Flowers Foods Inc (FLO) 2013 Q3 法說會逐字稿

Welcome to the Flowers Foods third-quarter 2013 earnings call and webcast. My name is Cliff and I will be your operator today. 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 would now like to turn the call over to Ms. Marta Jones Turner. Ms. Jones Turner, you may begin.

Thanks, Cliff, and good morning, everyone. Our third-quarter results were released and our 10-Q filed early this morning. You will find the release at a link to the 10-Q on the website in case you haven't already accessed those.

You know that before we get started, I must remind you that our presentation today 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 more fully in our SEC filings.

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. Following prepared remarks, we will open the call for your questions.

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

Thank you, Marta. Good morning and welcome to our third-quarter 2013 conference call. We appreciate your interest in Flowers Foods. 2013 continues to be a remarkable year for our Company as we take advantage of growth opportunities. We have achieved a 22.5% increase in sales in the quarter, 26.6% year to date. Earnings per share for the quarter was up 6% and year-to-date earnings per share increased 44% excluding one-time events.

It's important to point out that our direct store delivery segment which is 83% of sales performed very well in the quarter. Sales for our fresh breads, rolls, and snack cakes were up 23.2% and we continue to be very pleased with how our DSD team has responded to the market's needs.

Operating margin for DSD was strong even as the segment absorbed the carrying costs of the Hostess assets we acquired. We also increased marketing spend to support our brands in new markets and to support the relaunch of our acquired brands.

The DSD segment did incur costs for additional organizational structure to support our sales growth and to prepare for the reintroduction of Wonder, Merita, Butternut and Home Pride.

Our warehouse cake business performed relatively well. Mrs. Freshley's, our warehouse cake brand, held its own as competition in the snack cake category increased. Unfortunately, our warehouse frozen food service business did not perform as well. Let me tell you what impacted margins in this business which represents about 10% of total sales.

Margins were compressed for certain products and we are taking action to correct that situation. In addition, one bakery in the food service segment had difficulty with manufacturing efficiencies and our team is also addressing that problem.

What I want to point out this morning once again is that 90% of our business performed very well in the quarter delivering outstanding sales growth and operating earnings.

I would like to talk about another factor that can improve our margins even further, that is manufacturing efficiencies. We told you on our second-quarter call that our overall manufacturing efficiencies were down a few points as a result of the higher volume our bakeries have been running since last November when Hostess exited the market. In the third quarter, that pressure continued with our efficiency levels remaining lower than last year's third quarter. We are encouraged that in recent weeks we've seen improvement in efficiency levels as some seasonal volume has dropped off and our bakeries are able to focus more closely on production efficiencies.

I believe that we will again achieve efficiency levels in the 92% to 93% range which will improve our overall margins.

It's important to point out that our operations team across the Company have done a remarkable job as they produced over 20% additional volume for most of the year. Our manufacturing team successfully started three additional production lines in the quarter and added 49 production shifts throughout the Company to support our sales increase. That's a remarkable accomplishment and more production capacity is being added to support our growth in California.

In the third quarter, we acquired a bakery in Modesto, California that is now providing buns for that state. We also announced that we will soon be producing bread at the Henderson, Nevada bakery. The Henderson bakery was part of our Hostess acquisition and we expect to be producing in that bakery during the fourth quarter.

As we need additional production capacity, we expect to open additional bakeries. We will do a good job keeping you posted on any new developments in that area.

While we are talking about the Hostess acquisition, I will give you an update on the reintroduction of the Wonder, Merita, Butternut and Home Pride brands. At the very end of September, we started rolling out these brands in our DSD territories. We are still in that rollout phase as we accommodate the needs of our retail customers.

We told you previously that retailers reallocate their space at set times during the year. And working with their schedules, we are continuing to expand our newly acquired brands back into the marketplace. With limited IRI data, it is too early to give you a definitive report of how the brands are performing. But we are pleased with what we have seen so far. We will be able to share IRI data on our next call.

I can tell you that many consumers have contacted us to say they are happy to have their brands available again and also their comments on our product quality has been very positive.

Our sales team and independent distributors are doing a terrific job working with customers on displays and resets for the acquired brands. I want to recognize their efforts and say how much we appreciate their good work.

Next, let's talk about our California acquisition. We completed the acquisition of Sara Lee bread, buns, and rolls in California in late February. By the beginning of the third quarter, we had taken on all the Sara Lee sales in the state from BBU which means we now have in place a DSD distribution network that serves all of California.

Our team is doing a great job growing our business in the largest market in the US for fresh bakery products. Prior to the acquisition, our market share in California was 1.8 and today it is 12.2. Looking ahead, we see potential for steady incremental growth as we gain new customers and consumers in California.

