Flowers Foods Inc (FLO) 2008 Q3 法說會逐字稿

Greetings and welcome to the Flowers Foods Third Quarter 2008 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions).

It is now my pleasure to introduce your host, Marta Turner. Miss Turner, please begin.

Thank you, Keith. And good morning, everyone, thank you for joining us. On the call with us today are George Deese, our Chairman of the Board, Chief Executive Officer and President and Steve Kinsey, Executive Vice President and Chief Financial Officer. We'll discuss our third quarter results and the earnings guidance we gave you in our release this morning and of course then, we'll open for questions as Keith mentioned.

Our earnings release is posted on the website as is our updated IR fact sheet and we'll file the 10-Q on November the 13th. I do want to mention that we are going to have a management meeting -- our management team will be in New York for a company sponsored event on Tuesday, December the 2nd. We hope you'll mark your calendar to join us at that meeting either in person or on the webcast.

Now, of course, before we begin, I -- you know that I must point out that our presentation today may include forward-looking statements about our Company's performance. Those comments may include discussion about a number of factors regarding future performance such as earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow and other items.

The statements are based on our view of things as they are today. So, they may contain some degree of uncertainty. While we believe our statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to the matters we'll talk about during the call, important factors relating to Flowers Foods business are detailed fully in our filings with the SEC.

Now, I'm pleased to turn the call over to our Chairman, CEO and President, George Deese.

Thank you, Marta. Good morning and thank you for joining our call this morning. Let me start by saying that I certainly feel that Flowers Food is fortunate. We are fortunate to be in the food business, we are fortunate that our primary business is bread, a consumer staple that consumers buy in good times and in challenging times. We are fortunate to have developed operating strategies over several decades and that those strategies work.

We have a sound business model that over the long term generates significant cash to help fund our growth and reward our shareholders. We are fortunate to have had the foresight to continually invest in our bakeries to improve efficiencies and quality. And to have had the foresight to build two strong brands such as Nature's Own and Whitewheat and continue to grow with our local brands as well.

We have listened to the market and developed products that meet consumers' needs. And we have embraced innovation in all aspects of our business. Our information systems help us see into our performance daily, allowing us to quickly address changes in the marketplace. We're also very fortunate to have a team with experience and the confidence to manage our business even in challenging times. These strengths allow us to reward shareholders overtime by creating value through this business of baking bread.

Finally, we are fortunate that you have confidence in our ability to continue building shareholder value in the future. That confidence shows in Flowers Foods' performance in the market, especially in the past several weeks. For that, I say thank you. Rest assured that our team does not take our fortunate situation for granted, we are working diligently to further execute our strategies, to outperform in the marketplace and to continue delivering value for our consumers, customers, and shareholders.

Now, let's take a quick look at our third quarter results. We delivered strong sales and earnings growth for the quarter. Our products, our bakeries and our teams performed well as we continued our efforts to improve efficiencies and reduce operating cost. In the quarter, we completed two acquisitions, weathered three hurricanes and continued to grow our business even as the economy and the financial market experienced turbulent times. Our sales were up 21.2%, driven by our recent acquisitions, good unit growth, and pricing. Net income was up 21.8%. Earnings per share increased 20.8%. And EBITDA for the quarter was 10.4% of sales.

I want to thank our bakery team for exceptional work during the quarter. They achieved a 3% improvement in manufacturing efficiencies. Even that improvement and our pricing actions were not enough to offset our higher input cost and we saw gross margins decline by 50 basis points in the quarter. However, we delivered good results by achieving further improvement in our SG&A costs and that offset our lower gross margin. Our continuing efforts to move production closer to the market, and to reduce our logistics costs helped reduce our SG&A expenses.

Now, let's take a closer look at our sales categories. In the quarter, our branded retail sales were up some 20%, delivering this strong growth -- dollar growth, as well as unit growth shows the Flower's business continues to be strong even in the face of economic uncertainty.

Across all product categories, our branded products achieved solid growth showing the strength of our Nature's Own, Whitewheat and other brands. Information from IRI, once again, shows that our brands gained share in both dollars and units in the quarter and that we outperformed the fresh packaged bread category.

As I mentioned, our brands delivered across all categories, our branded white bread led by Whitewheat in regional brands were up double digits, which is well ahead of the category. In the soft variety category, our Nature's Own brand achieved similar growth with sales growth of an excess of 19%. Nature's Own all premium bread delivered double digit growth. Our branded buns and rolls and our snack cake brands also were up double digits for the quarter.

Sales of store brand, our private label, bread, buns and rolls, also were up in the quarter, although not at the expense of our brands. In the category as a whole, private label outperformed the category growth, I know you've asked this question many times, private label has been a strong presence in the fresh bakery category for several decades, holding about a 25% share of dollars and roughly 40% share of units in the fresh packaged bread and roll category.

When the economy is troubled, consumers typically eat more at home and buy more bakery items because those purchases help stretch the food dollar. For that reason, private label bread is experiencing some growth. But as I mentioned earlier, Flower's brands continues to experience strong growth as well.

Turning briefly to our food service business. Food service was stable with growth this quarter, driven by pricing and our recent acquisition. A few other highlights I'd like to mention for third quarter. As you know, we completed a merger with Holsum in Phoenix and the acquisition of the ButterKrust bakery in Lakeland early in the quarter.

In light of the economy and marketplace challenges, some have asked if we would do it again if we had known what was ahead of us. The answer is an overwhelmingly yes. You might ask why. I feel that because of these acquisitions fit so well with our growth strategy. Both bring efficient bakeries, talented teams, great products and great access to the market. Both have the potential to contribute to our long term performance and the creation of shareholder value.

