Flowers Foods' (FLO) CEO Allen Shiver on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Flowers Foods, (FLO)

Flowers Foods, Inc. (NYSE:FLO)

Q2 2014 Results Earnings Conference Call

August 12, 2014 8:30 AM ET

Executives

Marta Jones Turner - Executive Vice President, Corporate Relations

Allen Shiver - President and CEO

Steve Kinsey - Executive Vice President and CFO

Analysts

Farha Aslam - Stephens

Eric Katzman - Deutsche Bank

Sarah Burns - Findlay Park

Bill Chappell - SunTrust

Akshay Jagdale - KeyBanc

Amit Sharma - BMO Capital Markets

Operator

Welcome to the Flowers Foods' Second Quarter 2014 Earnings Call and Webcast. My name is Ellen, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

Please note that this conference is being recorded. I will now turn the call over to Ms. Marta Jones Turner. You may begin.

Marta Jones Turner

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

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

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

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

Allen Shiver

Thank you, Marta, and good morning, everyone. Our results this quarter were below our target, primarily resulting from growing pains associated with our expansion plans, combined with a very competitive marketplace.

Given all of the activities this past quarter, it’s important to keep perspective. Over the past two years, we have substantially increased our market share by acquiring brands of bakeries that allow us to expand in the new territories, as well as build our share in existing markets.

As we pursue these opportunities, we will continue to experience cost headwinds that will abate as we establish our sales in our new markets and optimize the operation of our new facilities.

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

Let’s talk about more about the quarter’s results. Clearly, we experienced pressure on the topline, which was impacted by promotional activity, Hostess cake return to the market and lower store brand and foodservice sales.

But before I discuss those factors, I will say, we are encourage that sales of our acquired brands, Wonder, Home Pride, Butternut and Merita were up about 35% from first quarter. In our new markets, sales doubled from last year’s second quarter up $21.4 million.

The contribution to sales of our new products was solid. Our DSD branded bread, buns and rolls business was up 3.1%. These successes show that while marketplace dynamics are pressuring our topline, we have fundamental brand and operational strengths that will continue to drive our growth.

Now let’s discuss the factors that contributed to the sales decrease. From a broad view we see the consumer spending remains under pressure. The level of promotional activity across all food categories is much higher than normal.

In most categories, including fresh bread, the increase in promotional activity is not driving growth in category volume. Promotional activity in fresh bread was high in the quarter. Our percentage of product sold on promotion was higher than normal, reducing our average price per unit.

In recent weeks, we have made progress reducing the number and the depth of our promotions. Our goal is to return to a more normalize level of promotions by quarter four of this year.

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

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

IRI shows at store brand loss unit and dollar share in the quarter, that category shift accounts for part of the decline in our store brand business and we also gave up some profitable store brand volume from unprofitable store brand volume during the quarter. We also exit some low margin foodservice business.

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

Another impact to our topline sales came from Hostess cake and their growing penetration in the market. Prior to the reintroduction of Hostess cake in July of ’13, we gained a significant amount of new cake business. As a reminder, our market share of the cake category increased from 5.7 to 8.6 when Hostess entered in the market.

Although, we have maintained a good portion of our cake sales, in the second quarter we’ve got a stronger impact from Hostess cake as increase distribution with several key customers.

While our sales are under pressure due to the return of Hostess cake, it is important to note that our share of the cake category is still 6.7 up a 1 point from 2012. This comparative pressure does not change our enthusiasm for the cake business.

Since we acquired Tastykake in 2011, our cake sales have increased significantly. Tastykake retail sales are annualizing at $460 million up $35 million from last year. Our strategy is solid. We will grow our Tastykake brand as we leverage the distribution strength of our DSD route structure to offering outstanding customer service and exceptional product quality.

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

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

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

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

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

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

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

We are seeing improvements in our production efficiencies compared to the second quarter of 2013. We continue to take further actions to improve our manufacturing productivity.

