Flowers Foods Inc (FLO) 2016 Q4 法說會逐字稿

Welcome to the Flowers Foods fourth-quarter and full-year 2016 earnings conference 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 J.T. Rieck, Vice President, Investor Relations.

Thank you, Ellen, and good morning, everyone. Our fourth-quarter results were released yesterday evening and you will find the earnings release on the Flowers Foods website. You can find the slide presentation that supports our discussion for today posted on the conference call page in the investors' center at FlowersFoods.com. We are on track to file our 10-K on February 22.

Before we begin, please be aware that our presentation today may include forward-looking statements about our company's performance. Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters we will discuss during the call, important factors relating to Flowers Foods' business are fully detailed in our SEC filings.

Now let's get started. Participating on our call today we have Allen Shiver, Flowers Foods' President and Chief Executive Officer, and Steve Kinsey, our Executive Vice President and Chief Financial Officer.

Now Allen, I'll turn the call over to you.

Thank you, J.T., and good morning, everyone. Thank you for joining us on the call to discuss our fourth-quarter and our full-year 2016 results and our progress with Project Centennial.

I'll start off with the top-line review as well as report on trends in the category. Then Steve Kinsey, our CFO, will provide details on our financial performance. In the second part of our call, we will give a progress report on Project Centennial. After our prepared remarks we will take your questions.

Turning to the summary results on slide 4. As a reminder we cycle the Dave's Killer Bread acquisition during the third quarter and the Alpine acquisition at the beginning of quarter four. Sales during the quarter increased 1.2% and 3.9% for the year, driven by DKB and growth of store-branded and foodservice sales.

Soft variety sales were down, but volumes did show improvement in the fourth quarter as our promotional activity normalized. Overall, the marketplace remains competitive. In the first half of the year we reduced promotional activity, but our core brand volumes suffered due to the competitive environment. In the third and fourth quarter we brought our promotion more in line with the category and volume trends have improved.

GAAP earnings per share for the quarter was $0.06 and $0.78 for the year. Adjusted earnings per share for the quarter was $0.16 and $0.91 for the year. Our results for the fourth quarter were in line with our revised guidance, but they do not reflect what we believe to be the real earnings power of Flowers Foods.

Last quarter I mentioned our commitment to delivering better results and in the fourth quarter, our team made good progress. We took findings from the diagnostic phase of Project Centennial, crafted strategic initiatives to transform Flowers Foods into a growing national brands company, and took initial steps during quarter four to set these initiatives in motion.

During the quarter we also reduced costs through improved planning to trim overtime hours, spent less on supplies and travel, and increased bakery throughput. We are just getting started and I thank the team for their drive to deliver improving results.

Now let's turn to the fresh packaged breads category trends on slide 5. The overall bread category trends improved modestly in the fourth quarter. Category dollars were up 0.3%. Pricing and mix shifts offset unit declines of 0.3%.

Store brands continued to lose category share and this quarter marked the 11th straight decline in store-brand dollar share of the category. Flowers gained 0.3 share points relative to the fourth quarter last year. This was driven by the growth of DKB in specialty premium, as well as strong performance in the sandwich, bun, and roll category.

On slide 6 we have the cake category trends. In the fourth quarter, the commercial cake category was up 2.2% in dollars and 0.9% in units. Flowers lost 0.6 share points, primarily due to stiff competition against Mrs. Freshley's in the warehouse channel.

A few comments on our organic brands. As shown on slide 8, while the total fresh bread category has been soft, the overall market for organic breads continues to grow. We have benefited from our move into organic breads with the acquisition of DKB and Alpine in fiscal 2015. Our share of the segment continues to increase.

When we announced the DKB acquisition, we targeted sales of $160 million to $170 million in fiscal 2016. I am pleased to report we have delivered above the top end of our range.

Admittedly, Alpine is off to a slower start. We had targeted $85 million to $95 million in sales for 2016 and fell short of that goal, primarily because we underestimated how long it would take to generate growth outside of the retail bread aisle. We are committed to growing our sales in other areas of the store and we are working to build strong retail relationships that will grow the Alpine brand.

We made good progress during 2016 integrating DKB and Alpine into Flowers. The investments we have made to expand our organic production capabilities are paying off. The conversion of our Tuscaloosa bakery to an organic facility, combined with capacity increases at both DKB and Alpine bakeries, allowed us to bring production in-house, improve freshness, and lower cost. As a result, we achieved our margin targets.

Organics are growing and we are focused on making sure we are capturing the opportunity. Looking ahead, we have a lot of exciting things in store for both DKB and Alpine and our focus is on making sure we execute and build these brands for the long term.

Now let's have Steve review the financials.

Good morning and thank you, Allen. Our fourth-quarter sales of $868.7 million increased 1.2% versus last year, driven by volume increases of 1.1% and a positive price mix of about 0.1%. Volume came primarily from DKB as well as store branded and foodservice business.

GAAP earnings per share for the quarter was $0.06 per share, or down $0.09 from the year ago. The adjusted EPS for the quarter was $0.16, equal to the prior year. Our earnings per share reflects several changes affecting comparability, namely legal sentiments, asset and trademark impairments, and settlements made in connection with our pension derisking strategy. Collectively, these items impacted earnings per share by approximately $0.10 per share. In the prior-year quarter, adjusted EPS excluded $0.01 per share relating to asset impairments and acquisition-related costs.

A little more detail on the items affecting comparability in the quarter. The legal settlement relates to an agreement reached to resolve litigation in the Rehberg matter. The parties are currently awaiting final approval of the settlement from the courts.

The asset impairment is due to the divestiture in the fourth quarter of certain idle assets and assets held for sale. By selling these assets, we reduced ongoing carrying costs by approximately $3 million to $4 million per year.

