Earnings Call Transcript - FLO Q3 2025

Operator, Operator

Good morning, and thank you for standing by. Welcome to the Flowers Foods Third Quarter 2025 Results Conference Call. Please be advised that today's event is being recorded. I would now like to hand the conference over to your opening speaker today, J.T. Rieck, Executive Vice President of Finance and Investor Relations. Please go ahead.

J. Rieck, Executive Vice President of Finance and Investor Relations

Hello, and good morning. I hope everyone 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 and at the end of the slide presentation on our website. Joining me today are Ryals McMullian, Chairman and CEO; and Steve Kinsey, our CFO. Ryals, I'll turn it over to you.

A. McMullian, Chairman and CEO

Okay. Thanks, J.T. Good morning, everybody. Welcome to our third quarter call. Our proactive efforts to strategically align our portfolio with consumer demand are yielding positive results. By effectively targeting areas of opportunity with differentiated offerings, we're finding pockets of growth amid ongoing pressures in the bread category. To address these challenges, we're redefining traditional loaf, incorporating value and better-for-you attributes that align with evolving consumer preferences. While it will take time, we're confident our strong portfolio of brands will successfully enable this transformation. I'd like to take this opportunity to thank our dedicated Flowers team for their hard work and resilience during this period of change. We are also grateful for the ongoing support of our shareholders as we strive to enhance long-term performance. And finally, I'd like to acknowledge that this will be Steve Kinsey's final earnings call after 18 years as our CFO. His contributions to Flowers have been invaluable, and we're deeply appreciative of his leadership throughout the years. We wish him all the best in his future endeavors. And with that, Daniel, we're ready for questions.

Operator, Operator

Our first question comes from Scott Marks with Jefferies.

Scott Marks, Analyst

First thing I wanted to ask about, you made some comments in the prepared remarks about consumer sentiment reaching a low point for the year in Q3, but you also made comments about expecting category demand to normalize as the economy strengthens. So maybe if you can just help us understand how you're thinking about that and maybe what gives you confidence in the recovery of the category and the normalization of demand?

A. McMullian, Chairman and CEO

Sure. Thanks, Scott. Of course, it's tough to pinpoint the exact timeline, right? But we do think over time, the category will stabilize. This is a very large category. It's a staple in many households in the United States. I think we've just got to get some of this noise out of the way. People are still very concerned about the tariff situation. The job market now with the government shutdown and the disruption that has brought, I think it's going to take a little bit of time to work our way through that. So we do see the weakness continuing at least partway into '26 from where we stand right now, but we do think over time, it will stabilize. I think in the meantime, it's important for us to continue focusing on the consumer, continuing to invest in the consumer, bringing those both value and better-for-you offerings to the consumer, which is clearly where they're going, and that's what we intend to do.

Scott Marks, Analyst

Appreciate that and then the second question for me would be, you talked about some of your newer investments pressuring margins a little bit, just investing to kind of generate consumer trial and ramp volumes. Maybe how should we be thinking about offsets to that within whether it's the supply chain efficiencies or any other offsets that you can call out for us?

A. McMullian, Chairman and CEO

Yes. You're spot on there, Scott. I mean we're focused on the long term. And so that means continuing to invest in the consumer. And we will continue to do that. I think you've seen us do that with all the innovation that we brought to market over the last several years. But the truth of the matter is, I mean, all innovation tends to pressure margins in the short term. They're newer items. But as we build scale and as we make targeted CapEx investments to increase our throughput and efficiency, we expect those margins to improve.

Operator, Operator

Our next question comes from Steve Powers with Deutsche Bank.

Stephen Robert Powers, Analyst

Congrats again, Steve, and thanks for your help over the years. My first question is a follow-up on Scott's initial inquiry regarding the consumer and your planning outlook for '26. You mentioned some signs of stabilization in the category during the third quarter, but also noted some weakening as the quarter concluded. So, as we look toward the fourth quarter and consider scenarios for '26, do you anticipate more of the same, or are you preparing for the possibility that conditions may decline before they improve?

