked about Flowers Foods’ wheat hedge position, Mr. Kinsey said Flowers is well positioned for the balance of 2019 but could face challenges in 2020.

“We are well within our strategy of hedging four to seven months, and we typically are on the long end of that,” he said. “So for 2019, we pretty much have our cost structure in place. There are some protein concerns. Just like last year, you had a lower protein quality crop, which means, eventually, you’ll have to blend that with higher spring wheat.”

He said the new crop will be discussed further when the company issues 2020 guidance.

In the first half ended July 13, Flowers’ net income was $118,961,000, or 56c per share, up 23% from $96,689,000, or 46c per share. Sales were $2,239,654,000, up 4.2% from $2,147,736,000. The fiscal 2018 results included restructuring charges of $2,483 million and multi-year employer pension plan withdrawal costs of $2,322,000.