Flowers Foods Inc (FLO) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2012 Flowers Foods earnings conference call. My name is Grant and I will be your operator today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

Now I would like to hand the call over to Marta Turner. Please proceed.

Thank you, Grant, and let me apologize for the slight delay. We had a little bit of a problem with our service provider and a phone number, so we apologize for the late start.

Our second-quarter results you know were released this morning and the 10-Q was filed as well. If you need copies of those, you will find both documents posted on the Flowers Foods website. During the call we will use the PowerPoint and you will find that on the webcast listen page.

As we get started, 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 the matters we will discuss during today's call, important factors relating to Flowers Foods' business are detailed fully in our SEC filings.

Participating on our call today we have George Deese, Flowers Foods Chairman and Chief Executive Officer; Allen Shiver, our President; and Steve Kinsey, Executive Vice President and Chief Financial Officer.

Now I am happy to turn the call over to George Deese, Chairman and CEO.

Thank you, Marta. Good morning to each of you and welcome to our second-quarter conference call. As always we appreciate your continued interest in Flowers Foods.

In spite of the challenges in the marketplace, we were pleased with the operating results for the quarter. Before Steve and Allen discuss the quarter's results, I want to comment on how I view Flowers Foods from my perspective.

First, as I look at how we are tracking relative to the new vision for the Company we announced in March of 2011, we are delivering the topline growth we told you to expect. Our long-term goal for sales including acquisitions is 5% to 10% annual growth and we're achieving that with last year's acquisition of Tasty Baking Company and our recent acquisition of Lepage Bakeries along with growth in our expansion and core markets.

We also told you that our goal was to have at least 75% of the US population with access to our fresh breads, buns, rolls, and snack cakes by the year 2016. With Lepage bringing access to New England and other key markets in the Northeast, 70% of the US population now has access to our fresh-baked products.

We see more opportunities ahead with acquisitions and market expansions that will help us reach or exceed our goal of 75%. It is also important to realize the growth potential of the newer markets we have added in the past five years.

Just as we have done for decades, our team will steadily grow our market presence in those markets by offering great customer service, outstanding quality, and products and brands that consumers want. That's just a reminder that when we do reach the 75% of US population base, Flowers Foods will still have a tremendous growth potential within our newer markets.

When we reset our vision for the future last year, we told you that we expected to deliver double-digit earnings growth over the long term. In the short term, our earnings remain under pressure from volatile commodity costs, volume is under pressure as consumers remain constrained by the weak economy, and the resulting higher competitive marketplace has also been a factor.

Once the shorter term challenges are behind us, I believe Flowers Foods will achieve our long-term earnings growth by leveraging our operational strengths, experienced team, and proven strategies. When I look back at the decades of steady earnings growth Flowers has achieved, that gives me confidence that our team will achieve similar performance in the decades ahead.

As I see it, the major issues we face today are commodities, industry consolidation, and competitive dynamics in the marketplace. The volatile swings in the commodities continue and that continues to challenge us as we manage through highs and lows that are more dramatic than I have ever seen in my four decades in the business.

Our team is focused on minimizing the impact of the volatility through new strategies that have been developed and continuing to be developed.

The industry consolidation continues and we believe that will bring additional growth opportunities for our Company. Consolidation will bring change but we are confident in our ability to compete.

While the industry is consolidating, it is and will probably continue to be highly competitive in the near term. Looking longer-term, our industry will need better margins for investments in bakeries, in products, brands, technology, and our people. As we think about the baked food industry, it is important for you to realize that Flowers Foods feels very confident in our position as a strong number two player in the category. We often have said, we don't necessarily want to be the biggest, but we certainly want to be the best.

From the strong number two position, we have solid growth potential in our new markets with acquisitions, opportunities to partner with key retail and food service customers, core market growth potential as we gain sales in our underdeveloped categories, and the list goes on.

You may ask why do I have confidence Flowers Foods can overcome the challenges and outperform the industry over time? My confidence is based on our competitive advantages and the importance our team places on maintaining those advantages. The first competitive advantage is our efficient bakeries. For decades we have invested in our bakeries and we have an advantage while others still have work to do. We will continue investing in technology and talent to maintain our position on being the low-cost producer.

Next we have great quality products. We know that our products must be delicious and fresh and healthy every day in every market with every consumer purchase. We also have the very best customer service in our industry. This is a Flowers standard. We knock it out of the park when it comes to having to meet our customers' needs always.

Another advantage is our win-win to embrace innovation. We know that we must always look for ways to do everything we do just a little bit better than we did yesterday.

The final competitive advantage on the point is our team. Our best advantage is the experience and talent and determination found in our team members at all levels of the Company. Yes, we do have challenges to overcome in the short term but those challenges pale in comparison to the great confidence I have in our team and our growth strategies and in our ability to create value for our shareholders over the long term.

Let me say once again how pleased we are to have the Lepage team members join our Company and as always, I say thank you to the Flowers team for working to make Flowers Foods the best in every way.

Now let's hear from Steve regarding our financial performance in the quarter. Steve?

Thank you, George, and good morning, everyone. As we move into the financials, I just wanted to remind you that we did cycle the Tasty acquisition during the quarter.