The trademark impairments are primarily the result of a brand rationalization initiative that began as part of Project Centennial. Given recent performance and the forecasted performance of certain brands as a result of the proposed rationalization, the performance of these brands changed and, therefore, resulted in an impairment.

GAAP net income for the quarter decreased 59.6% to $13 million. Adjusted net income for the quarter of $34.1 million increased 0.5%. Consolidated adjusted EBITDA for the quarter increased 1.2% to $87.7 million. The adjusted EBITDA margin was 10.1% of sales, equal to the fourth quarter a year ago.

Project Centennial-related costs in the fourth quarter were approximately $3.8 million, or $0.01 per share. Carrying costs associated with the acquired Hostess bakeries were $2 million in the fourth quarter, as compared to $2.3 million a year ago.

Depreciation and amortization charges for the quarter were $32.3 million, in line with the prior year. Amortization expense was $5.5 million. Adjusting for matters affecting comparability, the tax rate for the quarter was 33.8%, a decrease of 170 basis points compared to the fourth-quarter 2015 adjusted tax rate of 35.5%. The primary reason for the decline are certain discrete items and the Section 199 deduction.

Cash flow from operations was $62.8 million compared to $40.9 million in the prior-year quarter. The change is primarily due to changes in working capital and deferred income taxes. We ended the quarter with $958.2 million of debt. Our covered debt to trailing 12-month adjusted EBITDA is 2.1 times.

Now I'll pass the call back to Allen.

Thank you, Steve. Before we dig into Project Centennial, I want to remind you why we launched this initiative. To put it in simple terms, we are not satisfied with our results over the past few years. Let me repeat that: Our team is not satisfied with results of the past few years. The time has come for us to take Flowers Foods to the next level and do so quickly.

Project Centennial has revealed exciting opportunities for us to build on our key strengths. The goal of Project Centennial is to transform Flowers Foods. We want to attain the position and capability of a growth-oriented company and the efficiencies of a value company so that we can deliver top-tier shareholder returns.

We achieved this by building on our strengths, operating more efficiently, and delivering our national reach. The first step in this transformation was a comprehensive diagnostic examination of every aspect of the business. Nothing was off the table or out of scope.

We invested over six months in the process. We asked questions, we listened carefully, and we didn't shy away from difficult discussions or decisions. This phase is now over and we have a clear understanding of what factors have slowed our growth and what we need to do to dramatically improve our performance.

Three main factors have been impacting our business. First, the ongoing competitive market environment; second, evolving consumer preferences and a slowdown in the category; and third, operational complexity, which has impacted margin expansion. Through Project Centennial we have a roadmap to address each of these issues.

Our Centennial growth plan is based on two key takeaways from our comprehensive diagnostics. First, we must pivot Flowers toward the consumer. This means shifting our focus from growth by geographic expansion to grow through brands. We have an incredible portfolio of strong, trusted brands that will form the core of our growth platform: Nature's Own, Wonder, Dave's Killer Bread, and Tastykake.

The consumer is now our primary focus. While we have always paid close attention to consumer trends, we often did not capitalize on them. That will change. We will be investing in greater product innovation and marketing to keep our brands fresh and relevant to consumers.

Second, we must transition to a simpler operating model that is not only an improved margin structure, but also the resources to support profitable growth of our brands. So how will we unleash the potential of our brands and deliver value? Our plan follows four strategic initiatives: number one, reinvigorate our core business; number two, grow product adjacencies; three, reduce cost to fuel our growth; and four, invest in and develop leading capabilities. I want to walk you through each in more detail now.

Our first strategic initiative: reinvigorating our core business, focus on supporting our brands, and supporting distributors. Regarding our brands, we are implementing an improved assortment that better aligns our brands with their target consumers. We are also strengthening our trade promotion capabilities.

A more focused brand strategy will drive effective and relevant product innovation and realize a greater return on our investment in trade promotion and advertising dollars. Decades of bolt-on acquisitions have left us with a complicated portfolio of brands and SKUs. We have already begun work to streamline our brands and SKUs so that we can focus on those that are the strongest or have the greatest potential. As an added bonus, this action also increases runtimes and improves manufacturing efficiencies.

When it comes to our independent distributors, we can do more to support them in growing their business, thereby growing ours. This support will include improving distributors' ordering platforms, increasing the use of data and analytics, and promoting a free exchange of insights and best practices. In short, by taking these actions to reinvigorate our core, we are confident we will achieve our long-term goal of 2% to 4% compounded sales growth from our existing footprint over the next three to five years.

Our second initiative, capitalizing on product adjacencies, addresses changes in consumer behavior, where they eat, and how they shop. As a result of changing consumer needs and wants there are growing bakery segments that Flowers can capitalize on such as foodservice, in-store bakery, impulse items, and healthy snacking.

Targeting foodservice just makes sense, especially since today's consumer is eating out more. Our company already is the number one provider of foodservice bakery products. We believe we can leverage our foodservice experience toward higher-margin products with a point of difference. Unique specialty items are just as popular with consumers in the grocery aisle and we will translate our foodservice innovation to the retail sector.

Finally, we are going to look in adjacent product categories, such as healthy snacks, for new growth opportunities. We have been aware of potential in other categories for some time and have now developed strategies to heighten our investments and attention to these adjacent growth opportunities.

In looking at these first two initiatives, our primary objectives are to reinvigorate our core business and reduce costs in the short term. The next two initiatives that Steve will discuss will support profitable long-term growth. Steve?

Thanks, Allen. Clearly reducing cost is the key to fueling our growth plan, as well as driving margin expansion. We will accomplish this by reducing the complexity of our operating model and better leveraging our national footprint. Simply put, by reducing costs we gain the funds to build brands, make acquisitions, and return cash to shareholders.

