Flowers Foods Inc (FLO) 2009 Q3 法說會逐字稿

Greetings and welcome to the Flowers Foods call and webcast. At this time all participant are in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Marta Jones Turner, Executive Vice President Corporate relations for Flowers Foods. Thank you. Ms. Jones Turner, you may begin.

Good morning, everyone. We appreciate your joining our call today. Our third quarter earnings were released at 6:30 this morning. If you need a copy, you can find that on our website. And we plan to file the 10-Q on November the 19th.

To get started I must point out to you that our presentation today may include forward-looking statements about our Company's performance. These comments may include discussions about future performance including our earnings per share, sales, margin, operating profit, cash flow and other such items. The statements we make will be based on our view of things today so they may contain some degree of uncertainty. Although 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 matters we'll discuss during the call, important factors relating to Flowers Foods business are detailed fully in our filings with the SEC.

I also want to remind you that our management team will be in New York on Tuesday, December 1, for a company-sponsored event at the New York Stock Exchange. We hope you're planning to join us either in person or on the webcast. The security team at the Exchange requires an attendance list well in advance so please let us know by November 19, if you plan to join us. If you need more information call my office. Now on with our discussion of the third quarter call. On the call today we have George Deese, Chairman of the Board, Chief Executive Officer and President, and Steve Kinsey, Executive Vice President and Chief Financial Officer. George and Steve will discuss our results, then we'll open the call for your questions. Now I'm pleased to turn the call over to our Chairman, CEO, and President, George Deese.

Thank you, Marta, and good morning. Thank you for joining our call as we record our third quarter and year to date results. In the quarter we grew the top line by 4.6%, improved our operating earnings by 20.5%, and earnings per share by 17.2%. We are pleased with these results. As you know, more than a year ago the economy and competitive pressures in the marketplace began to impact some of the Company's results. Through our efficiencies, brand strength and careful execution in the marketplace Flowers Foods has been able to deliver solid results quarter after quarter in 2009 in spite of the economy. Changes in the competitive landscape and the heightened promotional activities we have seen in our key categories. As a third quarter unfolded we began to see sales of our branded product affected by the high level of promotions in fresh bread, buns, and roll category.

As we told you many times our team will not stand by and allow our market share to be eroded. We took action during the quarter to protect our position in the marketplace. Our deeper promotional activity was in place by the middle of the third quarter. As a result, by the end of the quarter, our sales dollars and units started rebounding. That rebound has continued through the first weeks of the fourth quarter. Let's take a look now at the U.S. bakery category in the quarter.

As reported by IRI, total US fresh packaged bread category was down 1.6% in dollars and up 2.3% in units compared to the third quarter of 2008. IRI also reported private label, our store brand share of bread was down in both units and dollars compared to the third quarter of 2008. It is important to note that fresh packaged bread, buns, and roll category is well developed. 99% of consumers buy fresh bakery product. Studies show that promotional prices may simply move unit volume between brands while the category suffers with an overall lower average price. The fresh bread buns and rolls category is one of the highest revenue and profit generating categories for food retailers. Keeping the bakery category a vibrant and healthy section is important to our customers and to Flowers.

Now, turning to our brand performance here in the quarter, the data from IRI shows that in our core market Flowers brands lost just over half a percentage point in dollar share, and about a point in unit share in third quarter compared to third quarter 2008. However, looking at the third quarter compared to the second quarter of '09, Flowers brands increased in dollar share and unit share.

More importantly, in the last few weeks, as we started our fourth quarter, we're seeing a marked improvement in our unit end dollar share for Flowers brands. As a reminder, IRI captures only about 48% of our sales. Across our product categories -- white bread, soft variety, buns, rolls and breakfast breads -- our brands continue to hold a strong position in the market even with the competitive pressures and deeper promotional pricing. Nature's Own outperformed the category in the quarter and it continues to hold a dominant share of the soft variety category throughout our core markets. We introduced two new items during the quarter, Nature's Own 100% whole grain bread and Nature's Own 100% wheat buns. We're very pleased with the consumer's acceptance of these new products. Our regional white bread brands were impacted by price promotions but continued to hold the leading share against branded competitors in our core DSD territories.

Now, let's take a look at the warehouse segment. I'm really pleased with the performance of our warehouse segment for the third quarter as they continue to post good sales and earnings increases. Once again, our Mrs. Freshley cake brand performed very well with a double-digit sales increase in the quarter. Mrs. Freshley snack cake continued to outperform in the market. Our food service sales continued to perform in line with the market but below the expected sales volume. As the economy improves, we are poised to take advantage of opportunities in the food service area.

A few other highlights of the quarter. We continued to strengthen our position in expansion markets. In the quarter, these markets contributed just over 1% to DSD sales, which is in line with our goals for market expansion. Our new Bardstown, Kentucky bakery continues to perform well. We opened that bakery with a bread line earlier this year. The second line for bun production is being installed, and we expect to begin producing buns at the Bardstown bakery in the first quarter. In August, we celebrated the one-year anniversary of our acquisitions of Holsum and ButterKrust. We continue to be pleased with the progress made at both businesses.