In spite of the marketplace challenges this quarter, we were pleased overall with the operating results. As Allen will discuss in a minute, the marketplace was very competitive during the quarter. We experienced significant increases in promotional activity over last year's second quarter as well as over the first quarter of this year. Input costs during the quarter were up as we had planned year-over-year and the increase in the promotional activity coupled with these input cost increases did negatively impact our topline growth as well as our margins.

During the quarter we did absorb approximately $3.5 million of unplanned interest expense related to the issuance of our bonds during the first quarter.

Net sales during the quarter increased 6.1% over the prior year's quarter and on a consolidated basis, price mix contributed 2.3% to this growth. Our volume was down 0.7% in the quarter and the Tasty acquisition contributed 4.5% to the growth.

Overall sales growth of the DSD segment was strong, growing at 7.6%. Price mix contributed 1.5% of the growth with DSD volumes up 0.6%. The Tasty acquisition contributed 5.5% to the DSD growth during the quarter.

The DSD volume growth excluding the acquisition contribution was driven by Nature's Own soft variety, cake, store brand, and growth in non-retail. The non-retail growth in the quarter was due primarily to food service.

Sales in the warehouse group were down 0.7% over the last year's second quarter. Price mix was up 3.8% and volume in the quarter was down 4.5% quarter-over-quarter. Gains in the non-retail channel, primarily food service, were offset by volume declines in store brand cake.

EBIT in the quarter was up $4.3 million or 10% over last year's second quarter. Adjusted for one-time items, EBIT was up $2 million or roughly 4.3%. DSD EBIT was up slightly in the quarter as a result of higher sales and improved manufacturing efficiencies. The warehouse EBIT was up $1.2 million or just above 23%, the result of improved price mix in the quarter coupled with improvement in manufacturing efficiencies.

Earnings per share on a GAAP basis was flat quarter-over-quarter. On an adjusted basis, earnings per share was down $0.01 or roughly 4.3% compared to the prior year's second quarter. This decline was the result of increased promotional activity, higher input costs, and higher interest expense.

Turning to the gross margin, the gross margin did decline 50 basis points as a percent of sales compared to last year's second quarter again as the result of higher promotional activity and the higher input costs. Input costs, ingredients packaging and natural gas were up approximately 4% quarter-over-quarter.

Our DSD margin in the quarter was down 130 basis points to 50.8% and the warehouse segment gross margin in the quarter was up 130 basis points to 24.7%.

Selling, distribution, and administrative costs in the quarter as a percent of sales were down about 70 basis points. Excluding one-time costs, SG&A as a percent of sales was down roughly 30 basis points. The decrease as a percent of sales was driven primarily by lower employee-related costs. Our EBITDA in the quarter was up $5.7 million or 8.8% from last year's second quarter and on an adjusted basis, we were up $3.4 million or roughly 4.9%.

Turning to the balance sheet and cash flows, cash flow from operations during the quarter improved significantly over last year's second quarter. The primary driver of this improvement during the quarter was less cash allocated to hedging activities.

During the quarter, we spent $15 million on capital expenditures and $22 million on dividends. There were no share repurchases during the quarter as we were maintaining flexibility on our balance sheet to close the Lepage acquisition.

We incurred net interest expense for the quarter. We did adjust the outlook for 2012 to now include Lepage Bakeries. Sales are expected to increase 7% to 9% with Lepage contributing approximately 2.5% to the total. I would say that we are tracking on the upper end of this sales range.

Excluding one-time costs, earnings per share is expected to increase 3.5% to 8% over last year's adjusted $0.96. Lepage will contribute $0.02 to $0.04 of this increase. Flowers' excluding Lepage earnings per share is now expected to be flat to slightly up over the prior year.

Given that we now know our cost structure for the full year, the back half performance is dependent upon net pricing actions and volumes. And I would also tell you that we are currently tracking on the lower end of the earnings guidance range.

With regard to acquisition-related costs, it is important to note that we anticipate approximately $4.5 million to $5 million of transaction costs will be incurred during the third quarter. This will bring the total acquisition-related costs for the full year to approximately $8 million. The nondeductible portion of these costs will affect the full-year tax rate by approximately 60 basis points and this is why we've adjusted the tax rate for our outlook in 2012.

Thank you. Allen will now update you on the overall operational performance.

Good morning, everyone, and thank you, Steve. Our sales increase of just over 6% for the quarter and 9.4% for the first half is evidence that our growth strategy works. As George and Steve mentioned, acquisitions continued to be an important factor in our sales growth. Add that to the strength of our DSD business, the power of our Nature's Own and Tastykake brands, and our ability to grow successfully through expansion market concepts, you can see why we have confidence in the future of Flowers Foods.

With Lepage coming on board at the beginning of the third quarter, you'll see us take full advantage of those new markets, new products, and additional production capacity.

Both Lepage and Flowers have unique strengths. As we combine our companies, we will emerge even stronger than before. While we are excited about these opportunities, we do have short-term challenges to overcome. In the retail marketplace, we are seeing a higher level of promotional activity as category volumes remain under pressure and competitors seek to maintain their sales.

Like most food categories, fresh breads, buns, and rolls are experiencing soft volume. In the fresh bread aisle, as with other food categories, we are confident that lower volumes are driven by consumers remaining under pressure from the weak economy. Categories that are complementary to fresh bread are also experiencing the same conditions.

