Flowers Foods Inc (FLO) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen. My name is Melissa and I will be your conference facilitator today. At this time I would like to welcome everyone to the Flowers Foods fourth quarter and fiscal year 2005 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period.

It is now my pleasure to turn the floor over to your host, Marta Turner, Senior Vice President of Corporate Relations. Ma'am, you may begin your conference.

Thank you, Melissa, and good morning everyone.

Participating in our call today we have George Deese, Flowers Foods' Chairman, Chief Executive Officer, and President; and Jimmy Woodward, our Senior Vice President and Chief Financial Officer. George and Jimmy will discuss our results and then respond to your questions.

Before we begin I do want to mention that we will be presenting at conferences in New York on March 14th and 15th and we're hosting an analysts' day at our Denton, Texas bakery on April 5th. If you need more information about those events, please just let me know.

Now, I must remind you that our presentation today may contain predictions, estimates, or forward-looking statements. Our use of the words "expect," "believe," or other such expressions will identify those forward-looking statements. While we believe them to be reasonable, these statements are subject to risks and uncertainties that could cause actual results to differ materially. In addition to the matters we'll discuss during the call, important factors relating to our business are described in Flowers Foods' filings with the SEC. Now I'm pleased to introduce Flowers Foods' Chairman, Chief Executive Officer, and President, George Deese.

Thank you, Marta, and good morning. I would like to take the opportunity to thank each of you for joining our call today and your interest in Flowers Foods. We're pleased to report good results for the fourth quarter and of course for the full year of 2005, especially in light of the challenges we faced in the back half of the year. It was a rewarding year, but a tough year. And the strengths of Flowers Foods are evident in our results.

As we announced in December, our bakery in New Orleans is operating and our sales volume there is recovering nicely, even though the population of some areas remain displaced. We continue to experience higher energy costs, transportation, and other related higher costs. Jimmy will discuss in detail our costs related to the hurricane and the amounts we have recovered through insurance.

Now, turning to our capacity issues that we talked about during the last half of the year. As you remember, during 2005 we added some 50 million in annual sales as the competitive landscape changed in the southeast. You will remember that the new volumes continued to strain and continues to strain our production capacity even today. And we are still incurring higher transportation costs to get the product to our customers.

New capacity is being added in strategic locations to better serve our new customers. In the second quarter of '06 we expect to open a new bread line in our Villa Rica, Georgia bakery, and a new bun line in Newton, North Carolina.

It is important to remember that through the first half of '06 our costs will continue to be high. It won't be until the second half of '06, when we are through the start-ups of the new lines that we expect to have improved cost.

One other issue that I continue to want to talk about is that through the last 12 to 18 months we have made concentrated efforts to reduce our contract production business and to grow our branded snack cake business. That effort is still in progress, and will continue through the year as we work to take cost out and improve margins in our snack cake business.

Looking at our sales, we're pleased that sales did show a strong 9.7% increase in the quarter and 10.6% increase in the full year. During the quarter, I'm happy to report that branded retail sales were up 10.4%. The growth was driven by double-digit increases in three primary retail classes. Those retail classes includes soft variety bread, where our number one brand, Nature's Own, continues to sell very well; white bread, where our local white bread brands continue to outperform the category; and Mrs. Freshley's multi-pack snack cake, which as our retail brand grew by double digits, primarily through increased distribution through our mass merchandisers.

Also in the retail channel, not because Private Label grew, but our share did grow because of new customers that came on in the last half of the year.

Our food service business continues to grow at a fast pace, both on the DSD side as well as in the frozen bread and rolls.

Our market share continues to grow in both retail and food service, and we expect these trends to continue. Flowers bakeries continues to add 1 to 1.5 to our DSD sales base as a result of expansion into new into territories over the last 2 years.

Before I turn the call over to Jimmy for a more detailed review of the numbers, I want to mention our announcement this morning that we have reached an agreement to acquire Derst Baking Company in Savannah. Derst will add about 45 million in sales this year and on an annual basis, some $50 million. We expect to complete this transaction in the near future.

