Flowers Foods Inc (FLO) 2014 Q2 法說會逐字稿

Welcome to the Flowers Foods second-quarter 2014 earnings call and webcast. My name is Ellen and I will be your operator for today's call. (Operator Instructions). Please note that this conference is being recorded. I will now turn the call over to Ms. Marta Jones Turner. You may begin.

Thank you, Ellen, and good morning, everyone. Our second-quarter 2014 results were released and the 10-Q was filed early this morning. The release and a link to the filing are on our website and the PowerPoint presentation that supports our discussion also can be found on the conference call webpage.

Before we began I must remind you that our presentation may include forward-looking statements about our Company's performance. Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially.

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

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

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

Thank you, Marta, and good morning, everyone. Our results this quarter were below our target, primarily resulting from growing pains associated with our expansion plans combined with a very competitive marketplace. Given all the activity this past quarter, it's important to keep perspective.

Over the past two years we have a substantially increased our market share by acquiring brands and bakeries that allow us to expand into new territories as well as build our share in existing markets. As we pursue these opportunities we will continue to experience cost headwinds that will abate as we establish ourselves in our new markets and optimize the operation of our new facilities.

Our team has done a great job over the two-year timeframe taking advantage of accelerated growth opportunities brought by the Hostess liquidation. As we work to establish a strong foundation for our continued growth we have confidence in our team's ability to face challenges and shape solutions that will keep us on track to meet our long-term goals.

Let's talk more about the quarter's results. Clearly we experienced pressure on the top line which was impacted by promotional activity, Hostess Cake return to the market and lower store brand and foodservice sales. But before I discuss those factors I will say we are encouraged that sales of our acquired brands, Wonder, HomePride, Butternut and Merita, were up about 35% from first quarter.

In our new markets sales doubled from last year's second quarter of $21.4 million. The contribution to sales of our new products was solid. Our DSD branded bread, buns and roll business was up 3.1%. These successes show that while marketplace dynamics are pressuring our top line, we have fundamental brand and operational strengths that will continue to drive our growth.

Now let's discuss the factors that contributed to the sales decrease. From a broad view we see that consumer spending remains under pressure. The level of promotional activity across all food categories is much higher than normal. In most categories, including fresh bread, the increase in promotional activity is not driving growth in category volume.

Promotional activity in fresh bread was high in the quarter. Our percentage of products sold on promotion was higher than normal, reducing our average price per unit. In recent weeks we have made progress reducing the number and the depth of our promotions. Our goal is to return to a more normalized level of promotions by quarter four of this year.

Also, with the successful reintroduction of our acquired brands behind us, we are focused on the distribution fundamentals necessary to improve top-line growth while maximizing our earnings opportunity.

Another fact related to higher than normal branded promotional activity was the reduction in store brand sales. In total our store brand business was down 7.8% with bread and buns store brand down 4.6% and our store brand cake down 19%.

IRi shows that store brand lost unit and dollar share in the quarter. That category shift accounts for part of the decline in our store brand business. And we also gave up some profitable store brand volume -- some unprofitable store brand volume during the quarter. We also exited some low margin food service business.

The category shift away from store brand to branded products and our decision to exit low-margin store brand and foodservice business should have a positive impact on our results over the long-term. However, these events are painful in the near-term since they impact our top-line sales.

Another impact to our top-line sales came from Hostess Cake and their growing penetration in the market. Prior to the reintroduction of Hostess Cake in July 2013, we gained a significant amount of new cake business. As a reminder, our market share of the cake category increased from 5.7% to 8.6% when Hostess exited the market.

Although we have maintained a good portion of our cake sales, in the second quarter we felt a stronger impact from Hostess Cake as they increased distribution with several key customers. While our sales are under pressure due to the return of Hostess Cake, it is important to note that our share of the cake category is still 6.7%, up a full point from 2012.

This competitive pressure does not change our enthusiasm for the cake business. Since we are acquired Tastykake in 2011, our cake sales have increased significantly. Tastykake retail sales are annualizing at $460 million, up $35 million from last year. Our strategy is solid, we will grow our Tastykake brand as we leverage the distribution strength of our DSD route structure by offering outstanding customer service and exceptional product quality.

IRi data also shows that our share of packaged breads continues to increase. Compared to the second quarter a year ago we are up 0.7 share points to a 14 share. looking back to the same quarter in 2012 our share of bread, buns and rolls is up 3.3 points.

As I mentioned, our team is doing a great job growing our business, especially in new markets. For example, we entered the Kansas City market about a year ago. In 12 months we have achieved a 10 share of bread and rolls fueled by the reintroduction of Wonder Bread and the strength of our Nature's Own brand.

Our share growth and expansion markets like Cincinnati, Pittsburgh, New York, California, and Kansas City, are evidence of our ability to grow our Company as we add DSD routes using our independent distributor model supported by strong brands like Nature's Own, Wonder and Tastykake.

Sales and our new markets contributed 5.9% of our total DSD sales in the quarter, which is strong performance. And as I mentioned before, it shows the strength of Nature's Own and our acquired brands.

As we discussed on our last call, we will continue to reopen our acquired bakeries as needed to support our growth in expansion markets. The startup of our Henderson Nevada and Knoxville, Tennessee bakeries and our expansion at the Modesto, California bakeries are all examples of our commitment to growth.

