BASIS OF ACCOUNTING — The accompanying unaudited Condensed Consolidated Financial Statements of Flowers Foods, Inc. (the “company”, “Flowers Foods”, “Flowers”, “us”, “we”, or “our”) have been prepared by the company’s management in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and applicable rules and regulations of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all the information and footnotes required by GAAP for audited financial statements. In the opinion of management, the unaudited Condensed Consolidated Financial Statements included herein contain all adjustments (consisting of only normal recurring adjustments) necessary to state fairly the company’s financial position, results of operations and cash flows. The results of operations for the twelve and forty weeks ended October 5, 2019 and October 6, 2018 are not necessarily indicative of the results to be expected for a full fiscal year. The Condensed Consolidated Balance Sheet at December 29, 2018 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Form 10-K.

ESTIMATES — The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The company believes the following critical accounting estimates affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: revenue recognition, derivative instruments, valuation of long-lived assets, goodwill and other intangible assets, self-insurance reserves, income tax expense and accruals, pension obligations, stock-based compensation, and commitments and contingencies. These estimates are summarized in the Form 10-K.

REPORTING PERIODS — The company operates on a 52-53 week fiscal year ending the Saturday nearest December 31. Fiscal 2019 consists of 52 weeks, with the company’s quarterly reporting periods as follows: first quarter ended April 20, 2019 (sixteen weeks), second quarter ended July 13, 2019 (twelve weeks), third quarter ended October 5, 2019 (twelve weeks) and fourth quarter ending December 28, 2019 (twelve weeks).

REPORTING SEGMENT — On May 3, 2017, the company announced an enhanced organizational structure designed to provide greater focus on the company’s long-term strategic objectives, emphasize brand growth and innovation in line with a national branded food company, drive enhanced accountability, and reduce costs. The new organizational structure establishes two business units (“BUs”), Fresh Packaged Bread and Snacking/Specialty, and realigns key leadership roles. The new structure also provides for centralized marketing, sales, supply chain, shared-services/administrative, and corporate strategy functions, each with clearly defined roles and responsibilities. The company has concluded that under the new organizational structure the company has one operating segment based on the nature of products the company sells, intertwined production and distribution model, the internal management structure and information that is regularly reviewed by the chief executive officer (“CEO”), who is the chief operating decision maker, for the purpose of assessing performance and allocating resources. Capital allocations, such as building a new bakery or other investments, impact both BUs, as the two BUs are so intertwined in the production of products, sales, marketing and other functions. Beginning with the first quarter of 2019, the comparative periods are presented on a consolidated basis due to the change to a single operating segment.

SIGNIFICANT CUSTOMER — Following is the effect that our largest customer, Walmart/Sam’s Club, had on the company’s sales for the twelve and forty weeks ended October 5, 2019 and October 6, 2018. Walmart/Sam’s Club is the only customer to account for greater than 10% of the company’s sales.

For the Twelve Weeks Ended

For the Forty Weeks Ended

October 5, 2019

October 6, 2018

October 5, 2019

October 6, 2018

(% of Sales)

Total

21.5

20.2

21.3

20.3

Walmart/Sam’s Club is our only customer with greater than 10% of outstanding trade receivables, representing 20.6% and 17.8%, on a consolidated basis, as of October 5, 2019 and December 29, 2018, respectively, of our trade receivables.

SIGNIFICANT ACCOUNTING POLICIES — Significant changes to our critical accounting policies from those disclosed in the Form 10-K are presented below. The policy changes for accounting for leases during the first quarter of our fiscal 2019 are a result of adopting new guidance issued by the Financial Accounting Standards Board (the “FASB”). See Note 2, Recent Accounting Pronouncements, of Notes to Condensed Consolidated Financial Statements of this Form 10-Q for details on the new guidance.

Leases. Primarily, the company leases real estate for distribution, manufacturing and office use, along with production and IT equipment. The company applies the new guidance to individual leases of assets, except for certain leases that employ the portfolio method. See below for the company’s policy around application of the portfolio method.