Derst is a wonderful family operation that has been in business some 129 years. We're excited about them joining us, and we know very positively that this acquisition will strengthen us in the Georgia and the South Carolina market. If you remember, the map, as we looked at it over time, we always had a blank in parts of Georgia and parts of South Carolina. This will now be filled and we're excited about it. We're excited about the Derst team joining the Flowers team to strengthen our entire organization.

At this time I'll turn the program over to Jimmy.

Okay. Thank you, George, and good morning.

You'll note fiscal 2004 ended January 1, of 2005 and the 2005 year we reported today ended December 31, 2005. So that was an unusual situation, to have two fiscal year-ends in the same calendar year. Both fourth quarters were 12-week quarters and both fiscal years were 52-week years, so it's all comparable.

For the quarter, consolidated sales increased 9.7%. The bakeries group sales increased some 10.7%. The volume there increased 6.2% on strong performance, as George mentioned, in branded white bread and in Nature's Own variety bread. Pricing to recover cost increases represented some 4.8%. And the small 0.3% negative mix shift was due to lower sales of our Cobblestone Mill products in the specialty bread category, and part of this was due to our production capacity challenge, which should be resolved in the first half of 2006.

The specialty group sales increased 6%, unit volume you see decline by 10.7 %. As expected, the transition out of the contract, snack cake production continued during the fourth quarter, and is now substantially complete.

We increased volume in the food service channel with frozen breads and rolls. We increased sales of the Mrs. Freshley snack cakes, primarily in the mass merchandiser channel. And we have added the Royal Cake operation, which added snack volume. The mix shift caused by these opportunities was some 10.2% favorable and we did have pricing of 6.5%.

Going into 2006, the transition out of contract production in snack cakes will bring about some change in the snack cake P&L. Much of the contract production was picked up by the customer at our dock so we had sales and cost of goods sold with a relatively low gross margin.

The sales of Mrs. Freshley's requires us to transport the product to the customer, so the P&L will have sales at a higher price point, the associated cost of goods sold, and then we will transportation cost in the SG&A line in that category. And George mentioned sales for the year increased some 10.6%.

The gross margin for the quarter was stable. The improved pricing and sales mix and the receipt of insurance proceeds offset costs related to hurricane Katrina, and the increases in costs we have experienced primarily in natural gas, labor, and Other cost.

To summarize the impact of Hurricane Katrina, we estimate the direct identifiable costs were $7.5 million or about $0.08 per share for the year. Approximately $1.9 million or $0.02 of that hit quarter 4 and 5.6 million or $0.06 hit quarter 3. We received the insurance proceeds of 1.5 million in quarter 3; again, about $0.02 per share; and 4 million in quarter 4, or $0.04 per share. The insurance proceeds offset costs of good sold and selling general and admin. As appropriate, we allocated the insurance proceeds to both categories.

This left us with some $2 million, or about $0.02 per share of direct identifiable hurricane cost that has not been recovered through insurance. We continue to incur some incremental cost and the insurance claim process is still underway.

Selling, marketing, and admin. costs were down as a percentage of sales at 41.1% for the quarter versus 42.4%. The increased sales, lower equity based compensation expense, and lower advertising expense were the primary factors. We also recorded a $900,000 charge that we classified as selling, marketing, and admin expense, because it was to write down a margin deposit we had at Refco, the company that recently experienced financial difficulty, and that is classified in the corporate information in the segment data.

The depreciation and amortization increased 5%, but decreased 0.2% as a percentage of sales. Our interest income on the distributor notes was offset by a higher interest expense on our line of credit which we had drawn on to fund share repurchases. During the quarter we did buy 529,100 shares at an average price of $27.09 per share.

The effective tax rate of 37.7% was slightly higher than the 37% we initially expected for the year because we did resolve various state tax audits during the year.

The minority interest in the variable interest entity eliminates the net income of that entity as we continue to have no equity ownership position.

