Flowers Foods, Inc.

Thank you and good morning, everyone. I hope you all had the opportunity to review our earnings release, listen to our prepared remarks, and view the slide presentation that were all posted earlier on our investor relations website. After today's Q&A session, we will also post an audio replay of this call. Please note that in this Q&A session, we may make forward-looking statements about the company's performance. Although we believe these statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to what you hear in these remarks, important factors relating to Flowers Foods business are fully detailed in our SEC filings. We also provide non-GAAP financial measures for which disclosure and reconciliations are provided in the earnings release at the end of the slide presentation on our website. Joining me today are Riles McMullen, Chairman and CEO, and Steve Kinsey, our CFO. Riles, I'll turn it over to you. Okay. Thanks, JT. Good morning, everybody, and welcome to the second quarter call.

Before we move to questions, I would like to address one thing right out of the gate. We are in the midst of a transition. The category is transitioning, and by extension, Flowers is transitioning. The continued challenging economic environment and shifting consumer trends have pressured our end markets and hampered our recent results. However, We are aggressively responding to that pressure, transitioning our portfolio to better align with current consumer demand. Now, this transition is going to take time to fully implement, and patience will be necessary. But we expect further benefits as we execute our portfolio strategy and continue to develop our deep pipeline of innovation. Our strategies are sound, and the early progress we've made in repositioning our portfolio gives me great confidence that we're on the right path to drive consistent long-term growth. I would like to thank the entire Flowers team for their tireless dedication in this process and our shareholders for their partnership and support. And so with that, Gigi, we'll take questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Our first question comes from the line of Steve Powers from Deutsche Bank.

Hey, great, and good morning, everybody. Riles, first for you, so on the branded side, you mentioned in the prepared remarks greater competitive intensity and also cited, you know, new lower-priced bread products as creating challenges in the current environment. Maybe just a little bit more detail there as to what you're seeing and what's incremental versus last quarter. And then also, versus us, and I think versus like sequential trends, you know, maybe the bigger change in trend came on the other side, you know, not unbranded. So, maybe also what you're seeing on that. And then if I could, I got to follow up for Steve. Okay, sure.

So, in terms of the competitive environment, you know, as we said, Steve, you know, the promotional environment is elevated, but relatively stable. You know, you've seen us promote a little bit more, particularly around, you know, our differentiated products continuing to drive trial awareness, household penetration, et cetera. And that's definitely paying some dividends, as you can see, with DKB's performance in the quarter. Yes, there have been some lower-priced entrants into the markets that is pressuring results somewhat. And I would say that's particularly affecting the traditional loaf area, which we're, as you know, particularly exposed to. We are addressing that. We have our own line of small loaves now, and we have more coming to address that value shopper. But I think, Steve, it's a continuation of the trend that we've seen in the sense that the market remains bifurcated. Certainly on the premium differentiated side of things, you see good performance. but you also see good performance on the value end, particularly in mass and club channels. So it's there, we're aware of it, and we're proactively addressing it. In terms of the other category, there was a lot of the private label businesses you know is bid business, so it's not unusual for it to come and go, and a lot of that on the private label side was driven by you know, lost business that eventually gets, you know, replaced by something else. But we're also seeing, you know, continued weakness in the away from home food service business as well. So that's what's driving that.

Okay. Okay. Very clear. Steve, if I could on the, I guess two questions for you. One is just on the updated tariff outlook. I wasn't clear from your remarks if, you know, previous, tariff costs have just been delayed because of volume dynamics, or if you've updated kind of structurally to a lower tariff cost run rate, number one. And then number two, I guess from a capital allocation standpoint, with this reduction in EPS guidance, the gap between your dividend commitments and your current EPS run rate is increasingly narrow. So just how you're thinking about that. I know the board just raised the dividend. You say you feel kind of good about overall, you know, kind of cash and capital positioning, but just how you're thinking about that and as you pay down debt, just the, you know, the relative constraint that the dividend may place on M&A aspirations. Thank you.

Thank you. Sure. With regard to the tariffs, actually, it's just structurally it's an update. You know, with things becoming, I guess, maybe more final, for lack of a better term. We just continue to follow the various countries and the changes from an overall rate. And so it's not really a delay. It's actually, we expect tariffs to pull back quite a bit based on what we're seeing currently. Overall, with regard to kind of the capital allocation structure, I mean, we've always taken, try to take a balanced approach And you're right, I mean, the board evaluates this, you know, quarter to quarter. And, you know, they'll take into consideration performance, you know, cash flow, liquidity. And, you know, this will be no different. You know, we'll continue to have those conversations and, you know, we'll continue to, you know, make decisions as things, you know, progress.

