THOMASVILLE, GA. — Even as the company held its earnings guidance for 2022 unchanged and raised the low end of its sales guidance, Flowers Foods, Inc. encountered new hurdles in the third quarter ended Oct. 8. In addition to experiencing margin pressure due to higher costs, the company’s adoption of new digital technologies (and resultant savings) is progressing slower than planned. Additionally, Flowers incurred more than $10 million in costs from an acquisition the company pursued that failed to materialize.

The company also experienced wins in the third quarter, including exceptional performance by its Nature’s Own brand. The success of Dave’s Killer Bread snack bars has been sufficient for the company to plan to roll out the brand nationally.

Flowers net income in the third quarter was $40.53 million, equal to 19¢ per share on the common stock, up 4.3% from $38.85 million, or 18¢ per share, in the third quarter last year. Sales were $1.16 billion, up 13% from $1.03 billion in the same period in 2021.

Adjusted net income during the quarter was $64.6 million, down 0.4% from a year earlier. Adjusted EBITDA was up 1.6% with EBITDA margins of 10.4%, down 110 basis points from last year.

Flowers retail sales rose 9% during the third quarter, to $748.4 million. Store branded sales jumped 32%, to $163.9 million. The sales gains were attributed to price increases by Flowers. Overall, pricing and mix contributed 17.8% of growth in the third quarter, while volume was down 5.1% in the quarter.

“Flowers’ record results in a challenging environment underscore the resiliency of our business and the ongoing effectiveness of our strategy,” said A. Ryals McMullian, president and chief executive officer. “Our performance reflects strong results from our No. 1 brands, which continue to resonate with consumers despite the impact of inflation on purchasing decisions. And we are successfully mitigating this inflationary impact with initiatives to enhance sales and margins.”

In early morning trading Nov. 11 on the New York Stock Exchange, Flowers’ shares rose 3.5% to $29.45, up from the previous day’s close of $28.45.

For the full year, Flowers is forecasting sales at $4.807 billion to $4.850 billion, up 11% to 12% from 2021. Previous guidance was $4.764 billion to $4.850 billion. The company’s earnings per share forecast was left unchanged at $1.25 to $1.30 a share. In 2021, adjusted EPS were $1.24.

While the company’s other top brands performed well, too, Nature’s Own stood out across the entire bread category in the third quarter. 

“As measured by IRI, Nature’s Own grew sales dollars more than any other brand in the fresh packaged bread category and added 10 basis points of unit share in tracked channels, the most out of all major brands,” Mr. McMullian said in pre-recorded remarks Nov. 10.

“Our premium brands, Dave’s Killer Bread and Canyon Bakehouse, both maintained unit share in the fresh packaged bread category as measured in tracked channels, even with double-digit price increases meant to offset inflation. Such a performance, in an environment where the private label bread category gained share in tracked channels, highlights the strength of our product portfolio and the resilience of demand.”

Overall, sales during the quarter of Nature’s Own rose 13.2%, Dave’s Killer Bread was up 11.1%, and Canyon Bakehouse was up 18.5%. New products are performing well, including DKB Epic Everything breakfast bread, Nature’s Own Hawaiian loaf, Canyon Bakehouse Brioche rolls, and Nature’s Own Perfectly Crafted Sourdough, Mr. McMullian said.

Another brand highlighted by Mr. McMullian was Wonder. The company recently announced a three-year partnership with the Macy’s Thanksgiving Day parade.

“This is the first time Wonder is participating in the parade, and we are capitalizing on that event with a series of promotions on social media and in‐store display,” he said.

Emphasizing the need for Flowers to grow beyond its core business, Mr. McMullian said the company’s innovation group has been tasked with developing new products aligned with consumer trends that do not require heavy up-front capital investment. The Dave’s Killer Bread snack bars represent the first products “developed with this new capability,” he said.

“Their success in test markets has encouraged us to expand distribution nationally beginning in January 2023,” Mr. McMullian said. “We are also testing a line of high protein DKB snack bars in select markets and have a robust pipeline of additional new products planned. We could not be more excited about this new innovation capability and the prospect it holds for driving future growth.”

A direct-to-consumer website at creationsbyflowersfoods.com allows consumers to sample the products before the national rollout, he said.

Turning to challenges facing the company, R. Steve Kinsey, chief financial officer, said gross margin as a percentage of sales, excluding depreciation and amortization, fell from a year ago by 310 basis points to 46.8%. 

Turning to challenges facing the company. R. Steve Kinsey, chief financial officer, said during a Nov. 11 conference call with analysts that gross margin as a percentage of sales, excluding depreciation and amortization, fell from a year ago by 310 basis points to 46.8%.

