Flowers Foods Inc (FLO) 2010 Q3 法說會逐字稿

Greetings and welcome to the Flowers Foods third-quarter 2010 earnings conference call and webcast. At this time all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (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.

Thanks, Diego, and good morning, everyone. Thank you for joining our call. You know that I must remind you that our presentation today may include forward-looking statements about our company's performance. 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.

Our third-quarter results were released earlier this morning and if you need a copy, you can find that release posted on our website, www.flowersfoods.com. We will file the 10-Q on November the 18th.

During the call today we will be using a PowerPoint presentation and you can access the presentation on the webcast listen page if you have not already found that. Participating in our call today are George Deese, Steve Kinsey, and Allen Shiver. I am very pleased to turn the call now over to Flowers Foods Chairman and CEO, George Deese.

Good morning. Thank you, ladies and gentlemen for joining our call and for your continued interest in Flowers Foods. A quick review of our agenda today. Following my opening remarks, Steve Kinsey, our Chief Financial Officer, will discuss third-quarter and year-to-date results. Allen Shiver, President of Flowers Foods, will give you our operating results, and then I will give a brief review of how we see next year unfolding. Following our comments we will open the line for your questions.

First, let's talk about our third-quarter results. I am sure by now you have read our earnings release. The quarter was both challenging and rewarding. Even though we fell short of our sales and earnings targets, we delivered earnings per share equal to last year's third quarter. I believe that our performance was good when compared to our peers in the baking industry and others in the food space. We continue to see weakness in the economy and high unemployment which does affect consumers.

Consumers today are more value driven. They are shifting more of their food purchases to different retailers from week to week, depending on where they think they will get the best value. Allen will explain why our promotional spend and pricing actions took longer than expected to execute, which had a negative impact on sales and earnings for the quarter.

I am pleased to report that we have had three successful start ups on our new cake lines. These lines are highly efficient and effective, which will help future sales and earnings. However, as Steve and Allen will tell you, the start ups impacted our earnings by $0.01 in the quarter. We also will update you on the new product introductions. I know the next area of interest for our investors is how the fourth quarter is shaping up. I am pleased to tell you that as we look at the first four and-a-half weeks of the fourth quarter, the business looks better. As a result of our higher costs, we have taken pricing action across all channels.

Our promotional activity is reduced, and the price points for items on promotion are higher. The production lines we commissioned in the third quarter are running close to our expectations and improving each week. We do have one more start-up, a second production line for sandwich rounds in the fourth quarter. These new lines will help us take advantage of growth opportunities. Our focus in the short-term is on bedding down, new production lines, new business, new DSD territories, new products and on improving profitability across the board.

Probably, the most important questions you and our investors have today, what is Flowers Foods' take on the announcement earlier this week of Bimbo/Sara Lee combination? First, let me congratulate the companies on their agreement. Consolidation of the fresh bakery business in the United States has been underway for several decades. The announcement that Bimbo Bakeries plans to acquire Sara Lee's fresh bakery business is a continuation of that ongoing consolidation. Flowers Foods has competed successfully against much larger businesses throughout its history. We will continue to compete effectively and grow our business as the competitive landscape changes with the combination of Bimbo and Sara Lee.

Flowers Foods has staying power. Since 1919, we have been focused on opportunities in the fresh bakery business. We have proven strategies that position us to serve the needs of our customers and consumers for fresh bakery foods. Let me remind you that our strategies are to grow our sales, to bake smart, give our customers extraordinary service, invest wisely, and to appreciate our team. To support these strategies, we have strong brands, exceptional quality, efficient bakeries, a highly motivated independent distributor network and an experienced team that is determined to keep Flowers Foods moving forward in every aspect of our business.

As we have done through many changes in the competitive landscape, we will continue to execute the growth strategies. Growing through bolt-on acquisitions, introducing new products, and expanding our geographic reach through market expansions. Steve and Allen will add more detail about the factors I've mentioned. I will turn the call now to Steve Kinsey for the financial report.

Thank you, George, and good morning, everyone. This morning, I will review the third quarter and year-to-date results, spend a few minutes on our revised 2010 full-year forecast and review briefly our outlook for 2011.

Now, taking a look at the summary of our third-quarter results, as George mentioned, we did face a few challenges in the quarter that affected both our top line as well as the bottom line. Promotional activity continued to be strong in the quarter, impacting both net revenues as well as margins. The quarter was also negatively impacted by costs associated with the start-up of three new snack cake production lines, as well as heavier than normal or planned costs associated with entering new markets and new product launches.

For the quarter, consolidated net sales declined 0.8%. Price and mix combined contributed a negative 2.4% to the decline, where unfavorable pricing was offset by a favorable mix shift as the Nature's Own brand performed well in the quarter. Volume was up 1.4% in the quarter driven by new products, heavy promotions, and growth of our snack cake business. And, acquisitions contributed 0.8% to the sales in the quarter.