For example, we have reached an agreement to sale our Fort Worth tortilla facility, which has had a negative impact on our production facilities -- production efficiencies. We are in the process of relocating too of the Fort Worth Flowers tortilla lines into core Flowers bakeries.

We remained positive about the growth opportunity in the retail tortilla category. Sales of the Fort Worth facility will reduce our overall costs while significantly improving manufacturing facilities.

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

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

The introduction of Cobblestone Bread Company is a good example of our ongoing investment to the future. After a successful test market period, we are in the process of introducing this new brands system-wide.

Our sales and marketing teams are excited about the opportunity to position Cobblestone Bread Company’s specialty breads and rolls for growth in segments of the bakery category where we are currently under developed. No doubt, these investments in our future certainly impacted earnings in the short-term. However, we are confident that will help us build value overtime.

I believe it’s important to look ahead to be certain Flowers Foods as a brand, the products and the bakeries, and most importantly, the team employees to continue building our sales and earnings. Not just this quarter or this year, but the years to come.

Before I turn the call to Steve, I want to say that I appreciate the efforts of our team during the quarter, which is successful start-up of production lines at our Henderson and Knoxville bakeries, our newest production capacity in Modesto and at other bakeries continues to show improvement.

Our team members and distributors in new markets also did a great job in growing sales of our branded products. We have the best and the most experience team in the industry that is committed to overcoming these near-term challenges, while staying focus on achieving our long-term goals.

I will now turn the call over to Steve Kinsey to give us a financial report. Steve?

Steve Kinsey

Thank you, Allen, and good morning, everyone. As you can see from result and as Allen discussed, the quarter was a challenge. Our overall margins were impacted by pressure on the topline and added costs.

We did have non-recurring items in the quarter as well and asset impairment related to our Fort Worth tortilla operations, which I will discuss more fully in a moment. On the positive side, as Allen said, we are encouraged by the improvements we have made at our Lepage operation during the quarter.

Turning to the quarter’s results, sales in the quarter were down 2.3%, a positive net product mix of 0.6% was offset by decrease volume of 2.9%. The slightly positive price mix was driven primarily by positive mix shift.

Overall, pricing was down due to promotional activity. Volume declines resulted from branded and store branded cake, as well as declines in store branded bread, buns and rolls. Despite encouraging results in our expansion market, our core market sales were pressured by the reintroduction of Hostess cake and a strong promotional environment.

Our DSD branded retail business had mix performance, growth in our branded bread, buns and rolls do not offset declines in branded cake and promotional core market. Our expansion market representing 5.9% of total DSD sales performed well and contributed growth of 2.9% to the overall DSD business.

Our Warehouse business had a 13.3% quarter-over-quarter decline in sales, driven primary by decreases in snack cake and foodservice. The Warehouse branded cake business and the store brand business both continue to be negatively impacted by Hostess cake brands.

Also during the quarter, we exited less profitable foodservice business, which contributed to the decline in sales for the Warehouse segment. In total our cake business was down 12%. Our DSD cake business was down approximately 11% and our Warehouse cake business was down roughly 13%.

As Allen stated, however, our share is 1 share point from just prior to the Hostess exit in the cake market in late 2012 and as a reminder today, in late July, we did cycle the re-launch of competitive brands.

Adjusted for the asset impairment this quarter and the acquisition related costs incurred last year, adjusted operating earnings or EBIT was down 13.3% compared to last year’s second quarter.

Adjusted EBIT margins were down 100 basis points year-over-year to 8% of sales. A slight increase in gross margin as a percent of sales is more than offset by higher selling distribution and administrative costs as a percent of sales.

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

The acquired facilities carrying costs and additional interest expense from the acquisition negatively impacted earnings per share by $0.02 this quarter compared to the prior year. A lower tax rate in the quarter positively expected earning per share about $0.005 to $0.01 per share.