In addition to the economy, we feel the fresh bread category is down due to an overall reduction in the number of households combined with a slight shift to in-store bakery products. In spite of the lower volume experienced by the category in the second quarter, our DSD business delivered increased volume driven by sales growth with our Nature's Own and Tastykake brands.

George mentioned the ongoing challenge of volatile commodity costs. Our bottom line in the quarter was impacted by headwinds from higher input costs and higher promotional activities. However, we improved operating income as our bakeries further improved their operational efficiencies.

I want to again congratulate our manufacturing teams for increasing our productivity levels. In this time of volatile costs and marketplace pressures, we are at an advantage with the Flowers way, which put simply is getting the job done better.

With our unique culture and spirit of determination, our team has achieved the highest efficiency levels in our Company's history. As we have said before, the improvements we have achieved in manufacturing efficiencies over the last few years is equal to the production capacity of two bakeries that we did not have to build. We are keenly focused on further improvements that will maximize production efficiencies and minimize our logistics costs.

Other highlights of the quarter, our expansion markets delivered growth within our goal of 0.5% to 1% of goals. We are pleased with the recent introduction of our own Nature's Own brand into the Philadelphia market.

New products also performed within our expected 3% to 5% of sales growth. Tastykake continues to bring excitement to Flowers' core territories. This is a win-win situation. Our distributors are growing their sales, retail customers are pleased with Tastykake's contribution to their profitability and of course, Tastykake is helping Flowers' grow sales and profits as well. We are focused on innovative new products for the Tastykake brand and we continue to use social media and product demos to build consumer demand.

In our warehouse group, our cake business has now cycled the loss of a significant customer from a year ago and we should show improved sales comparisons for the remainder of the year. As with Tastykake, we are very focused on growing our warehouse cake business through new products and new customers.

Also this quarter work is under way at our Oxford, Pennsylvania bakery with our new bread line to be in production by mid-2013.

Looking at IRI data, for the first time we can share IRI's multi-outlet information, which captures about 85% of retail sales for the category. The new IRI data adds information from Wal-Mart and other mass merchandisers, select dollar stores, drug stores, and selected club stores. Going forward, our reference to IRI data will represent their new multi-outlet database.

IRI data confirms the fresh bakery category is under pressure with units down 3% in the South market and down 2.7% in the total US. Dollars were down 0.5% in the South market and down 1.6% in the total US. IRI reported Flowers' branded sales were slightly down more than the category. This may be due in part to the pricing that we put into place in the market late last year combined with a significant increase in competitive promotional activity.

Our regional white bread brands accounted for most of our sales declines in the quarter. I'm happy to report that the Nature's Own soft variety breads performed well with units up 2.1% and a dollar increase of 6.1%. This is a solid achievement in such a competitive environment. We continue to evaluate opportunities to leverage Nature's Own brand strength as we develop new products that fit consumer needs for more health-conscious bakery foods.

Nature's Own Oatmeal Toasters are our newest product, introduced just two weeks ago. This is an innovative and delicious breakfast square for the toaster offered in two flavors -- cinnamon raisin and cranberry orange.

IRI data for the quarter shows that Flowers' branded market share held relatively steady, which is encouraging under the market pressures that we have described. In the IRI South market, our dollar share was 25.3% and our unit share 20.7%. In the total US, our dollar share is just over 10% and our unit share 8.7%. IRI reported also that store brand share remained below that of prior years.

Turning to food service, Technomic reports industry growth of just under 4% for the year. Flowers' total food service sales were up 3.9% compared to last year's sales, driven primarily by new business with existing customers and by the addition of new customers.

In the warehouse segment, our food service business was up in both dollar sales and unit volume for the quarter. We are encouraged by new food service business that we have gained with our broad line distributors as well as selected national accounts.

As I close, I want to stress how excited our team is about our opportunities for continued growth despite short-term category challenges. I would like to remind everyone of the tremendous size of the fresh bread and roll category. In fact out of 260 different supermarket product categories monitored by IRI, fresh bakery is number two in total unit sales and number three in total dollars sales only behind carbonated beverage and milk. With a category this large, we are confident in our plans to grow our Company in our existing markets, our new expansion markets, and through additional acquisitions as industry consolidation continues to ramp up at an ever-increasing pace. This is truly an exciting time for Flowers Foods and our team.

With that, I'll turn the program back over to George.

Thank you, Allen. Thank you, Steve, for your comments. Before we turn it to Q&A, I would like to say that I've never felt better about the Company. Over time we have certainly created a tremendous value for our shareholders. We've increased sales. We've increased earnings. We've increased market share. We've developed new brands through innovation, through IT, and so the Company is the same Company that it has been. There are short-term difficulties. In the long pull, we always win and we will win this time.

So with that, operator, I'll open it up to Q&A.

(Operator Instructions). Farha Aslam, Stephens Inc.

Good morning. George, now that you've closed the Lepage acquisition and have really gotten under the hood, is there anything that you found notably that surprised you on the upside or downside?

Farha, I found no surprises. I would say, though, that we've known this company for a long time. We've have always had a lot of confidence in their ability to do a wonderful job in the marketplace by being very efficient, having great products that consumers want in that New England market. So at this point, no surprises and just look forward for the future and adding some of our product lines to their DSD system and growing the marketplace with them.

