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FLO > SEC Filings for FLO > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for FLOWERS FOODS INC


7-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of the company as of and for the twelve and forty week periods ended October 5, 2013 should be read in conjunction with the company's Annual Report on Form 10-K for the fiscal year ended December 29, 2012.

OVERVIEW:

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is segregated into four sections, including:

Business - discussion of our long-term strategic objectives, acquisitions, and the competitive environment.

Critical Accounting Estimates - describes the accounting areas where management makes critical estimates to report our financial condition and results of operations. There have been no changes to this section from our Annual Report on Form 10-K for the fiscal year ended December 29, 2012.

Results of Operations - an analysis of the company's consolidated results of operations for the two comparative quarters presented in our consolidated financial statements.

Liquidity and Capital Resources - an analysis of cash flow, contractual obligations, and certain other matters affecting the company's financial position.

There were several significant events during the forty weeks ended October 5, 2013 that will provide additional context while reading this discussion. These events include:

Stock Split - On May 22, 2013, the board of directors declared a 3-for-2 stock split of the company's common stock. The record date for the split was June 5, 2013, and new shares were issued on June 19, 2013. All share and per share information has been restated for all prior periods presented giving retroactive effect to the stock split.

Sara Lee and Earthgrains acquisition - On February 23, 2013, the company completed its acquisition of certain assets and trademark licenses from BBU, Inc., a subsidiary of Grupo Bimbo ("BBU"). The cash used to acquire these assets was approximately $50.0 million. The company acquired from BBU in the acquisition (1) perpetual, exclusive, and royalty-free licenses to the Sara Lee and Earthgrains brands for sliced breads, buns, and rolls in the state of California and (2) a closed bakery in Stockton, California. In addition, we received a perpetual, exclusive, and royalty-free license to the Earthgrains brand for a broad range of fresh bakery products in the Oklahoma City, Oklahoma, market area. The Oklahoma license purchase was completed during fiscal 2012 for an immaterial cost. We financed this acquisition with cash on hand and debt. We believe the California acquisition resulted in a bargain purchase because the Department of Justice (the "DOJ") required BBU to divest these assets, which resulted in a more favorable price to us than would have normally resulted from a typical arms-length negotiation. Thus, the fair value of the assets acquired exceeded the consideration paid by approximately $50.1 million after tax. The company agreed to a $10.0 million escrow holdback provision as a part of the Sara Lee California acquisition. The escrow holdback is described in more detail in Note 4, Acquisitions.

Acquired Hostess Assets - On January 11, 2013, the company announced that it had signed two asset purchase agreements with Hostess Brands, Inc. ("Hostess"), as the "stalking horse bidder" for certain Hostess assets. One of the agreements provided for the purchase by the company of Hostess' Wonder, Nature's Pride, Merita, Home Pride and Butternut bread brands, 20 bakeries, and 38 depots (the "Acquired Hostess Assets") for a purchase price of $360.0 million. The company paid $18.0 million as a deposit for the Acquired Hostess Assets during our quarter ended April 20, 2013. On July 19, 2013, the company completed the Acquired Hostess Assets acquisition for a total cash payment of $355.0 million as a result of a purchase price adjustment related to the Butternut trademark. The company purchased 36 of the 38 depots included in the original bid. A second proposed Hostess asset purchase agreement provided for the purchase of the Beefsteak brand for $30.0 million. This second agreement was topped by another bidder and the agreement terminated. In connection with this termination we received a break-up fee of $0.9 million during the first quarter of 2013. For most of the third quarter, we incurred carrying costs of $5.3 million related to these acquired facilities, such as workforce-related costs, property taxes, utilities and depreciation, and these costs were primarily included in the materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately) line item in our Condensed Consolidated Statements of Income, however, we did not begin introducing the brands associated with the Acquired Hostess Assets to the marketplace until near the end of the third quarter on September 23, 2013. The re-introduction of the brands will continue over the next several months and throughout fiscal 2014.