To complete the update on acquisitions, let's talk about Lepage. We lapped the Lepage acquisition in the first week of the quarter. Lepage was in good position to benefit from Hostess's exit from the market last year. We are pleased with how that business is performing and with how consumers in the Northeast are responding to our Nature's Own and Tastykake brands along with Wonder and Home Pride.

The Northeast is a new market for Flowers and we continue to believe it has tremendous growth potential over time.

Our ERP systems have recently been implemented at Lepage. Training and support are underway as we continue the integration process.

A quick look at our sales. We had good results across all categories. Branded sales increased 29.3% and brands accounted for about 55% of our total sales in the quarter. Strong double-digit growth of Nature's Own, our regional white bread brands, buns and rolls, and Tastykake drove that growth.

Our share of store brand was down to 17% of our total sales as a result of strong growth in our branded business. We won't discuss the details from the IRI data but that information is provided at the end of the presentation materials. As you would expect, the IRI data is very positive reflecting our strong sales growth.

Expansion markets, which are markets we've entered in the last five years, exceeded our goal of contributing between 0.5% to 1% of sales.

Let's hear more details about the financials from Steve and then I'll make a few comments before we open the call for your questions. Steve?

Thanks, Allen, and good morning, everyone. As Allen mentioned, sales in the quarter continue to be robust increasing to $878.5 million, growth of 22.5% over the third quarter last year. Volume growth continues to be strong contributing 20.1% as we benefit from the November 2012 exit of Hostess from the marketplace.

Price mix was negative 1.2% in the quarter with favorable pricing being offset by a negative mix shift. This negative mix shift is primarily attributable to our warehouse food service and cake businesses.

Acquisitions contributed 3.6% to the quarter's growth. We did cycle the Lepage acquisition early in the quarter and continued to benefit from the acquisition of the Sara Lee brands in California.

Revenue from the recently acquired brands of Wonder, Merita, Home Pride and Butternut were insignificant to the quarter as they were reintroduced to the market during the last two weeks of the quarter.

Operating earnings in the quarter excluding the acquisition related costs were up approximately 4.4% this quarter over last year's third quarter on an adjusted basis. This increase in adjusted operating earnings was driven primarily by the impact of stronger sales volumes, partially offset by decreased manufacturing efficiencies, margin pressure in our warehouse food service business, the increased marketing costs, and carrying costs associated with the facilities purchased from Hostess.

During the quarter, we recognized $2.8 million of carrying costs and cost of goods sold and $2.5 million of depreciation related to the recently acquired facilities.

Depreciation and interest expense was in line with our expectations. The effective tax rate in the quarter was 32.4%. This decline over the prior-year rate of 36.4% was driven by the recognition of a favorable discrete item. The discrete item affected earnings positively about $0.01 per share.

GAAP earnings per share for the quarter were $0.16. Adjusting for the acquisition-related costs in the quarter of approximately $0.02 per share, earnings per share were $0.18. This compares to the adjusted $0.17 per share in the third quarter last year or a 5.9% increase.

Gross margin in the quarter of 46.7% of sales was flat compared to last year's third quarter. On a volume neutral basis, input costs defined as ingredients, packaging, and natural gas, continued to track and were up approximately 3% which is in line with our full-year guidance.

Year-to-date gross margin was 47.6%. Selling, distribution and administrative expenses adjusted for acquisition-related costs as a percent of sales were 36.5% this quarter versus 35.2% in last year's third quarter. The 130 basis point increase is primarily attributable to higher marketing expenses and workforce related costs. Marketing expenses were about 40 basis points of this increase.

Turning to the balance sheet, cash provided by operations was a positive $45 million in the third quarter. During the quarter, we did incur additional debt of $337 million which was primarily the funding of the acquisition of the Hostess assets. We ended the quarter with approximately $927 million of debt on the balance sheet.

Cash flow remains strong and we will continue to focus on paying down debt. Our debt to EBITDA leverage ratio based on the trailing 12 months of EBITDA through the end of the quarter was approximately 2.3 times. We do continue to track ahead of our initial projections from a leverage perspective.

I think it's important to recap three factors that impacted our third-quarter earnings. First, we had higher marketing spend to support our new markets and our brands. Second, our increased volume, new market, and preparation for the relaunch of acquired brands required us to increase our workforce and add territories to support the growth. Finally, our frozen food service miss due to inefficient bakery and margin pressure in certain areas of that business did significantly impact our results.

As Allen told you, we expect margins on that business to improve as we work to correct some of these issues.

