Flowers Foods Inc (FLO) 2013 Q2 法說會逐字稿

Welcome to the Q2 2013 Flowers Foods second-quarter earnings call. My name is Dawn and I will be the operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Marta Jones Turner. Ms. Marta Jones Turner, you may begin.

Thank you, Dawn, and good morning, everyone. Our second-quarter results were released this morning and the 10-Q also was filed. You will find that release and a link to the filing on the website in case you need that.

You know that before we get started this morning I must remind you that our presentation may include forward-looking statements about our Company's performance. Although we believe those 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 the call, important factors relating to Flowers Foods' business are detailed fully in our SEC filings.

Now to our presentation. Participating on the call this morning we have Allen Shiver, Flowers Foods President and Chief Executive Officer, and Steve Kinsey, our Executive Vice President and Chief Financial Officer. George Deese, our Executive Chairman, is also with us.

We have a lot to cover so we have put the IRI data that typically we go over in our comments back in the footnotes of the presentation. Let me give you the order of how we are going to talk about the matters that we need to cover. First, Allen and Steve will comment on our second-quarter performance. Next they will discuss the Hostess acquisition and then Steve will talk about our guidance for 2013. And of course then we will open the call for your questions.

Now I am very happy to turn the call over to our President and Chief Executive Officer, Allen Shiver.

Thank you, Marta. Good morning and welcome to our second-quarter 2013 conference call. We appreciate your interest in Flowers Foods.

From any perspective, our second-quarter results were outstanding. Once again our team did an incredible job of taking advantage of opportunities to serve our customers. We achieved a 31.8% increase in sales, another record performance for our team and significantly above our goal for 5% to 10% annual growth.

Adjusted earnings per share growth was 71.4% for the quarter, shows our strong performance in these exceptional times to our industry. Our adjusted EBITDA margin was 11.8%, which is in line with our goal of between 11% and 13%. No matter how you look at it, the second quarter was another eventful quarter for Flowers Foods. We continued integrating acquisitions, opened a new bread line in Pennsylvania, and entered into new markets in Central and Northern California.

After the quarter ended, we completed the Hostess acquisition and we also acquired a bun bakery in Modesto, California.

We have a lot to cover on the call today and we know you want us to get to questions as quickly as possible. So Steve, please give us the financial highlights for the quarter.

Thank you, Allen, and good morning, everyone. As Allen mentioned, our second-quarter results were very strong. Sales increased during the quarter to $898.2 million an increase of 31.8% compared to the second quarter last year. Volume was strong in the quarter, up 21.8% primarily the result of gains in the marketplace as a result of Hostess brands exiting the market back in November of 2012.

Price mix in the quarter was down quarter over quarter 0.9% with pricing gains being offset by a mix shift primarily in our case business. The Lepage and Sara Lee acquisitions contributed 10.9% to the second-quarter sales growth. Just a reminder that we did cycle the Lepage acquisition one week into the third quarter.

Operating earnings in the quarter excluding the acquisition-related costs was up approximately 62.2% this quarter over last year's second quarter on an adjusted basis. Overall, the increase in operating earnings was driven primarily by the impact of stronger volume and the contribution from the Lepage acquisition.

During the quarter we also experienced significant costs related to our market expansion in California. Interest expense was $6.2 million in the quarter, which was relatively flat quarter over quarter. I will update you on full-year interest expense in just a moment when we discuss 2013 guidance.

The effective tax rate in the quarter was 35.6%. GAAP earnings-per-share was $0.22 for the quarter. We incurred acquisition-related costs in the quarter of approximately $0.02 per share. Earnings per share adjusted for new costs was $0.24. This compares to $0.14 per share in the second quarter last year while our (inaudible) approximately 71% increase.

As expected on a split adjusted basis, the Lepage acquisition contributed slightly above $0.01 to the quarter's earnings per share.

Gross margin in the quarter as a percent of sales increased 120 basis points to 47.5%. This overall improvement as a percent of sales was driven primarily by stronger sales volume. Selling, distribution, and administrative expenses as a percent of sales was 36.3% this quarter versus 36.1% in last year's second quarter. This increase as a percent of sales was primarily attributable to distribution costs related to our marketing expansion and workforce-related costs.

Turning to the balance sheet, cash provided by operations was a positive $89 million in the second quarter. We ended the quarter with approximately $582 million of debt on the balance sheet. During the second quarter, we paid down $56 million in debt. Cash flow remains strong and we will continue to focus on paying down debt as we move forward.

I will talk more about the debt capital structure in just a moment when we discuss the Hostess transaction.

Now I will turn the call back to Allen to discuss operations.