New term loan - On April 5, 2013, we announced that we entered into a senior unsecured delayed-drawn term loan facility ("new term loan") with a commitment of up to $300.0 million to finance a portion of the pending acquisition of the Acquired Hostess Assets, and to pay certain acquisition-related costs and expenses. There were $1.7 million in financing fees associated with this new term loan, which includes a fee of 20 basis points on the daily undrawn portion from May 1, 2013 through the borrowing date of July 18, 2013. The company borrowed $300.0 million under the new term loan on July 18, 2013 to fund a portion of the purchase price for the acquisition of the Acquired Hostess Assets.


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Amendment to the Credit Facility and Term Loan - On April 5, 2013, we announced that we amended our existing $500.0 million senior unsecured revolving credit facility (as amended, the "credit facility") and existing unsecured term loan (as amended, the "amended term loan"). The amendments provide for less restrictive leverage ratios and certain more favorable covenant terms, update the respective base agreements to address changes in law, and include applicable conforming changes in light of the new term loan. There were no costs associated with these amendments and we made a final payment of $16.9 million, which repaid the amended term loan in full on August 5, 2013.

Accounts Receivable Securitization facility - On July 17, 2013, the company entered into an accounts receivable securitization facility (the "facility"). The facility provides the company up to $150.0 million in liquidity for a term of two years. Under the facility, a wholly-owned, bankruptcy-remote subsidiary purchases, on an ongoing basis, substantially all trade receivables. As borrowings are made under the facility the subsidiary pledges the receivables as collateral. In the event of liquidation of the subsidiary, its creditors would be entitled to satisfy their claims from the subsidiary's pledged receivables prior to distributions of collections to the company. We include the subsidiary in our consolidated financial statements. The facility contains certain customary events of default, representations and warranties, and affirmative and negative covenants. As of October 5, 2013, the company had $125.0 million outstanding under the facility with $25.0 million available. As of October 5, 2013, the company was in compliance with all restrictive financial covenants under the facility. An additional $15.0 million was drawn early in our fourth quarter of fiscal 2013.

BUSINESS:

Flowers is focused on opportunities for growth within the baked foods category and seeks to have its products available wherever baked foods are consumed - whether in homes, restaurants, fast food outlets, or institutions.

Delivery methods and segments

The company has structured a network of bakeries through much of the U.S. to serve retail and foodservice customers with fresh bakery items, such as breads, rolls, buns, and snack cakes. We have two distinct delivery systems for delivering our products. First, the direct-store-delivery segment (the "DSD segment") products are delivered fresh to customers through a network of independent distributors who are incentivized to grow sales to build equity in their distributorships. The second delivery system is found in the warehouse delivery segment (the "warehouse segment"), which ships fresh or frozen products to customers' warehouses and customers then distribute these products to their individual depots, stores, or restaurants. Our manufacturing facility locations have been assigned to either the DSD or warehouse segment depending on which method is used to primarily deliver and sell their products.

The DSD segment operates a highly involved system of reciprocal baking whereby individual bakeries have an assigned production mission to produce certain items for their own region as well as for other DSD bakeries' regions. This system allows for long and efficient production runs that help the company maintain its position as a low cost producer. Bakeries within regional networks exchange products overnight through a third party transportation system so that at the beginning of each sales day, every bakery in the DSD segment has a full complement of fresh products for its independent distributors.

Consumers and our product portfolio

The company recognizes the need to stay in touch with changing consumer trends regarding baked foods. As a result, ongoing research on consumer preferences is conducted and outside resources used to stay current on changing taste, flavor, texture, and shape trends in bakery products and food in general. Our marketing, quality assurance, and research and development staffs collaborate regularly as new products are considered, developed, tested, and introduced.

Brands are important in the bakery category and the company has invested over several decades in its brand portfolio through advertising, promotion and packaging. Nature's Own, introduced in 1977, was developed to address the developing trend of consumers demanding baked foods with a healthier profile. Nature's Own, from inception, offered baked foods with no artificial flavors, colors, or preservatives. More recently, Nature's Own has removed high fructose corn syrup from its recipes and also added specific healthier ingredients such as fiber and omega-3.