Okay. Remind me, is there a target payout ratio? I mean, I'm assuming you're running now quite higher than ideal? Is there a stated long-term target?

No, we currently do not have a stated targeted payout ratio. Okay. Yeah.

Okay. You can go. Sorry, Riles. I didn't mean to cut you off.

Just in terms of the payout ratio, One thing that we like to remind people is that if you look at that on a cash basis, it's quite different than it is on a GAAP basis just due to DNA being significantly above our capex. So just wanted to remind you of that as well.

Yes, understood. Thank you so much.

Sure. Thank you. One moment for our next question. Our next question comes from the line of Bill Chappelle from Truist Securities.

Thanks. Good morning.

Good morning, Bill.

So I guess back to the competitive question, you know, I guess 10 years ago, maybe not that long ago, it was supposed to be a duopoly between you and Bimbo. And, you know, the thought would be, hey, everybody play well in the sandbox on the pricing. But, you know, but instead all the players kind of competed for, you market share competed for capacity utilization and gave that up for profits. And so gross margin never really improved. And we had a kind of a six, seven year period where it's been pretty benign. Are we going back to the, you know, five, six, seven, eight years ago, where it's buy one, get one free and more competitive and figuring out more ways where it's kind of a race to the bottom on profitability? Or is it not that bad?

Yeah, I don't think it's that bad. I think that what you're seeing more than anything else, Bill, as I said at the opening, is a pretty significant transition in the category, primarily driven by significantly shifting consumer trends. And we can spread that over a lot of different things, right? We can spread it over health and wellness, mob movement, GLP-1s, whatever it is. ultra-processed foods, all that sort of stuff. It is really changing the dynamics in food and particularly in baked foods. For whatever reason, they tend to get called out quite a bit when the ultra-processed argument comes up. And I think we're seeing a lot of that now. We are committed to aggressively innovating to work our way through this transition. Most of, we can have a conversation about food service, but that's more macroeconomic driven. But on the retail side of things, what is being most affected is traditional loaf. Those less differentiated white and wheat breads are what are being affected the most. That is why we're innovating so aggressively to work our way through that. We've seen tremendous success. with things like Dave's Killer Bread, Canyon Bakehouse, across different sub-segments of the category too, not just breads, but sandwich buns and rolls, breakfast, et cetera. And we're winning in those areas. Keto is another example that I would give you. Our keto products were up, I think, 37% in the quarter. And that segment of the category continues to grow. We have a wonderful slate of innovation coming out in Q3 to further address the soft disease categories. That's really the solve for us, Bill, is just working our way through this de-emphasis by the consumer, if you will, on traditional loaf as it stands today and towards more innovative and differentiated products in addition to value offerings. Now, having said that, with regard to traditional loaf, we do have plans to address that even more directly. I'm not going to get into it today for competitive reasons, but we do have plans to address the relative weakness of large brands like Nature Sun.

Got it. Well, just to follow up, I mean, I don't doubt you have plans to improve profitability, but you obviously don't work in a vacuum. So how about your competitors? I mean, not just Bimbo, but Think about the dozens of smaller regional competitors who are usually the bad guy when it comes to promotions and driving to try to drive volume. Are you comfortable that everyone is working on the same goal or could it get worse from that standpoint in terms of competitor pressures?

Well, look, I mean, this has always been a competitive category. And our competitors are going to do what they're going to do. That's not within my control. What is within my control is what Flowers is going to do. And our strength is in our brands. Our strength is in our innovation. And that's what we're going to continue to focus on.

Okay. Thanks so much.

Thank you. One moment for our next question. Our next question comes from the line of Jim Solera from Stevens.

Good morning. Thanks for taking the question. I wanted to touch on something you'd mentioned in the premier remarks about, you know, wonder, obviously helping to contribute to share gain and cake and that that didn't see any cannibalization and tasty cake. Are you able to just give us some commentary around, is that just due to the geographies where wonder is rolling out? Or do you have retailers where, you know, in the regions that tasty cakes a little bit more formidable that you have tasty and wonder in the same set?

Yeah, maybe a little bit. I mean, Tasty, as you know, is particularly strong in that mid-Atlantic region, whereas Wonder, naturally, is more of a national brand. I'll admit I'm a little bit surprised that there hasn't been more cannibalization, but I'm quite pleased that there has not been. But Wonder, the launch of that line of products has vastly exceeded our expectations. And now even our forecast, you know, off of early results, it's running ahead of that. You know, retailers continue to be excited about it. The consumer has accepted it with enthusiasm. And we're going to continue to add to that. You know, we've got more innovation coming for one or two. So we've been extremely pleased with the results there.