Delivering on this initiative is job number one for the entire Flowers team. We are targeting at least 250 basis points of net EBITDA margin improvement by fiscal 2021. We can realize this by expanding our shared services philosophy, simplifying our operations, and creating an operating model that better fits our geographic reach. Work is already underway to achieve our long-term EBITDA margin goals.

In the fourth quarter, as Allen mentioned, we did focus on a few small initiatives and saved approximately $0.01 per share. That was a good start, but there is still much to do. In the near term, we have identified at least $45 million of run rate savings we can achieve by fiscal 2018, primarily this will be through increased cost discipline and purchased goods and services, just one of the buckets of opportunity identified in the project.

The systems and teams are already being put in place to make this happen. We have also begun the work to implement continuous improvement processes, expand on our shared services organization, and optimize logistics in our overall network. Each of these contributes to an improved operating model and serves our long-term margin goals.

In addition to realizing savings by reducing our indirect spend, to achieve sustainable cost savings and margin expansion, we need to enhance our capabilities and become a more centralized and analytics-focused company. Doing so requires strategic investment or redirecting resources to upgrade our technology, enhance our financial planning and analysis capabilities, and redesign our performance management system for greater accountability and responsibility.

Clearly there is a lot to be done and we are committed to delivering on the strategic objectives we've outlined today. Before I turn the call back to Allen I want to share a preliminary roadmap for implementing Project Centennial.

While there are many aspects to this project, we view it generally as two phases. In fiscal 2017 and 2018 we will focus on transformation: optimizing our brands, reducing costs, and creating a more streamlined operating model. As I said earlier, we have already begun work on these initiatives.

During this phase we anticipate top-line growth to be approximately flat to up 2% and EBITDA margins of approximately 12% to 13%. Once we have strengthened the organization, in 2019 and beyond, with a more efficient organization, we anticipate our actions to reinvigorate the core and grow product adjacencies that will begin to deliver on the top line, driving sales growth between 3% to 4% and EBITDA margins of roughly 13% to 14%.

We believe that by achieving these financial goals we can become a company that is capable of delivering high single-digit EPS, cash to shareholders through dividends and opportunistic share repurchases, and solid total returns to the shareholder over the long term.

Turning to the outlook for fiscal 2017, reflecting overall category trends, for fiscal 2017 we are anticipating sales to be flat to up 2%. We are forecasting adjusted EPS in the range of $0.85 to $0.95 per share. Excluding Project Centennial, costs currently expected to be in the range of $25 million to $30 million, or approximately $0.07 to $0.09 per share.

Our earnings-per-share outlook reflects higher workforce-related costs, offset by only slight input cost deflation. We also anticipate increased expenses from depreciation and amortization and interest in 2017. A great deal of the work will be done in 2017 to reduce complexity and strengthen capabilities and we expect to realize net benefits from these actions in fiscal 2018. Costs associated with these efforts are anticipated to be weighted to the first half of 2017, while the majority of benefits are expected to be realized in fiscal 2018.

There are a couple of other factors affecting 2017 results to keep in mind. First, in January 2017 we completed the sale of our mix business. As a result of the sale, we expect to recognize a gain in the range of $31 million to $33 million, or approximately $0.09 to $0.10 per share. Our guidance is presented on an adjusted basis and excludes this gain.

Second, as a result of changes in accounting rules for stock-based compensation and the impact on the federal tax rate, we anticipate our tax rate in the first quarter of fiscal 2017 to be approximately 39.5%. However, for the full year this should level out and we are forecasting our tax rate to be approximately 35.5%.

Finally, for fiscal 2017 we are expecting depreciation and amortization to be in the range of approximately $145 million to $150 million and net interest expense of roughly $17 million to $18 million. Shares outstanding are forecasted to be approximately 211 million.

We continue to expect solid cash flows in 2017 with capital expenditures forecasted to be in the range of $95 million to $105 million. This will result in strong free cash flow conversion to support Project Centennial, debt reduction, dividends, and opportunistic share repurchases.

Now I will turn the call back to Allen.

Thank you, Steve. We are confident that we are on a path to better growth and profitability. We have developed a powerful set of efficiencies and growth strategies and our Board of Directors and team are unwavering in their commitment to see them through.

My commitment is just as firm; however, the results will not be immediate. A transformation like this takes time, careful execution, and substantial investment. We are fundamentally changing the way we approach our business because the world around us has changed.

While we are acting with urgency to affect these changes and improve results, we will be methodical in our approach and follow the structure and the processes we have developed. We believe our long-term shareholders will be rewarded with ownership in a truly best-in-class operation that delivers superior results.

Flowers is a company that is committed to excellence. With Project Centennial we are doing everything we can to maximize the potential of our brands, provide opportunities for our team, and deliver enhanced value for our shareholders.

Thank you for your time. Let's begin the Q&A.

(Operator Instructions) Farha Aslam, Stephens Incorporated.

Good morning. Allen, could you share with us a little more color on the Project Centennial brand rationalization and top-line growth: what brands are now your key focus, what brands are you rationalizing, and some details on the algorithms of that kind of accelerated growth in 2019 and beyond?

Farha, as I mentioned earlier, as we have grown over the years we've accumulated a lot of brands that have contributed to our company over time. I mentioned our primary brands: Wonder, Nature's Own, Dave's Killer Bread, Tastykake. I mentioned our primary brands earlier and as we move forward, they will continue to be our primary focus.

Although as we look at certain regions of the country, there are specific brands that have unique regional demand that we will be very careful in making any changes there. So as far as our brand focus, it is the brands that we mentioned earlier, but also we will be evaluating very carefully strong regional brand before we make any quick decisions.

And then the details on how that 2019 and beyond -- is that really driven by volume, pricing, new category adjacencies? Just some color around what gives you confidence that you are going to be able to accelerate growth 2019 and beyond.

