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Executives

Marta Jones-Turner - Executive Vice President, Corporate Relations

George Deese - Chairman of the Board, CEO and President

Steve Kinsey - Executive Vice President and Chief Financial Officer

Analysts

Farha Aslam – Stephens Inc.

Heather Jones - BB&T Capital Markets

Ann Gurkin – Davenport & Company LLC

Eric Katzman - Deutsche Bank

Mitchell Pinheiro - Janney Montgomery Scott

David Libowitz – Horizon Asset Management

Flowers Foods (FLO) F2Q08 Earnings Call August 14, 2008 10:30 AM ET

Operator

Greetings and welcome to the Flowers Foods second quarter 2008 earnings conference call and webcast. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions)

It is now my pleasure to introduce your host, Miss Marta Jones-Turner, Executive Vice President of Corporate Relations for Flowers Foods.

Marta Jones-Turner

Thanks, Doug, and good morning, everyone. Thank you for joining us. On the call with me today are George Deese, our Chairman of the Board, Chief Executive Officer, and President, as well as Steve Kinsey, Executive Vice President and Chief Financial Officer. We’ll discuss our second quarter results, our earnings guidance, and also update you on operations and our recent merger and acquisition. Then we’ll open our call for your questions.

Before we get started, I must point our that our presentation today may include forward-looking statements about our company’s performance. These may include discussion about a number of factors regarding future performance such as earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow, and other such items. These statements are based on our view of things today so they may contain some degree of uncertainty. While we believe our statement to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matter’s that we’ll talk about during the call, important factors relating to Flowers Foods business are detailed more fully in our filings with the SEC.

Now I’m pleased to turn our call over to our Chairman, CEO, and President, George Deese.

George Deese

Thank you, Marta. Good morning and thank you for joining our call. Before we get started with a discussion of the second quarter, let me welcome two new teams to Flowers Foods. As you know, we recently finalized our merger with Holsum Bakery in Phoenix as well as our acquisition of ButterKrust Bakery in Lakeland, Florida. I want to say how pleased we are at to welcome these two companies to Flowers. The Holsum merger brings about $150 million in annual sales. Two efficient bakeries, excellent products and brands, and a very talented team. Holsum also fits well with our growth strategy of expanding into new geographic territories, bringing us access to new markets in Arizona, New Mexico, Nevada, and Southern California.

ButterKrust brings about $70 million in annual sales, a very good manufacturing facility, great products, and a talented team. The Lakeland bakery also addresses our need for additional production capacity in the fast-growing Florida market. Both Holsum and ButterKrust operate profitably and we expect synergies over time. Steve will give you updated guidance that takes the merger and acquisition into account. Let me say once more we are very pleased to have these two fine companies joining Flowers Foods.

Turning to our second quarter results, we exceeded our internal sales and earnings plans for the quarter. I am pleased with the results we delivered, especially when you take into consideration that during the quarter we had our steepest commodity cost increases for the year. You will remember that we told you the second quarter would be impacted by those steep increases. We also told you to expect some leveling of commodity costs in the back half of the year.

During the second quarter, our products, our bakeries, our team performed well in spite of challenging costs. We continued our efforts to improve our efficiencies and reduce our operating costs. Looking at the results for the second quarter, sales were up 13.1% driven by pricing and good unit growth. Net income increased 8% even with the highest commodity cost hitting during the quarter. Earnings per share was up 8.3%. EBITDA for the quarter was 9.7% of sales, impacted by the higher cost.

Let’s look at our sales categories. Our branded retail sales were up 15.8% in the quarter, delivering this strong dollar growth as well as unit growth shows that Flower sales are strong despite current economic trends. Across all product categories, our branded products achieved solid growth. Once again, sales for our branded retail products represented a higher percentage of our total sales in the quarter. That shows the strength of our Nature’s Own, Whitewheat, and other regional brands. Once again, according to IRI, our brands gained share in both dollars and units in the quarter and we outperformed the fresh packaged breads category as a whole.

Looking at our retail sales by category, our white bread brands led by Whitewheat and local bread brands grew double digits which was well ahead of the category. In the soft variety category, we had double digit sales growth and units were also up, showing the trend of Nature’s Own brand. Our Nature’s Own all natural bread also showed growth in the quarter. Our newest entry, Nature’s Own breakfast products, also outperformed the category. Our brand of buns and rolls up in double digits for the quarter and performed better than the category.