I'd like to bring you up to date on where we are with the integration of Holsum and ButterKrust . First, Steve will report that sales and earnings from these acquisitions are tracking as we expected, we already capturing synergies in both the areas, particular down in Florida. We are bringing both companies into our information systems. First ButterKrust by year end and Holsum in first quarter of next year. Also, I'm happy to say that this week, consumers in Arizona and Las Vegas area are seeing Nature's Own breads in their market for the first time as Holsum distributors enter to use the brand across their territories.

Our growth potential is solid with both acquisitions and these new operations help meet our capacity needs that we've been talking about now for several years. We continue to go into new markets. During the third quarter, we did enter the St. Louis market and the Wichita, Kansas market. As you remember, our market expansion efforts over time have contributed about 1% a year to our DSD sales. We will continue to push our boundaries to reach new markets with Nature's Own and Whitewheat and our other brands.

Talk a little bit more about capacity. When we announced our market expansion strategy in 2004, I told you we would need to build or buy a bakery about every 12 to 18 months to have the necessary production capacity to keep up with the growth. We have delivered on that promise, adding new bakeries in Denton, Texas, Newton, North Carolina. We also have added production lines to existing bakeries in other parts of the Company.

Our newest bakery in Bardstown, Kentucky is well underway and we expect to begin production of bread there in the spring of '09. You will remember that ButterKrust -- that the ButterKrust acquisition in Florida brings us substantial production capacity and as a result, we will not need to build a new bakery in Florida, as we had planned prior to the acquisition.

Hurricanes kept us active also for the quarter. As you know, we had three hurricanes in the quarter. I guess Ike was the most serious of those three. But I am happy to say that our team executed our crisis preparedness plan flawlessly and did an excellent job of managing through these storms. Although we had two bakeries without power for a short time, our profits are on the market and our teams did a wonderful job. And we did so without -- we did have expense but also sales took care of that, so we're not saying we had any extra costs for the quarter.

There's no shortage of opportunities for us in the third quarter from acquisitions to hurricanes to growing economic crisis. In the face of all of that, our team remained in focus on executing our strategies and once again delivering good results.

Now, I'll ask Steve Kinsey if he will give you the more detailed report of the quarter. Steve?

Thank you, George. And thank you, all, for joining our call today. This morning, I will just discuss our third quarter performance, renew the updated 2008 full year guidance and then discuss briefly the preliminary fiscal 2009 guidance.

As George said up front, our third quarter performance was strong. We had robust sales growth in the quarter and overall our margins, both in dollars and percent fared well in the quarter. Net income from the quarter improved roughly 22% quarter-over-quarter to $27 million. Our operating margin, or EBIT as a percent for the quarter was slightly up at 7.4% of sales. This is in line with our year-to-date EBIT margin, which was also 7.4% of sales, which also was slightly up but compared to the same period last year. This improvement primarily is due to our increased sales from pricing, our efficiency gains in the quarter as well as our continued focus on driving costs out whether it's in -- above the line in the margin or in SG&A.

Diluted earning per share for the quarter grew approximately 21% to $0.29 per share and our year to date earnings per share was up almost 19% compared to prior year at $0.94 per share. As George said, our brands continue to perform well in the market place, our consolidated sales growth for the quarter was 21.2%. Pricing and mix contributed 10.9% of that growth and volume represented 10.3% of the growth. Looking at volume, acquisitions represented about 9% of the growth in the quarter and our core business without the acquisitions was up about 1.2%.

Looking at our direct store delivery group, or DSD, they also performed very well in the quarter as did our warehouse delivery group. If you take a look at the segments, the DSD sales were up 24.7% for the quarter, a pricing mix in that segment contributed about 10.6%. The DSD volume in the quarter was up 14.1% and again, acquisitions added about 11.2% of the segment growth. And the core markets were about 2% of that growth. Also as George mentioned, our expansion markets continued to trend about the 1% of sales on the quarter.

Our warehouse delivery group sales were up 6.1% quarter-over-quarter with price and mix contributing about 8.9% of that growth. They did see a decline in volume of about 2.8%. The volume decrease really -- so it's primarily in the snack cake category. As George mentioned, some of the softness in the food service sector seems to have stabilized and maybe that's bottomed out and the trend, hopefully, will turn in that category.

Year-to-date to the third quarter, consolidated sales were up 14.7% to $1.8 billion for the same period last year. The year-to-date increase was achieved through federal pricing index of about 10.4% and our volume was up roughly 4.3% with acquisitions contributing about 2.8% of the volume increase.

Looking at gross margin in the quarter, our gross margin dollars did increase about 20%, but as George said, our gross margin percentage declined 50 basis points to 48.1%. And again, has been true for the year, the primary driver for this decrease in gross margin has been the increase in our input costs in the quarter as well as the year and primarily as the input of -- increase in flour for the year. If you looked at our total ingredients for the quarter ex the acquisitions, we were up about 21%.

However, looking back at the second quarter of 2008, this was a pretty significant improvement. If you recall, we had dropped in the quarter -- second quarter to about 45.7% of sales. So, as we had planned and discussed, the back half is coming together nicely for us and as we talk about the full year guidance, you will see that we expect to have a good year. We're still targeting a 47.5% to 48% gross margin for the full year and we do -- and as you will see, the year-to-date margin is down about 160 basis points, that's 47.5% compared to the same period last year.