To recap sales and operations, we had good results across all categories in the quarter as our team focused on meeting consumer needs. Steve mentioned the volume increases we achieved since Hostess exited last November. Let's look at how that volume contributed to our sales categories.

Branded sales increased more than 35% and brands accounted for about 55% of our total sales in the quarter. Nature's Own and Tastykake were the primary drivers of that growth with acquired brands also performing well. Our share of store brand remained relatively stable at about 18% of our total sales.

As Martha mentioned, we won't go over details from the IRI data, but that information is provided at the end of our presentation materials. As you would expect, the IRI data is very positive, reflecting our strong sales growth in the quarter.

Our Food Service business was good in both our DSD and Warehouse segments. Food Service accounted for about 19% of sales in the quarter, reflecting a 23% increase over last year's second quarter. Expansion markets, which are markets we have entered in the last five years, exceeded our goal of contributing between 0.5% to 1% of sales.

We continued to add to our customer base. In the quarter, we added over 800 store locations, bringing our new stops for 2013 to over 29,000.

Turning now to operations, our strategy over time has been to continuously invest in our existing and our new bakeries, improve our product quality, and enhance our brands. That strategy positioned us to be able to take on significant new volume in our existing bakeries when Hostess exited the market.

I'm externally proud of our team for their performance as we added new volume throughout the Company. With the volume we've added, it isn't surprising that our production utilization for both bread and cake is higher than normal. Since November, we have reopened some idle capacity in Brattleboro and other bakeries to help address the need. We also commissioned a new bread line in the quarter at our Oxford, Pennsylvania bakery that was part of our Tasty acquisition.

In keeping with our strategy to constantly improve processes and use new technologies, the Oxford bread line includes several innovative new technologies that make it among the most efficient in the country. The Oxford startup was smooth and the new line is well-positioned to serve our expansion markets in that region.

I want to give a special thank you to our team members at Oxford along with our support team, who are part of building and starting up the new bread line.

Our integration of Lepage and Sara Lee California continues to be on track. As expected, Lepage is a great complement to Flowers and now their New England markets offer Nature's Own and Tastykake as well as Lepage's Country Kitchen and Barowsky's organic brands. The Lepage integration is going well and is on schedule.

You will remember that in February 2013, we acquired the Sara Lee brand for California and started our phased rollout of that new business. In mid-June we completed the last phase and now offer fresh bread and rolls available throughout the state. Our team in California continues to do a great job building our business on the West Coast.

Before the Sara Lee California acquisition, our brands had a 2.4 dollar share in California. With the rollout, Flowers' brands now have a 12.5 dollar share of the California market according to the IRI reports in mid-July. This is in line with what we told you to expect. As we continue to gain consumer acceptance for our brands in California, we will achieve steady growth for years to come.

We are also working to establish our own production capacity for California as evidenced by our July acquisition of a high-speed bun bakery in Modesto, California.

To recap the second-quarter performance, I think it is important to point out that the Flowers team is the most important [shooting] factor in our ability to deliver exceptional results. Using the systems and resources our strategies have created over time, we are aggressively growing our business as we serve the needs of our customers. As we move forward, we will continue building on the solid strategies that have worked well in the past.

Now let's take a look at the Hostess acquisition. Just after the second quarter ended, we completed the acquisition of Wonder, Merita, Home Pride, Butternut, and the Nature's Pride brands; 20 bakeries and 36 warehouses. The Hostess bread brands have been off the market since November 16, 2012 but our research gives us confidence that the brands have staying power with consumers and with refill customers.

The Wonder brand continues to have a 96% aided brand awareness in core markets. From a customer standpoint, food retailers are well aware of the power of the Wonder brand, which drove good margins for them and also once had the highest household penetration of any brand in the white bread segment.

The other bread brands we acquired, Merita, Home Pride, Butternut, and Nature's Pride, have strength in selected regional markets. We plan to reintroduce the brands in a way that will enhance consumer choices, strengthen the overall category for retail customers, build our distributors' business and of course, positively impact the Flowers Foods bottom line.

Our plans to reintroduce the new brands across markets served by our DSD system are being finalized for this fall. We have good indication that our retail customers are excited about supporting our reintroduction of the brands.

Adding Wonder and the other acquired brands to the Flowers Foods portfolio gives us the opportunity to strengthen and consolidate our brand lineup. From a national brand standpoint, we will continue to position Nature's Own as a healthy soft variety bread and premium specialty brand. Nature's Own is the number one selling loaf bread in the country and we continue to see it driving growth in our core and in our new markets.