Okay, so it sounds like Lepage is going to be a relatively easy integration into Flowers. So do you feel like your Company is prepared for incremental acquisitions? How would you describe the M&A market today?

Farha, first question I will answer. Integration, we have had over 100 acquisitions since we went public. I would say all of our integrations have gone off very well. They are always a hiccup here and there but nothing that has been drastic anywhere and so we are very confident about being able to integrate Flowers and Lepage together.

And to the question about future acquisitions, M&A activity, I would say that -- I feel, as I've stated early on in my comments, consolidation will continue. And no specifics but I believe with all sincerity like I have been saying for a number of years, that this industry will have to consolidate as our customers consolidate, as the world gets bigger, as more requests come in terms of technology and products and taking care of the marketplace. I think it's very tough for smaller companies to participate. And you could say, almost say you wish that wasn't true but then in fact it is true. So I think we will continue to see that. We know when you read in the press through these other difficulties going on in the baking industry and we just feel like all of this will over time accrue to Flowers' benefit and we will be able to participate even though we took on some debt, we still feel very comfortable about the balance sheet and our ability to do so.

Thanks. And just turning to Flowers, Steve, could you share with us how much you expect those input costs to be up for the full year this year and kind of what pricing actions you might consider to offset those costs?

Farha, we really haven't changed our guidance from the 6% to 9% but I would say we are on the lower end of that range. So as you can tell, the first half when you go back and look at the first half, we were up double digits so in the back half even though costs or commodities have been rising from our perspective, we know that cost and you can tell we should see some relief from a cost perspective year-over-year. It will gradually get better as the back half progresses.

With regard to pricing actions, we are on schedule to do what we typically do. We typically target fall, October timeframe to move actions into the market and we are in the middle of those negotiations as commodities have increased and it seems that they are settling in at a higher level for the back half and as you look forward.

Okay, thank you very much.

Mitch Pinheiro, Janney Capital Markets.

Good morning. So George, you referenced heightened competitive environment, also softer volumes related to consumer weakness, yet these themes seem to stay with the category and they have been -- when hasn't the bread category been highly competitive? Is there anything -- are you seeing any differences in the type of competition, competitive strategy? And with regard to the consumer, are they eating the ends of the bread? Is that what's driving volumes down or are we seeing a switch -- just a consumer habit switch away from bread? Can you talk about that, how it is different now than it was in years past?

I will say a few words and I would like for Allen to follow and Steve if necessary on this question. I think from a competitive standpoint, I think the whole issue is probably this. I think all of us know that anybody you see reporting on food today has to talk about weakness in volume. And I think the consumer continues to be under pressure. We know about the -- you hear every day how much unemployment we have. You hear about how many people in poverty. So I think with that we need jobs in the nation to help alleviate some of that.

But I think in the meantime until that helps, help comes, I think what the food industry [reps] continue to look at and study -- and I know this is probably being done by all of us -- if volume is down, is the tremendous price promotions going to have to drive that volume or is it a matter that it's down, then it's down? That's a tough question to answer. But most people continue to promote very heavy hoping that will get their volume back. But in a lot of cases the volume is just down and I'm not sure how much you promote -- does that drive the volume back?

So I think the consumer has got to get well. I think we have been sick and that's going to take some help. So I hope that is coming but like I say in the meantime, we've got to make sure -- and the reason we've had to get more promotion-driven, we saw a little of our -- more of the volume disappear than we wanted to so we had to promote a little more just to protect share and be competitive.

But in the long run and I said that early on, too, in the longer run, the food industry and in particular the baking industry, you look at the baking industry, look at the margins that all companies are reporting and you see being reported are certainly not up to the standards we probably had three or four years ago. And to be able to invest in this business, with plants, with products, with innovations, we must have margins so we can reinvest in our industry and I'm confident that that will come back.

I think we're in a time of consolidation where everybody is fighting for that last loaf but this too shall pass and we will get back to a more normalized standpoint and see the consumer healthy. It will not stay this way in my opinion. The question is how long and I can't answer that.

Mitch, this is Allen. Just a couple of other comments. I think evidence that the consumer is still under pressure from an economic standpoint, the first of the month business has always been better than the end of the month but we continue to see polarization with the first of the month becoming even larger as consumers have more dollars in their hands.

I think also you have heard other food companies make the point that there are less households today. Population is up slightly but there are less households. So if you think about purchases of a loaf of bread, you are buying a loaf of bread for the household and not for specific individuals.

There is a -- if you really look closely at the category, there's a slight uptick in the in-store bakery category but again that's a very small segment relative to the wholesale bakery but there is a slight tick up there. And really I think those are the big issues that we are dealing with. Consumer is looking for promotional activity and in a category, George said it well. In a category that is flat to down, additional promotional activity like we are seeing just doesn't really make sense for the long haul.

So again this will pass and we look forward to the economy righting the boat and to the category getting back to the growth that we've seen in the past.

Thanks, just two other quick questions. One is you referenced store brand cake being down in the warehouse segment. But you would think that that would be a positive that would help margins. I was just curious why margins were weaker than I was looking for in that segment?

And then the second question is just at Tastykake, is there -- can you talk about sort of your -- any incremental revenue you've seen from Tasty year-over-year now that you've had it, what type of growth rate Tasty has had on a same-store sales basis?

