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Flowers Foods, Inc. (NYSE:FLO)

Q4 2012 Earnings Call

February 7, 2013 08:30 am ET

Executives

George Deese – Chairman & Chief Executive Officer

Allen Shiver – President

Steve Kinsey – Executive Vice President & Chief Financial Officer

Marta Turner – Investor Relations

Analysts

Farha Aslam – Stephens

Jonathan Feeney – Janney Capital Markets

Heather Jones – BB&T Capital Markets

Bill Chappell – SunTrust Robinson Humphrey

Akshay Jagdale – KeyBanc Capital Markets

Amit Sharma – BMO Capital Markets

Gary Wu – Fieldpoint Capital

Operator

Welcome to the Q4 2012 Flowers Foods Earnings Call. My name is Lorraine and I will be your operator for today’s call. (Operator instructions.) Please note that this conference is being recorded. I would now like to turn the call over to Ms. Marta Jones Turner. Ms. Turner, you may begin.

Marta Turner

Thanks Lorraine, and good morning everyone. Our Q4 and full year 2012 results were released this morning. If you need a copy of course you’ll find that release posted on our website. We expect to file the 10(k) on February 20th, and I also want to announce that Flowers Foods Analysts Day will be held in New York on March 20th. So we’ll send more details in a few weeks but we wanted you to have that date on your calendars.

Participating in our call today we have George Deese, Flowers Foods Chairman and Chief Executive Officer; Allen Shiver, our President; and Steve Kinsey, Executive Vice President and Chief Financial Officer.

We’ll open the call for your questions following our prepared remarks but first you know that I must remind you our presentation today may include forward-looking statements about our company’s performance. Although we believe our statements to be reasonable these statements are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters that we’ll discuss on the call today important factors relating to Flowers Foods’ business are detailed more fully in our SEC filings.

Now I’ll turn the call over to Flowers Foods’ Chairman and CEO, George Deese.

George Deese

Thank you, Marta. Good morning to each of you and welcome to our Q4 and 2012 conference call. As always we appreciate your continued interest in Flowers Foods.

It is an understatement to say that these are interesting times for Flowers Foods and for the baking industry. I know you have questions about recent announcements regarding the Hostess assets, the Flowers stock in [Ors Bid] as well as our pending acquisition of Sara Lee assets in California which are being divested by Bimbo as part of a consent order with the US Department of Justice.

Although our normal practice is to be transparent about our business and matters of interest to analysts and investors there are many questions we simply will not be able to answer for you today. I know you understand that these matters are in the legal process and for that reason, and in some instances for competitive reasons, much of what you may want to know we will not be able to discuss today. Even so, in our prepared comments this morning we will share what is appropriate about these matters.

Of course the purpose of this call is to discuss our results for the quarter and the year. Before Steve and Allen give you the detailed report I want to share my perspective with you, comparing our performance against the long-term goals we set out in 2011 for Q4 and the full year of 2012. We delivered sales growth of 14.7% for the quarter and 9.8% for the year. Excluding one-time charges, EBITDA margins were 11.5% for the quarter and 10.9% for the year and earnings per share increased 65.0% for the quarter and 7.3% for the full year, excluding one-time charges.

We continue to track well ahead of schedule on our goal to have our bread products available to at least 75% of the US population by 2016. During Q4 we did announce the agreement for Flowers to acquire the license to distribute Sara Lee and Earthgrains Brands in California. We discussed the details of that on our call in November. As we mentioned in our press release the transaction is scheduled to be completed later this month followed by a staged rollout of the acquired brands in California.

On January 29th Bimbo filed a motion with the court seeking to temporarily suspend the transaction. A hearing on this matter is set for February 13th. Beyond that we cannot comment. Also in Q4 Hostess Brands made a decision to exit the marketplace and liquidate their business. Their sudden departure from the market put Hostess retail and food service customers in a tailspin as they sought to fill the void.

Flowers team members and our distribution partners did an absolutely amazing job of serving customers in the wake of this market disruption. One of our ongoing strategies is to provide exceptional customer service and I am so proud of the efforts from our team members around the company in sales, in manufacturing, distribution, accounting, and all other departments. You can clearly see the positive impact their efforts had on our Q4 results.

