Flowers Foods Inc (FLO) 2014 Q1 法說會逐字稿

Welcome to the Flowers Foods First-Quarter 2014 Earnings call and webcast. My name is Ellen, and I will be your 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.

You may begin.

Thank you, Ellen.

Good morning, everyone.

Our First-Quarter 2014 Results were released, and the 10-Q was filed this morning. You'll find the release and the link to the filing on our website. We have a PowerPoint presentation to support our discussion, and that's posted on the Conference Call page.

You know that before we begin this morning, I must remind you our presentation today may include forward-looking statements about the Company's performance. Although we believe the statements to be reasonable, those statements are subject to risks and uncertainties that could cause actual results to differ materially.

In addition to the matters we'll discuss during the call, important factors relating to Flowers Foods' business are detailed fully in our SEC filings.

Participating on our call today, we have Allen Shiver, Flowers Foods' President and Chief Executive Officer, and Steve Kinsey, Executive Vice President and Chief Financial Officer. Following prepared remarks, we'll open the call for your questions.

Now I'm happy to turn the call over to President and Chief Executive Officer, Allen Shiver.

Thank you, Marta. Thank you for joining our call today.

We reported strong results for the quarter. Especially when compared to the dramatic growth we achieved in last year's first quarter, resulting from Hostess liquidation. In the first quarter of 2014, we achieved sales growth of 2.6%.

Let's look at our results by segment. Our DSD segment, which represents 84% of our business, was up 5%, driven by volume increases in our branded bread business, acquisitions, and positive price mix. It's interesting to note that our DSD sales were up 31% if you go back two years to the first quarter of 2012.

Our market share of bread, buns and rolls for the total US has also increased 3.3 points over the two-year time frame. Our growth shows that our team remains well-positioned to take advantage of the opportunities brought on by industry consolidation.

As expected, sales in our Warehouse segment were down 8.3%, due primarily to pressures on the warehouse cake business as Hostess cake has returned to the market. Our Warehouse cake business has been impacted more than our DSD cake because Hostess cake distribution is through warehouse delivery.

Even so, looking at the two-year review, our Warehouse segment has maintained much of the cake business gained in 2013. Compared to the first quarter of 2012, Warehouse cake has increased 13.5%.

Looking at our total cake business, including sales through both DSD and Warehouse segments, our cake business is up 22% over the first quarter two years ago.

Much of our growth in cake is driven by a roll out of the Tastykake brand through our DSD system. Our Tastykake brand at retail is now annualizing at almost $500 million. Our total share of the cake has increased 1.9 points in the two-year period.

Our earnings were solid in the first quarter, especially when you consider that since this time last year we've taken on carrying costs for the acquired Hostess assets and strengthened our infrastructure by opening three new high-speed bread lines to support our sales growth and adding a substantial number of new distributor territories.

These investments are needed for Flowers Foods' future growth. I am pleased that our earnings were strong in spite of these costs that we've taken on since quarter one of 2013.

As we told you at our March Analyst Day, our manufacturing efficiencies are improving.

In the quarter, efficiencies were up 1 full point over the fourth quarter to 92.3%. That's well on the way back to our historic high of 94%.

We've also improved day-to-day operations at our Fort Worth tortilla facility. We continue to evaluate our tortilla business, and we are exiting low-margin food service contracts.

The action we took to realign the Fort Worth tortilla business as part of our DSD segment allows us to focus on growth opportunities in branded retail tortillas. This is where the margins are much better.

The integration of our systems at Lepage continues, and we are seeing steady improvement. I think it's important to clarify the issues at Lepage.

Our SAP integration is complete, and there are no problems with information flow across the business. The ongoing problem is in the transition to Flowers' ordering and forecasting model.

Previously, Lepage had a centralized model. Flowers' model is decentralized and puts the ordering decision closer to the marketplace.

Training at Lepage continues. And, as I said, we're making progress on the transition through our Flowers forecasting system.

During the quarter, we also added a high-speed bread line in Modesto, California. You may recall that we acquired that bakery in July 2013 as we sought a production solution for the Sara Lee California business we acquired from BBU.

Modesto had an efficient bun and roll operation; now we've added a bread production line. I want to thank our team members who worked to plan and execute the successful start-up of the Modesto bread line. That bakery, along with the Henderson bakery that we opened in November, is helping to meet our needs for the California market.

