Stand by. Welcome to the Flowers Foods third quarte 2026 Results. At this time, all participants are in listen-only mode. After the speaker's presentation, we will open up for questions. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's call is being recorded. I will now like to hand it over to our first speaker, J.T. Rieck, Executive Vice President of Finance and Investor Relations. Please go ahead.
Thank you, 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 Anthony Scaglione, our CFO. Ryals, I will turn it over to you.
Okay. Thanks, J.T. Good morning, everyone. As you heard in our prepared remarks, our results reflected many of the challenging conditions we discussed last quarter and highlighted areas where we need to move faster and with greater emphasis on focused execution. While we are seeing encouraging signs in the business, including improving sequential trends and growing awareness in the Nature's Own franchise, the pace of improvement was slower than we anticipated, but we are not sitting still. We are accelerating initiatives already in flight to better align our value proposition where the market is going. This includes advancing innovation, pursuing new business, and investing behind our leading brands. We are excited about the progress we are making and what it means for the future of our business.
While it is taking some time for these initiatives to lift our results, they are putting us on a stronger path forward and increasing our confidence in the long-term potential of the business. The large, attractive markets that we serve across fresh packaged bread, cake, better-for-you snacking, and food service offer compelling opportunities for future growth. Our strengths, anchored by our leading brands, extensive network, and most importantly, our people, provide a solid foundation to drive long-term shareholder value. With that, Victor, we are ready to open it up for questions.
Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question will come from the line of Jim Salera from Stephens. Your line is open.
Hey, guys. Good morning. Thanks for taking our question. Ryals, I wanted to ask you about the pricing strategy going forward, given in the prepared remarks you mentioned, heightened promotional environment. Obviously, we can see the divergence and the share trends, and I wonder if part of that just has to do with the net price you guys are still getting. Can you give us any thoughts on how we should think about the pricing lever, the back half of this year, I guess 4Q of this year, but then really more importantly into 2027 as we fine-tune our models and think about how much you will be able to offset some of the inflation headwinds we have seen?
Yeah, sure, Jim. Thanks for the question. Yeah, certainly price is something that we are looking at. I think it is only part of the story, though. We believe that the bigger issue is some of the shifts that we are experiencing in the category in terms of consumer preferences, price- pack architecture, which obviously has a price element to it, of course, meaningful differentiation. Those are the items that are winning in the category right now, and where we currently have gaps, though, we are filling those gaps, as you know. In fact, as we speak, we are doing that. We just relaunched our Nature's Own small loaf, for example, and we have more of that coming in 2027.
I think we are taking a hard look at price, promotions, promotional effectiveness, leveraging the tools that we have to be sure that the promotions we do run are as effective as possible. That said, the promotional environment has been pretty intense. Particularly this last quarter, we saw pretty intense promotional activity. Price sensitivity among consumers is certainly an issue, but it is not the only issue.
If we try to put some guardrails around that, I mean, do you think it is possible that we could still see a low single-digit benefit from price mix in 2027, or should we be thinking about it as more flat-ish?
Yeah, I think we are not in a position to talk about 2027 right now. I think all the dynamics that Ryals mentioned is obviously going to play a factor where we will set a [Lao], and it is going to be a tale of two stories: organic wheat versus traditional wheat. They are exhibiting different cost inputs, so that is going to have a factor on how we look at the overall portfolio, both on traditional loaf as well as on the organic side.
Okay. Then if I could just ask one other one on the input costs. We talked to a lot of folks this earnings season about transportation cost increase, and so we are just hoping you could help us size up what you guys are seeing in your freight contracts. Maybe help quantify how we should think about that as a percentage of sales and kind of the magnitude of the increase as we move forward and look to 2027. Thank you.
Yeah. So maybe just talk about a little bit of inflation and commodities overall, just to give that context. So for fiscal 2026, generally speaking, we benefited from our hedging programs. We saw rising commodity prices, specifically in the back half, year-on-year, in Q3 for commodities, ingredients, packaging. They were relatively flat on a rate basis compared to a year ago. So markets, while they were elevated during the quarter versus 2025, our coverage and inventory provided us protection. In Q4, and it was already in our guide, so it is nothing new. We already factored this in. We expected higher raw material inflation as coverage began to lapse, and that is clearly going to be an area that we are spending a lot of time on as we look at 2027, although it may be more of a first- half versus a second- half headwind.