Through the years, the company's product offerings have included some form of cake. In recent years, snack cakes have been developed and introduced under several brands, such as Bluebird and Mrs. Freshley's. In 2011, the company acquired Tasty Baking Co. ("Tasty") resulting in the addition of the iconic Tastykake brand to our brand portfolio. Prior to the acquisition, Tasty operated two bakeries in Pennsylvania and served customers primarily in the northeastern U. S. with an extensive line of Tastykake branded snack cakes. Subsequent to the acquisition, we have expanded Tastykake to the majority of our other markets.


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Strengths and core competencies

We aim to achieve consistent and sustainable growth in sales and earnings by focusing on improvements in the operating results of our existing businesses and, after detailed analysis, acquiring businesses and properties that add value to the company. We believe this strategy will result in consistent and sustainable growth that will build value for our shareholders.

The company is also committed to maintaining a shared Information Technology group that meets all of our bakeries' needs and maximizes efficiencies where available. The consumer packaged goods industry has used scan-based trading technology (referred to as "pay by scan" or "PBS") over several years to share information between the supplier and retailer. An extension of this technology allows the retailer to pay the supplier when the consumer purchases the goods rather than at the time they are delivered to the retailer. In addition, PBS permits the manufacturer to more accurately track trends in product sales and manage inventory.

We have developed and publicly announced our long-term goals over five-year time horizons. Compensation and bonus programs are set with benchmarks to the company's long-term goals. The majority of our employees participate in an annual formula-driven, performance-based cash bonus program. In addition, certain employees participate in a long-term incentive program that provides performance-contingent common stock awards that generally vest over a two year period. We believe these incentive programs provide short and long-term goals for our most senior management team and aligns their interests with those of shareholders.

We believe our highly automated bakeries that focus on quality permit us to bake products that meet consumers' needs. We also strive to maintain service levels for customers, consumers, and suppliers that exceed what is expected. The design of our delivery systems and segments permits us to allocate management time and resources to meet consumers' expectations.

Competition and risks

In January 2012, Hostess filed for bankruptcy for the second time since 2004. In November 2012, they filed a liquidation motion seeking permission to wind down the business. The motion was approved on November 21, 2012. At that time, Hostess immediately stopped production and sold out their remaining inventory. Hostess discontinued serving their customers by late November 2012. These events significantly impacted the industry as these Hostess sales shifted to other providers to meet consumers' needs. These providers included Flowers, Grupo Bimbo (the "Arnolds", "Thomas", "Sara Lee", and "Entenmann's" brands), Campbell Soup Company (the "Pepperidge Farm" brands), smaller regional bakeries, retailer-owned bakeries, and store brands.

Sales are principally affected by pricing, quality, brand recognition, new product introductions, product line extensions, marketing and service. Sales for the twelve weeks ended October 5, 2013 increased 22.5% over the twelve weeks ended October 6, 2012. Sales for the forty weeks ended October 5, 2013 increased 26.6% over the forty weeks ended October 6, 2012. As disclosed throughout this report, this increase was primarily due to volume increases resulting from the Hostess liquidation and, to a lesser extent, the Lepage acquisition in fiscal 2012 and the Sara Lee and Earthgrains acquisition in 2013. While we expect sales to grow, we cannot provide any assurance regarding the level of growth considering the current economic environment and competitive landscape in the baking industry. The baking industry will continue to see market fluctuations as companies compete for market position in the absence of Hostess.

Commodities, such as our baking ingredients, periodically experience price fluctuations, and, for that reason, we continually monitor the market for these commodities. The cost of these inputs may fluctuate widely due to government policy and regulation, weather conditions, domestic and international demand or other unforeseen circumstances. We have continued to experience increased commodity costs during 2013. We enter into forward purchase agreements and other derivative financial instruments in an effort to manage the impact of such volatility in raw material prices. Any decrease in the availability of these agreements and instruments could increase the effective price of these raw materials to us and significantly affect our earnings.