Looking forward to 2006, George has already stated that we announced today the pending acquisition of Derst Baking Company, and therefore increased our sales guidance to 1 billion 870 million to 1 billion 895 million, an increase of 9 to 10.4%. We have assumed no additional insurance proceeds will be received in that guidance, and we have assumed that Derst -- you know, Derst is a profitable operation. During 2006 we expect it to be earning a neutral because we will incur integration cost, and then it will begin to contribute to the consolidated earnings in 2007 and beyond. So we expect net income of 3.6 to 4 % on sales -- the D in 870 to the B in 895 -- that's a net income of 68.6 to $74 million. We would expect the 62.3 million share still to be an approximate estimation because of the average share calculation and the fourth quarter purchases offsetting the issuance of shares for Derst. So that would then yield a range of $1.10 to $1.19, which is an increase of 11 to 20%.

The guidance we are giving includes 5 to $0.06 per share of cost to be incurred for equity-based compensation under FAS-123R.

Our 2006 capital expenditures remains in the 58 to $63 million, and we are supplementing our capital spending with equipment leases to expand the production capacity, as George has mentioned.

So with that, I'll turn the call back to George.

Thank you, Jimmy.

I would just like to repeat that I certainly have complete confidence in our sales guidance of 1.870 to 1.895 billion for '06 and the earnings expectations as Jimmy discussed.

However, as we have mentioned, our costs will remain high through the first half of the year as we transport products further than usual and continue to absorb higher costs. Our plan takes that into consideration, with the last half of the year more heavily weighted in terms of year-over-year improvement in earnings.

We did take pricing action in the fourth quarter, as we discussed at the previous analysts call, and some additional price increases at the beginning of the fiscal year to partially offset our higher cost. We look forward to bringing on new production capacity in the May-June time frame, which will allow us to begin to drive down costs further as we produce products closer to the growth markets.

Our second half of '06 results show the benefit of added production capacity and the lower transportation costs, assuming the startup of our new line goes according to plan and as expected. With the new capacity we expect to be in position in the second half to take on new business as changes in the marketplace continues. During the second half, we also plan to introduce new products that are already in the pipeline, and we will again begin to grow our DSD footprint, which we feel has been very successful in the past two years.

Our cash flow continues to be strong, allowing us to make capital investments, pay dividends to our shareholders, consider strategic acquisitions, and to continue our share repurchase program.

I'd like to take just a moment to say a special thank you to our teams in Louisiana and along the Gulf Coast for their outstanding efforts during and after Hurricane Katrina. They have faced extreme personal losses, yet they are determined to carry on our business and their lives. And this team makes me very proud to be a part of this Company and just so all of them will know, all of the people in Flowers thank you and feel honored to be a part of the Flowers team.

So going forward, all of us remain focused on growing our business, on driving out cost, and on creating value for our shareholders. Now, Jimmy and I will be happy to take your questions. So Melissa, I will now turn the mic back over to you.

Thank you. The floor is now open for questions. [OPERATOR INSTRUCTIONS] Your first question is coming from Tim Ramey with D.A. Davidson.

Good morning and congratulations, gentlemen.

Good morning Tim.

I'm just wondering, George, about your comment on growing the DSD footprint in the second half. What do you think that contributes to '06 growth?

Jim, I feel that with the added capacity that we have in place, I feel there is another 3 to 5 million consumers that we're looking at in a given market and I have been very careful not to say where those markets are, but we do have plans to enter a market that will give us that kind of population growth in the last half of the year.

Okay. Good.

And we do have that in our guidance.

Good. And just on the -- one of the things I have worried a little bit about is, with the price increases that there will be some elasticity of demand or units, but it sure didn't seem like that in the 4Q. What are your thoughts there?

Well, I look at especially our bread, buns, and roll category, when I look at the retail environment, both RIN panel data, we did have increases in the fourth quarter and they went off without any issues.

Cake, I think is more acceptable and problematic, they make so many choices from a snack standpoint. We are trying to be very careful on the pricing of cakes on the snack arena, because it's not just competitive cakes, but if you walk in a convenience store or a supermarket, there are so many choice, and we just have to be very careful that we do not get our prices out of line on that category.

But back to the DSD and the frozen bread and rolls, prices increases are in and solid.

Thank you.

Thank you.

Thanks, Tim.

Thank you. Your next question is coming from Leonard Teitelbaum with Merrill Lynch.

Good morning.

Good morning, Len.

Just a couple of questions, please. You said you are getting out of the contract baking area. Who were you baking for?