With the addition of Wonder, we now have a national white bread brand that will help accelerate our growth especially in new markets.

Tastykake will continue as our national brand for snack cakes. We have grown Tastykake from about $225 million at retail in 2010 to a brand now annualizing at over $400 million. We feel good about the growth potential for Tastykake.

When it comes to our regional brand portfolio, you will remember that as we have made acquisitions over the decades, we have acquired a number of strong, popular white bread brands. Home Pride and Merita and Butternut are strong additions for our regional brand portfolio. We are confident that these brands will help us grow both in core markets and in selected new markets.

The 20 bakeries we acquired from Hostess are strategically located across the country. One of the questions we often hear is when will we reopen the Hostess bakeries? At this point we are able to meet consumer demand through our existing bakeries. We are confident that consumer demand will increase as we reintroduce the Hostess bread brands. As we need additional production capacity, we plan to reopen the bakeries.

As we look ahead to integrating the Hostess assets, I have confidence in our team's ability to execute well. Although we currently have more integration underway than normal, we have proven throughout our history that we have a successful integration strategy. We have made more than 100 acquisitions since Flowers listed publicly in 1968, 12 acquisitions since the spin-out of Flowers Foods in 2001.

Our team has experience and our operations are strong. Our structure allows us to absorb and integrate new business effectively.

It is important to realize that until the Hostess acquisition was completed, we were benefiting from increased volume without adding substantially to our costs.

Steve will now review the financial aspects of the Hostess acquisition and then discuss our guidance for 2013 including the impact of those factors. Steve?

Thank you, Allen. Turning to the financial aspect of the transaction, as you know the purchase price was $355 million. It was a purchase of assets only. And we funded $300 million of the transaction using a new five-year term loan and the balance was funded through an AR securitization. Overall, the AR securitization we grew $100 million -- used -- and funded the balance of $55 million using the securitization and then the remaining proceeds of that draw were used to pay down other debt.

After closing the Hostess transaction, the material components of our debt structure now include the $400 million senior notes, a $300 million unsecured term loan, a $150 million AR securitization as I just stated, and have drawn $100 million and our $500 (sic) unsecured credit facility. This should provide us with the capital and liquidity necessary as we continue to expand and complete the integration of our most recent acquisitions.

Cash flow has been strong through the first half and as of August 8, our debt to EBITDA leverage ratio based on the trailing 12 months of EBITDA through the end of the quarter was 2.3 times. At this level we are tracking ahead of our initial projection for debt following the closing of the transaction.

Allen did mention that we have been enjoying the benefits of our share expansion without a majority of the costs. As we look at the back half, we will begin to have incremental interest expense roughly an additional $3 million as a result of the new debt. We will also experience plant carrying costs which includes utilities, property taxes, maintenance and security for the additional 20 bakeries and 36 depots of approximately $8 million to $9 million and the forecasted depreciation and amortization for the new asset is approximately $5.5 million to $6 million in the back half.

We also have one-time costs related to the deal and estimate those to be approximately $5 million to $6 million and these should all occur in the third quarter.

This leads us to the 2013 guidance. Sales are forecasted to be $3.79 billion to $3.82 billion for the year and earnings per share of $0.92 to $0.98 excluding the one-time accounting gain and the one-time acquisition-related costs. The full-year gross margin is forecasted to be 47.5% to 48% of sales.

Due to the fact that we have taken on several pieces of debt throughout the year, I thought it would be hopeful to provide the full-year interest expense. We are forecasting a full-year interest expense of $29 million to $31 million. Additionally, we expect full-year interest income to be approximately $15 million to $16 million.

Capital expenditure is forecasted to be approximately $90 million to $100 million for 2013.

Again thank you for your interest with Flowers Foods and I will turn the call back to Allen.

Thank you, Steve. 2013 is a remarkable year for a Flowers Foods. It's important to mention that our ability to take advantage of opportunities did not happen by chance. We have invested over time to create a dynamic business model, very productive bakeries and the best team in the food industry. That has allowed us along with a good deal of hard work on the part of our team members across the Company to deliver what we believe will be our best year ever in both sales and earnings growth.

It is also very important to point out that we still have significant growth opportunities ahead as we steadily increase our sales in newly acquired and expansion markets. Our growth strategy in new markets is proven and looking ahead, we expect to continue to meet or exceed our long-term goals.

Our mission is to deliver value for our shareholders, team members, partners, customers, and consumers. To do that we realize that we must constantly keep our products and brands relevant to consumer needs and our service levels the very best in the industry. That is the Flowers way.