On January 11th Flowers was chosen as a stalking horse bidder for certain Hostess assets and that process continues through the bankruptcy procedure under the direction of the court. We do not know and we cannot speculate on the possible outcome of the auction scheduled for February 28th. It is important to remember that any transaction resulting from the auction will be subject to regulatory approval.

What I can tell you today is that our focus remains on serving our customers, delivering a good value for consumers, managing our business and building shareholder value. I am confident in our team’s ability to do well as we maneuver through the changing competitive landscape. We started 2013 with continued strong results across all channels and we have confidence in our business as we look forward to the year ahead.

We did tell you in the press release that we are delaying giving specific guidance for 2013. However, we expect the year’s results to meet or exceed our long-term goals. Now I’ll turn the call over to Steve Kinsey.

Steve Kinsey

Thank you, George, and good morning everyone. Q4 net sales of $749 million increased 14.7% compared to the prior year. Volume was strong in the quarter, up 10.3% excluding the Lepage acquisition. This was driven primarily by new business as the result of Hostess Brands exiting the market. Price mix was down quarter-over-quarter 2%, off from strong comps in Q4 2011 and a shift of mix within our Cake group.

In order to help cover increased input costs we did see overall pricing sequentially improve late in Q3 and early in Q4. The Lepage acquisition contributed 6.4% to the quarterly growth. Lepage is performing as expected and we are pleased with the contribution from this acquisition.

As you can see, volume growth during the quarter was strong across the portfolio. Our GAAP earnings per share were $0.28 per share this quarter compared to $0.17 in Q4 last year, up 64.7%. You should note that one-time charges were immaterial to both quarters and did not affect EPS. This is a stronger finish to the year than anticipated and is primarily due to strong volume gains as a result again of the exit of Hostess Brands from the marketplace.

As expected, the Lepage acquisition contributed approximately $0.01 to the quarter’s earnings per share. Also impacting earnings per share in the quarter were higher interest expenses related to the April, 2012, public debt issuances and an increase in shares outstanding as a result of the Lepage acquisition. We also did experience a better than expected tax rate, impacting earnings approximately $0.015 in the quarter. The improvement in the rate was driven by better than expected benefits from several discreet items related primarily to state income taxes and purchase price accounting.

Operating earnings in the quarter excluding one-time costs were up approximately 67% this quarter over last year’s Q4 driven primarily by the impact of better sales volumes and earnings from the Lepage acquisition. Our gross margin in the quarter as a percent of sales increased 200 basis points to 47.9%.

This overall improvement of the percent of sales was driven by stronger sales volumes, overall production efficiency gains quarter-over-quarter and a sales mix improvement in the core business, as well as through the Lepage acquisition. Lepage contributed approximately 20 basis points as a percent of sales to the improvement.

Input costs, ingredients, packaging and natural gas excluding acquisitions were up 9.8% quarter-over-quarter. This brought the full year impact from input costs to just over 6% in line with our full year guidance. Though input costs were up in absolute dollars, as a percent of sales they were down 100 basis points.

SD&A expense as a percent of sales excluding one-time costs in both years were 36.4% this quarter versus 36.8% in last year’s Q4. The 40 basis point improvement shows our ability to leverage selling, distribution and administrative costs as we continue to grow sales through organic growth, acquisition, and expansion markets.

Turning now to cash flow, cash provided by operations was a positive $35 million in Q4. Year-to-date cash provided by operations was approximately $217 million, up roughly $83 million over the prior year. This improvement reflects a significant reduction between years in the use of cash required to fund hedge margins. Going forward, one of our priority uses of cash will be focused to pay down any pre-payable debt.

Capital expenditures during the quarter were $18 million. This brings our 2012 total spend to $67 million, down slightly from our previously planned total year spend. We paid dividends of $22 million in the quarter and opportunistically repurchased 5 million of company stock during the quarter to offset the dilutive effect of share-based comp in the acquisition.

Overall cash flow in the quarter was strong, allowing us to finance our cash needs through operating cash flows. We did end the year with $535 million in long-term debt, up approximately $250 million from the prior year. Our total debt was $607 million, up roughly $280 million over the prior year. The primary increase in debt was to fund the purchase of Lepage acquired during Q3 2012.