Our snack cake brands also achieved double digit growth in the quarter. Our sales of store brand or private bread, buns, and rolls also increased in the quarter, due primarily to pricing. Private label did have a slight uptick in the fresh packaged bread category, but let me point out again that Flowers brands outperformed the category and also outpaced private label in terms of growth.

In summary for the quarter, we re-opened our bakery in Arkansas to add capacity. We needed the sales in Nature’s Own premium specialty breads continue to grow. As we announced earlier, we closed the snack plant in the Atlanta area. We made progress on the new bakery in Bardstown, Kentucky which we expect to open in the first quarter of ’09. Our Nature’s Own breakfast line which was introduced in the late spring gained good consumer acceptance. Of course, I have already mentioned the addition of Holsum and ButterKrust and the opportunities those new companies brings to us.

The second quarter was by any measure eventful for our company. We are pleased to deliver good results in a difficult commodity environment. That was possible because our team stayed focused on our strategies and outperformed in the marketplace. Now I’ll ask Steve Kinsey to give you more detail reporting for the quarter.

Steve Kinsey

Thank you, George, and good morning. The second performance was good, meeting our internally established targets, even in the face of our steepest input cost increase for the year. Net income for the quarter improved roughly 8% to $23.9 million from $22.2 million. Year-to-date net income was up 17.9% compared to the same period a year ago. Our operating margin or EBIT as a percent of sales for the quarter declined approximately 50 basis points to 6.7% of sales compared to 7.2% a year ago as a result of pressure from the ingredient cost increases. The EBIT margin for the first half however was up slightly at 7.4% compared to 7.3% of sales for the same period last year.

Diluted earnings per share for the quarter grew 8.3% quarter-over-quarter to $0.26 per share. Earnings per share for the first half was up 18.2% over the prior year at $0.65 per share.

Sales growth for the quarter was 13.1%. Pricing and mix contributed 10.9% of the growth and volume represented 2.2% of the growth. The direct store delivery group sales were up 14.1% for the quarter. Price and mix contributed 12.1% of that segment’s growth and DSD volume was up 2%. Expansion markets in the quarter added approximately 1% of the sales growth. Our brands performed well in the quarter, generating strong volume growth. Our warehouse delivery group sales were up 9.1% quarter-over-quarter with price and mix contributing 6.3% and volume 2.8%.

Snack cake products performed well in the quarter while we continued to experience softness in certain segments of the food service category, primarily casual dining and broad line distribution. Year-to-date sales were up 11.9% to $1.22 billion over the $1.09 billion compared to the first half of ’07. Year-to-date increase was achieved through favorable pricing and mix of 10.2% and volume increases of 1.7%.

The gross margin as a percent of sales was significantly impacted in the quarter down approximately 300 basis points from 45.7% compared to 48.7% in the second quarter last year as a percent of sales. As we commented on our last call, our ingredient costs, primarily flour, increased dramatically quarter-over-quarter. The 2008 Q2 ingredient costs were up some $38 million or 34% over the prior year, an approximately 430 basis points increase as a percent of sales.

Also affecting the gross margin for the quarter was higher allowances and promotions and $1.3 million of costs related to the closure of the Atlanta snack facility which I will discuss in a minute. We also recommissioned a [inaudible] facility in the quarter and incurred costs related to this startup. The year-to-date margin as a percent of sales was down just over 200 basis points at 47.1% compared to 49.3% for the same period last year. Ingredient costs year-to-date were up approximately $76 million year-over-year or 31%. The majority of the other components of cost of goods sold, however, were relatively flat to down slightly as a percent of sales quarter-over-quarter and year-to-date.

Gross margin dollars, did however increase in the quarter by approximately 6% and year-to-date by approximately 7%. Selling, marketing, and admin expenses as a percent of sales decreased to approximately 36.6% for the quarter or just over 200 basis point improvement over the prior year percentage of 38.4%. The quarter-over-quarter improvement as a percent of sales was driven primarily by increased sales and the lower employee-related and advertising and marketing costs in the quarter as a percent of sales.

Though fuel costs were up in the quarter, we continue to benefit from the distribution and production rationalization minimizing or eliminating our miles driven. Depreciation and amortization as a percent of sales remain relatively stable quarter-over-quarter. During the quarter we did close and exit our Atlanta snack cake production facility and move production to other flour snack cake facilities as planned. The Atlanta facility was sold in 2007 and leased back until production could be moved this quarter. Under accounting rules, the gain of $2.3 million was deferred until we exited the building this quarter. As mentioned above, we did have closing and severance costs of which the majority was reported in cost of goods sold related to this transaction in the quarter of approximately $1.6 million. Therefore, the net effect of this item on the quarter was approximately $700,000 positive. We also had approximately $400,000 of costs in the first quarter related to the closure and move. This makes the net effect on earnings as a result of the sale and closure to be approximately $300,000 for the year, relatively inconsequential to earnings.