Thank you for participating in our call this morning. In a moment we will open the call for your questions. But before we do that, I want to answer one of the questions that we have heard from many of you. That question is -- what about the reintroduction of Hostess snack cake and how is that affecting Flowers snack cake sales?

The short answer is we are very confident in the strength of our cake business. Let me tell you why. Since we acquired the Tastykake brand in 2011, we have increased sales significantly, almost doubling our cake sales. Consumers across the South and Southwest and more recently, New England are responding well to the Tastykake brand.

We believe that direct store delivery or DSD is the most effective distribution system for fresh snack cakes as it is for fresh breads and rolls. Tastykake is distributed throughout our DSD system, which serves about three quarters of the US population. Our distributors are in the stores daily and providing the best possible service to our customers.

Since Hostess left the market in November, Tastykake sales have grown at a good pace. Our brands, our broad product offering, the freshness and the quality of our products, and our customer service have helped us gain new business. We realize that Hostess cakes may have a place in the market but we have confidence that our cake business will weather that reintroduction very well.

In the first two weeks since Hostess reentered with cake, IRI data shows that our cake brands have maintained their share. Interestingly, the cake category as a whole increased as Hostess came back into the market. So again, I will say that we have confidence in our cake business.

Now let's open the line for questions. Dawn, if you would open the line please.

(Operator Instructions). Farha Aslam, Stephens.

Good morning. Congratulations on a great quarter. In kind of going forward as you look at how you are integrating California, when do you anticipate bringing California onto your own production systems?

Farha, we mentioned earlier in the call that having our own production for supplying California is very important. We're in the process of putting that plan together. Modesto is one step in that direction. But our overall production solution for California is -- continues to be underdeveloped. But we are very confident in our future growth from a sales standpoint. We are also very confident that we will have the right production solution in place relatively soon.

Do you anticipate exiting that agreement with Bimbo early? Because I know there is about a $10 million agreement if you start producing the product yourself early. So I just wanted to make sure how do you anticipate that changeover to occur?

We are aware of the timeline with Bimbo and the supply agreement, but at this point, we have got some loose ends to put together and some questions to be answered before we can really detail the timeline.

Farha, this is Steve. I think look at the balance sheet -- we have a (inaudible) receivable out there of $7.5 million, which anticipates meeting at least the February deadline. So we did take that into consideration when we did our purchase price back in the first quarter.

Great. And then if you look at gross profit and commodity costs, when do you hit the highest commodity costs in your P&L? How do you anticipate that lower commodity cost to flow through your numbers?

If you recall, we do hedge and our strategy is to be four to seven months. It could be longer if we see the need to do so. For 2013, our highest costs really have come in the second quarter and we will see some relief in the back half. It won't be dramatic but we should begin to see some easing in the back half as we refer to the rest of this year.

Fantastic. And my last question is your sales guidance was significantly ahead of my expectations. Does that anticipate entry into new markets that you hadn't been in before with Hostess? Could you just give us some color on the composition of your sales guidance?

I wouldn't say the sales guidance for this year doesn't reflect any real significant new markets. It does reflect the reintroduction of the brands that we acquired and we are looking for significant help in many of our newer markets we are currently serving as we reintroduce the acquired brands.

Okay. Then long-term once you are over sort of these transition costs in terms of distribution and carrying costs for the additional plants, where do you anticipate EBITDA margins could go long-term?

We set our goal at 11% to 13%. When you look at other CPT companies, a lot of those are well north of that. Although we are DSD and it is a more costly way of disturbing product, although it's more appropriate for our category. I think George has said many times that once we get to 13%, we should be able to move that another 100 to 200 basis points and work towards that goal. So I do believe over time we can exceed the current 13% that we have established.

From a timing perspective I would hate to commit myself today but we do believe it is achievable.

Thank you.

Brett Hundley, BB&T Capital Markets.

Good morning, everyone. I wanted to stay on Farha's last question there for a minute and just think about your long-term growth expectations. I am thinking about 2014 and some acquired brand coming online, market expansion possibly being better than expected, lower inputs possibly. And is it -- is there a potential to exceed that long-term target in 2014 or is it really something that you just feel more comfortable about Steve talking to over time?

Brett, I would say we are not prepared to give any 2014 guidance today. But when you look at 2013 and the costs that we are experiencing, whether it's in the market expansion, we are seeing a little bit of efficiency drop as we are meeting the needs of the marketplace for production, commodity costs end up being -- supplies of wheat and some of the major commodities seem to be easing. So there are some things that seem to be working in our favor but to get into 2014 at this point may be a little premature.