Of course we have startup costs associated with new production lines. It can take a year to 18 months to bring manufacturing efficiencies in line with our standards. We also remain interested in acquisition opportunities that fit with our overall growth strategy. We are in contact with companies that offer synergies that support our long-term growth objectives.

I've already discussed the actions that we're taking to increase sales and improve our results by focusing on fundamentals and leveraging our team's experience. We are also focused on reducing our cost. From an overall standpoint our team is drilling down to be certain our cost structure is right at every location.

We are seeing improvements in our production efficiencies compared to the second quarter of 2013. We continue to take further action to improve our manufacturing productivity. For example, we have reached an agreement to sell our Fort Worth tortilla facility, which has had a negative impact on our production facilities -- production efficiencies.

We are in the process of relocating two of the Fort Worth flour tortilla lines into core Flowers bakeries. We remain positive about the growth opportunity in the retail tortilla category. The sales of the Fort Worth facility will reduce our overall cost while significantly improving manufacturing facilities.

During the quarter we were encouraged by the steady improvement at our Lepage operation. We've had team members from around the Company helping with all aspects of the Lepage business and their efforts are paying off as the Lepage team delivers improved results week after week.

We continue to make investments that position us to achieve our long-term growth objectives. During the quarter and in recent months, we made investments in new production capacity, expanded in new markets and introduced new products, all of which is necessary to establish and expand the foundation of our future business.

The introduction of Cobblestone Bread Company is a good example of our ongoing investment for the future. After a successful test market period we are now in the process of introducing this new brand system wide. Our sales and marketing teams are excited about the opportunity to position Cobblestone Bread Company's specialty breads and rolls for growth in segments of the bakery category where we are currently underdeveloped.

No doubt these investments in our future certainly impacted earnings in the short-term. However, we are confident they will help us build value over time.

I believe it's important to look ahead to be certain Flowers Foods has the brands, the products and the bakeries, and most importantly the team in place to continue building our sales and earnings, not just this quarter or this year but for years to come.

Before I turn the call to Steve I want to say that I appreciate the efforts of our team during the quarter. We achieved successful startups of production lines at our Henderson and Knoxville bakeries, our newest production capacity in Modesto and our other bakeries continues to show improvements. Our team members and distributors in new markets also did a great job in growing sales of our branded products.

We have the best and the most experienced team in the industry that is committed to overcoming these near-term challenges while staying focused on achieving our long-term goals. I will now turn the call to Steve Kinsey to give us the financial report. Steve?

Thank you, Allen, and good morning, everyone. As you can see from the results, and as Allen discussed, the quarter was a challenge. Our overall margins were impacted by pressure on the top line and added costs. We did have a nonrecurring item in the quarter as well and (inaudible) and payment related to our Fort Worth tortilla operation which I will discuss more fully in a moment. On the positive side, as Allen said, we are encouraged by the improvements we have made at our Lepage operation during the quarter.

Turning to the quarter's results, sales in the quarter were down 2.3%, a positive net price mix of 0.6% was offset by decreased volume of 2.9%. The slightly positive price mix was driven primarily by a positive mix shift. Overall pricing was down due to promotional activity. Volume declines resulted from printed and store brand cake as well as declines in store branded bread, buns and rolls.

Despite encouraging results in our expansion market, our core market sales were pressured by the reintroduction of -- (technical difficulty) -- Hostess Cake and a strong promotional environment. Our DSD branded retail business had mixed performance. Growth in our branded bread, buns and rolls did not offset declines in branded cake and promotional core markets.

Our expansion markets, representing 5.9% of total DSD sales, performed well and contributed growth of 2.9% to the overall DSD business. Our warehouse business had a 13.3% quarter-over-quarter decline in sales driven primarily by decreases in snack cake and foodservice.

The warehouse branded cake business and the store brand business both continue to be negatively impacted by Hostess Cake brands. Also during the quarter we exited less profitable foodservice business which contributed to the decline in sales for the Warehouse segment.

In total our cake business was down 12%. Our DSD cake business was down approximately 11% and our warehouse cake business was down roughly 13%. As Allen stated however, our share is up 1 share point from just prior to the Hostess exit in the cake market in late 2012. And as a reminder today, in late July we did cycle the re-launch of the competitive brands.

Adjusted for the asset impairment this quarter and the acquisition-related cost incurred last year, adjusted operating earnings, or EBIT, was down 13.3% compared to last year's second quarter. Adjusted EBIT margins were down 100 basis points year-over-year to 8% of sales. A slight increase in gross margin as a percent of sales was more than offset by higher selling, distribution and administrative cost as a percent of sales.

Overall EBIT margins were impacted by lower than planned sales and higher cost. Earnings per share for the quarter of $0.21, adjusted for the asset impairment, were down 12.5% compared to last year's second quarter as adjusted EPS of $0.24.

The acquired facility's carrying cost and additional interest expense to fund the acquisition negatively impacted earnings per share by $0.02 this quarter compared to the prior year. The lower tax rate in the quarter positively affected earnings per share by $0.005 to $0.01 per share.

We did see gross margin improvement quarter over quarter. Gross margin was 47.8% compared to 47.5% in last year's second quarter. The 30 basis point improvement as a percent of sales was driven primarily by lower ingredient cost, lower outside purchases as a percent of sales and a better product mix.