Mitch, on the store brand cake question, we did lose some significant business this time last year. We are seeing some growth in additional business in store brand cake so we are optimistic about the remainder of the year to improve our comps from a sales standpoint on store brand cake.

Really can't provide you the details on Tastykake and what it's doing incrementally but I will say that there is a tremendous amount of excitement from our independent distributors, tremendous excitement from our retail customers as well as our marketing group who is excited to have a strong brand like Tastykake to be able to build for the future. But Tastykake has been nothing but positive as we rolled it across the Company.

Okay, thank you.

Eric Katzman, Deutsche Bank.

Good morning, everybody. A couple of quick questions. First I guess, Steve, you made the comment about the tax rate and I think you said it was going to be higher for the year. Can you just give me a little more details on that?

Yes, Eric, if you look at the cost incurred on the M&A activity now that we have closed the deal and I said we're expecting about $8 million total for the year, a significant portion of that will be nondeductible for tax purposes. So that does affect the rate and that's what's pushing it up to the 36.8% from roughly 36% originally planned so it's pretty significant.

Obviously since we closed the deal in the third quarter you will see a greater impact in the third quarter because of quite a bit of costs coming in from the Lepage deal. But that is the primary driver of the rate increase.

But for those of us who exclude some of your one-time costs associated with M&A, how do we --?

(multiple speakers) Go ahead.

How do we view the ongoing tax rate as opposed to how the Lepage acquisition and the one-time items are affecting that rate?

I think you would look at the normalized rate around 36% and that is really driven by the fact that when you look at the manufacturers' deduction, the Section 199, that's based on taxable income. So with income being kind of flattish, if you will, then we've made some pension contributions that will affect -- that are deductible for tax that we've already expensed for book this year so that did change the rate slightly as well from the 35.5% that we had projected early on.

Okay, so sorry to get so detailed on this but your guidance of 10 -- I'm sorry, $0.99 to the $1.04, is that including -- that's obviously including Lepage but is it -- are you including the $8 million and then also are you using the 36.8% on the tax rate?

No, the guidance would exclude those one-time costs, so we're using the normalized tax rate, not the 36.8%.

Okay, all right. Second question has to do with I think you said that your sales guidance for the year was on track but EPS would be at the lower end. And so with your input costs being a benefit for the most part in the second half, I think that was in answer to Farha's question, is it the promotion or the mix that's going the wrong way? Maybe you can kind of bridge those two.

Eric, it's really the promotional activity. It's really gotten strong year-over-year. And as the year has progressed, it's picked up, so that's what we are -- we are factoring some of that into the back half. I did mention we're looking at some pricing actions in the back half as well. So the back half will be -- it's all about what the [net's] getting price ends up and how the promotional activity carries through into the back half, and then the effect of that on volume.

Okay, this is promotion I guess not on the -- this is not I guess topline promotion but more like SM&A related in-store activity or something?

No, it's really more like cents off at the point-of-sale. So you are seeing a lot of buy-one-get-one-frees in the marketplace. You are seeing a lot of rollbacks in price. So it's kind of a combination, but it's all at point-of-sale.

Eric, that's what I also said earlier. I am not for sure that the overall food industry -- everybody is fighting, trying to push the volume needle up and if -- the consumer has only got so much money. I'm not so sure that is going to really drive the volume back up, or are we just giving away a lot of cents. And we are trying to measure that and use good judgment, but it is very competitive.

Okay, then that kind of follows up -- or my last question, both George and Allen, it seems -- this is something I've been trying to focus on a bit more, but it seems like the Nature's Own business is doing reasonably well in a competitive marketplace. Tasty seems to be on track, et cetera. Store brands are in check, so it seems like the weakness in the category to you as well as kind of these local and regional white bread product.

How do you think -- one, is that true? Two, how are you performing like in terms of, if you can, your market share of these local and regional brands versus the struggling players out there?

This is Allen. You are right about the strength of Nature's Own and the strength of Tastykake. Both of those brands, they are commanding a premium in the market today. If you think about the regional white bread brands and the consumer profile, the consumer demographics of who is buying that product, it's middle to lower income in many cases, so that is the economic group that is being pressured most by the tough economy. So you are correct that the regional brands with the white bread and buns are being impacted more than Nature's Own and other stronger brands.

But I think how do you deal with that is really looking specifically at a pricing strategy for those categories. Are there opportunities to adjust package sizes? Are there opportunities to do different things that can bring that consumer back? But we are really focusing on maintaining the very best quality that we possibly can and making sure that we continue to put emphasis at the sales level on those regional brands because they are very important.

I guess, Eric, also the good news about Nature's Own, I think some of those people are trading up because of the, as they perceive, healthier attributes. And as I study IRI, even though when private label and/or competitors and/or Flowers drops the price promotion, you drive some white units but not what you would think so we do see people trading somewhat up and some people just cutting back and not consuming as much.

Can you say how much these local and regional breads are -- however you want to kind of define that -- can you say how much are those down for the category and how much has yours declined?

I think the number is probably in the 5% neighborhood, 4% to 5% on white bread and we are tracking along with that or a little below that.

Okay, I will pass it on. Thank you. Have a good end of summer.

Heather Jones, BB&T Capital Markets.

Good morning. Real quick question. How much of your DSD sales are represented by this new IRI data?