Also I would like to add that the reintroduction of our Hostess brands, we will be reintroducing in most markets in the fall but again, that's a long-term process and we just don't generate those incremental sales overnight. So both the reintroduction of the brands and then also as we bring individual plants on speed to handle that additional volume, it will be a very methodical organized process that won't happen overnight.

To that point, on the reintroduction of Hostess brand, it sounds like it is more of a Q4 event as opposed to kind of equal reintroduction in Q3 and Q4. Is that fair to characterize it like that?

I would say yes. There will more activity in Q4.

Okay. I think, Allen, you made the comment that you can provide for consumer demand with existing capacity that you have. Are we to take that comment that given previous demand levels for those brands, you could supply those levels from existing production lines? Is that fair to say?

I think what we said is currently we are able to take care of existing production needs. But also as we reintroduce the brands that we have acquired, we will be able to innovate these. But I think it is important to point out that again, they were done in a very organized and methodical method. It will be on a market by market situation and it will really be driven by the growth of our sales and our brands with consumers in the market place.

Brett, this is Steve. Another point, since November, we have replaced a lot of that space with our current brand so there will probably be some brand cannibalization. (technical difficulty) So as we roll this brand out, we will rationalize SKUs and we will look at our space and try to make sure we have the right mix of product on the shelf.

Great. And then, Allen, actually your comment at the end of prepared remarks, it sounds like your cake business is holding up well. I know there's been a lot of questions on that and so I wanted to dig somewhat deeper and just characterize Tasty so far during Q3 and it sounds like growth has continued to be maybe stronger than expected given some of the events of this so far in Q3. And so again, I just wanted you -- do you believe Tasty growth has held up better than expected during this time or had you always expected gains to continue into Q3?

Brett, when you have a competitor reenter the market place you are always kind of playing on your toes. I will say that we were confident that we would be able to hold onto our Tastykake as Hostess reentered the market place. And again, the primary reason for that is the strength of our DSD network. Our independent distributors are excited about the Tastykake brand. We've got a brand with some very unique item. We are putting up a tremendous amount of focus on constantly improving our product quality, shelf space, holding onto the shelf space that we've gained with our retailers is very important.

And we are doing a lot of great work on product freshness to make sure that our products are the freshest in the market.

So I don't want to say that it was a complete surprise that we held onto our business but again, we are very early in the game and I'm confident that our team will hold the cake business that we've gained and we will continue to grow Tastykake for the long haul.

Bill Chappell, SunTrust.

Good morning. I guess, first trying to understand on the quarter, there was margin compression from last quarter to this quarter. So is there any way to kind of quantify the expenses in terms of ramping up Sara Lee of California or is it just with Bimbo agreement just a lower margin business?

Bill, really coming out of the first quarter to the second, we had a ramp up in production coming into our summer season which historically has put some pressure on our facility. We did see some proficiency drop and that was primarily part of the reason for the margin compression. Really nothing that we are concerned about but as we do bring on new production and are able to rationalize the new production to the right markets, I think you will see that. You will see the efficiency gains come back.

As you may recall, this happened several years ago when we were in the situation where we had tight production and it's just the time and the need to get maintenance into the plants.

Okay, then as I look to Allen on the comments of the acquired facilities, I guess two questions there. One, I don't understand how you can move into new markets kind of with your 500-mile radius unless you do open some of these. So is a thought that this is a postponement until next year to move into kind of the upper Midwest or some of the Northeast and you really want to back fill your existing markets first?

Then the second with that is -- all those facilities, is there a way to reduce carrying costs? can you sell some of the real estate? Or if you are just planning to never reopen them?

I think if you look at -- looked to the past of how we've expanded territory, we have entered new markets and we have been transporting product from probably a distance further than we would like at the point that we have built our business in new markets and we can support reopening of plant or of building a new bakery. That's what we have done in the past.

So that model has worked really well and as we look at the acquired bakeries that we have recently picked up, we will approach it the same way. We will probably enter new markets and be transporting products from our current bakeries further than we would like and there is a point that we are established in the marketplace and our sales support the reopening of the bakery, we will look at those one at a time.

So I will give you the impression we will continue to enter new markets and as we do that, we will build our sales volume from existing clients and when sales volumes are acceptable, then we will reopen the bakeries in those markets.

Just following that, for example can you service all the needs of Milwaukee from your plant in Kansas City? I mean is that the kind of stretch you are talking about?

It's a market-by-market decision and so that I don't give away anything to competition, I'd rather not comment on individual markets. But it's obvious that we are going to continue to grow the Company. There's some very attractive markets we are not currently serving today and to do that adequately, at some point we will need to reopen bakeries.