When the company receives substantially all the economic benefits from and directs the use of specified property, plant and equipment, transactions give rise to leases. See Note 4, Leases, of Notes to Condensed Consolidated Financial Statements of this Form 10-Q for further qualitative and quantitative information around the company’s lease portfolio. Our classes of assets include: land; buildings; machinery and equipment; furniture, fixtures and transportation equipment; and construction in progress.

The company has elected the practical expedient within the guidance to not separate lease and non-lease components within lease transactions for the following classes of assets: land; buildings; and furniture, fixtures and transportation equipment. The company has elected the short-term lease exception (lessee only) for all classes of assets and does not apply the recognition requirements for leases of 12 months or less. Lease payments for short-term leases are recognized as expense either straight-line over the lease term or as incurred depending on whether the lease payments are fixed or variable. These elections are applied consistently for all leases.

The company has elected to apply a portfolio approach for leases with similar terms and conditions, commencement dates, and executed at or near the same time as one another, as it is reasonably expected that application of the lease model to the portfolio would not differ materially from application to the individual leases.

The company allocates consideration (i.e., lease payments) to the lease and non-lease components within a transaction on a relative stand-alone price basis to lease and non-lease components within a transaction.

The company presents operating lease payments as cash outflows from operating activities and financing lease payments as cash outflows from financing activities in the Condensed Consolidated Statements of Cash Flows. The amortization of the right-of-use asset is presented in the same line item as the change in the operating lease liability in the other assets and accrued liabilities line item.

The company will use the applicable incremental borrowing rate at lease commencement to perform the lease classification tests on lease components and to measure the lease liabilities and right-of-use assets in situations when discount rates implicit in leases cannot be readily determined. We will also apply the “bright-line” thresholds within the guidance for lease classification for all classes of assets.

On July 9, 2019, the company issued a voluntary product recall for certain hamburger and hot dog buns and other bakery products due to the potential presence of small pieces of hard plastic that may have been introduced during production. The products recalled were distributed to retail customers under a variety of brand names in 18 states. The costs for the product recall were $0.8 million for the forty weeks ended October 5, 2019.

In June 2018, the company received from a supplier several shipments of inferior yeast, which reduced product quality and disrupted production and distribution of foodservice and retail bread and buns at several of the company’s bakeries during the second quarter of 2018. While the supplier confirmed that the inferior yeast used in the baking process was safe for consumption, customers and consumers reported instances of unsatisfactory product attributes, primarily involving smell and taste.

In addition, the company incurred costs associated with inferior whey during the third quarter of fiscal 2018. A voluntary recall was issued on July 18, 2018 due to the potential of tainted whey. Costs associated with these inferior ingredients were reclassified from material, supplies, labor and other production costs and selling, distribution and administrative expenses to the ‘(Recovery) loss on inferior ingredients’ line item in our Condensed Consolidated Statements of Income.

Beginning in the second quarter of fiscal 2018 and continuing through the first quarter of fiscal 2019, we have recognized identifiable and measurable costs associated with receiving inferior ingredients. We have received reimbursements for a portion of previously incurred costs. These reimbursements are presented as recoveries on the ‘(Recovery) loss on inferior ingredients’ line item in our Condensed Consolidated Statements of Income. We continue to seek recovery of all losses through appropriate means. The table below presents the (recovery) loss on inferior ingredients (amounts in thousands):

	For the Twelve Weeks Ended					For the Forty Weeks Ended
	October 5, 2019		October 6, 2018			October 5, 2019			October 6, 2018
Loss on inferior ingredients	$	—	$	2,265		$	1,409		$	6,149
Recovery on inferior ingredients		—		(4,156	)		(1,822	)		(4,156	)
(Recovery) loss on inferior ingredients	$	—	$	(1,891	)	$	(413	)	$	1,993