From a big picture perspective, we believe we are making the right decisions for the long-term as we right size organization to support new sales, protect our brands and improve margins and efficiencies throughout the Company. Our intent is to create an organization that can maintain the sales volume we've achieved and continue to grow profitably from a solid base.

This leads us to 2013 guidance. We are revising our [2000] forecast for earnings per share. Sales continue to track within our previously provided guidance of $3.79 billion to $3.82 billion for the year. However, we are adjusting our earnings per share guidance to $0.90 to $0.93 per share. This revision is primarily the result of the factors that Allen and I both mentioned earlier.

We are forecasting our full-year gross margin to be on the low end of the targeted range. Full-year interest expense is now expected to be $29 million to $30 million and capital expenditures are forecasted to be approximately $90 million to $100 million for the year.

We are pleased with how sales are trending and expect to continue to benefit next year as we grow new geographies and capture share in existing markets. From a cost perspective, we are focused as always on cost reduction initiatives and believe that we can continue to drive earnings within our stated long-term goals. We will provide 2014 guidance on our full-year and fourth-quarter call for 2013 in early February 2014.

I thank you for your interest in Flowers Foods and I'll turn the call back to Allen.

Thank you, Steve. Looking back on how much growth we've achieved in just a short time makes me appreciate the Flowers team even more. In two years, we've grown sales by roughly 35% and earnings per share by about 40%. This is a tremendous achievement on the part of our team.

Since November 2012, we have served customer needs in the face of dramatic marketplace disruption that occurred when Hostess exited the market. And in doing so, we have seen our sales volume increase more than 20% year to date.

This year, we acquired $140 million in sales as part of the Sara Lee California acquisition and our team created a statewide distributor network to serve customers. We've just begun the work to take full advantage of the Hostess assets we've acquired but I am confident in our team's ability to use those assets to continue delivering sales and earnings growth for years to come.

Our updated guidance reflects the strong sales and earnings growth that we will have achieved in 2013. To support the very strong sales growth this year, we have put structure in place so that the business will be sustainable. Now we are working to rightsize the organization or in other words, make certain that we have the right positions in staffing and the right number of sales territories to support this new business.

As we do that, and also improve our manufacturing and logistics efficiencies, we believe margins will improve even further. We have invested over time to create a dynamic business model, very productive bakeries, and the best team in the food industry. That solid foundation has allowed us to take advantage of recent growth opportunities.

We expect 2013 to be our best year ever in both sales and earnings. And yet we still have growth opportunities ahead as we steadily increase our sales in newly acquired and expansion markets and as we continue to consider acquisitions. We know we must constantly keep our products and brands relevant to consumer needs and our service levels the best in the industry. That's the Flowers way and that's the way that we build shareholder value.

Thank you for participating in our call this morning. We will open your call for your questions in just a second but before we do that, I want to answer one of the questions that we've heard from many of you. And that question is -- now that we are lapping the Hostess exit from the market, which was a year ago this month, how will we achieve incremental sales going forward?

It's a fair question but our team has confidence in our ability to continue growing sales and we will do that in several ways. First, our new markets. Those that we've entered in the last five years have tremendous potential as we gain customer and consumer acceptance for our Nature's Own and Tastykake brands. New markets will also benefit from the relaunch of Wonder, Merita, Butternut and Home Pride because in many of those new markets those brands held a solid market share and consumers will react positively to their return.

Second, over time, we will continue to expand our geographic reach. We've told you that we will consider the assets that we acquired from Hostess much like a series of bolt-on acquisitions that we can use to expand the business and grow much like we have in the past.

Of course in our core markets, we expect to grow by penetrating the category further as we introduce new products and as we take advantage of channels where we are underdeveloped.

Finally, acquisitions have always been part of our growth strategy. In the short term, we will focus on integrating and growing with our recent acquisitions but we are always willing to consider acquisitions that makes sense from an operations and financial standpoint.

So I hope that answers the question of how we approach future growth. Now, if we could open the lines for questions.

(Operator Instructions). Farha Aslam.

Good morning. First if we could just start with a little bit more detail on the three issues in the quarter and the first one, food service. Could you just share with us exactly what the impacts were and what actions you are taking to correct the issues?

Really cannot get into specifics because it is associated with one specific product line. We are addressing the issues there. We actually gained some additional business that did not work out quite like we had planned and we are taking action there. Also we had one manufacturing plant that struggled with efficiencies and we are also taking action there.

So overall, the food service business has been under pressure from a margin standpoint but this is a very specific problem that I really don't want to get into the details but we are on top of it. We understand what the issues are and we are taking action.

How long will it take to fix it?

We are looking at early next year, probably into the first quarter but we are very confident that we will have the fix in place very soon.

Okay.

This is Steve. The impact on the quarter for that was probably $0.01 to $0.02 per share.