At the beginning of the fourth quarter we announced the acquisition of Leo Foods, a tortilla business that adds about $30 million in annual sales. Leo's increases our growth potential by bringing us additional capacity for tortillas and a new customer base as well. The total US tortilla category is about 3 billion annually for retail and foodservice. Our acquisition of Leo Foods is an important strategic move for our Company and a significant step in this important category. One recent study suggests the US tortilla manufacturing industry comprises over 30% of the packaged bread market, second only to white bread. I am pleased that we're taking steps to grow along with this very important sector in the baking business. We want to welcome Leo's team in Fort Worth to Flowers Foods. Now Steve Kinsey will give you a more detailed report of our financials. Steve.

Thank you, George, and good morning. As George said, the quarter was impacted by competitive promotional activity within the category. What we discussed in our second quarter call has now more fully played out and we found it necessary to compete more heavily in the promotional arena in order to maintain our share. Also as a reminder, outside of the promotional activity, a couple of other items also had an effect on our financial results in the quarter. We lapped the October 1, 2008, pricing initiative which as you may recall were fairly strong given the commodity head winds we faced, especially in the first half 2009. Also in the third quarter we lapped the acquisitions of Holsum Bakery in Phoenix, Arizona, and ButterKrust bakery in Lakeland, Florida.

Overall the 4.6% sales growth in the quarter was driven primarily by acquisitions. Excluding the two acquisitions as well as the mix plant acquisition earlier this year sales were up slightly. In the quarter price and mix contributed about 1.4% of the growth, acquisitions approximately 4.2% while our core volume was down about a percent. The volume declines continued to be driven by softness in the non retail channel of primarily food service, vending and institutional sales. We also experienced pressure on our branded white breads historically into this quarter as the result of the promotional activity in both brands and private labels. And our core sales growth was not as strong as anticipated as a result of the higher competitive promotional activity in the marketplace.

Despite the pressure on the top line we were able to expand our operating margins and net income during the quarter. Earnings per share in the quarter was $0.34 compared to $0.29 per share last year, an improvement of 17% year-over-year. Operating income in the quarter increased approximately $9 million or 20.5% over last year's third quarter. As a percent of sales the operating margin was up 110 basis points at 8.5% compared to 7.4% last year. Acquisitions were neutral to earnings in the quarter and year to date acquisitions were accretive approximately $0.02. Gross margin dollars were up slightly in the quarter compared to last year. However, the gross margin of 46.5% as a percent of sales was down 160 basis points compared to last year's 48.1%.

The gross margin in the quarter was negatively affected by higher ingredient costs, heavier than planned promotional activity and the overall lower than planned core sales growth. We do not get the gross margin lift we had originally anticipated primarily as a result of the heavier than planned promotional activity within the quarter.

Map spend in the quarter in the DSD segment, which is primarily where we spend our map dollars, was approximately 6% of DSD sales. Even with the lower than anticipated sales we continued to lever the SG&A costs which were down approximately 280 basis points as a percent of sales compared to the same quarter last year. This improvement continues to be driven by distribution in administrative efficiencies. We expect the full year SG&A expense as a percent of sales to be down approximately 150 basis points year-over-year for fiscal 2009. Net interest income in the quarter declined due to higher interest expense resulting from debt service related to last year's acquisitions. The effective tax rate for the quarter of 35.5% is slightly below the full year expected rate of 36% as a result of several favorable discrete items in the quarter.

Now moving to the segments, first, directional delivery or DSD segment. Sales increased 1.6% driven by pricing mix of 1.8% and acquisition growth of 3.5%. As George indicated earlier, our volume was down approximately 3.7% in the quarter. Our branded sales in the quarter were up in the quarter however as a result of acquisitions and growth in soft variety. Overall private label increases in the quarter were primarily due to the 2008 acquisition which as you may recall had a larger share of private label sales. Volume declines in the quarter were driven primarily by declines in branded, white bread, and continued softness in the food service and lower volume in institutional sales. Operating margins and DSD were flat in the quarter as a percent of sales at 9.6%. Gross margin was down in the quarter about 170 basis points as a percent of sales in the DSD segment primarily the result of the higher ingredient costs as well as the effect of promotional activity within the segment.

Turning to our warehouse delivery group. The warehouse group posted strong sales increase of 20% driven by price and mix of 5.6%, volume growth of 6.5%, and acquisition growth of 7.9%. Branded multipack cake performed very well during the quarter. Operating margin in the quarter as a percent of sales is up 650 basis points to 11.3% in the segment. Overall operating margin improved 183% quarter over quarter. Gross margin in the warehouse group as a percent of sales was approximately -- was up approximately 200 basis points. The warehouse segment continues to show strong improvement through the third quarter as a result of our focus on the branded products within the segment. Overall the warehouse group saw strong improvement in branded cake sales while food service continues to be soft.

Now moving to the balance sheet, our balance sheet remains strong. Operating cash flow in the quarter was $50 million. Our cash allocation overall has remained pretty consistent. In the quarter we spent approximately $19 million on capital expenditures and paid dividends of about $16 million. There were no share repurchases in the quarter, but year to date we have repurchased $27.6 million or approximately 1.2 million shares under our share repurchase program. However, be did pay down debt by $19 million in the quarter.