As George mentioned, we have deferred giving any specific guidance on 2013 pending more clarity on the Hostess and BBU transactions. As he also said, 2013 has started strong and we continue to see the same strong trends we saw at the end of 2012. We do believe we will meet or exceed our stated long-term growth guidance of 5% to 10% annual sales growth with double-digit earnings increase excluding any one-time acquisition-related costs in 2013.

Again, thank you for your interest and now I will turn the call over to Allen.

Allen Shiver

Good morning, everyone, and thank you, Steve. I want to follow up on one point that George made. He emphasized that our team members throughout the company rallied to serve customer needs when Hostess exited the marketplace on November 16th. As a reminder, that was the Friday before Thanksgiving, the start of one of the busiest weeks of the year for our customers – not a time when customers can afford to have empty bakery shelves.

The efforts of our team members across every department in every location were simply extraordinary as we worked overnight to increase production levels and provide the additional service to take care of our customers. Of course that’s the Flowers way, but under the circumstances it was truly remarkable what our team and our business partners accomplished.

As Steve pointed out, our sales and earnings results for the quarter shows the benefit of our team’s efforts. Using IRI data let’s look at the marketplace and review how the category performed in the quarter. The fresh bakery category continued the same downward trend of about a point in both dollars and units. This is the same category trend that we have observed for the past two years. I am pleased to report that Flowers branded units continued to outperform the market. Led by our own Nature’s Own brand our branded sales were up 12.9% in units and almost 10% in dollars.

That strong performance was reflected in the sales numbers we reported today. Our sales growth also translated into gains in our market share. According to IRI for the quarter, Flowers’ share of the fresh bakery category for the total US increased to 11.6% in dollars and 10.4% of units. Looking at IRI data for the first few weeks of this year we see even further improvement in Flowers branded performance and market share.

Our total food service business including DSD and warehouse was up double digits in the quarter compared to overall food service industry growth of just over 4% for 2012. In the quarter, our expansion markets delivered sales within our goal of 0.5% to 1.0% of our total sales increase. You will remember that our newest markets are in Pennsylvania. We are making good progress there as consumers get to know our brands.

You also may recall that in the fall we introduced the Tastykake and Nature’s Own to our Lepage routes in the Northeast. Our sales team, trade customers and consumers are excited about having these new brands in the marketplace. We’re also pleased with how Tastykake continues to gain traction across Flowers’ core markets. New products again performed in line with our goal to contribute 3% to 5% to sales. Some of our newest products are Tastykake Kandy Bar Cakes made with Hershey’s chocolate.

On our last call we told you that we were taking pricing of 4% to 6% that’ll cover anticipated higher input costs for ingredients and other items. We also said that we were reducing our promotional activity. The pricing that we’ve put in place in the early fall is in effect as we begin the new year, and it has been accepted throughout the market. And continuing the trend we saw in Q4, the overall level of promotional activity is somewhat lower.

When evaluating our change in price mix for the quarter, please remember that our individual snack cake business is up significantly in both our warehouse and DSD segments. This increase in snack cake sales and the related shift from multi-pack to single-serve had a significant impact on our price mix comparisons from quarter to quarter.

Looking at operations, our bakeries once again achieved improved productivity even as our poundage increased across almost all product lines. Again, it is a testament to our team’s efforts. Over the last three years we have achieved consistent improvements in our efficiency levels as we work to use our resources better than ever before, reducing our damaged products, and using our information systems and our teams’ experience to have the right products at the right location at the right time. All those factors allow us to use our existing production capacity more wisely, and that has allowed us to absorb the significant sales growth that we achieved in Q4 as Hostess exited the market.

Our new bread line at our Oxford, Pennsylvania, bakery is being installed and we expect to begin bread production on that line by late spring. That additional capacity will help us serve the growing needs of our newer markets and relieve some tight capacity in our bakeries currently serving those markets. As we continue to enter new markets and introduce new products and brands, we will need more production capacity. Our strategies for managing growth have been successful in the past and we expect them to continue to guide our future.

We continue to be very pleased with the Lepage acquisition and the integration of that business is going very well. This past quarter our team at Lepage successfully introduced both Tastykake and Nature’s Own to the marketplace. These brands were introduced during a period of time when marketplace demand was very, very high due to the Hostess situation. Congratulations to our Lepage team for a job well done.