We also cycled the Sara Lee California acquisition in the quarter. It is gratifying to see the progress being made in the California market.

We now have a strong portfolio of brands with Sara Lee, Nature's Own, Home Pride, and Wonder. We also have excellent access to market and our own production capacity. All these things further enhance our ability to grow in California. Last quarter, California was at a 12.6 share of the total category.

Our acquired bread brands continue to perform well. As we told you at the Analyst Day in March, we're gaining good incremental sales as the brands regain strength across our markets.

One other important development regarding the acquired brands. I am very pleased to tell you that as of the beginning of quarter two, Wonder, Home Pride, Merita, Butternut brands are available through all of our major retail customers.

Our new markets achieved growth higher than our stated goal in the quarter. As expected, our acquired brands, along with Nature's Own and Tastykake, are steadily gaining share in new markets.

Our new markets are showing the benefit of those strong brands and of the exceptional service we provide to customers through our distribution system. We have tremendous growth potential in those new territories as we continue to gain share over time.

We also will push our geographical boundaries further to enter additional markets in the future, especially those with major population centers. As we told you at the March event, by 2018 we expect 90% of the US population to have access to Flowers' fresh bread, buns, rolls and snack cakes. And we will continue to gain market share as we reach new markets.

Our market share of total bread, buns and rolls sold in the US, as reported by IRI, increased in the first quarter compared to the same period last year, gaining 1.3 share points of dollars to a 14.1 share.

At our Analyst Day, we told you to expect our market share for bread, buns and rolls to reach a 20 share by 2018. We also said that we expect to grow our cake business to a 12 share from our current 7 of total snack cake sales in the US.

I know you're interested in our plans for the assets we acquired from Hostess.

Our Knoxville bakery started bread production this week. With Knoxville now running, we have opened two of the bakeries that we acquired from Hostess. You will recall that we opened the Henderson, Nevada, bakery in late November of 2013.

As we told you in New York, we expect to open several additional bakeries over the next two to three years. We have listed 9 bakery properties and 21 warehouses for sale.

Before we hear from Steve, let me say again that the first quarter was a strong quarter.

We continue to see opportunities ahead for increased sales and increased earnings. Our team is focused on improving the business, executing in the marketplace and continuing to build value.

Now Steve will give the financial report.

Steve?

Thank you, Allen.

Good morning, everyone.

To begin with, a quick reminder. As Allen stated, we did shift the Fort Worth tortilla operations from the Warehouse segment to the DSD segment in Q1 of this year. All historical data related to this business has been moved as well. And the overall impact on the first quarter was fairly immaterial, slightly less flat than $1 million in earnings before tax. A significant improvement over the back half of 2013.

Also, for those who might be new to the stock, our first quarter is a 16-week quarter and fiscal 2014 is a 53-week year.

Turning to the quarter.

Sales in the quarter were up 2.6%, with price mix contributing 2.9%. The acquired Sara Lee California business contributed 1.2% to the growth. Volume in the quarter was down 1.5%; and as Allen stated, we did cycle the Sara Lee acquisition in the quarter.

Overall, the performance of our DSD branded retail business was very strong. Our branded bread and buns showed significant growth driven by Nature's Own, the acquired brands, and growth in our expansion markets. Expansion markets contributed 2.3% to the quarter's sales growth.

We continue to see pressure on our cake business, both in the DSD and Warehouse segments, resulting from the reintroduction of Hostess cake.

However, as Allen said, we are pleased that we have held onto a significant portion of the cake gains over the past two years. And we continue to be excited with the opportunities to expand our cake share as we roll out the Tastykake brand in our new markets.

Our Food Service business was up in dollars during the quarter, driven primarily by pricing. Volumes were flat, with fast food increases offsetting institutional declines. The DSD fast food and quick serve channels performed very well during the quarter.

We are also very pleased with the relaunch of the acquired brands and their contribution to the overall sales growth. We believe we can leverage these brands and the acquired facilities as we continue to increase penetration in existing markets and enter new markets with a stronger product mix and immediate production capacity as needed to meet our growth targets.

Operating earnings, or EBIT, was down 6% this quarter compared to last year's first quarter. Our EBIT margin was 8.5% of sales, still strong despite being down slightly from last year. Several factors contributed to the overall decline.

First, we added $6.8 million of carrying costs associated with the recently acquired Hostess bread facilities. This affected our EBIT margin by 60 basis points.