Turning to our updated 2009 guidance, as a reminder, 2009 is a 52-week year versus 53 weeks in 2008. This extra week accounted for approximately 2% of sales in the prior year. Annual sales are now expected to grow at a rate between 7.5 and 8%. Based on these growth rates, sales should be $2.595 billion to $2.607 billion. Acquisitions will account for 6.8% to 7.2% of the growth. Our previous sales forecast assumed we would maintain a higher level of pricing and be able to absorb the extra week from 2008. However, given the level of promotional activity taking place within the category and the defensive efforts to protect our share we've had to pull back some.

Just as a comparison of 52 weeks to 52 weeks, we estimate that 2000 sales would have been up 9.5% to 10% year-over-year. For the year net income excluding the gain on acquisition is expected to be 4.9% to 5% of sales. Excluding the gain on acquisition, earnings per share for the year should be $1.37 to $1.40, an increase of 7% to 9.4% over 2008. Also comparing 52 weeks to 52 weeks from an earnings perspective earnings would be up 8.7% to 11.1%. As you may recall the 53rd week last year contributed about $0.02 to earnings per share. The earnings per share number is calculated using an average of 92.8 million shares outstanding.

Now looking at our preliminary 2010 guidance we still anticipate top line pressure as we move into next year. However, with the benefit of the anticipated cost tail winds, we expect 2010 to be a good year from an earnings perspective. Our preliminary sales forecast for 2010 is growth of 2.5% to 4.5%. Growth from recent acquisitions should be approximately 1% and core growth of roughly 3%. The preliminary EPS -- earnings per share growth is projected to be 10% to 15% over 2009, and our capital expenditures in 2010 are estimated to be $85 million to $95 million. Now I will turn it back to George.

Thank you, Steve. I have confidence in Flowers Foods ability to deliver good results in 2009 as our guidance indicates. I also have confidence that 2010 will be a good year for our Company. Like most other food businesses, we are seeing softer top-line growth for the near term. However, we continue to improve profits and increase margins. We will manage through these difficult challenging times and emerge an even stronger Company. We will do that by executing our strategies even better than before. We will make further improvements to our efficiency, and we will make distribution systems more effective.

At the end of 2009, which is only a few weeks away, we will be stronger operationally, our DSD footprint will be larger, our balance sheet will continue to be sound and we remain on track to deliver record sales and earnings. Looking ahead to 2010, we will have improved commodity costs. We expect to continue improving our margins. We have several new Nature's Own product that we will be introducing in the first quarter. We will have those available for our analyst day in New York. Our guidance for 2010 takes these positives into consideration, combined with the marketplace dynamics. 2010 will be another record year in sales and earnings is my feeling.

Flowers Foods takes the long view. We manage the Company with long-term interest of our customers, associates, and stakeholders in mind. We have been in this industry for a long time and we understand the business. We know what it takes to manage a business and deliver results. We have the most cost effective bakeries in the industry. We have the most effective and efficient distribution network. We have proven that we can take care of our customers with products, service, and value that help them meet their goals. We deliver quality products at a good value for consumers. We have the organizational discipline that allows us to navigate through difficult times. Our team has proven over time that we deliver shareholder value through stock appreciation, dividends, share repurchases, and capital investments.

Our growth strategy remains unchanged. We will continue to grow in our core markets and expansion markets. We will build new bakeries to support that growth. We see opportunities to make acquisitions that fit strategically with Flowers Foods. Our management team has the talent and ability to manage top-line growth with quality earnings growth. We do all this in a consistent and predictable manner which we call the Flowers way. Now, we will turn the line back to you for Q&A.

Thank you, sir. (Operator Instructions)

I know we have some questions, George.

I'm sure we do.

Thank you, ladies and gentlemen. Our first question comes from the line of Heather Jones with BB&T Capital Markets. Please proceed with your question.

Hello?

Hello, Heather.

Good morning.

How are you?

Fine.

Quick question. First, a details question. You mentioned that map spend was 6% of DSD sales for the quarter. Could you give us a year-ago comparison?

Compared to last year we're up about 170 basis points.

Thank you. In the price competition you're seeing in the marketplace, is that coming -- are you seeing any list price reductions or is it largely coming through higher promotional spending?

Heather, I didn't quite understand the question. I think I got it, though. What we've seen to this point is higher promotional spend, reduction in net price, I guess, but higher promotions.

And you mentioned that your share performance markedly improved during the latter part of the quarter. What is the overall -- clearly it sounds as if you're increasing your investment, but what is -- has the overall competitive environment stayed as difficult, or has it become even more challenging?

I thought it became even more challenging. I think we said in the first quarter, in the second quarter that we had been seeing lot of change. I certainly like margins, and we tried to protect those margins as long as we could, but, Heather, what happens over time, if you start losing units, sooner or later, as retailers reset bakery departments, if you're losing units, your space gets -- takes a cut. So we decided to make a change in our strategy and correct this issue, and we did correct it. We didn't lose any units overnight. We didn't gain them back overnight. Toward the end of the quarter and certainly through the first three or four weeks of this quarter, we are seeing improvements in units and dollars.

And I guess, I was wanting to talk about a narrower time frame. Like if you compare this to the beginning of, say, September, relative to now, has the competitive environment become more challenging?