As it relates to fuel, as we mentioned on the last call, our fuel costs, part of it is hedged, part of it we have contracted transportation costs. So while year-on-year it has increased, we have been able to manage that either through the contracts or through the rates that we have had with our transportation providers.
Thank you. One moment for our next question. Our next question will come from the line of Scott Marks from Jefferies. Your line is open.
Hey, good morning, all. Thanks very much for taking our questions. First thing I wanted to ask about, you called out some of the continuing pressures in the space and that it is the pace of improvement with Nature's Own has taken a little bit longer. Some of your innovation has not kept up with trends in the category, and I understand those are a bit of a longer- term benefit. So as you think about the here and now, how are you thinking about maybe stemming some of the pressures within your own business? I know you called out extensive cost controls. Just wondering if you can give us a sense of how you plan to approach that and how we should be thinking about those levers.
Yeah, sure. We're already pulling some of those levers. We're estimating roughly a $20 million cost takeout for this year to directly address that issue. There are opportunities for improvement in procurement. There are also opportunities for additional efficiencies in the bakeries. We're always working on that in terms of greater productivity out of the bakeries, controlling our stale. Scott, these are the basic blocking and tackling everyday tactical items that the team works on to combat some of the headwinds we face. More importantly, though, is the focus on getting our branded volume stabilized.
So again, back to those portfolio gaps that we're actively filling, the relaunch of the small loaves, which, by the way, also benefits from the halo, if you will, of the Nature's Own advertising campaign. They're the same formulation, clean label, non-GMO. We'll get the halo effect of that. Those have just relaunched.
It's only been a few weeks, but we're already seeing some very promising returns on that give us confidence that we can recapture our fair share of that segment. With regard to the broader Nature's Own franchise, since the relaunch, we have seen sequentially improving share trends across the Nature's Own franchise. The traditional loaf, which has been the weakest part of the overall segment of the category, continues to lag behind, but even it has shown some sequential improvement. We're not getting the results as fast as we had hoped that we would, but nevertheless, we are seeing those green shoots of improvement that give us confidence that this is the right strategy, the right path forward. Our customers are excited about it. They're telling us that when we join them for meetings.
Of course, when you've got your customers behind something, that's a really good early sign that you're doing the right thing. DKB, Jim asked the question a minute ago about price. I do think there is some price sensitivity with DKB, but it's a lot more than that too. I mean, as recently as Q1, DKB was up in units. This is a very recent phenomenon that has occurred. Frankly, our overall share has been very stable over the last few years until very recently. I can draw a direct line between that, what's happened with share and the changes in consumer preferences, which we're actively working to address.
Understood. Appreciate all the color there. Then maybe secondly from me, there was a comment in the prepared remarks about working with bank partners to ensure financial flexibility for next year. Wondering if you can just give us an update on your thinking around capital allocation, including the dividend, as well as capital expenditures going forward. Thanks.
Yeah, no worries. First off, just wanted to reiterate, we remain in compliance with all covenants and have very strong relationships with our bank group. That being said, we want to provide the company with the most flexibility as we continue to face a potentially challenging environment in the year ahead from a commodity standpoint, category standpoint, consumer standpoint. While 2027 we continue to work on and shape up from a planning perspective, we're building in that flexibility ahead of any potential constraints that could arise. We expect to have an update on that front before year- end. To answer your question on the dividend in particular, clearly the dividend is an important topic and shareholder consideration, and our board reviews that policy each and every quarter. We share with them the relevant items across a number of dimensions, including cash generation, our leverage profile, capital investment.
They take those elements into consideration when forming the basis of their actions, and we expect to announce any decision that the board takes in our normal cadence after next week's board meeting.
Understood. Thanks for the call-out. I'll pass it on.
Our next question will come from the line of Steve Powers from Deutsche Bank. Your line is open.
Hey, great. Thanks and good morning.
Hi, Steve.