Lenny, on the cake side, I'm sorry, but I can't give specifics on that. But major customers that we have had in their arena had began to put in their own capacity and we recognized that we could -- choices would be -- realistic to that type of arena or really look at going after the branded retail, and we chose the path of -- we felt Mrs. Freshley is a good brand. That brand is now up to annualizing at $225 million of retail this past year, which is significant. And we feel like we can be a $250 million retail brand this coming year, or the year we're in now.

Okay. That's very helpful. What percent of capacity are you running in that business now?

On the snack side?

Yes. Have you replaced all of the Private Label yet? Or are the margins going to get hurt for another year or so as you look to fill it up?

We have not replaced all of the capacity yet.

Okay so that's on the comp. The Refco deposit, is that in for settlement at some point in the future? I know it's a long line of guys --

Yes, Lenny, that represented roughly 50% of the deposit account that we had there.

Yes.

And so we wrote off -- based on the public information that we have available, and we would work with people that potentially would take our position and give us the cash for the balance that we still have.

Okay. But the 900,000 is gone and there's no protection --

Well, there's the potential, again, if we wait it out and Refco through bankruptcy, if we were to recover dollar for dollar then we would take the 900,000 back. But we don't really think that's probable at this point.

Okay. And that's tax deductible, right?

Yes.

All right. Have you worked a sensitivity to fuel, Jimmy? In other words if we were to make an assumption of -- if someone wanted to create an index or whatever, have you worked at -- let's say 5% up or down or 2% up or down movement in fuel, what it would mean on an earnings per share basis? Assuming no price recovery.

Yes, we have not specifically worked that because we use so many third-party contract carriers for the transportation side and because the distributors there, the gas cost of the route trucks, so we really have not worked that. I know -- I have looked at data in terms of white bread pricing. It's interesting how that roughly tracks the trend of a gallon of gas and gas has obviously risen much faster than white bread prices have.

Could you give us some feel as to what your packaging costs are up, year-over-year?

Well, our packaging, we look at -- what we've publicly said is our major ingredients and our major packaging and oven fuel, all of that in total is expected to be up some 6% year-over-year.

Can you quantify that?

You know, it will be a little bit than $20 million.

Okay. That's helpful.

Now, if we take a look at Derst, it's profitable now, but it's going to be earnings neutral this year. We can understand that. Are you going to be replacing -- is that going to be strictly the bake -- the factories, excuse me, are they going to be strictly for the Derst territory, or are you going to use that to integrate other areas around Savannah?

No, it will be used strictly for the, quote, existing Derst territory. As we go through the process this year of integration there will be some fringe areas that we would be looking at from -- say, from a synergistic standpoint.

Yes.

And they do have a little extra capacity that can help us through the summer as we go forward. But Lenny, some -- I'm happy about that acquisition. I think it will just really give us strength in that overall marketplace.

It does seem to plug a gap there. And that's my last question: as we take a look at your -- and maybe this was the question Tim was going for too -- if we take a look at your expansion of -- controlled expansion of that arc, if you will, that you have talked about over the years, is there a major area that's on the drawing boards, if you had to prioritize it, that you would like to look at? Or is it just going to be opportunistic buys? In other words, St. Louis or someplace like that that seems to be a large metropolitan area that you would like to attack in a more aggressive way? Can you just give us some kind of a feel for that?

As opportunities do present themselves, we've publicly said we think we can push that territory on further up through parts of the Northeast, the Midwest, and West. So Lenny, we do have one that will happen this year, and I'd rather not give you the specific market just yet.

Sure.

But I will before we do that.

Okay. And I promise this is the last one. The spread that you are using in the earnings, 110 to 119, is that more energy related than anything? Or is there something else in there that we ought to be aware of?

I would say it's-- you know, it's-- it's energy. We've got a lot of our ingredients covered. A lot of our oven fuel covered for the year. As we transition, again, the snack cake business, we're incurring transportation costs that, historically, that the customer picked it up at the dock. So we're just trying to provide range around -- and transportation -- fuel-related would be the most --

Because you have said in the past you are covered out through wheat. You have got fuel covered. Natural gas covered. I would guess it would be the fuel surcharge on common carrier, plus--

Right.