Quarter-over-quarter, and through year-to-date, through the third quarter as you look at the other components costs of goods sold as a percent of sales, majority of them would be relatively flat to slightly down. Selling and marketing admin expense as a percent of sales for the quarter decreased to approximately 37.7% of sales which is a 50 basis point improvement over the same period last year. As George indicated, we are still focused on driving out distribution costs by moving production closer to the markets and we stay focused on trying to keep admin costs and selling and marketing costs in line.

We continually look for opportunities to improve margins. George mentioned our efficiency gain for the quarters, and again as we bring on new production capacity and we continue to expand our markets, we will continue to look to move production closer to the markets and continue to work on the distribution costs.

The decrease in net interest income for the quarter is the result of higher interest expense for debt service on the acquisition, a related loan, and the outstanding balances on our revolver. Interest expense for the quarter was $1.9 million and we estimate the full year interest expense to be approximately $5.7 million. The higher interest expense was offset by interest income on our distributor notes. Looking at the third quarter tax rate of appropriately 35.7%, it is inline with our full year expected rate of approximately 36%.

As you can see and I would have to say that our balance sheet probably shows the most obvious change in the quarter. We took on significant leverage in the quarter as a result of the acquisitions and also to meet certain working capital requirements. Currently, we're levered just above one times our trailing 12 months EBITDA and we ended the quarter with roughly $265 million in bank debt. $170 million of this debt is related to the two acquisitions and the remaining $94.5 million or $95 million is primarily the result of working capital requirements and the share repurchases in the quarter.

Our working capital decline in the quarter really is attributable to our hedging activities and it's based on how we cover and how the usage unfolds for the year and as we'll indicate later, some into next year. So, we are having some margin calls and needs as we move throughout the year.

During the quarter, we did repurchase 1.5 million shares of common stock for $38.2 million. We funded approximately $26.5 million of our capital expenditures and we paid dividends of $14 million. For the year and through the third quarter, cash flow from operations as you can see, was still strong at about $50 million and we are well in compliance with our debt covenants at the end of the quarter.

Looking ahead, we're confident our operating cash flows will continue to be strong and remain our primary source of cash. If you look at our cash allocation, we will be focused on debt reduction as we move through the remainder of this year and into next year, in addition to the other items that we had historically spent cash on, the CapEx and dividends, share repurchases when the opportunity presents itself. Over time, we have generated significant cash and there's no fundamental changes in our balance sheet and we expect to continue this as we look out over the near term.

We have updated our 2008 guidance based on the year-to-date performance, as well as the impact of our recent acquisition. We now project that 2008 sales will be approximately $2.42 billion to $2.43 billion. It's roughly an 18.8% to 19.3% increase over the prior year. Price and mix are expected to provide 10% to 11% of this increase, volume is 6% to 6.5% and as you recall, this is a 53-week for us in our fiscal year, and that week now is project to provide about 2% of increase. The overall volume growth of 6% and 6.5% does include acquisitions of 4.5% to 5% for the year.

Net income is now targeted to be approximately 4.7% to 4.8% of sales or $113 million to $117 million for the year. If you look at the estimated shares to be outstanding and roughly $93 million of our targeted earnings per share for the year of $1.22 to $1.26, an increase of 19.6% to 23.5%.

We anticipate the acquisitions and related integrated costs for the full year will be dilutive again, approximately $0.01 to $0.02. As George mentioned, in the third quarter, they were basically neutral. I think a couple factors contributed to that one. The integrations are progressing nicely on this -- there's a lot of opportunity in the acquisitions and we're beginning to see some of that. And the third quarter, we did not have a full quarter of interest expense, nor were the shares that were issued for the acquisition out -- outstanding for the whole quarter.

With only nine weeks left in the year, we are confident in our guidance that we provided. As George said, the category has proven to be pretty resilient in economic downturns, and we believe the current downturns should be no different.

This morning, we also have given you preliminary sales and earnings guidance for 2009. If you look at the current financial crisis and the sudden downward movement in commodities, volatility and uncertainty were definitely the buzzwords in our planning process for 2009. From the early stages of our planning to the final plan, we've seen dramatic swings in input costs as commodities again fluctuated wildly. However, that we have remained steadfast in our execution of the strategy and philosophies that have worked well for Flower's Foods in the past.

We are projecting 2009 sales to increase by just over 12% of a range of 14% to $2.72 billion or $2.765 billion. With the two recent acquisitions adding approximately 7% -- 7.5% or so to this increase. As a reminder, 2009 will be a 52-week year compared to 53 weeks in fiscal 2008. Of -- pricing and mix will contribute about 5% to 6% and the volume and growth excluding the acquisitions will be about 1% to 2% for the year. This reflects sales growth ex acquisitions in total for 2009 of 6% to 8%, which is in line with our targeted long term growth of 5% to 8% that we believe is necessary to obtain sustainable growth over time.

Based on these sales targets, net income for 2009 is estimated to be $124 million to $135 million or 4.6% to 4.9% of sales. To use the estimated average shares outstanding of $93.3 million, earnings per share for 2009 are targeted to be $1.33 to $1.45 per share or an increase of 9% to just over 15% compared to 2008.

Though we do not provide quarterly guidance, it think it's important to point out that we do anticipate tough comps in the first half of 2009, particularly in the first quarter, due primarily to input cost increases during that time period and George will comment more on commodities in just a moment.

Capital spending is estimated to be between $75 million to $85 million for fiscal 2009. In year modeling deprecation and amortization expense as a percent of sales should remain fairly consistent with the 2008 run rate and this does take into account additional depreciation and amortization of the recently acquired assets and intangibles as well.