We did see gross margin improvement quarter-over-quarter. Gross margin was 47.8% compared to 47.5% on last year’s second quarter. The 30 basis points improvement as a percent of sales was driven primarily by lower ingredient costs, lower outside purchase as the percent of sales and better product mix. These improvements were partially offset by lower than anticipated revenue, higher cost related to return products of sales, higher packaging workforce and utility costs.

Carrying costs related to the acquired Hostess facilities reduced gross margin by 30 basis points, while start-up costs related to the Knoxville facility, the Henderson bun line and Modesto bread line further reduce gross margin by 20 basis points. The topline was pressured by volume declines in our cake business promotional activity and both core and expansion market and our exit from certain low margins business.

Higher than planned promotional activity significantly impacted the net price during the quarter and led to the overall price decline. Promotional activity also negatively impacted margins. As Allen stated we are taking actions to correct promotional activity and expect to see reductions in promotions not the beginning of the fourth quarter.

Cost related to return product or what we terms as sales continue to run above historical averages. Driving this increase is this introduction of the acquired brands, new products and accelerated pace for entering in new markets and the overall promotional environment. So focusing on product mix and promotional activity should allow us overtime to bring these costs in line with overall expectations.

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

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

During the second quarter we continue to work through integration issues with the Lepage acquisition. As Allen said, we have made great improvement in laying the issues related to immigration and SAP conversions are behind us. Compared to last year’s second quarter Lepage’s operating earning before tax was down approximately $4.7 million.

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

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

Selling, distribution and administrative costs in the quarter were 36.4% of sales compared to adjusted 35.7% of sales in last year’s second quarter. The primary driver of this 70 basis point increase was higher distributor discount as a percent of sales.

This increase was not completely offset by a decline in workforce related costs due to ongoing costs related to market expansion, route conversion and an increase headcount resulting from our growth.

We are in the process as Allen stated in exciting the tortilla operation in Fort Worth. The operational impact in the quarter was approximately $3.3 million pretax loss or $0.01 per share.

We also recorded an asset impairment during the quarter for $4.5 million or slightly more than $0.01 per share. The impairment was the result of the write-down certain equipment and intangible at this facility.

The impairment was driven by shutting down of certain core entity alliance and exiting business of certain customers. We do have a singed contract to sell the facility and certain reduction equipment and anticipate an additional pending or surcharge once the deal closes, which we expect will be in the third quarter.

Turning to the balance, cash flow in the quarter was strong. Cash flow provided by operation was a positive $51.1 million and year-to-date we have paid down $95.9 million of debt, ending the quarter was approximately $826 million in debt.

At the end of the quarter our debt-to-EBIDTA ratio based on the trailing 12-month EBIDTA was 2.1 times. During the quarterly we also paid dividends of approximately $25 million and funded roughly $21 million in capital expenditures.

We continue to focus on debt repayment. You will see in the Q that we increased the size of AR securitization from $150 million to $300 million at the end of the -- after the end of the quarter. Given the favorable rates associated with this debt instrument, we now have more flexibility to manage our overall debt costs. In the quarter we did not buy any stock so we have approximately 8.5 million shares remaining on the current authorization.

Turning to our outlook for 2014, based on our year-to-date results and looking forward, what we believe continues to be a competitive market in the near-term we are adjusting our 2014 guidance.

We now expect to sales range of $3.88 billion to $3.94 billion. Revenue growth of 3.5% to 5% over 2013 and expect an adjusted earnings per range of $0.92 to $0.98 per share, an increase of just about 1% to 7.7% over the prior year adjusted earnings of $0.91 per share.

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

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

From an ingredient perspective, if we specifically isolate our last half 2014 flour, we expect to see only modest tailwinds compared to the last half of 2013 and the first half of the year. It is important to note that weak future prices have been moving lower, other key variables such as basis and meal feed have moved in the direction that has not been beneficial to flour prices.

We expect those two variables negatively affect our overall net flour costs by continuing to partially offset the benefits for the decline in wheat futures. In an effort to help mitigate price volatility we are on the long end of our four to seven months hedge guidance. We are beginning our 2015 planning efforts so it will be pre-matured today to comment directly on 2015 costs.