In the quarter we did also receive insurance proceeds of $686,000 related to the damage of a distribution facility in 2007. The increase in net interest income for the second quarter of 2008 continues to be due to lower debt service and an increase in interest income on distributor notes, resulting from the sale of new territories. In the back half of 2008 and forward, however, for the next few years, we will see an increase in interest expense due to borrowings to finance our recent acquisitions which we will discuss in a minute.

The second quarter tax rate of 35. 7% does reflect a slight benefit from this discrete item. We still anticipate the full year rate to be approximately 36%. The balance sheet continues to remain strong. During the second quarter we funded approximately $8.6 million in capital expenditures and paid $13.8 million in dividends. There were no share repurchases during the quarter. Cash flow from operation was negatively impacted in the second quarter as a result of the commodity hedging and margin cash being funded. However, looking at year-to-date cash flow from operations, it came in very strong at $56.1 million. At the end of the quarter, we had $6 million drawn on our credit facility.

We have updated our 2008 guidance based on our year-to-date and targeted back half performance and the impact of our recently announced acquisitions. This does not include, if any, future acquisitions. I’d like to also remind you that 2008 is a 53 week year giving an extra week for the fourth quarter.

We’ve increased our 2008 sales projections to $2.4 billion to $2.245 billion. It’s roughly a 17.8% or 19.1% increase over the prior year. Price and mix are expected to provide 9.5% to 10.5% of the increase, volume 6% to 7%, and the extra week 1.5% of the increase. The volume growth does include from the acquisitions approximately 4.5% to 5% for the year.

Net income is now estimated to be approximately 4.5% to 4.7% of sales or $109.2 million to $114.7 million. Given the approximately 93.4 million average shares outstanding following the acquisitions, we are targeting earnings per share of $1.17 to $1.23, an increase of 14.7% to 20.6% over 2007. Though both acquisitions are profitable, the effect of the acquisitions, including interest, the additional shares issued, and integration costs on the back half of the year will be dilutive. If the integration is successful, we are projecting the acquisitions to be accretive to earnings by year two. We will not comment specifically on margins at each business, however, over time, through synergies, efficiency gain, and brand extensions and mix improvements, both of these businesses, we believe, should see improved margins.

As George commented, we are very excited about the acquisitions and the great opportunities they provide Flowers. In addition to stock, we did finance the acquisitions with bank debt. We entered into a five year term loan for $150 million and drew down approximately $20 million on our existing credit facility. We anticipate that over the next five years, we will be able to fund debt repayment through operating cash flows. The 2008 capital spend remains unchanged and is estimated to be $95 million to $100 million. This includes our normal maintenance spend as well as construction of our Kentucky facility. This does not include, however, equipment that may be acquired under operating leases for new production lines at existing or new facilities and as we stated earlier, we do not anticipate any major spend in 2008 due to the acquisitions.

To sum up, the second quarter results were good in the face of the commodity spike. As we move to the back half of 2008, we are still facing significant cost pressure year-over-year, however, we do expect some relief as compared to the first half. We will stick to our hedging and pricing strategy that the market permits. At this point in the year we are still encouraged with the back half and feel that our guidance reflects nice growth year-over-year.

Now I will turn it back to George.

George Deese

Thank you, Steve. Our team is focused on delivering good results in 2008. As you can see from our guidance, we expect to do just that. From [inaudible] perspective I would like to point out that the fourth quarter will have additional pricing and we will have an additional week of sales and earnings due to our 53rd week as Steve indicated for this fiscal year, so I would take that into consideration.

Our plan for 2009 is well underway. As you know, the markets are very volatile. Although we are not ready to give you details for next year, we do know that our input costs will be higher. I can tell you we believe our cost increases in 2009 will be similar to the levels we experienced this year. We will, however, follow our proven strategy that helps us out visibility for our cost. Once our future costs are defined, and our plans made, we will take action to further improve efficiencies and take costs out wherever possible. Then we take pricing as needed in a timely manner.

At this point we expect to take additional pricing late in the third quarter and as the beginning of the fourth quarter. On our third quarter call we will give you more detail about our plans and the outlook for 2009.

