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Edited Transcript of FLO earnings conference call or presentation 17-May-18 12:30pm GMT

Q1 2018 Flowers Foods Inc Earnings Call

THOMASVILLE May 25, 2018 (Thomson StreetEvents) -- Edited Transcript of Flowers Foods Inc earnings conference call or presentation Thursday, May 17, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Allen L. Shiver

Flowers Foods, Inc. - President, CEO & Director

* J. T. Rieck

Flowers Foods, Inc. - Treasurer & VP of IR & Financial Analysis

* R. Steven Kinsey

Flowers Foods, Inc. - CFO & Chief Administrative Officer

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Conference Call Participants

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* Akshay S. Jagdale

Jefferies LLC, Research Division - Equity Analyst

* Amit Sharma

BMO Capital Markets Equity Research - Analyst

* Brett Michael Hundley

The Vertical Trading Group, LLC, Research Division - Research Analyst

* Brian Patrick Holland

Consumer Edge Research, LLC - Analyst of Small and Mid caps Staples & Protein and VP

* Farha Aslam

Stephens Inc., Research Division - MD

* Grant Blandford O'Brien

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Timothy Scott Ramey

Pivotal Research Group LLC - Co-Head of Consumer Research and Senior Analyst of Food, Beverage, and Nutrition

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Presentation

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Operator [1]

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Welcome to the Flowers Foods First Quarter 2018 Earnings Conference Call and Webcast. My name is Ellen, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to J.T. Rieck, Vice President, Investor Relations and Treasurer. Mr. Rieck, you may begin.

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J. T. Rieck, Flowers Foods, Inc. - Treasurer & VP of IR & Financial Analysis [2]

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Thank you, Ellen, and good morning, everyone. Our first quarter results were released yesterday evening. The earnings release and our updated investor presentation is posted in the Investors section of the recently refreshed Flowers Foods website. Our 10-Q was filed with the SEC yesterday evening.

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

Okay. Let's get started. Participating on the call today we have Allen Shiver, Flowers Foods President and Chief Executive Officer; and Steve Kinsey, our Executive Vice President and Chief Financial Officer. After their prepared remarks, we'll open the lineup for questions.

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

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [3]

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Thank you, J.T. The first quarter was encouraging on several fronts and reflects the progress that we're making on our strategic priorities to drive profitable growth and remove costs. We're achieving solid momentum, and we have confidence that we can reach the goals that we set for fiscal 2018.

As you know, over the past year, we've been working on Project Centennial, and we are executing on initiatives that increase our focus on the consumer, while removing complexity and cost from our business. Our goal is by 2021, we can drive sales growth of 3% to 4% and achieve EBITDA margins of 13% to 14%. The restructuring we began last year, which will be completed in early 2019, has resulted in a more cost-effective, functional structure. Teams are now empowered to grow our core brands, improve productivity and capitalize on opportunities in underdeveloped geographies and underdeveloped product adjacencies. Working together in new and dynamic ways, our team will be executing with greater urgency and accountability on these strategic priorities.

For the quarter, we delivered record sales and posted solid sales growth of 1.6%, which was ahead of our first quarter targets. Our portfolio of strong brands continues to outperform the packaged bread category, even with the price increases we took early in the first quarter to recover significant input cost inflation.

Adjusted earnings per share was $0.30 for the quarter, up 20% year-over-year. This trend is in line with the guidance we have given for the full year.

We are pleased with the solid performance demonstrated by our core brands in a competitive marketplace. For the seventh straight quarter, our market share increased, according to IRI, improving 0.6 share points to 15.8. These share gains were driven primarily by continued growth from Dave's Killer Bread and solid performance from our Nature's Own and our Wonder brands in the traditional loaf segment.

The revitalized brand teams we put in place last year have been executing on our strategic brand initiatives, and there is now a solid innovation and marketing pipeline of new products that we have just begun to introduce.

In last April, we introduced a booming berry variety to our successful DKB bagel line. As you know, the bakery category is large, and there are significant segments, like breakfast, where we can show share growth with unique products. The breakfast segment is approximately $2 billion of retail. And since launching DKB breakfast items last year, we've doubled our market share.

At the start of the second quarter, we launched Nature's Own Perfectly Crafted, a line of artisan-style bakery breads. It is delicious, a very special loaf with thick slices, soft texture and distinctive packaging. This new line also has the better-for-you attributes that are so important to consumers today.

And for the summer grilling season, our Wonder brand has partnered with the USO for a Camo for the Cause promotion. With unique packaging and thousands of special in-store product displays, we are proud to support the USO.

These are just a few examples of new innovation, and we have been pleased with how things have been progressing. Over the next few quarters, we will have more new products come to market with clear points of difference and consumer appeal.