The deconsolidation of the variable interest entity contributed roughly 0.6% of the decline, excluding the effect of the VIE decline in sales in the quarter -- excluding the effect of the VIE decline, sales in the quarter would have essentially been flat to slightly down. However, as the slide does show, the overall trends in revenue have been improving throughout the year. Our DSD segment sales declined 2.5% quarter-over-quarter on heavy promotions.

Promotions and features in DSD were up roughly 250 basis points as a percent of sales quarter to quarter. Strong brand performance drove volume increases in DSD during the quarter of roughly 1.7%. This is up from the 1% we experienced in the second quarter this year. Store brands reflected that the pricing pressure in the category declined in dollars and increased slightly in units during the quarter.

Our warehouse segment sales grew 6.5%. Combined, price and mix drove sales 2.2%. This is with negative pricing being offset by favorable mix shift. Acquisitions contributed 4.1% to the growth in warehouse in the quarter and volume did increase slightly. Within the warehouse segment, overall foodservice continued to be soft, offset by strong performance in the snack cake channel. Allen will comment more on the effects of our promotional spending and pricing plans in a moment, as well as share some of the IRI and share data.

We continue to see improvement in the gross margin as a percent of sales, up 60 basis points quarter-over-quarter. This improvement was driven by lower input costs; input costs during the quarter were down approximately 5% to 6% quarter over quarter. The quarter improvement input costs was somewhat offset by higher workforce costs and start-up costs for new production lines, as George and I have mentioned.

Our DSD segment experienced 140 basis point improvement in gross margin as a percent of sales, primarily as a result of lower input costs. The warehouse segment gross margin was down 120 basis points as a percent of sales, due to higher labor ingredients, and as we said they absorbed all of the startup costs in the quarter. Even though the quarter-over-quarter improvement was not as strong as we experienced in the first half, we are still targeting an approximately 100 basis points or so improvement on a full-year basis.

The roughly 110 basis points increase in selling, distribution, and administrative costs as a percent of sales was due primarily to lower sales and increases in workforce-related costs. Looking to the full year, we are still targeting a 50 to 75 basis points increase as a percentage of sales.

Earnings before interest, taxes, depreciation and amortization as a percent of sales declined 50 basis points from 11.6% to 11.1%. The EBIT margin as a percent of sales also declined approximately 70 basis points quarter-over-quarter. The overall declines in EBITDA and EBIT were driven by the effects of the top line pressure as well as the costs we have discussed.

Earnings per share in the quarter were flat quarter over quarter at $0.34 per share. Decreases in the operating margins were offset by lower taxes and earnings per share also benefited slightly from share repurchases. Cash flow during the quarter continued to be strong. Operating cash flow in the quarter was $73.5 million. During the quarter, we spent roughly $19.4 million on capital expenditures and paid down roughly $20 million in debt. We also acquired approximately 822,000 shares of common stock for $20.6 million during the quarter. Our balance sheet does remain strong and gives us great flexibility to continue to focus on our core growth strategy.

Turning to the remainder of 2010, we are adjusting our full-year sales guidance to flat to slightly up from our prior expectations of 1% to 2% growth. The downward adjustment is the result of a longer than anticipated promotional environment. This change in full-year guidance reflects negative full-year pricing and mix, overall volume increases, and increases from acquisitions, as previously guided of 0.5% to 1%. With the adjustment in sales forecast, we are projecting that earnings will be near the lower end of our most recent guidance and, therefore, we are targeting -- we are tightening our range for the full-year EPS growth to 10% to 12% from our prior guidance of 10% to 15%.

I would also remind you that our full-year 2010 guidance does grow off of a 2009 base that excludes the $0.02 accounting gain in the prior year. As George mentioned, we have taken pricing actions in the fourth quarter. It is early and we continue to monitor the consumer response. Allen will speak to the overall market in a moment.

Today, we are also providing preliminary 2011 guidance. Several factors will play into 2011. The most significant being the volatility in the commodity markets and the ability to price into the market to offset input cost increases. Taking these factors into consideration, we are forecasting sales growth in 2011 to be approximately 3% to 6% and earnings growth -- and earnings per share growth of approximately 8% to 13%. We expect to spend $90 million to $100 million in capital expenditures in 2011. Though we don't anticipate cost inflation at levels experienced in 2008 spikes in the commodity markets, the spikes in the commodity markets still are significant from where we have been most of 2010.

We are currently forecasting input costs, ingredient input costs, which as you know is ingredient, packaging and natural gas to be up between mid-single digit and high single-digit percentages 2011 over 2010. The commodity markets are very volatile. The economy is still very fragile, and we have not seen any major change in consumer buying patterns to indicate a wholesale shift in confidence. So, we are thinking cautiously about 2011. Now, I will turn the call to Allen.

Thank you, Steve and good morning. From an operations standpoint and in the marketplace, Flowers Foods is stronger than ever. I want to go through the IRI information that we regularly share with you, and then I will give you more detail about some of the factors that George mentioned earlier. As you know, our market share information is from Flowers' custom database for the IRI South food drug and mass market. It is important to note that IRI only captures about 48% of our total retail sales.