We also have continued to work through integration issues with the Lepage acquisition. Compared to last year's first quarter, this negatively impacted the quarter approximately $0.01 per share.

This is an improvement of over the 2013 fourth quarter impact. And, as Allen stated, we continue to make progress towards correcting these issues.

As I said earlier, we have seen improvement in the results of our tortilla facility, with the impact being very immaterial in the quarter, less than $1 million. EBIT margin in the quarter was also impacted by the overall effect of our declining cake volume in both our DSD and Warehouse segments quarter over quarter.

Earnings per share for the quarter of $0.29 were down 6.5% compared to last year's first quarter on an adjusted basis. Overall, we are pleased with this performance, given the additional costs I just discussed.

The acquired facilities, carrying costs and interest expense to fund the recent acquisition negatively impacted the quarter approximately $0.03 per share.

Turning to gross margin.

We are very pleased with the improvement in our gross margin in the quarter. Gross margin was 48.6%, compared to 48.2% in last year's first quarter.

This 40-basis-point improvement as a percent of sales was driven by a 120-basis-point improvement in input costs as a percent of sales. This improvement was negatively affected by a 40-basis-point decline as the result of $4 million of carrying costs during the quarter related to the acquired Hostess facilities and another approximately 50-basis-point decline due to higher workforce-related costs.

Decreased efficiencies quarter over quarter negatively affected gross margin by approximately 30 basis points.

Though we have short-term cost pressures that are negatively impacting gross margin, we expect longer term to continue to see gross margin improve as we sell certain idle bakeries and warehouses, continue to work on improving our efficiencies, and work through the short-term issues at Lepage.

Selling, distribution and admin costs in the quarter were 36.8% of sales, compared to an adjusted 36% of sales in last year's first quarter. The primary driver of this 80-basis-point increase was higher distributor discounts as a percent of sales.

These increases in distributor discounts as a percent were not completely offset by a decline in workforce-related costs, due to the ongoing cost related to our market expansions, our route conversion both in California and the Northeast, and increased headcount resulting from our growth.

Now turning to our balance sheet.

Cash flow in the quarter was strong. As you can see, cash flow provided by operations was a positive roughly $122 million in the first quarter.

During the quarter, we were very pleased that we were able to pay down roughly $82 million in debt, ending the quarter with approximately $840 million in total debt. So at the end of the quarter, our debt to EBITDA leverage ratio based on the trending 12-month EBITDA was 2.1 times.

During the quarter, we also paid dividends of approximately $24 million and funded roughly $24 million in capital expenditures. We also repurchased $9.5 million of common stock, or approximately 465,000 shares under our share repurchase program. We have approximately 8.5 million shares remaining on the current authorization.

Turning to the 2014 outlook.

What I would say here is recently we have seen a run-up in wheat due to the impact of drier weather and global political instability. We will see the most impact from this run-up in the back half, primarily in our fourth-quarter costs.

However, we are pleased overall with our ingredient coverage for 2014. But we still have a few items open that could negatively impact our results. However, this is all reflected in our 2014 guidance.

Thank you for your interest in Flowers Foods, and now I'll return the call back to Allen.

Thank you, Steve.

In the second quarter, we're seeing continued strong performance in our expansion markets. We're encouraged by the results of our test market, the Cobblestone Bread Company's specialty bread and rolls.

Our efficiencies are improving. We're making progress addressing challenges in Fort Worth and at Lepage. 2014 will be another good year of performance for Flowers Foods.

We also see growth opportunities for years to come as we gain share in expansion markets, stretch into new territories, introduce new products, and make future acquisitions.

Our strategies are proven. Our team is experienced and motivated. The Flowers way continues to deliver for our shareholders.

Ellen will now open the call for questions.

Thank you. We will now begin the question and answer session.

(Operator Instructions)

The first question is from Farha Aslam with Stephens.

Please go ahead.

Hi, good morning.

Good morning.

Three questions.

The first, with your manufacturing efficiencies, they were 92.3% this quarter. What is your target, and when do you think you can achieve that?

Farha, historically, our high has been 94% on efficiencies. We're well on the way back to that number.

To set a specific date may be a little tough. But I would certainly expect us to be closing in on that number by the end of this year.

Okay, so end of second half is achievable?

Yes.

Okay.

And then an update on Aunt Millie's. When do you think they will start distributing Flowers products into the Chicago market? And how will that flow through into your P&L?