Like most companies, our 2009 performance will be dependant on consumers and whether buying patterns will change in the current economic time. I can assure you that we are keenly focused on these current trends and we are committed to growing sales and earnings and we are prepared to take whatever actions are necessary to maintain our unit and protect our brand. Our guidance at this point reflects our best estimate of the current and projected trends.

Like recessionary times in the past, this too shall pass and I think at Flowers, we're [more] successful for protecting our brand and market share, we should emerge as an even stronger company when we pull out of this economic recession.

Now, I will turn it back to George.

Thanks, Steve. As you can see from our updated guidance, we expect to deliver good results for 2008 and course for the year ahead. As a reminder, our strategies are proven, our business model works, and our team is the most experienced and talented in the industry. The guidance we have given you for 2009 shows that we expect to continue growing our business and delivering good results for our shareholders, despite challenging economic times.

Our hedging and forward buying strategy helps us have visibility for our cost. Once our future costs are defined, we do take action to further improve efficiencies and take out costs wherever possible. Then, we take pricing as needed in a timely manner.

On our second quarter call, we told you that we expected our incremental input costs in 2009 to be similar in proportion to those we experienced from 2007 to 2008. I need to fine tune that information for you. As the costs of commodities and other input items have moderated in the last few weeks, we now expect 2009 input costs to be in the $75 million to $80 million range, which is about 60% of our increased cost this year compared to last year.

We continue to execute our hedging strategies and we have taken coverage for wheat and other input items a part of 2009. That is all incorporated in the guidance we have given you today. For competitive reasons, I will not discus the specifics of our coverage. I can tell you that our planning for 2009 is complete and we have operations budgets in place as well as projections for sales and earnings that are reflected in our guidance today.

To help offset our higher input cots, we continue to make improvements in efficiencies and in logistics and to reduce costs wherever we can. That effort has always been going on and will continue to go on forever seems like. We also have taking pricing action to help offset that higher costs we will experience in 2009. On average, our prices increased about 5% to 6%.

When you think about 2009, please remember what Steve mentioned. We told you this year that the second quarter would be our most challenging quarter on a year-over-year comparison. Although we delivered second quarter results that were on plan for us, the market was surprised by opinion myths according to the consensus.

It is important for you to know that first quarter of 2009 will be our toughest quarter in the year when you look at year-over-year input costs and the issue that it could have with earnings per share. As we look ahead to 2009, all costs are not equal quarter-to-quarter. The first quarter, underline the first quarter will be difficult on a quarter-to-quarter comparison. We expect the second quarter will be the second most challenging in '09. Our plan and our guidance for 2009 takes all of these factors into consideration and we're confident in the ranges we are providing today. I just ask you to remember that costs fall differ quarter to quarter.

We are pleased that we're in the bread business. Our past experience shows that consumers buy bakery products in good times as well as in troubled economic times. In fact, one loaf of bread and a few other inexpensive food items can make several meals for families. The staff of life, bread of course, truly does help feed a family when times are tough. Sales of our branded products are solid and growing, although there is some movement between channels, food service retail and so forth. Our product line and excess to market makes us well positioned to address these changes.

Our teams are focused on having the right products on store shelves at the right price. We know the importance of having our local teams apply their expertise to serve each location with the right mix of products at the right price. We are flexible to change quickly if consumers change their buying patterns, or if customers' needs change.

With our proven strategies, our solid business model, our experienced team, our strong brands and our great quality baked foods, we believe we are well positioned to deliver good results for 2008 and to continue building value for the shareholders in 2009 and beyond.

We are excited about the growth opportunities in the west as the Holsum team introduces Nature's Own to their markets. We also continue to see good growth potential in our expansion markets as well was our core markets. Our team is focused on further improving our efficiencies. We are executing on proven strategies. We like the baked food business and we are well positioned to deliver good results going forward as we focus on our growth opportunities.

Now, Steve and I will take questions. Keith, I turn it back over to you, but Keith, let me ask the first question to myself if I was sitting in the audience today and that has to do with our hedging philosophy. All of us can look back on Monday and see how the football game could have been played better on Saturday. Because you look at hedging, this is a strategy that has worked so well for the Company for many years, I would really point to the last four or five years of great execution.

I feel good about our positions. Sometimes, you can look at where the hedges are and you can say you bought too high, you didn't wait long enough to get the lows. I personally found out, when you wait for lows, sometimes you end up having the highs. So, we look at it for the long pull. We said many times that we do hedge out six, nine months even a year if we feel that that's a good position for us to be in.

In thinking about that, we did see wheat up to $10, $13 category. We did not participate in that, neither did our customers and neither did our consumers this year. You can see times when wheat could get to $350 even though I don't predict that. Sometimes we do not participate in the lows. But what we try to do over the long term is have the right price, the right products for our customers and consumers, not only for today but tomorrow and for the future and try to do that right. So, I feel the strategies are correct and our costs are in line and with the pricing that we have in place, that's how we can feel confident about giving you the guidance that we give you today.

But Keith, I will turn it over now for further questions.

Okay, thank you. (Operator Instructions).

And our first question comes from Heather Jones with BB&T.

Good morning.

Good morning, Heather.

Very good quarter. Congratulations.

Thank you so much.

I have a question on your hedging and I'm not going to ask specifics, but it's more of a qualitative type question. You said that you had some of your coverage, I believe that's what I heard you say, some of your coverage in place for '09 and was wondering, I believe last year that you had almost all of your wheat coverage in place going into the year. Wondering if this is a change in direction or just given the volatility in the markets, if you felt it was best to wait before completing your coverage. Just wondering what we should expect for the last few months of this year.