Hey. I guess you've emphasized the difficult category backdrop, but obviously there's a share component too. I guess, can you just maybe just a little bit more thought or a little bit of thoughts from you as to how you're thinking about that decomposition between the category itself and what Flowers specifically controls through better execution, better assortment, et cetera? Just trying to get a better sense of how you're seeing those two different drivers and how much control you really think you have over the trajectory of the business into 2027, just relative to category momentum.
Yeah. Good question, Steve. Thank you for that. So obviously, the overall category remains weak, so we start with that. Category is down almost, I think, almost 3% in units in the quarter. Then, as you start to decompose that, as we have been saying, traditional loaf, 20 oz traditional loaf, remains the weakest part of the sector. Obviously, we are very concentrated in traditional loaf. So getting that stabilized, as we've been saying for several quarters now, is priority number one. Hence the Nature's Own relaunch, the move to clean label, the move to non-GMO. We believe these are the right things to do for the consumer, our customers, and our company. We are beginning to see some results there. As I said, DKB is a more recent phenomenon in terms of the unit pressure. Several reasons for that.
Some of the price sensitivity, but there's also consumption issues there too. DKB indexes the highest among high-income consumers. They are also the ones that use GLP-1s the most. Not terribly surprising to see a bit of pressure there. DKB continues to hold up better with the lower-income consumers than it is with the high-income consumers. I attribute a lot of that to the GLP-1 drugs. We have actions to address that, Steve, in terms of innovation, protein items. Filling the gap that we have in terms of sourdough has also been an issue for DKB. We have sourdough in DKB, only in California, and it's growing very, very well in California. We have great confidence that that is going to be a very important addition to that part of the portfolio. Back to the 20 oz loaf, very important to get that stabilized.
While we're working on that, the relaunch of the half loaves to pick up our fair share of that and to help stabilize the overall volumes is also an important part of the picture. Also remember that we're not just a traditional loaf business. We have a very large billion-dollar food service business, and we also serve private label. In the meantime, while we're working to rebuild this branded business, we are aggressively filling volumes with new wins and food service and private label, in addition to wins for our branded business, because that will help mitigate some of the operating deleverage that we've been experiencing.
Okay. Very good. Thank you. Anthony, you talked about the difficult cost environment, particularly looking out to the first half of next year. A lot of the initiatives that Ryals just spoke to are going to take some time to have some return in terms of volume impact. I guess, without asking for guidance, I'm curious as to how you're seeing the first half relative to where you've positioned the fourth quarter. Is the fourth quarter a reasonable run rate to talk about the starting point of 2027, or is the fourth quarter going to be a trough and we'll start to see improvement as the new year begins? Just a question of trajectory of improvement off what hopefully is the bottom here in the back half of 2026.
Yeah, that's a great question, Steve. I think from an inflationary standpoint, many of the commodities that we're exposed to, we're seeing that increase in price right now in Q4. Sequentially, assuming there's not a significant shift in geopolitical or something like that, we're expecting that pressure to continue as we think about the first half of next year and looking at it through the lens of the first half versus the second half. Sitting here a couple of weeks ago, a couple of months ago, it looked like wheat was really starting to rally. That has come down. As we look at all the data that's out there that we can take into consideration, it looks like there's more acreage. It looks like the geopolitical there's softening there. There's good indicators that there could be some relief from an inflationary standpoint.
But I would say that is probably more of a second half, just given our hedging programs, given where pricing is, more of a second half versus a first half relief. So we are expecting continued pressures in the first half of next year as it relates to the inflationary side.
Okay. Very good. I will leave it there. Thanks so much.
Thanks, Steve.
Thank you. One moment for our next question. Our next question will come from the line of Max Gumport from BNP Paribas. Your line is open.
Hey, thanks for the question. Wanted to turn back to the balance sheet conversation, and really just trying to get a sense for how you're feeling about the health of your balance sheet. Obviously, you took decisive action earlier this year by cutting the dividend, which I think was a good step. But given your updated outlook for 2026 and the operating conditions that you expect to persist into 2027, it feels like you've found yourself a bit stretched again from a leverage perspective. I mean, your second- half EBITDA this year would imply a very high leverage ratio above your covenant. You included commentary in your remarks about proactively working with your bank partners to ensure you have ample financial flexibility. You also, in the 10-Q, had a comment about seeking an amendment on the covenants attached to your debt.