Farha, that is a licensing agreement with Aunt Millie's. And they are actually introducing the brands as we speak.

If I'm not mistaken, they're already in the marketplace. And again, it is simply a licensing agreement.

Those markets were markets that we did not have on our immediate expansion plans. And Aunt Millie's is a very good bakery that will do a good job getting the brands back into the marketplace.

Farha, this is Steve.

That will actually come in as royalty income. We don't expect that to be material at this point. It would still be reported in SG&A as an offset. If it were to become material, we would have to move it out to the sales line.

Okay, great.

And then my last question relates to the promotional cadence in the category. Could you share with us how you're seeing the market develop as you're reintroducing that Wonder brand?

The category continues to be aggressive from a pricing standpoint. The conditions that we've described in the last two calls really continue.

From a positive standpoint, if you look at IRI numbers, you'll see that the growth in private label in the segment, private label's basically flat for the last quarter. But our promotional activity as it relates to brands continues.

And how are you responding to that?

Farha, we're protecting our brand share.

IRI will show that in many, many cases, Flowers is the market leader from a pricing standpoint. But at the same time, we have to protect our share in our marketplace.

Okay. Thank you so much.

Thank you, Farha.

The next question is from Eric Katzman with Deutsche Bank.

Please go ahead.

Hello. Good morning, everybody.

Good morning, Eric.

Let me just follow up on Farha's question. Is the price competition coming from BBU? Or is it coming from retailers funding it, or some of the smaller players that are still out there?

Eric, the price competition is primarily coming from competitive bakers. So you have the list.

Okay.

And with wheat cost, as you mentioned, Steve, rising, why do you think that the market is still as promotional as it's been the last couple of quarters? Have you sensed anything since the quarter ended with input costs going up that it could get a little more rational?

Eric, I continue to be optimistic with all the changes taking place in the category that over the long term, pricing should become more rational. I wish I could report today that that was the case.

But we're really -- I would not say there's a deterioration in pricing. It's really more of the same that we've experienced the last couple of quarters. Really nothing in the way of commodity spikes or concerns that would push pricing one way or the other.

I would say most bakers probably have some coverage on. And since the spike just happened recently, you've probably already priced most of your programs and products through the summer.

We'll continue to watch the back half; and as always, we typically take our pricing actions late fall. We'll build those off of the wheat prices at that time.

Okay.

And then Steve, a question, you noted in the press release that you're in the process divesting some of the Hostess pieces that you don't want. That's, I think, $10 million you said of cost could come off. That's around $0.03 a share.

Does that give you confidence in the high end of your guidance range? How do we think about that relative to the $0.07 spread of your guidance range today?

Currently, we are in the process of marketing of those facilities. I would say if you look in the 10-Q, we have sold some of the warehouses.

But to date, we have not sold any of the bakeries as far as closing any deals. We would have to close that sometime in the second quarter to get that benefit in the back half.

Right now, I would say that's still up in the air as to when that benefit would start to roll in. Some of that's factored in, but not all of that's factored in. To hit the upper end of the range, probably you would need some of that to happen pretty quick.

Okay.

And then last question and I'll pass it on.

Allen, you mentioned that all major national retailers are now selling Wonder bread, Merita and some of the others. I assume that includes a Bentonville-based retailer that reported results this morning.

When did you start shipping in there? And did that initial shipment start to influence the results you just reported? Or is that to come starting with the second quarter?

Eric, we started at the beginning of quarter two. And the retailer in question obviously does a very good job with the white bread segment.

The brands that we introduced -- Wonder, Merita and so forth -- are strong brands in that white bread segment. So, yes, they will have a very positive impact on the overall brand growth.

Okay, great. Thank you. Good luck.

Thank you.

Thank you, Eric.

Thank you.

Our next question comes from Sarah Burns from Findlay Park Partners.

Good morning.

Can I just ask about the new bakeries you've opened and where you are in utilization rates for those? And typically, when you open a new bakery, how long does it take to get to your ideal level of efficiency?

Sarah, we'll talk first about the Henderson, Nevada, bakery. Again, it was a bakery that is well-positioned geographically to help us not only in California, but also Arizona and that part of the world.

In terms of efficiencies, each bakery is a little different based on conditions of equipment and so forth. But very encouraged about the progress in Henderson in terms of overall efficiencies.