On our Q3 call we outlined our plan for the Sara Lee and Earthgrains business in California as part of the BBU divestiture. Since then, our California team has been gearing up for the integration which is scheduled to begin later this month. I want to thank everyone who has been involved in planning for this acquisition. It’s taken a tremendous amount of work to reorganize our distribution system, add new team members and coordinate plans with our trade customers. The good news is that we are ready to go live when the transaction is completed subject to the court’s decision on February 13th.

Across the company our team members are doing a phenomenal job at a time when the marketplace is in a state of change and our trade customers need our help to serve their consumers. As George said, we realize you want to know more specifics about the business. We hope you understand that we cannot share those details today. As we move through the year and events unfold we look forward to sharing more information about the growth opportunities ahead for our company.

With that, I’ll turn the call back to George.

George Deese

Thank you, Allen. Thank you, Steve. As you can see we are focused on doing business the Flowers way. Our team understands the baked foods category and we have invested over several decades in our bakeries, our distribution systems, our brands, products, and team. Through these investments and the efforts of our team, Flowers has become the second-largest baking company in the country.

We are confident in our strategies and in our team as we manage through changes underway in our industry. But make no mistake, this continues to be a competitive category. We are constantly on watch to keep our products and brands relevant and our service high as we meet the needs of our customers and deliver good value for consumers. We look forward to seeing you on March 20th at our Analyst Day at the New York Stock Exchange. Lorraine, now we’ll open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator instructions.) And our first question comes from Farha Aslam from Stephens. Please go ahead.

Farha Aslam – Stephens

Hi, good morning. Congratulations on a great quarter. A couple of questions, the first one starting off with sales. Your sales in the quarter exceeded our expectations which is likely due to the Hostess transaction or the market share gains. But you only had one month when Hostess was really out of the market. I know you can’t give full-year guidance but we want to understand sort of the progression of sales as you’re entering F2013. Were you signing up incremental customers in the December timeframe that are going to come online in Q1?

Allen Shiver

Farha, this is Allen. It was a very busy time to say the least. We did see quite a few additional new customers come online in Q4. I would say that that continues but not at the rate that we saw in Q4. We are encouraged that looking at both the IRI data and our internal data, we are encouraged looking at the first four weeks of this year that the rate of growth is continuing and in some areas accelerating.

Farha Aslam – Stephens

Okay, so we should plan for really strong growth again in Q1. And then when we look at gross profit, it looks like you got great leverage from your facilities. What capacity utilization do you have in your facilities? Can you handle this additional volume coming in?

Allen Shiver

Farha, we’re doing a good job handling the capacity that’s in our plants today. I mentioned earlier that our Oxford bread line will be coming online. We’re also looking at other ways to make adjustments in existing facilities to get more capacity out of our plants, but as we stated we’ll continue to look for opportunities to advance with new production facilities.

Farha Aslam – Stephens

Okay, and my final question is really on the SG&A line. It looks like you got more significant leverage on the gross profit line versus SG&A. Could you just share with us are there expenses in SG&A that you’ve taken on as a result of these changes in the market?

Steve Kinsey

Farha, this is Steve. When you look at SD&A a lot of the distribution costs is down there so getting the product to the market, there was some cost incurred with that as well as we began to ramp up in California as Allen said in his comments. And there’s been significant cost associated with that as well.

Farha Aslam – Stephens

Could you quantify that, Steve, particularly that California expansion cost roughly?

Steve Kinsey

For competitive reasons I would say we probably don’t want to get into the details of that but it has been pretty significant.

Farha Aslam – Stephens

Okay, that’s helpful. Thank you.

Operator

Thank you. And our next question comes from Jonathan Feeney from Janney. Please go ahead.

Jonathan Feeney – Janney Capital Markets

Good morning, thank you very much. Nice quarter. I know it’s premature, we haven’t had a court decision but I guess if you can walk us through to the extent you can comment philosophically how you’re looking at both the share gain and potential assets you’re going to be potentially integrating here. I mean are you going to, is it going to be a traditional Flowers business model of all owner-operators? I mean is that the sort of company philosophy you’ve implemented in past acquisitions and you know, how flexible would you be as far as taking on some of the legacy business practices of any of those assets? Thanks.

George Deese

Jonathan, thank you for joining our call today. I know this is your first time on this particular call.

Jonathan Feeney – Janney Capital Markets

It certainly is and I’m happy to be here.