Our branded sales continued to outperform the category in the quarter. Flowers units were up 4.3% compared to the category increase of 0.6%. Our dollar increase was 2.3% for the quarter, compared to the category, which was down 0.7%. With increased branded sales, our market share was also improved. Our dollar share of the total category was up 70 basis points, and our unit share was up 70 basis points, as well.

We continue to hold the number one branded market share with a 23.3% dollar share and a 19.2% unit share, as reported by IRI. Our strongest share growth remains in the soft variety bread category, where our Nature's Own brand performed very well this past quarter. In fact, IRI South numbers confirm that Flowers Foods has a 44.7% share of the soft variety category led by our Nature's Own brand.

On a national basis, using IRI Reviews database, Nature's Own continues to be the number one brand in the bakery category based on volume, and the number two brand in the country based on dollar sales. New products play an important role in our brand performance. This past quarter, new products contributed about 5% to our sales in the quarter. Our Nature's Own sandwich rounds continues to be one of our most successful new items.

As George mentioned, we have added a second production line for Nature's Own sandwich rounds. That line had a successful start-up just last week in our Denton, Texas bakery. We recognize that in the short-term, marketing and distribution costs increased with new product introductions and, yes, we incurred some of these introductory costs this past quarter. However, the successful development and introduction of new products is a core component of our growth strategy and that will not change as we move our company forward.

Turning to store brands, given the continued difficult economy, we monitor store brands share very closely. For the third quarter, IRI data for the total US shows store brand breads down 50 basis points in dollar share and down 90 basis points in unit share. During the quarter, we continued to achieve growth in our new DSD markets. As with new product introductions, expanding into new markets adds costs in the short term. In the third quarter, some of our higher labor cost was related to new markets.

Sales from new markets contributed 60 basis points to our DSD sales results this past quarter. We are pleased with the progress that we're making in new markets such as Indianapolis, Washington, DC, Pennsylvania, and Southern California. As we move forward into the year ahead, expanding into new markets will continue to be an important part of our overall growth strategy.

Now, to the foodservice category. Foodservice is an important part of our business, about 28% of our sales. While we have seen some recent volume increases, our foodservice sales remain soft reflecting the continued impact of a difficult economy. Our strategy is to be the low cost producer and the low cost distributor. We're poised to serve our foodservice customers as the economy improves and their business returns to a more normal level of growth. I would like to now address a few of the factors that affected our third quarter results.

Our top line results for the quarter were impacted by a higher level of promotional activity and a delay in getting all of our new pricing into place. We had expected to reduce our promotional activity to a more normal level during the quarter. However, marketplace conditions prevented us from accomplishing this objective. In fact, our promotional activity in the quarter was actually higher than second quarter 2010. At this point, four weeks into the fourth quarter, we have been successful in reducing the number of products that we have on promotion while increasing the price points on the promotional items that remain.

Turning to regular or every day pricing, we have also taken pricing action across all distribution channels. Throughout 2010, the entire baking industry experienced price deflation in the fresh bakery category. As many have commented before, deflation in this category is simply not healthy for the baking industry or for our food retailers.

As we look ahead, some inflation is a must. Costs are up. Our input basket for 2011 includes higher costs for major ingredients such as flour, sugar, shortening and cocoa. Many other costs such as fuel and healthcare are also up significantly. As you know, we work to quantify well in advance our additional costs for the year ahead. Then, we do everything that we can to reduce costs by re-examining every aspect of our operation. After we have exhausted efforts to improve efficiencies by reducing costs, we then take pricing action in the marketplace. The pricing that we have taken in recent weeks is in keeping with that strategy.

As I mentioned earlier, our earnings for the quarter were also impacted by start-up costs for three new snack cake production lines. This capacity was added to meet increasing production demand as we continued to achieve sales growth in our snack cake business. In the fourth quarter, those new production lines were operating much better, which is reflected in our improved manufacturing costs and production efficiencies.

In summary, from an operations standpoint, our Company has never been in better condition. We continue to invest in capital projects, adding new capacity to our Company and improving our manufacturing efficiencies in existing operations. Our continued capital investments reflects our long-term commitment to be the low cost producer in our industry. Our business relationship with our retail and foodservice customers is strong.

Our customers recognize the value of our brands and the level of customer service that Flowers brings to the marketplace, and our Nature's Own brand which will approach $1 billion in retail sales in the next few years continues to lead our share growth in both our core markets and especially in new or expansion markets. Thank you for your attention. I will now turn the call back over to George.

Thank you, Allen. To follow up on next year's guidance, we have our plan in place for next year and Steve outlined for you our preliminary guidance. Let me emphasize that what we have given you today is preliminary. We all know that we're still in unchartered waters in regard to unemployment, volatile commodity costs, taxes, healthcare, and other costs, which are not fully settled for next year. In addition, like most well managed companies, Flowers Foods has already taken waste and low hanging costs out of our operations. For that reason, it will be important for us to watch pricing and promotions carefully as 2011 unfolds.