This evaluation has been very revealing, especially in terms of the opportunities in our core markets that we are currently not taking advantage of. It is truly an enterprise evaluation from one extreme to the other, looking at all elements of our business.

The marketing investments that we have made in the past have helped us build a great variety of strong brands. What I am excited about is the savings that we are going to be generating with Project Centennial will allow us to reinvest a significant portion of those savings back into building our brands at a much higher level than what we have done in the past. That is exactly what we need to be doing at this point to grow the top line.

My final question is perhaps for Steve. On that $45 million of cost savings, does that all fall to the bottom line? How much would be reinvested? What's the total savings that you anticipate out of Project Centennial and how much do you expect to be reinvested and how much to come to the bottom line?

Sure. When you look at the $45 million that basically represents purchased goods and services and we are anticipating at least a $45 million savings from that particular work stream. So when you look at the Company we have done a good job in the past looking at our direct spend and we've kept a good focus on that. Our indirect spend has been more decentralized, but through the project now we will take a more centralized philosophy on how we bid that spend out and we feel like we can generate at least a $45 million savings opportunity.

That should happen early on in the project; that would be 2017, 2018, so I would anticipate a portion of that will drop to the bottom line. But we will begin in 2018 start investing back in the business, so some of that margin opportunity may go back into the business as well. But I would say there are other buckets of opportunity that we are also working on in tandem with the purchasing goods and service bucket. And as those opportunities come online, we will update you on those and add the benefits of those as well.

When you look at the total from the project, we have seen many companies come out with these projects in the past couple of years and I would say what we are trying to do is take a calculated approach to this and make sure as we update the market that we are confident in where we are headed.

I would also point to in the press release we talked about a net -- over the life of the project a net 250 basis point improvement in our EBITDA margin. We've always focused on EBITDA margin as one of our main measures, so obviously to drive a 250 basis point net margin improvement and to invest back in the business, as Allen indicated, over the life of this project we are expecting substantial savings that have been identified.

That's very helpful, thank you.

Akshay Jagdale, Jefferies.

Good morning. I wanted to follow-up on Project Centennial. Just to play devil's advocate for a second, you had these long-term targets out there of 8% to 10% EPS growth. Obviously, with Project Centennial you have some investments that are going to have you below that rate for next year, which we weren't expecting. And then in the outyears you are basically guiding to the same growth rate.

So one way to look at it is this project is basically enabling your long-term guidance. And perhaps we had the wrong expectation, but why shouldn't we expect a significant project like this to actually enhance your previous growth rates? So that's my first question.

Akshay, let me comment and then I'll call on Steve. I mentioned earlier that our leadership team, we're not happy at all with the recent results. And I also mentioned that our current model, regional model that we have expanded dramatically in the last five years, there are a lot of inefficiencies with our regional model.

So that is why Project Centennial is extremely timely to help us adjust our model and to really take this company to the levels that potentially, quite frankly, we have the opportunity to hit.

Whether it's looking at the business from A to Z is, quite frankly, something we needed additional help and organization to do. A good example is what we just commented on purchase goods and services generating $45 million in savings this coming year or year and a half. That is the first step and there will be many other work streams that will help us generate savings that we can reinvest back in the business as well as taking to the bottom line.

Not sure if that answers your question, but if we continue to do the same things that we've done in the past, it's hard to expect dramatic improvement in results. That is why we have initiated Project Centennial and we are excited about the progress. Steve, any --?

What I would say is when you look at the project, obviously a project like this -- and I know you're aware of this -- has many moving parts and pieces. And as we move out of the diagnostics phase and begin to implement some of these opportunities, we just want to be -- we want to kind of take a cautious approach when we look at what we're promising.

There's still a lot of work to be done around several of these key initiatives with the purchase goods and services being the first. But, again, over the life of this project, the next four to five years, we've identified, as Allen said earlier, what we feel will be substantial savings. Some of that will need to be reinvested. As the project progresses we will be able to update the anticipated benefit from the project.

But I go back to the 250 net margin improvement. When you look at performance over the last two to three years, obviously it has not been where we would've liked it to have been, but we feel like, at minimum, the 250 basis point improvement represents a significant amount of cost being taken out of the business and it will give us a strong foundation for hopefully driving stronger margins in the future as well.

That's helpful. So just to be more direct there, does this project --? If you didn't initiate this project, would you have not been able to meet your goals? Or initiating this project, does it increase the confidence you have in achieving your long-term goals or are you also hopeful that eventually you could exceed those?

This project should accelerate our achievement of the goals and it does add to our confidence level that we can achieve the goals. And a personal goal for me is to exceed those goals.

Okay. Just as a point of clarification, I know you're guiding to net margin expansion and I'm glad you made that distinction. You are not ready yet to share the gross numbers, but just so that we understand, there have -- I'm assuming that gross targets have been talked about and targeted, you're just not ready to share them, right? So there's a plan in place here, probably part of which is sensitive from a competitive standpoint, and as such you're not giving us all the details.

But is it fair to say that there is a much bigger sort of gross number that's identified and as you put concrete plans behind it you will communicate that with us?

I think you're right on point. When you look at the project obviously it's not -- it's an expensive project, number one, and we expect to achieve significant benefits based on the diagnostics. So there is a gross number; we do have plans in place to achieve the gross savings number by various work streams and we will talk about those at the appropriate time in the future.

Okay, I'll get back in queue. Thanks.

Brett Hundley, The Vertical Group.

I just wanted to stay on that topic actually, the gross savings versus the net number, and maybe delve back into the mix of allocation of those reinvested funds. So should we think about more money flowing into brand support promo in order to drive growth? Should we think about more reinvestment going into technology, as you mentioned? Should we think about an important M&A allocation?