Any -- okay. Very good. Thank you very --

Len? I would even mention also, even though Louisiana, as I said earlier, their sales are recovering nicely, we're now at two shifts of product back at the New Orleans plant. When it closed it had three shifts, which means we are still having to transport quite a bit of product in and around Louisiana, and that just takes time to work that on out.

So backing up what Jimmy says, I think it would be as much a logistics uncertainty as anything we're talking about. We feel good about the sales and we feel good about the ingredients and packaging, where we are, even though it's higher than we want it.

So the unknown, in my mind, would be the distribution or logistic side of -- until we get these new lines up and running to cut out the cost.

Thank you very much.

Thank you, Len.

Thank you. Your next question is coming from Farha Aslam with Stephens.

Hi, good morning.

Good morning. Are you there, Farha?

Sorry. Just going into deeper detail regarding your ingredients: can you specifically talk about how far out you are covered in wheat and how your sugar buy is looking?

Well we don't -- we don't really want to give too many specifics.

Yes.

You know, we do use futures and forward buying, and we look at it in terms of the -- you know, we use both bread flour and high glutin flour. Shortening, and natural gas, I would tell you that we're hedged for the majority of the year. You always have -- like with the futures, you still have to consider the basis that -- if you remember the fourth quarter last year, we had a spike in the basis that cost us some. So we're -- we feel pretty comfortable with our positions, without giving too much detail as to -- for competitive reasons.

Sure, but you are pretty comfortable with sugar at kind of all-time highs? Recent highs here.

Well, sugar -- the base food groups primarily uses high-fructose corn syrup. The granulated sugar is primarily a snack cake back cost. It obviously has been higher and we expect it to be higher in '06. We do expect, as the refinery has come back on line in Louisiana that was our primarily supplier, that those things will begin to normalize.

Okay. Great. I was surprised advertising expense was lower in the quarter. Any particular reason for that?

Farha, it's a great question. We said at the beginning of the year last year that we knew there were more competitive factors and we wanted to really get back on our Nature's Own, which we did. When capacity really became an issue and all of the events of the hurricane put more strain on our capacity, we thought it was unwise just to keep advertising at at heavy rate in view of the fact that we were out of capacity and couldn't sell any more -- or couldn't produce any more.

So we're back on strain this year and that was just a fourth quarter event because of all of the issues.

Okay. And your -- Villa Rica is coming on in the second half and that's going to be a mix benefit, and then you have two bun lines -- are they up and running yet? In your core territories?

Let's see. I think maybe you are thinking about -- of course, Miami and Crossville --

Right.

-- came on. Yes, they are producing, doing a good job. The new lines coming on, of course, will be a bread line for Villa Rica and the bun line will be in Newton, North Carolina, which will come on early in the second quarter.

Okay. And then you were talking about going into a new market. That's in addition to North Carolina.

That's correct. We're already sure of the North Carolina market. This new territory will be on the 100, 150-mile boundary that we're push into.

Okay. Great. Thank you very much.

Thanks, Farha.

Thank you. Your next question is coming from Eric Katzman with Deutsche Bank.

Hey, good morning, everybody.

Good morning, Eric.

Congratulations. Another great quarter.

Thank you.

And I guess my questions will be following up on Lenny a little bit on Derst. Historically, I think you have purchased brands and assets at roughly, you know, call it six times EBITDA. It is fair to say that this acquisition was within that range?

Lenny -- I mean, Eric, I would say that we were -- that's probably a little low on this particular acquisition. We considered this one, it's right in our backyard, a very strategic, important acquisition. We did use shares because that's what we had to do to get the transaction done on a tax-free basis with the shareholders of Derst.

Yes.

And we look forward again to, starting 2007 and beyond, it will contribute to the consolidated earnings.

And you are saying that the -- just so I understand it right -- the amount of shares that -- the average shares for 2006 --

Yes.

-- should not change with the difference versus '05 being the amount of shares that you issued for this deal.

Yes. Not substantially. The 529,000 shares we bought in the fourth quarter --

Yes.

-- really haven't had the full impact yet, since they were so late in the year.

Right.