These improvements were partially offset by lower than anticipated revenue, higher costs related to returned product or stales, higher packaging, workforce and utility costs. Carrying costs related to the acquired Hostess facilities reduce gross margin by 30 basis points while start-up costs related to the Knoxville facility, the Henderson bun line and Modesto bread line further reduced gross margin by 20 basis points.

The top line was pressured by volume declines in our cake business, promotional activity in both core and expansion markets and our exit from certain low-margin business. Higher than planned promotional activity significantly impacted the net price during the quarter and led to the overall price declines. Promotional activity also negatively impacted margins.

As Allen stated, we are taking actions to correct promotional activity and expect to see reductions in promotions by the beginning of the fourth quarter.

Costs related to returned product, or what we term as stales, continue to run above historical averages. Driving this increase is this introduction of the acquired brands, new products and accelerated pace for entry into new markets and the overall promotional environment. So focusing on product mix and promotional activity should allow us over time to bring these costs in line with overall expectations.

We incurred $4.5 million of carrying costs during the second quarter associated with the recently acquired Hostess bread assets, negatively impacting EBIT margins by 50 basis points. Approximately $2.5 million of the carrying cost is reported in cost of goods sold and $2 million is reported in depreciation and amortization.

As stated on our Q1 call, we expect that fiscal 2014 carrying costs for the closed facilities to be approximately $22 million. And we did cycle the closing of the Hostess bread asset acquisition early in the third quarter.

During the second quarter we continued to work through integration issues with the Lepage acquisition. As Allen said, we have made great improvement and believe the issues related to integration and SAP conversion are behind us. Compared to last year's second quarter, Lepage's operating earnings before tax was down approximately $4.7 million.

Our focus now is getting results back in line with our expectations for the Lepage acquisition and we are encouraged by what we are seeing now that the issues are behind us.

There remain opportunities to relieve cost pressures that are negatively impacting gross margin. We expect longer-term to see gross margin improve as we sell idle bakeries, improve efficiencies and further leverage sales growth in the expansion markets.

Selling distribution and administrative costs in the quarter were 36.4% of sales compared to adjusted 35.7% of sales in last year's second quarter. The primary driver of this 70 basis point increase was higher distributor discounts as a percent of sales. This increase was not completely offset by a decline in workforce-related costs due to ongoing costs related to market expansion, route conversions and an increased headcount resulting from our growth.

We are in the process, as Allen stated, in exiting the tortilla operation in Fort Worth. The operational impact in the quarter was approximately a $3.3 million pretax loss or $0.01 per share. We also recorded an asset impairment during the quarter for $4.5 million or slightly more than $0.01 per share.

The impairment was a result of the write down of certain equipment and intangibles at this facility. The impairment was driven by shutting down of certain corn tortilla lines and exiting business of certain customers. We do have a signed contract to sell the facility and certain production equipment and anticipate an additional pending or surcharge once the deal closes which we expect will be in the third quarter.

Turning to the balance sheet, cash flow in the quarter was strong. Cash flow provided by operations was a positive $51.1 million and year to date we have paid down $95.9 million of debt, ending the quarter with approximately $826 million in debt. At the end of the quarter our debt to EBITDA ratio based on the trailing 12-month EBITDA was 2.1 times.

During the quarter we also paid dividends of approximately $25 million and funded roughly $21 million in capital expenditures. We continue to focus on debt repayment.

You will see in the Q that we did increase the size of our AR securitizations from $150 million to $200 million at the end of the -- after the end of the quarter. Given the favorable rates associated with this debt instrument, we now have more flexibility to manage our overall debt costs. In the quarter we did not buy any new stock, so we have approximately 8.5 million shares remaining on the current authorization.

Turning to our outlook for 2014. Based on our year-to-date results and looking forward to what we believe continues to be a competitive market in the near term, we are adjusting our 2014 guidance. We now expect a sales range of $3.88 billion to $3.94 billion for revenue growth of 3.5% to 5% over 2013. And expect an adjusted earnings per share range of $0.92 to $0.98 per share, an increase of just above 1% to 7.7% over the prior year adjusted earnings of $0.91 per share.

Competitive pressure, continued investment in our brands and expansion markets, and slightly less than planned tailwinds from commodity costs in the back half are affecting our outlook for the remainder of the year. We also remain very cautious about the overall economic health of the consumer.

Also you should remember that 2014 is a 53-week fiscal year for Flowers. The extra week in 2014 is expected to add 1.8% to sales for the full year.

From an ingredient perspective, if we specifically isolate our last half 2014 flour, we expect to see only modest tailwinds compared to the last half of 2013 and the first half of the year.

It is important to note that wheat future prices have been moving lower; other key variables such as basis and meal feed have moved in a direction that has not been beneficial to flour prices. We expect those two variables to negatively affect our overall net flour cost by continuing to partially offset the benefits of the decline in wheat futures.

In an effort to help mitigate price volatility we are on the long end of our four- to seven-month hedge guidance. We are beginning our 2015 planning efforts so it would be premature today to comment directly on 2015 costs.

Let me close by saying we remain committed to our long-term goals. I have confidence that we can significantly drive stronger margin through better management of promotional activity, reducing costs related to returned product or stales, continuing to drive efficiency improvement and eliminating the majority of the plant carrying costs related to the acquired Hostess facilities.