George Deese

Thank you. You know, we did say upfront there’s just some things we cannot talk about. As you know, this has been handled in bankruptcy court and it’s very technical and legal. So we can’t speculate on the future because things are not final, not only from the court standpoint but also for competitive reasons that we just can’t comment on that beyond what we already said.

Jonathan Feeney – Janney Capital Markets

Okay. I guess then let me ask a more broad question from this existing quarter. This industry big picture has been experiencing consolidation I think that’s been positive for a long time and yet you look at the margins of different operators, they’ve been slowly increasing but slow to really move. With the disappearance, clearly you picked up some business and it was a great tailwind to the great sales you did this quarter but are you seeing any signs that there’s more rationality out there now – not just obviously that there’s more rationality among Hostess because they’re not there but more rationality from maybe third-tier players that would control the low end of the market? Thank you.

George Deese

Jonathan, thank you. What I will say, I think if you look at IRI you can form your own opinion on that is what I would point you to. I’d rather not comment on what our competition is doing. We’re focused on what we’re doing and that is giving great service to each individual customer as Allen pointed out and filling the void that is out there. And we are so pleased with our people and what they’ve accomplished, and they’re doing a great job and I appreciate them so much.

Jonathan Feeney – Janney Capital Markets

Great, well thank you very much. It’s clearly working.

Operator

Thank you. And our next question comes from Heather Jones from BB&T Capital Markets. Please go ahead.

Heather Jones – BB&T Capital Markets

Good morning. I wanted to go back to the SG&A question and you mentioned, I mean from what I understand your IO costs are pretty much a set percentage. So in taking on the new Hostess share gains during the quarter, what incremental distribution costs should we be thinking about that were in there for the quarter? And I’m not talking about related to California but just with the new Hostess share gains, and are those going to continue into Q1? I’m trying to think about how we should think of leveraging your overhead structure.

Steve Kinsey

Yeah Heather, if you recall the distribution from our manufacturing facilities to our distribution centers, that’s ramped up quite a bit to get the additional volume into the marketplace so that would be the primary driver of the distribution cost increase. So you’re correct in your assumption on the discount structure – that is a relatively cost of percentage compared to sales. The big driver would be transportation from the plants to the distribution centers.

Heather Jones – BB&T Capital Markets

And is that a cost that’s going to be a large headwind in Q1 or was it just ramping up in Q4 and now we should see more leverage of the overhead line?

Steve Kinsey

Yeah, I think you’ll see it continue to ramp up slightly, I don’t think anything significantly different over Q4.

Heather Jones – BB&T Capital Markets

Okay, I’m sure you know where I’m headed with this. When you’re leveraging in this new business into your plants you’re [far about it] – you’re getting good left gross margin line. But it doesn’t look like if you look at SG&A year-on-year you didn’t get much more leverage than you had in Q1 through Q3 despite a really dramatic increase in volume, which intuitively doesn’t make sense given you would think a lot of your overhead is fixed and can be leveraged. So I know you can’t talk about the acquisition, you don’t want to give guidance but how should we be thinking about when should that overhead leverage really kick in?

Steve Kinsey

From the admin perspective I think we did a good job leveraging that. And then there were some higher workforce-related costs in that number; again, as we’d taken on some additional responsibilities to get product into the marketplace. From a comp perspective year-over-year there’s some slightly higher workforce comps as well so again, the primary drivers of it have been workforce costs as well as distribution costs. Some of that’s related to fuel – you’ve seen fuel prices move up and down so that’s a driver as well.

Our targeted SD&A as a percent of sales is somewhere around 36%, 35% to 36% so we’re not far outside of that range and we should be able to continue to see that improve. And also the Lepage acquisition is still being integrated so there are some duplicate costs there from an administrative perspective.

George Deese

The other thing I would comment on, as you know in Q4 we had two holidays and anytime you have holidays there’s always some added costs in that process and sometime sales fall off during those two holidays. So that also contributed I think.

Heather Jones – BB&T Capital Markets

And we’ve heard of some companies prepaying bonuses to get ahead of tax increases. Did you guys do any of that?

George Deese

We did not.

Heather Jones – BB&T Capital Markets

Okay. And then your corporate expense line which is tied into the SG&A discussion, that went up over 50 basis points year-on-year. Is that the line item where we would see these costs associated with California or what would be in that line item that caused that increase year-on-year?

