Flowers Foods, Inc., producer of Nature's Own, Wonder, Tastykake, Dave's Killer Bread, and other bakery foods, reported financial results for the company's 12-week third quarter ended October 8, 2016.

Summary:
Compared to the prior year third quarter where applicable

• Sales increased 3.8% to $918.8 million. Acquisitions of Dave's Killer Bread ("DKB", until cycled September 12, 2016) and Alpine Valley Bread ("Alpine") contributed 4.4% to the overall sales increase. 
• Diluted EPS decreased 9.5% to $0.19. 
• Adjusted diluted EPS⁽¹⁾ decreased 8.7% to $0.21. 
• Net income decreased 8.2% to $40.2 million, adjusted net income⁽¹⁾ decreased 10.0% to $43.3 million. 
• Adjusted EBITDA⁽²⁾ decreased 3.0% to $101.7 million. 
• The company continues to expect for the year ending December 31, 2016:
  • Sales range of $3.930 billion to $3.986 billion. 
  • Diluted EPS range of $0.88 to $0.93. 
  • Adjusted diluted EPS⁽¹⁾ range of $0.90 to $0.95.
• Issued 10-year senior notes that allowed the company to extend debt maturities, reduce interest rate risk, and repay existing term loans. 
• Continued execution of Project Centennial, a comprehensive business and operational review. 
• Recorded a legal settlement charge of $1.25 million related to an agreement that was entered into subsequent to quarter end to settle a class-action misclassification lawsuit in Connecticut.

(1) See reconciliations of non-GAAP measures in the financial statements following this release.
(2) Earnings before Interest, Taxes, Depreciation and Amortization. See reconciliations of non-GAAP measures in the financial statements following this release. 

CEO's Remarks
"While we are pleased with the performance of Dave's Killer Bread, which continues to gain share as America's #1 organic bread brand, our results in the third quarter were affected by challenging category dynamics and elevated marketing and legal costs," Allen Shiver, Flowers Foods president and CEO, said. "We remain acutely focused on driving growth and increasing efficiencies, including our Project Centennial efforts. The initial diagnostic phase is complete, and we are now finalizing our plans to implement strategies intended to grow sales and improve margins. Today, Flowers is a strong company with a team dedicated to excellence. Looking ahead, we are confident we are taking the right steps to build on our strong foundation and enhance shareholder value over the long term."

Project Centennial Update
During the quarter, Flowers progressed towards the completion of the first phase of Project Centennial, which included a comprehensive diagnostic evaluation of opportunities to drive growth, reduce costs, and make investments intended to strengthen the company's competitive position and improve margins over the long term. 

In mid-October, Flowers began the second phase which entails formulating and executing new strategies to capture growth opportunities. To fund these initiatives, the company is currently finalizing the specific actions necessary to achieve savings through identified operational improvements that include further use of the company's shared services capabilities, network optimization, and better leveraging the company's expenditures on goods and services. The company anticipates finalizing the implementation plans in early 2017, and expects to provide additional details on Project Centennial when Flowers fiscal 2016 results are released in early February.

Consolidated Third Quarter 2016 Results Commentary
Consolidated sales for the quarter were $918.8 million, an increase of 3.8% compared to the prior year third quarter. Of the consolidated sales increase, acquisitions until cycled contributed 4.4%, pricing/mix increased 0.3%, and volume decreased 0.9%.

Diluted EPS in the third quarter 2016 was $0.19, a decrease of $0.02, or 9.5%, when compared to third quarter 2015 diluted EPS of $0.21. Excluding settlement costs associated with our pension de-risking strategy, a legal settlement charge discussed below, and additional interest expense resulting from the payoff of the term loans described below, adjusted diluted EPS was $0.21, a decrease of $0.02 per share, or 8.7%, when compared to third quarter 2015 adjusted diluted EPS of $0.23. In the third quarter of 2015, adjusted diluted EPS excluded acquisition-related costs and facility closure costs of $0.02 per share.

Subsequent to quarter end, on November 8, 2016, Flowers Foods' subsidiary, Lepage Bakeries, reached an agreement to settle a class-action lawsuit in Connecticut for $1.25 million, including attorneys' fees and certain non-economic terms which are intended to strengthen and enhance the independent contractor model. This agreement, which includes 49 territories, is subject to court approval.

During the third quarter, the company issued $400 million of senior notes due 2026 and bearing a fixed interest rate of 3.5%. Proceeds from the notes were used to repay debt outstanding under our existing term loan facilities and a portion of our accounts receivable securitization facility. In connection with the payoff of the term loan facilities, debt issuance costs of $1.9 million associated with the term loan facilities were recorded as interest expense in the current quarter. Net interest expense, excluding the additional interest expense resulting from the payoff of the term loams described above, increased when compared to the prior year third quarter due to higher borrowings resulting from investments in DKB and Alpine in fiscal 2015.