By focusing on cost reduction and leveraging sales through our brands and market expansion, we should be able to return or improve to our historical margins over time. Thank you for your continued interest in Flowers Foods, and now I will turn the call back to Allen.

Thank you, Steve. Before we take your questions I want to focus your attention on five key reasons why our team has confidence in the future growth of our Company.

First, we have the brands that consumers are looking for. Our Nature's Own brand is the number one brand in the category with three of the top five SKUs nationally. Strong regional brands like Sunbeam and Bunny continue to support our business in the class of white bread sales.

Brands like Tastykake open up new opportunities for us to continue to grow in the snack cake arena. And the acquisition of the acquired brands -- Wonder, Butternut, Merita and HomePride -- all those provide us with added brand strength, especially as we move into new markets.

The second key factor I would like to leave you with is our bakeries. Due to our long-term commitment to capital expenditures, our bakeries set the standard for the industry for manufacturing efficiencies and the highest level of product quality.

The third item is distribution. Flowers' independent distributor program is a competitive advantage that continues to strengthen, especially as we work together to build our branded sales in new markets.

Customers, our trade customers, both retail and foodservice, they are very much aware of the consolidation that is taking place in the bakery category. Customers know how important fresh bakery is for their success and more than ever they are showing consistent support for Flowers Foods.

And finally, the most important factor and the one factor that I want you all to remember is the Flowers team. Our people make the difference. We are blessed with individuals that understand the business and work tirelessly together to achieve our goals.

These are just five of the many reasons why we are confident that we will achieve our long-term goals. We remain enthusiastic about Flowers Foods opportunities to grow in the packaged bread and the cake categories. Thank you for your attention and we will now open the line for your questions.

(Operator Instructions). Farha Aslam, Stephens.

Starting with promotions, given the promotional cadence in the category what gives you confidence in your statement to pull back on the depth and frequency of promotions in the second half and particularly in the fourth quarter?

Farha, I think the category has had a good example of -- all this promotional activity really is not driving the category growth. I think our trade customers realize that better than ever. A lot of activity is taking place within our retail customers from a category management standpoint and they are focused on how can they maximize sales and profitability in their bakery department.

So based on the experience of the past 12 to 24 months we are optimistic that -- from a timing standpoint that, not only from a baker's side but also from the customer's side, the trade customer's side, they will see the benefits of less promotions.

And can you just give us a quick update on the sale of the nine facilities, where they stand?

Farha, this is Steve. When you look at -- we currently have contracts on three or four of those. We anticipate we may be able to close one or two by the end of the year that could roll into the beginning of the next your, but we are working to continue to sell those facilities.

We have sold roughly 11 or so warehouses for net proceeds of just between about $5.5 million this year. Basically no gain related to that because of accounting -- purchase price accounting, you basically set the basis of the proceed price. So we are encouraged that we have the contract on the three or four facilities.

Great. And then my final question relates to both Lepage and the tortilla facility. Steve, you were really good to highlight kind of what the costs of each were in the quarter. Could you just give us a read on what the costs are anticipated to be for each for 2014? And then would we not see those costs in 2015 because these issues will be fixed?

Are you asking when we look at what the negative impact of Leo's has been in 2015 --

Yes, and Lepage.

-- 2014?

Yes.

I mean if you look at the quarter, the roughly $3.3 million negative impact, we will continue to see some cost in the back half as we -- until we sell that facility. And then we have some costs related to moving -- we are moving two of the [flour lines to Flowers'] legacy facility. So there will be some cost with that. Now hopefully as we work through the issues that cost will come out next year. But we do anticipate some cost in the back half of this year.

Sure. But would be the total cost for 2014 roughly?

Roughly in 2014 it is going to be roughly about $5 million to $6 million.

Great. And then for Lepage you highlighted that it cost you about $4.7 million in the quarter. What would you expect it to be for the full year impact?

We looked for the -- over the full year we -- hopefully all the issues are behind us. Coming into the first half it was roughly $6 million or so total cost and then hopefully in the back half it will be mutual for the back half. And hopefully positive as we make improvements.

So overall -- part of the cost at Lepage is we have entered new markets as well. So there is not a quite comparison of apples to apples, so we are continuing to incur some costs there related to the new market, so that is why it has also more time to bring it back up to what you saw at the acquisition.

So between the tortilla and Lepage you expect roughly you could have a $12 million swing in profitability in 2015 versus 2014?

Right, you are right, 2015 versus 2014. Yes, that is a good point.

Great. That is helpful. Thank you.

Eric Katzman, Deutsche Bank.

Let me just start off with kind of the balance sheet cash flow side of things. After a great performance after Hostess's bankruptcy, the Company has struggled a bit over the last let's say nine months, the stock has been really weak.

And yet despite a leverage ratio that is very reasonable and strong free cash flow based on how the Hostess acquisition was done, you only increased the dividend by, what was it, 6%-7%. So why shouldn't investors look to the Company to be more aggressive with the free cash flow to reward them when the income statement side of things is very disappointing?

Eric, this is Steve. We have had strong cash flow for the first half of the year. We did see cash flow drop off some in the second quarter. But philosophically we have always been fairly conservative from a cash flow perspective. Given that debt leverage I think the focus has been on paying down debt.