One important point is that our new cross-functional operating structure allows our brand marketing efforts to be much more strategic. For example, these new product launches I just described are being executed around a marketing strategy that includes a 360-degree brand activation program to drive consumer awareness and trial. We now have the support of our field marketing teams to drive marketplace execution. Overall, we are confident this is a more focused and effective approach than we've used in the past.

While we are growing in the fresh bakery category, we realize our cake business is not as profitable as it should be. As I mentioned on the last call, our cake team is focused on profitability and executing on the fundamentals. This team is streamlining the assortment, rationalizing price points, prioritizing innovation, rightsizing capacity and identifying investments to drive manufacturing efficiency. There is no quick fix, but we will be aggressive in taking actions necessary to improve the financial performance of our snack cake business.

The transition to our new organizational structure is one of the most powerful things that we are doing under Project Centennial. To put it simply, we have a new, energized teams that are working cross-functionally on achieving our strategic priorities. The business units create strategies that maximize the value of their brands and business lines. Dedicated brand teams and field marketing groups work to drive profitable growth. Our Chief Marketing Officer and his team support the business units through consumer insights and research-driven innovation.

The sales team executes in the marketplace. Our retailer engagement has never been stronger at both the national and the local levels. Also we now have a dedicated distributor enablement team that has dramatically improved our partnership with the independent distributors. Order quality is improving. That is putting fresher products into the marketplace and helping distributors build their business.

Our supply chain group also has been restructured to emphasize a greater focus on quality, continuous improvement, efficiencies and network optimization. Our bakeries are now headed up by leaders whose sole responsibility are plant operations and product quality.

In addition, the work we did last year on brand and market assortment has given us a clearer long-term view of our capacity needs, which is valuable insight as we optimize our manufacturing and distribution networks.

For the first time, we have a team completely focused on value creation, strategic growth and acquisitions. M&A remains a key component of our growth strategy. And our finance and technology functions are becoming more analytical and forward-looking. We've centralized and standardized processes and have put more focus on reducing costs across the company.

The benefits of our new organizational structure are already yielding results. We have recruited exceptional talent who have brought us new capabilities, and we promoted high performers from within. The fresh perspective that comes from these actions have been powerful and has made the entire company more effective. I am very proud of the Flowers team and how they're adjusting to all of the changes that we've made over the past year.

Looking ahead, in terms of our Project Centennial priorities, our attention is on completing our organizational restructuring and accelerating our supply chain initiatives. We expect these to be significant drivers of cost savings and efficiencies.

We are also evaluating a robust pipeline of M&A opportunities within the bakery foods space. We recognized this is an area where we can drive significant value with acquisitions that build on our competitive strengths. However, we will continue to be disciplined in our process, mindful that valuations are high, and we do have meaningful investment opportunities with our -- within our own operations.

There's certainly a lot of good work going on, but I want to make this clear: We are not going to be satisfied until we achieve the long-term sales and margin goals. While we're making good progress on the cost savings initiatives we identified for Centennial, we intend to stay aggressive and to make sure those savings are not lost through inflation or inefficiency in other parts of the business.

Now I'll ask Steve to review the financials and provide our outlook for the rest of the year. Steve?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [4]

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Thank you, Allen, and good morning, everyone.

Let's start with the items affecting comparability in the quarter, which amounted to approximately $0.06 per share. The most significant items were Project Centennial-related, consulting and restructuring costs that totaled $7.7 million.

We also recorded a pension settlement charge of $4.7 million, an IDP-related legal settlement of $1.4 million and a multiemployer pension plan withdrawal cost of $2.3 million.

Now turning to first quarter operating results. Total first quarter consolidated revenue increased 1.6%. Adjusting for the mix manufacturing business we divested early last year, sales increased 1.7% compared to the prior quarter.

DSD segment revenue was up 1.6% in the first quarter, driven primarily by strong sales of DKB, partially offset by lower sales of traditional bakery items. Price/mix increased 3.4%, while volume decreased 1.8%. The majority of our price/mix this quarter came from the growth of DKB and our overall sales mix.

As discussed on prior calls, we did address the commodity inflation we are experiencing with pricing early in the quarter, which did help to offset the ingredient cost inflation. We remain focused on productivity initiatives to offset the other inflationary cost pressures we are experiencing.

Warehouse segment revenue was up 2.2% in the quarter, excluding a 50 basis point decline associated with the mix manufacturing business. Price/mix decreased 3.6%, while volume increased 5.8%. Most of this increase was driven by higher food service and store-branded retail sales, partially offset by lower sales in our Warehouse organic business and contract manufacturing.

Consolidated adjusting operating margin was 7.3% of revenue compared to 7.2% in the first quarter last year. Adjusting operating margin in our DSD segment was flat with the prior year. Sales increases due to improved price/mix and lower SD&A costs were offset by lower manufacturing efficiencies as well as higher input cost and labor inflation.