Net income in the third quarter 2016 was $40.2 million, a decrease of 8.2% when compared to the third quarter 2015. The decline in net income was driven primarily by higher workforce-related costs, marketing expenses, legal costs, depreciation and amortization, pension plan settlement cost, legal settlement charge, and net interest expense, partially offset by lower income taxes and the absence of facility closure costs and acquisition-related costs.

Excluding settlement costs associated with our pension de-risking strategy, the legal settlement charge, and additional interest expense resulting from the payoff of the term loans described above, adjusted net income was $43.3 million.

Consolidated adjusted EBITDA for the quarter was $101.7 million, a decrease of 3.0% when compared to the third quarter 2015. Adjusted EBITDA margin was 11.1%, a decrease of 70 basis points when compared to the prior year third quarter. As a percentage of sales, declines in input costs (ingredients, packaging, and utilities) and distributor distribution fees were offset primarily by increases in workforce-related costs, marketing expenses (primarily due to the rollout of DKB) and certain legal costs. As anticipated, purchases of co-manufactured product have begun to decline as a percentage of sales, due to the additional organic production capacity provided by our Tuscaloosa, Ala. bakery, which began producing organic bread at the beginning of the second quarter 2016.

Cash Flow
During the quarter, cash flow from operating activities was $91.2 million, capital expenditures were $25.7 million, and dividends paid were $33.2 million. Also during the quarter, the company issued $400 million of senior notes. With the net proceeds from the issuance, combined with cash generated from operations, the company made net payments on debt borrowings of $46.6 million.

DSD Segment Third Quarter Results Commentary
Direct-Store-Delivery (DSD) segment sales for the quarter were $768.9 million, an increase of 3.0% compared to the prior year third quarter. Of this increase, the DKB acquisition contributed 4.0% until cycled, volume decreased 2.1%, and pricing/mix increased 1.1%. Excluding the DKB acquisition until cycled, positive price/mix in the branded retail category was more than offset by volume declines in the category driven by the competitive marketplace. Branded soft variety and specialty loaf breads, as well as branded cake, experienced the largest declines, partially offset by growth in branded buns and rolls and store brand loaf breads. Non-retail and other sales decreased primarily due to volume declines.

DSD segment operating income for the quarter was $66.3 million, a decrease of 10.1% compared to the prior year third quarter. Operating margin for the DSD segment was 8.6% in the third quarter, as compared to 9.9% in the prior year quarter. Items negatively impacting DSD segment operating income and adjusted EBITDA are described below. Also negatively impacting DSD segment operating income was higher depreciation and amortization expense and the legal settlement charge. In the third quarter of 2015, DSD segment operating income was negatively impacted by facility closure costs of approximately $0.7 million.

DSD segment adjusted EBITDA, excluding the legal settlement discussed above, for the quarter was $95.4 million, a decrease of 5.0% compared to the prior year third quarter, adjusted for facility closure costs. Adjusted EBITDA margin for the DSD segment was 12.4% in the third quarter, as compared to 13.5% in the prior year quarter. As a percentage of sales, declines in input costs and distributor distribution fees were more than offset by higher workforce-related, legal, and marketing costs. Outside purchases of DKB products have decreased due to the additional capacity provided by the Tuscaloosa bakery conversion, as well as the Alpine bakery in the Warehouse segment.

Warehouse Segment Third Quarter Results Commentary
Warehouse segment sales for the quarter were $149.9 million, an increase of 7.8% compared to the prior year third quarter. Of this increase, pricing/mix decreased 1.3%, volume increased 2.8%, and the Alpine acquisition contributed 6.3%. Excluding the Alpine acquisition, volume growth of branded retail bakery/deli items, contract manufacturing, and foodservice (driven by new foodservice products for certain customers), more than offset volume declines of branded retail items and pricing/mix declines largely due to lower foodservice and contract manufacturing pricing/mix.

Warehouse segment operating income for the quarter was $12.3 million, an increase of 8.1% compared to the prior year third quarter. Operating margin for the Warehouse segment was 8.2% in the third quarter, the same as the prior year quarter. Higher depreciation and amortization expense negatively impacted Warehouse segment operating income. Lower input costs and increased sales positively impacted Warehouse segment operating income and EBITDA. 

Warehouse segment EBITDA for the quarter was $16.9 million, an increase of 13.1% compared to the prior year third quarter. EBITDA margin for the Warehouse segment was 11.3% in the third quarter, as compared to 10.7% in the prior year quarter. As a percentage of sales, increases in workforce-related and marketing costs were more than offset by lower input costs and increased sales volumes.

Dividends and Share Repurchases
Year-to-date, the company has repurchased approximately 6.9 million shares. Currently, there are 6.8 million shares remaining on the company's current share repurchase authorization. As in the past, the company expects to continue to make opportunistic share repurchases under this authorization.

Since the beginning of fiscal 2016, through both dividends and share repurchases, the company has returned $224.1 million to shareholders.