Flowers Foods, Inc.
Q4 2013 Earnings Call Transcript

Published: 6 Feb 2014

[Operator:]

Welcome to the Flowers Foods' fourth quarter 2013 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 like to turn the call over to Marta Jones Turner. Ms. Turner, you may begin.

[Marta Jones Turner:]

Thank you Ellen, and good morning, everyone. Our fourth quarter and full-year 2013 results were released earlier today. We also expect to file the 10-K on February 19. You will find the release on our website, and the PowerPoint presentation that supports our comments is posted on the conference call page. I do have an announcement that I want to make before we get started, while – we will soon host an Analyst Day on March 20 at the New York Stock Exchange. In a few days, we will be sending more information, but I thought you would want to mark your calendars for March 20. Well, you know that I must remind you that our presentation today may include forward-looking statements about our Company's performance. Although we believe the statements to be reasonable, those statements are subject to risks and uncertainties that could cause actual results to differ materially. In addition to the matters we will discuss during the call, important factors relating to Flowers Foods business are detailed more 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. Now I am pleased to turn the call over to Allen Shiver. Allen?

[Allen Shiver:]

Thank you, Marta, and good morning, everyone. Thank you for joining us. First, I want to share a few thoughts about Flowers Foods' recent accomplishments, and where we are today. Our sales are up over $700 million, or 23% over last year. We have added more than 20 million to the population base that now has access to our fresh bread brands. Today 79% of the US can now find our breads in their markets. We have grown our customer base by 19%, and our DSD system now serves about140,000 customer locations significantly strengthening our access to new markets. Our market share of the total US has grown from 10% in mid 2012 to almost 14% today, with further growth ahead. Nature's Own sold $1.1 billion at retail in 2013, with a 17% increase. Our brand portfolio was strengthened by the addition of the bread brands that we acquired from Hostess last year. Our access to market in California has increased by having the Sara Lee brand for bread, buns and rolls in that state. Tastykake is proving to be a strong player across our markets. Tastykake sales have almost doubled since we acquired the brand in 2011. With the acquisition of the Hostess bread assets, we also have strategically located bakeries that we can reopen, as both market demand and our sales grow. All these factors combined to give Flowers Foods a powerful foundation from which to continue growing our sales and our earnings. Added to those strengths, we have an amazing team that simply is the best in the industry, with proven ability to deliver for our shareholders. To put all of this into perspective, 2013 was a year of exceptionally strong growth for Flowers Foods, but our growth story is not over. I have confidence in our ability to continue delivering growth, as we build our share in newer markets, strategically extend our DSD reach, build out opportunities in the strong south market, while taking full of advantage of other growth opportunities. Now speaking more directly about the quarter, and the full year results we reported this morning. With the strong sales increase, and 31.9% gain in adjusted earnings per share, 2013 was a record year for Flowers. You know that in the first half of the year, we benefited from significant volume increases that we achieved because of Hostess's exit from the market in late 2012. In July 2013, we completed the acquisition of the Hostess bread assets. So for the second half, our results were impacted by interesting expense and carrying costs for those assets. On our last call, we also told you about a few short-term issues that impacted our second-half results. I want to bring you up to date on those matters this morning. On the warehouse segment issue, which involves the Fort Worth tortilla bakery, we have made good progress on improving operations and efficiency levels. We also took pricing on our tortilla business, and we are confident that we will improve operating margins in the first quarter. Next, our overall manufacturing efficiency levels are improved. We told you on the third quarter call, that our bakeries have been impacted by tremendous volume increases during the year. I am pleased to report that in the fourth quarter, manufacturing efficiencies improved 200 basis points, compared to the third quarter. This trend is continuing, and we are confident in our ability to regain efficiency levels above 92%. I want to recognize the exceptional efforts of our team in achieving improved results in our bakeries as they worked to further increase our efficiencies, while maintaining focus on producing the highest quality products possible. We told you on the last call that the integration of the Lepage bakeries was continuing,[Author ID1

[Steve Kinsey:]