Steve Kinsey

Yeah, all of the acquisition costs primarily would be reported there so any additional legal fees related to M&A or legal fees related to what’s going on with the courts would be recorded at the corporate level.

Heather Jones – BB&T Capital Markets

Okay. And my final question is you all talked about pricing kicking in but the pricing in DSD as far as on a year-on-year basis wasn’t as positive as it was in Q3 which I would have anticipated it being more positive, and given that you rolled through some new price increases. Was there a mix impact during the quarter or did I misunderstand the timing of when those price increases would hit? Or can you give me some help on that?

Allen Shiver

Heather, this is Allen. As you remember early in the year we took pricing, and as we went through the year promotional activities really heated up. As I mentioned, we saw that fall off as we moved into Q4 – late Q3, Q4 – and I think that it makes the year-over-year comparison for the quarter a little confusing. I think also the comment about the single serve snacks, we have picked up a significant amount of Tastykake snack cake business in convenience stores and other outlets that when you do the math on a per unit basis it brings that average price down as well. But I think the biggest factor was kind of the spike of promotional activity as we went through the year and then that promotional activity level has come down as I mentioned earlier.

Heather Jones – BB&T Capital Markets

Was it still aggressive at the beginning of Q4?

Allen Shiver

We were seeing price promotions reduced in the beginning of Q4.

Heather Jones – BB&T Capital Markets

Okay, thank you so much.

Operator

Thank you. And our next question comes from Bill Chappell from SunTrust. Please go ahead.

Bill Chappell – SunTrust Robinson Humphrey

Good morning. Can you talk a little bit about I guess the market share gains? I’m just trying to understand and I’m not sure that you can answer this, but kind of the overlap of your markets versus Hostess’ markets? And how much do you think, barring future transactions how much of this do you think is sustainable, that you can hold onto in the existing markets?

George Deese

Bill, I think that’s hard to say. You know, we could sustain it all but there’s no way we could predict that. All I’ll point back to is our exceptional service and our distributors do a great job in the marketplace, have great relations at all levels with our customers. So we’re all in as you well know in trying to make sure we do a great job but I wouldn’t give any guidance on the market share issue.

Bill Chappell – SunTrust Robinson Humphrey

And then just trying to understand the competitive dynamic – have things continued to get better or more rational as we’ve moved into 2013? Do we now with several months behind us think that the worst is behind us of this kind of four-year issue?

Allen Shiver

Bill, are you referring to promotional activity?

Bill Chappell – SunTrust Robinson Humphrey

Yeah, like the buy one get one free and heavy promotions and deep discounting and that sort of stuff.

Allen Shiver

I would say the reduction in promotional activity that we saw in Q4 is continuing as we go into the new year. I would not say it’s dramatic. I would say there is a reduction in promotion activity and we’re seeing a continuation of that.

George Deese

Bill, I did say in my remarks that this has always been a competitive environment and I think it’ll always be a competitive environment because it’s so important to the grocers, it’s so important to the consumer that the top people in the food industry are always focused on bread, eggs, milk, etc. And for that reason I think you’ll always be competitive even though as Allen said there has been some improvement.

Bill Chappell – SunTrust Robinson Humphrey

And then just one last housekeeping one: I think last quarter you talked about the SG&A from Lepage. Can you maybe give us an update for this quarter on what that was and then how Lepage is going in terms of integration?

Allen Shiver

Overall, Bill, the Lepage integration is going very well. And then from an SG&A perspective, I think it’s very similar to the last quarter. I don’t have that in front of me, Bill.

Bill Chappell – SunTrust Robinson Humphrey

Okay, but you think last quarter is a good gauge?

Allen Shiver

Yeah, last quarter would be a good gauge.

Bill Chappell – SunTrust Robinson Humphrey

Okay great, thank you.

Operator

Thank you. And our next question comes from Akshay Jagdale from KeyBanc Capital Markets.

Akshay Jagdale – KeyBanc Capital Markets

Good morning and congratulations on a good quarter. Just can you share with us what the gross margins were by division? I know you put those out in Q3 but can you help us with that? I’m trying to get a better sense of what drove the consolidated gross margin up 200 bps, if it was more DSD or warehouse.