A. McMullian, Chairman and CEO

More towards the status quo with some opportunity for improvement. I mean you're spot on that in Q3, periods 8 and 9, we saw the category begin to stabilize. But comparing that to 5 named storms last year and 0 this year was a pretty tough compare in period 10. So you could see the category did fall off in period 10. But since then, it started to migrate back to where it was trending in periods 8 and 9.

Stephen Robert Powers, Analyst

Yes. Okay. Perfect. Yes. So more just the comparisons versus the storms of last year. Makes sense.

A. McMullian, Chairman and CEO

Yes, that's right.

Stephen Robert Powers, Analyst

Okay. And then the other question I wanted to ask is it was just around Simple Mills. It was a point of upside, at least versus our estimates in the quarter. And in the prepared remarks, talked about general strength and performance in line with your own expectations. Maybe just go a little bit deeper and highlight some of the areas where you've seen the most progress since acquisition and where as you integrate and build further, you see the most opportunity?

A. McMullian, Chairman and CEO

Yes. The first thing I would call out is just the collaboration effort between our teams. The integration is going exceedingly well. We're finding areas of opportunity in customer engagement, in procurement, among other areas, and across their categories, they still continue to perform very well, and as we noted in the prepared remarks, in line with our expectations. We're very excited about next year for Simple Mills. Of course, we're not giving guidance today, but they do have quite a bit of new innovation coming for next year that we're all pretty fired up about, and so we're overall, Steve, we couldn't be more pleased.

Operator, Operator

Our next question comes from Jim Salera with Stephens.

James Salera, Analyst

Steve, it's been a pleasure working with you. Hopefully, you have a long vacation planned as we get into the beginning of next year, taking advantage of some time off. Ryals, I wanted to maybe ask a little bit more detail around the other segment because branded retail actually came in ahead of what we were modeling and the other piece came a little bit behind. I would assume that's foodservice, just given some of the headwinds that QSR and the industry has been facing. But can you offer any color there, maybe kind of foodservice and your private label business performance?

A. McMullian, Chairman and CEO

Yes. Jim, the foodservice business has been under pressure, not surprisingly, given the economic environment and consumer sentiment. So that's really all that is. I would continue to note, though, that despite that weakness, the work that we've done over the last 2 to 3 years to improve the profitability of that business is still delivering very nicely on the bottom line. So that's good to see. But we would expect that to recover as the economy recovers. It tends to ebb and flow with that. So nothing terribly unusual there. Volumes were a little bit better in that other category, primarily due to vending. So you may note that as well. Private label is interesting because it has been weak. You can see that in the syndicated data, which may seem kind of strange given where we are economically. But the price gaps between private label and some of the lower-priced branded products have narrowed significantly. And so I would chalk it up to that.

James Salera, Analyst

Okay. Is it a fair way to think about just because we have a little bit less visibility on foodservice. Is that kind of run at the same pace of industry traffic? Or is there a way for us to think about kind of incorporating that into our model?

A. McMullian, Chairman and CEO

Yes. You can look at traffic, which would be a good indicator. And remember, our foodservice business is really broad, right? So it's broad line through the big distributors, but it's also QSR, which has clearly been under pressure. We compete across all those channels. So it's just general weakness across foodservice given the economic environment.

James Salera, Analyst

Okay. And then if I could sneak in one more. You guys brought down your expectations for headwinds from tariff, but we've also recently seen some step-up in ag commodity prices. Can you just offer any thoughts around how we should kind of be putting together puts and takes as we think about modeling your '26 gross margins, if there's maybe opportunity for upside there or with kind of all the moving pieces, that should probably be a little bit more conservative from our view.

R. Kinsey, CFO

I mean, Jim, Ryals has made a statement. Obviously, we're not prepared to give guidance for 2026 today. But what I would say, when you look kind of across the whole bucket, we are still expecting inflation. I mean wheat commodities are still very volatile. There are other things that are going to be up next year. Obviously, we only had tariffs for part of the year this year. So when we give guidance on 2026, my guess is you'll see some inflationary pressure with regard to input costs.