Thank you, Allen. Good morning, everyone. Flowers Foods posted another quarter of good growth. As Allen stated, 2013 was a record year for Flowers Foods. Overall, we are pleased with the year, and look forward to the opportunities in 2014. First, we will take a look at the quarter, and then we will discuss 2014 guidance. I would remind you that it was mid-November last year, when the former Hostess brand exited the market. So we did cycle the sales gains from that event during the quarter. Sales in the quarter were up 12.6%, with Pride contributing 3.6%, and volume 6.2 – 6.3% to the growth. The acquisition of the Sara Lee brand in California contributed 2.7% growth to the quarter. The miss from our targeted sales projections for the full year is primarily attributable to more than expected DSD sales in the fourth quarter. This has not changed the fact that our team executed well throughout the year, capturing market opportunities due to the assets of the Hostess brands from the marketplace. Adjusted operating earnings or adjusted EBIT was down 4.4% this quarter, compared to last year's fourth quarter. Overall, stronger sales were offset primarily by lower manufacturing efficiencies, and the carrying costs of the recently acquired Hostess bread facilities. We continue to work on production rationalization and efficiency improvements. Though we have seen sequential quarterly improvement in our efficiencies compared to last year's fourth quarter, efficiencies were down and cost us about $0.02 per share in the quarter. Carrying costs associated with the recently acquired Hostess bread facilities were $5.3 million in the quarter, and negatively affected the EBIT margin 60 basis points as a percent of sales. We have worked to reduce carrying costs where possible, and this is a flat improvement over the forecasted amounts. Total carrying costs for 2013 were $10.6 million. We now expect the fiscal 2014 carrying costs of the closed Hostess bread facilities to be approximately $27 million. This is down slightly from the $30 million forecast we gave you late last year. Allen mentioned that the integration of our SAP platform did not go as planned at Lepage. This negatively impacted the fourth quarter earnings by approximately $5.5 million, or approximately $0.015 of earnings per share. The system integration is complete, and we are focused on fine-tuning certain processes that should allow us to get the Lepage's earnings back on track during the first quarter of 2014. Adjusted EBIT for the full year was up 32.8% over the prior year. Depreciation and interest expense was in line with our expectations. The effective tax rate for the quarter was 29.5%. This decline over the prior year fourth quarter and over the statutory rate is primarily the result of the recognition of several discrete items during the quarter. This reduction quarter-over-quarter was approximately $0.01 per share on the quarter. The full-year rate without the bargain purchase gain was 33.6%. The lower rate affected full-year earnings by approximately $0.02 per share. Earnings per share for the quarter were flat compared to last year's fourth quarter. Adjusted full-year earnings per share of $0.91, was up 31.9%, compared to last year's adjusted earnings per share of $0.69. The gross margin in the quarter was 46.9%, compared to 47.9% of last year's fourth quarter as a percent of sales. The reduction at the percent of sales was primarily related to the carrying costs and the decreased manufacturing efficiencies. The full-year gross margin as a percent of sales was 47.4% compared to 46.9%, up 50 basis points year-over-year. Improvement from the full-year gross margin were driven primarily by stronger sales. As a percent of sales, adjusted selling, distribution and administrative costs in the quarter were 36.7%, compared to 36.4% in last year's fourth quarter. The full-year adjusted selling, distribution and administrative costs as a percent of sales were 36.2%, compared to 36.4% last year. The primarily drivers of this increase were higher workforce costs, and costs associated with market expansions. Cash provided by operations was a positive $50.2 million in the fourth quarter. We ended the quarter with approximately $924 million of debt on the balance sheet. Cash flow remains strong, and we will continue to focus on paying down debt. Our debt to EBITDA or leverage ratio, based on the full-year of 2013 EBITDA excluding the gain on acquisition was 2.3 times leverage. In the quarter, we did buy back $5 million of stock or 231,000 shares. For the full year, we repurchased 436,000 shares, and we have 9 million shares remaining on our current authorization. This brings us to 2014 guidance. First, let me remind you that 2014 is a 53-week year. We are forecasting sales growth of 6% to 10%, or $3.98 billion to $4.13 billion in sales. Sara Lee California acquisition should add approximately 1% to the increase, and the 53rd week is forecasted to add 1.8%. The remainder of the increase will be driven by organic growth. Earnings per share for 2014 is expected to be $0.98 to $1.05 per share. This is approximately a 7.7% to 15.4% growth over the 2013 adjusted earnings per share of $0.91. Earnings growth will be driven by top line growth and cost reduction initiatives, such as improved manufacturing efficiencies. We are forecasting input cost deflation in 2014, however costs related to the employees and facilities are expected to increase year-over-year. Capital expenditures for the year are forecasted to be $95 million to $100 million. Included in this forecast is the buyout of leased equipment of $8.5 million, and investments in our IT infrastructure of $9 million. Now I will return the call back over to Allen, before we go to Q&A.

[Allen Shiver:]

Thank you, Steve. As I mentioned earlier, 2013 was a year of unprecedented growth for Flowers, and our team did an outstanding job of serving the marketplace and growing our business. But 2013 is over. Now our team is focused on opportunities ahead. With the recent acquisition of Lepage, Sara Lee California, and the Hostess bread assets, combined with the volume growth that we achieved following Hostess's exit from the market, sales are up almost $1 billion in two years. Our team is focused on bedding down the new business we have added, and making certain that we have the right infrastructure from which to continue growing. We are working hard to right size the organization, and to keep our cost standards in line. But I want to be certain you recognize that Flowers now has a powerful foundation from which to continue growing. We have a tremendous opportunity to grow sales, as we continue to build market share in our newer markets, and strengthen our position in the South market. I encourage you to look closely at the US map as it is included in your deck. This map will help you visualize the growth opportunity that is ahead for our Company. We have a market presence that now reaches 79% of the US population, but about half of that is under-developed Flowers brands. As you can see, Flowers brands now hold a 28.3% share of the IRi South market, while our share of the total US is about 14%. The markets we currently serve outside the South, represent just over half the total population that has access to Flowers brands today. It is important to understand that outside the South, our share is much lower, simply because we are relatively new in those markets. With our strong brands, great quality, effective distribution model, and our focus on giving exceptional customer service, we have proven our ability to build share in new markets. We will continue to do that, and now we have the additional brand strength and idle bakeries that can be opened as needed to serve those markets. I hope you can tell that our team is excited about our growth opportunities for 2014 and the years ahead. We have the brand, the bakeries, and most importantly, the team to get the job done. As our guidance indicates, we expect 2014 to be another year of sales and earnings growth for Flowers. We are confident that we have the right strategies, the brands, the bakeries, and most importantly, the team that can continue to take this Company to new levels, as we work to build value for you, our shareholders. Thank you, and operator, Ellen if you would please open the line for questions?

[Operator:]

Thank you. (Operator Instructions) The first question is from Eric Katzman with Deutsche Bank. Please go ahead.

[Eric Katzman:]

Good morning.

[Allen Shiver:]

Good morning, Eric.

[Eric Katzman:]

I guess my first question Steve,[Author ID1

[Steve Kinsey:]

Eric that relates to the purchases of the product that’s being produced for the California market, the [Author ID1

[Eric Katzman:]

On the year. Okay. I thought you said something to do with the tortilla plant, and that you had maybe gone out,[Author ID1

[Steve Kinsey:]

It relates primarily to the Sara Lee products.