And you are right, we are comfortable with the leverage ratio where it is today. And from a dividend perspective, specifically as we look at future cash flows and we -- and the Board will make decisions about the appropriate level of the dividend. If we believe cash flow will continue to be strong, and our forecasts are that it continues to be strong, at the right time the Board will raise the dividend appropriately.

Okay. Second, I mean I guess it is hindsight is a little 20/20 of course. But was it a mistake not to go after the Hostess brands, the snack cake side, when it was in bankruptcy and you could have bid on it? Because that seems to be, correct me if I'm wrong, more of the fly in the ointment versus the bread side of things.

Eric, we are very excited about the growth of Tastykake and, as we mentioned on our last call, our focus is building our Tastykake brand. Monday morning quarterback, you can look back, would it have been a good move to buy Hostess Cake? I'm very comfortable with the decision that we made and long-term our DSD structure will help us build Tastykake into a very strong national brand.

So looking back on it no regrets here. Anytime you have a major competitor come back in the market like Hostess Cake there is going to be an impact. I think in our deck we have a nice comparison of a three-year comparison of where we were prior to the Hostess reintroduction.

And also remind us that Hostess Cake built their brand through Direct-Store-Delivery over many, many years. And that is exactly what we're doing with Tastykake, building our brand on our DSD route. So very optimistic about the future of Tastykake.

Okay, last question. Obviously what we're seeing today with the promotion is pretty broad-based across the industry. You mentioned it is pretty ineffective. So a lot of other companies are taking that reality and announcing restructuring to cut cost to have more firepower to deal with the promotion.

I guess the history of this category is that when things go bad in promotion they have lasted a lot longer than you have hoped for and forecast. So kind of following up on Farha's comments, it seems like investors are doubting that the promotion is going to turn around for the better. So what are you doing to reduce cost to give you the firepower in the market to compete unfortunately on a price basis?

Eric, we are looking at all elements of cost and if you go back and look at the amount of growth we've had over the past three years, obviously we have added cost in many different areas. Now is the time we've got our team focused on simplifying our offense, making sure we look at every part of the operation to eliminate excessive costs.

At the same time we've got to take significant actions where there are problems. And the manufacturing efficiencies that presented the problem at Leo's required action and we have taken action there. The issues that have been -- that were evident at Lepage required action, we have taken action there as well.

But the team is very much focused on making sure that our costs stay in line and that we -- at the same time that we have the foundation to continue building this Company for the future. So there is very much of a short-term need to tighten our belts. But at the same time we're extremely optimistic about growth in the future.

Okay, thanks. I will pass it on.

Sarah Burns, Findlay Park.

Just a couple of questions. Firstly, the promotional environment. Is it in your existing markets or is a predominantly in the new markets that you are taking share that you are seeing the most aggressive stances?

The promotional activity that I mentioned is really companywide. Some markets are a little hotter than others. But overall the level of promotional activity is higher than we would like to see.

Okay. And secondly, I am surprised it is so intense given the sort of industry consolidation we've seen over the last couple of years. Back to Farha's question, what gives you the confidence that people are going to step away from the brink in the back half?

You are exactly right, consolidation in the industry, the categories should become more rational. Eventually we feel that we will see that. We are hopeful that it happens in the back half. We are focused on making sure that we don't have excessive promotional activity and that the promotions that we are running are effective.

One of the -- I think one of the learnings in this category, and I mentioned our retail customers early, with the perishable product that has a six- or seven-day shelf life pantry loading really isn't an option. So if you are from a supermarket standpoint, if you have excessive promotional activities, consumers are not going to load the pantry with loaves fresh bread.

So this is a category that has some unique characteristics. And I'm really optimistic as retailers focus more on category management they have a better understanding that price promotion to an excessive degree is not good for anyone here.

Actually the shift from store to branded was actually promising on that front during the quarter.

There were two elements that impacted our private label sales. Number one, the excessive brand activity on promotions pulled some volume from private label. And also we elected to walk away from some unprofitable private label during the quarter as well.

Okay. And any chance of you quantifying what you walked away from on the unprofitable -- on the sales line?

Steve, I don't think we --.

Sarah, I don't think we would disclose that publicly.

Okay fine. Back to a following from Farha's questions. Given the fact that you probably absorbed close to $12 million this year on Lepage and tortilla -- and Dallas-Fort Worth tortilla plant. I am surprised that you sort of -- as we look into early 2015 that you haven't got greater visibility, that you still have to be cutting guidance which I thought was pretty achievable for the full 2014.

But at the same time you are actually saying that the promotion -- we think the promotional outlook will get better. It just seems to be a conflicting statement.

When you look at the outlook for 2014 I think the impact on the first half, we did miss our internal projections on the second quarter. And it will take some time, as Allen said, to get -- to change the promotional cadence for Flowers coming in the fourth quarter. So the impact of that is still to be seen in the third quarter.

And quite honestly the impact of that in the fourth quarter, once we change that cadence does it affect our volumes? We don't think it will significantly impact that, but there is a risk there as well. So that really was driving a lot of the change in the outlook for 2014.

And finally one last question. I think it was in the last quarter you expected your sort of productivity measures to sort of normalize in the fourth quarter of this year, sort of 93, 94. Is that now being pushed back by a couple of quarters?