As you have heard me say before, consumers buy bakery products in good times as well as more difficult times. Our products are a good value and they deliver the flavor, variety, and quality consumers demand. We are well-positioned to deliver good results for the remainder of 2008 and we are putting our plans in place to do the same for 2009 and beyond. Our team is excited about the growth opportunities we have at Holsum and ButterKrust as well as the growth and expansion markets and core territories. The Holsum merger brings two strong bakeries, wonderful quality products, a talented team, access to key markets in Arizona and Nevada as well as reach into Southern California. Holsum adds about 29 million consumers to our population served number which means about 143 million people or about 47% of the US population will have access to Flowers products.

With a base of $150 million in sales, Holsum provides a solid foundation. Over time we will introduce our Nature’s Own, Whitewheat, and other favorite Flowers brands into those markets. ButterKrust also is the kind of bakery that brings us much needed capacity in one of our fastest growing markets. The additional production capacity added by the Lakeland bakery will meet our capacity needs in the Flower market for many years to come. ButterKrust products are of great quality and have a strong team as well. The addition of Holsum and ButterKrust strengthens Flowers Foods from an operational standpoint, from a talent standpoint, and by broadening our relationship with existing customers as well as new customers. Flowers Foods has grown through acquisition since we listed publicly. These recent acquisitions are good strategic fits for our company. Going forwards, we remain committed to growing through acquisitions and through market expansion. In the third quarter we will be entering new markets that are adjacent to our existing territory. For competitive reasons we will not announce those new territories but we are continuing our strategy to grow muscle through market expansion.

In summary Flowers Foods has never been stronger and we look forward to a good finish in ’08 and plans are well underway for fiscal ’09. Our team is focused on executing our proven operating strategies which will result in increased shareholder value. Our cash flow as Steve said remains strong. We will continue to invest in capital improvements, dividends to our shareholders, strategic acquisitions, repurchase of Flowers Foods stock, and pay down our very manageable debt level.

In closing, let me be clear. This was a very important quarter for us. We completed two critical acquisitions, delivered good results and increased guidance despite commodity and expense headwinds. I’ve seen many recessionary cycles during my 44 years in this business and I know good execution is what will drive Flowers Foods to continue to produce excellent results in any environment and that is what we intend to do as a management team.

Now Doug, we will take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Farha Aslam with Stephens Inc.

Farha Aslam – Stephens Inc.

You had noted that in the fiscal first half you had a 31% increase in ingredient costs. Would you be willing to share with us what that is for the fiscal second half?

Steve Kinsey

I think looking at the dollars we have told you for the year where we’ll be at roughly 22% on all input costs including packaging. But the back half, obviously the greatest amount came in the first half and we will see some relief in the back half but I’m not sure we’re willing to share the exact number at this point for competitive reasons.

Farha Aslam – Stephens Inc.

George, if you could share with us a little bit more about the Holsum bakery that you’ve acquired. That serves the Nevada and Arizona and California, are they already in California?

George Deese

Yes, let me start back over there. We are excited about this opportunity. A wonderful company, wonderful owner who will continue to run our business. Great market position in Arizona, number one in the marketplace. I know they entered the Nevada market 10 to 15 years ago and it made good progress there, and they’ve always had some presence, for a number of years had a little presence, in Southern California, but when a competitor exited that market, it did give opportunity, some three or four months ago, for them to move in more than they had been before, and as time moves forward, we see that we can help them expand that market even more so than they are today, so we see very good opportunities in Southern California. 0

Farha Aslam – Stephens Inc.

George, how much capacity does Holsum have in their plant? Are they kind of at 100% capacity or do they have a little bit extra capacity that they could leverage?

George Deese

There is some extra capacity. We feel very comfortable that we can now have good market expansion without any added capital at this time.

Farha Aslam – Stephens Inc.

Is there capacity to take the Nature’s Own products in there as well or will you kind of need to build additional capacity because they have their own brands and then you’re going to layer on Nature’s Own on top of that or are you going to maybe switch out and put some Nature’s Own in place of some regional brands?

George Deese

They do a wonderful job on the Holsum brand as well as Aunt Hattie, as well as the Roman Meal brand, and it’s a solid business. We will layer on top of that our Nature’s Own which we have systematically done throughout acquisitions of the past, and we think this will be a very good market and again there is capacity to do the Nature’s Own brand until we get to a higher level and if that takes more capital we’d be more than willing to do it at the right time.

Operator

Your next question comes from Heather Jones with BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

I may have missed this but did you say the acquisitions will be dilutive in the back half because of the integration costs?

Steve Kinsey

Yes, due to the integration costs and the interest there will be dilution in the back half.