It depends on the competitor. And I'd rather not talk about each competitor, but it had been almost just as intense from most competitors.

Okay. Two more questions. Going into next year, your sales guidance, I understand, I thought you said about a percent in terms of acquisitions, but of the remaining 1.5 to 3.5% is that all volume? Do you anticipate negative price mix due to higher promotional spending? Could you give us a further breakdown on an organic basis what you're anticipating?

I'll let Steve maybe get into percentages. Let me say up top that we expect the fourth quarter to be more of the same, and we're going into the first quarter with some optimism but we'll have to see what the reaction are from our competitors before we can be more sure of that because we certainly have not seen anything at the marketplace that indicates at this point there will be a marked improvement. We hope so. And we enjoy margins, because eventually all of us to have invest back in this business, not just in promotions. We have to invest in equipment, we have to invest in people, we have to invest in brands. Certainly I think the retailers at some point would like to see some changes in their overall sales dollars as well, see an uplift on that. I would underline again, fourth quarter will be more of the same, and we'll just to have see how the first quarter looks. We'll take appropriate action.

Okay.

Looking at the mix of that increase, Heather, and this is preliminary guidance, but I would say it's primarily the remainder after acquisitions will be primarily volume.

My final question is on DSD, including your geographic expansion, volumes were down about 0.4% in Q2, this quarter they were down 3.7. Sequential deterioration on a year-on-year basis. Could you rank for us -- you mentioned food service, institutional, regional, white breads. Could you rank for us how -- the sequential deterioration?

I can't give you the exact breakdown on it, but Heather the foodservice, institutional business as we all know, certainly slowed down from last year. Until we got competitive on white breads toward the end of the quarter, it was pretty significant, the loss that we did take in, in white bread. That's not the case today. But again, that's why we had to take action. Soft variety breads had a good quarter, and there's a lot of buy one get one frees in the specialty part of the marketplace, which also played a part in this.

Okay, all right, thank you very much.

Thank you, Heather.

Our next question comes from the line of Farha Aslam with Stephens, Inc.

Good morning.

Good morning, Farha.

Could you share with us your thoughts on input costs in terms of where you are with purchases of wheat, et cetera?

Are you talking about '09?

'09 and looking out into 2010.

In 2010 we basically covered it. I think on the last call we were expecting favorable costs to be up roughly $45 million. We're still within that range, and 2009 is covered, so we have good insight to the costs for the remainder of the year. As far as 2010, we're -- with our guidance, we're very comfortable with the top line and the bottom line, but as far as the costs for next year, for competitive reasons at this point we're not ready to disclose anything but I would say we are maintaining our strategy to hedge on that six to nine-month time frame. And we do expect some tail winds going into 2010, but at this point that's really all we're providing.

Okay. When you look at M&A opportunities that you see in the bakery space, has the increased promotional activity hurt independents, and are you seeing any increasing desire by those companies to sell?

Farha, I'd say that since most of our markets in the southeast, southwest, across California, there's not many independents left in that actual core market so I have not focused on what has happened outside of our market that much, even though I know this promotional pricing is throughout the United States and depending on how they recover would depend on how well they're doing. I would say that based on year before last and the evidence of this year of our acquisition strategies that we're really in tune with trying to grow this business and expand our footprint, so acquisitions is at the top of our priority list, so that we can grow organically and through acquisition.

My final question, and I will pass it on, in terms of your selling and distribution expenses going into next year, do you think there's room for further improvement in that after such very good gains this year?

Yes, we are forecasting still levering that, and I think we've said that in the past that we believe there's another 50 basis points or so as we move into next year.

Thank you very much.

Thank you, Farha.

Thank you. Our next question comes from the line of Eric Katzman with Deutsche Bank.

Good morning, Eric.

My first question has to do with the top line, and it sounds like you saw a pretty kind of quick recovery in your volume and share once you decided to push the promotional spending pedal to the metal. Can you just talk about at the elasticity? Was it as you expected, and kind of how does that work going into 2010 in terms of your confidence that greater spending, I suppose it's particularly in the white regional breads, is going to drive the volume next year?

Eric, thanks for that question. I think I said in my prepared remarks, there's not lot of additional product sold because of promotions. Based on higher promotions, you end up getting back to your share, or someone has stole your share. We did start at the beginning of third quarter with some promotions, and it rolled up midway, or almost midway of the quarter, pretty well in everywhere. And it did take a few weeks. It wasn't automatic. It takes -- as I mentioned, you don't lose it overnight and you don't gain it back exactly overnight. By the end of the quarter, certainly these first two or three, four weeks this quarter we did see things getting back to before we felt like they should be. So given the competitive dynamics of where they are, we'll pretty well continue through the fourth quarter on what we have in play. And we're monitoring from our retailers what's expected at retail from them, and we'll take appropriate action. We did have some promotions the first quarter last year, year before that almost none. Second, third quarter, it did roll up, so we are -- what we're prepared to do, and I said if you lose units you end up losing space in the market, and we just will not let that happen. At the same time, we remain the low-cost producer and having the most efficient distribution systems and being able to lever a lot of things, we feel like we can do what we have to do to protect our share, but yet take care of our shareholders, our customers, and the consumers, and our associates.