You did say that's a quality question didn't you?

That's a qualitative.

I'm kidding you. Heather, again each year brings on a different set of facts. Just to reiterate, I feel like our strategy does work, we are covered. Parts of '09, I would not say specifically on the term of that because of competitive reasons. Heather I would say as I said, I give you an indication the first quarter is by far the heaviest and the costs will be the highest for the year. I will say that the back half of the year looks more attractive and when we see an opportunity to buy and participate in those hedges for the latter part of the year, we have and we will.

Okay. And you said you took pricing up 5% to 6%, I was wondering if you could give us -- I thought you were taking some pricing in August, I don't know if this -- you're talking to the same price increase. I'm wondering if you think that's the only price increase you should have to take for '09.

I would say that we announced in August, but it's affective like October 1st.

Okay.

We always look out at the year ahead and see what is needed and that's based on why and when we do it. We feel that this -- if things stay in place, like they are today and that's if, we did not see further price increases until maybe October again of next year. That's not a promise because the facts change and it dictates we'll do something different, we'll just have to work on that at that given time, but as we see it today, I feel good for the next 12 months.

Okay.

12 months from October and to next October.

Okay and wondering on your sales guidance increase and also appreciate the early look at '09. But on your sales guidance increase for this year, was wondering -- it would seem, based that you raised it, that you didn't see any discoloration in your volume trends during October but I just wanted to doubt check that -- if that was the case, that you didn't raise guidance because of early -- quicker integration of the acquisitions. So, just wondering if October trends held up for you.

I did say in my prepared remarks that we did see a little change over not significantly, not enough to worry about, and we do things based on trend and we did see and I did say that private label was up slightly for the quarter. It was again up slightly in October. I'd say that October was not robust, but it's not an alarm. I don't see that as an alarm at all.

September to October, usually -- September is usually our slowest month quite frankly. October is better than September, but I don't see an alarm there at all. Steve, you want to follow up on the guidance on the sales question one more time?

Yes, I mean if you look at the -- I think your question is since we've completed the quarter and moved into the fourth quarter, are we seeing any trends that would alarm us on volume on our core business because I don't think at this point we've seen anything that really concern us.

And Heather, I think you followed up with a question I didn't quite get is on the question part of the --

I was just wondering of your sale -- because you did mention a slight deceleration. So I was just wondering with the raise and the sales guidance was that -- did that reflect that your integrating -- integration with the two acquisitions is going smooth or you're getting Nature's Own products into the southwest quicker than you thought. I'm just wondering if that's what it --

Yes, that's --

Okay.

That's very true. The two acquisitions on -- from a tracking standpoint is ahead of we thought we'd need from sales standpoint. That is a true statement.

Okay, all right. I appreciate and congratulations again.

Thank you, Heather.

Thank you. And the next question comes from Diane Geissler of Merrill Lynch.

Good morning.

Good morning.

Morning.

Hey, I think I missed this in your commentary. I think you said that the commodity cost you expected to be up now $75 million to $80 million, what was the original expectation there?

I think we talked about it, we thought it would probably equal somewhat the last year and we said now that we expect to be about 60% of last year, which I think last year we're talking terms of $120 million, so last year, now we're looking at $75 million to $80 million.

All right perfect. And then I guess --

And I did say a lot of that would come in the first half.

And is that just a reflection of how well hedged you were in 2008 that you'll still see costs up year-over-year or is it because now you've laid in some hedges for the first part of '09 that are going to be a little bit above where market prices are? What -- how does that factor in?

Well, we won't be -- we won't be that specific but we did -- because you know we had a great first quarter last year. The year we're in now. The first quarter of '08 was simply outstanding and even though we're performing well in the marketplace, we also had good input costs for the first quarter.

Okay, well, I guess I'm -- I'm hearing your comments about price, that you don't expect to take more pricing until the back half -- October of next year and I guess if wheat costs continue to trend down, is there some other component that would pressure you to take pricing increases again next year?

No, if commodities tend to trade down, if there's no other obstacles we would not need to look at priding again for a while. But we don't -- I'm couching that statement by we do not know. Things are volatile, gosh, it changes every day. Used to be you could go through a whole month and commodities wouldn't change a nickel. And daily we see $0.30, $0.50 up and down. So, any day or any moment you might see that --

I hear you on that. I got you.

Something in the world change that could blow us out of the water from going up on price. We just can't predict that.

Okay.

And Diane, just as a reminder, even though wheat or flour is a significant component of the ingredients, there's still other big components as well, sweeteners they're up -- they're projected to be up, and then oils are up pretty substantial for net year as well.

Okay, I was just tying to figure out if you're trying to call out something to us other than wheat that is on your radar -- that you have -- you're concerted is on your radar screen and that you think might actually be going up next year. That's really --

You always have the typical things from labor to [franchises], et cetera et cetera.

Okay.

But that's always expected and in our guidance.

Okay, and I missed the expansion markets are Wichita and --

St. Louis.

St. Louis?

Yes, we moved into that -- those markets just a few weeks ago.

Okay, and when you think about your expansion market, do you tend to think of them in terms of we want to add ex million dollars in revenue or we want to add ex number of routes, how do you -- when you think about how many markets because you go into that provides a little bit of color there that I would appreciate that.

You probably won't believe this, but it's non-scientific. Really, Diane, the real truth is when we see an opportunity that presents itself; we do want to expand into our fringe markets. Of course, fringe markets are different today than they were 10 years ago. And we want to grow our company, we want to expand the Nature's Own, Whitewheat brands. We want to take care of our customers better, be more important to all of our customers so you -- we need to expand for that reason.