Okay. And then shifting gears a little bit on, just talk on Simple Mills. As you talk about innovation, and I can appreciate, you know, there's kind of a broad range of stuff you guys can lean into. Should we expect to see Simple Mills as, you know, kind of an outsized contributor on the innovation side? Or are you really speaking to the legacy portfolio brands? And then as maybe a part two to that, I'm in the Midwest, and I saw Simple Mills pretty prominently at a club retailer the last time I was shopping there. That could have just been something that was there that I missed, but maybe any comments. Is that something you guys are seeing more engagement with club, or do you guys have a rotation in club? Any call there would be great.

Okay. On the innovation front, as I was responding to Bill's question, I was speaking more in terms of the core category, Jim. However, Um, simple mills will also continue to aggressively innovate. I think I mentioned on maybe the last call that they had kind of been on a every other year, um, innovation rotation. You know, we're working with them to speed that up and we have aggressive plans for them for next year. Um, in terms of the club rotation, I'm not quite sure I understood the question, but if you, if you were saying that you were in a, in a club retailer and, and didn't see what you're used to seeing, that's probably due to rotations.

Yeah, I think it's more that – I'm sorry, go ahead. No, no, go ahead, Jim. I had seen Simple Mills more prominently than I had traditionally seen it, and so I wasn't sure if you guys were on a rotation that hadn't been the case before.

Nothing's changed. They have rotations in club. I will just add they continue to grow their distribution points and had another nice quarter of that in Q2. So that business continues to perform very, very well, even though in the second quarter they were somewhat affected by that cyber attack at UNFI. And even with that, still performed in line with our already high expectations. We expect that to continue. They're doing great.

Great. I'll pass it on. Thanks, guys.

Thank you. One moment for our next question. Our next question comes from the line of Mitchell Pinheiro from Sturdivant and Company.

Yeah, hey, good morning. So, you know, when you talk about, like, the transition, you're in the midst of a transition, and it's going to take time. I mean, it's going to take, you know, how fast Do you see your innovation and some of your other plans that you have to address this? I mean, this is a long time to turn around an aircraft carrier. You know, NatureZone's a huge brand, and your other loaf products. I mean, it's the bulk of your business, so... The transition, I mean, this is going to be a five-year minimum time period to sort of get this turned around, or are there, I don't want to say quicker fixes, but are there more near-term things that you see that can speed up this transition?

Yeah, fair question. I'm not going to put a time on it today. But I did note that some patience is going to be required. It's not an overnight fix. This is a generational shift in our category, perhaps a once-in-a-lifetime shift that needs to be addressed. Mitch, I do think that the category, and I'm speaking mostly about traditional life, I do think that the category will stabilize eventually. Now, I don't know if that's next quarter or this time next year. It's hard to say, but I do think that it will stabilize. I think that we're seeing a lot of things, primarily the shift in consumer tastes and behaviors. I think part of this is kind of the final throes of the pandemic reversion that you all were asking us about every quarter. You know, when the worst of the pandemic was over, you know, when was that going to happen? I think that's part of it, too, you know, in addition to the health and wellness and GOP1 issue. So I do think it's going to find its footing. What's important for us is to make sure that, you know, as it begins to stabilize, that we're winning in that environment. You know, I'm not saying that traditional loaf is going to go away. There are still tens of millions of loaves of traditional loaf sold, you know, every day. but I do think it's going to be smaller perhaps than it has been in the past, and that needs to be replaced by something, hence the hyper-focus on innovation and bringing new, exciting products to consumers that have the attributes that they want. That's going to be important. But even in the traditional loaf area, I do think that there are opportunities for us to further separate ourselves. We do have the number one brand. We still have the number one SKU. There's a lot of things to like about being number one in a category, you know, even though it's declining. But, you know, we will continue to invest behind brands like Nature's Own to ensure that it performs as well as it can given the, you know, given the environment. But yeah, that is going to take some time and, you know, it's going to take some time for the, you know, the the innovative segments of the category to more than offset, you know, any declines in traditional loaf. But again, I do think that we have the ability to further mitigate, you know, any further losses, even in that soft traditional loaf category.

And then how are you looking at your gross margin as it relates to the lower volume and the sort of the negative fixed cost leverage. Do you have levers there you can pull to maintain your gross margin despite the volumes being under pressure?