Heather Jones - BB&T Capital Markets

So can you give us an idea of the implicit increase in guidance for the core business with your new guidance? I guess another way to word it, estimated dilution from acquisitions in the back half?

Steve Kinsey

We expect probably $0.01 to $0.02 dilution from the integration and the acquisition costs in the back half of the year.

Heather Jones - BB&T Capital Markets

Do you anticipate, because you said accretive by year two, and I assume you were talking about two calendar years from ownership?

Steve Kinsey

Yes, we expect by 2010.

Heather Jones - BB&T Capital Markets

Do you expect them to be dilutive next year or just neutral?

Steve Kinsey

Next year will be neutral to slightly dilutive.

Heather Jones - BB&T Capital Markets

George, your comments on pricing and I may be reading too much into this, but my interpretation was you seemed a little more cautious about taking pricing than you have in the past and again maybe I misread that but I was just wondering if you could talk about your outlook going into fiscal ’09 given that you’re expecting costs to be up dramatically once more. Do you see any indications that the consumer is becoming more resistant to higher pricing or if you could just speak to that.

George Deese

It’s a great question. If I said I was more hesitant about pricing I certainly didn’t mean to... I was looking at the Wall Street Journal yesterday on Page A-3 and the headline was, “Bumper Harvest Not Enough To Ease Food Costs.” I think the whole food industry, we had headwinds last year, we’re having headwinds this year, there will be the same type headwinds next year, so we really have no choice except first of all, before we put out pricing, what I did say that we are always working for finding inefficiencies and taking them out of our operation, reducing costs wherever possible, but then when we know how much more price we have to get, we go do it. I think our customers have confidence in us that we’re not trying to gauge anybody, we’re just trying to stay in business and continue to expand our reach, expand our plants, build plants as necessary so that we can continue to serve the marketplace and serve our existing customers and as much as we hate it, this is part of the cost and consumers... I think if you look at this year, as I’ve said repeatedly, private label has not gone up or down, I did say however that we saw just a slight uptick in this quarter, not enough to be concerned about though. Flowers certainly outperformed that. So you can see a slight uptick but I’m not overly concerned about it. I think all of us will manage through t through innovation and new products and giving people reason to stay with your brands or trade up.

Heather Jones - BB&T Capital Markets

Have you taken advantage of the recent, it started moving back up again yesterday, but over the past month the break in commodity costs? Have you been working to cover your ’09 needs?

George Deese

Heather, I’d rather not comment on ’09 at this point. We will do it at the beginning of next quarter but you can be assured that Flowers strategy is working.

Steve Kinsey

Heather, this is Steve. I’d like to circle back real quick on your question about dilution. One other component I failed to mention was the number of shares. We’ve got 900,000 shares for the back half of this year and we issued approximately 2 million shares on the acquisition, so that’s a part of the dilutive factor, looking at the effect from the acquisitions as well. As George commented, we think there’s great opportunity and depending on the success of the integration ad how well things move and how well we are executing and getting the integrations in place. 2010 we think we should be on track to see great performance there.

Heather Jones - BB&T Capital Markets

But the $0.01 to $0.02 dilution that you mentioned just a couple minutes ago, that includes these extra shares?

Steve Kinsey

Yes it does.

Heather Jones - BB&T Capital Markets

And actually I was getting ready to get off but I just realized I had one more question.

George Deese

And ahead of that, that is in the guidance. Our range includes the effect of the acquisition.

Heather Jones - BB&T Capital Markets

Does your guidance include these gains in sales and insurance recoveries?

Steve Kinsey

It does. We have not removed any of the components of earning.

Heather Jones - BB&T Capital Markets

My final question, I tried to adjust warehouse delivery margins for the gains and all to get what’s going on with the core business and just was wondering if you could give us guidance under your direct store continues to be incredible how it’s performing, but I wonder if you could give guidance on where you think snack margins can go and timing of getting there.

George Deese

Let me comment. I think Steve did mention in his comments that snack continues to improve and see an improvement. I think all of us are aware that part of that segment is our food service business and food service has been slow and sluggish. That will improve as we gain new customers. More importantly, what it will improve is the economy changes. I think the result for retail is the result of what’s going on in food services. Food service people I think are still consuming as much or more product. They purchase in a different place, so we see it in the retail certainly addressing, trying to take advantage of the trend to bring people back home. I think food service is still solid. We have not lost business per se for customers, it’s just the consumer has changed their eating patterns somewhat. There is some pressure because overhead and all is basically the same, so we do see some pressure on food service until we get out of this economic slump.