We've been able to expand our markets and do it cautiously so that we don't kill the P&L as well and that has proven to work well for our shareholders and so we will continue on that same trend. Opportunities present themselves and are based on where a need might be with customers and/or capacity and capacity restraints also plays a part in this.

Okay, so really it's a market by market decision. In other words, you see okay, there's a pocket here, lets look at that and strategize how many routes we would need to cover that. Its not necessarily we want to have 1% to 2% revenue growth every year from expansion.

No, but I hope we can keep this 1% going for a long time.

Okay.

Over and above our normal business. Thank you, Diane.

Thank you.

Thank you. And your next question comes from Eric Katzman from Deutsche Bank.

Hey, good morning everybody.

Morning, Eric.

Morning.

Congratulations, great quarter. It's frustrating to see the stock down as much as it is, but I guess that's our side of the volatility equation. Guess first question, you've got a lot of your business on scan based trading so you see very, very quickly what's going on at the market. How does potential retail or inventory cut backs play into the outlook and are you seeing any impact in the bread category and in your business?

On the fresh DSD business of course which is the majority of our business, that's a day to day business and inventory -- we've never had an inventory issue because we want to sell fresh -- the fresher the better. So inventory is not a problem on fresh. Even on the frozen side, we have not seen anybody trying to cut back or say we've got too much inventory. We tried to make sure that we managed that through our information systems and that we keep just enough on hand, because we don't like the inventory on our side either. And we try to manage that.

So, I don't -- Steve, I don't know of any issue or problem --

Yes, we don't any issues with -- on the frozen side where inventory seems to be trending up and they're seeing a [a sign] for concern, Eric. And again, as George said, on the fresh side the inventory or scan based trading remains with the distributor and the company, the risk there. So, we haven't seen any push back from customers about the amount of inventory being put in the stores.

Okay, that's comforting. Second question has to do with kind of the competitive dynamics and specifically given the credit market conditions, I suppose that some of your more challenged competitors, whether they're private or interstate or something like that are probably having difficulty in terms of letters of credit and where they were able to hedge. And so to the extent that input costs are down, is it your expectation that they could be more aggressive on pricing given that they probably couldn't hedge in '08?

Eric, I couldn't comment on our competition because I don't know. This has always been a competitive market, as you know, and we have a visibility into that and we always have and will remain competitive. I think Steve mentioned we've got to protect our brands and our units and our volume.

I've said many times though, our industry, as you look at the public companies announced, I know margins as compared to most packaged food companies are still in the low quartile of quality earnings. And I would just think we all got to grow our business and earnings for our shareholders. But I don't have a clue on what they're doing. I'm trying to stay focused on this business and do all the right things on our team on a daily basis to grow our business and take care of our customers and consumers.

Okay, last question and then I'll pass it on. I haven't asked this one in a while, but what is the health of your DSD entrepreneurs, what are their financial kind of situation like. I mean you have the advantage of having a low cost go to market strategy, but on the other hand, you're, I guess, to a certain extent dependant upon those DSD operators as being healthy in terms of their results and their lifestyle etc. do you have a view into that and how do you kind of account for that in your outlook?

Eric, I'm happy to say that as I look at it, in fact because of the whole fuel issue over the past 18 months or so, we've been very cognizant of keeping an eye on what our margins are for our distributors and looking at the gasoline effect of all of that. And based on all the insight I can see because of -- of the sales growth we've had, their margins are based off of different product categories and that has worked very successfully and my view is we're doing better than ever and now with the fuel coming down, I think it's even better for them.

Okay.

As I look past for a long time, I think its -- the program is working very well.

Okay, see you in December. Thank you.

Thank you, Eric.

Thank you. And the next question comes from Tim Ramey of D.A. Davidson.

Good morning, congratulations.

Thanks, Tim. Good morning.

Morning.

Just I would echo everything you said about Monday morning's quarterbacking, nobody's done it better, but -- there's always a but, I assume if you just looked at a market basket of commodities right now that they would be down significantly, looking at energy, grains, sweeteners, edible oil and so on. And you are very aligned with this, the largest value retailer, 20% of your sales go to Wal-Mart. What makes you confident that you can hold prices in that environment? That's a bold statement I think.

I'm not trying to be bold, I'm just trying to be honest and confident in our brands and our execution in the marketplace. We have not seen -- with our present pricing, which did go in October, I guess that's why I can be confident today in that -- can that change in the future? It always can. But so far so good. And we just have to stick to that. If facts change, we'll have to change our game plan some.

And just one other question on share repurchase. Some of the -- some of your other competitors have paradoxically backed away from their share repurchase [Fairley] yesterday, said they'd put theirs on hold, Kellogg I think has backed away a little bit. Do you -- do you view this as just as attractive a time as any, or are you trying to be a little closer to the vest, particularly with the new bank notes out there?

I would say Tim that we continue to -- or we've always bought opportunistically, we've never had planned buys so I would say that would still be our strategy going forward, but as we have taken on levers, we would also be focused on allocating debt repayments of -- there will be a balancing as to how we allocate the cash, but I don't -- have not seen any indication that we would suspend our premium or -- at this time.

Okay, good to hear. Thank you.

Thanks, Tim.

Thank you. And the next question comes from Mitchell Pinheiro of Janney Montgomery Scott.

Yes, hello. Good morning.

Good morning, Mitch.

I got on the call a little late, so please bear with me here. The Holsum is now making Nature's Own? The two -- the Tucson and Phoenix bakeries. How many routes is Nature's Own on and were there any costs associated with getting that production up and running out there. Any costs in this third quarter?