Also impacting the DSD segment adjusted EBIT was a $2.5 million impairment of a note receivable from a non-IDP customer.

Adjusted Warehouse operating margin was down 80 basis points as a percent of sales, impacted primarily by a shift in mix from the higher-margin branded bread items to lower-margin cake and food service items and higher freight. These were offset somewhat by lower SD&A cost.

Looking at our consolidated results. Gross margins declined 60 basis points as a percentage of sales due to higher outside purchases and ingredient costs as well as lower production efficiencies. As Allen mentioned, we are not satisfied with the reduced efficiencies, and our supply chain team is focused on addressing the underperforming assets in order to improve gross margins.

It's important to note, the restructuring and cost programs we've been working on have primarily benefited our SD&A functions. These programs were the primary driver of an 80 basis point decrease in our adjusted SD&A expenses. As we complete the restructuring and accelerate our multiyear supply chain optimization initiatives, we expect to improve overall manufacturing efficiencies and achieve our long-term EBITDA margin objectives.

Reflecting the net of higher production cost and lower SD&A as a percent of sales, as well as the impact of the $2.5 million asset impairment noted earlier, adjusted EBITDA margin decreased 20 basis points to 11%.

GAAP earnings per share for the quarter was $0.24 per share. Excluding the items affecting comparability mentioned earlier, adjusted EPS in the quarter was $0.30 per share, up $0.05 compared to the prior quarter -- prior year quarter. The effect of the new tax law accounted for approximately $0.04 of the increase in adjusted EPS.

Now turning to cash flow. Cash flow continues to be strong. Operating cash flow during the quarter was $97.1 million, or up $15.2 million from the prior year. This increase was primarily due to lower Project Centennial-related consulting costs and a lower effective tax rate, net of a $10 million voluntary pension contribution.

Capital expenditures were $26.6 million in the quarter as compared to $17.5 million a year ago.

We ended the quarter with $795.7 million in net debt. At quarter end, our net debt to trailing 12-month adjusted EBITDA was 1.8x.

Our financial position is strong. As of the quarter end, we had approximately $682 million of liquidity available on our credit facilities.

For 2018, we continue to expect sales to be in the range of flat to up 1.6% and adjusted EPS to be in the range of $1.04 to $1.16 per share, including the benefit of approximately $0.14 to $0.16 per share due to tax reform.

Our forecast is for top line to be driven primarily by incremental volumes from DKB as well as from the brand growth initiatives we have coming into the market during the second and third quarters. We're encouraged by the performance of our brands in the marketplace so far this year, but we do continue to see a competitive environment overall.

We are pleased with the performance of DKB, as its growth has served to offset softer volumes from our core branded items. This mix shift does positively benefit sales, but overall it's generally neutral to margins, as DKB's margins are currently in line with overall corporate averages.

We are on track with our cost-cutting savings initiatives: PG&S, organizational redesign and supply chain optimization. From these initiatives, we are targeting approximately $38 million to $48 million of gross savings in 2018, which is incremental to the $32 million of gross savings we realized in 2017. A portion of these savings are being invested into incremental marketing and innovation programs to drive brand growth. These incremental costs will primarily impact margins in the second and third quarters, tracking the brand growth initiatives that Allen mentioned earlier.

We continue to expect approximately $40 million of input cost inflation in 2018, which we have addressed through pricing actions and continuing to focus on improving manufacturing efficiencies. We are seeing a tight labor market, which causes increased turnover at the bakeries and contributes to the lower manufacturing efficiencies.

Also keep in mind that outside purchases have increased to support the growth of Dave's Killer Bread, which has temporarily pressured margins.

And finally, like other companies, we are experiencing a tight trade environment, which offsets a portion of the savings realized from the organizational restructuring.

For 2018, we expect a full year tax rate of approximately 25% to 26%.

We remain comfortable with our EPS guidance range, which we believe appropriately balances the factors we are seeing in the marketplace and the progression on Project Centennial. The upper end of the range assumes a rational competitive environment, steady growth from DKB and solid performance from our new product introductions. The lower bound incorporates continued softness in the core brands, a competitive marketplace and further inflationary cost pressures.

On balance, our financial performance so far this year is in line with our expectations. Our Q1 top line performance was encouraging, and we are pleased with the progress being made to reduce SD&A cost. As I've detailed, production costs are experiencing upward pressure. And as Allen stated, we are addressing the increase in these causes -- these costs.

Overall, we've made progress with Project Centennial. The savings realized through our PG&S and the ongoing organizational restructuring have helped to offset the transitory factors impacting our gross margin. Long term, there is a clear path through supply chain optimization to improve our production through supply chain -- to improve our production cost structure, and we are confident, given the success of our strategies to reduce SD&A, that our supply chain initiatives will allow us to drive margin improvement in line with overall goals.