Let me close by saying we remained committed to our long-term goals. I’ve confident that we can significantly draw stronger margins, through better management and promotional activity, reducing costs related to return product of sales, continuing to drive efficiency improvement and eliminating the majority of the planned carrying costs related to acquired Hostess facility. By focusing on cost reduction and leveraging sales through our brands and market expansion, we should be able to return or improve to our historical margin overtime.

Thank you for your continued interest in Flowers Foods and now, I’ll turn the call back to Allen.

Allen Shiver

Thank you, Steve. Before we take your questions, I want focus your attention on five key reasons, why our team has conference in the future growth of our company. First, we have the brands that consumers are looking for.

Our Nature’s Own brand is the number one brand in the category with three of the top five SKUs nationally. Strong regional brands like Sunbeam and Bunny continue to support our business in the class white bread sales.

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

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

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

Customers, our trade customers both retail and foodservice, they are very much aware of consolidation is taking place in the bakery category. Customers know how important fresh bakery is for their success and more than never they are showing consistent support for Flowers Foods.

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

These are just five of the many reasons why we’re confident that we will achieve our long-term goals. We remain enthusiastic about Flowers Foods opportunities to grow in the package bread and the cake categories.

Thank you for your attention and we’ll now open the line for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Farha Aslam with Stephens. Please go ahead.

Farha Aslam - Stephens

Hi. Good morning.

Allen Shiver

Good morning, Farha.

Farha Aslam - Stephens

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

Allen Shiver

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

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

Farha Aslam - Stephens

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

Steve Kinsey

Farha, this is Steve. When you look at -- we currently have contracts on three or four of those. We anticipate we may be able to close one or two by the end of the year that could roll into the beginning of the next year. But we are working to continue to build a facility. We have some roughly 11 or so warehouses for net proceeds of just between about $5.5 million this year. Basically no gain related to that because of accounting -- purchase price accounting, you basically set the basis at the purchase price. So we are encouraged that we have the contract on the three or four facilities.

Farha Aslam - Stephens

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

Steve Kinsey

Yes, when we look at the negative impact of Leo’s has been in 2015…

Farha Aslam - Stephens

Yeah.

Steve Kinsey

Yeah, if you look at the quarter, there are roughly $3.3 million negative impact. We’ll continue to see some cost in the back half as we -- until we sell that facility. And then we have some cost related to moving -- we are moving two of the Flower lines to Flower’s legacy facilities. So there will be some cost with that. Hopefully as we work through the issues, that cost will come out next year but we do anticipate some cost in the back half of this year.

Farha Aslam - Stephens

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

Steve Kinsey

Roughly, in 2014 -- it’s going to be roughly about $5 million to $6 million.

Farha Aslam - Stephens

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

Steve Kinsey

You look for the four years, we are -- hopefully all the issues are behind us. Coming into the first half, it was roughly $6 million or so total cost and then in the back half, it will be neutral with the back half and hopefully positive as we make improvements. So overall --part of the cost at Lepage is we have entered a new market as well. So there is not quite comparisons of apples-to-apples, so we are continuing to incur some costs there related to the new markets. So that is why it has taken also more time to bring it back up to what you saw at the acquisition.

Farha Aslam - Stephens

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

Steve Kinsey

Right, you’re right, 2015 versus ‘14. Yeah, that’s a good point.

Farha Aslam - Stephens

Great. That’s helpful. Thank you.

Marta Jones Turner

Thanks Farha.

Operator

The next question is from Eric Katzman with Deutsche Bank. Please go ahead.

Eric Katzman - Deutsche Bank

Hi. Good morning.

Allen Shiver

Good morning Eric.

Eric Katzman - Deutsche Bank

Let me just start off with kind of the balance sheet cash flow side of things. After a great performance after Hostess' bankruptcy, the company has struggled a bit over the last let's say nine months, the stock has been really weak. And yet despite a leverage ratio that’s very reasonable and strong free cash flow based on how the Hostess acquisition was done, you only increased the dividend by, what was it, 6%, 7%. So why shouldn't investors look to the company to be more aggressive with the free cash flow to reward them when the income statement side of things is very disappointing?