Are you guys prepared to maybe give us a mix so we can think about or maybe we can get more comfortable with how that reinvestment drives the growth targets that you have laid out?

Brett, we are really not prepared today to give you details on how we plan to reinvest a significant portion of the savings. I mentioned earlier that our marketing spend will certainly increase, especially behind the brands that I mentioned earlier, but also at the same time we will be looking for opportunities to grow the Company, whether that's M&A or other areas moving into different segments.

I think the most important thing to realize today is that our immediate priority is focused around reducing cost: cost associated with the model, cost associated with the current way that we do business. And also, as we move further into the project the sales growth aspect will become clearer in focus, but today we are focused on really improving our model from a cost standpoint.

Okay. Allen, I think one of the reasons I asked that question, too, is just, for me personally, I don't think it's possible to overstate the importance of something you mentioned in your prepared remarks, which is the Company shifting or pivoting from what has been a geographic expansion strategy for many years to one that is now focused on growth by brands. I, personally, am hopeful that not only can that help the Company, but maybe even help the category as well given my own views.

Can you delve a little bit more into the strategic work that you've been doing over the past six to seven months and why you feel now is an important time to make that particular pivot?

Brett, I think the success we have had with Dave's Killer Bread really is a good indication of how the food category continues to evolve. The organic segment, if we had been looking at it 10 years ago it would be a very different story. We are excited with not only Dave's Killer Bread, but Alpine.

It really is a good example of how reinvesting in brands, appropriate brands at the right level with the right product line and the right consumer benefits, that's how we've grown this company in the past. And looking forward I'm excited about being able to have the investment funds to put back into our brands to really take us to an entirely new level of sales and operations.

But even though the category is relatively flat, it's still a $31 billion category, which is one of the largest in the supermarket. And if you look at our core business, there are many segments of the category that are opportunities for us today, even in our core markets. Again, I'm excited about the opportunity to grow the top line and I'm equally excited about the initiatives we have to reduce costs associated with our current model.

Then just last from me; Steve, it doesn't appear that your 2017 guide has any type of capital allocation within the model. Looks like you guys have a pretty full tax rate modeled in.

My question for you would just be, as you go through a lot of work here in 2017, what will be your ability and desire to apply capital along the way, whether it might be share repurchase, any incremental return, etc.? I appreciate it.

Sure. Again, when you look at the -- I would say, number one, when you look at the cash flow of the business it's still very healthy and we expect cash flow to continue to be strong. When you look at overall capital allocation, philosophically I don't anticipate a lot of change from that perspective.

We may need to redirect some of our capital spend internally as we look at projects being generated by Project Centennial. But from the shareholder perspective, you will continue to see us I think focus on our dividend and we will continue to look at share repurchases more opportunistically as we work through some of the initiatives from the project.

Thanks so much.

Tim Ramey, Pivotal Research Group.

Good morning, thanks so much. Wondering -- there is some discussion about changing the model and yet I'm concerned that there isn't anything that would really fundamentally limit future legal activity on the misclassification issue. Close to settling one suit; there's still many more to go. The dollars weren't as big as we worried they might be.

But it seems like as long as those drivers are independent contractors and sole proprietors, not corporations, there is continuing liability and risk there. Can you give us an update on your efforts to convert some of them to S corps and other structures?

Tim, we are encouraged with the progress that we've made with distributor litigation that you mentioned and that we had mentioned several weeks ago. We continue to have confidence in the independent distributor model. We're taking many actions to continue to strengthen the relationship that we have with our business partners and we are very bullish about continuing to grow this company working with our independent distributor model.

The enhancements that we are making are very much of a win-win situation, both for distributors and for the Company. At the end of the day, it's all about selling more product. So we are very bullish on our distributor program and especially excited about Project Centennial and the additional investment that we will be able to put behind our brands, which benefits our distributors as well as the Company.

Okay. And just on the dividend comments you made a minute ago, I think your payout ratio right now, if we assume the midpoint of your future guidance, is about 71% and that's pretty high for a company that has growth goals. It would be appropriate for a company that is just all about cash generation and delivering sort of steady-state earnings.

Have you thought about whether that payout ratio is too aggressive?

Tim, when you look historically at the Company our payout ratio has been 50% or slightly north of that. We have said that because of the flattened earnings the payout ratio has moved up and our goal is to drive that back in line by improving our overall performance from a margin perspective. So as you see earnings grow, the goal would be to bring that back into a more normalized range.

Okay. And just one more on Project Centennial, if I could. I didn't hear a lot about sort of changing the mix between warehouse-delivered and direct store-delivered, although it seems like you have pressed to shift some product from direct store to warehouse. Your competitors are obviously moving in that direction. Is there any high-level thoughts you could give us on that?

Tim, really not at this point. As I mentioned, all components of our current business model are under evaluation and really we are not prepared to share any -- we're not prepared to share that level of detail at this point.

Thanks so much.

Brian Holland, Consumer Edge Research.

Thanks, gentlemen. Good morning. So if I could just start; looking at the cadence here in 2017 and 2018, you called out $0.07 to $0.09 of Centennial costs that are being excluded from the guidance, but you have also said that there are investments to be made front-half-loaded in 2017. I presume that that's tied efforts to centralize the business model and then start realizing the cost savings going forward.

But can you just help separate for us what is in that $0.07 to $0.09 that's being backed out? What specifically, to the extent that you can give detail, are the costs upfront in the first half of 2017 and how do they help you start to generate those cost savings as we move to the end of 2017 and into 2018?

Primarily when we talk about Centennial costs currently, those costs are basically related to outside third parties, so it would be basically any consulting cost. And that may not all be our current partner; that may be other partners who come in to help implement projects.

And then just -- but the costs that you talked about that are going to weigh a little bit on the front half of 2017, what are they specifically tied to and how do we think about that helping to start generating these cost savings that you are looking to out in 2018 and beyond?