Now I will pass the call back to Allen.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [5]

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Thank you, Steve. In summary, we're pleased with our performance in the first quarter. It reflected the competitive strength of our core brands and the strategic initiative on which we have been executing in connection with Project Centennial.

Looking ahead, we will continue to work with urgency to maintain the momentum we've built to drive profitable growth, enhance ROIC and create value for our shareholders.

Now let's open the line for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Farha Aslam with Stephens.

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Farha Aslam, Stephens Inc., Research Division - MD [2]

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First question is about pricing. Could you share with us the level of pricing you've implemented into the marketplace, and how retailers, and particularly consumers, have received that pricing?

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [3]

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Farha, we mentioned earlier that we have implemented pricing early in the quarter. It varies from one market to the next in terms of the amount of the price increase, but we monitor those -- that very closely. The -- our retailers have been supportive, as they -- they're excited about brands like Dave's Killer Bread that is retailing at a price point that benefits both the baker and the retailers. So we've been pleased with the pricing that we have taken, and it's a market-by-market situation of overall reaction.

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Farha Aslam, Stephens Inc., Research Division - MD [4]

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Okay. And then as a follow-up. Your SG&A costs in this quarter were particularly low compared to our expectations. Could you share with us kind of what we should anticipate SG&A to be for the year, and how, in particular, marketing and your recent pension actions will impact that line?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [5]

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Sure. Farha, when you look overall at the SD&A as a percent of sales, I think you should continue to see the trend. What you're really seeing is the impact of our organizational changes. There was a nice labor improvement in the quarter. Marketing spend was up in Q1, but we expect to see that accelerate in Q2 and Q3 as we progress through the year. And then overall, with regard to the pension plan, we do have a derisk strategy in place, and we are executing on that. So several of the charges around the pension plan, you've seen that now for several quarters. A lot of that has to do with lump sum -- lump sums being taken by retired or terminated plan participants. So we do expect that to continue and -- as we kind of work through the derisk strategy.

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Farha Aslam, Stephens Inc., Research Division - MD [6]

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Okay. So SG&A as a percentage of sales kind of -- for the next 3 quarters to be a bit higher than the first quarter because of increased marketing expenditures. Do I have that right?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [7]

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Yes. They may be up slightly, but hopefully sales continue to show good performance as well.

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Operator [8]

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Our next question is from Brett Hundley with The Vertical Group.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [9]

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As we look out across fiscal '18 and incorporate Q1, can you give me a little bit of guidance on how gross input cost inflation falls and maybe where it might be most acute? I have my assumptions on this, but I wanted to see how they line up.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [10]

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Generally, when you look at how the -- kind of the cadence of cost increases around overall input cost, inflation in the first half is probably slightly higher than the back half. I wouldn't say it's overall significant, but we are seeing higher inflation in the first half. So that does have a greater impact in Q1 and Q2.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [11]

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And Steve, if you can try and characterize this for me, are Q1 and Q2 relatively similar? Or is one larger than the other there?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [12]

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From a percent of sales perspective, probably similar. Q2 maybe slightly higher given where we were last year.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [13]

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Okay. That's helpful. And then can you give me a sense of what percentage of DKB is being co-packed today versus in-house?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [14]

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Yes. The primary thing being co-packed today with DKB actually is in the breakfast category. Most of the bread that's being produced in-house, there is a slight number of -- a slight portion of the volume that is being co-packed. So it really is around the breakfast items.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [15]

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Okay. And then lastly for me. You guys talked to some momentum as it relates to production cost increases, and that makes sense given all the variables that you talked about. I just wanted to revisit your growth savings target for 2018, the net impacts from reinvestment and just try to get a sense of slack in the system, so to speak. So as you guys try and combat what seems to be some higher production cost increases, do you feel like you can rein in reinvestment spend at all? Or are these higher production cost increases really just something that you and others have to eat over the near term in order to maintain your strategy and grow the overall category over time?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [16]

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When you look at the pressure on gross margin for the quarter and you look at the labor aspect, a couple of things really are happening here. One, we actually are seeing a benefit on overall company employees. We are down slightly from a labor perspective. What we have seen is an increase in our contractor outsourced labor, so we are working on trying to rightsize from a production standpoint with regard to those contracts. Also when you look at tonnage with -- in the company, we are down slightly from a tonnage perspective. That's impacting the overall efficiency ratio. As you can see, we're down pretty significant for the quarter. And that means cost per pound is up. A lot of that is being driven by labor, so we have to rightsize labor to drive that overall cost percentage down. I think we've talked about several times, 100 basis points on the efficiency ratio is pretty significant to overall earnings and margin. So it's imperative that we get -- that we bring that back in line with where it has been historically.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [17]

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Brett, we -- when we think about supply chain optimization, I mean, we -- it is very much of a priority for the leadership team. We are -- we're early in the process, but we see significant improvements in overall supply chain structure and adjustments as we go forward. So that's very much of a priority moving forward.