Now, let me sum up why I feel so good about the future of Flowers Foods. First, our business model is the envy of the industry. It is tried and proven and time tested. Our business model works. Although we refine our strategies as the marketplace and the competitive landscapes change, the course Flowers Foods will follow is currently charted. We will continue to execute our growth strategies to invest in our plants, products, people, and processes. We will continue to innovate with new products in our bakeries and with our information technology systems. Nature's Own and our regional brands are strong and provide a great platform from which to grow. Our products are a nutritious bakery foods that offer a good value. They are products that consumers and customers want and need.

Our growth strategy works -- it is a three pronged strategy. We grow by introducing new products and serving new customers in our core markets, expanding our DSD territory through market expansion and by making bolt-on acquisitions. Acquisitions have been an important part of our growth. We have made more than 100 acquisitions since listed publicly in 1968. We see good opportunities ahead to merge independent baking businesses into Flowers Foods. Our bakeries are powerhouses are bakery excellence.

Throughout our history, we have remained true to our strategy to invest in our bakeries to improve our efficiencies and our quality. We help build new bakeries, adding new production lines and improve our older ones. We have taken out less efficient capacity and we will continue those efforts going forward. As evidence of our commitment to this strategy, I remind you that over the last five years, our capital investments and operating leases, total, were about $500 million.

That strategy has helped us maintain our position as low cost producer. We recognize the need to continue investing in our bakeries for the future and we will do so. We have rewarded our shareholders with a strong dividend policy, by investing in our business and making acquisitions and through our stock buyback program. Our investments yesterday, today, and tomorrow are possible because of our strong balance sheet. We have the financial power to continue our strategies and to make investments that we believe will build value for our shareholders over the long term.

The underlying factor that makes all this possible, our very best advantage, is our team. Throughout the Company, we have the most experienced and motivated people in the industry. Every day, they guide our operations and grow our business and make the right decisions to keep Flowers Foods on track. Flowers Foods team members are simply the best, and we will continue to invest in them in our operations, our brands, and our processes to keep our Company growing. I believe in Flowers Foods and in our ability to create value for our shareholders. We look forward to finishing this year and to the opportunities ahead in 2011 and beyond. Diego, let's now open the lines for questions.

(Operator Instructions) Our first question comes from Farha Aslam with Stephens Inc.

Good morning.

Good morning, Farha.

I have a question first of all on the promotional aspect. Are you seeing a significant -- could you just give us more color on how much the promotional aspect produces -- went through the quarter and how they are shaping up today? Can you just give some more color around that?

Farha, I will take a shot at it. Allen did indicate in his remarks that the third quarter, which we had thought would be much better and we tried to make changes to the third quarter for the better actually got worse. Third quarter was higher than the second quarter's -- some of retail sales.

As we look at the fourth quarter, we have made those adjustments. We have been successful in reducing the number of items we feature, but trying to be a lot more effective. When you have too many items out on special, it is hard to get the displays needed to generate the volumes you need. So a lot of times you end up just reducing price on too many items that you can't execute properly, so that has been accomplished, so the fourth quarter we will see as a percent of retail sales a lower percent of retail sales being in the promotion pipeline.

But in terms of the competitive landscape, have you seen generally others do the same thing or is it more just you're changing your promotional strategy?

Farha, I would say that leaders lead, and we have led that. We have seen each market is different. This is still a local business market to market, and seems there is a lot of authority at different local levels depending on the company on doing different things, but again we have seen some improvement, very recent, very recent.

Okay. And then in terms of M&A, you [set] that share repurchase during the quarter; could you share with us color on your M&A flow and how that's going to factor into share repurchases?

Well, Farha, if you look at the share repurchases in the quarter, our strategy really is to make sure that shares issued for acquisitions as well as stock-based comp is not dilutive during the year. And if you go back to probably the first quarter queue, you would see where we put roughly a 1.5 million to 1.8 million shares into stock based comp and we were kind of behind our run rate for the year, so we're trying to stick to our strategy to make sure that those shares are non-dilutive, so that drove as far as the share repurchase decision in the third quarter.

Farha, following up on the pipeline, I would say that like I have been saying for years, the consolidation will continue. We did see a big consolidation being announced this week, and I am sure that will not be the end. I think we'll continue to see that consolidation continue, and we will continue to work with certain individuals to make sure that we can keep adding companies into Flowers that makes operational sense and which will have to drive the Company going forward.

Thank you. And then my final question is that Bimbo's announced a aggressive CapEx program in conjunction with their Sara Lee asset purchase.

Yes.

Looking to build one new bakery a year, and you're targeting one new bakery every twelve to eighteen months. Can the baking industry grow adequately to absorb two new bakeries annually?