Those costs are specifically tied to the project. They deal with beginning to implement the initiatives that we've talked about around the project, so that would be one-time costs again around implementation of initiatives.

Okay, fair enough. I can follow-up with that offline. With respect to portfolio optimization, and I appreciate you're not able to get into specifics about -- too many specifics about how -- what might be impacted, etc. But at a high level, can you help us think about -- put into context the zero, the flat growth to 2% growth in the next two years?

Any sense of how much of your base today on the top line would be impacted by efforts to optimize the portfolio? Like how much of those sales might be coming out and be dilutive. So maybe there's an underlying expectation about how the category might perform in 2017 and 2018?

When you look at your guidance for 2017, we took that into consideration. Typically when you do kind of a brand or SKU type rationalization project there is a temporary dip in sales, so we considered that in our flat to up 2% for 2017.

Okay. And then last question. Just looking at the category now, it sort of strikes me now as I analyze the data that the backdrop in fresh bread is as stable or maybe as bullish for the branded leaders as it's been in quite some time. Maybe even before the Hostess bankruptcy.

You've got private-label share at -- going back as far as we have it, we're at trough levels here. I don't know if that is at an all-time bottom, maybe you can fill in the blank there. But we have the independents starting to decelerate and maybe that is commensurate with wheat, which has come off the bottom here in August. And then your underlying volumes have also improved and that seems to be tied, maybe among others, to increase merchandising.

So I guess first part is are we -- can you attribute some of what you are talking about here with portfolio renovation? Are we already seen that and is that what's helping to drive the volume, the more targeted merchandising?

Then, secondly, just your thoughts on the backdrop here, maybe relative to the last five years in fresh bread; if you are kind of seeing things play out the way maybe you hoped they had for -- you hoped that they would for some time now.

There are a lot of things that we're excited about when we look at the category. This private-label has always had an excessive share of the total fresh bakery business, and as we reported, we've continued to see private-label share decline for the whole category. That is a positive for those bakers like Flowers Foods that are focused on developing brands.

I think the growth in the organic category with branded products growing at a very premium price is a good example of the changes that are taking place with our millennials now dealing with childbearing age and have families of their own. So I think the overall category trends are very positive and we look forward to being able to meet the consumer demand. Not only meet, but also have the funds coming out of Project Centennial to beef up our marketing efforts in those areas.

Again, I think long-term trend, as far as category and opportunity to grow branded products, are very good. Steve, I'll let you take part two.

I think generally when you look at the again at the SKU rationalization that's not -- if you look at our recent performance, I would say it's not driven by initiatives from the project. Those were all around Allen's comments regarding our trade promotion spend returning to normal levels, so from that perspective, there's still benefit to be realized from the overall Project Centennial.

Okay, I'll follow-up offline. Best of luck, gentlemen. Thank you.

Bill Chappell, SunTrust.

Thanks, good morning. Just two on Centennial. One, so going back to the SKU rationalization, you have 21 brands now. Any idea what we will have in three, four years? Is it 10, is it 15, or do you plan on supporting all 21?

Then, with that in mind, as you are doing SKU rationalization or possibly getting out of some brands, do you expect share or growth to actually go down before it goes back up?

One of the good things about the fresh bakery business is the product turns very fast and with our systems that are in place, it's very easy to see what brands and what products are contributing to sales. As we move forward, if we do and we will, we will eliminate certain brands, but we will do that by replacing them with a brand that is going to turn more dollars and at a greater rate in hopefully the same space.

Making sure that you maintain shelf space with the retail environment is very important, so it's not just about making decisions to eliminate certain brands or certain products. It's more about, when you do that, to make sure that you're replacing it with a brand that has the growth potential and can generate not only replacement sales but generate more turn for both the Company and the retailer.

So that is -- when we say SKU rationalization, I think the other part of that coin, the other side of that coin is to make sure that the space that those SKUs were occupying that we replace that space with brands and products that are going to generate additional turns compared to the brand that they replaced. I think that's a real important part of the whole process.

Bill, I think just a follow-up on Allen's comment. When you look overall at SKU rationalization, it's really within a brand portfolio so it doesn't mean a brand is going to go away. But I think a big part of this initiative, and Allen had mentioned this in his comments, will be the efficiencies that come out of this project.

We expect a lift on the top line, but we also expect it to drive margin expansion because it's going to make the organization more efficient.

So you could still have 15 to 20 brands in five years?

I wouldn't speculate on that. We're still going through that process, but you would see a reduction in the number of SKUs available.

Then just second, Steve, just trying to understand the EBITDA improvement guidance. At one part in the presentation you said expect at least 250 basis points of EBITDA improvement by 2021, but then you are also saying expect EBITDA margins to be 13% to 14% in 2019 and going forward. I think if my math is right that would put you at 250 basis points by 2019. Am I missing something?

Again, when you look at the -- it's going to be a process over the next three to five years. We are trying to drive the overall growth. From that perspective the 250 basis points I said was a net, so as the benefits come online you should see a step improvement in margins as well.

Okay. So 2019 is maybe what we should be focused on for now?

Yes, I think in that three- to five-year window you should focus on the overall margin improvement.

Last one from me. I assume your consultants have shown you the marketplace and competitors. Is -- 13%, 14%, isn't that kind of the high-water mark for most companies with the DSD network of your size and scale? Is it really achievable to get much higher than that and how do you look at this in comparison?

I would say today I would not speculate on going beyond the 14%, but again the project has identified, as we said earlier, significant savings opportunities. Some of those will be reinvested in the business to drive growth from a top-line perspective, as well as driving margin expansion from cost reduction. But to move beyond the guidance we've laid out today, we are not prepared to do that.

Okay, thank you.