[Allen Shiver:]

Eric, we had some outside purchase related to our cake business, and then we also had some outside purchases in a smaller way in other part of the company.

[Eric Katzman:]

Okay. And then, I guess, on Allen – just a broader question. Obviously a lot of worries in the markets around consumption, and whether it is due to consumers trading down or trading up, or the impact of the SNAP cuts. Can you just talk a little bit about the broader market, what you are seeing from consumers? And then, also you put prices up in the fourth quarter, and what has kind of been the competitive reaction to that?

[Allen Shiver:]

Yes, Eric, we continue to see the consumer under pressure, just like other food companies. We continue to see a polarization between business being much better the first of the month versus the end of the month. The overall bakery category to continues to be relatively flat. They are up slightly and in dollars, but relative flat in volume. So we are excited about the opportunity to be able to reintroduce and brands to the marketplace, and we feel like our new markets represent the biggest opportunity for the Company. And in our mature markets, we are looking at different product categories where we may be underdeveloped. So we have growth opportunity even in our mature markets with segments of the category that we are not fully developed. So overall, we continue to see the consumer under the same pressure that everyone else has seen.

[Eric Katzman:]

And then…

[Allen Shiver:]

As far as the pricing, the pricing that we took back in the fourth quarter, we continue to hold that pricing. But overall, the trends that we are seeing, that we mentioned on our last call in the marketplace on pricing, they really continue.

[Eric Katzman:]

Okay. All right. I will pass it on. Thank you.

[Operator:]

The next question comes from Farha Aslam with Stephens Incorporated. Please go ahead.

[Farha Aslam:]

Hello, good morning.

[Allen Shiver:]

Good morning Farha.

[Farha Aslam:]

You did mention on your last call as you were rolling out Wonder that you hadn’t been able to get into all of your retail outlets just because of the timing of the shelf sets. Can you update us in terms of where we stand with being able to put wonder in key retailers?

[Allen Shiver:]

Farha, we’ve done a very good job of getting distribution of Wonder in the majority of retailers. There is one retailer that is – that we are continuing to work on, and we are optimistic that we will be putting Wonder in that chain hopefully this spring. But really other than that one retailer, we have very good acceptance of the Wonder brand.

[Farha Aslam:]

Okay. And then, can you just update us on where the tortilla facility stands, and kind of how – what it cost in this quarter? And kind of what we can look for, going forward from that facility?

[Allen Shiver:]

Steve, I’ll let you comment on the quarter impact, and I can comment on the long-term.

[Steve Kinsey:]

Sure. For the quarter, it cost roughly $3.5 million to slightly over a $0.01.

[Farha Aslam:]

Okay.

[Allen Shiver:]

Farha, we have made good progress in our Fort Worth tortilla plant. We have raised prices on products produced out of the facility, and we are also working to substantially improve our efficiency levels, and lower our cost of production. So we are not fully there, but we have made dramatic improvements in the last, really the six to eight weeks.

[Farha Aslam:]

Okay. And could you share with us a little bit more detail on the SAP implementation, kind of what impact that had on sales and earnings – you have quantified earnings for us, but sort of color around that? And what are the steps that we need to take to fix it?

[Allen Shiver:]

Steve, I will let you mention the financial part, and then I will comment on.

[Steve Kinsey:]

If I were to look at really what happened – we, typically with integration, bringing up the systems, there was a few things that probably from a training perspective, we didn't function quite properly. So it did really affected more the ordering and the sales number, which equated to lost profits over the quarter. We have gone in now, and we have gotten the ordering bedded down. We are feel good now about where we are. So we are working on now, making sure we are getting the right products mixes in the market, and bringing back the sales revenue. Overall the projection on revenue is probably just slightly above the earnings miss for the quarter. So it probably cost us somewhere between $7 million or $8 million of revenue on the quarter.

[Farha Aslam:]

Okay. Thank you very much.

[Allen Shiver:]

As far as the, back on Lepage, Lepage's ordering system was different than Flowers' order forecasting system. The progress is being now, made now as we put our system in place, is training the team to make sure that our orders are accurate, and make sure that our top line is back. And we are making good progress there.

[Farha Aslam:]

So maybe one more quarter?

[Allen Shiver:]

We’ll see improvements as we continue to go through this quarter.

[Farha Aslam:]

Okay.

[Allen Shiver:]

Yes, the goal would be, Farha, to have this taken care by the end of the first quarter.

[Farha Aslam:]

Okay. Perfect. Thank you.

[Operator:]

The next question is from Jonathan Feeney with Janney Capital Markets. Please go ahead.

[Jonathan Feeney:]

Thank you very much. As you enter these markets with the new Hostess facilities, presumably it, I mean, it seems like it has gone rather well. But presumably, there was some disruption – you are adding supply to a market where demand doesn't change. Do we reach a point, say later this year, that you could actually see an improved pricing dynamic, as you lap that entry? Or was it just a case that – it was really just one for one, and there isn't a temporarily – aggressive promotional dynamic in the margin?

[Steve Kinsey:]

Jonathan, I think long-term celebration in this category will lead to better pricing. In the short-term, I really wouldn't say entering new markets is creating a price volatility. Whenever you do introduce a brand to the marketplace, there may be some front-end promotional activity, but that is really minimal. So I really, I am not sure I am really answering your question, but I don't see the expansion into new markets with the Wonder brand having a negative impact on pricing.

[Jonathan Feeney:]

And just refresh my memory on, what factors about consolidation specifically? Is it just closing the plants, or is it behavior along the leading players that are going to drive superior price rationality in your opinion – in two or three years out?