Okay, that's helpful. And then just on the second two things on volumes, you have clearly added the workforce 90 basis points. Is that really the cost of opening up Henderson, Nevada and other such costs like that?

Henderson is part of the cost increase but I would say a larger effect in the quarter is the additional production shifts that we've added throughout the organization and the additional independent distributor routes that we've added to our overall structure. So with the sales growth that we achieved, cost comes with that.

Also we incurred as we mentioned, the carrying costs on the acquired brands and the Hostess business and as you know, we are very early in the reintroduction of those brands to the market.

And when do you expect sales to grow to offset that 90 basis point hit for the workforce increase?

I'm sorry. Could you repeat?

So your sales are growing and your workforce costs as a percentage of sales increased. When do you expect that to equalize where sales growth offsets the increase in workforce?

Two things are happening. One is we expect as we develop the brands in the marketplace that we've recently introduced, we are confident that they will generate incremental sales and at the same time, we are looking at all aspects of the business to make sure that we've rightsized the cost structure and we will take actions on any areas that we may have added excessive costs.

As I mentioned in my comments, we are working very hard to rightsize the organization based on the additional -- the significant sales that we've picked up.

Right. And my final question relates to M&A. Recently, we have had Maple Leaf Foods in Canada announce that they are possibly looking at strategic opportunities regarding their bakery business. Do you feel like it would be too soon after Hostess to take on an acquisition of that size or would you be willing to consider it?

We really can't comment on that. We are aware of the situation with Canada Bread but really would not be appropriate to comment.

Okay, thank you very much.

Eric Katzman, Deutsche Bank.

Good morning, everybody. I guess I'd like to focus in on -- you talked about the DSD business being pretty much in line with what you thought and performing well. Can you just talk a little bit more about the competitive environment there? How is competition reacting to your significant share gains? And I think in the last call you had mentioned the need to in the likely taking of price up as this year ended -- maybe you can comment on that and then a couple follow-ups.

We have taken pricing in the low single digits in the quarter. We have some additional pricing to take as we finish out the year and get in position for the 2014.

In terms of activity in the marketplace, I really have not seen a dramatic change from last quarter. Obviously as we've expanded into some new areas, the existing competitors are trying to do everything they can to hold onto their share but I would say that it's encouraging with the success that we were having developing brands in new markets. But we've gotten some pricing, we have some more to pick up as we finish the year and I wouldn't say that there's really any real big changes taking place in the marketplace.

Okay. And just I guess there's been a lot of questions broadly about deflation and input costs and promotional levels. I guess to the extent that you are taking pricing, are you signaling that your input cost basket for whatever reason is likely to be up a bit in 2014? Steve, maybe you could comment a little bit about that and whether you are seeing -- or maybe you are seeing a pullback in promotion if other people are experiencing inflation versus deflation. Maybe just talk a little bit about that.

When you look at 2014, as we said, we are really not prepared to give guidance today. We will talk about that more in the early part of next year when we actually give our full-year guidance. But overall, as we think about next year obviously there are signs that some of the costs such as wheat have pulled back some but there are other components to that such as basis, mill feed that go into flour. You are seeing those kind of stabilize at higher levels.

You look at employee related costs. We are seeing an increase there, you have healthcare increases. It's kind of some of the typical things you would expect from an employee perspective.

And then Allen talked a lot about new markets and developing those. There is a cost associated with that. So while there's components of the cost structure that may pull back, some of the other components are increasing. So when you look at the -- I would say we took a moderate price increase across the board and some of that really is lagging from what we've seen in the past year or so really with the cost structure and how it has changed and how things have elevated and stabilized at a new level if you will.

So that's how we view some of our pricing actions as well. But overall I would say ultimately the market and the consumer will determine price and we are well aware of that and we continue to monitor that.

Okay, last question and I'll pass it on. Allen, your product lines are obviously more staples very basic. I am sure you're aware that the food industry has been struggling to trying to explain where all the volume has gone. You are in a very different position. But when you look at the overall category, how do you feel about the health of the category given so many of us are trying to understand why center of the store volumes are just broadly weak?

If you look at the category for the quarter, dollars were up about 2% and volume was down about 1%, 1.1%. I think the way that I look at the category I think you have to really keep it very clear that it's a huge category. It's a $31 billion, $32 billion category. The recent trend has been down slightly but again, the consolidation that is taking place within the industry to me far outweighs any type of slight down trend in the overall baked food category.

So we are very confident that there's a lot of room for continued growth for our Company and it's not just about new markets. There are also segments of the category that we are underdeveloped and that we are working hard to develop a bigger presence in and we feel like this is going to provide growth for many, many years to come.