Farha, you better ask our suppliers. No, I'm kidding you. Let me go back and say this. I think it will put some pressure on the industry, not on the wholesale side, but possibly on some of our suppliers. We have been committed to this strategy of taking out old capacity. I mentioned $500 million in the past roughly five years, approximately, and we plan to stick to that strategy and we've said either acquisitions and/or new plants depending on geographic territory and how well positioned the bakery that we would buy, how well it is equipped and how efficient it is also would determine do we build in those markets that we acquire in. But, the goal is to work like the dickens to make sure we continue to be the low cost producer.

So do you think that some of the new capacity is a replacement of old capacity so it won't cause too much production to come online or do you think it is going to be incremental?

In some certain cases I think it will be incremental, but in the main I feel like it will be some quite a bit of replacement. There is a lot of old capacity in the United States, and as you think about the announcement that was made, you know I am assuming -- I don't want to assume. I don't want to predict what they're thinking, but new technology as you have the opportunity to see Bardstown, Newton, and/or Denton, you see this new capacity, great quality, a lot more efficient, a lot more effective, and we are continuing to try to get there as well.

And thank goodness we started five or six years ago. Of course we've always had a history of being up to date with our -- the board has always worked with us to make sure that we have the tools we need to get the job done with.

Okay, thank you very much.

Thank you.

Our next question comes from Mitchell Pinheiro with Janney Montgomery Scott. Please state your question.

Hi, good morning, everybody.

Good morning.

George, what, so the pricing implied in your fourth-quarter guidance or your full year 2010 and then pricing in the 2011, how would you frame that?

Mitch, I would frame it -- we -- the new cost does come into these businesses. And I mentioned some of them like healthcare all of a sudden will be a bigger cost for all of us as we go forward. We know the commodities have really shot up since June 29th I think was that magic date -- go back and look at June 29th until what it is today. It has been tremendous.

And the baking industry, I can't speak for the baking industry. Flowers Foods will do what it has -- tries to do to -- you have to pass the cost along, and that's what we have done so far is trying to pass off through to our customers and evidently to the consumers it is a new cost structure based on the commodity cost.

So of the 3% to 6%, top-line growth in '11 in your guidance, what is -- what's pricing in that?

Mitch, this is Steve. It's preliminary guidance and for competitive reasons I don't think we would be willing today to talk about the amount of pricing we put into the market. I think as we'll do IRI data you will be able to gather that, but I would say pricing would be a strong component of the 2011 price of the --

Okay. That's helpful. And the difference between the low end and the high end of guidance, what would be the primary or contributing factor to getting from the low to the high end?

Yes, I think the effect of pricing on the consumer reaction in volume and really what happens from a competitive standpoint.

Okay. How about implied in your earnings guidance for '11, certainly we can sort of figure out commodity inflation, but what are you sort of forecasting for the non-commodity inflation such as healthcare, labor costs, and the other non-wage costs?

If you look at the total cost which would include commodities, you know it is a low, mid -- low to mid single-digit percentage increase across the board. Commodities are a little stronger than that. But we look at the other costs, it is low to mid-single digit percentage increase.

Okay. With the Sara Lee sale, and the FTC review, would you guys be interested in any potential if there were to be you know, asset divestitures required? Would you have an interest?

You know, what I was saying, I will not comment on the FTC and what they may do. Our strategy though is to continue to work on those bolt-on acquisitions, and if one or two of those is bolt-on, that would certainly meet our strategy.

Okay. In terms of your capacity needs, I get the sense that when you look at the Baltimore, Washington market, the Delaware market as you head north that maybe some of the -- one of the gating factors might be the amount of miles to those markets from your current capacity as well as having capacity to support better growth. So clearly, it looks like as you head on the east side you're going to need an acquisition or a new bakery. What do you think -- does any of this happen in 2011 to support those markets? Or is my premise incorrect?

No, I think your premise is accurate. In time, I would not -- we don't have anything announced at this point. We'll continue to work with our team and the board on the right time for that, and when it does unfold, we'll happily announce it. And as you indicated, it could be either or.

I guess in Allen's remarks with the 60 basis point I guess contribution from new markets, you know, that would seem to me to be a little lower than maybe, I don't want to put words in your mouth, but a little lower than where you probably would have expected, so maybe a little slightly slower growth from the newer markets. A, I would like to know exactly if that's a correct premise, but, number two, if it is lower, why wouldn't it have been higher? What were the gating factors in new market growth?

This is Allen. As I mentioned earlier, we are pleased with the growth in our new markets. From the growth percentage standpoint, it may be a little slightly slower than what we would like to see. I think reasons for that is really the competitive nature of the promotional atmosphere in the marketplace. But we have a very good foundation with which to build on.

Our Nature's Own brand, especially in the soft variety category, is being really well received in the new markets, and also our white wheat, our Better for You brand of white bread, is also being well received. So I think you're correct that the percentage is a little less than what we would like to see. And the primary reason for that is the marketplace conditions, but that is not an indicator of our long-term strategy to continue to grow in these new markets.

Sure. Did the DSD route system grow year over year at that same rate or I thought you would like to grow the route system by a percent or so a year. Is that still on track?