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Operator [18]

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The next question is from Bill Chappell with SunTrust.

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Grant Blandford O'Brien, SunTrust Robinson Humphrey, Inc., Research Division - Associate [19]

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This is actually Grant on for Bill. I guess our first one is just on the growth of the portfolio ex-DKB. Obviously, DKB is really strong, and we just want to get a sense of kind of how the other brands are doing.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [20]

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Yes. We're excited about the renewed marketing activity that we have targeted at our brands, such as Nature's Own. We've introduced, I mentioned it earlier, our new Nature's Own crafted, which is a -- has been a great addition to a very strong brand. We also have marketing programs that are energizing our targeted energized brands, like Wonder with our tie-in with the USO. And again, we have a much more robust marketing calendar looking forward than I can remember. So very excited about the -- what is taking place within our marketing group, combined with great execution from our new structure from a sales standpoint. So we're very encouraged looking forward.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [21]

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Just when you look specifically at brands, we wouldn't really get into that detail competitively. But overall, our branded growth is still being driven by DKB. We are still seeing some pressure depending on the segment or category with certain brands. But white -- it was in the white bread category, Wonder continues to perform very well, as does Nature's Own butter bread. And then for the first time in several quarters, we've actually seen our dollars in soft variety improve quarter-over-quarter, so that's very positive.

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Grant Blandford O'Brien, SunTrust Robinson Humphrey, Inc., Research Division - Associate [22]

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Okay. And actually, our second question is just on the synergy realization from Project Centennial. I don't know if you're willing to break that out, but how big the savings were this quarter and maybe the cadence for the rest of the year?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [23]

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I mean, when you look at the $70 million to $80 million, and that equates to roughly the $38 million or so for the year, I'd say we're in line with the guidance that's out there. And it's fairly pro rata year-over-year. So a lot of that is org driven, as well. So if you look at a pro rata, you'll be okay.

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Operator [24]

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The next question is from Akshay Jagdale with Jefferies.

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Akshay S. Jagdale, Jefferies LLC, Research Division - Equity Analyst [25]

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Okay. Perfect. So I know you talked a little bit about the impact of DKB. If you could provide a little bit more clarity on that, it'd be great. So my question is really, DKB, from the way I understand it, it's having an extremely positive impact on your mix number in DSD, like I think it's the vast majority of the price/mix number that's showing up in your P&L. But in terms of tonnage, it has a negative impact. And in terms of margins on DSD, it's probably negative too, right? So that's how I understand it. Can you give us some, like, quantification around that? Just because I think it would be useful for the market, for us to adjust our expectations on what we should be assuming for price and how positive sort of DKB is going to be in terms of revenue contribution and EBIT contribution this year. That would be helpful.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [26]

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Akshay, I'll comment on overall brand development. I'll let Steve finish the rest of your question. We are excited about the growth of Dave's Killer Bread. From a margin standpoint, that brand is in line with other products in our portfolio. But I want to make sure that you understand that while we're seeing dramatic growth with Dave's -- it's the #1 brand in the organic category. The organic segment of the bakery category is the fastest growing. So while we're excited with Dave's Killer Bread, we're also equally excited about the development and marketing work that's taking place with our other brands. I mentioned Nature's Own and Wonder. Our other regional white bread brands, such as Sunbeam, Evangeline Maid, Bunny, all of those, it's encouraging to see the marketing support that's taking place behind our entire portfolio of brands. So again, the margin being generated from Dave's is encouraging, but it's really in line with the other products in our category. Steve?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [27]

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So Akshay, when -- kind of back to the point you made about the sales and top line and LMA, DKB is a high-growth brand. And typically when you have a high-growth brand, you're also investing in that brand quite a bit. So there is a lot of -- still some investing that's taking place overall in DKB. From a production perspective, we're still fairly limited to 3 quadrants of the U.S. The Northeast is a big growth quadrant for us, and we are seeing good growth there. But not having production in that market is costing from an overall margin perspective to deliver DKB into the Northeast. So when you look broadly at the DKB margin, comparing maybe to Nature's Own, it is below that. I would -- it's not negative from a margin perspective, but it's still a brand that we're investing in. And we still believe that the overall margin can continue to grow. But I'd say, it's in line to slightly above corporate average from an overall margin perspective today.