As we mentioned earlier, the Knoxville bakery literally was just reopened this past week; and we're excited about that facility as well. Really providing significant capacity relief for the marketplace in that part of our geography.

As far as efficiencies, each bakery is different. But I would say within six months to one year, we should be making significant progress to get our efficiencies in line hopefully with other plants.

Thank you very much.

Sarah, this is Steve.

When you look at the Henderson facility, currently we only have a bread line operating there. We haven't opened up the bun line yet. So that bread line is operating pretty much, I think it's two shifts; and we're working on the third shift.

Right, okay.

Our efficiency level in bread at Henderson is 90% currently.

Great. That was the figure I was wanting. Okay, thank you very much. Well done on a nice quarter.

Thank you.

The next question is from Bill Chappell with SunTrust.

Please go ahead.

Good morning, Bill.

Good morning. Thank you.

Trying to dig into the DSD numbers, and I'm sorry if you've given this. But if you take out the tortilla business and maybe even the cake business, can you give us an idea what the growth would have been?

Because I assume tortilla, you gave was the bottom line impact. I don't know what the top line impact is, but I'm assuming that was in decline.

If you look at the DSD business and you pull out the overall cake decline, we typically don't give this specifically. What I would say is you would be up another 100 to 200 basis points; so it was pretty significant.

Okay.

And on the cake side, are you starting to see moderation in terms of, basically for Tastykake, of a reacceleration of growth? Or is it still going to go through another quarter of tough comps there?

Bill, I think the right way to look at our cake business is if you compare against quarter one of last year, obviously that was a very unusual, exceptional quarter.

I like to look at our brand growth over a two-year period, and really starting with our Mrs. Freshley's brand. Again, comparing to that quarter one that we just completed to quarter one two years ago, the brand is up 44%. Likewise, if you look at our Tastykake brand, again, for the same two-year time period, the Tastykake brand is up 30%.

So those are dramatic sales increases, which hopefully is a good illustration of the overall health of the cake business on both DSD and Warehouse. Now, obviously, we're competing against some pretty tough comps last year. But overall, our cake business is healthy.

Bill, the Hostess relaunch was in mid-July, late July. So the second quarter will be probably another tough comp, and then we'll then see that level out in the back half.

And then back to the Bentonville retailer. Can you answer this simply -- was it worth the wait? Are you comfortable with the product placement you're going to have?

I think the thought was you could have always gotten in there on quick standalone displays, but just trying to get more color on that.

Bill, our sales team is excited about being in that retailer with the acquired brands. And the team in Bentonville is also excited about the opportunity to get these brands back in their customers' hands. So it's a win-win all the way around.

Great.

The last one, Steve. Can you just remind me -- this is a loaded question -- but the thought process on dividends, payout ratio and the time of the year you typically adjust that?

Sure.

Actually, we typically adjust that at our first quarter Board meeting and annual shareholders meeting; and that's coming up next week. Our goal would be to keep the dividend yield in line with where we have been.

As you know, we're very focused on returning to our shareholders. And the dividend's very important to the management team and the Board. So I don't expect any change philosophically in that when we meet next week.

Thanks so much.

Thank you, Bill.

The next question is from Brett Hundley with BB&T Capital Markets.

Please go ahead.

Good morning.

Good morning.

Good morning. I just want to stay on Wonder, et cetera, being back in all retailers now.

Should we expect any incrementally better coverage of carrying costs because of that? Would there be further needs over the short time for opening of new bakeries? How should we think about that?

Brett, obviously, as Allen said, and you can see in the IRI data, those brands are doing very well in our expansion markets. So every dollar of incremental sale will help offset some of the carrying costs. And then at the right time, as volume warrants it, we'll make decisions about opening facilities.

I think right now, with the opening of the Knoxville plant, what we've done on the West Coast, we're pretty much set through the rest of 2014. And as we talked about in March at the Analyst Day in New York, we'll probably make an announcement late in the year about the next bakery to be opened.

But as Allen said, we're very pleased where the brands are performing and really excited about getting them into all of our major retailers and now in the new markets.

I'm sorry. I wanted to stay on that topic too because the Hostess-related sales did come in better than I expected during the quarter. And I wanted to talk further about the reimplementation and just get further color on your belief about where this space is coming from broadly.

Bill, the Hostess reintroduction, are you speaking of our brands that we acquired or Hostess cake?

Your bread brands that you acquired.