We're still seeing good progress from an efficiency standpoint and we were actually up this quarter compared to last quarter about 100 basis points or so.

So you feel you are still on track to achieve your sort of -- that metric for the end of the year?

Yes, I think -- yes, because when you look at the efficiency ratio there is really five or six plants that are affecting that, Leo's was one of those. And now we believe we have taken care of that situation. And now we are working on the other three or four from trying to raise their overall efficiency, which we think will be achievable by the -- into the back half.

Okay. I will jump back in. Thanks for your time, guys.

Bill Chappell, SunTrust.

Can we go back to the cake business? I'm just trying to understand your optimism and what happened intraquarter. Because I understand you still have the 6.7% share, but if we are doing the math right it sounds like you lost 25% of your share over the past -- over the first half of the year which is pretty meaningful especially going against a fragmented industry.

So trying to understand like what gets you back on track. Did you actually get kicked out of certain relationships by Hostess? Or is it just consumer take away due to promotions is what is hurting the share?

Bill, the cake category is very much of an impulse driven category. And with the news of Hostess' reintroduction to the marketplace, they have done a good job getting off right displays. And most of the cake is sold on off right displays, certainly the incremental cake. And in most supermarkets there is only going to be one, possibly two off right displays of cake.

So with the Hostess reintroduction, our Tastykake brand, and also our Mrs. Freshley's brand, was really not included on display as often as we would have liked.

From a pricing standpoint there really is not a pricing problem in the cake category. It is really a function of the news of Hostess' reintroduction to the marketplace and how that affects displays and presence in the supermarkets.

We are very confident. Our independent distributors, they are excited about selling the Tastykake brand. We've got several new items that we continue to introduce new items under Tastykake to keep the brand alive and well. And we are working very hard to regain the off [rack] displays that are very important in this category.

So it is really a function of the news of Hostess coming back. They did a good job getting distribution. And now I think our strength -- our DSD strength over the long term will prove out.

I'm sorry, I'm missing something. Hostess, the launch happened a year ago. But something happened -- seemed to happen this quarter that did make it worse than your expectations. So I'm just trying to -- help me understand near term what happened. And then along the same lines do you need to turn on advertising? Do you need to step up something to make it more of a national brand like Hostess is?

Bill, the real change this past quarter is that they expanded distribution in probably more channels than what we've seen in the past. So in addition to supermarkets, the mass merchandisers and also there is some expansion from Hostess into the convenience store channel. So more than anything else looking back at last quarter it was more of an increase in distribution from their standpoint.

And just on the subject, does that mean Hostess is going DSD now if they are going to the convenience store channel?

No. No, they are going to market through warehouse distribution. In the convenience store channel they have various different structures in place depending on the geography and the accounts. But again, to my knowledge they are not expanding with the traditional DSD as we have.

Okay, and then switching to just the bread business. I mean should we look at the branded versus store brand as simply Wonder is back on the shelf and it's just taking share or cannibalizing your existing share on the white and then store brands? Or is there something incremental and your kind of I guess legacy markets?

The excessive promotional activity that we mentioned, a great deal of that was in the white bread category, private label is dominated by white bread more so than soft variety and buns. During the quarter there was again a lot of activity in the promotional area on the branded side. And also there were some private label bids that came up that we decided that were not profitable for us.

And we made the decision to walk away from some existing private-label business. So it was kind of the combination of the amount of branded promotion impacted private-label. And then also our decision to walk away from several private-label accounts because they were unprofitable also impacted our private-label number.

Okay. And then the last one for me. Going back to Eric's question. I think I'm right in saying that typically the annual dividend payout is only addressed each May. So, Steve, are you saying we are waiting -- the Board is basically taking a pass and waiting until next year before they do anything with the cash, both dividend and share repurchase? Or would you look to take advantage of what will be a more depressed stock this morning?

We meet -- each quarter we do discuss the dividend. Traditionally we have raised it in May. So the Board will meet in the next week or so on our regularly scheduled meeting. And at that meeting they will address it and do whatever they think is appropriate.

Okay, I will turn it over.

Akshay Jagdale, KeyBanc.

So, Steve, my question is about the guidance. So can you just talk about the sales guidance specifically? Based on my math it implies that the back half organic growth overall for the Company needs to be around 3% to 5%, which would be an acceleration from down 1% so far this year. So one, is that correct?

And secondly, if that's correct what are the factors that are driving the acceleration? And then secondly, maybe another way to approach it is can you talk a little bit about the reduction in the guidance on the top line? How much of that has to do with what's actually already happened versus your expectations for the back half?

Sure, when you look at the back half -- I mean, your 3% to 5% is right, but you need to remember that week 53 adds about 1.8% to 2% to the total.

Well, I am excluding that. If I exclude that it is still 3% to 5%.

Yes, so I mean we are assuming some acceleration in the back half. As Allen said, if we get the promotional activity under control for the fourth quarter we should see a lift there as well. So I would say your calculations are in line with how we are looking at the back half.

So how much of the -- can you talk about how much of the -- how are we going to go from negative 1 organic growth to plus 4, which is in the middle of your guidance? I mean what are the driving factors? Because I think most people are not going to assume that the promotional activity is going to abate and all of a sudden be successful.