CRITICAL ACCOUNTING POLICIES:

Our financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). These principles are numerous and complex. Our significant accounting policies are summarized in the company's Annual Report on Form 10-K for the fiscal year ended December 29, 2012. In many instances, the application of GAAP requires management to make estimates or to apply subjective principles to particular facts and circumstances. A variance in the estimates used or a variance in the application or interpretation of GAAP could yield a materially different accounting result. Please see our Annual Report on Form 10-K for the fiscal year ended December 29, 2012, for a discussion of the areas where we believe that the estimates, judgments or interpretations that we have made, if different, could yield the most significant differences in our financial statements. There have been no significant changes to our critical accounting policies from those disclosed in our Annual Report on Form 10-K filed for the year ended December 29, 2012.


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RESULTS OF OPERATIONS:

Results of operations, expressed as a percentage of sales and the dollar and
percentage change from period to period, for the twelve week periods ended
October 5, 2013 and October 6, 2012, are set forth below (dollars in thousands):



                                                                                                      For the Twelve Weeks Ended
                                                                                                                  Percentage of Sales                  Increase (Decrease)
                                                          October 5, 2013        October 6, 2012        October 5, 2013         October 6, 2012        Dollars           %
Sales
DSD segment                                              $         729,831      $         592,250                   83.1                    82.6     $   137,581         23.2
Warehouse segment                                                  148,661                125,032                   16.9                    17.4          23,629         18.9

Total                                                    $         878,492      $         717,282                  100.0                   100.0     $   161,210         22.5

Materials, supplies, labor and other production costs
(exclusive of depreciation and amortization shown
separately below)
DSD segment(1)                                           $         352,515      $         287,939                   48.3                    48.6     $    64,576         22.4
Warehouse segment (1)                                              115,283                 94,569                   77.5                    75.6          20,714         21.9

Total                                                    $         467,798      $         382,508                   53.3                    53.3     $    85,290         22.3

Selling, distribution and administrative expenses
DSD segment (1)                                          $         288,012      $         225,024                   39.5                    38.0     $    62,988         28.0
Warehouse segment(1)                                                22,381                 18,830                   15.1                    15.1           3,551         18.9
Corporate(2)                                                        17,136                 13,472                     -                       -            3,664         27.2

Total                                                    $         327,529      $         257,326                   37.3                    35.9     $    70,203         27.3

Depreciation and amortization
DSD segment(1)                                           $          25,754      $          20,716                    3.5                     3.5     $     5,038         24.3
Warehouse segment(1)                                                 3,923                  4,067                    2.6                     3.3            (144 )       (3.5 )
Corporate(2)                                                           160                    (26 )                   -                       -              186           NM

Total                                                    $          29,837      $          24,757                    3.4                     3.5     $     5,080         20.5

Income from operations
DSD segment(1)                                           $          63,550      $          58,571                    8.7                     9.9     $     4,979          8.5
Warehouse segment(1)                                                 7,074                  7,566                    4.8                     6.1            (492 )       (6.5 )
Corporate(2)                                                       (17,296 )              (13,446 )                   -                       -           (3,850 )      (28.6 )

Total                                                    $          53,328      $          52,691                    6.1                     7.3     $       637          1.2

Interest expense, net                                    $           3,171      $           3,568                    0.4                     0.5     $      (397 )      (11.1 )
Income taxes                                             $          16,269      $          17,892                    1.9                     2.5     $    (1,623 )       (9.1 )

Net income                                               $          33,888      $          31,231                    3.9                     4.4     $     2,657          8.5

1. As a percentage of revenue within the reporting segment.

2. The corporate segment has no revenues.

NM. Not meaningful.