George, I understand that as Interstate became more aggressive in the market that certain retailers who had maybe moved them off shelf over the last couple of years smelled probably a good deal and took the bread back onto the shelf for however long that lasts. Are you kind of surprised that some of the retailers, despite your service levels and DSD/scan-based trading capability and the new products that you've put into the market the last couple years, are you surprised that these retailers were willing to step down and just put some product on the shelf that's really just on deal as opposed to supported as strongly as you support your brands?

Yes, I'm surprised every day somewhere, but also, Eric, what I would say would be, given one of the worst recessions we've had in quite some time, I think retailers have been looking for more value, so that they could try to protect their consumers against -- their competition in the retail market. So I'm surprised, but at the same time not surprised, because the retailer has to compete, and they've been trying to find the best value they could to pass on to their consumers.

Okay, then if I could just move to the cost of goods line and just understand a little bit more on Farha's question, Steve, I didn't understand what she said. You said that you still expect cost inflation in 2009 to be $45 million, and that in 2010 that it will drop, that you expect a tail wind on cost of goods?

Yes, if you look at our original projections for 2009, excluding acquisitions, we were forecasting overall input costs to be up roughly $45 million year-over-year, and that is still a good projection, as we finish tout year. Going into 2010 we do expect cost tail winds. And we talked about that some. We haven't quantified that, and we're not prepared to do so today on this call for competitive reasons, but as I say, we are maintaining our strategy to hedge in that six to nine-month time frame.

Okay. All right, I think I'll leave it there and pass it on.

Thank you, Eric.

Thank you. Our next question comes from the line of Mitch Pinheiro with Janney Montgomery Scott.

Just following up on Eric's last question, you're not giving any color on your commodity cost benefit, but is it -- can you talk about the -- say the weighting of the benefit? Will it be stronger in any particular quarter than another? I mean could--.

Mitch, quite candidly, and at some point we'll probably put some color to it, but for competitive reasons we feel like that that type of information could have hurt us the past two years, our competitors, and this point we're just not prepared to go much further. At some point we will, but I think it's premature for us to give that number. I said in my comments we do see improved commodity costs for 2010.

From -- looking at the heightened promotional activity, do you think -- what's the intent? Is the intent by the competition -- is it aimed at defending against private labels, or is it, could you put color on what you think the intent of the promotional activity is?

Yes, Mitch, I'd like to and I think that's an excellent question. As we go back and look at last year when the economic situation toppled, so to speak, I thought the baking business held up relatively good last year. In fact, it was good enough that we felt like we could take on pricing, and we did increase prices, we led the way last October. And don't hold me to it. I think the number was 6% or 7% price increase, and unfortunately, nobody followed that, but we maintained that through the year, even though, as the year went along, we've had to promote and have lost some of that. Not the net -- well, the net price we have. Then dry wholesale we just promoted a lot.

I think because of the recession, that the food industry in general thought, well, we've got do more for the consumer. I think the retailers were pushing hard to try to find value to pass along to the hurting consumer, and as we know, unemployment now is 10.2%. Hopefully that's a peak, and we know it's worse than that when you really count everybody. So I think not just the baking industry, but retailers and food companies in general try to pass along more value to the consumer, and -- but as a result, people are not consuming more. We did see some shift from food service over to retail. More people are eating at home. But at the end of the day I don't think anybody is consuming more food. So what we've done in the baking industry is getting less for our product. Whoever's got hottest specials for a given time might pick up some share, but at the end of the day, everybody is going to get pretty equal. We think our brands can carry a premium. They do carry a premium, but you can't be way out of line. If you get way out of line, you do end up losing units, eventually losing space. So we're just not going there any more. We're going to protect what we have. We've worked too hard to earn it. We have earned it, and even though we love margins, because we do have to invest back in the business to be long-term supplier to retailers and the foodservice industry.

Do you have -- you did well in this quarter, and actually all year with SG&A leverage. Is that going to continue into the first half of 2010?

Yes, Mitch, I think we'll continue to see lever on the SG&A line. And as I said earlier, we're still anticipating another 50 basis points as we move into next year.

Okay.

Which is what we've kind of thought all along, even as 2009 progressed.

It gets off to a good reflection. If you look back, we said all the time, as we put in new production lines, new bakeries, we were trying to get where the mass of people are so it would eliminate a lot of logistics cost, and this is a great benefit of results of that investment we made over time.

How does -- if a retailer went into and had this -- a clean floor initiative, how does that affect DSD sales? Is that a -- I mean, DSD, you've always been more nimble than a warehouse delivered product because you can get more space. End caps, extra tables in the bakery section, what does that do, do you think, to business longer term?

When I think about it, you have certain items that are real impulse. A lot of times, especially on cake and specialty items, a lot of times the consumer is not going into the supermarket thinking, I'm going to buy a sweet roll. But if it's on display, out in the middle of the floor with a somewhat value price, looks attractive, well merchandised, we got a good shot at selling that. If it's just in the shelf, it's not as effective. So price promotions does not work as effective just on the shelf. I do think, though, every year you have different retailers who go through this process of saying, I want a clean floor. So this is sort of a rolling event in my mind. Will this last for the next five years? I don't think so. Will it last the next year in certain customers? I think so. But people roll in and out of that, and clean floors, by the way, look great. But it's the sales of more merchandise, I don't think so. Now, on white bread, special displays versus shelf, unless you've got a real hot price, and you're the only guy doing it, you don't sell a lot of extra product on white bread. But specialty products, cake, Nature's Own has always been a good item that displayed well off shelf.