I don't think we've published a percentage growth for route expansions, but I will say that we continue to add new routes in our new markets, and the existing routes continue to strengthen and we'll continue to grow in that line.

This is Marta. One of the things that's really important to remember is that that is a five-year window, and every year new markets grow in the core, and that's part of the difference in percentage as we look at it. Some of those markets that you mentioned are actually in core now in northern Virginia.

Got you. And then the last question I have is since the Bimbo/Sara Lee announcement, have you -- have your phones been ringing as far as acquisition, you know like sort of reigniting any interest there?

My phone stays busy, Mitch. No, I can't comment on that. I would like to, but as we see things that we think are relevant, we'll be happy to announce it.

Okay. All right. Well, thank you.

Thank you, Mitch.

Thank you. Our next question comes from Heather Jones with BB&T Capital Markets. Please state your questions.

Hi. Good morning. This is actually Brett Hundley standing in for Heather. How are you?

Hi, Brett.

Good morning.

Good morning. My first question, just real quick, Allen, you talked to and, George, you clarified it, that promo was indeed slightly higher in Q3 compared to Q2. I think you made some remarks that pricing overall -- it just didn't get into place as quickly as you had wanted to, so was the sequential improvement in price mix there due to -- I think you guys had talked about an improvement in mix on Nature's Own. Is that what that was really due to?

Yes, I think the big driver of the mix shift would have been the Nature's Own products and the -- the new product sandwich rounds has been performing very well, but overall the Nature's Own brand is driving the mix improvement.

Okay, okay. But the promo was indeed higher and at least overall pricing as we look at it, how would you describe that in Q2 to Q3?

As we mentioned, the promotional activity in quarter three was actually higher than in quarter two, and we have taken actions to reduce the number of items on feature as we're moving into quarter four. And we've also increased the price points of those items that remain on feature in quarter four, and that impacts our Nature's Own brand as well as our other brands in the retail marketplace.

I think you're right in your question, Nature's Own was quite a bit of driver on that third quarter.

Got it. And then the volume improvement that you saw sequentially in DSD, I was wondering if you guys would talk a little bit about recent volume trends as it relates to branded and private label within DSD?

I think Allen commented on that and I can just follow-up to say that the category continues to be pretty flat. Branded has continued to perform well, and Allen mentioned I think private label units and dollars were actually down again for the -- slightly flat, to down slightly.

The category was basically flat. Our branded products were up 4.3% on units and 2.3% on dollars, but again that's based on IRI, which is about 48% of our business.

Okay.

But you have to say because of the heavy promotions on branded. Private label really has not grown.

Okay. And then, George, I wanted to go back to your comment on leaders leading and maybe not seeing pricing come as quickly as you had taken with some of your competitors. And I am going to ask you for your opinion here, maybe asking a lot but I will ask it anyway. What is your -- can you give us a general sense of your outlook for the pricing environment, and I am curious as it relates to the consolidation that you mentioned with SLE and Bimbo. Does that affect the pricing dynamic positively or negatively now that we're going to be in a waiting period here for this deal to get done? What's just your overall sense on the pricing environment as it relates to your competitors?

Truth is, I really can't comment on that. I have no idea how that could shape up. I don't know. We will stay focused on our business and we've outlined what we've already done for the fourth quarter this year and going into next year, but I will not comment on obviously what our competitors might do. I don't know.

Okay. And then just one other question. George, you also talked about how you still see good opportunity to merge with some independent bakeries out there, and I kind of wanted to piggyback on Mitch's line of questioning; just you hear some about just how it's -- or rather some people bring up the topic that it is just becoming harder and harder to make solid, accretive acquisitions in this space as you grow geographically. And I was just wondering if you would talk to that. I know you also addressed how the competitive environment plays into some of your geographic growth as well, but just wanted to talk about that a little bit more as it relates to your strategy and your take on that.

Well again, that was each family and that's basically what would be left as we talk about independent bakeries would be sort of family type situations, and each one of them has a unique opportunity, I am sure. As I mentioned, there is a lot of older -- this is an older industry equipment-wise in a lot of locations, not throughout. So this is on old industry. So I think companies have to look at it, am I going to reinvest? Am I going to go again and leverage up tremendously as a family or is it time to cash out due to the consolidation.

And we just have to measure as we meet each one of those what is the real value of putting these two companies together. And we have always said first of all, always first before we get to the financial part, what does this do for Flowers' operationally? Does the two companies make a lot better operation for the Company? And that's why we always say we don't jump five states to acquire. It is always trying to be adjacent to our territory, so that we can have two and two together makes five, and then we go to the financial part of it, and you know if you can't make it work, over time, we'll just have to get there through the greenfield plants, because we must grow the Company. We want Nature's Own before a lot more consumers than we have it today.

Got it. I appreciate you taking my questions.

Yes, sir. Thank you.

Our next question comes from Tim Ramey with D.A. Davidson. Please state your questions.

Good morning, George.

Good morning, Tim.