So can you give us sort of a bridge from where we are today to this back half guidance? I mean, how much of that is promotions in your numbers, how much is sort of base business picking up, however you want to help us there?

Sure. I mean one thing is we have cycled the cake re-launch, so we do -- that comp should come back in line hopefully and we should not see as much loss on the cake business in the back half.

And then from the new branch perspective, as Allen mentioned, we are seeing a pretty strong cadence in expansion markets with the new brands. So we are expecting more lift in the back half from the Hostess brands. And as I said earlier on week 53, so --.

And then hopefully the promotional cadence will improve. So that is kind of -- those are kind of the buckets if you look at where we are expecting to lift in the back half.

Okay. And then just if you take a step back, I mean you guys have been focused on obviously growing the top line quite a bit. Prior to the Hostess acquisition obviously the operational performance had been very good. And more recently you've had a lot of growing pains.

So wouldn't you say this is the time to maybe to take a step back and deliver on the margins and get that part of the equation right before you start to step back on the pedal? I mean your SG&A leverage, which had been a hallmark of the Company for decades is -- we are not seeing that because you're investing in future growth. But perhaps we should -- have you considered taking a step back on those investments to get the margins back on track and then start to reinvest?

Akshay, the terms -- I'm not sure the term step back is accurate. But we are very focused on really settling the operation. You are exactly right, the last 2.5, 3 years have been extremely busy with category consolidation. We feel that we have made the right decisions in the past to grow the Company.

And now we are focused on really settling down the operation, building our market share especially in new markets, and continuing to build our business over the long term. We are focused on every area of cost to make sure that as we've gone through this growth period we are not carrying any costs that we don't need to. And at the same time we are focused on building on our strengths, which is our Direct-Store-Delivery system.

So stepping back is not the right description, but we are settling down the rate of growth that we've had over the last three years. And we are very optimistic that continued growth is right in front of us for all of the reasons that I mentioned earlier.

And, Steve, can you give us an update on the gross margin guidance? So where, I believe previously, correct me if I am wrong, but you had said you were going to expect a level of gross margin expansion. Where are with your expectations on gross margins for the year?

When you look at the full year we are still forecasting gross margin to be up slightly, roughly probably 40 to 60 basis points.

Okay. And just one last one. When I look at your business, your DST business specifically, I mean this quarter I think you had like pretty much negative incremental gross margin. Can you just talk maybe broadly of the weakness you are seeing generally relative to your guidance on margins, how much of it is controllable do you think internally versus industry issues such as category weakness or promotional pressures?

Akshay, when you look at the quarter kind of and actually look at the year and what we've been seeing, and we've talked about this quite a bit, is the ramp up and stale or returned product. There is significant cost associated with that product. And through our thrift store system the recovery is not sufficient to offset that.

So just in Q2 alone and that with a couple million dollars over last year's second quarter. So that is a significant bucket of cost that we are very focused on and we have an opportunity to improve.

Now what has been driving that increase has been the accelerated expansion in new markets because our brands are not -- are still trying to get traction in the new markets. The promotional activity causes a mix shift among brands because people are really sifting based on price sometimes and, as Allen said, hasn't been very efficient. So that is driving the stale increase.

So -- and the new products, we had the re-launch -- we had the new product Cobblestone Bread Company that we introduced in the second quarter. As that is gaining traction we are seeing a high stale rate or returned product costs there. So that one item alone could be a significant driver on margin over time.

We didn't get here overnight and we won't fix it in a quarter or two. It is a longer-term fix, but it is definitely one of the major items that could drive improvement from a margin perspective. And in the quarter we had extra costs related to start up. And as we are bringing these plants back online we will have that cost over the next two or three years. But again, we will try to manage that as best as possible.

And then the extra -- costs related to ex-promotions in the quarter were significant compared to last year. And then now that we've hopefully ironed out the tortilla issue and we have really made great progress on Lepage and begin to see that turn, getting that one operation back in line with where it was when we acquired it will again be another huge bucket that goes a long way to improving margin.

So maybe is this a good characterization to think of sort of the base business? Margins are suffering from some industry issues, which include higher promotional activity. But more importantly your expansion margins are much lower than the base business today because it is a different type of expansion than you've had in the past, right.

So can you -- if that is correct can you give us a sense of sort of in these expansion markets how much lower are your margins today and I am guessing that is something you can control and bring back to your Company average over time or relatively quickly.

Akshay, each expansion market is different. But you are correct, as you enter a new market with new cost it takes a period of time for your brands to grow. And each of our expansion markets, we look at individual expansion markets on a weekly basis and measure our improvement week over week. But it is all about making sure that the cost structure is in line with our sales and that we are growing the top-line sales in each one of these expansion markets.

The good news is that with the acquisition of the acquired brands like Wonder and Butternut and others it helps us accelerate that improvement timeline in new markets. But you are right, we expect margins to be lower as you enter new markets. Each market is different though.

Akshay, I think your characterization of kind of issue is right on. And when you look at expansion markets, in some markets it could be as much as half of our normal margin, so it is pretty significant.

Okay, great. I will pass it on.

Brett Hundley, BB&T Capital Markets.