Last question is concerning expansion markets. So expansion markets I think you talked about maybe contributing 1% of DSD sales. What's your embedded number within your 2010 guidance? For expansion in markets?

Well, we continue to use this 1% number and we feel like we can continue to do that.

It just sounds low, given the significant opportunity on a population basis out in the West Coast markets that you're entering, and some of your push into the Midwest and obviously your success you've had in the Mid Atlantic, or the Baltimore-Washington, northern Virginia market. That, to me, it just seems like -- is it a conservative estimate, or are you finding more difficulty in getting more shelf space, more distribution?

No, I would not say it's more difficult. Being timing is so important when you make those moves holds us always when the retailer or foodservice customers really wanting you there, and we've got the capacity to take care of it. And naturally, some markets are better than others. Sometimes execution might be better than others. But also back to your previous question, in new markets, it is real important, back to the special display event, with a new brand in town, you put forth a tremendous extra effort to get those off-rack displays so your brand is seen by all the consumers in those markets.

Mitch, 1% could be conservative. I think we are conservative by nature. But we want to be realists, as well. We don't want to get ahead of ourselves.

Thank you very much.

Thank you, Mitch.

Thank you. Our next question comes from the line of Tim Ramey with D.A. Davidson.

Good morning, all.

Good morning, Tim.

Just a question about kind of the trends for 2010. I assume when you say you've stepped things up a bit for the fourth quarter, that means you have gotten more competitive on price. If we look at year-to-date performance, or really even trailing 12 or 16 months, the performance has really not -- it's all been driven by acquisition and pricing. So if we think about pricing kind of exiting the year maybe down, and starting 2010 down, what gives you the confidence that you can do 3% core sales growth in 2010? We really haven't seen much in the way of unit volume growth.

Well, you haven't, but I have. Most recent, as we have gotten more competitive.

So just on the basis of a few weeks, we're going out with that level of confidence?

I believe -- I believe in our numbers, and I believe that -- we're not the lowest guys in town, our brands do command a premium and I feel very comfortable where we are.

Also, Tim, George mentioned earlier in the call, new products, and we'll talk more fully about these in our management meetings in December and we have several new products that we'll be launching at the beginning of the year which we think will give us a nice sales lift as well.

Tim, even in last quarter's call I mentioned some new products. A couple made it but quite a few didn't because we were not ready. We will see those in the first quarter. You will see those if you join us in New York in December.

Just a question on the SG&A performance which has been really excellent. Can you give us any more break down? I think you gave us sort of a half a sentence on some distribution and some overheads, but -- and I think you mentioned that some of that might continue into 2010. What's causing that really strong performance?

The large part of is it driven by distribution and the majority of that would be fuel costs are down. So hopefully, those costs continue to stay low or trend down as well in the current environment.

Okay.

In addition to that, some of our new production lines close to the market.

Sounds good. Thank you.

Thank you.

Thank you.

Our next question comes from the line of Ann Gurkin with Davenport.

Good morning.

Good morning, Ann.

I just want to follow up on pricing. As you look to 2010, I guess your opinion on your ability to hold wholesale pricing, I know you've discussed this a little bit, but given increased competitive pressure, I know Sara Lee has been out saying they're going to recalculate pricing to the -- to accumulate volume. I'm just curious to your read on your ability to hold your wholesale price.

Well, we're basically still holding our wholesale pricing. There have been some changes here and there, but not Companywide, some on a market by market situation. We still are in the mind that we'd like to hold our wholesale prices and promote from there. We might have to change at some point, but we're not prepared to make a big move on that now. Hopefully, hopefully, as the economy picks up, and we hope that happens, and this industry has to get more healthier to make investments back into the business. Hopefully the retailers also will realize that all -- the deflation that's been going on the past year is not necessarily the most healthy thing in the world. And hopefully unemployment can begin to come back stronger, that we can see a moderation from a pricing standpoint, at some point next year. No prediction there, but some moderation.

Do you reset wholesale prices once a year as it rolls through market? How does that work?

Depending on what's going on with the commodity equation, basically -- I guess historically what we've tried to do is look at pricing in October, September/October, looking at the following year, based on what we think our cost structures are. But if something abnormal happens, there's nothing wrong with looking at it in March or June or any other time of the year that you need to go to customers and make adjustments.

And secondly, your long-term sales target I think has been 5% to 8% growth. Do you need to change that number, or is that still number out there that's--?

We're not ready to back up on that at this point. We realize that next year the 2.5 to 4.5 is not with that long-term goal but I think next year we'll just to have get through that year, but we want to stay with our 5% to 8%.

That's great, thank you.

Thank you, Ann.

Thank you. Our next question comes from the line of Bill Chappell with SunTrust.

Good morning.

Good morning, Bill.