[Allen Shiver:]

The category continues to consolidate. Really can't really speculate about what is going to happen on long-term on pricing. But if you look at the category today, is Bimbo, Flowers, Pepperidge Farm, and several independent bakers. And if you compare that to 5 years ago, and certainly 10 years ago, that is a very different picture than what we were dealing with then.

[Jonathan Feeney:]

And over that time – I mean, has it been – I mean, presumably, there has been consolidation in place for decades in the bread industry, the milk industry and several others. Has there been steady improvement in the markets you are in right now due to that consolidation?

[Allen Shiver:]

Jon, what do you mean by steady improvements?

[Jonathan Feeney:]

I mean, when you talk about your prior expense, where maybe in some of your markets that where you have high share, you can look – think back 20 years ago, where there were a lot more players. It was a lot less rational, and that actually led to improved margins, improved profits per unit specifically.

[Allen Shiver:]

Well again, I would say that, looking forward the category continues to be price competitive. I mentioned earlier, we are really not seen any change from last quarter's call. But we do have confidence that we can reintroduce our brands, and we expand our geographical footprint, and do that in the way that we have done in the past. And long-term, we are building our brands, and establishing business in new markets.

[Jonathan Feeney:]

Okay, thank you very much.

[Operator:]

The next question comes from Bill Chappell with SunTrust. Please go ahead.

[Bill Chappell:]

Good morning.

[Allen Shiver:]

Good morning, Bill.

[Steve Kinsey:]

Good morning, Bill.

[Bill Chappell:]

Just looking back at the guidance, and I just want to make sure my math is correct. The SAP plant cost you $0.015, or the SAP implementation a $0.015. The Fort Worth plant probably cost $0.04, and you got an extra week. So it seems like we are pretty close to the guidance in terms of just – lapping some of the one-time issues for 2014. So I am trying to understand – I understand that you are going to have the incremental carrying costs, but is that the right way to look at it? Are you kind of expecting the rest of the business that was unaffected to be – kind of up just a few percentage points in terms of profitability?

[Steve Kinsey:]

I think generally you are looking at it correct. You may be a little strong on the [Leo's] affect, I think it is probably more around $0.03. But in general, looking at the year and the guidance, the range, there were a lot of factors in the back half that did affect earnings. And the real key is making sure we drive those costs down and get those things corrected, and the majority of them are. So we feel good about we were headed into 2014, because we have identified what the issues were that really affected ‘13. And the other big driver in ‘13, would be the tax effect of $0.02. So if you take out the tax effect and kind of level the playing field, and the operational growth, we believe it will be a pretty strong year coming into ‘14.

[Bill Chappell:]

So I guess, that is my question, like is that something – I mean, from a management standpoint, just lapping the one-time issues and making the numbers, it doesn't seem like you would be happy with that. So I mean, actually should I assume this is conservative? Or are there other headwinds that we are missing, or expectations, integration risks that we are missing?

[Steve Kinsey:]

No. There are still a few things that have to happen. That we talked about the Wonder relaunch, we know we need to get that – get those brands into all the hands – of all the retailers. We need to make sure that we have the things corrected that did happen in the fourth quarter, and as Allen said, we are making good progress. So right now, I think the guidance we have out there is really the best estimate, based on the factors, as we know them.

[Bill Chappell:]

Okay. And – go ahead?

[Allen Shiver:]

Bill, I think the – within our guidance, we have – our growth plan as represented there, as we continue to build our business in new markets. We will share more details at our Analyst Day about plans for Hostess bakeries reopening. So within that guidance, it also has some growing costs as we move and expand our boundaries.

[Bill Chappell:]

Well I guess, maybe to the carrying cost number, can you give us an idea what that assumes, in terms of total facilities that you will be carrying without opening?

[Steve Kinsey:]

Well, right now in our guidance we have the $27 million that I mentioned in the comment, talking about the full-year call for 2013. We have forecasted $27 million for 2014.

[Bill Chappell:]

Sure. I just didn't know if that meant like – is that 18 facilities that are idle that are – anything like that?

[Allen Shiver:]

Allen, will give you more details on that in March, but that is still the vast majority of all of the facilities.

[Bill Chappell:]

Okay. And then, just a final thing from me. Just trying to understand going back – I think we were to look at the Nielsen IRi data recently, it had looked like Bimbo had become maybe a little more promotional in the past few – couple of periods. And kind of to Jonathan's question, I mean, are you seeing a competitive response? Are we really looking for a more rational environment a year or two out? Or could we see at this year?

[Steve Kinsey:]

Well, it is hard to speculate about pricing, and I do not want to do that. I will say that the trend that we saw, that we have seen really for most of last year continues. And it still remains a market-by-market business. Pricing is very different from one area of the country to another. But long-term, consolidation should lead to better pricing for the overall category. But at present time, the trend that we have been seeing is still here.

[Bill Chappell:]

Got it. Thanks so much.

[Marta Jones Turner:]

Thanks, Bill

[Allen Shiver:]

Thank you, Bill.

[Operator:]

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

[Brett Hundley:]

Hi. Thank you. Good morning, everyone.

[Allen Shiver:]

Good morning.

[Brett Hundley:]

Steve, just real quick, just to clarify, the $27 million in carrying costs for 2014 – I mean, I assume you are making some assumptions within guidance on a certain level of coverage of those carrying costs? Or are you not? Are you just assuming it is another straight hit of $27 million?

[Steve Kinsey:]

Yes. I mean, it is based on all of the items in – it is kind of pro-rated throughout the year. It is about half of our gross margin, and the other half is depreciation.

[Brett Hundley:]

Okay.

[Steve Kinsey:]

So it is the full amount. There is no – I mean, there is assumptions internally about when some things may roll off.

[Brett Hundley:]

Yes.

[Steve Kinsey:]

How we get to the $27 million versus the $30 million we gave you at the end of last year. But it is basically prorated throughout the year.