85% of the total category is represented by the new data. Heather, that would be pretty much true with our business as well.

Okay, so 85% of your retail DSD sales?.

Yes.

Okay, and a follow-up to Eric's question, if I look at what your soft variety breads did during the quarter versus the numbers you gave for Flowers branded, my interpretation, it looks like the drag from these regional white breads got dramatically worse during Q2 and I'm just wondering if I'm interpreting that correctly?

I wouldn't say dramatically worse. We have seen a continued pattern of sales decline in regional white bread brands but I wouldn't say dramatically worse for the quarter.

Okay and looking as far as your input costs, have you guys fully implemented the new program of I think it's hedging four to seven months out? Is that now fully implemented as we start considering 2013?

I would say, Heather, that was the guideline. It was the strategy. It is the guideline. What we also said that depending on markets and depending on time, we are not bound by that. So again, it depends. Ultimately what we want to do is if the market is cheap, we want to go longer. If it's higher than we think it should be we want to be shorter so therein lies the dilemma in working through those issues.

Okay, is there any scenario where you would've gotten so aggressive that we wouldn't be anticipating meaningful cost pressures in 2013?

I think at this point, Heather, we are still assessing 2013 and we are not ready to give much guidance. But you've seen what the market has done and we are sticking with our strategy to hedge but we are not willing to talk about our positions at this point.

As far as going to the promotional environment, wheat costs did move down this year until June and some of your competitors have noted that they are hedged through the end of this year but really nothing beyond that. Do you think the industry has changed, that even with higher input costs going into 2013 it will continue with this aggressive activity or once they start to experience significant cost inflation, do you expect them to become more rational?

I think with significant cost increase, people have to be more rational. Now you still might have the same number of promotions but normally what happens you would see a higher level of -- instead of 2 [to] 4, maybe 2 for 5, just for instance.

Okay and my final question is just -- and I have heard some of this commentary from some other companies but just price elasticity seems to have increased over the last few years and so now that we're looking at another round of input cost inflation, do you still plan to stick with your strategy of passing it completely along in price or, given the impact on volumes, looking for other cost savings to maybe so you don't pass it completely on in price?

Heather, let me take a stab at it. I believe that this wholeheartedly that first thing we do is work on the cost side and do everything we can to eliminate any waste in the Company and ultimately, though, after you do that if you have to pass along cost, you got to be willing to do that. So we would and would plan to pass along the cost of commodities after we see how much more costs we can take out.

Okay, all right. I appreciate it. Thank you very much.

Tim Ramey, D. A. Davidson.

Thanks, Steve, just following up on something I think I heard you say, it sounded like you said working capital due to reduced hedging was down. Or maybe I interpreted that incorrectly but it didn't sound like just to follow up on the last question as of 7/14 you probably weren't very aggressively hedged, at least, or didn't have a lot of positions on.

Tim, when you look at the improvement in our working capital and the cash flow, last year we did have some hedges that turned against us, so we did have quite a bit of cash allocated to the hedge margin. This year as we have adjusted our strategy of four to seven months, we're not prepared today to talk about where we are. We are covered for the rest of 2012 and the levels of our hedges would obviously indicate that since we are not using as much cash, there is not as much margin requirement.

Okay, but covered at least throughout the rest of this calendar year?

Yes.

Just kind of circling back, I think Allen touched on this and the question has kind of been raised. But I cover some of the infant formula like Mead Johnson, and we've certainly seen household formation down. We've seen birth rates down. This doesn't sound like something is coming to the rescue kind of issue. It sounds like we might have quite a hole for an extended period of time, maybe a generational type of thing relative to fewer households and fewer babies kind of in the pipeline. And I presume that when they graduate off of infant formula they go to bread. Have you thought much about that and how that should position you in the coming years?

I'll take a stab and Allen is more -- he's on the marketing side a lot better than I am and I will let him answer it. But I think what we have to do and the food industry must do is continue to innovate, if you recognize this is an issue. How do you innovate around -- people are still eating so even though there are smaller families or less families, people still consume products, so we've got to be innovative enough to find what are the products that we can bring to market that continues to attract all consumers? And I am not trying to predict how many babies will be born. I am more focused on how do we innovate to attract those consumers who are still in the market and buying products?

Tim, the only thing I would add is as we know the reason for the reduction in households is the baby boomer generation is now moving into kind of that empty nest stage of their life. The good news is you've got the millennials that are really starting to come into the childbearing years with their families. So we do see that change taking place as we go into the years ahead with the millennials developing hopefully a rebound to the overall food market. But I think the important thing is -- and I mentioned in my comments earlier the relative size of the fresh bakery category. Again number three in dollars relative to other product categories.

So in a marketplace that is consolidating, I think it's important to just remember that we are dealing with a huge category here that offers lots of opportunities for growth.

Thank you.

Akshay Jagdale, KeyBanc.

This is John Morgan in for Akshay. Good morning. A quick follow-up. Related to a lot of the promotional activity you are experiencing, how much of that can you attribute to the Hostess bankruptcy?

I wouldn't take a stab at that. Allen, you might want to get -- we just call it the marketplace without naming competitors.

Okay and then maybe a quick second question would be with regards to your DSD business, it looks like the organic growth revenue growth is the lowest it's been in several quarters. How did the performance of that segment overall compare to your expectations for the quarter?