Yeah, we do. We do. And, you know, we closed a baker earlier this year, Mitch. You know, we've closed several in the last few years. That's not the only lever we have to pull, but it's certainly one of them. You know, there are, you know, path to market efficiencies as well that we can extract. And, you know, we have we have plans in place to address all of that. The other thing I would note is that via our portfolio strategy, the food service business, we're a very scaled food service player. We have refilled that volume with much higher margin business, and thus the profitability of that away from home business is up significantly. I've mentioned that a few times, but I think it bears repeating. today in the context of what you just asked. So it's not just closing bakeries or lines or whatever. There's also optimization of the portfolio, if you will, to margin up to better business to help address that overhead leakage that you referenced.

I guess this last question, this is on M&A. Obviously, M&A is a quicker way to help transition to other markets. products, other adjacencies. And I guess, you know, having just acquired Simple Mills, I mean, is there an appetite for further M&A? I mean, right now with the way you're, you know, the 3.2 levered, or is this something that we'll see over time?

I would say, you know, as of today, Mitch, probably a little bit more over time. I mean, obviously, we're focused on debt pay down right now. But as always, we continue to monitor the market, I guess I would also offer up that there are other ways to do M&A other than cash. So it has been and will always be one of our big strategic priorities.

All right. Well, thank you for the answers. Thanks, Mitch.

Thank you. One moment for our next question. Our next question comes from the line of Scott Marks from Jefferies.

Hey, good morning, guys. Thanks for taking our questions. First thing I wanted to ask about is you just touched upon, you know, still putting investment dollars behind Nature's Own, you know, in some of the more mainstream low parts of the portfolio. But in the prepared remarks, you talked about more of the, let's say, promotional activity being in kind of the differentiated parts of the portfolio to drive trial and repeat purchase. So maybe as we think about the investments in the more mainstream traditional loaf part of the category, how should we be thinking about those investments? Will that be behind marketing, without the promotional, without the packaging redesign, just trying to understand how those investment dollars will be spent.

Yeah, it'll be a mix of promotional support, but that's always been the case. That's not new. Like we always say, we view promotions more as a tool to drive trial and awareness than than necessarily unit share. And I think if you look back at our market share performance, even through this tough transition period, our market share performance, particularly on a relative basis, has been impressive. And I think that will continue, and I think that's a testament to our overall strategies and our brand support and promotional strategies. But yeah, it'll be a mix of marketing, dollar support, and promotions. But that's, again, no big change there. We've been doing that.

Got it. And then as we think about these, you know, differentiated, better for you offerings that you're talking about, maybe some of the small loaf products that you mentioned, just what part of the portfolio is that in terms of just overall mix right now and relative to where you want that to be, you know, three, five, seven years out?

Yeah, in terms of small loaves, you know, it's pretty small right now, actually, but growing, you know, and I think, That could ebb and flow a little bit with the economy, Scott. But from a more demographic perspective, we see a lot more smaller households now. So from that standpoint, I think it will continue to be a pretty big part of our portfolio and the category. In fact, some retailers are even resetting shelves with small loaf segments within the shelf. So I think that's an indication of how important it is to the retailer as well.

And then just on maybe what you would consider, you know, the more differentiated part of your portfolio, you know, how should we think about current mix versus where you want to get that to?

Well, that's a focus for us. And so over time, you know, you'll see that continue to grow and be a bigger and bigger part of our portfolio, not only within the bread category, but within, you adjacent segments, you know, with our DKB bars and our snack bites and simple meals on top of that, you can, you know, it's pretty obvious you're seeing us really lean into that area. We like it because we think it's the right thing to do for the consumer, and we also like it because it's premium and the profits are quite robust. You know, that's also been a focus of our M&A efforts as well.

Got it. And then maybe if I could just squeeze one more in. You mentioned retailers resetting some shelves, focusing on smaller loaves. Maybe what other changes have you seen from retailers recently to address some of the pressures and competitive intensity that you've spoken to?

Yeah. I think other than the small loaves, you've obviously you've seen significant growth in organics. And with a 75 share, we've been the primary beneficiary of that. So we've seen substantial space gains, particularly in mass for DKB, which I think really highlights the bifurcation of the category. Because when you think about mass as a a value shopper's paradise, the fact that they're also focusing on premium tells you a lot about the category. But other than the small loaf piece, not a whole lot more has happened yet from a retailer standpoint. But I do think that that is coming at some point. I think we'll see some amount of shelf reallocation that reflects these consumer trends as we go forward.

Understood. We're passing on. Thanks so much.

Thank you. At this time, I would now like to turn the conference back over to Ryle McMullen for closing remarks.

Okay. Thank you, Gigi. I want to thank everybody for taking time today and joining us for questions. We appreciate your interest in our company, and as always, we look forward to talking with you again next quarter. Take care.

This concludes today's conference call. Thank you for participating. You may now disconnect.