Steve Kinsey

During the quarter, Akshay, we had strong improvement in DSD. It was up roughly 200 basis points kind of in line with the consolidated total. And then warehouse, if you recall last year margins were down pretty significantly but it was up almost 400 basis points but it’s just a lesser percent of the sales. But it was strong growth across the whole.

Akshay Jagdale – KeyBanc Capital Markets

Okay, that’s helpful. And in terms of the gross margin performance as you went through the quarter, was it better in the back half? I would assume it was directionally – would that be a good way to think about it?

Steve Kinsey

Yeah, it improved as the quarter progressed.

Akshay Jagdale – KeyBanc Capital Markets

Okay. And since you last gave guidance or talked publicly, wheat costs have come down. What can you say about the cost of goods sold or commodity inflations for 2013?

Steve Kinsey

If you recall on the last call I believe we said it would be low- to mid-single digit increases on input costs and that’s still true. Even though it has pulled back some slightly we have good visibility into the first half of the year and the back half is still the open period, but beyond that we wouldn’t talk specifically about the percent at this point.

Akshay Jagdale – KeyBanc Capital Markets

Okay. And so if I think of, I know you don’t want to be specific and I appreciate that, but if you help me just with the drivers of gross profit specifically let’s say on DSD, you talked about the direction of their volume and sales growth continuing to be strong. You mentioned IRI, you mentioned your branded sales so volume seems to be up double digits in recent months for your bread business. Commodity inflation is in check. What else, in terms of the promotional activity what we’re hearing is that regionals are continuing to be very competitive especially in this environment and even though Hostess is no longer producing bread and was highly promotional some of these gains that you have in terms of market share you still in the first six to nine months have to honor some of those contracts. So what I’m really trying to say is the impact if there is any of reduced promotional activity is probably a little bit of a longer term issue. Is that a fair way to think about it?

Steve Kinsey

I’ll comment real quick on the margin and I’ll let George or Allen comment on the promotional activity. The volume within our plants is doing a lot of overhead coverage so that was also a contributor to the gross margin improvement, and as Allen said we have some additional production capacity that’s in the works. I think over time running the plants at this level from an efficiency standpoint has been good. We had strong gains in the quarter so that was also a contributor to the quarter, and we should continue to see that coming into 2013. And then on the question regarding promotional activity I’ll let Allen or George follow up on that.

Allen Shiver

Akshay, on our branded promotional activity there are no contracts. I mean that is just how we run our business based on marketplace pressures and marketplace needs, so I’m not aware of any contracts on branded promotional activity. And I would say that as we said earlier, the trend that we saw in promotional activity in Q4 continues as we’ve moved into the new year, which is slightly downward.

Akshay Jagdale – KeyBanc Capital Markets

Okay. And this is obviously publicly available data – Hostess has been reporting monthly financials. The difference between their gross and net sales was somewhere around 24% most recently, it used to be around 10% a few years ago from what I know. Can you help us directionally understand if that’s a high number or a low number because in the past I believe Flowers has talked about promotions in DSD being somewhere around 5% of sales. So I don’t think those two numbers are comparable but I’m just trying to get a sense of how promotional was this company that just is in the process of liquidation?

George Deese

Akshay, we’d rather not comment on Hostess’ business. I mean that’s still their business even though they’re out of business. What I’d say would be that we’re again focused on our business, our margin structure and our business model and that is our only direction we can go in at this point.

Akshay Jagdale – KeyBanc Capital Markets

Okay, and just one last one on capacity within your plants. I was under the impression you were operating pretty close to 100% capacity so I’m actually quite impressed that you were able to produce 10% more volume without adding new plants. Can you help me understand that? How much flex capacity do you have and what are your utilization levels now?

Allen Shiver

Yeah, I wouldn’t say what we have available but what I would say is what we’ve always said about capacity is when we talk about the 100% that’s 120 hours on bread and buns as we look at full capacity. As you know, there’s 168 hours in the week so that yields flex, and so trying to come to grips with you with that I’d just point out from 120 to 168 – that’s not saying we’re at 168 hours, we’re not there by the way – but I think this goes to show how efficient our plants are. And as they take on new volume it really goes and helps the overall bottom line and margin process and we’re real pleased with that. But I’d rather not get any further into how much is available going forward.