Steve said it well. If you look at our expansion markets, reintroducing Wonder, Butternut, Merita, the other brands, is helping us grow significantly in our new markets.

Couple I'd like to call out, for just exceptional performance. If you look at the IRI data for Kansas City, we're now up to an 8.2 share; Cincinnati, we're an 8 share; and in markets like St. Louis, we're now up to 8.5 share.

The new brands in conjunction with Nature's Own and our Tastykake really are helping to establish our business in these new markets.

And in your core legacy markets where the reimplementation of Hostess has come out, are you still comfortable with how Nature's Own (inaudible) or volumes are performing?

Yes, we are.

Brett, it's Steve.

If you look at the category, and I think Allen mentioned this in his comments, we actually saw private label down quite a bit this quarter. So it would appear that these brands are taking some of the volume back from private label, as well as taking probably some volume from competitors' brands.

Okay.

And then, Steve, do you care to call out any type of negative weather impact during the quarter?

Overall, I would say there was some impact in the Northeast, just because it was more severe than historical. But I would say weather did not impact us materially. It could have helped in some markets.

Okay.

And then just my final question. Allen, I think it's interesting that in the US food space we've seen diversification within the M&A landscape be rewarded by investors. And I think that's changed a little bit from recent years.

And you've talked about and you've stuck to your strategy as far as geographical growth. You have two basic products across bread and cake.

But can you just talk a little bit about your thoughts over the next three to five years, conversations you might have with your management team, the Board, et cetera, as far as -- of course staying with that strategy of expanding geographically, but maybe also looking at diversification. If you could just give an answer to that, I'd appreciate it.

Brett, obviously we have more to do geographically; so you mentioned that. I think we're very positive about the success of our DSD business.

There are some adjacent product categories that lend themselves well to DSD that potentially could be opportunities in the future.

Tortillas is a good example. We have got a lot to do in terms of developing our branded retail tortilla business, and we're going to be focusing our DSD team's attention on that segment. But there are other product categories that at the right point in time that we would consider looking at.

In the near term, we're excited about the growth potential to get to that 90 share of DSD distribution in the US. And we're very excited about the success we're having in new markets with the combination of Nature's Own and Tastykake with the brands that we just acquired.

I would say we're always looking for opportunities. But in the near term, we're focused on growing our DSD business.

Thanks.

Thank you, Brett.

Next question is from Akshay Jagdale with KeyBanc Capital Markets.

Please go ahead.

Good morning, Akshay.

Good morning. Couple questions.

First one, just on sales growth for the remainder of the year. Obviously, you didn't change your guidance for the year. But this quarter, sales growth came in a little bit lighter than we were expecting.

How did the sales growth performance come in relative to your internal expectations? That's the first question.

And secondly, your guidance implies a pretty significant acceleration into the back half or for the remainder of the year. Can you help me understand how or what are the drivers of that acceleration? Thank you.

Sure.

Internally, I would I say we were off slightly or off somewhat from what we had expected internally as well. But we're coming into the summer season, which we see a lot of acceleration usually. And then we do expect the back half to pick up with getting the new products in the new markets.

But we just felt like right now we're still targeted to hit within our range that we have out there. So when we get through the summer season and see how performance has been, then we can make decisions about if we need to adjust anything. But in the near term, we felt comfortable leaving the guidance we have there.

And can you help me with the incrementality of these new brands? I think you had mentioned at your Analyst Day it was 20% incremental in 4Q. And then at the Analyst Day, the level was more around 55%.

What is the incrementality that you saw from the newly-introduced brands in the quarter?

Akshay, the incrementality is very positive. We're around 75% as a total.

Obviously, in new markets where the brands have been reintroduced, where we had a very low share of the white bread segment, the incrementality is probably higher than that in new markets. But overall, we're very pleased with the results in that area.

And how should we conceptually think about the reintroduction basically into Walmart? How is that going to conceptually impact your sales? Because obviously, it's a big customer for you already. You had a really good year with them last year.

I did see that this year your sales, especially in the Warehouse segment, to that customer are down pretty significantly. But can you just help us understand how this will flow through?

The real question is, how incremental can the reintroduction of the Hostess brands be to your overall sales as a result of the introduction into Walmart?

Akshay, obviously the largest retailer in the country not having the brands approved until the beginning of the first quarter, obviously that impacted our numbers in the quarter.