“Comparisons were impacted by higher ingredient and packaging costs, partly offset by higher sales that leveraged labor expenses, and lower production volumes and outside purchases of product,” he said.

On a more positive note, Mr. McMullian said supply chain pressures, which adversely affected results in the first half of the year, were less impactful in the most recent quarter.

Flowers lowered its forecast for cost savings to be realized in 2022 from operational efficiencies and procurement, with the savings expected to be $20 million to $30 million, down $5 million on both ends of the range. Investments Flowers is making “in digital” will generate meaningful savings over time, enhancing margins, Mr. McMullian said. As the company progresses in its enterprise resource planning (ERP) implementation, the company has needed to invest greater resources to be sure the project is successful.

“At the same time, adoption of these new digital technologies at some of our bakeries was a bit slower than expected and continued operational inefficiencies somewhat hampered our efforts,” Mr. McMullian said. “So, while we remain excited about the long‐term potential of digital, some of the cost savings benefits we expected in the second half of 2022 will be pushed into 2023 as we focus our resources on ERP implementation and improved operational performance. Meanwhile, our ERP program remains on track, and we are confident in our ability to implement it as planned.”

Exploring potential acquisitions is a strategic priority of Flowers, and in the third quarter the company incurred $11.6 million in costs from the pursuit of a potential acquisition that failed to materialize.

“Although we are disappointed in the result, we remain committed to our disciplined approach as we consider additional acquisition targets,” Mr. McMullian said.

Offering macro insights about the environment for baking, Mr. McMullian said inflation is pressuring the foodservice category. He predicted the trend of consumers eating more meals at home would continue because of the lower relative cost. 

“We expect to benefit from these trends as we focus our efforts on growing branded retail sales,” he said. 

Commenting on the strength of private label bread sales, Mr. McMullian said store branded bread gained 100 basis points of unit share in the third quarter but once again said strength was concentrated in the mass merchandise channel where private label retail prices have not yet been adjusted upward to reflect higher costs.

“Overall, demand elasticity has been in line with our expectations, remaining below historical levels.”

In a Nov. 11 earnings call with industry analysts, Mr. McMullian added, “But digging down a little deeper into that, what you see, as we mentioned last quarter, is that this is very concentrated in the mass channel. In the mass channel, some of the retail prices on private label have been held down a little bit lower.

“If you flip and look at grocery, the story looks quite a bit different. In fact, we gained 10 basis points of share in grocery in Q3, and then later in the quarter that actually accelerated, and we gained 60 basis points of unit share in grocery.”

Covering inflationary costs while holding onto market share has been a tricky balance, he said. While the competitive environment has remained somewhat rational, Dave’s Killer Bread lost some unit share in the quarter.

“We are doing some promotions,” Mr. McMullian said during the earnings call. “As you might expect, DKB being a super-premium item, we’ve had a little bit of unit share loss in DKB.”

To counteract the share loss, Flowers has targeted promotions to keep the brand “front and center,” so consumers will return to the brand once inflationary pressures abate.  

“For some folks, obviously, (a super-premium loaf of bread) is going to be out of reach in the short term. And that’s why it’s also important that we keep up our media and advertising, digital, social campaigns to make sure we keep these brands, front and center, in front of those consumers,” he said. “So that when relief does come, and thankfully, at least we got a better inflation report yesterday, hopefully, that trend continues. 

“We’re very attuned to the number of households that we’ve gained since 2019. We certainly want to hold on to those households.”

An area bringing in results below expectations in the quarter was the West Coast, particularly California, Mr. McMullian said.  

“We’ve done kind of some background research to figure out exactly what's going on out there,” he said. “And really, you’ve got a state that already has very, very high cost. Fuel has been a better story for most of the country lately, but it’s still very high in California. Rent escalations, everything else. I think the consumer in California is just a bit more pressured perhaps than what we see in other parts of the country. And so, as we’re looking at our share, we see a little bit more weakness out there on the West Coast right now.”

Looking toward 2023, Mr. McMullian said he expects inflationary pressures to persist. 

“We continue to expect inflation to be strong,” he said. “And labor, transportation, all of those continue to show significant inflation and really no signs of any of that reverting at this point. So, without getting into specifics yet for 2023, I would say you could continue to expect some of the same pressures you're seeing this year with regard to those margins.”

In the 40 weeks ended Oct. 8, Flowers net income was $179.8 million, or 84¢ per share, up 7.7% from $166.87 million, or 78¢, a year earlier. Sales were $3.72 billion, up 11% from $3.35 billion.