Are you talking about the DSD business?

Yes, DSD segment.

Again, we talked about obviously our expectations probably would have been higher than what we actually experienced in the quarter, John, but again it's all driven by the promotional activity and the net selling price. That kind of accelerated as the quarter progressed and again if you look at some categories, we were the product leader so we did have some volume effect from that as well. But as we typically do, when we start seeing dramatic volume affects, then we get more promotional as well to try to protect our volumes.

So I would say revenue in that category probably is a little softer than we had planned as we thought about the year.

John, I would just add with our brands Nature's Own and Tastykake, it was a good quarter but there are other segments, we talked about them earlier, some of our regional brands that were more susceptible to price promotional from competition. Those were the areas that we are taking note of.

Great, thank you very much.

Ann Gurkin, Davenport.

Good morning. I wanted to start with innovation and you highlighted a new product this morning. It sounds like Pepperidge Farm is stepping up their innovation in the back half of the year and so how do you anticipate competing against what could be a more kind of innovative environment?

Ann, I did read that Pepperidge Farm announcement and I think one problem maybe was directed at the fresh bread baking business and the rest of them was probably on the cookie and cracker side. As I mentioned to Tim earlier, I think as the consumer changes, we've got to be more focused on not losing consumers to this category. And Allen mentioned I think the toaster bagels, Allen, do you want to touch on that again?

Yes, I thought the Nature's Own new product, our Oatmeal Toasters are a pretty unique product for the breakfast category. Again, there's nothing like that in the market today. But just to comment about new products in general, the health -- even though the economy is dealing with some tough times, health and nutrition continues to be more important than ever. Our Nature's Own brand is positioned perfectly to develop products that meet those health and nutrition concerns. So things like clean labels, reduced sodium, there are a lot of health attributes that are under evaluation now that can lead to new products.

On the other side, Tastykake positions us with an exciting brand of cake that really lends itself to new product development, so we've got some really exciting new products in the queue that we will be talking about as we get later in the year under our Tastykake brand. So the new product engine is alive and well.

Great. And then with respect to Tastykake, can you comment on repeat purchases in markets in which you've rolled out that brand?

Anytime you introduce a new brand to a market place where the brand awareness is not extremely high, you are going to have some sales issues in the very beginning but we are pleased with the rate of growth of sales with Tastykake in new markets. Focusing a lot on product demonstrations to sample product to get it into consumer's hands and once they try Tastykake once, many times we have a new customer. So we are pleased with the progress.

And then third, on -- I am sure it is a price gap between store branded white bread and branded white bread, can you comment on where that gap is now and do any adjustments need to be made?

I mentioned in my comments that the good news in this economy is that the sheriff store brand is not increasing. In fact store brand continues to trend down. As far as the gap between store brand and our major brands, it really varies by market and by customer but the gap is still too wide and should be narrowed over time. But I think the good news again is that we are not seeing growth in the share of store brand products.

That's great. Thank you all very much.

Amit Sharma, BMO Capital Markets.

Good morning, everyone. Steve, can you provide us a view on interest expense for the year? Is it still going to be approximately $11 million for the whole year?

No, the $11 million I think we talked about on the last call was the increase. The total interest expense for the year is going to be roughly $20 million, $21 million.

This is net of interest income?

No, that is the total interest expense. Then you will need to net out the interest income.

That will be about $12 million?

Yes, net interest expense is about $8 million.

$8 million, got it. Okay. George, can you please share your view on the grains market? Clearly we have plentiful wheat here but wheat has clearly gone up in sympathy with corn. How do you view this playing out as we go towards the end of the crop cycle here?

Well, I think looking at the USDA, they've talked about corn, their announcement just last Friday or this past Monday outlined another downtrend on bushels per acre of corn. As you stated, plenty of wheat but all of the -- it's all in sympathy of soybeans and corn and I think the whole issue of corn is probably over for the year. Soybeans, I think predictions could be some rains could help that some. But I think corn is what it's going to be.

So if we look usually our prices brings lower prices over time and what I mean by that, I think we will see farmers plant hedge to hedge everything they possibly can do. I see it right here in Thomas County, where farmers are taking woods and pines out of service and putting in fields to plant in. If it happens here in Thomas County, it is probably happening in other parts of the United States.

So I think farmers are robust. I think they will be planting hedge to hedge and we will see wheat planted first, the winter wheat crop, that's what we mostly buy. And I think by January, February, we will know all that's planted and what it looks like.

But I would -- we have had two or three dry summers. We often say there can't be a fourth but who would have thought it's going to be the third? And it has happened. But I am confident, though, the farmers and the world will solve the problem. We know there's more people consuming more but also between the farmers and the seed companies, I think they are going to continue to develop ways that we in turn will get more yields per acre in the long pull.

Okay, so it appears that you are not expecting another leg up from these levels, barring a dreadful turn in weather again for soybeans as well?

I believe you said the question was do we expect cheaper prices on wheat?

No. I'm saying you are not expecting another leg up from where wheat prices are today?

Well, I think volatility is still out there. We could see another run up, but they need to see a rundown at some other point.