So I think the size of the category really trumps any type of short-term decline.

Okay.

Innovation remains an area that is very important to the Company. We spend a lot of time making sure that we understand the consumer and any type of changes that are taking place in buying habits and wants and needs really focused on the millennial group as they have a bigger influence on the overall marketplace.

So still very bullish about the future. The size of the category and the slight downward tick is not that significant.

Okay, thank you. I will pass it on.

Jonathan Feeney, Janney Capital Markets.

Good morning. This is Mark Williams on for Jonathan. Your DSD business is experiencing very strong volume growth and margins look to be doing very well especially against historical averages in Q1 and Q2. And Q3 appeared a little bit softer, looked more reverted to the mean. Could you just give me a little bit of color on what is driving that lower profit per unit? Is it a temporary growing pain issue or is it something more related to geographic or customer mix?

A big part of the factor in the third quarter would be the carrying cost of the new Hostess facilities. That did -- not put pressure because we were expecting that -- that did bring the margins down some compared to the first couple of quarters but that was well within our plan and we knew once we close the deal we would have this cost. That was about $3 million in cost of goods sold related to that and about another $2.5 million or so in depreciation.

So that was the big driver of the pressure in the quarter and then also as we talked about the new markets and the investment in the new markets related to our existing brand as well as the relaunch of the Hostess Brands in the back part of the quarter.

Did that answer your question?

Yes, these were expected. Are these issues that over time you would expect -- are they just growing pains as you get -- as you rightsize the business these should normalize?

Yes as you look at that business obviously, with those brands, we only had a couple of weeks of revenue so over time as we expand our revenue and continue to grow the top line, those costs, you should be able to more than cover those costs and see your margins expand again. It's just really part of the growth over the next couple of years.

Okay, thank you.

Bill Chappell, SunTrust.

Good morning. Can you walk through or help us understand what the surprise was in terms of the DSD and I say that in terms of both the marketing step up and maybe if there was some margin issues in terms of production, just because you knew what the volumes were for the past few months. I think you knew what the Wonder Bread rollout was going to be so where was the delta versus what you were expecting as we looked at this quarter?

Bill, as I mentioned earlier, our DSD business really performed extremely well in the quarter. The costs that were associated with the Hostess acquisition were anticipated and those costs were covered within DSD.

I think and I don't want to use the surprise but the real problems in the quarter and we are working hard to correct those, really revolve back to our food service, warehouse food service business and that's an area that we are very much on top of in terms of taking corrective action.

We knew that there would be additional costs going into the quarter and we also knew that the benefit of the reintroduced brands would really not have that big of an impact in the quarter. So our DSD business was really in line with expectations and what we are working hard on is to correct the problem that we ran into in our warehouse food service business.

Yes, I guess I was focused on the comment that higher than expected marketing expenses.

They were elevated over last year. That was part of the reason for the increase.

So it wasn't a surprise; it was just higher?

Right, right.

And then as I look at the Wonder Bread rollout in your existing categories, was that completed in the quarter, is there still room to grow or room to expand as we move into this quarter?

The rollout continues to be underway. Each market is really a different story in terms of the brands' penetration but we still have room to grow and that rollout continues for the rest of this quarter and probably early 2014.

Okay. And then the last question for me is as I look at let's take Henderson, Nevada as an example, what is the ramp from when you announced it is open to you are fully servicing the new territory and then are there any other planned or announced that I missed -- formerly Hostess launches for this quarter?

The ramp up -- I think your question from a closed plant to actually back in production, Bill, it really depends on each individual facility. In the case of Henderson, it's probably been a four to five month process of getting that facility back ready to go. We have not made any other announcements about reopening any of the other closed facilities that we acquired. So as I mentioned in my comments, when we make those decisions, we will alert the market as to our plans.

Great, thanks for the color.

Tim Ramey, Davidson.

Good morning, thanks a lot. Just wondering, can you give us a little more detail on the difference -- the specifics of what is in the acquisition-related costs that we're excluding from adjusted EPS?

Yes, in those costs, Tim, you'll have security, you'll have utilities. What's excluded?

Yes, the things that you are taking out of these $0.16 GAAP number.

Oh, the $0.02, that primarily relates to the -- I'm sorry, I misunderstood, I thought you were talking about the plant closing. That's primarily the banker's fees for the deal and some legal fees associated with the deal. They are one-time acquisition costs.

Okay. So we shouldn't expect to see a gap between GAAP and adjusted going forward unless there's some other transaction that occurs?

Right. It was all transaction related.