Operator, Operator

Our next question comes from Max Gumport with BNP Paribas.

Max Andrew Gumport, Analyst

Congrats, Steve. First, on the dividend and on cash. So you noted you're reducing your expectations for CapEx this year as you focus on returning to a more normalized leverage ratio. I was hoping you can talk about the balance between pulling this lever, pulling down CapEx versus reconsidering whether the dividend is at an appropriate level. And I'm really asking because it feels like an acknowledgment or an early admission that this combination of your leverage and the dividend are restraining to some degree your ability to invest in the business.

R. Kinsey, CFO

Yes, we actively consider capital allocation every quarter and throughout the year because it's crucial to us. We are committed to delivering shareholder value. Regarding our capital expenditures, the reduction is part of our strategy focused on deleveraging and is also influenced by the timing of our projects, some of which have been postponed to next year. We have reassessed our projects to ensure that we only pursue those that offer the best returns. This decision is independent of any considerations regarding dividends. Our Board reviews the dividend on a quarterly basis. I don't want to speculate or jump ahead, but our primary goal is always to enhance shareholder value. The Board will make decisions based on the specific circumstances at the time concerning dividend policy. While our approach to capital allocation remains consistent, we are mindful of our leverage ratios and payout ratios, and all of these factors will be taken into account as we plan for future capital allocation.

Max Andrew Gumport, Analyst

Okay. And then coming back to margins. So this quarter, your gross margin was down 190 basis points. EBITDA margin was down 160 basis points, and that looks to be despite the tailwind you've actually had some lower ingredient costs as a percent of sales. So it feels like negative price mix and lower volumes are really starting to pressure your margins, given the competitive environment and the consumer environment don't seem to be swinging to positive at least in the early part of '26. It's not clear that either of those pressures will be dissipating in the near term. So I'm just curious how you're thinking about the potential need to navigate through several more quarters of margin pressure.

R. Kinsey, CFO

Yes, when you examine the gross margin, there is obviously pressure from the top line. Ryals discussed the consumer, and you've seen that we have increased promotional activity, which is contributing to some of the gross margin pressure. However, the main factor affecting gross margin is actually Simple Mills, as they are fully co-managed, resulting in higher costs for that product. This is a significant point that influenced the gross margin for the quarter. We'll see this change in February of next year. If the category stabilizes or we observe an improvement in overall consumer sentiment, excluding any inflationary effects, margins should benefit from that. Additionally, on the SG&A side, we transitioned a large portion of our labor force in California from independent distributors to company employees, which has been a major factor. We will also see that change next year, and overall labor costs have increased. So, in terms of SG&A as a percentage of revenue, it does return to the pressure on the top line. However, I wouldn't highlight any single item as significantly impacting the overall EBITDA margin from SG&A other than labor.

Operator, Operator

Our next question comes from Mitchell Pinheiro with Sturdivant & Co.

Mitchell Pinheiro, Analyst

Steve, I want to congratulate you on a remarkable tenure. It has been a pleasure working with you, and you are the third CFO of Flowers that I've encountered, with this being the longest term. So once again, congratulations. Ryals, I have a question. On one side, you discussed a generational shift in your prepared remarks, and on the other hand, we are seeing consumer weakness, particularly at the lower end of the market, yet people are still purchasing and bread has continually evolved to be healthier. This seems to be a natural progression, so I'm interested in how you might connect the generational shift with the current economic weakness you mentioned.