Just to follow up on a couple of those questions, on the volume side, excuse me real quick -- on the volume side, just want to make sure I understand for 2010. You're talking about no real change in wholesale price, promotion knocks down the overall price 5 percentage points so that would imply you're looking for kind of 4% to 6% volume growth, to get to your sales number of 2.5 to 4.5.

I'm looking at something I'll answer your question. As far as the detail, it's still very preliminary, but I would say you're in the range.

Okay. And that's, as you said, driven by new production and continued share gains?

Yes. Primarily volume driven, and as I mentioned, the new product introductions, then share gains and expansion market that George talked about.

Is there any lag in terms of the new product? Should they all be on the shelves by first quarter?

As we know it now that would be correct. That could be something in the back half that additional products, but we think January and February time frame with the new items as we know it today.

Okay. Then when I look at kind of the gross margins, and I understand you're not detailing cost of goods sold going for next year, but is there anything that holds you back from getting back to the kind of 49%, 50% gross margins you saw a few years ago in terms of commodities starting to settle back in?

The biggest challenge will be top line. Even with the cost tail winds, if you've lost the pricing, or the net pricing has come down, then that's also going to put some pressure on the margin. So even with the cost tail winds I don't think you can expect the 49% range of margins until we get some pricing back into the--.

Bill, I would follow up to that by saying our plants are in great shape operationally -- we have very automated plants, as you've seen. This promotional activity is hurting the gross margins, that and the commodities for this year, of course. But when that moderates, we -- and it will at some point. We just don't know when. Moderation will have to come about. I think we have an opportunity to get back into the 48, 49, but we don't see that on the immediate horizon, until we do have moderation.

And just one last thing on the promotional activity. You may have touched upon this, but is there -- is there just certain states or certain regions where it's more intense? Is it nationwide? It sounds like it's really more than just one player. It sounds like you've had multiple players get more aggressive than you would expect to make a nationwide push.

As I look at the IRI from the U.S. standpoint, I see it all around the United States. This has been, depending on what time frame you look at, I'd say over the past eight to ten months, every competitor has better pricing than we have, to the market. So it has been a wide spread.

Got it. Thanks so much.

Thank you.

Thank you. Our next question comes from the line of Akshay Jagdale with Keybanc.

In terms of, if you look at your guidance and how it's changed for '09 from when you first gave it, your sales guidance now has come down by about $160 million. You have talked a lot about weakness in foodservice, et cetera. How much of that lower guidance or where your numbers are going to be lower comes from the economy versus promotional activity? And then if you could also break down how much of the volume weakness this year has come from foodservice that would be great.

Akshay, we can give you that off-line. We don't have it right here available, but you hit on all of the three key points why sales are down. It is volume related, it is the economy, it is price. And certainly we all know foodservice trend has been down since mid part of last year.

So how much for next year? Your assumptions for organic growth, 1.3% to 3.3%, how much of that -- what are you factoring in? Are you expecting the foodservice demand to improve or not? And you talked about promotions, so we have that number. But can you talk about what your expectations for the economy are? Is it just status quo? An improvement from where we are? And do you think we're at bottom right now? I'm just trying to get a sense of what you're thinking of for next year?

I will tell what you our customers think who are in the foodservice business, because I do talk to them, and our people stay in touch with them. They think they're at the bottom. I think it's all going to come down to, does this unemployment keep going up. If the keeps going up, I don't think we've seen the bottom yet. And we know last week's announcement went from, what, 9.8 to 10.2. So we see 10.5, that means we hadn't bottomed yet. I don't think we'll see bottom until we see the unemployment moderate or start going the other direction. So I still think that's unanswered, but in our thought we're basically thinking about a flat volume for foodservice next year.

Okay. And in terms of if we think of, if you also think of any up side to your numbers, is it a fair statement that if promotional activity eases, there could be -- that would be the primary source of upside to any numbers if there is any?

I think that's a true statement. I said hopefully we'll see some moderation next year. We're not counting on it. But if that moderation happens, we could see some up side.

I mean, the one thing that has surprised a lot of us is how long this pricing war has lasted and continues to go on. Has, in your view and the benchmarking that you do, has your competitive advantage shrunk relative to what it was like five years ago or something? Because it seems like you do have a competitive advantage on the cost side, and you proved some of that this quarter. But I'm just trying to get a sense of how is it that weaker competitors are able to lead this promotional activity and sustain it for a long period of time?

Well, you'd have to look at their results. We all see each other's numbers at the end of the quarters, and some do not report. I don't know how they do it. But I think our evidence shows that we're able to maintain margin and build on the margin. So our competitive advantage has never been stronger. We've continued to invest in our business to keep that competitive advantage.

Last question, I think, going back to some of the long-term targets. Your long-term target for EBITDA is about 12% and you've said SM&A to sales is going to go down by 50 basis points, 50 to 75 from where we're going to end up today, so around 35%. If what you said before is true, that you can go to 48%, 49% gross margin, you add those numbers up, and D&A is 3% your EBITDA should be north of 15, it just doesn't add up. If you were to be 12% EBITDA over the long term with SM&A to sales of 35% that gives you a gross margin of 44 which is where we are today. So just wanted to -- is there up side to your long-term EBITDA estimate if you do get gross margins up in the 48% range?

