THOMASVILLE, GA. — A major shift from private label to branded retail sales and a 36% increase in adjusted net income were among highlights in third-quarter financial results of Flowers Foods, Inc.

Flowers net income in the third quarter ended Oct. 3 was $44,347,000, equal to 21¢ per share on the common stock, up 2.3% from $43,358,000, or 20¢ per share, in the third quarter of 2019. Net sales were $989,650,000, up 2.4%, from $966,561,000.

Beneath the relatively modest changes in net profits and sales were dramatic underlying shifts in each.

Earnings in the third quarter were dragged down by restructuring charges totaling $20,100,000, up from $3,277,000 a year earlier. Results in the quarter benefited from a gain totaling $7,153,000, related to a pension plan settlement and curtailment gain.

Included in the $20.1 million in charges were $13,493,000 associated with lease termination and lease impairment charges associated with a decision to vacate leased  distribution depots during the quarter, Flowers said in a Form 10-Q, filed Nov. 5 with the Securities and Exchange Commission. Flowers said the decision to leave the depots is meant to help the company optimize its distribution network and is expected to “reduce lease costs and generate overall efficiency savings.”

Also in the quarterly restructuring charges were about $6 million in employee termination benefits.

A. Ryals McMullian, president and chief executive officer, said the company will generate $20 million or more in cost savings this year because of the organizational restructuring together with portfolio and supply chain optimization efforts.

Adjusted net earnings were $62.4 million, up 36% from the same quarter in 2019.

Flowers achieved sales growth in the third quarter despite a 5.7% drop in volume. Branded retail sales surged 12% to $657.1 million during the quarter at the same time private label sales fell 10% to $136.6 million. Non-retail and other sales fell 15% to $196 million during the quarter.

“Though total volumes have been down in 2020, our profitability has improved markedly as we are now seeing the true power of our focusing on brands,” Mr. McMullian said Nov. 5 in a pre-recorded earnings call. “So, as we are working to capitalize on the opportunities before us, we also recognize that we are operating from a position of strength with our portfolio of top brands, like Nature’s Own, Dave’s Killer Bread (DKB), Canyon, and Wonder. We expect that focus to allow us to retain many of our new consumers even as the demand environment moderates.”

Flowers attributed the surge in branded sales to the COVID-19 pandemic, new product introductions, diminished promotional activity and fewer product returns. The drop in private label sales reflected a shift of customer buying to branded retail products, and the drop in non-retail sales was driven by the effects of the pandemic on foodservice business.

During the Nov. 5 call, Mr. McMullian expanded on the contributions of recently introduced products.

“DKB buns and extensions of our Nature’s Own Perfectly Crafted line are delivering excellent early returns,” he said. “We’ve made further progress in standing up our new innovation capabilities, and we are developing plans to deliver more distinctive and differentiated items that meet our consumers’ changing needs.”

As a result, he said the company is “becoming a more branded-focused company, which will ultimately boost our ability to drive shareholder value.”

Expanding on this shift, he said the company has divided its portfolio into four groups ranging from high-growth brands to items with only limited profitability.

“Segmenting our portfolio this way establishes clear roles for the brands and products within our portfolio, which is designed to drive more targeted decision-making around our brand investments to deliver the highest return,” Mr. McMullian said. “I do want to emphasize that while some of our private label and foodservice business underperforms from a margin standpoint, each plays an important supporting role in our portfolio.

“Our intention is to improve their performance, working collaboratively with our customers.  We believe that can be accomplished with price certainly in some cases, but that’s not the only way.  As strategic partners to our customers, we are working to find ways to improve profitability on our side of the table, too. That could include more efficient distribution, manufacturing, formulation, packaging, and other options.  While there will likely be cases where we are unable to find a mutually acceptable solution to achieving the levels of profitability we require, our intention at the outset is to continue serving our customers in a way that is beneficial to both parties.”

R. Steve Kinsey, chief financial officer and chief administrative officer, said gross margin during the third quarter, excluding depreciation and amortization, rose 2.4 percentage points because of the shift to higher-margin branded products.

“Partially offsetting that benefit was $1.9 million related to startup costs incurred with the conversion of our Lynchburg, Virginia facility to an organic bakery,” he said.

Mr. McMullian said the Lynchburg plant has been operating since early October and is “producing great quality DKB products for the market.”

“This additional production is intended help us improve our days of service, our quality in the critical Northeast markets and provide some needed relief to our other bakeries currently serving that market,” he said. “DKB is still growing at a rapid clip, with 2020 retail sales now expected to exceed $800 million.  Lynchburg is a powerful example of our strategy to reorient production to the highest-margin and highest-growth portfolio segments.”

Mr. McMullian also commented on efforts to improve results of the company’s cake business, particularly its Navy Yard baking plant in Philadelphia.

“Recall that as part of our organization restructuring, we named David Roach president of cake operations, with the sole objective of improving performance at the Navy Yard,” he said. “In this particular case, our primary goal is not to drive growth in the near term, but rather to improve operations. We have automated our production lines, upgraded the management team, and improved efficiencies. Our work is far from complete, but I am pleased to report that we are beginning to see the green shoots of improvement after a rather protracted period of underperformance.” 

In a conference call with investment analysts Nov. 6, Mr. McMullian was asked about the effects of COVID-19 on bread business associated with the school year. He characterized the pandemic’s effect on sales related to school as a mixed bag for the company.

“We missed the back-to-school bump that we normally get in the fall, with all the kids staying home or having gone and getting pulled back,” he said. “But then again, on the other side of the equation, you have elevated in-home eating if the children are home all day, which is really what we saw at the outset of this, right? I mean everybody is sitting right at home, kids at home, parents at home, so you get that increase in at-home eating.”

Asked whether the pandemic was impeding new product introductions, Mr. McMullian said the DKB buns and Nature’s Own line extensions have been well executed this year in the midst of the pandemic.

“And we’re not the only ones,” he said. “Our competitors have put new products forth. We’ve gained new shelf space during this period. …In some ways, the COVID circumstance has been a positive relative to new product introductions. Because what we have seen in the mix shift is somewhat of a shift away from traditional loaf to buns and rolls and to breakfast items. And so as we’ve introduced new items in those categories, from that standpoint, it’s actually been a positive rather than a neutral.”

Mr. McMullian described pricing to date in 2020 as fairly flat but added that promotional activity is “well beneath historical levels.”

With the financial results for the third quarter, Flowers updated its guidance for 2020. The company anticipates sales of $4.35 billion to $4.37 billion, up 5.5% to 6% from 2019 and up from previous guidance of $4.29 billion to $4.33 billion. Diluted earnings per share were forecast at 65¢ to 70¢ per share, down from 78¢ in 2019 and down from 66¢ to 76¢ as offered as guidance after the second quarter. Adjusted EPS guidance was raised to $1.23 to $1.28, up as much as 33% from 96¢ in 2019 and up from the company’s most recent projection of $1.15 to $1.25.

The outlook for business amid the pandemic carries a high degree of uncertainty, Mr. McMullian said, adding that Flower intends to “maximize our current performance while preparing for the time when demand normalizes.”

“If nothing else, we believe the current environment validates our portfolio strategy to drive margin improvement as we shift our focus to branded retail products.”

He said branded retail sales, while not as strong as at the peak of the pandemic, remain well above pre-pandemic levels.

“The real question is how long those trends will last and what the trajectory of the normalization process will be,” he said.

In the 40 weeks ended Oct. 3, Flowers net income was $96,494,000, equal to 45¢ per share, down from $162,592,000, or 77¢, during the first nine months of 2019. Sales were $3.36 billion, up 5% from $3.21 billion in the same period last year.