Steve Kinsey

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

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

Eric Katzman - Deutsche Bank

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

Allen Shiver

Eric, we are very excited about the growth of Tastykake. As we’ve mentioned in our last call, our focus is building our Tastykake brand. Monday morning quarterback, you can look back it would have a good movement about Hostess cake. I’m very comfortable with the decision that we made.

In long term, our DSD structure will help us build Tastykake into a very strong national brand. So looking back on it, I have no regrets here. Anytime you have a major competitor come back in the market like Hostess Cake, there’s going to be an impact. I think in our deck we have a nice comparison, a three-year comparison of where we were prior to the Hostess’ reintroduction.

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

Eric Katzman - Deutsche Bank

Okay. Last question, obviously what we're seeing today with the promotion is pretty broad based across the industry. You mentioned it is pretty ineffective. So a lot of other companies are taking that reality and announcing restructuring to cut cost to have more firepower to deal with the promotion. I guess the history of this category is that when things go bad in promotion they have lasted a lot longer than you have hoped for in forecast. So kind of following up on Farha's comments, it seems like investors are doubting that the promotion is going to turn around for the better. So what are you doing to reduce cost to give you the firepower in the market to compete unfortunately on a price basis?

Allen Shiver

Eric, we’re looking at all elements of cost. And if you go back and look at the amount of growth we’ve had over the past three year, obviously we’ve added cost in many different areas. Now, as the time, we’ve got our team focused on simplifying our offense, making sure, we look at every part of the operation to eliminate excess of cost.

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

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

Eric Katzman - Deutsche Bank

Okay. Thanks. I’ll pass it on.

Allen Shiver

Thank you.

Operator

The next question is from Sarah Burns with Findlay Park. Please go ahead.

Sarah Burns - Findlay Park

Good afternoon.

Allen Shiver

Good morning Sarah.

Sarah Burns - Findlay Park

Good morning.

Steve Kinsey

Hello, Sarah.

Sarah Burns - Findlay Park

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

Allen Shiver

The promotional activity that I mentioned is really company wide. Some markets are little harder than others. But overall, the level of promotional activity is harder than we’d like to see.

Sarah Burns - Findlay Park

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

Allen Shiver

You’re exactly right. Consolidation in the industry, the category should become irrational. But eventually we feel that we will see that. We are hopeful that it happens I the back half. We are focused on making sure that we don’t have excessive promotional activity and the promotions that we are running are effective.

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

So this is a category that has some unique characteristic. And I’m really optimistic as retailers focus more on category management. They have a better understanding that price promotion to an excessive degree is not good for any one here.

Sarah Burns - Findlay Park

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

Allen Shiver

There really -- there were two elements that impacted our private label sales. Number one, the excessive brand equity on promotions pull some volume from private label and also we elected to walk away from some unprofitable private label during the quarter as well.

Sarah Burns - Findlay Park

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

Allen Shiver

Steve, I don’t think….

Steve Kinsey

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

Sarah Burns - Findlay Park

Okay, fine. And back to a follow-on from Farha's questions. Given the fact that you probably absorbed close to $12 million this year on Lepage and tortilla -- and Dallas Fort Worth tortilla plant. I am surprised that you sort of -- as we look into early 2015 that you haven't got greater visibility, that you still have to be cutting guidance which I thought was pretty achievable for the full 2014. But at the same time you are actually saying that the promotion -- we think the promotional outlook will get better. It just seems to be a conflicting statement?

Steve Kinsey

When you look at the outlook for ‘14, I think the impact on the first half we didn’t miss our internal projections on the second quarter. And it will take some time, as Allen said, to get -- to change the promotional cadence for Flowers coming into fourth quarter. So, the impact of that is still to be seen in the third quarter. And quite honestly, the impact of that in the fourth quarter once we change that cadence does it affect our volumes. But we don’t think it will significantly impact that but there is a risk there as well. So that’s really driving a lot of the change in the outlook for 2014.