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Akshay S. Jagdale, Jefferies LLC, Research Division - Equity Analyst [28]

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That's helpful. And just one more point of clarification. So when we look at the numbers available to us in Nielsen-IRI, it's showing that the brand is growing like 70-plus percent, I think, which is great. And I know the growth rates are really strong. But can you just give us a sense -- because I feel like we're extrapolating that and applying it to the entire DKB portfolio and that might be the wrong thing to do. So can you just give us some context and sort of looking at Nielsen and those growth rates and extrapolating that to the entire DKB portfolio? Because I -- from what I understand, the shipments for DKB are up strong, but not 70%.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [29]

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Yes. Overall, when you look at the brand and you look at the category, it's a smaller base than the traditional bakery category. So you do see elevated growth rates. If you look at in 2017 and our category growth was around 45% to 50%, I'd say, internally, we're more in line with that than the 70% that you're maybe seeing in Nielsen and IRI. You have to remember there are a lot of outlets that are excluded as well. So it does impact that as well.

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Akshay S. Jagdale, Jefferies LLC, Research Division - Equity Analyst [30]

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Helpful. And one last one. So your guidance, which you've maintained, right, it implies a pretty significant acceleration in EBIT growth for the remainder of the year without really significant acceleration in top line, so the margin expansion is going to be much greater. What's driving that, if it's not commodities, right? Commodities, you said, are somewhat similar front half, back half. Pricing is coming in, so I'm guessing pricing contribution will be greater as the year goes along. And then I'm assuming the cost savings are also greater as the year goes along. Are those the 2 main drivers that get you to that accelerated growth for the remainder of the year?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [31]

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Yes. So generally, when you look at the guidance, the guidance, I'd say, is a range. And we've talked about the factors that impact where you land within that range. Allen talked about it. I talked about it. When you look on the gross margin line, there are really 3 large buckets impacting the overall margin: Input cost, which we believe we've addressed through pricing. The labor market or the cost of our labor, which we are addressing, as Allen said, with urgency. We realized that we need to get that in line in order to accelerate the margin growth for the rest of the year. So there are -- we are taking action and looking at the overall labor cost within production. And then with regard to outsourced production, again, some of that is beyond our control just because a lot of that growth is in breakfast. But we will continue to work on the margin profile of those items, as well, and continue to try to drive overall margin improvement within the organic space.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [32]

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Akshay, I'll just add. I mentioned earlier, this whole supply chain optimization, we're early in the process of generating savings from overall structure, but that, as well, is going to be a real top priority as we finish the year and should generate significant results.

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Operator [33]

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The next question is from Tim Ramey with Pivotal Research Group.

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Timothy Scott Ramey, Pivotal Research Group LLC - Co-Head of Consumer Research and Senior Analyst of Food, Beverage, and Nutrition [34]

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A lot of focus on DKB, but it really is a pretty stunning story thinking back almost 3 years ago when you did the deal. Just doing the math off of the share numbers that you've presented, I mean, it looks like that business is maybe 2.5x or 2x the size that it was just 3 years ago. Is that fair?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [35]

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Yes, I would say that's a reasonable estimate.

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Timothy Scott Ramey, Pivotal Research Group LLC - Co-Head of Consumer Research and Senior Analyst of Food, Beverage, and Nutrition [36]

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That's pretty impressive. And thinking about other categories where you don't have significant penetration. Obviously, dinner bread and rolls, you're underrepresented there. Is that an area where DKB could play? I assume you've thought hard about that, but what are your thoughts?

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [37]

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Tim, we'll -- we're very excited about the growth of Dave's Killer Bread. It's very important that you don't overextend the brand. We have to make sure that the brand is present in categories that are appropriate for the positioning of the brand. We do agree that there are other opportunities within the retail space. We will continue to look at the bakery deli opportunities that are out there. And whether that's Dave's Killer Bread or other brands, we see other opportunities to grow the top line.

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Timothy Scott Ramey, Pivotal Research Group LLC - Co-Head of Consumer Research and Senior Analyst of Food, Beverage, and Nutrition [38]

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Sure. And then cake sure was still down a scooch from last year, but it looks like it's inflected in the last 2 quarters and is moving a little higher. Is that Tastykake sort of finding a floor or growing again? Or can you speak to how Tastykake is performing in the market? I assume that, at some point, the incursions from Hostess and others would probably slow.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [39]

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I mean, overall, when you look at the cake category, you've seen things kind of stabilize. And when you look at from a brand perspective, we continue to see, I'd say, [decent] gains or improvement from a share perspective. Tastykake is, I would say, holding its own within the marketplace. Mrs. Freshley's has had some improvement through the warehouse distribution with a couple retailers. It's very strong in vending, which isn't measured in IRI. So I'd say, overall, Tastykake is doing well from margin perspective. It has stronger margins than Mrs. Freshley's, just given the economics where they play in the category. And we still feel like there's some whitespace for Tastykake, so we're still pleased that we have the brand.

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Timothy Scott Ramey, Pivotal Research Group LLC - Co-Head of Consumer Research and Senior Analyst of Food, Beverage, and Nutrition [40]

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Okay. And I would kind of go back to your comment on M&A. I know you're not going to talk about any specifics, but this is -- if I think about the long-term arc of Flowers, this is about when you normally would reload with a -- some sort of a deal. You mentioned valuations are high. Is there anything -- not specifically, but do you feel like there are things that either are in-market fill-ins or market extensions that would be attractive?