Operator

Your next question comes from Ann Gerkin with Davenport and Company.

Ann Gurkin – Davenport & Company LLC

Continuing on with the discussion about the warehouse business, can you help me understand the reversal from the decline in the first quarter to a positive volume in the second. What drove that reversal?

Steve Kinsey

In the second quarter the volume increases were driven by snack products. We had nice volume growth in the multipack snack cakes in the mass channel.

Ann Gurkin – Davenport & Company LLC

Can you help me with the outlook for SM&A expenses in the second half since we saw such nice improvement in the second quarter?

Steve Kinsey

We’re still targeting the 100 to 150 basis point improvement for the year so I think the back half should be relatively similar to the first half.

Operator

Your next question comes from Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank

I guess a few questions. First of all, you’ve made a strategic acquisition or two strategic acquisitions. Anybody who knows the company well knows that Holsum is a business that you’ve longed for for a long time. It seems like a good match. To the extent that the input cost environment is quite volatile, and now that you own it and you’re in there, were they as let’s say well-hedged as you have been and is that part of the dilution equation in that you kind of have to true up their pricing vis a vi inputs or is it more just a function of their ongoing margins and the price paid?

George Deese

Eric, I’ll say it this way. They were always pretty proactive and always, I don’t know exactly, but I’d say they were a little above where we would be at this point in time for this year even though the hedge is somewhat higher. But if you look out, and I know they’ve just taken some price increases recently to try to offset that, as you look out I’d say as we talk about margins probably the biggest difference in margins that they have versus Flowers at this point is probably product mix. They’re a little more heavily into restaurant institution business buns which does not carry quite the margin that bread does. That’s why we will be so in tune to get Nature’s Own introduced at the marketplace which over time will help dry the margin to the levels that we’re normally used to.

Eric Katzman - Deutsche Bank

Has their business been taking market share from competition and benefiting from I guess the move from a very fragmented category to a more consolidated one just like you have in your core areas?

George Deese

Due to our competitor pulling out of markets and being less effective, they have taken advantage of that.

Eric Katzman - Deutsche Bank

Kind of more of a question for Steve, but it’s kind of capital allocation. Again, great long term strategic positioning here. You didn’t buy back stock in the quarter or much this year. How much of that is a function of being in kind of black out periods due to M&A discussions versus allocation to capital because certainly even with the debt that you’ve put on for these deals, the balance sheet is still very strong relative to what you could take on and it seems to me that if you wanted to continue to buy back stock, you could unless the lawyers are telling you otherwise.

George Deese

I think you’re right. For most of the second quarter we weren’t in a blackout due to the acquisition. I think our capital allocation, you’ll see it stick to our strategy, investing in our bakeries, paying dividends, and making share repurchase opportunistically, and that’s part of the reason we decided to go with the term loan. We wanted to keep our credit facility there against dry powder if you will for any potential acquisition or flour stock if we think it’s the right time to make that purchase, so we don’t see any constraints going forward because of debt levels to make share repurchases, but again, our strategy has been more to do opportunistic buys than to have a planned buy of stock, so it’s still part of our strategy and we expect to stick with that going forward.

Eric Katzman - Deutsche Bank

Then I guess lastly to George, you’ve done some initiatives which have obviously helped the top line in terms of the organic products under Nature’s Own and kind of moving like the mixed shift positively. I think you’ve had more mixed success with kind of ethnic initiatives, but do you detect any limitation on your ability to move the mix up even with pricing and the consumer maybe being a bit more pressured?

George Deese

I think innovation is only limited by our imagination. I think there are still opportunities for Flowers to innovate on some better view type products. We’ll be very careful though that we did not put any products under the Nature’s Own that really doesn’t fit. As I’ve said repeatedly, I think this will be a billion dollar brand in the very near future. You know if you look back to the IRI information you did see a little pressure on the very top premium products. This quarter I mentioned a slight downtick and it looks like that’s where most of the pressure probably came is in the highest priced products, not necessarily Flowers from a category standpoint.

Operator

Your next question comes from Mitchell Pinheiro with Janney Montgomery Scott.

Mitchell Pinheiro - Janney Montgomery Scott

I was looking at my notes from last year. By the end of the third quarter last year, it looks like you were 75% to 80% covered for your flour needs for 2008 so as we look forward here and I know you’re not talking about ’09 but when we get to the third quarter conference call and we start talking about sort of commodity coverage, I was hoping... Are we going to see, are you going to be reasonably covered for ’09 by then or are you now covered or can you talk about that in any way?