You have your normal testing process that you go through, but wouldn't -- it wouldn't be a big number. Didn't think it would be something we should talk about outside of the fact we do a lot of testing and sampling the market and going our key accounts for product. You do those type of things, but like you do on any new product introductions, but we're so pleased with the quality that these two plants are producing, they always do a great job on quality and I'm just thankful that they're doing a great job with Nature's Own.

So you'll be in all their routes as well?

Yes, I would say that Arizona and Las Vegas and southern Nevada was first and southern California is now coming on strong.

Okay, breakfast breads. The Nature's Own breakfast breads. How big of a contribution did they have in this quarter? I know you weren't fully distributed in the second quarter and with Wal-Mart taking on more of that product, it seems like that would have an impact.

We might have to answer that offline, I'm not sure we've got that -- I don't have it on top of mine, I just don't have the number available. We're pleased, I can come back and say though the strategy of having these breakfast breads, muffins, bagels, under the Nature's Own brand, I think is certainly in good course. We have had growth. We do have a major competitors which does a great job and we might just have to keep that number off line if you don't mind.

Yes, I don't mind. As far as -- the space you're getting for breakfast breads, is it incremental or taking away some space from existing Nature's Own or other branded products?

I'd have to say both. You always have the strategy of going to the retailer and trying to get new space. That's always what you want. And a lot of times that happens. And some of the times, they will say you've got three or four SKUs that's not doing what it should be, why don't you put the new product in that space.

Right.

So we've had some of both, but I'd say overall, we've had some success on gaining new space.

Is -- from a margin perspective, do the breakfast breads have higher average or lower margins than your regular Nature's Own line?

Well, I'd say quarter by quarter margins will get better as with any new product, any new brand, you always suffer some extra returns.

Right.

And that comes out of margin of course. So over time as we gain share and learn what store the merchandise in properly, sales will come down but in quarter by quarter, I think we'll see those margins improve.

Well, it's my understanding -- Thomas's margins are off the chart strong and I would suspect that -- and no one's really been able to knock them off, they maintain a very strong market share even through other bread companies have tried English muffin and those types of products. I don't think anybody's tried it with the Nature's Own brand, with the strength of a Nature's Own brand. So it would seem like there's some market share to be gained there and also with high margins. Is this fair.

Thank you for the comment.

Okay.

We do have strong competitor and we think the Nature's Own brand will help us in that as we go to market.

Okay. And I -- again, sorry I missed, but you said Wichita, St. Louis are new expansion markets. How are they -- where are they going to be sourcing their product from? Which bakeries?

Out of our Arkansas operation at this point.

Okay. And were there any hurricane costs or sales benefit in the quarter?

I believe I did make a point early on that we did have the three hurricanes, we did have some expense, but fortunately, and each one is different, but this particular quarter we were able to, because of the added volume that we -- our sales teams managed to get product from our other bakeries around those plants that were closed and we took care of the market, I think, beautifully. We did sell enough product to offset the losses so we came out at least even.

Okay.

If you can come out even you --

Right.

You'll be happy.

Okay. And then, last question was when it comes to I guess how you look at pricing, in both -- and this is both in the retail side and in the food service side. When it comes to food service, in particular, you're the largest player in your markets and probably arguably one with maybe the highest service levels, potentially the highest service levels. Is there -- is that part of the equation when it comes to pricing and why Flowers is able to maintain those levels or is it strictly -- is it always bid out and the lowest cost wins?

Well, we're -- we're pleased with our food service business, Steve did mention it seemed like the market is improving a little on the food service side. As you know, we do have a great relationship with our customers and in that, we keep them informed on our cost, what's going on. And we talk to them about some of our hedging strategies and work together.

So, when we do need pricing for obviously reasons, most of the time it's not a battle because people do believe our company and the trust factor. So we are able to get a pricing on an as needed basis. Commodities do go up and I -- Mitch, you wasn't on the call earlier, what I did say was our customers and our consumers participated on the high end of the commodity cost. Sometimes neither will they participate in the very lowest costs. We try to look at it over the six month to 12-month horizon and how a fair input cost and fair cost to our customers and consumers and trying to get a fair return and we just try to manage it that way.

Okay, thank you very much.

Thank you, Mitch.

Thank you. And the next question comes from Farha Aslam of Stephens Inc.

Hey, good morning.

Hello, Farha.

Couple questions first, could you tell us how California expansion is going?

Well, we're pleased, back to -- we're certainly pleased with our Holsum acquisition. The strategy is working right no what we thought it would be. As we said on the last analyst call, that the prior ownership had moved into the California market as one of the competitors basically moved out and you really got to look at it, what we can provide that maybe some of the other bakers aren't.

And we believe so much in our model of going to market through our independent distributors along with great brands and Nature's Own and Whitewheat and overall good programs. So -- Southern California won't -- it's not going to be a huge factor for us in the immediate future. We will grow steadily we trust and that's what we're seeing as we've gone there and that will again introduce more products to the marketplace. It's just going to take time.

And then you had mentioned about $120 million in costs for this year. That was specifically ingredient costs or I thought it was my understanding that your total costs this year were closer to $150 million to $160 million when you consider packaging and labor.

Steve, you'll have to answer it.

Yes, Farha, I think originally back on the second quarter call we had given an indication of the magnitude of our costs increase and we had said on the input costs it would be similar, and that's where the $120 million came from. But we modified that today to say we're looking at $75 million, $76 million of input costs for the year. So we had guided down on the input costs. That does not include total costs, that would just be our ingredient packaging and natural gas.