Interested in your comments on gross margin. Gross margin was benefited this year by input costs down 5% to 6% in the quarter. You're telling us inputs will be up mid-to high single digits next year, but the guidance seems to imply gross margin benefits. Can you comment on that situation?

Tim, you're referring to next year?

Yes, yes, sir.

Tim, this is Steve. We did say our guidance next year is preliminary, but what I think I can tell you today is obviously with the cost increases and commodities driving a big part of that, there will be some pressure on the gross margin, but as we look at '11, we see some leveraging again on the SD&A line, so it kind of you know moves back and forth between those two lines.

So bridging from 3% to 6% sales growth to 8% to 13% EPS growth would be SD&A and/or share repurchase or interest expense?

You can open up that leverage, but interest is not a big component. I would say we continue on our share repurchase program, we continue to lever SD&A and then, hopefully, we lever some on the revenue line as we get out from this promotional activity.

Okay. And, George, you made some positive comments at the top of the call about the last four weeks being more encouraging, but I just pulled up the transcript from this call last year and you did kind of the same thing. You said, "more importantly in the last few weeks we started our fourth quarter, we're seeing a marked improvement in our unit and dollar shares of Flowers brands."

It didn't end up being that way for 2010. And I know you're saying leaders lead and you've got to kind of try and calm this promotional activity down, but what gives you a sense, or what gives you the confidence that 2011 might be different than 2010 at least from the standpoint of where you were looking at it this time a year ago?

If you go back and look at 2008, when we had a similar situation with commodities, I'd point back to that as an indication of what should be, where it does not, we don't know -- I want to underline the word preliminary. What we said today next year is preliminary. We've got to see how the fourth quarter plays out, and as the first quarter unfolds, that's why I said we like to watch very carefully. And I did say that. We like to watch very carefully what happens with the overall pricing and promotion front.

As far as fourth quarter is concerned, the only thing I would say -- we have made the adjustments with our customers. They have made the adjustments in most cases I assume with the consumer. And Tim, you know and I know. You have been in this business a long time. When you go up sometimes -- when you do see volume declines, what I am encouraged about is customers accepting and we'll just have to see what happens with the units during the fourth quarter. Thing is though, and it is not just sales and units. We also have to have profitability, so I put all of that together.

I am not just saying -- I am just not talking about units and dollars and not talking about profitability as well. All three of those things sort of go hand-in-hand with us, and we always have to fine tune based on where the fallout is. And just because we led doesn't mean if it is the wrong strategy we will have to correct it somewhere down the road. But we think it is the right strategy and it is ultimately up to the consumer and whatever our competition ends up doing.

But I would say when you look at the food industry, and seeing all of these costs coming, I don't see how many people can just afford to see it and do nothing. I don't think there's -- I think what we have found out had and you heard the retailers say it; all the deflation has not helped them. The other consumers been helped some, but I say and you know as well because again, you have been in this business a long time.

The United States consumer is the most blessed in the world with food costs, and because of the great manufacturing and distribution system that we have in the nation, and the great workers that help get it done, we do a great job in feeding the nation at a very low cost as compared to most places around the world.

And just one other if I could. One of your strategies that has been so effective over the years is doing end market acquisitions; when you acquire somebody with great overlap, you get bigger drop sizes, you get larger end market shares, your whole efficiency just improves dramatically. And there is tremendous overlap, perhaps 100% overlap between Bimbo and Sara Lee. Shouldn't we expect the 2011 competitive environment to be that much more difficult based on this? You seem to be pretty sanguine about the post Bimbo/Sara Lee outlook.

I seem to be what? I am sorry.

You seem to be relatively comfortable or not concerned.

I am always concerned with competitors. I run a little scared all the time probably, but confident, but confident because I know what our company has done and what it can do as you've indicated. Number one, I would say that none of us know when this deal gets accomplished. You know and I know it takes a long time to put things together once the deal is complete, so none of us knows what the year brings and how long it takes to get this approved and pulled together and executed. So, Steve Kinsey made a comment after he went through the preliminary guidance, that the word is caution. So we remain cautious, but confident, and we have to make adjustments if things don't go the way we think they go.

Thanks a lot, George.

Thank you, Tim.

Our next question comes from Akshay Jagdale with KeyBanc Capital markets. Please state your question.

Good morning, George, Steve, and Allen. I just want to focus a little bit on the cost side. Your guidance for costs came in well below what I was expecting, so I just wanted to -- your thoughts on what we may be missing. I mean, wheat is up 60%, it's about 25% of COGS, so that alone should be up at least 15% and it should be same for the industry.

I know you guys have hedges and the timing of hedges that we don't have access to, but how confident are you about your guidance on the cost side? I know you told everyone to be very cautious on the revenue side, but on the cost side can you give us a sense of maybe what I am missing when I am just thinking of commodity costs for the industry which seem to, in my opinion, seem to be up a lot more than what you're guiding to, so, one is why is your guidance different than what I am computing and, two, how locked in are you on those costs?