George Deese

I’ll try. You’re trying to keep me talking about next year. Somebody asked earlier, I did say our strategies are in place and we will get into detail in it on the next quarter. Obviously I can’t say too much more than that but be assured that our strategies continue to work well for us as we look at next year.

Mitchell Pinheiro - Janney Montgomery Scott

So then if I look, you’d mentioned today that, and I’d love to get a little clarity on this, that you expect to take additional pricing in the third quarter and in the beginning of the fourth quarter?

George Deese

Depending on the customer, the last weekend of third quarter, but beginning of the first quarter, pretty well everything will be into effect unless it’s a contract or something and then we have to wait until January 1, but in essence, we’ll take pricing being in fourth quarter which pretty well takes care of the fourth quarter as well as probably the first three quarters of next year at that point.

Mitchell Pinheiro - Janney Montgomery Scott

So there will be an increase somewhere into Q3, Q4, and then again at the end of Q4?

George Deese

No. There might be some selected contracts that might be on an annual basis that will have to be renewed January 1, but let me also follow that and say this though, even though we try to look at basically annual pricing the best we could, I think we’re in a world that so many unknowns are in place that we are telling our customers, we can’t just talk about annual anymore, this is the price for this season and depending on what goes on they might be further increased to mid-year which we haven’t had to do lately, but things are so volatile that we just don’t know at this point. We will take enough pricing in the fourth that under normal years would circle us around to profit the third or fourth quarter the following year.

Mitchell Pinheiro - Janney Montgomery Scott

In terms of pricing, the magnitude of the price increase, can you help us there?

George Deese

Mitch, we’re not ready to say that yet for competitive reasons but will say at the next call. It will be significant.

Mitchell Pinheiro - Janney Montgomery Scott

In terms of staying on the pricing side, how has pricing fared in the New Mexico, Arizona, Southern California markets? Have they increased sort of in line with your markets or ahead of the game or behind?

George Deese

I’d say typically the western market retails are higher than the southeast as we’ve said for 35 or 40 years, it seems like the southeast is always one of the lower priced retail markets. So they are somewhat higher than we are from a retail standpoint.

Mitchell Pinheiro - Janney Montgomery Scott

And has the delta of the price increases like year-over-year, have they been higher, lower, or like on par with the increases that you’ve been implementing?

George Deese

I’d say it’s pretty well on par and it’s always historically been higher so they are higher but I’d say on a year-on-year situation it’s probably been on par with increases we’ve taken.

Mitchell Pinheiro - Janney Montgomery Scott

Is the pricing higher than the south just due to distribution cost differences and flour still costs basically the same, is there any other, is there some factor that drives prices higher?

George Deese

I would say typically that market is probably derived quite a bit from a California standpoint, but a lot of competition comes from California, and as we know it’s higher to manufacture and ship products out in that area versus I’d say the southern part of the United States.

Mitchell Pinheiro - Janney Montgomery Scott

So shipping and from outside of California has always been a good strategy. Is there still cost advantage to that strategy?

George Deese

From California into Arizona?

Mitchell Pinheiro - Janney Montgomery Scott

Yeah, Arizona into California.

George Deese

I’d say it’s good strategy.

Mitchell Pinheiro - Janney Montgomery Scott

Looking again at the acquisitions and I guess Steve you said that the acquisitions would be accretive in year two, so does that mean basically from August 1, 2008 through August 1, 2009, not to expect any accretion and then basically fourth quarter of next year’s third and fourth quarter next year is when you think it’s going to --

George Deese

I’d say that would be pretty reasonable.

Mitchell Pinheiro - Janney Montgomery Scott

And then last question --

George Deese

And the reason I say it’s reasonable, we should be through with putting in the SAP systems shared service concepts, inter-plant baking, reciprocal baking arrangements that we go through diligently to make sure that we’re the most efficient manufacturer in the United States. Those basic things do take time but we think the synergies are there and we think the team will do it and do it well and by the back half of next year we should begin to recognize that.

Mitchell Pinheiro - Janney Montgomery Scott

And I assume we’ll have some sort of like late January early February analyst meeting out in Phoenix? We’ll talk about that later. Just the last question would be marketing spending. You had shifted some marketing spending to the breakfast breads from Q1 into Q2. Is that any impact in this quarter?

George Deese

No. I would say though that it was impact, seemed like each second quarter to do with, as I think about second quarter, I think about Memorial Day and July 4 is always a huge season for buns. Typically buns are not as profitable. Bread is our most profitable item so a little shift there, and as Steve indicated, we did price along with competition with our customers to be in the arena for the consumer for those two holidays and it’s pretty big impact.