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Results of operations, expressed as a percentage of sales and the dollar and percentage change from period to period, for the forty week periods ended October 5, 2013 and October 6, 2012, are set forth below (dollars in thousands):

                                                                                      For the Forty Weeks Ended
                                                                                                  Percentage of Sales                    Increase (Decrease)
                                        October 5, 2013         October 6, 2012         October 5, 2013         October 6, 2012         Dollars            %
Sales
DSD segment                            $       2,392,705       $       1,893,957                    82.3                    82.5      $   498,748          26.3
Warehouse segment                                514,750                 403,092                    17.7                    17.5          111,658          27.7

Total                                  $       2,907,455       $       2,297,049                   100.0                   100.0      $   610,406          26.6

Materials, supplies, labor and
other production costs (exclusive
of depreciation and amortization
shown separately below)
DSD segment(1)                         $       1,140,100       $         924,603                    47.6                    48.8      $   215,497          23.3
Warehouse segment(1)                             384,610                 302,541                    74.7                    75.1           82,069          27.1

Total                                  $       1,524,710       $       1,227,144                    52.4                    53.4      $   297,566          24.2

Selling, distribution and
administrative expenses
DSD segment(1)                         $         935,267       $         732,708                    39.1                    38.7      $   202,559          27.6
Warehouse segment(1)                              76,128                  62,931                    14.8                    15.6           13,197          21.0
Corporate(2)                                      53,519                  38,190                      -                       -            15,329          40.1

Total                                  $       1,064,914       $         833,829                    36.6                    36.3      $   231,085          27.7

Depreciation and amortization
DSD segment(1)                         $          76,178       $          62,684                     3.2                     3.3      $    13,494          21.5
Warehouse segment(1)                              13,120                  14,140                     2.5                     3.5           (1,020 )        (7.2 )
Corporate(2)                                         471                     (73 )                    -                       -               544            NM

Total                                  $          89,769       $          76,751                     3.1                     3.3      $    13,018          17.0

Gain on acquisition
DSD segment(1)                         $          50,071       $              -                      2.1                      -       $    50,071            NM
Warehouse segment(1)                                  -                       -                       -                       -                -             -
Corporate(2)                                          -                       -                       -                       -                -             -

Total                                  $          50,071       $              -                      1.7                      -       $    50,071            NM

Income from operations
DSD segment(1)                         $         291,231       $         173,962                    12.2                     9.2      $   117,269          67.4
Warehouse segment(1)                              40,892                  23,480                     7.9                     5.8           17,412          74.2
Corporate(2)                                     (53,990 )               (38,117 )                    -                       -           (15,873 )       (41.6 )

Total                                  $         278,133       $         159,325                     9.6                     6.9      $   118,808          74.6

Interest expense, net                  $          10,426       $           6,527                     0.4                     0.3      $     3,899          59.7
Income taxes                           $          75,333       $          55,244                     2.6                     2.4      $    20,089          36.4

Net income                             $         192,374       $          97,554                     6.6                     4.2      $    94,820          97.2

1. As a percentage of revenue within the reporting segment.

2. The corporate segment has no revenues.

NM. Not meaningful.


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CONSOLIDATED AND SEGMENT RESULTS

TWELVE WEEKS ENDED OCTOBER 5, 2013 COMPARED TO TWELVE WEEKS ENDED OCTOBER 6,
2012

Consolidated Sales.



                                For the                       For the
                           Twelve Weeks Ended            Twelve Weeks Ended
                            October 5, 2013               October 6, 2012
 Sales category              $              %              $              %         % Increase
                        (Amounts in                   (Amounts in
                         thousands)                    thousands)
 Branded Retail         $    483,289        55.0 %    $    373,686        52.1 %           29.3 %
 Store Branded Retail        148,993        17.0           131,194        18.3             13.6 %
 Non-Retail and Other        246,210        28.0           212,402        29.6             15.9 %

 Total                  $    878,492       100.0 %    $    717,282       100.0 %           22.5 %

The 22.5% increase in sales was generally attributable to the following across all sales categories:

                                                            Favorable
. . .
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