A. McMullian, Chairman and CEO

Yes. I think it's more than just the economic weakness. Certainly, that plays a role, Mitch. I mean you've been around a long time, and you've seen when we enter periods of economic uncertainty, there's always trade down from traditional loaf to more value-oriented brands like private label or otherwise. So I do think that, that does play a role in this, but the shift that we're really talking about is centered around traditional loaf, meaning the traditional 20-ounce soft variety and white breads, and there has definitely been a shift, frankly, that's been underway for several years now, but it has just accelerated over the last 12 to 18 months, where the category is really bifurcated into premium, differentiated, or value, and traditional loaf has really taken it on the chin because of that. That's very impactful for us, obviously, because we're very concentrated in that category, particularly given we have the #1 brand and #1 SKU in that category, but we are intent on redefining traditional loaf. We think we've got a great opportunity with the strength of our Nature's Own brand to lead the category in the transformation of that particular segment. We clearly acknowledge the challenges that we're facing in the short term, given that consumer shift, but we have growing optimism in the longer term, and that's primarily due to two things: one, our team, which I think is the best in the industry; and two, our portfolio of #1 brands. So we will continue to invest in the consumer, continue to innovate. You've seen us do that over the last several years, we're making significant progress, and while at the same time, working to optimize our cost structure. I mean you look in the quarter, Mitch, and you see Canyon up 6% in units, Dave's Killer Bread, up 10% in units. You've seen us enter into the small loaf category that definitely addresses a consumer need. And in the quarter, we gained 15 points, 15 full points of unit share, and we're already #2 under that Nature's Own banner, and while that category is growing 85%, obviously, off of a small base, but significant growth. So I believe we're doing all the right things for the long pull while we try to mitigate the challenges in the short run.

Mitchell Pinheiro, Analyst

Nature's Own has clearly been a huge success story, primarily focused on traditional loaves. However, I'm interested in where brands like Merita, Sunbeam, and Captain John Derst's bread stand. While I recognize their significance for regional shelf space, it seems they are not receiving much attention, and I'm curious about their strategic importance.

A. McMullian, Chairman and CEO

Yes. That's been a change that's been underway for many years now, Mitch, and I would tell you that the regionals have been fairly de-emphasized over the last 8 years or so, 8 to 10 years, and the primary reason for that is retailer consolidation. You can't run a national ad with Sunbeam, which you can with Wonder, and you can with Nature's Own. Now certainly, they do play important roles in particular markets like take Sunbeam in Atlanta or Bunny in Louisiana, they are still very important brands, but they're much smaller than they used to be. They've been supplanted by the likes of Nature's Own and Wonder over time.

Mitchell Pinheiro, Analyst

So, my final question on that is, while you may not want to eliminate brands, having these smaller brands certainly adds unnecessary complexity. Is that not a concern? Do you have a plan to address that?

A. McMullian, Chairman and CEO

I agree with you about the complexity, and that's one of the reasons we anticipate some near-term margin pressure from the innovations we are introducing. The small loaf products are growing quickly, but they are still relatively small in scale. Adding these products introduces complexity into a bakery that is used to efficiently producing large volumes of established brands like Nature's Own Butter bread. However, this aligns with what consumers want, and we are dedicated to meeting the needs of today's and tomorrow's consumers. Over time, as we make targeted investments in the bakeries to improve efficiency and capacity for these products, we expect margins to improve. Therefore, I'm not too worried about this situation. It's a short-term challenge that I am willing to address because I am focused on delivering for the consumer.

Mitchell Pinheiro, Analyst

Okay. And just a couple of things. You're down to 44 bakeries. Is that going to be the right number for a while? Or are there opportunities for additional consolidation?

A. McMullian, Chairman and CEO

We are constantly reviewing our cost structure and recognize that there is still more supply chain optimization to achieve. While it's difficult to predict exactly when and where this will happen, it's essential for us to focus on efficiency, especially in the current environment. Simplifying processes, sharpening our focus, and ensuring our cost structure is optimized are priorities for us.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn it back to Ryals McMullian, Chairman and CEO, for closing remarks.

A. McMullian, Chairman and CEO

I want to thank everybody for taking time today and joining us for questions. We very much appreciate your interest in our company, and as always, we look forward to speaking with you again next year, actually. So take care. Thank you.

Operator, Operator

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