Akshay Jagdale – KeyBanc Capital Markets

That’s helpful, I’ll pass it on. Thanks a lot.

Operator

Thank you. And our next question comes from Amit Sharma BMO Capital Markets. Please go ahead.

Amit Sharma – BMO Capital Markets

Hi, good morning everyone. Allen, I just wanted to take another shot at the market share discussion. Our understanding is that the bakery contracts, the supply contracts are longer-term. Is there any time associated with the contracts that you have gotten since the Hostess liquidation?

George Deese

I’m going to let Allen follow up on the issue about share. What I would say, as you look out on promotions a lot of times that can be twelve weeks in advance sometimes depending on the customer. That’s not contractually but it is an obligation once you tell a customer what your plans are. Most customers want at least 12 weeks, some want 24, so that’s not contractual. You can call it contractual but it is agreed upon that you plan on running these promotions and specials for X time. So Allen, you can follow up on the market share

Allen Shiver

I would just say on market share we did see the growth that I mentioned in my comments in Q4, and looking at our growth rates as we move into the new year we’re seeing slight improvements over those share gains that we generated in Q4. So we’re very optimistic about being able to maintain and hopefully improve the rate of sales growth that we saw in the quarter.

Amit Sharma – BMO Capital Markets

Got it. And then I understand that the Hostess situation is still not fully resolved but Steve, thinking ahead is there any way you could take a proactive position in the commodities market expecting the sort of volume hat will come your way if this goes as planned?

Steve Kinsey

When we look at it from a purchasing perspective, Amit, we would be very conservative about how we look at this until we have some more clarity from the courts on where we’re headed and where the process ends up. It would be dangerous to take on more coverage than you actually needed if something were to fall out so we’re taking a conservative approach on that.

Amit Sharma – BMO Capital Markets

Sure, that makes sense but I just want to understand, the risk if that if you are not protected on your commodity needs for this volume there is a risk that you might be more exposed to spot markets at least for that volume. Is that fair?

Steve Kinsey

Again, I wouldn’t want to comment on specific coverage for competitive reasons but there’s always a risk that the markets move quickly because there’s a lot of volatility in the commodities market. So you have to manage that as you see appropriate.

Amit Sharma – BMO Capital Markets

And just one more: now in this improving competitive environment is it fair to say that it’s easier for you to get 4% to 6% of pricing going forward? Or are we still in sort of flux?

George Deese

Amit, as you heard us say we don’t just go out and put price increases out. There’s always a reason that we have to look at pricing and that is always driven by what’s going on on the cost side from maybe labor, maybe commodities which is the main reason. (Inaudible) will be an issue going forward as we all know so there’s always going to be something going on and when it does you have to take a look. But our number one effort is always looking to see are there ways we can continue to be more efficient, reduce costs so that the customer and consumer doesn’t have to have the full impact of what’s going on in the marketplace.

Amit Sharma – BMO Capital Markets

Alright, thank you very much.

Operator

Thank you. And our next question comes from Gary Wu of Fieldpoint Capital. Please go ahead.

Gary Wu – Fieldpoint Capital

Hi, can you just give us an update on how the regulatory process on the Hostess bread brand is going? Do you anticipate needing to make any kind of divestitures or face any other hurdles? And finally, do you think the transaction will be treated differently by regulators because it’s a distressed asset sale?

George Deese

Gary, again thank you for joining us today. As we said early on this matter is handled by the bankruptcy court, it is legal proceedings and we really don’t want to comment or speculate about what will happen during this process. So I just want to leave it there because it is complex and we’d just rather not get there.

Gary Wu – Fieldpoint Capital

Okay, that’s fair. One other quick one: can you just explain why Bimbo wanted to back out of the Sara Lee/Earthgrains transaction?

George Deese

I’d go the same way. I can’t speculate on what their decision was on that.

Gary Wu – Fieldpoint Capital

Okay, that’s all I had. Thank you.

Operator

Thank you. And I will now turn the call over to Mr. Deese for closing remarks.

George Deese

Thank you, Lorraine, and thank you for joining us today. It’s exciting times at Flowers Foods and we look forward to seeing you all on March 20th, and we look forward to doing business the rest of the year and years to come. We feel like we’re in a unique time in the history of our company and we’ll continue to add value to our shareholders. Thank you so much.

Operator

Thank you. And thank you, ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.

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