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [41]

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Yes. Again, we're not going to comment on specifics as far as M&A. But our strategy is very similar to our strategy of the past. We're looking at opportunities both in the fresh bakery category. We'll also look at opportunities in adjacent categories. So we will -- when we have something to announce, we'll be sure to do that.

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Operator [42]

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The next question is from Amit Sharma with BMO Capital Markets.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [43]

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On -- a quick clarification on pricing. So you took pricing in the quarter. Is it fully offsetting the commodities inflation, the marketing -- the pricing that you have in the market yesterday? Or is there more to come?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [44]

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I would say, generally, most of the pricing is in the marketplace. And for the most part, we are seeing it offset the vast majority of overall input cost inflation. But as we talked about, there are other items within the gross margin that we're seeing inflationary pressure beyond input cost. So we're -- yes, most of the pricing, I would say, is in place in the market.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [45]

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Got it. And then previously, sometimes your price gap with your closest competitors get out of whack sometime. Where are those price gaps related to historical levels? Or where would you like them to be?

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [46]

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There are markets where our prices is -- continues to be the leading price. But again, it's very much of a market-by-market situation. We are seeing some category movement in the direction that we've established. So time will tell. It will be different in each market.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [47]

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Got it. And then Steve, a little bit surprised about the gross margin, right? I mean, you laid out pretty nicely what the buckets are. But your comment that [Project Terra] is more of a SG&A impact, not a gross margin, although procurement and supply chain savings are part of the savings as well there, right? So just help us understand. I want to talk about SG&A as well. But on the gross margin side, is any of the Project Terra savings contributing to gross margin yet in this so far? Or it's all in the SG&A line?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [48]

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The vast majority is hitting SG&A. I mean, we talked about earlier the $70 million to $80 million did have a small component of supply chain optimization. But seeing the pressure in gross margin, as Allen stated, we'll need to -- it will really begin to accelerate some of the supply chain initiatives and really staying focused on that. I think from my seat, what gives me confidence is we executed very well last year on the SD&A initiatives, and you're seeing that flow through. And now we're shifting focus, not dropping focus on the SD&A, but we're shifting some focus to supply chain optimization. And I think you can see, when we become focused, we're able to execute. And that gives me confidence with regard to the overall supply chain cost. It's nice to have the top line growth. And now if we can bring in the gross margin component of this, I think there's really some exciting things ahead of us.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [49]

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Sure. And I want to have -- I have a question on SG&A, but let me finish with the gross margin quickly. So you said some of that is beyond your control and you're talking about co-pack there. But isn't that part of planning? Like you would know that you don't have capacity for breakfast in DKB. So since you were launching it, you knew at that time. Wouldn't you know that you have to go outside for that product?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [50]

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Well, with regard to the overall capacity, that is part of the planning. It just takes time to get production in place. So we are looking at production opportunities around breakfast and traditional DKB items. It's just not there yet.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [51]

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I'm just trying to understand perhaps the growth was faster than what you (inaudible) that's why you had to go out. Or was it always part of the plan?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [52]

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Yes, I mean, the brand continues, I mean, to perform very nicely. So yes, I would -- I don't want to say it's outpacing what we thought it could do, but it is growing at a nice pace. And we do need to catch up from a production perspective.

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Amit Sharma, BMO Capital Markets Equity Research - Analyst [53]

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All right. Just one more on SG&A. So can you unpack it a little bit for us in terms of how much did marketing dollars go up? And how much of that was [Project Terra]? How much of that was perhaps -- I know headcount reduction is another bucket if you want to line out.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [54]

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I mean, we wouldn't give it specifically for competitive reasons. But I would say, when you look at the overall drop in SD&A, a big part of that drop is driven by labor. And the marketing spend was not up significantly in Q1. A lot of that is coming in Q2 and Q3.

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Operator [55]

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Our next question is from Brian Holland with Consumer Edge Research.

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Brian Patrick Holland, Consumer Edge Research, LLC - Analyst of Small and Mid caps Staples & Protein and VP [56]

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I wanted to focus, again, if I could, on the gross margin line. It would appear to me that for the midpoint of your guidance to be achievable, you would need at least modest gross margin expansion over the balance of the year, unless SD&A is going to be even lower than what I'm modeling right now. So when you think about your 3 buckets, again, if I just -- I understand and appreciate the focus that you have on each of those components. But just wondering, timing, first on the pricing, was there a phase-in such that all of the pricing wasn't in place in Q1, so maybe you get a little bit of that? Or maybe now you're fully in place as we go Q2 and through the balance of the year, so maybe that's a little more of an offset than it was in Q1? And then the other 2 buckets, again, you've gone into great detail about what the issues are and your intentions to address them. But I'm just curious how soon you think that can flow through, such that we can see gross margins improve over the balance of the year. And then just within that, can we expect gross margins to improve versus 2017 in 2018?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [57]