So that's ingredient packaging --

Natural gas.

Okay, those were my key question, thank you very much.

Thanks, Farha.

Thank you. And we have a follow up question from Eric Katzman of Deutsche Bank.

Hey, I guess my question has to do with your working capital change. Steve, could you go through that in a little bit more detail. And I think you also mentioned something about margin calls. Can you kind of be a little bit more specific on that?

So if you look at the change in working capital for the quarter, it was negative and that's primarily the result of our ending activity, Eric. If you're -- if the market's at one level and your head is at a different level, sometimes you have to go ahead and plug the cash up front. And as we talked bout our first half next year, its obvious that we're probably funding some of that at this point. Then as the hedges rolling to be used, to be used or they roll into the period of actual use then net cash over time will come back in theoretically and it all washes itself out. So really the negative effect on the working capital for the quarter is primarily due to the margin on the hedges.

So the -- so looking at the full year '08, so you -- I guess you've got some acquisition impact which will probably be something on the negative to working capital, but will that be a significant use of cash for the year or neutral if its out there?

It's really hard to say because it moves with the market daily. Not trying to predict the commodities market. So as that fluctuates daily then that fluctuates when the cash goes out or cash comes in. so I would say it would be -- it would really be unfair to try to predict that. All subject to the market.

Okay. All right. Thank you.

Thank you.

Thank you. (Operator Instructions)

We have a question from David Leibowitz of Horizon Asset Management.

Good morning.

Good morning, David.

Briefly, the guidance on profit margins for next year, what would be the prime contributor to having the margins shrink? And you told us all the things that could go wrong, but if we were to try to prioritize which one might be the triggering factor, which would you suspect it might be?

David, it's hard to say, I would say since our all -- we don't have all the input costs like that of 100%. They could -- that could go some either way. There have been questions about pricing on the phone today, how that really turns out. Our price is in and it's all projected out. I do have to feature more. There's a lot of variables, we feel good about that range. Obviously you see where we are for the year and we're projecting again, basically, keeping that margin and then hopefully even growing slightly.

Okay. And the second question, what percentage of your new markets are now being served wit your full arsenal of product? In other words, we have the two acquisitions move in to the two new territories what percentage of your potential customs are now stocking the basic Flower's line?

David, I'd say in principal, all of our new territories, depending on when you went in, and you remember that's a rolling equation. I'd say Northern Virginia, that was one of our first, certainly has a full array of Flower's providence. Wichita, which is only four or five weeks, would be somewhat limited.

And you do it over probably first six months that you have -- it would take to get a full array of products in. looking at the merger of Holsum, they had their own strong product line and what we're doing is supplementing that product line with our number one brand and our number one brand is soft variety bread in the nation. So that is on most of their territory now itself, California and that will -- southern California, San Diego specifically, will begin to have Flower's products. So they will not have the full array of Flower's products in Phoenix.

When you say a full array, they already have their own white bread brand or certain food service type products. So everything will be available to them and they already had a lot of those products under their own brand.

Okay, and the last thing, when you open a new territory and then start introducing the Flower's brands, are your profit margins as good as you get in the established arena or is it more a matter of gearing up and taking 18, 24, 36 months, whatever it might be to reach the established margins?

Dave, I'll let Steve holler upon it from a financial viewpoint, but what I would say is anytime you move into a new market, new products which the market may not know your brands, your most the time successful in getting space, but the consumers don't always pick it up immediately. So you go that growth period. So you'll have heavier cost up front, which does limit the profit margin some. But what we've seen over time, year, 18 months or so, no more than 24 months, those new territories are on par with the rest of our margin throughout the company. Steve, is that fair --

I would say, David, in addition to having to feature to attract the consumer, you're also layering in addenda distribution costs and typically in a new market, those routes will be operated by company until we can establish a sales base and that sometimes can be more -- that's more expensive for the company in that point because you're having less volume until you built the route average there. So in that --

Thank you --

So that does affect the margins.

Okay, thank you very much.

Thank you, Dave.

Thank you. And the next question comes from [John Mamork] of Ironworks Capital.

Thanks, can you update us as to the performance of the pension assets on a year to date, number one. And number two, what you've assumed about pension expense or income for next year in your guidance for '09.

Sure John. Looking at the -- obviously all the markets have been hit, our plans no exception. If you look at what we're projecting for 2008, typically you lag in year when you look at expense on the pension. We're projecting roughly $7 million of pension income because we did freeze our plan about five years ago. And looking at the 2009 as of this week we're projecting roughly $2.5 million.

So it's a pretty substantial hit and it still remains to be seen as to where the funds end up the year or so. I don't anticipate that would improve any and still some possibility that that could drop. But in our plan and guidance, we have roughly $2.5 million for next year pension income.

Your valuation date is December?

December 30.

30, I guess. As of right now or sort of October month end, is the -- you were $34 million over funded, end of '07, are you still over funded or --

Our fund is that is still pretty healthy, and we're still projected to be around that 100%, slightly over funded for the year.

Great. Thank you.

Thanks, sir.

Thank you. There are no additional questions at the present time. Do you have any closing comments?

Keith, I would. Thank you for hosting the call today. As I said earlier, we were fortunate to be in the food business, we're fortunate that our products, our fresh bakery foods is a consumer staple. We're fortunate that our strategies work. Now we'd like to stop this moment and thank our entire Flower's Foods team for delivering good results in the third quarter and for all their continued efforts to improve our business. Thank you all for joining today. See you in December.

Thank you. This concludes today's teleconference. You may now disconnection you phone lines. Thank you for your participation.