Mitchell Pinheiro - Janney Montgomery Scott

I guess the final thing on marketing and related to your new breakfast breads, are sale rates tracking on plan and can you talk about how the breakfast breads have been received and any further tweaks to your strategy there?

George Deese

I would say that under the Nature’s Own banner that it’s been well received by the consumer. We have gotten many letters in from consumers saying that they are pleased with the product. Any new product that you go in the market with, especially of this caliber, until you build up the consumer franchise, you do have heavy sales. We have, but it was planned, it was anticipated, but that’s a sacrifice we’re willing to make for the long term.

Operator

Your next question comes from David Libowitz with Horizon Asset Management.

David Libowitz – Horizon Asset Management

A few unrelated issues if I may. First, the Holsum transaction is accounted for as a merger ad ButterKrust is an acquisition. Were these done for tax reasons or are there other implications to be read into any of that?

George Deese

I’ll say this. The ButterKrust was all cash. It was a situation with one owner that didn’t want to exit the marketplace, so it was treated as an acquisition. We looked at Holsum as a merger because the owner of the facility, we saw it as a merger because putting his business with ours makes good common sense and he will continue to run the business so that was the reason for the merger.

David Libowitz – Horizon Asset Management

So there was no actual tax savings for doing these two transactions the way they did rather than both of them being either purchases or mergers?

George Deese

I think David from Flowers perspective, the structures that we sued, we think offered us the best alternatives to completing the acquisitions. I would not want to comment on the seller’s tax position, I don’t think that would be appropriate, but the all-cash transaction in Florida provides Flowers with we think the best, will give us good tax benefits, and then typically with the merger, it’s a step up in basis for the acquire so there’s not significant tax benefits from that transaction, but we’re still happy with the purchase price and we think the appropriate structure was used to complete the acquisition.

David Libowitz – Horizon Asset Management

I don’t want to be misunderstood, I was specifically talking tax implications for Flowers having nothing to do with the sellers. My second question, the price of fuel has been coming down. How does that impact your operating costs, especially in terms of the baking itself?

George Deese

We do not use gasoline per se to bake with, we use natural gas for that. As you know we do hedge out on that as much as we can. We’re hedged out now. There was of course some impact in our levels compared to last year. But on the gasoline itself, as you know our independent operators supply their own gasoline for their own vehicles. Energy though does hit us at the bakery as well as our transportation system getting from the bakery through different hollers. They have to get the product from our bakery to these distribution centers and that cost is passed along to us, which was pretty significant for the quarter. I think probably $3 million to $3.5 million impact.

David Libowitz – Horizon Asset Management

Another question. In terms of the acquisitions that we hope to add on to the business, are any of them expected to close or might any of them close before the end of this calendar year?

George Deese

We are closed. We closed on --

David Libowitz – Horizon Asset Management

No, I’m talking about the ones that George referred to where he said he would not be specific as to where you were looking to move into --

George Deese

That’s new markets, not new bakeries.

David Libowitz – Horizon Asset Management

Okay, my apologies.

George Deese

We will be moving in those markets in the very near future before our next analyst meeting and call.

David Libowitz – Horizon Asset Management

The last question, given the continued bankruptcy of one of your major competitors, is there a time limit where a judge must say either you exit bankruptcy voluntarily or we decide to change a Chapter 11 to a Chapter 7?

George Deese

Our legal advisors say there is no set timeframe. It is up to the judge and there’s no magic date to our knowledge. The judge can keep granting quarter after quarter after quarter I assume as long as that judge feels like there’s some reasonable expectation of either coming out of bankruptcy or some other transaction is taking place. We’re not knowledgeable of any of that at this point.

David Libowitz – Horizon Asset Management

Does that give you an opportunity to perhaps encroach into their markets given that the longer they stay in bankruptcy the less efficient they’d have to be as a competitor?

George Deese

I think it does present some opportunity because some customers would probably see it as, I’m not sure what is happening there, I know Flowers can supply, you are successful, you have great products, great people, so could you serve me? We do have some of that and that is part of the reason we continue to expand our market.

Operator

There are no further questions in the queue. I’d like to hand it back over to Mr. Deese for some closing comments.

George Deese

Thank you Doug and thank you for joining our call today and thank you for your continued interest in Flowers Foods.

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Source: Flowers Foods F2Q08 (Qtr End 07/12/08) Earnings Call Transcript
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