That sounds right. I guess my concern was in the warehouse segment and maybe you answered this but you really did see margins down I guess about 500 basis points sequentially. And if you were just isolating on the idea that Hostess would reenter the market and compete with Mrs. Freshley's and so on, you might have predicted that. You said that a lot of that had to do with this frozen issue.

Can you give us a little more detail on that? Would you attribute all of that margin degradation on a sequential basis to the frozen issue?

The majority of our issue in warehouse group was associated with the food service piece of the situation. I did say we are encouraged with how well that Mrs. Freshley's has done in the market holding onto the share that we have gained and so again, we are encouraged by the progress of Mrs. Freshley's. We are also excited about the growth of Tastykake on our DSD business. So we are excited about the future for our cake business both warehouse and DSD.

So would you expect based on what you just said both those businesses to continue to grow on an absolute basis from the levels they are at right now?

Both businesses meaning?

Meaning Mrs. Freshley's and Tastykake.

We anticipate Tastykake to continue to grow. Tastykake is on tap to be a $430 million brand at retail this year. Our Mrs. Freshley's brand again showing really good growth. Probably going forward as we cycle the Hostess shutdown this time last year, we will not be seeing the type of growth in the future -- short-term future that we saw last year but we are confident that both Tastykake and Freshley's are going to continue to grow.

Okay, thank you.

Brett Hundley, BB&T Capital Markets.

Good morning, everyone. I wanted to go back to your comment, Allen -- a couple questioners ago had just talked about the Hostess relaunch and where that was relative to Q3 and I'm wondering if you can give slightly more color. I mean obviously you are going to continue that well into 2014. But have the relaunch gained a significant amount of momentum or more modest momentum since Q3? Can you talk at all about how it is trending relative to your initial levels there that you realized during Q3?

The reintroduction of the Hostess cake brand in the early weeks, we saw a lot of distribution primarily in the supermarket channel. A lot of our growth over the past year has been in other channels like convenience stores and dollar stores. We have not seen a lot of activity from hostess in those channels. But again, cake is very much of an impulse item. A lot of the sales are driven by displays and consumers that are not expecting to make a purchase and so the distribution part of this especially as it lends itself to DSD is really in our favor.

So we are very bullish on the future of both Tastykake and Mrs. Freshley's and I think a big part of that is as we grow our cake business in channels other than the supermarket channel, that really appears to be a strengthening part of our business.

Allen, I meant more related to the bread add that you have.

Acquired brands.

Oh, the acquired brands. I'm sorry. Wonder, Home Pride -- the bread brands, that's which are asking?

Yes, I'm just wondering what the momentum has looked like on that reintroduction as it has obvious implications for your top line and your bottom line as well. And I'm trying to get a sense of how that reintroduction is trending from Q3 levels.

The best answer is it's very early in the game. We literally have only been back on the market a few weeks. We are encouraged and each market is a different story. Many of the markets, the acquired brands were very strong and we are seeing good numbers coming out of those markets. Other markets where they were quite as well known, the numbers aren't quite as strong.

But we are very confident in the long run that Wonder, Merita, Butternut, Home Pride, those brands are going to be very significant parts of our overall product line. We will be able to do a better job next quarter giving you some specific numbers on how they are performing.

Is your -- the acquired brands reintroduction going particularly well in one region of your footprint?

I would say overall it's going well. California has done a nice job of reintroducing the brands into the marketplace. Also on the other side is Lepage. Lepage is doing a very good job reintroducing Wonder. So I really wouldn't say there's any region that stronger than others but again, it's early in the game.

Okay. And then you mentioned that you took the Sara Lee sales over in California at the beginning of the quarter. I'm curious if you saw any efficiency improvement from that action or if that's expected to come maybe in Q4 and quarters ahead? And then maybe if there's potential to grow operating efficiencies as you get better there or dedicate other facilities or whatever it is?

Of course, the Modesto acquisition gave us the ability to take a large portion of the bun business back internally with internal production. The Henderson start-up with bread in Henderson will allow us to do the same thing and start taking again a portion of that volume back from BBU. As far as Modesto and Henderson, based on the equipment in those facilities, efficiency level should the comparable to the rest of our plans.

Okay, so it's fair to say you have not seen much efficiency improvement yet from taking over that sales base in California?

Correct.

Not at this point.

Yes, not at this point. I think the big news in California is that our team has done a great job putting our independent distributor program in place and now we have DSD ability to serve all of the supermarkets in the state and again, that positions you to really start growing as we move forward. So a big part of what's happened in California has been putting the distribution system in place.

We really obviously over the long-term definitely feel it's an advantage to have our own production for a lot of reasons.

Absolutely. Our plan is to produce our own product.