Amit Sharma, BMO Capital Markets.

Good morning, everyone. Allen, Steve, if we think about that 250 basis point EBITDA margin expansion over the next several years, conceptually how much of that is cost saving? And how much of that do you attribute or could you attribute to just having a better mix as you consolidate towards potentially larger brands within your portfolio? Is there a way to think about that?

I'll let Steve comment, but when I think about that opportunity, the bulk of the 250 basis points is going to come out of cost savings. Again, I don't want to undersell the opportunity to grow the top line, but again the most immediate priority is to make sure that we reduce cost to the model and the bulk of the 250 points should come out of cost savings.

Steve, I'll let you comment as well.

When you look at the near-term opportunities, a lot of that is driven by cost initiatives. What that will do is strengthen the business to begin to capitalize on the top-line initiative Allen talked about when he was talking about reinvigorating our core business.

Got it. Then, Allen, going back to what you said, if most of that is indeed coming from cost savings -- and we didn't hear too much about that today. Look, you have a fantastic team there from a number of years that everybody has been there, probably getting used to working a certain way. How do you maybe motivate or maybe cajole some of these people to do things differently or they are really used to doing to drive this level of cost savings through the Company?

If you look at the history of our company -- and by the way, you are exactly right; we have got the very best team in the industry with the most experience available. But if you look at our company in the rearview mirror, we've been through a lot of change through the years, going back to the Keebler days, Mrs. Smith. We can go on and on.

I think one of the real strengths of the unique culture that we have in place is that our team is all about winning and they understand in order to win you have to make adjustments at the appropriate time. Our leadership team is confident that as we go through Project Centennial the adjustments that we will be making will be in the best interest, best long-term interest of our company. And just based on the nature of our team, they will be 100% supportive.

Amit, just to follow-up. One aspect of the project has been to look at performance management and I mentioned that in my comments about enhancing capabilities. So there is an effort underway to look at the compensation structure to make sure we are driving the appropriate behaviors.

And that goes down the chain, right? Not just for the top management, but it goes -- filters down through the organization to maybe --?

Yes, this will be across the organization.

Great. Then just one last one from me. Steve, as we have DKB now anywhere -- [through] the acquisition, can you talk about the margin structure for that brand? Is it still dilutive to your overall margins or is it in line or better than what your core margins are?

I would say that brand, as Allen said, is -- generally organic categories perform well for us. We've been pleased with the acquisitions and the performance to date.

I won't comment specifically about their margin structure, but I would say we are pleased with where they are today and the performance we've seen over the last six months as those businesses have become fully integrated into our business. I still believe there's some room for margin expansion within the organic category, but where we are today we're very pleased with that.

Got it, thank you.

Brett Andress, KeyBanc Capital Markets.

Good morning. When you say at least $45 million for 2018, it seems like that's all coming from just one bucket of cost. So I guess one other cost buckets outside of procurement do you think have the most opportunity? And how much of that $45 million that you are targeting are you assuming flows through 2017, if any?

You're right on that; that is one bucket that's primarily our indirect spend. We expect to start seeing some benefit from the initiative in the back half of 2017 and have it fully ramped up in 2018 to reach the $45 million target. Again, that's at least $45 million from that particular bucket.

A few other initiatives that we have begun work on is continuous improvement; we talked about that. We've talked about now for a couple years initiatives around sales and our order quality, so there's another opportunity from that work stream as well. And then Allen talked about network configuration.

So we are looking at, from a production efficiency standpoint, making sure -- and that will tie in some to a continuous improvement -- making sure we are driving the necessary efficiency gain. So there's some other buckets that will start to fall into place as the project progresses over the next 12 to 18 months and we will update you on the savings from those at the appropriate time. But today I would say that we are not ready to talk about it.

I think it's important to remember the $45 million that we are mentioning today is really step one. And as Steve mentioned, we have many other work streams that we are also excited about. We will share those with you at the appropriate time.

So those buckets would be incremental to the $45 million?

Yes, they would be.

Yes.

And I guess do you have a target or something in mind for direct spend? I know you are targeting $45 million for indirect, but is there any way to quantify what you see is the potential on the direct side?

I think what we would stick with is the approximately 250 basis points, the margin expansion on EBITDA, by 2021; the next three to five years. And that would include the direct spend as well.

All right. And I was hoping you could give a little bit more detail on what you guys found related to your footprint, because I think, from the outside looking in, those 49 plants that you have really represent your largest cost center. So did you really have any findings that you guys can execute on here in the coming years?

Yes, as I mentioned earlier, we have expanded this regional model to basically a national company. That was one of our -- the obvious findings coming out of Project Centennial is that our current infrastructure, we need to take action to become more efficient. And as we move down the road you will be hearing more about those changes that we will be looking at.

But there are some significant savings with improved, whether it's manufacturing efficiency or other elements of the current model.

And just last one on net interest expense. I think it was a little higher than we were modeling, but it would be helpful if you could walk through the moving parts. How much of what you guys are guiding to is a function of higher rates and maybe how much is a function of reduced interest income this year?

Sure. When you look at -- interest income is roughly in a range of $19 million to $21 million and then interest expense -- then the net number on interest expense around that. So you are going to see a slightly elevated interest expense because of the -- converting a portion of our debt to fixed rate from the floating rate.

Eric Gottlieb, D.A. Davidson.

Good morning. I think I'm going to start off with a non-Project Centennial question for a change and then I will jump in there.

So I know that DKB and Alpine have been consolidated, but I'm trying to get a better sense of pricing promotional activity, which are now being masked by the two organic brands that carry a higher price. So can we break out DSD sales, in particular volume and pricing, ex DKB, and the same for warehouse and Alpine? Is that possible?

Yes, we would not break that out by individual brand.