So if we have those at the beginning of the year and then let's say we close the Derst acquisition 4 to 6 weeks from now, the way that whole average calculation works, I think it will still be close to that.

Close to flat?

Yes.

Okay. All right.

And then the -- so, I know it's difficult to talk about the acquisitions, but you have an independent route system. Does -- what is Derst's system like? Is it a wholly-owned distributor? Or -- how did they go to market?

They went to market with their own sales department. They were not independent.

Okay. And obviously because it's such a strategic purchase for you, I guess that doesn't bother you? Would you change that over time? What's your thinking there, George?

We'll be reviewing it over the next few months. As you know, all except new territories is, of course, distributors. And we would anticipate the same there at some point.

Okay. And then, Jimmy, going back to what you said about the change from contract manufacturing to your own product. So sales should be a little bit higher, like for like. Gross margins should be a little bit higher, but SM&A is higher because of the transport costs, so net/net, you still work out for this being in your favor.

Yes.

Okay. And then, I guess last question is the CapEx budget, that includes for '06 -- that includes your buildout, your expected buildout of the routes in the second half?

Yes.

Okay.

Yes.

All right. I think that's what I need to know. Thank you.

Thanks, Eric.

Thank you. Your next question is coming from David Leibowitz with Burnham.

Good morning.

Good morning, Dave.

A couple of totally unrelated questions. First question, and I may have missed this: Did you tell us how far out you are hedged on wheat this year?

We didn't give specifics, David. We do have, I would say, coverage for the majority of the year, but we haven't given detailed specifics.

Is your coverage more or less expensive this year than last year?

Well, just on that component, I would say it's relatively flat.

Okay. And next question: what is your percentage white bread versus varietials as we enter this year versus as we entered last year?

White bread versus variety? Is that the question, David?

No, the question is what percentage of your total revenue is white bread versus varietal bread at this point.

Well, you have to look at it I guess in a couple of different ways. From a DSV standpoint, variety would be a little ahead of white bread. Of course when you add in superpremium in addition to soft variety, it would be -- and what I'd like to get to that number is probably in the 55 to 60 percentile on variety bread.

Yes, if you look at both -- and there, again, David if you look at both branded and Private Label, the white bread would be obviously much more in the store brand, but still in total there's more variety in specialty bread than there is white bread.

David, this is Marta. We are working on updating the IR fact sheet for -- using the 2005 numbers and we should have that posted on the website and that includes those charts. Should be later today or early in the morning, and that would give you a real clear picture of what -- how those products break out.

Great. Thank you.

Now, just two more questions, if I may. First, the acquisition that you are alluding to for later in the year. Could you tell us if it's going to be larger than Derst?

We have not made public any acquisition later in the year. I think what we said later in the year was expanding into new markets.

Okay. I thought in answer to Mr. Teitelbaum's question you said there might be another one that --

I think the question -- I think I heard it right and I'll repeat again, of course we don't comment on future acquisitions. We're always out looking, but the market that I was talking about, we would be going into a new market. That would not include an acquisition later in the year.

Okay. That would just be entering a new market.

That is correct.

Okay. And I presume, then, that the cost of entry is computed into the earnings estimate you gave us this morning for '06?

Yes, it is.

Excellent. Thank you very much.

Thank you.

Thank you, Dave.

Thank you. Your next question is coming from Heather Jones with BB&T Capital Markets.

Thanks, and good morning.

Hey, Heather.

Hey, Heather.

Real quick, the cost that you associated with Katrina: before, I think at your analysts day, you included sugar in that. But given that sugar has stayed so high, did the total that you put in the release today, does that include sugar?

It does.

Okay.

We -- part of that is because we had to convert from bulk sugar to bag sugar, and then the price is higher.

And you said your guidance for '06 doesn't include potential insurance recoveries?

It does not. Again, the timing and the amount of insurance recovery is always subject to the claims process, which is ongoing, and so it's hard for us to give you a reasonable estimate of how much that would be and when we would get it.

So there's no way that you can give an estimate of what you --

Not really. There again, obviously we have what we believe to be about $2 million of cost we incurred last year that we have not been reimbursed for. Now, of course we have a deductible. I think it's about a half million dollars, so order of magnitude it would be, you know, that much for last year, and then it's a matter of continuing the claims process and providing documentation of what incremental cost is being incurred this year that is in fact insurable.