Let's say, Akshay, when we said 10 to 12, and that's still our stated goal, 10 to 12, I think we were at 7% to 8% when we said that, made that prediction. We're not raising that but as you can see this year, I think Steve said -- Steve, did you give an EBITDA percent for the quarter?

No, I did not, but it's roughly 11.

It's roughly 11%, so -- 11.6, I think Steve just said. So you can see that we do have opportunity. But I didn't say we would see 48, 49 next year. It is going to take a it lot of moderation, to keep commodities in line to be able to do both of those.

But longer term, there could be upside, right? Obviously we could argue today that there's downside to your long term sales growth target, but given where you are today, EBITDA 11.5%, clearly there has to be upside to your EBITDA long-term target, if you can maintain a gross margin above 44%, correct?

I'm always optimistic about our business. I always think we can do bet her, but it takes -- we don't live in a vacuum, but there's competitors, there's -- sometimes things are out of your control that, things happen. But I'm an optimist. I always believe the glass is half full, not half empty. And I know we can always do better. But I'm not going out on a limb and saying that we can be at 15%. What we are constantly at 12, then we would begin to raise that, if things continue to look that well, we'd move that target up.

Okay, thank you very much. I'll follow up off line.

Thank you, Akshay.

Our next question comes from the line of David Leibowitz with Horizon Asset Management.

A few unrelated items. First, on the Leo's acquisition, is Leo's going to remain the name you use, and if so are you going to move the Tesoritos brand into Leo's?

David, Leo's will be our name. Some brand names came with it. Our go to market brand though is Mi Casa. Tesoritos was our cake brand for just any market. Very excited about that by the way, David, thanks for asking the question. We -- I mentioned that according to some information I just read that in the bread category, that tortillas are second only to white bread. So what an opportunity. And I'm excited that we're now participating more, and we see good growth in this segment of the business. And we will be, by the way, both food service and retail not just one or the other.

And where does Leo's rank in terms of market share? Are they second to Gruma, or are there others in between?

There's a litany of companies out there, David. Gruma is by far the number one person in tortilla business with a huge share, and I can't remember off the top of my head how much that is. But you have a litany of tortilla producers throughout the United States.

And the next question, how many -- what percent of your tortillas go into what are called wraps, sandwich wraps, or is that a separate market altogether?

I'll probably classify that as sort of a different market.

Okay. Switching topics now quickly, with all the numbers you gave out, and I may have missed it, did you say how much you have hedged going forward into 2010 on your major commodities?

David, we didn't, and for competitive reasons we're not prepared to go there yet. We could change that at some point, but for competitive reasons we're not willing to tell. What we did say, two or three times, we would have better costs next year than this year.

And again, an unrelated item, given the Company's need to either open a new facility or acquire a facility, or expand a facility every 12 to 18 months and the larger you get, obviously the more frequent this will become, where do we stand on the issue for 2010 at the moment?

2010, we're finishing up, I said we're opening -- did open barge town this year with a bread line. A new bun line will be going in, is going in now, the and we'll be producing buns first quarter of 2010. And in our meeting in New York we will lay out our investment program for next year, which is all about growth, and seen sales improvements in some categories, and that's where we will be investing quite a bit of our money next year.

Lastly, without trying to steal your thunder for the New York meeting, is your biggest concern for next year competitive pricing, or the overall economy, or how would you rate -- rank your major concerns for next year?

I believe I'll have come back and say it's economy, and unemployment particular. I believe competitively eventually our industry has to get more healthier, and that means better margins and better pricing somewhere down the road. Nobody can continue to not pass along value to their shareholders and stakeholders. So eventually people have to get that correct. But for us to live up to what we know for our potential, I think the consumer has to get more comfortable with the economy. We're fortunate that in the food business, fortunate to be in the bread business, but for the overall economy to work we've got see people go back to work so people can buy automobiles and refrigerators and homes, so the economy gets rolling again.

Thank you very much. I look forward to seeing you in New York.

Thanks, David. Looking forward to it.

Thank you. Our next question comes from the line of Eric Katzman of Deutsche Bank.

Thanks for taking the follow-up. Steve, I wanted to ask about, in terms of the forecast, I know you don't want to get too specific, but looking out into 2010, to the extent that you do get a volume response because of the greater promotion, and the fact that you're a DSD, and I think somebody else pointed out that your volume trends have been a bit weaker as 2009 has progressed. How much lift do you get in terms of absorbing the fixed costs or the facilities operating at -- on a higher volume level as opposed to this year where it's been more about pricing?

Well, for 2010, what I would say and I think you noted, the more volume and throughput we have in our plants, the more overhead we're able to occur. And that leads to efficiency gains which typically get to the margins. So as some of our volume recovers, while we're not as stressed at where our efficiencies are at this point, we do see some improvement as we get volume back into our plants.

Oh, I'll leave it there. Thanks.

Thanks, Eric.

Thank you, ladies and gentlemen, we have no further questions. At this time way like to turn the floor back to management.

Thank you, and thank you for joining our call today and your interest in Flowers Foods. Our strategies are working. We have been innovative with our product and brands, and our team is fierce and motivated to win every day in the marketplace. Thank you for your confidence in Flowers Foods, and we look forward to seeing you in December in New York. Thanks.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.