Just trying to get a sense for how comfortable do you feel with your balance sheet, and how do you think about getting yourself out of this leverage situation?
Yeah, great question. As I mentioned earlier, we're working with our lead banks, and again, expect to have an update by year-end. And we're highly confident, based on the conversations and discussions to date, that we will be able to put in place additional relief, specifically addressing what we see as potentially a concern in 2027 as it relates to our covenants. And those conversations are progressing well. We also have actions we can take. We're looking at our CapEx. We're looking at the investment in the business. You mentioned the dividend. We're looking at the dividend. These are all things that we take into consideration, recognizing the dividend is a board action with management input.
So want to make sure that as we look at 2027, and as you recognize some of the challenges from an inflationary standpoint, we're doing everything to try to look at it through the lens of how do we deleverage over time, how do we continue to have the capacity to invest in the business to support our brands, recognizing that there's going to be some cost pressures that we're going to need to deal with. And we are addressing that proactively through these conversations with our banks and proactively through some of the levers that we will pull in 2027 as it relates to investments and costs.
Great. As a follow-up on that, I mean, you did mention that you are still investing for growth. I guess, what's giving you the confidence that you can do both at once, that you can delever while also invest to try to drive the top line, whether it's advancing innovation or pursuing new business or investing more in your leading brands? Why do you think you're capable of doing both at once, and why not just focus entirely on the balance sheet, given where you're at currently? Thanks very much.
Yeah, I think at the end of the day, we need to continue to invest in this business. Over time, that's going to provide the best opportunity from a top-line perspective for us to recapture share, to recapture growth. We have to balance that investment with the returns and with the cadence of the deleveraging. So it's a profile that we remain cognizant of, and we're balancing that across multiple dimensions. But to think that we would just pull back on those investments in the short term, we have to look at this as a multi-quarter, multi-year journey and be balanced in the approach. We feel confident that the way that we're going to approach it is a balanced approach.
Okay. Thanks very much.
Thank you. One moment for our next question. Next question will come from the line of Mitchell Pinheiro from Sturdivant. Your line is open.
Yeah. Hey. Good morning.
Good morning.
So food service sales and volume, I guess, were up in the quarter, I think I read. So how do you put that against a weak category growth that had trends beyond just your traditional loaf weakness? You have the GLP-1 pressure. So is the food service business a function of having the right customers, or I would just love your comments around that.
Yeah, Mitch, a lot of the growth in food service is new business wins. We have reorganized our sales force with food service. We have mostly an internal sales force now, which has been a huge benefit for us. The team has done a great job at securing new business, expanding business with current customers as well, has also been a part of that.
And then, moving to just your promotional activity, it was up. It didn't really move the volumes. Is that because the promotional activity is on your newer and smaller products? Smaller product lines, I should say.
No, it's not so much that, Mitch. It's really, I mean, remember that, first of all, the base sales in this category are very, very high. So getting lifts from promotional activity has always been a fairly difficult task. I would describe the effectiveness of our promotions in the quarter as uneven. So we had some that were more effective than others, is the way that I would frame it. Some of our activity in the mass channel, for example, was not as successful as our activity with more traditional grocers. And some of that just has to do with the overall price point, so that in mass, for example, the promoted price maybe isn't low enough to drive enough volume. As I was addressing one of the first questions on the call, I said we're taking a hard look at our promotional effectiveness.
I think we can do an even better job going forward. Then, of course, when you look at DKB in the quarter, obviously, was a disappointment to us, but I would also call out that we were very heavy on promotion in the third quarter of last year and not as heavy this year. So that also contributed to some of what I would describe as unexpected unit declines in the quarter. So it's more uneven than across the board, promotions aren't working. That's not the case.
Thank you. This concludes the question-and-answer session. I would now like to turn it back over to Ryals McMullian, Chairman and CEO, for closing remarks.
Hey, Victor. Thanks. Just want to thank everybody for taking the time today and joining us for questions. We very much appreciate your interest in our company. As always, we look forward to speaking with you next quarter. Take care.
Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.