Within the existing plants -- and again I don't know where all of them are located, some are in the South or the Southern half of the country. Is there a way to take off some of the carrying costs of those that might be close to your existing facilities that you just don't need?

Again at this point, we have not reintroduced the brands and it really depends on sales volume and the capacity that's going to be needed. Some of the plants in our existing territories may be needed. Some of the plants may not. But again, we will make decisions on a market-by-market basis. If there is a plant that we don't need and we determine that, then we would be able to lower some carrying costs there. But again, we are not at that point yet.

But there's nothing to prohibit you from disposing some assets?

No.

One last question. You kind of highlighted three brands of Nature's Own, and Wonder, and Tastykake. Is it a thought that over the next few years you go to kind of a three-brand strategy? Does it make more sense from a marketing and advertising just to focus around three brands versus dozens of regional brands in different categories?

Bill, I will say with the Nature's Own brand is certainly a national brand with over -- I think we will annualize it at about $1.1 billion in retail sales this year. So I will say that Nature's Own will be in all of our markets. Tastykake, much like Nature's Own, really has the potential to be a national brand with the same rate of growth. We are excited about Tastykake.

Wonder has the potential to be a national brand of white bread but I will say that we will be very careful in how we roll out the Wonder brand. In the white bread segment especially, consumers are very loyal to the white bread brands that they grew up with and we have a lot of examples of that from Bunny in Louisiana to Dandy bread in Miami. A lot of good examples for regional white bread brands are important.

And so I will say that if there is a brand of regional white bread that we need in an individual market, we potentially could market both, the Wonder and the regional brand. But we will be careful how we roll out our brand strategy on a market-by-market basis.

Okay, I actually had one last one. Are you still planning on doing pricing in October?

All of our costing is under evaluation. We mentioned commodities earlier but as we all know, there are a lot of other components of cost and we are evaluating our pricing for the back half. If you look historically, we have taken pricing in the back half that carries us into the new year and we are currently evaluating our increased cost so that we can get that into place.

Got it, thank you.

Akshay Jagdale, KeyBanc.

Good morning and congratulations on a good quarter. So I just wanted to follow-up on those questions on gross margin. So that was useful, the context you gave us on the efficiency issue. Can you just order of magnitude like how much of an impact was that efficiency issue this quarter? And how long is it going to last?

Actually if you look historically, we've had that happen during the summer months. Efficiencies will pull down. It's not that significant overall but it's around 50 basis points or so that typically the pressure it puts.

Then the other factor I didn't mention also, Q2 was actually our highest quarter of commodity costs for the year, so there was slight pressure from that as well coming out of Q1.

That's helpful, and then the other factor that I noticed and again I appreciate the extra detail on gross margins in your Q. The Sara Lee expansion and the BBU contract obviously also depressed margins it looks like at least by 50 basis points. Right? Is that correct and --?

Yes, the outside purchases did put pressure on the margin as well. But I don't think we would talk about the exact percentage, but it was a contributing factor to the quarter.

Steve, what was the commodity inflation this quarter?

If you just look volume, the volume certainly on a -- from a product perspective is probably between 3% and 4%, slightly up from what we saw in the first quarter.

And your guidance for the year for commodities is still the same?

Yes, it's still that 3% to 5%.

Are you locked in fully now for the year?

Coming into the back half and looking at how we view and our philosophy on what a period of time we take coverage, we are pretty confident about our cost structure in the back half.

Right, so when I look at your gross margin guidance, it implies that gross margin in the back half are going to be better certainly than what we saw this quarter. That's correct, right?

It could be flat to slightly improved, yes.

These costs just in terms of your EPS guidance, I just want to make sure -- what costs related to Hostess are included in there? Clearly the interest seems to be included. Are you stripping out the one-time costs? Just help me understand what parts of the cost component that you mentioned related to Hostess are actually included in your guidance?

Everything on that slide is included in our guidance except for the one-time acquisition cost in the third quarter of roughly $5 million to $6 million. Everything else is included.

Okay, great. And then just longer-term, we've talked in the past about getting to historical margins, gross margins, and when I think of that I think of 56% or so margins in DSD back in 2004. Operating conditions are as ideal as they should be or would be or have been in the last 10, 20 years. Is the expectation still that we can get to those type of margins eventually or is there anything that is structurally different in your business today that would preclude you from getting to historical or better gross margins in this operating environment?

Actually I will comment and let Steve add to. I would say that from our team's standpoint, we are very focused on improving margins as we go forward. I don't want to give you a specific commitment to a number on a given day but I will say that the category continues to be in transition. There remain a lot of moving parts but I do feel confident that the changes that are taking place should enhance margins over the long term.