Okay. Well, I'm not asking in particular for those two brands; I'm asking for what they would be without it. Is that --? No? Okay.

I'll just comment on pricing in the category in general. The same competitive pricing scenario that we've described on past calls continues. As far as pricing activity in the marketplace, we are seeing no change in basically the trend that we have described in the past.

Okay. But you had said that you were matching your promotional activity to match your competitors and I'm trying to figure out how your pricing level has changed from last quarter or two quarters ago. And it's hard to do that with DKB mixed in.

I think that the IRI data that tracks specific brands is a good resource to monitor those changes.

Got it, okay. Then touching on Brett's question, back to Project Centennial. As far as the shift to brand versus geography, I'm wondering if there any regions that you're actually looking to exit as part of the Project Centennial to focus on the ones you've had more success on or believe you could have more success on. Sort of a regional rationalization along with that SKU rationalization.

It would be premature to comment on that at this point.

Okay. My other question is -- so we talk about $25 million to $30 million and then we have costs -- we didn't talk about any costs for 2018 yet. But I'm wondering if there is an estimate of the total spend over a five-year period and when the expected breakeven point is.

Obviously, we look at the project and just the fact we're trying to capture the benefit over the next three to five years. There's a significant ramp in the first year, year and a half, and then things should fall off pretty significantly after that.

So from a cost perspective, we're not willing to give a total today, but from a flow perspective, we would expect to ramp up 12 to 18 months and then start to see these projects contribute more strongly to the overall bottom line.

Okay. And then as far as SKU rationalization, can you talk about the 250 basis points being more of a cost-cutting plan rather than growing sales? But I'm wondering; the SKU rationalization is more of a replacement plan, so how much plan is there to actually move into adjacencies and other markets there?

It doesn't seem like -- it was talked about, but it didn't seem like it was a real true objective and I was just wondering if we could shed some light there. And then I will pass it on.

It is a very true objective. I think what we're trying to do is share with you how we are thinking about the priority at this point. Again, as I mentioned earlier, the priority is focused on reducing cost and generating funds to reinvest in the business and take a significant portion to the bottom line.

But we are evaluating product adjacencies and we will continue to do that. I would expect that could potentially drive our acquisition opportunities as we look forward. That is an important part of the overall concept, but the most urgent position right now is to focus on the cost side.

Okay. Would you sell these regional brands or just shut them down?

I wouldn't want to speculate there.

Okay, all right. I'll pass it on, thank you.

Mitch Pinheiro, Wunderlich.

Just a couple quick things. On the 2017 guidance, when you look at your lower -- the low end of the range, a down EPS year, and if you had flat earnings, is that all workforce-related cost or is there any other element we have to think about in terms of the margin pressure?

When you look at our general cost increases for the year, there was a significant portion of tied to workforce, whether it's salary or benefits. But then also there are a lot of things going to be happening in 2017 around the project, so we won't --. We tried to be cautious with our guidance, because we're not -- we don't have a crystal ball, so we can't guarantee 100% that everything falls into place on the day we think it will, so we tried to build some of that into our guidance as well.

Are there -- year over year are there incremental legal costs built into your guidance? Is it flat? Any help there?

Obviously, we can't comment specifically about legal costs and how they are tied to certain cases. We did build in some incremental legal expense for the year, but beyond that I couldn't comment.

Then on Project Centennial, the reason you are now brand-focused versus geographic-focused is that simply you are fully distributed; you have basically a full reach? Or is there another aspect? Is it just that some of the new areas are just -- you are not earning a return that you expected? Is that --?

How do you -- why now on the brand focus? I thought you've always been relatively brand-focused. Nature's Own has become the number one brand; you bought Dave's Killer Bread, Tastykake, etc. I mean why --? I don't understand. Is brand focus simply the need to promote more, the need to advertise more? Can you talk about that?

You are exactly right; our company has always been brand focused. I think what we're excited about is coming out of Project Centennial, generating significant savings that we can invest at a much higher level in our brands than what we have been able to do in the past. And I think that is really the story about building brands; innovation that is certainly in step with the changing consumer.

So you're right; we've always been focused on our brands. We're excited that now we will be able to invest in those brands at levels to continue to fuel our future growth.

Then just a couple other things. In terms of -- you talked about healthy snacks, a focus on healthy snacks. Do you have something in the pipeline now? Is that just a drawing board potential goal there or would you anticipate sort of an acquisition strategy around healthy snacks?

Mitch, as we have all observed, today's consumer continues to change their eating habits with snacking becoming really a round-the-clock activity. I don't want to really share any of our strategic plans, but we are interested in that particular segment of better-for-you snacking. And at the appropriate time we will be happy to share our plans.

Okay. And would healthy snacks leverage both the DSD and the warehouse aspects of your business?

Mitch, it would really depend on the item.

Okay. And then, I guess finally, just want to understand on your $45 million of the indirect cost reductions goal, what is your confidence level on that? Is it 100% confidence that you can reach that or is there some potential just -- not risk but, yes, I guess risk to the numbers?

When you look at the $45 million, we feel like the opportunities we identified there we feel pretty confident about those. Again, there's a range of opportunity and we feel like at least the $45 million, we should be able to capture that.

Mitch, I will answer also, based on the team that we are fortunate to have, my confidence level is 100% or better. And we demonstrated a good start with the savings we generated in quarter four and we are off to a good start with the best team in the industry.

Okay, thank you.

That concludes the question-and-answer session. I will turn the call back to Allen Shiver for closing remarks.

Ellen, thank you. Again, for our team members that are listening to the call, I want to thank you for the great start in quarter four with Project Centennial.

We're excited about the new year as we move forward. It will be a year of transition, but we are making all of the right decisions to take care of growing this company for the next 100 years.

Thank you for your attention this morning and this concludes our call.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating and you may now disconnect.