Akshay, this is Steve, obviously we won't discuss where we are as far as purchases go. The market has run up like you said roughly 60% since the June, July timeframe, and our strategy is to buy six to nine months ahead, but that's just really just a guide. We can go in and out of that range as we deem appropriate, so I would say from a cost perspective, we may not be covered at the same level we have been in prior years or we could be beyond that, but from that perspective, the range we gave the midsingle-digit to high single-digit roughly 5% to 10%, so pretty wide range, and so I think we're fairly comfortable with the guidance we're giving there.

But a lot does depend on where the markets go. And we think as we saw in '08 there is some ability sometimes -- there will be ability to price as costs continue to climb, so we do have some of that into our thought process as well, and we try to forecast where we think the market is going to be heading. We have a lot of advisors and staff that do that and we talk to outside advisors. And markets go up and down and we try to stay within our strategic plan as far as how we buy, but I say all that just to say we are fairly confident at this point with our cost forecast.

Yes, I mean you have been pretty cautious on saying what you are but just another way to put it, in '08 in the spot market wheat costs or wheat prices were up about $3.60, and in '11 they're pointing to about $3. So in the spot market and what we can track, the cost increase relative to '08 is not as much and that's clear, but it is not as little as you're saying or your guidance implies. So I'm just still unclear on that, and maybe we could follow up off line. But it seems to me that your cost guidance implies that your hedging, et cetera, has put you in a pretty advantageous situation relative to the industry. Would you like to comment on that or --?

Again, we wouldn't comment from a competitive standpoint where we are on hedges, and we definitely don't know where the industry is on their hedge position, so. Our guidance takes into consideration our best estimate of the costs based on the coverage we know internally and at this point we're comfortable with where we are.

Okay. Just to follow up on Tim's question, if I just do the math, it seems to me that you're guiding to about 4% or 5% increase in COGS and roughly same amount of increase in pricing, so the way I was looking at it was flattish gross margins and then everything else coming from below the P&L below that with SM&A or share repurchases, so is that roughly in line with how you're looking at it today?

We do see some slight margin expansion across the whole. Although the gross margin may be under pressure, but again as George and I both said, it is very preliminary, and we to want see where the fourth quarter comes out and then we'll make adjustments as necessary, but I would say there is some growth in there. It is not all coming from share repurchase. There is leverage on the SG&A, but there is still efficiency gains that are possible, and manufacturing, and then there is some top line things that are possible if you can get better control of sales in the industry, which is you know always pretty high run rate.

And, George, just in terms of the comparisons with '08, and you started '08 and I think saying pricing would be up 7% or 8%, and I think wheat costs may have moved up a little bit as you were reporting a quarter and as the year unfolded, and you ended up getting a lot more pricing than was initially anticipated. Do you think that that's a possibility this year? I mean It seems to me that wheat costs and just costs for the industry, the baking industry, are going to be up significantly, and you may need in some cases double-digit price increases, but is that a possibility?

Well, I say looking at it as honestly as I can, we don't know the whole back half what's going to happen next year, but if we put all of this in our plan the best we knew how, and it remains to be seen. We don't know what competition is going to do. So, we just have to wait.

And just one last one for Steve. Did you say what your cost guidance for 2010 is, your commodity basket?

No, I didn't say anything about it on the call. But It is still in line with what we guided to earlier which was I think roughly a 4% to 6% decline or, I am sorry, 6% to 7% decline.

And what are promotions running as a percentage of sales in 4Q and so far relative to 3Q?

We would not disclose anything in the fourth quarter at in point. But as Allen said, we have to pull back on our promotional price and the number of items we have on promotion.

Great. All right. I will pass it on. Thanks a lot.

Thank you Akshay.

(Operator Instructions) Our next question comes from Bill Chappell with SunTrust. Please state your question. Thank you.

Good morning.

Good morning.

Just a couple quick questions. First on pricing for 2011 in light of what you have for the commodity basket. Have you already taken the price increases needed to overcome what you're seeing or will there be another round necessary as we move into 2011?

Bill, we announced that we did take pricing to October 4th, and that is in place. I would rather not comment about anything in the future until we see what others are doing in the marketplace.

You have a pretty good idea of the input basket when you took that price increase.

Yes.

And then second, just for housekeeping, tax rate for the full year this year and do you see that changing much going into next year?

No. It should be very similar on a full year basis.

If it was a little below what I expected in the quarter --

The quarter was a little below because we did have some discreet items in the third quarter. That's the quarter you typically do a lot of your filing so you go back and true up some of your reserves.

Okay.

That affected the third quarter rate, but the 35.5 or 10 in the 35 is very similar for six, so I think that's good for modeling purposes.

Great. Thanks so much.

Thank you, Bill.

Ladies and gentlemen, there are no further questions at this time, I would turn the conference back to management for closing remarks. Thank you.

Thank you, Diego and in closing I would like to say we recognize that today is Veterans day. We want to offer our thanks and admiration to all veterans as well as all the military men and women who are currently serving our country. Thanks for joining our call this morning.

Thank you. This concludes today's conference. All parties may disconnect now.