Got it. Last question is when you look at your competitive set on the independent bakers side, not the public or large companies but independent baker, what's your view or what's your sense of where is their margin structure? How is their hedging policy so that if we do see this increased volatility in the grains market, is that competitive set likely to get more promotional or the ability to get more promotional is just hindered by the margin structure and the hedging policies?

You know, I would predict and I don't know this for a fact I would think, though, most independents are shorter-term people than public companies. I would think they are probably shorter -- a lot of them do not use hedging. So chances are they are using higher-priced wheat as we speak. I don't know that but probably. So you would think with margins already compressed and with higher input costs that it could get less. We have not seen that yet but I think as the year goes through, we will probably see -- could see as many promotions but you could see a different price level possibly.

Got it. Thank you very much.

Bill Chappell, SunTrust.

Good morning. Just have a few quick questions. One, and you might have covered this, on the accretion from Lepage it was originally $0.03 to $0.05. It's now $0.02 to $0.04. Is that just timing of the deal and finance costs?

Some of that was timing, but also as soon as we announced that deal, we have seen commodities move up and we are factoring in the possibility of higher commodities in the back half for that business.

So was Lepage not as hedged as you were?

You know, they had some coverage. I would say that it would not have been as long as Flowers.

Okay, on that same kind of note, I assume when you come to October you are looking to do some pricing to offset these commodities for next year. Is that pricing kind of baked into your full-year guidance in terms of what it would affect on the fourth quarter?

Yes, as we look at the pricing actions necessary in the back half, we have estimated the effect of those and tried to estimate an effect on volume as well.

Steve, just to your earlier comments, it is really going to come down to what is the real net price for the back half -- for that back quarter.

So we should know by the time you get to kind of late October kind of whether you've covered the commodity costs for next year?

Yes.

Okay, and then finally just on Tasty, is there any kind of -- I'm sorry if I missed it -- an update in terms of number of doors or market penetration or kind of where we are in that stage?

Yes, I can get that information for you. At this point we've expanded the Tasty brand to all markets with the exception of our Phoenix plant and our El Paso plant so the biggest percent of our DSD network is selling Tasty today and I can get the specific numbers for you and get that to you a little later, Bill.

Okay, great. Thank you.

(Operator Instructions). Doug Thomas, JET Investment Research.

Good morning. All right, George, I don't know if this is going to help you out in the near term, but I am having toast, an English muffin. I'm about to have a Tasty chocolate doughnut and I got loaf of bread to feed the ducks this morning, so I think --

Doug, thank you.

That should all help out.

Absolutely. Thank you.

George, I had a couple quick questions for you. One was nothing like the lowest interest rates in our lifetimes to I guess make a person more willing to take on a little bit of debt and I'm just wondering from your vantage point as this consolidation continues in the industry, what is your and the Board's appetite for taking on debt here at these what I consider to be absurdly low levels to continue to facilitate consolidation as your competitors, particularly the smaller ones, find themselves under increasing pressure?

Thank you, Doug. I'm going to let Steve take that.

Doug, this is Steve. I think we've said this before but our goal is to remain investment-grade and based on our current level of EBITDA and our current footprint and how we are viewed by the rating agencies, about 3 times trailing 12-month's EBITDA is really where things are starting to get nervous and moving ratings. So somewhere I would say we are both comfortable somewhere around the 2 but we could lever up to 3 to take advantage of these opportunities and still maintain our investment grade rating.

Okay, I appreciate that.

As if we reach the 3, I would tell you we would have a plan in place to quickly bring that back down.

Okay, then secondly, whenever I think when investors hear you guys talk, they always take away this cost reduction continuing -- continuous improvement, all the things that obviously great companies do all the time in terms of particularly improving their competitive positions during weak periods like this. But there are some offensive things in terms of I know some of these technology programs that your retail customers have in place in terms of being able to identify particular demographics right down to specific customers. And I am just wondering -- Kroger has a program. Safeway is rolling out a program. I don't often -- I don't recall getting promotional offers at retail or online or anything for bread or even Tastykake type of products. Everything seems to be at the store.

But I'm just wondering are there opportunities given the fact that you guys are really a national player now and in multi-category and have to be viewed by your customers as a valued branded innovative partner, are there opportunities to do a better job of tailoring programs that sort of create customer loyalty as opposed to for example just giving cents off at the store?

Doug, we are currently very involved with -- again, it's a customer by customer situation. We are involved in many of their loyalty card programs not only on -- to deliver say a coupon or deliver advertising but we are also -- and dunnhumby information is a good example. We are buying that information to learn more about the consumer to help drive our marketing and new product development projects.

But we are very involved and again it is a customer by customer situation with -- there's social media activities, couponing, utilizing their loyalty card and other web-based delivery vehicles, so we feel that that certainly is where the market is at currently and it's going to become an even bigger factor in the future. So we're very much focused on that area.

There again you would seem to have significant advantages over some of your smaller rivals. But for example the cross-selling opportunities to get people for example who don't realize that you make Nature's Own and they are buying Tastykakes, I think that would provide you with some synergies and some economies of scale that your competitors don't have.

Good point, thank you.

Doug?

Yes?

I was just going to say we agree with your assessment.

Thanks, George. Good luck to you guys.

Thank you for your question. We have no further questions at this time so I would now like to turn the call over to Mr. Deese for closing remarks.

Think you, Operator. I thank all of you for joining us today and look forward to seeing you on the road. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.