But now that we are in place and we're still working through final rack sets and getting really good support with display activity. But because of that approval in additional space, it's one of the reasons we have confidence in our guidance going forward.

I don't think we can quantify at an individual retailer, but just to say that approval of the acquired brands in that account is significant to our sales growth going forward.

So lastly, do you think that will positively impact the incrementality number, which currently stands at 75%?

I would say yes. Again, especially as we look at new markets.

Another positive, we've been seeing the entire category trending down for several quarters. And it was encouraging; the category is actually up slightly in terms of both dollars and units this past quarter. So that also is a good sign.

Okay. And then one for Steve on gross margins.

Really very good quarter's quota on that. I wanted to just make sure we're modeling it correctly sequentially.

Last year, if I remember, you got out of the gates really fast. And then there were some growing pains, as you call them, for the remainder of the year.

I'm guessing we're not going to see that this year. So we should, in my estimate, build off of the performance that we saw this quarter. Is that the right way to think about it?

Will percentage gross margin build off of where we were sequentially from now? Is that the best way to think about it?

Yes, I think we do expect gross margin to be up year over year. So you should see it continue to improve on a quarterly basis, based quarter over quarter, as we move through the year.

The one caution I would say, and I did mention, wheat cost being up primarily in the fourth quarter. Right now, we think we're in good shape there. But if it were to continue to run, that could change that.

But I would say based on what we know today, we expect to have incremental improvement in gross margin year over year.

Just one last one on the California expansion and the Sara Lee acquisition.

The contribution from that particular business was much lower than I would have expected this quarter. Is there some seasonality there?

Because you've lapped it now, and it looks like the incrementality is at the low end of what your plan was implying for the full year from that particular acquisition. So, any color there?

And then if you can update us on the route buildup, because obviously that was a big drag on SG&A again this quarter.

When you look at California, if you recall, that acquisition was late February. There are really only two periods where we cycled that particular acquisition in the quarter.

And then when you look at the overall cost from the route buildup, that's an ongoing cost until we are established in all the new markets. But that is fairly significant to the overall margin.

Akshay, in terms of routes, we now have over 400 routes serving all of the major retailers in California. And it's exciting that now that we control our own destiny from a manufacturing standpoint.

Product quality is substantially better. Product is fresher; and our cost structure, as we're producing our own product, will be better over time. We're encouraged about the future for California.

When do you expect that SG&A to sales to normalize? In other words, the 400 routes that you have, I'm guessing compared to your other mature markets, are maybe 50% utilized. And you're still paying those distributor fees, which is what's causing the drag, right?

Am I, one, understanding that correctly? And just roughly, when do you we expect that to normalize? Is that in a year or two years or three years?

Typically, in a new market, it takes 18 to 24 months to really build that base and get the margin contribution up to where we like for it to be. So you're probably looking at another two years or so for that to stabilize.

Akshay, from an operations standpoint, we really look at California as a big opportunity as opposed to a drag.

One of the encouraging things is that we're building that route structure primarily with branded business. Nature's Own is doing well. Home Pride is a brand that's doing extremely well in California, as well as Sara Lee. So we're encouraged and bullish about our results in California.

Great. Thank you.

Thank you.

(Operator Instructions)

The next question is from Amit Sharma with BMO Capital Markets.

Please go ahead.

Hello, good morning, everyone.

Good morning.

Thank you very much.

Steve, can you talk about Lepage? Is it still about a 1% impact on top line?

Sure. When you look, overall their sales were fairly strong in the quarter. They were kind of flattish year over year.

As Allen said, it really gets down to the order rate forecasting. There we're doing things a little differently than what we do across the whole.

We're spending a lot of time training and trying to make sure that everyone has the right tools to get the ordering back in line. And then we opened three facilities up there over a fairly short period of time just because of the production needs. So we are working through manufacturing efficiencies there as well.

The good thing is we have all the issues identified, and we think we have a plan to improve those. And we're still targeting having most of this corrected by the end of this quarter -- second quarter. We feel good about that.

First quarter impact, still about 1% on top line?

Really, what happened in the first quarter is you just missed opportunity. Their sales were not down quarter over quarter. It's just that we missed some of the selling opportunities by not having the order forecasting in that we needed.

Major channel data is showing a pretty steep decline, so I think something is wrong with IRI in terms of how they're showing the sales if your sales are flat.

We can talk about that offline.