[Brett Hundley:]

Okay. And then, Q4 DSD sales coming in late due to expectations, is that pretty much all Tasty? I am curious if you feel the need to recalibrate expectations there? Or put another way – what you are seeing thus far during Q1 relative to Q4?

[Allen Shiver:]

Our DSD business is very solid. Looking at Q4, as far as sales projections, it was slightly below what we anticipated. But I have never felt stronger about the ability of our DSD business to deliver going forward.

[Steve Kinsey:]

And Brett, when you look at the fourth quarter – we have talked some about Lepage, that was significant part of that. Allen talked some about the cake being slightly affected. So the DSD cake was slightly affected. And the other was just general, some of the weeks didn't come through like we had planned in the last couple of weeks of the year. Some of that was weather-driven, I think some of that could have been driven around the holidays. So it just didn't, come out quite as planned. But there is no reason to recalibrate how we think DSD can perform.

[Brett Hundley:]

Okay. And then, I just – Allen, I just want to get some further color on – I thought it was important what you said about the map of the US, and where your total coverage is from a 79% standpoint. But a lot of those markets need to be developed much further. And so, I guess, just any color you can give us on your ability from a timing standpoint, to really develop those markets fully the way you want them to. And it you want to talk to different regions, I think that would be helpful as well. Thank you.

[Allen Shiver:]

Okay. The – what we have accomplished in California to date, to me is a very good example of our teams ability to grow in new markets. We had a multi-phased rollout , and now serve all the major supermarkets in California. Our internal goals were exceeding those, our team is in place for future growth. I really think if you look at the map, you can see many of the markets that we have recently moved into, are some of the largest population centers in the country. And we understand how to build our brands, and we understand how to develop our business in those markets. So I think you have got the internal aspect of – we have a long track record of being able to do this. I think another good point is that, on the retail trade side, we have a great reputation with the retailers. Many of the retailers that I have mentioned in the past, they are encouraging us to serve all of their stores. So in the case of national retailers, as we move into new markets, we are getting their support with product authorizations, and support with displays and so forth. So I – we are very confident. If you look at our market share on a total US basis, I mentioned we are about a 14[%], and we expect the number to continue to move up. But the key is making sure that we do that in a controlled organized fashion, so that we can make sure that the earnings are there to coincide with the sales growth. So looking back, I mean, this has been a real exciting year. We have kind of a peg down in many new markets, and we are going to be developing those markets. The acquisition of the Hostess brands really helps us do that. If you look at the bakeries that we acquired, geographically some of the bakeries that are sitting idle, are in really key markets across the country. And as we build market share, and as consumer demand increases, we will talk more about reopening those plants. We are off to a very good start with the opening of the Henderson bakery, and those have gone extremely well. We are really excited about our product quality coming out of the plants. I expect the share in California to grow significantly, as we are selling bread produced by our plant versus co-packers. So really pointing to California, as an example of doing a job, expanding the DSD footprint, and our plans are to do the same thing in other markets.

[Brett Hundley:]

Thank you.

[Operator:]

The next question comes from the line of Sarah Byrnes with Findlay Park Partners. Please go ahead.

[Sarah Byrnes:]

Good morning. I have just a couple of questions. Could you tell me what your estimate is of the market share that is still held by the independents, i.e. not the top three?

[Steve Kinsey:]

Sarah, we can...

[Sarah Byrnes:]

About 22%.

[Allen Shiver:]

About 22%.

[Sarah Byrnes:]

And is that some way in any particular markets?

[Allen Shiver:]

The independents that are left are – they have concentrated market share in their geography. Again, I can't really give that to you over the call this morning.

[Sarah Byrnes:]

Okay.

[Allen Shiver:]

But we would be happy to provide the information to you.

[Sarah Byrnes:]

Perfect thank you. And second question into the gross margins. Obviously, you both – actually the 1% margin gross margin decline, you're probably at 20% [ph] was due to outside purchases. Could you break through – just a little on the other two?

[Steve Kinsey:]

Sarah, I had a hard time hearing you, but I think you were asking what caused the drop in gross margin, in addition to the outside purchases?

[Sarah Byrnes:]

That's right, Sir...

[Allen Shiver:]

The other...

[Sarah Byrnes:]

I'm not sure. I said 1%. You know you said [INDISCERNIBLE] outside purchases. Can we just wait the remaining 80 basis points?

[Steve Kinsey:]

Yes. The other two main items will be the carrying cost and the Hostess facilities and the loss in efficiency.

[Sarah Byrnes:]

Okay. Fine. Thanks. As for the other questions, I'll come back to online.

[Allen Shiver:]

Thank you.

[Marta Jones Turner:]

Thank you, Sarah.

[Sarah Byrnes:]

Thank you very much.

[Operator:]

The next question comes from Amit Sharma with BMO Capital Markets. Please go ahead.

[Amit Sharma:]

Hi. Good morning, everyone.

[Allen Shiver:]

Good morning.

[Amit Sharma:]

You had talked about a good start to the relaunch Wonder Bread and other Hostess brand into your core markets as well. What is expectations internally in terms of – how much of if you look at Hostess sales prior to their business? What is the expectation in these markets? What share of those sales can you recapture with these brands?

[Allen Shiver:]

Yes. Each market is different. I mentioned that our best results so far have been in our new markets. And if you think about the product category, white bread is a segment of the market where brands are extremely important. The brands that we acquired, Wonder, Home Pride and Merita, those are very, very strong white bread bands. So the brands are really helping us significantly as we go into new markets, that we are able to put a Wonder brand with majors on, to complete our product line. The – in our mature markets in the South, we, as far as developing incremental sales, naturally that is much lower than what we are seeing in the new markets. But at the same time, consumers that were loyal to, for example Merita bread in the South they have either gone to a competitor's brand or went to store brand. So we are seeing some incrementality in bringing back some of the customers that left, even in our established markets. But it is, the growth in our established market is not as significant, as the growth that we are seeing in new markets.