Sarah Burns - Findlay Park

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

Steve Kinsey

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

Sarah Burns - Findlay Park

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

Steve Kinsey

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

Sarah Burns - Findlay Park

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

Steve Kinsey

Thank you.

Sarah Burns - Findlay Park

Thank you.

Operator

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

Bill Chappell - SunTrust

Good morning.

Allen Shiver

Good morning, Bill.

Bill Chappell - SunTrust

Can we go back to the cake business? I'm just trying to understand your optimism and what happened intra quarter. Because I understand you still have the 6.7% share, but if we are doing the math right it sounds like you lost 25% of your share over the past -- over the first half of the year which is pretty meaningful especially going against a fragmented industry. So trying to understand like what gets you back on track. Did you actually get kicked out of certain relationships by Hostess or is it just consumer take away due to promotions is what’s hurting the share?

Allen Shiver

Bill, the cake category is very much of an impulse driven category. And with the news of Hostess’ reintroductions to the market places, they have done a good job getting off right displays and most of the cake is sold on off right displays, certainly incremental cake. And most of the supermarket, there’s only going to be one, possibly two off right displays of cake.

So with the Hostess reintroduction, our Tastykake brand and also our Mrs. Freshley’s, was really not included on displays as often as we would have liked. From a pricing stand point, there really is not a pricing problem in the cake category. It’s really a function of the news of Hostess’ reintroductions to the market place and how that affects displays and presence in the supermarkets.

We are very confident. Our independent distributors, they are excited about selling the Tastykake brand. We’ve got several new items that we continue to introduce new items under Tastykake to keep the brand alive and well. And we’re working very hard to regain the offright displays that are very important in this category. So it’s really a function of the news of Hostess coming back that did a good job getting the distributions. And now I think strength -- our DSD strength over the long term will prove out.

Bill Chappell - SunTrust

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

Allen Shiver

The real change this past quarter is that they expanded distributions and probably more channel then what we’ve seen in the past. So in addition to supermarket, the mass merchandiser and also there is some expansion from Hostess into the convenience store channel. So more than anything else, looking back at the last quarter was more of a increase in distributions from that standpoint.

Bill Chappell - SunTrust

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

Allen Shiver

Nom they are going to market through warehouse distribution. In the convenience store channel, they have various different structures in place depending on the geography and the accounts. But again, to my knowledge they are not expanding with the traditional DSD as we have.

Bill Chappell - SunTrust

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

Allen Shiver

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

And we made the decisions to walk away from the existing private-label business. So it was kind of the combination of the amount of branded promotion impacted private label. And then also our decisions to walk away from several private-label accounts because there we profitable also impacted our private-label number

Bill Chappell - SunTrust

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

Steve Kinsey

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

Bill Chappell - SunTrust

Okay, I will turn it over.

Steve Kinsey

Thank you.

Operator

The next question is from Akshay Jagdale with KeyBanc. Please go ahead.

Akshay Jagdale - KeyBanc

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

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

Steve Kinsey

Sure, when you look at the back half, I mean 3% to5% is right, but you need to remember that week 53 adds about 1.8% or 2% to the total.

Akshay Jagdale - KeyBanc

Well, I am excluding that, if I exclude that it’s still 3% to 5%?

Steve Kinsey

We’re assuming some accelerations in back half. As Allen said, if we hit the promotional activity under control over the fourth quarter, which you see a lift there as well. So I would say your calculations are in line with how we are looking at the back half.

Akshay Jagdale - KeyBanc

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

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

Allen Shiver

I mean, on e thing is we have cycled a cake relaunch. So we do -- that comps have come back in line hopefully and we should not see as much law from the cake business in the back half. And then from the new brand perspective, as Allen mentioned, we are seeing a pretty strong cadence in expansion markets with new brand. So we’re expecting more lift in the back half from the Hostess brand. And as I said earlier, week 53 so -- and then hopefully the promotional cadence will improve. So that kind of -- that was kind of the bucket that we look at where we are expecting to lift in the back half.