Sure.

And then last quarter you gave ACV levels for Hostess brands at 37%. What is that level now?

I actually asked for that number before the call this morning, and I do not have that. It's substantially higher than it was last quarter. If you'll permit, I will give you the exact number on a callback.

Sure.

The question that I had on that is if it is substantially higher, which is in line with expectations, what kind of conversations you're having after the retailers have had a few months to look at the performance of those brands.

Are you getting incremental shelf space in those where you have five, six months to show the performance of those brands yet?

The conversation with retailers is very positive. Retailers understand in this business that brands in the white bread segment are very important. Brands are important period, but especially important in the white bread segment.

When you'd have discussions about Wonder, which, again, if there is a national brand of white bread, it would be Wonder. They're very positive about supporting the brand in their stores.

Each individual retailer resets their bakery departments at different times. And again, it's based on turns and contribution to their business.

But we are seeing growth in terms of overall shelf allocation for the acquired brands and are getting a lot of support from the trade.

And just a further discussion on Hostess brands, $42 million sales in Q1. We are entering into seasonally stronger period.

I understand that this is a 16-week quarter. But sequentially, as you come into the large retailer as well, sequentially should we build for a larger contribution from Hostess sales, Hostess brands?

The sales and contribution that we anticipate from the acquired brands are included in our guidance. So I would not recommend any change at this point.

No, no, not to change, but just to get a better understanding of what is the contribution from the Hostess brand.

If you adjust for the extra four weeks in the quarter and the fact that we now have the brands in all of our major retailers --

Right.

They have performed very well in expansion markets. That's where we've really seen the great growth.

I'm not sure it will be huge acceleration, but you could see potentially a slight pick-up in the Hostess brands, just because now we have a much greater penetration in the market.

And then, Allen, you talked about category getting better. And clearly, the major channels show both volume and dollar sales for the category improve in the first quarter versus 2013.

Can you talk about, is that the sales driving that? Is that sustainable?

Again, the category was up 1 share point in dollars; and it was up 0.8 in units. Whether it's sustainable, I would certainly hope so. There's a lot of activity in the category from an overall health and nutrition standpoint.

But we see that as very -- it's a change from the past. So we see it as certainly a move in the right direction. Time will tell; but we're optimistic it's sustainable.

Just a follow-up on that.

Are you seeing retailers being a little bit more supportive of the category? Are you seeing just because we were down sort of like catching up or easier comp, if you may?

Retailers understand very well how important this category is to their overall business. They also understand the consolidation that is taking place in the baking industry. And Flowers is getting a lot of support, especially in our new markets.

I would say that in terms of the category, attitude from retailers is very positive. And the retailers' attitude in terms of support for Flowers is also very positive.

Just one more, final question from me.

If we look at Hostess sales -- not only just brand sales, but Hostess total fresh bread sales -- now, you give that breakup of how much of your fresh bread sales are in private label brand and food service. Is it a similar division for Hostess as well?

All of the acquired brands is in the branded segment of our reporting.

I understand that. But the question really is, do you have opportunity to recapture some of Hostess' private label and food service sales as well? Or is that opportunity gone to third parties?

It was an asset only deal. We acquired the brands. And any contracts it would have had with private label suppliers, we did not acquire any of that.

But they were not a big private label supplier when they exited. But any opportunities they gave up in private label or food service, we have had the opportunity to recapture some of that through the normal bid process.

What private label that Hostess had at the point of liquidation, it would have been redistributed to the remaining bakers at that time based on the bidding.

And you garnered a good share of that business as well then?

Our focus has been growing the branded business and not the private label business.

I don't have the numbers in terms of what Hostess had and what we picked up. But our focus has been on building the branded business.

Got it. Thank you very much.

Thank you.

We have no further questions at this time.

I'll turn the call back over to Mr. Allen Shiver for closing remarks.

Thank you very much for your support.

This is certainly a very exciting time for Flowers Foods. We have a wonderful team.

I'd like to use this opportunity to really recognize our manufacturing teams for the outstanding job that they've done bringing multiple plants and multiple lines up into operation -- a fantastic job. We're excited about the results, and we're very optimistic about the rest of the year.

Thank you so much, and we will talk with you next quarter.

Thank you, ladies and gentlemen. This concludes the Flowers Foods First-Quarter 2014 Earnings call and webcast.

Thank you for participating. You may now disconnect.