[Amit Sharma:]

That is perfectly understandable – understood. In terms of able to put a number on it? Do we think we can do 3/4 of the sales, half, more than that? Any color on that would be…

[Allen Shiver:]

The increments…

[Amit Sharma:]

In newer markets, yes?

[Allen Shiver:]

Yes. If we look at the new markets, individual markets where the incremental sales increased for the categories is in the 75% to 80%. Overall, if you look at a blended number, it's a good mentality is the 25% to 30% range, as far as increase.

[Amit Sharma:]

Got it. And then the, perhaps a follow-up to the last question, but a slightly different on regional bakers. When you talk to them, or when you look at the marketplace, what is the health of the regional baker? What is the mindset here? Do you think they are well capitalized, they are – their margin structure in the right place, where you expect a good fight, as you try to gain back from the share from them, as you launch the Wonder Bread? Or you feel like you are happy with what they have, and wouldn't put up lot of fight for that?

[Allen Shiver:]

The – I don't want to speculate about each individual independent baker, but the story is very different from one company to the next. In general, the independent bakers benefited from Hostess exit from the market, just like Flowers did. But to talk about each one specifically, I think probably wouldn't be appropriate.

[Amit Sharma:]

All right. And that is – would probably take too long as well. But overall, we generally tend to focus on the large players in terms of competitive environment, and their impact on promotional activity. But given the regional guys are over 20% share, I mean, what is the message that is coming out of them? Will they be looking at this commodity deflation as an opportunity to hold onto the share, or fight aggressively for it? Or go along, and focus more on margins?

[Steve Kinsey:]

Amit, this is Steve. What I – if you look back over time, last five years or so, and you look at new markets and expansion markets that we entered. Most of those markets would have had one or two regional players, as well as at that time, one or two major players. And we also have a chart on this on one of our decks that shows good steady market share gain and penetration over that five-year period. I mean, the Baltimore-Washington area would be a good example of that. St. Louis was a good example of that. So we have entered – we have had good success in markets through our brand strength, and has always been one or two independents or one or two major players in these expansion markets. So I think that is what gives us confidence as we introduce new markets that we can continue to gain share.

[Amit Sharma:]

That is helpful. So just one more for me. When you talked about opening the Henderson, Nevada factory, and I might have missed it – did you quantify what sort of extra expenses were with that, in terms of either total growth profit or EPS? And is that a fair number to assume for every new bakery that you opened from the Hostess assets?

[Steve Kinsey:]

Yes. It really depends on the condition of the bakery or the size. Henderson, Nevada, we brought up actually one line in November. So it was fairly insignificant. It was less than $1 million. So I would say that could be a good, kind of directionally – a good guidepost – somewhere between $500,000 to $1 million when we bring up a bakery. And that would exclude any additional capital expenditures though.

[Amit Sharma:]

I am sorry…

[Allen Shiver:]

At our March meeting, we will provide you a more detailed – not only about Henderson, but future plans for other bakeries.

[Amit Sharma:]

Got it. Okay. Thank you very much.

[Marta Jones Turner:]

Right.

[Operator:]

The next question is from Brian Rafn with Morgan-Dempsey Capital. Please go ahead.

[Brian Rafn:]

Good morning, everybody.

[Allen Shiver:]

Good morning Brian.

[Brian Rafn:]

Give me a sense – you migrate from the Southeast US, and you are heading West, North in the new territories. Are there any incremental market share cap? You talked about kind of 28.3% in your kind of legacy South markets, 14% overall. Is there any cap, from the standpoint from coming out of the South, brand loyalty with those customers, where that 28% is maybe not achievable 10, 15 years out in the other markets? Or you fully feel that your expectation is that you can push those same incremental market share that you have in the South across the US?

[Allen Shiver:]

Brian, my expectation is with time, we can develop market share in any new market across the country that are similar to what we see in the South. The reason I feel that way is because of the brand selection, team that we have in place and the fact that we are in the process of doing it now. You can look at our overall share, has gone from 12-14 on the US basis within the last several years. Now with the brands we acquired the bakers we acquired, there is no reason we cannot take the overall share up significantly. Brian, my expectation is with time, we can develop market shares in any new market across the country that are similar to what we are seeing in the South. The reason I feel that way is, because of the brand selection, the team that we have in place, and the fact that we are in the process of doing it now. You can look at our overall share, has gone from 12% to14% on the US basis, just within the last several years. And now with the brands that we have acquired, the bakers we acquired, there is no reason that we can't take our overall share up significantly.

[Brian Rafn:]

Okay.

[Allen Shiver:]

We will not be a 28% within the next several years, but we are certainly going to be moving the number north of 14%.

[Brian Rafn:]

Yes, okay. I think that's fair. You talked on your CapEx Budget, $95 million I think to $100 million, how much of that would be applied to opening incremental closed bakeries you acquired from Hostess, if any?

[Steve Kinsey:]

What we said was, we would give guidance on that at our Analyst Day in March. There is some there, but we will talk more fully about that in a couple of weeks.

[Brian Rafn:]

Okay. Can you – maybe I will ask you a little different. If you look at what you did in Henderson, how much, because when you were in Milwaukee with us, you talked about there was a standard that Flowers has, in plant quality that is not always there in the competitors. On a plant-by-plant basis on a normal size plant, what might it be in CapEx on the front end to bring the plant online, to your standards, from where it exists today?