Okay. Now with the tax rate, should we be using a higher rate for '06?

No. I think we did resolve a state tax audit last year. We don't expect anything over and above what we have got reserved in our financials. So I think 2006 will be around the 37%. And then you have that slightly increasing -- if you think about 2005, we still had some net operating loss carry-forwards that we used up in 2005.

Yes.

And that's slightly -- that lowered the manufacturing tax credit that we got under the new law, so as we go into '06 we'll actually have a higher manufacturing tax credit. So when you factor all of that in, I think it will be around 37%.

Okay. Now, how much did Private Label increase during the quarter?

Are you talking about from a sales standpoint?

Right. Yes.

Total market -- when you look at the total market, Private Label is actually down. I said ours was up due to gaining some new customers and we were up roughly 10%, I believe.

Up 10%?

Yes.

Now, are you still gaining new customers or is this more just still cycling what you gained in the latter part of '05?

It goes back to the June, July time frame. That's when those customers came on.

Okay. So in October and November, you weren't still gaining customers then, you were just still getting what you gained like in the summer.

Not anything significant.

Okay.

That's correct.

And then as far as -- going to Specialty, it introduces I guess more volatility with the fact that you'll be taking on the transportation costs, but are generally when you are doing the shipping, your shipping as Mrs. Freshley, shouldn't that be higher margins than on contract?

We think once we have all of the issues worked out and we are experts at it, that margins should be better. After we go through this transition.

And how long do you think it will be to get your capacity back to where it was precontract, manufacturing? I mean, get it back to where it was before you started eliminating this contract business?

I would point toward the latter part of the year and into the first part of next year. I think things will keep picking up with Mrs. Freshley throughout the year.

Okay. And then my final question is, I was wondering if you all could give us some kind of idea of the capacity constraints you refer to and the resulting higher transportation costs, if you could give us some idea of the order of magnitude of that.

Well, I think if you look at -- back to the capacity issues, especially during the summer of last year, as we took on business, our cost was absorbed and that's why I said I feel better, I think, June, going through the rest of the year, those costs and year-over-year earnings will be a lot better then than now because the cost will be taken out. So we are still absorbing quite a bit of cost until that capacity comes on in-- Villa Rica. In Newton, North Carolina, as well as finalizing our Louisiana -- a third shift getting back into the New Orleans plant.

Okay. And when do you expect the third shift to come on?

I think we'll see that also in the June, July time frame.

Okay. Thank you very much, and good quarter.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question is coming from Mitchell Pinheiro with Janney Montgomery Scott.

Hey, good morning.

Hey, Mitch.

A couple of things. I think I'm confused still on the specialty division, so -- you lost some contract packing as expected, but you are saying that the decline in profitability is the shift in the-- where the onus is on freight charges? Is that -- do I understand that right?

Shipping and transportation both, due to the new method of doing it versus the old method, when contract -- when you do a contract with somebody in the business already, it's less SKUs, it's a lot of volume, and it's a [DOT] pickup. So now we're having more SKUs, delivering the product ourselves, so it's a matter of working through those costs and--

Okay. Well, it just sounds like to me, I mean, where you would expect the margins to be much healthier in your branded -- your Mrs. Freshley's business, than a contract packing arrangement. With the increases sales, I'm just surprised that the specialty profits were down as much as they were.

Mitch, I think it's a timing issue.

Okay.

And some of it too, Mitch, is -- again, we have not replaced all of that volume yet. So you still have the -- obviously, the fixed overhead of those snack cake lines and to the extent we have not replaced all the volume, some of it shows up in the gross margin line in addition to the transportation line.

Okay. And then -- and so this is part of -- as you get your hands -- you know, your arms around I guess pricing and your capacity, adjustments, you would normalize in the second half of '06? Is that what we're saying?

Yes.

Okay. Also, Cobblestone Mill -- what are the issues there?

It has been capacity and the Villa Rica equations solves tremendously our whole issue with Cobblestone Mill. It's a great -- we still feel excited about the brand, it's just a matter of constraints on our capacity.