Okay. And then just lastly, just more of a broader question -- your gross margins once reached that 49% to 50% level and the market has obviously undergone a lot of change since that time whether it's commodity cost, volatility, bankruptcies, M&A, etc., and I'm just curious with steadier commodities, they are certainly elevated relatively speaking but with steadier commodities and improved competitive set and even some work that you've done internally, can we think about margins getting back to that level at some point given everything that I just mentioned.

Yes, Brett, we have talked about this quite often and we do believe that the margins can continue to grow and actually if you look at DSD, they carry a pretty strong gross margin already. Where we really need to work on margin is in the warehouse business on the food service side. We do think over time we can continue to improve that.

But we do -- in our five-year forecast and as we look at the business, we do think now that things are beginning to settle down. We do anticipate margins improving over time. A lot of that I think will be driven by the DSD business and the power of our brands and continuing to leverage the revenue growth from the new markets as well.

I appreciate it.

Akshay Jagdale, KeyBanc.

Good morning. First question probably for Steve. You mentioned the three things impacting your business negatively this quarter or just impacting your results and you mentioned frozen food service negative $0.01 to $0.02 EPS impact. What was the aggregate impact of the workforce related costs? And I think you mentioned marketing as being up 40 bps, right? But if I have that incorrectly just let me know. I just want to get a sense of what impact have the other two items had on EPS.

Overall, the workforce related costs and cost of goods sold run through the efficiency measures and that was about $0.01 to 0.015 in the quarter.

Okay, and marketing, just 40 bps up year-over-year, right?

Yes, correct.

Okay. You lowered your full-year midpoint guidance by $0.035. Should I interpret that as just the weakness in frozen continuing or do you also have some workforce related issues that you are expecting to be worse than before?

I think the big adjustment to guidance does comes from the food service side of the business and as we continue to enter these new markets in the fourth quarter, we have seen some cost ramp up there related to workforce as well as just the cost of getting the brands into the marketplace. Those are probably the two big drivers of the reduction in guidance.

Okay and just growing pains if I may in DSD, whether it's adding routes in California, adding plant capacity, buying products from third party, is that just -- is it fair to say that it's hard to predict right now for even you internally which is why the gross margin has sequentially come down since 1Q of this year? Is that a fair statement that with the growth and as explosive as it has been, it's even hard for you to predict that particular item?

I would say overall I think we know our business pretty well but with the amount of growth we've had in such a short period of time, as Allen said, trying to rightsize things, making sure that we continue to serve the market because we really can't have a slip there, there are other costs that have been added and we haven't had this type of growth in such a short period of time. So I think that's a fair assessment when you look at it.

It's just really trying to make sure that we number one, service the market and now we focus on costs as we begin to bed things down.

I think you are exactly right that priority one was making sure that we took care of the marketplace and we've added costs to do that and now as things start to settle down in terms of trends that we are more accustomed to seeing, we are working hard to make sure that the organization is rightsized and that our cost is in line. So the good news is if you look historically that's one of our strengths and we certainly know how to do that.

Long-term again I think Brett had asked this question but historically gross margins were about 50% and you've mentioned that over time you expect to get back to those levels. So one, do you still expect that? And two, if you just look at the components of your COGS which you break down in your Q which is very helpful, what component are you going to leverage the most longer-term to get to these historical levels? My guess is you have ingredient, workforce, packaging, utilities and others. It looks like the other line item is one that has increased a lot but just curious to know what your thoughts are there.

When you look at the overall gross margin and obviously we will leverage the revenue expansion over time. We have a lot of options now from production perspective with the acquired facilities from Hostess as we begin to over the next three to four years rationalize production and make sure we have --- in the right markets.

And then again, product mix into the marketplace. I think we've talked some about that, just making sure you have the right products on the shelf so you are not having to pick up as much product over time. As you put new brands in the market and as you enter new markets, until consumers become familiar with those brands, there is a pretty high cost of doing business there. So we will over time -- we've entered a tremendous amount of new markets in the last couple years so I think over time we will be able to leverage the product mix as well.

Then workforce-related costs, I think you will lever that off of sales. We do a pretty good job from a cost perspective there. I think those will be the main drivers on the COGS wheel.

Again, do you still expect I guess, Allen, to get back to historical levels above 50% on a consolidated basis? That's one question.

And secondly, when should we expect that your gross margin to start moving towards that? Because right now sequentially they sort of came down. I know there's a lot of moving parts but generally speaking, are we talking about 2014 or we should start to see some steady improvement towards longer-term, sort of the 50%-ish range?

You are correct, that is still our target to get back to 50% gross margin. It's very difficult to tell you the timing on that. Obviously we would like to see that happen very soon and that is a priority for us as we grow the Company. But you are also accurate that we are experiencing some growing pains and there will be some temporary setbacks as we move towards that goal of gross margin but that is our target. It is just very difficult to give you a timeline on it.