[Steve Kinsey:]

I would say, it just depends on the condition of the facility. We have had – it has varied pretty dramatically, as we have made acquisitions over time. So to say that it is X dollars per average, really would not be a good indication. What I would say about the facilities that we have targeted to open – we will talk more about this – they are pretty good shape. So it is a modest amount. It is not anything significant.

[Brian Rafn:]

Okay, okay. All right. Is there any point, as you look out in incremental growth, where you – you might so to speak, cut bait, where you would say, look, we are growing these peripheral markets. We have these many closed bakeries. And at some point, you hit that time threshold, where you know you are not going to keep the plant, and then you start liquidating assets? I am just wondering if that is three, five years out, or might you just carry these plants kind of open-ended?

[Allen Shiver:]

Brian, we will talk more about that at the Analyst Day in New York. But as we really get a better feel for consumer demand and how fast we can grow our business, we will make decisions about some of the assets, and whether they need to be put on the market or not. We will talk more about that in March.

[Brian Rafn:]

Okay. And then just on the snack cake platform, your sense, your experience in purchasing and launching Tasty – relaunch of Tastykake – would your aptitude toward snack cakes, not just breads, snack cakes, the sweeter breads, would that have all changed in acquisitions you might look at going forward?

[Steve Kinsey:]

I would say that we will continue to look at opportunities to grow our cake business. The Tastykake brand and we mentioned it earlier, we have doubled the sales since we acquired Tasty. And our independent distributor network, our distributors like having a brand like Tastykake. It fits really well with what we are doing on the bread, buns and rolls side. So it is a category that represents opportunity for us. And we would certainly look at any opportunities out there, to continue growing our cake business.

[Brian Rafn:]

Okay. And then, if you look across all of the factories, all of the bakeries that you run, what might be your plans in 2014, kind of net hiring, headcount, and then kind of payroll, wage and salary inflation?

[Steve Kinsey:]

Could you repeat that, please?

[Brian Rafn:]

As you look at – across all of your bakeries, what might you be seeing for 2014 in employee headcount, hirings, new job hiring. And then, the second question might be what do you see for kind of wage and salary inflation?

[Steve Kinsey:]

Well, typically we wouldn't disclose any hiring plans or any increases. I would say, overall in our guidance, there is slight inflation from an employee cost perspective. It is not anything – it is low single-digit. And that typically is how we would give guidance on that.

[Brian Rafn:]

Okay. And I missed your opening comments. What are you seeing from the standpoint of commodity costs inflates and inputs? And if you do any forward buying, hedging or whatever for Flower on that?

[Steve Kinsey:]

We did say that we expect our input costs to be down for the full year. But when you look at the employee costs, and the carrying cost of the plant, its total costs will be up. And we do forward buy. We hedge our main commodities, and we are typically out four to seven months. And then, I would say, we are typically on the longer end of that, especially when the pricing gets more favorable.

[Brian Rafn:]

If we're in bread product lines, how – we know J&J snack foods. They are always doing recipe reformulations, new flavorings and that type of thing. How much of that you do on the bread side, cinnamon bread versus white bread? I am just wondering how much incremental thing, in kind of in a flat market can you drive consumer taste with new offerings?

[Allen Shiver:]

We spend a lot of time and energy on consumer research, to make sure we understand where the consumer is headed. In general, we have more new product introduction in the snack cake area than we do on the fresh bread side. But if you look at our Nature's Own brand, we have done a really nice job through the years of continuing to introduce new items, that are on trend with consumer changes and taste patterns. So that is very important, I feel it is critical to building strong brands for the long-term, and we will continue to develop new items.

[Brian Rafn:]

Thanks, guys. Appreciate it.

[Marta Jones Turner:]

Thanks, Brian.

[Steve Kinsey:]

Thank you.

[Operator:]

The next question if from Akshay Jagdale, KeyBanc. Please go ahead.

[Allen Shiver:]

Good morning, Akshay.

[Akshay Jagdale:]

Good morning. Can you hear me?

[Allen Shiver:]

We can. Good morning, Akshay.

[Akshay Jagdale:]

Perfect. Thanks. So a couple of questions – I missed some part of the call, so if I am – if you repeat anything, I will go back to the transcript. So in terms – can you help me out with the growth margins by segment this quarter? What were the gross margins for DSD and warehouse?

[Steve Kinsey:]

Gross margin for DSD was 51.5%, and warehouse was 23.9%.

[Akshay Jagdale:]

Okay. So basically, sequentially the margin for DSD went down. So you have talked and you have discussed this significantly, can you quantify the overall growing pains if you may, what impact it is having on your margins right now? So and we have talked on and off about efficiency, outside purchases, and then investments for future growth. If those are the three buckets – first off, am I missing any buckets – and if you could just quantify, help us in the ballpark, quantify what impact each of those are having currently on your margin structure?

[Steve Kinsey:]

Sure. I mean, if you look overall, there are – there have been costs as we have expanded markets. A lot of the market expansion is down in SD&A, so that would be in your net operating margin. But on the gross margin line, we have talked about some factors this quarter that affected DSD. And we also have talked about factors, such as in the warehouse, the tortilla plant that affected the last two quarters. From a – when you look at the gross margin, we are up roughly 50 basis points year-over-year. Going into 2014, we are targeting improvement in gross margin. So I would say individually, each one is probably, less than 10 or 20 basis points. So it is – I would say it is not significant individually. Collectively, they have had a pretty good strong effect on gross margin.

[Akshay Jagdale:]

So – what is your embedded expectation for margins in 2014?

[Steve Kinsey:]

When you look where we are…

[Akshay Jagdale:]

Gross margin?

[Steve Kinsey:]

We would say, we would be up roughly probably 30 to 50 basis points year-over-year.