Akshay Jagdale - KeyBanc

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

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

Steve Kinsey

Akshay, the terms, -- I’m not sure the term step back is accurate but we’re very focused on really settling the operation. You are exactly right the last 2.5 or 3 years, we’ve been extremely busy with category consolidations. We feel that we have made right decisions in the past to grow the company. And now we’re focused on really settling down the operation building our market share, especially in new markets and continuing to build our business over the long term. We’re focused on every area of cost to make sure that as we’ve gone through this growth period, we’re not carrying any cost that we don’t need to. And at the same time we’re focused on building on our strength, which is our address to delivery system.

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

Akshay Jagdale - KeyBanc

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

Steve Kinsey

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

Akshay Jagdale - KeyBanc

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

Steve Kinsey

Akshay, when you look at the quarter and actually look at the year, and what we’ve been seeing and we’ve talked about this quite a bit at the ramp up and stale or returned product. And there is significant cost associated with that product. And through our thrift store system, the recovery is not sufficient to offset that. So even -- just Q2 alone and that with a couple of million dollars over the last years second quarter.

So that’s a significant bucket of cost that we are very focused on and we have an opportunity to improve. Now what’s been driving that increase has been the accelerated expansion in new market because our brands are not -- we’re still trying to get traction in the new markets.

The promotional activity causes a mix shift among brand because the people are really shifting based on price sometimes. And as Allen said, hasn’t been very efficient, so that’s driving the sale increase. And the new products, we had the relaunch -- we have the new product Cobblestone Bread Company that we introduced in the second quarter. That’s getting traction. We’re seeing a high stale rate or returned product costs there.

So that one item alone, it could be a significant driver on margin over time. We didn’t get there over night and we won’t fix it in a quarter or two. It is a longer term fix but it is definitely one of the major items that could drive the improvement from the margin perspective.

And in the quarter, we had extra costs related to the startup. And as we’re bringing these plants back online, we will have that costs over the next two or three years. But again, we will try to manage that as best as possible. And then the extra -- cost related to ex-promotions in the quarter were significant compared to last year. And then now that we’ve hopefully ironed out the tortilla issue and we’ve really made great progress on Lepage and begin to see that turn. Getting that one operation back in line with where it was when we acquired it, will again be another huge bucket that goes a long way to improve the margin.

Akshay Jagdale - KeyBanc

So maybe is this a good characterization to think of sort of the base business? Margins are suffering from some industry issues, which include higher promotional activity. But more importantly your expansion margins are much lower than the base business today because it is a different type of expansion than you've had in the past, right. So can you -- if that’s correct can you give us a sense of sort of in these expansion markets how much lower are your margins today and I am guessing that’s something you can control and bring back to your company average over time or relatively quickly?

Allen Shiver

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

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

Steve Kinsey

I think your characterization of kind of issue is right on. And we look at expansion market, some markets that could be as much as half of our normal margin. So it is pretty significant.

Akshay Jagdale - KeyBanc

Okay, great. I will pass it on.

Allen Shiver

Thank you.

Operator

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

Unidentified Analyst

Good morning, guys. This is actually [Umar] (ph) filling in for Brett.

Allen Shiver

Good morning.

Unidentified Analyst

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

Allen Shiver

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

Unidentified Analyst

Okay. So mostly was from the exit and the reduced cost from those operations?

Allen Shiver

Probably on the foodservice side of the business.

Unidentified Analyst

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

Allen Shiver

The category is actually flat to upside with. We mentioned earlier, there are many food categories that are trending down significantly. So I think that the overall category is flat to slightly up as positive. We’re very optimistic. Again, it’s a $31 billion category. The rate of a consolidation as we’ve seen continues to accelerate and we feel that Flowers is on a very good position as a strong number too to continue to grow.

