THOMASVILLE, GA. — While lower-income households appear to be shifting their buying to lower-priced baked foods, a long-term move toward premium products in the bread category is likely to continue, said A. Ryals McMullian, president and chief executive officer of Flowers Foods, Inc.

In prepared remarks released Aug. 11 in connection with second-quarter financial results, Mr. McMullian addressed bread market dynamics in an uncertain economic environment. He said economic turmoil has been reflected in changes in where consumers have been shopping with more food purchases being made at value‐oriented merchants such as mass, dollar and club stores.

“Lower-income consumers have tended to trade down to less expensive products more than those with higher income,” he said. “This behavior has been particularly stark in the premium category, where higher-income consumers have actually increased purchases of some products, including DKB (Dave’s Killer Bread). On the other hand, we have seen lower-income households reduce their number of purchases. We are closely monitoring these developments and maintaining our marketing investments to keep our brands top of mind and entice these consumers back when that economic pressure is relieved. In short, we believe the premiumization of the category remains a long‐term trend despite some shorter-term challenges.”

In the meantime, Mr. McMullian said Flowers has a broad product line leaving the company “well positioned to support consumers in this unique environment.”

 Mr. McMullian also commented on what he called a “pause” in the long-term decline in private label’s share of the bread market. He said it would be incorrect to simply attribute this change to a trade down by consumers in response to rising bread prices.

The improved private label performance has been driven by concentrated activity in the mass merchandise channel “where private label retail prices have not adjusted to reflect recent inflationary pressures,” he said.

“The resulting wide price gaps to branded products seem to be driving much of the stabilization in private label share,” he continued. “Areas of retail that reflect price gaps more in line with historical levels, such as in the grocery channel, show continued private label share losses.”

The company has raised or is raising private label prices in markets where the gap had widened excessively and where pricing had not kept pace with rising input costs, Mr. McMullian said.

Flowers net income in the second quarter ended July 16 was $53.68 million, or 25¢ per share on the common stock, down 4.8% from $56.36 million, or 26¢ per share, in the second quarter last year. Net sales were $1.13 billion, up 11% from $1.11 billion a year earlier. Adjusted net income in the quarter was down 5.2%.

Flowers lost 10 basis points of market share during the second quarter, with several factors contributing. A packaging shortage affecting DKB was a factor, though its effects were mitigated during the quarter, Mr. McMullian said. He also cited a stock-keeping unit rationalization program as a contributor, especially in cake, foodservice and private label, and he said price increases taken earlier than usual left the company in a “temporarily less competitive position.”

The market share loss was not across the board. Nature’s Own and Canyon Bakehouse gained share, and even DKB gained share despite “regional capacity constraints and packaging shortages,” Mr. McMullian said. He said the DKB problems have been resolved and that Flowers remains “supremely confident” in the brand’s growth potential. In particular, he said increased West Coast capacity will be a boost there and that the brands is performing well in the Northeast.

Tracked channel sales of Nature’s Own during the quarter rose 12%, DKB was up nearly 10% and Canyon Bakehouse sales jumped 22%.

“We’ve maintained many of the new consumers we gained during the height of the pandemic, and we are working to build upon that growth through continued elevated marketing and brand investments,” Mr. McMullian said. “Our 17.5% dollar share exceeded pre‐pandemic levels in the second quarter of 2019 by 80 basis points. Investments in innovation are delivering promising results from recent launches, including DKB Epic Everything breakfast bread, Nature’s Own Hawaiian loaf, Canyon Bakehouse Brioche rolls, and Nature’s Own Perfectly Crafted Sourdough.”

Flowers’ test with DKB snack bars continues to generate good results, leading the company to pursue expanded distribution and strengthening Flowers’ resolve to look further across categories.

“Our core business is solid and growing, but we also intend to diversify and leverage the power of our No. 1 brands to move into adjacent categories,” Mr. McMullian said.

Mr. McMullian commented on other developments during the quarter, including the impending closing of a plant in Phoenix and an investment in Base Culture, a baked foods startup focused on the gluten-free market.

With the Phoenix closing later this year, Mr. McMullian said Flowers will produce less private label and foodservice product in the area. Other area baking plants will “service the remaining branded retail needs,” he said, adding that the company is committed to maintaining ample capacity to service future growth.

He described Base Culture as a “fast growing, female founded and led baked foods company.” Its products are gluten-free and grain-free sliced bread and other baked foods.

“The products are both paleo and keto certified and are on trend with consumers seeking those attributes,” he said. “We expect our investment will allow Base Culture to grow distribution, scale marketing, and bolster its existing manufacturing capabilities to offer its products to more consumers than ever before. We have been considering venture type investments for some time as we seek to enhance our internal agile innovation efforts, and we believe this is a great first move into that space. This small investment may serve as a model for future investments in other leading‐edge companies.”

Breaking down the company’s financial results in the prepared remarks, R. Steve Kinsey, chief financial officer and chief accounting officer, said the 11% sales increase in the quarter reflected higher prices/improved mix of 14.4% and a volume drop of 3.4%. Gross margin as a percentage of sales dropped 240 basis points, to 48.1%. The tightening margins reflected higher ingredient and packaging costs.

Notwithstanding the relative strength of private label during the quarter, Mr. Kinsey said Flowers’ price increases have been successful.

“So far, the impact of our price increases on demand has been in line with our expectations with elasticities remaining below historical levels,” he said.

Looking ahead to the balance of the year, Flowers is projecting earnings per share of $1.25 to $1.30 for the year, up 5¢ on the low side from previous guidance.

“At the end of the second quarter, 97% of our key commodities were covered,” Mr. Kinsey said.  “As always, we will execute our hedging strategy to minimize volatility and provide adequate forewarning to allow for price adjustments. We remain optimistic that, combined with other internal actions, we should continue to be able to obtain the higher prices necessary to mitigate inflationary costs.”

During an Aug. 12 call with investment analysts, Mr. Kinsey said cost pressures on Flowers are expected to peak in the third quarter (currently under way) and then ease in the fourth. Mr. McMullian said Flowers was taking additional pricing during the third quarter.

Year-to-date net income was $139.27 million, or 65¢ per share, up 9% from $128.01 million, or 60¢, in the first half of 2021. Net sales were $2.57 billion, up 11% from the year before.