And just one last one, DSD pricing at 3%. Obviously you don't take pricing on your whole portfolio so my guess is you might have taken even a little bit higher pricing otherwise. But in an environment where wheat costs are down, the fact that pricing is up, doesn't that tell you that the environment is getting more rational or am I reading into that too much?

I think the number is closer to 2% than the 3%. I would say we have also in addition to raising everyday prices, we've also pulled back on promotional activity. I think it's too early to say that the category is having a significant change. Individual markets are very different on pricing comparing one to another but you would hope over time that our pricing becomes more rational and we will see.

Great, thank you. I will pass it on.

Amit Sharma, BMO Capital Markets.

Good morning, everyone. Allen, you mentioned expansion from your existing markets as one of the drivers of growth as you lap last year's acquisition of Hostess. Historically, you mentioned 0.05% or 1% contribution from these markets. What should we think about going forward considering the newer brands that you are going to introduce in these markets? Are you willing to change that outlook a little bit?

I like to use the comparison if you look at our market share in our core markets of the Southeast and Southwest, we are in the 29%, 30% share area. If you look at our market share in the total US, we are about a 14% today. That gap comparing the good job that we've done developing the business in the Southeast, Southwest, the gap between the 30% share in our core markets and the 14% share overall really points to the opportunity for growth for the Company.

I think to take a step back and look at the future, to me that is probably the best indicator.

The new markets historically have been 0.05% to 1%. We are well above 2% this year. It has been really strong growth.

That's exactly what I'm getting to is so this 2% bump, is it mainly one time as you got access to the shelf space due to vacuum or this is a new normal going forward?

I think looking at the markets that we've entered and how we define new markets, it's a market we've been in for five years or less, I do think over the next couple of years we will continue to see good strong growth from expansion markets.

Got it. And the California, the share going back to -- or going to over 12%, is that largely Sara Lee or is Nature's Own starting to make a impact in that market yet?

It is really both. Sara Lee had a nice share in California but consumers in California are reacting really well to the Nature's Own brand as well. So both Nature's Own and Sara Lee and in a smaller way, Tastykake will become a bigger part of our growth in California.

And final question from me, historically, Allen, your acquisitions have tended to be in markets contiguous to your existing markets or something that gives you a good leverage to your DSD network. Any reason to believe that that might change given some of the opportunities or you will stay to that policy?

Yes, we said that we will continue to evaluate acquisitions as they present themselves. But we've also said that with the acquisition of the Hostess assets, the manufacturing plants that we bought, the brands that we've bought, we also have the ability to expand with our brands and the plans that we've acquired.

So we will continue to look at acquisitions but in the near-term we are really focused on digesting the current acquisition.

Got it.

What we acquired last year.

Perfect, thank you very much.

Alton Stump, Northcoast Research.

Thank you. A quick question on the carrying cost front I guess topic looking ahead in the coming years, any idea on what the timeframe is as to when you may be able to decide which of -- what you did buy with the 20 facilities -- which ones you may be able to shut down permanently? Is that going to happen in six months or is it 12 to 18 months out? Just any color you could give us on that front?

We've said that as we continue to develop our business in new areas and our brands continue to grow that will make decisions on reopening plants. I think the best guidance I can give is that we'll keep you posted, we'll make those decisions one at a time. And it will take place over the future months and years but it's really predicated on how well we are developing our brands and our sales as we expand.

Excellent, thanks, Allen. And just a real quick follow-up as you are bringing Wonder back onto the shelves, any color there? It's obviously very early in the process but as to how much share you've been able to hold that [of course] you picked up at the end of last year when Hostess was removed. How responsive have your customers been to letting you keep the share that you gained for your own brand, namely Nature's Own, as you bring Wonder back on the shelves?

Overall, our trade customers have been very supportive in terms of reintroduction of the brands that we acquired and we are very encouraged by that. I mentioned earlier it's very early in the game. Our focus is developing incremental sales and reestablishing the brands in the marketplace at the same time. So we've gotten a lot of great feedback from consumers who are happy to have Wonder back on the market or Home Pride. I think our manufacturing team has done a wonderful job with product quality as we've reintroduced the brands.

But it's going to take time and I think product distribution is one of our strengths of our sales department and I'm very confident we are going to do a good job reintroducing the brands to the market.

Great, that's helpful. Thanks, Allen.

I would like to turn it back over to Mr. Shiver for closing remarks.

Again, we thank you for your interest in Flowers Foods. This is a very exciting time for our Company. We are confident as we move forward from here. We will look forward to talking with you next quarter. Thank you very much.

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