But being able to pin that to a given quarter or two quarters is difficult but I do feel good about the direction the overall category is headed.

Okay, just to follow-up on that topic a little bit, so what would be the drivers? What would be the main driver of incremental margin expansion from here? The way we've thought about it is Hostess under its previous management was spending two to three times what a normal bread company spends on promotions. So we think as you -- as the shelf normalizes and you reset some of these shelves later this year, perhaps the mix and realized price points will continue to move up even as commodities come down.

That to me seems like the biggest lever but can you help me understand from your perspective what the biggest leverage for incremental margin expansion longer term?

I think your view is probably correct. When we look at margin and we look where we've seen the biggest drivers have been the efficiency gains that we've experienced over the last few years. As we continue to ramp up sales and we get production rationalized and we get that closer to the market, that also helps drive better margins.

Then one other thing to point out is some of the cost we just talked about for Hostess would also be in COGS, so that will put some pressure on it in the near term. That's what we get as we grow the sale, we get the sales base where it needs to be. So looking over -- looking out in the next quarter or two years, there are a lot of things that are happening in 2013 that as we grow the market should provide some relief whether it's the commodity costs pulling back -- hopefully that continues to be a trend of getting back, of getting the efficiencies back to where they need to be once we have the production kind of rationalized. Those are the main drivers of the margin (inaudible).

Allen, how would you categorize the competitive environment specifically from a promotional and pricing standpoint? I think some of your competitors have said it's equally competitive. So since the Hostess liquidation and you are buying it, there really hasn't been a change. I would expect there to be a change at some point but one is, do you expect a change over time meaning better, more rational pricing and less promotions for the category?

Two, are you seeing any of that or the opposite right now?

I would say it's still a market-by-market business but overall, I would say that I'm actually seeing a slight improvement in overall pricing and a slight reduction in promotional activities. Our hope that those trends would continue but again, it is very much a market-by-market situation, and it is hard to make a general statement that applies to the overall. But I am encouraged that we are seeing directional business in both what I will call everyday pricing in the category and then a slight reduction in promotional activity.

That's helpful. One last one and this is more long-term strategic related to Hostess. I can appreciate why you are not giving accretion guidance but just, Allen, maybe help us think strategically more quantitatively. So the way I have thought about it is there was roughly $900 million in bread sales that Hostess had. I think the run rate of share gains that you are showing are somewhere in the $350 million range. So between to 35% to 40% of what was available you guys have gained in terms of share gains.

Is the goal as you introduce Hostess back on, is the goal to incrementally add to that sales gain and improve the overall margin profile and then look at that in terms of returns relative to what you are investing, or how else do you think about it in terms of how it will evolve?

As far as quantifying our sales plans, I think that is the guidance that Steve gave you earlier. That's our best estimate of the impact on sales in this year. But I would say more strategically that we feel that we can generate incremental sales in our core markets with the reintroduction of brands like Merita, Home Pride, and others. We also feel like there is significant growth in new markets with the addition of the Wonder brand.

There are many new markets that we are currently serving today. Nature's Own is doing very well in that market but we don't have a strong brand of white bread. So the Wonder brand in many of those new markets will help us generate incremental sales there. But I will say that it's represented in -- our best estimates are represented in the guidance that we gave you today.

Is there -- at some point will you be providing accretion guidance for Hostess itself?

Since it was not an ongoing business, I would say we probably will not provide accretion guidance. It really gets back to market expansion and hitting the markets for those brands where they are strong. So as we plan to reintroduce brands and we look at annual guidance on a going forward basis, we will include what we expect to do in those markets. But it's really hard to give accretion since we didn't buy a business that was in place.

Okay, great. Thank you so much for being generous with your time. Thanks.

Timothy Ramey, Davidson.

Good morning, thanks. Just a follow-up I think on Akshay's question. As I have looked at the numbers on slide 17, it looks to me like you're telling us there's roughly $35 million of ongoing annual costs related to interest expense, plant carrying costs, depreciation and amortization. If we tax effect that -- and it looks like sort of $0.11 of earnings dilution before you get your first dollar of sales. Obviously I know there's going to be a dollar of sales somewhere along the way. Is that kind of the right way to think about it?

If you take out the one-time acquisition costs, yes. I think you are looking at it right.

Okay, and for me it was a spectacular quarter obviously but the big surprise was warehouse delivery being as strong as it was, which I have to assume some of that is -- that's Mrs. Freshley's, is it not? And you made comments that you thought Tastykake would be able to defend its position because of DSD.

Can you talk a little bit more about your outlook for the warehouse delivery side of things?