Good morning, guys, this is actually Omar filling in for Brad. Actually most of my questions have been answered by now, but I just had a quick one on warehouse margins, they were stronger than expected. Do you guys think that anything has structurally changed within the segment? Given the improvement going forward is it actually sustainable? Can you guys provide a little bit of color over that?

I mean overall when you look at warehouse margins, we did exit some very unprofitable business and that really was the main driver of margin improvement there.

So mostly it was just from the exit and the reduced cost from those operations.

Correct. Primarily on the foodservice side of the business.

Okay. And overall on the bread category conditions, do they worry you guys? I just want to just get a little bit of -- if you guys could talk a little bit about the difference that you are seeing across retail and foodservices, from a big picture standpoint.

Yes, the category is actually flat to up slightly. We mentioned earlier there are many food categories that are trending down significantly. So I think the fact that the overall category is flat to slightly up is positive.

We are very optimistic. Again, it is a $31 billion category. The rate of consolidation, as we have seen, continues to accelerate. And we feel that Flowers is in a very good position as a strong number two to continue to grow.

So there also segments of the category that offer opportunity to Flowers and our Cobblestone Bread Company is a new brand that has been developed to help us grow our business in those underdeveloped segments of the market.

So the promotional activity that we have mentioned this past quarter and really past year to 18 months, we do feel over time that the promotional activity is going to be reduced. And that is probably going to be driven as much by the retail trade as anything. So very optimistic about the health of the category and we are excited about the opportunity for our Company as consolidation continues.

That is very helpful, guys. Thanks for taking my call.

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

Steve, $4.7 million EBIT impact from Lepage, do you have a sales number as well, what kind of sales downfall will we have in that business or have you fully recovered sales now?

From a sales perspective I think they are tracking about in-line where they were. But that is on the total region and we have entered some new markets. So I would say the base business is probably off slightly.

Okay, so okay. So not a whole lot of delta between where we are in 2014 versus 2015 on the sales line from that business? Other than the first (multiple speakers).

Yes. There is not much change there.

Okay. And then the Hostess expansion into Walmart, can you talk about that a little bit? Now that you have a little bit more time to look at trends, are we fully in all Walmarts? Are sales tracking in line with expectations?

Yes, we are -- the brands that we acquired, Wonder, Merita, HomePride and others, we do now have distribution in Walmart. We are in the [mods] on rack within their bakery department. And we are getting quite a bit of support from a display standpoint. So even though that was a -- we were slow putting that together, we have now completed and have full distribution on the acquired brands.

Now on the -- are you in the main bread aisles yet or is that shelf reset still to happen later in the year?

You are in the set.

That is correct. We are in line on the bread rack in the bakery department. So we have overcome that hurdle.

Okay. Quickly on Cobblestone, what should we model for in terms of expectations or contribution to the top line in 2015 or thereafter?

Steve, we really haven't projected that number publicly at this point. We are very early in the process. We ran about a three-month test period and we are currently in the process of expanding this brand into really across our DSD footprint.

And we are excited because many of the categories the Cobblestone Bread Company addresses are categories where we are underdeveloped. And we'll be -- probably on our next call we will develop more insight into what we expect out of Cobblestone Bread Company.

That would be helpful. Just two more quick ones for me. And as you think about the promotional, one more question on that. You expect it to moderate in the fourth quarter, but if your competitors do not follow your logic are you prepared to go solo on that and scale back your promotion even if the category continues to be promotional? Or would you stay at these levels to protect share in that case?

Obviously we have no idea of what the market reaction is going to be to our actions. And what we have got to do is focus on our business and growing our top line and hitting our earnings number. We feel that we can do that with less promotional activity than we have today. If the marketplace follows that is fine, if they don't, fine. We are going to continue with the direction that we have laid out.

We are focused on strong brands, making sure we have the best product quality in the marketplace. And our independent distributors are extremely aggressive and making sure that we have off rack displays to drive that top line is very important. So really can't predict what the marketplace reaction will be to our reduction in promotional activity. But that is our plan and we are very confident that we can make it work.

Got it. And then one final one on M&A. And you talked about open to being more -- in doing more acquisition. At this point looking what is happening in the snack cake aisle and looking how Tasty has sort of slowed down a little bit from really strong growth last year or earlier this year. Is that an area where you will look to bulk up the portfolio a little bit or is it still focused mainly on consolidation in the fresh bread category?

Your question is about acquisitions in the cake category?

Yes, whether it makes sense to bulk up that portfolio or are you still going to continue to focus on consolidating the fresh bread side of the business?

We will look at opportunities as they are presented. Obviously we have a lot of growth opportunity and we have said it in multiple situations, the hostess acquisition is a multi-year roll out. We have bakeries that are idle today that we own that can be recommissioned as we continue to grow in new markets. If the right cake opportunities come along we will certainly take a look. But I would say that is not our top priority right now.

Got it. Thank you.

We have no further questions at this time. I would like to turn the call back to Mr. Allen Shiver for closing remarks.

Thank you so much for your attention. Thank you -- hopefully you hear a voice of confidence from our team. And looking forward we are confident. We have the brands, we have the bakeries and most importantly we have the most experienced team in the industry to get the job done. Thank you for your attention this morning, this will conclude our call.

Thank you. Ladies and gentlemen, this concludes the Flowers Foods' second-quarter 2014 earnings call and webcast. Thank you for participating. You may now disconnect.