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Yes. So more broadly, I would say, when you look at the pricing initiatives, there was a phase-in early in the first quarter, so they might -- they'll be a slight impact coming in to Q2. But I'd say, generally, everything was there for most of -- for the full quarter of the first quarter. And again, when you look at the initiatives around some of the cost impacts in Q1, as Allen said, we're being fairly aggressive with trying to accelerate some of those because we know we've got to get gross margin back in line and take some of those costs out. So when you look at full year 2018 gross margin, we are projecting that the -- there will be some margin improvement now.

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Brian Patrick Holland, Consumer Edge Research, LLC - Analyst of Small and Mid caps Staples & Protein and VP [58]

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Okay. That's very helpful. And then just last one for me. Most of my questions have been answered. But just curious on the cake business. I think it's been a fantastic success story, what you've done with Dave's Killer Bread. We've seen the inflection in Wonder, so improved productivity there, which certainly would lend some confidence here that with greater focus, and you talked about new leadership in place on sweet bake -- or on your cake business that maybe we can see a similar lift. I'm just wondering about timing of those initiatives, when we would expect to see more marketing behind those brands and kind of the innovation ramp start to roll out there. If you could just help us understand maybe the timing of some of those initiatives, that would be helpful.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [59]

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Brian, I mentioned earlier that really optimizing our cake business is a top priority. Our leadership team is fully engaged. We're in the SKU rationalization process as we speak. And quite honestly, that will drive a lot of the manufacturing improvements and efficiencies that we plan to implement later in the year. But in order to try to break it out quarter by quarter, that's a little difficult to do at this point. But I can tell you that getting our cake business on track from a profitability standpoint is top priority. And we are -- we have a great team that is in place. And it's very much of a constant topic of discussion. So change is underway, and it is top priority.

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Operator [60]

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Our next question is from Rob Dickerson with Deutsche Bank.

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Unidentified Analyst, [61]

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It's [Matt] on for Rob. Following up on the outsourced production, how quickly do your incremental costs typically disappear from -- after a decision to in-source your volume is made? And how easy -- or how much investment is needed to convert your existing capacity to organic or new product types?

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [62]

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Sure. With respect to the labor question, typically the outsourced jobs are the more unskilled labor, so we're able to flex that fairly quickly depending on overall production volume. So that can almost -- it would be a ramp because you'll have to make sure you're not stressing the overall process, but we do have the ability to flex that more readily than in-house labor. And then the second part of the question around production on DKB. Again, with regard to outside purchases, a lot of that is driven by the breakfast category, and we do have limited capacity there. With regard to the main item, most of that is being produced in-house. A lot of the cost and pressure on margin there is coming with shipping runs. I mean, obviously, it's very -- it's a long run to get product from the South to the Northeast or from the Midwest to the Northeast, so that is putting some of the pressure on the margin. We've talked about this now for a quarter or 2 that given the growth in the Northeast, we really do need production capacity closer to that market, and that is part of the supply chain optimization that we're focused on.

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Unidentified Analyst, [63]

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Perfect. And on the timing for the supply chain optimization, I just wanted to understand first if the initiatives are something you'll eventually be giving more detail on when the time is right or if we'll learn more about them after it's done and it's already reflected in results. And second, if you can -- if you expect to see any benefit from the network optimization piece in 2018.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [64]

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Yes. With regard to the production capacity, for competitive reasons, we would do that more close to the event. It would be probably similar to what we did with Tuscaloosa where we converted a plant, but we wouldn't want to talk about that too far in advance. And then the second part of the question, can you repeat that, please?

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Unidentified Analyst, [65]

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Yes. Just if you expect to see any benefit from the network optimization piece in 2018 or if it's more still just on the sourcing and the organizational restructuring.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [66]

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Sure. When you look at network optimization, to drive the gross margin improvements that we're talking about, it will require some of that to flow through in 2018. But it will ramp as the year progresses, yes.

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Unidentified Analyst, [67]

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Okay. So there is some benefit.

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R. Steven Kinsey, Flowers Foods, Inc. - CFO & Chief Administrative Officer [68]

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Yes, there will be some benefit, yes.

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Operator [69]

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And we have no further questions at this time. I'd like to turn the call back to Allen Shiver for closing remarks.

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Allen L. Shiver, Flowers Foods, Inc. - President, CEO & Director [70]

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Thank you, Ellen. Again, I want to recognize the extremely hard work that's taking place by our team. Thank you for all the support and your involvement this morning. We look forward to our next update. Ellen, this concludes our call. Thank you.

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Operator [71]

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