Tim, obviously the Tastykake brand is doing very well. Our warehouse distributed brand, Mrs. Freshley's, is so far is holding up. There are many of the qualities from a product assortment standpoint, customer relationships are helping to hold onto that business, but obviously as Hostess reintroduces, that is a direct competitor to our Mrs. Freshley's business and we are doing everything that we should be doing to hold onto the gains that we have generated. But that business is important to us and we intend to hold onto it just like Tastykake.

Is there anything else in there that we should be aware of that would account for the year-over-year gain or is that largely Mrs. Freshley's?

Tim, it's our Food Service business, as he mentioned earlier, it was up substantially. Food service is growing both in new markets and in our core markets, so when you look at that consolidated warehouse segment number, it represent growth in both Food Service and in prices.

Got you, okay. Just to be clear, the $3.4 million -- congratulations on the cost of the incremental interest expense. That's spectacular. So if we kind of think about this for 2014, I understand you not giving us guidance but is that an annualizable number for 2014 or do you think that with cash flow it might be a little bit less than that?

Obviously the markets are very favorable from a rate perspective so we are very pleased with where we landed. On our debt, I think looking ahead unless something happens dramatically to the interest rate environment, I think you could use that as a good proxy going forward.

Great, thanks for your help.

(Operator Instructions). Amit Sharma, BMO Capital Markets.

Good morning, everyone. Allen, we look at -- and this is also a follow-up to what Steve said earlier about when you reintroduce your Hostess brands, you do expect a level of cannibalization and as we look at relative share dislocation since Hostess, independents have gained in our calculation more than their fair share of market share.

Is that -- how do you see that? Is that an opportunity or is that an indication that you don't necessarily need a strong brand, independents are strong in some markets and they will continue to be a fierce competitor in those markets.

I think you mentioned -- we are expecting cannibalization and our focus is on generating incremental sales when we reintroduce the Wonder brand and other regional brands. So it's all about generating incremental sales and that's exactly what we will do. We will minimalize cannibalization.

On the -- I would comment on -- there are individual independent bakers that have done a good job of capitalizing on the opportunity. Like Flowers, many of the regional bakers, they have strong white bread brands in their individual markets and there was a void in the marketplace and they stepped in and filled that void. So I look at their growth similar to what has happened in many of our markets just on a smaller geographic scale.

But again at the end of the day, it's all about building brands and that's exactly what we are doing. You've got some independents that are doing the same thing.

Would you characterize as competing against the independents a little bit more favorable versus competing against a national competitor so that incremental share gains as you start to relaunch Hostess brands are easier or more difficult to come against this competition?

Really the way I think about it is more from our point of view in how well these brands fit into our brand portfolio? What is our individual need especially in new markets? So it really doesn't -- it's not whether we are competing against an independent or whether we are competing against a larger competitor, it really depends on what is our position in the marketplace? What is our brand strategy? At the end of the day, that's the deciding factor on how we did it.

Got it. And one longer-term question, (inaudible) and consolidation in the bakery aisle, but if we look at some of the other categories and see consolidation, ready-to-eat cereal comes to mind as well, very consolidated. That category hasn't seen sort of margin improvement despite the consolidation. Is that a fear that despite being consolidated there is going to be enough competitive activity in this category to minimize future [margin] gains?

Really it is hard to compare against other categories but I can say what we are doing is we are focusing on our manufacturing efficiencies. Steve mentioned earlier that we are really focused on being able to handle the additional volume that is in our plant today. We will be opening additional plants to help provide more capacity. So step one is really making sure that our bakeries continue with our strategy of being the low-cost producer. That's the starting point.

And we feel like that our model positions us over the long haul to improve margins, our independent distributor model on the sales side, complementing our DSD business with our warehouse segment also fits very well. So we are optimistic about growing the topline and at the same time, keeping the focus on lowering our costs to make sure we continue to be the low-cost producer.

Got it. If I may ask just one more, when you do decide to bring some of those bakeries online, Steve, can you give us some estimate of what our capital or other operational costs involved on the per bakery basis?

Today we are not prepared to do that really (technical difficulty). Obviously there will be some facility that will need more capital than others, but as we begin to look at the rollout, we will give guidance if that's appropriate. Today we don't really have any guidance to give on the CapEx related to those statements.

Got it, okay. Thank you very much.

I will now turn the call back to Allen Shiver for closing comments.

Thank you for your interest in our Company. This is an exciting time for Flowers Foods. I would like to close again with a very special thank you to the Flowers team for the wonderful job that everyone continues to do. Thank you very much. This will end our call.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.