How about -- could you, for 2005, what was the dollar amount of new products versus 2004? Do you have that kind of number?

I don't have a specific on new products, Mitch. We do look at new customer -- it was kind of an interesting year because you look at new customers, new products, new territory, and you had a lot of changes going on, particularly in the Gulf Coast markets, as business shifted from one customer to the other, et cetera. So I don't really have a specific number targeted to just new products, and we, in fact, did -- I think George indicated with the new capacity, will enable us to get back on track as far as new product and introductions because we had some early in the year but then in the back half of the year our capacity issue created a situation, we essentially just didn't have them.

Okay. And so what is the outlook for new products in '06?

Second half introductions.

Okay.

They are already in the pipeline and --

In both bread and specialty?

That's correct.

Okay. Looking at Derst for a second, just a quick back of the envelope calculation, it looks like their average weekly sales per route is about 70% of what your average is. Is -- I don't know if that's accurate, but --

You took those sales dollars divided by the number of routes we disclosed.

Yes.

Yes.

And just, so -- 70% -- my question is, what would be the reason for that lower dollar sales volume? And can you talk about their mix of business? It is more heavy in Private Label? Do they have snack cake? Do they -- are there any other -- do they distribute other bakeries' snack cakes or anything along those lines? Can you talk about that?

Mitch, actually it's heavily skewed toward retail business. They have a strong franchise. They have the Sunbeam brand in most of their markets. They have Captain John Derst, which is a product that they have had in the market for a number of years, a very strong franchise.

What is that?

It's a semi-white loaf of bread under the Captain John Derst brand and it does a great job in the market.

Old-fashioned.

It's an old-fashioned-type product.

This is a perfect example, I think, of over the year where most companies who have joined us have not, even though they have developed a strong franchise, I think the item they are missing is our Nature's Own and Cobblestone. So what you will see is a perfect example of where we'll lay in -- going back to your 70%, to get them to 100%, with Nature's Own and Cobblestone Mill and a little better cake line than what they have had, will get them up to our norm.

So they do have a cake line?

They do. They purchase -- they do not produce cake. They buy cake from other suppliers.

Okay. Okay. And in terms of their bakery, they have one bakery, how would you characterize the bakery? Relative to your system?

They have two bread lines, one white bread line and one old-fashioned variety bread concept.

Will it need any capital upgrades?

No. Well, not to say never, not in the immediate future. They've always been a very successful manufacturer of products.

Okay. Last question, regarding your DSD expansion, the -- typically. when you expand on DSD, it's -- they are not profitable initially, but you -- at least in the industry in general, but you have managed to expand at least without any let's call it dilution over the last year or two. Is that still expected? I mean, going into these new markets, it is a -- will it be a positive out of the gate, or will there be some drag?

Mitch, it is in our numbers. You know, northern Virginia, the Washington, Baltimore, we said there's about a six-month drag. It was not major. We overcame it pretty quick. That is all factored in our guidance. The territory that we will be going in I don't think will be a drain over the 12-month time frame.

Okay. Okay. Thank you very much.

Thank you, Mitch.

Thank you. Your next question is coming from Tim Ramey with D.A. Davidson.

Just a follow-on, please, on the Private Label question. As we think back to the 2Q, or really, I guess, the 3Q, where you did pick up some incremental business in 2005. Is the plan sort of to replace that with your territory expansions or replace that growth with the territory expansion in 2006? Or are we going to have a difficult comp in the 3Q of this year?

I feel, Tim, that the added expansion and the new products will help offset year-over-year sales equations that you are referring to.

Okay. Thank you.

Yes, sir.

Thank you, Tim.

Thank you. I will turn the call back to George Deese for his closing comments.

Thank you, Melissa, and I really appreciate all of you joining in with us this morning, taking your valuable time. I would like to comment that I look forward to seeing you in New York, March 14th and 15, and then of course out in Denton, Texas, our new bakery, on April 5th. We appreciate your continued interest in Flowers Foods, as this management team and all of our people work to expand our business, expand our margins, and create shareholder value. Thank you very much.

This concludes today's Flowers Foods conference call. You may now disconnect.