[Akshay Jagdale:]

And that – that assumes a decline in commodity costs, and an offset from higher D&A roughly? Or it just seems like a pretty small increase, so can you help me understand that in light of your weak – ?

[Steve Kinsey:]

Well, we also have the carrying costs for the facilities that are in our – on DSD, they are in the gross margin line, and we will have a full-year of those costs, versus a half year.

[Akshay Jagdale:]

Right. But – your costs – your ingredient cost are going to be down. And your pricing in DSD seems to be stronger than I had expected, which tells me there is good pricing power in that business, relative to history. Can you just help us understand – maybe a better question is, how do you go from the margin that you have today, to what the margins have been historically? So what would be some of the buckets that would really add to the margin structure, from what you are guiding to for ‘14 longer-term? Right? There is about 300, 400 basis points that you have lost over the last what, five or six years. And you have said, you expect to get back to those historical numbers eventually. So what are the big buckets that will get you there over time?

[Allen Shiver:]

Over time, a couple of the big buckets – typically, we have talked about this – if you look at the – from the revenue perspective, we have talked about this industry, because we have done some remarkable jobs serving the market. Over the last year, we did see saw our [stale] rate move up a couple of points. So over time, we will bring that back into historical averages, because that has affected our rate, and that will probably add to that, a point or more. It is pretty strong. And the other big item that affected us over the last 12 to15 months has been the efficiencies, getting those back in line. So with the growth we had, it will be another strong driver over the next couple of years. And beyond that, when we work the carrying costs out of the equation, that will also be a big driver. So really. The three buckets are, the largest three buckets would be, sales control, efficiency gains, and making the decisions on these Hostess facilities and bringing the carrying costs down. And the three of those together would be pretty significant.

[Akshay Jagdale:]

Okay. And how would you characterize the pricing that you are seeing in the market? I know when we had you on the road – I was expecting you know 3% to 4% increase in Nielson IRi pricing to be a pretty good outcome for the year, given where wheat costs are. And so, it seems like there pricing is sticking pretty well. How would you characterize how the pricing environment right now?

[Steve Kinsey:]

The pricing that we put into place going into the fourth quarter is in place. As far as the overall promotional environment and pricing environment, really we've seen no real significant change from last quarter. Really has not improved and not deteriorated overall. There are certain markets in the country that are kind of hotspots for promotional activity and we understand were those are at. So overall the pricing environment really has not changed are medically from the last call.

[Akshay Jagdale:]

Okay. And this one, last one – I do not know if you already said this, – but what part of your business under-performed your expectations in the fourth quarter? It seemed like the cake business was weal but did the quarter come in weaker than you had expected slightly? And if so, what part of the business was specifically weaker, and why?

[Steve Kinsey:]

Okay. I don't know if you heard this, because I think you said you might have joined late. But there, we had on our SAP integration at Lepage, we had a slight misstep that cost us $0.015. That really had to do with, once we the system sin, it was kind of around the ordering process. We have gotten that pretty much worked out, so we expect to see that continue. So we did under-perform there from a DSD perspective. And then also, we talked about some cake pressure with the Hostess relaunch of the brands there. So we did see some pressure, in both DSD and warehouse, from a cake perspective. So those were the two big items I think that were different, than the warehouse issue in the third quarter that really affected the fourth quarter. But if you look at those...

[Akshay Jagdale:]

So what is on the cake side, on the cake side, what specifically happened in the marketplace that you weren't expecting? Because the view going in was, you knew Hostess was going to be on the shelves. But you felt good about your positioning, especially in the C-store channel, which is where you would gain most of the share. Was most of the underperformance in sort of the warehouse business, and what part of your expectations underperformed? Right? So what happened – they were just more promotional or your brands weren't as good?

[Allen Shiver:]

Akshay, whenever you have a major competitor enter the category, or in this case a competitor come back into the category, it has an impact. The – we saw sales impact on our Mrs. Freshley business warehouse business, we also had some short-term sales impact on our Tastykake business. So but again, we feel like that looking at the long-term, those brands are going to be just fine. And we will continue to build both brands as we expand our markets, and introduce new items and do the things we know how to do. But there was an impact with the Hostess cake coming back into the market in the short-term.

[Akshay Jagdale:]

Okay, great. Thank you for taking all my questions.

[Marta Jones Turner:]

Thanks, Akshay.

[Allen Shiver:]

Right.

[Operator:]

The final question is from Eric Katzman, Deutsche Bank..

[Eric Katzman:]

Great. Thanks for the follow-up. I will make it quick. So the long-term guidance on top line has typically assumed some kind of M&A. But from an antitrust perspective at this point, do you think that that is not really likely? And therefore guidance in the future, not to steal your thunder, guidance in the future is really predicated more on the core?

[Steve Kinsey:]

You know when you look at the long-term guidance right now – we have talked about, Allen has talked about bedding down what we have. So I would say in the near-term, even though we look at any opportunity that presents itself, we don't have – for 2014, other than the Sara Lee sales, we do not have any acquisition potential in that guidance. And then when we meet in March, we will talk about how we look at the M&A – or are thinking about the M&A environment going forward.

[Eric Katzman:]

Okay thanks.

[Operator:]

Thank you. That was the last question. Now, I will like to turn the back over to Mr. Allen Shiver for closing remarks.

[Allen Shiver:]

Good. Thank you for the interest in our Company. This past year was a record year for Flowers Foods. I want to take this opportunity to again, thank our Flowers team for the extraordinary efforts we took place in the market. We look forward to a successful 2014, and have tremendous confidence about our ability to execute going forward. Thank you for your interest.

[Operator:]

Thank you ladies and gentlemen, this concludes the Flowers Foods fourth quarter 2013 earnings call and webcast. Thank you for participating. You may now disconnect.