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

So the promotional activity of that we’ve mentioned this past quarter and really past year to 18 months. We do feel that overtime that the promotional activity is going to be reduced and that is probably going to be driven as much by the retail trade as anything. So very optimistic about the health of the category and we’re excited about the opportunity for our company as consolidation continues.

Unidentified Analyst

That’s very helpful guys. Thanks for taking the call.

Allen Shiver

Thank you.

Marta Jones Turner

Thank you, [Umar] (ph).

Operator

(Operator Instructions) Our next question is from Amit Sharma with BMO Capital Markets. Please go ahead.

Amit Sharma - BMO Capital Markets

Hi. Good morning, everyone.

Allen Shiver

Good morning, Amit.

Amit Sharma - BMO Capital Markets

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

Steve Kinsey

Yeah. From a sales perspective, I think they’re tracking about in line where they were. But that’s the total region we have entered some new markets, I would say the base business is probably off slightly, yeah.

Amit Sharma - BMO Capital Markets

Okay. Okay. So, not a whole lot of delta between where we are in ‘14 versus ‘15 on the sales line from that business other than the first…

Steve Kinsey

Yeah. There is not much change there.

Amit Sharma - BMO Capital Markets

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

Steve Kinsey

Yes. We are -- the brands that we acquired, Wonder, Merita, Home Pride and others. We do have -- now have distribution in Wal-Mart. We are in the malls on rack within their bakery department and we are getting a quite a bit of support from a display standpoint. So even though that was a -- we were slow putting that together, we’ve now completed and have full distribution on the acquired brands.

Amit Sharma - BMO Capital Markets

And, Allen, how do you in the main bread aisles yet or is that shelf reset still to happen later in the year?

Marta Jones Turner

Yeah. Amit, that we don’t.

Allen Shiver

That’s correct. That we are inline on the bread rack in the bakery department, so we have overcome that hurdle.

Amit Sharma - BMO Capital Markets

Okay. Quickly on Cobblestone, what should we model for in terms of expectations or contribution to the topline in ‘15 or thereafter?

Allen Shiver

Steve, really haven’t projected that number publicly at this point. We are very early in the process. We ran about a three-month test period and we’re currently in the process of expanding this brand into really across our DSD footprint. And we’re excited because many of the categories that Cobblestone Bread Company addresses are categories where we are underdeveloped. And we’ll be probably on our next call we will develop more insight into what we expect out of Cobblestone Bread Company.

Amit Sharma - BMO Capital Markets

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

Allen Shiver

Obviously, we have no idea what the market reaction is going to be to our actions and what we are going to do is focus on our business and growing our topline and hitting our earnings number.

We feel that we can do that with less promotional activity than we have today. If the marketplace follows, that’s fine, if don’t fund, we’re going to continue with the direction that we’ve laid out.

We’re focused on strong brands, making sure we have the best product quality in the marketplace and our independent distributors are extremely aggressive in making sure that we have off rack display to drive that topline is very important.

So, really can't predict what the marketplace reaction will be to our reduction and promotional activity. But there is our plan and we’re very confident that we can make it work.

Amit Sharma - BMO Capital Markets

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

Allen Shiver

Your question is about acquisitions in the cake category.

Amit Sharma - BMO Capital Markets

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

Allen Shiver

We will look at opportunities as they are represented. Obviously, we have a lot of growth opportunity and we’ve said it in multiple situations. The Hostess acquisition is a multi-year rollout. We have bakeries that are idle today that we own, that can be re-commissioned as we continue to grow in new markets. If the right cake opportunities come along, we’ll certainly take a look, but I would say, that’s not our top priority right now.

Amit Sharma - BMO Capital Markets

Got it. Thank you.

Allen Shiver

Thank you.

Operator

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

Allen Shiver

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

Operator

Thank you, ladies and gentlemen. This concludes the Flowers Foods Second Quarter 2014 Earnings Call and Webcast. Thank you for participating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!