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FLOWERS FOODS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of the financial condition and results of operations of the company as of and for the twelve and twenty-eight week periods ended July 12, 2014 should be read in conjunction with the company's Annual Report on Form 10-K for the fiscal year ended December 28, 2013. 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 28, 2013. • 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 that will provide additional context while reading this discussion. These events include: • Hostess Asset Purchases - On July 19, 2013, we completed the acquisition of certain assets of Hostess Brands, Inc. ("Hostess"), which included the Wonder, Nature's Pride, Merita, Home Pride and Butternut bread brands, 20 closed bakeries and 36 depots (the "Acquired Hostess Bread Assets"). We began the re-introduction of certain of the Acquired Hostess Bread brands in our third quarter of fiscal 2013. We have not completed our assessment of the plants and depots, but we have determined that we intend to sell certain plants and depots that do not fit into our long-term operating strategy. Several of the depots have already been sold but the remainder are classified as held for sale in our Condensed Consolidated Balance Sheet included in this Form 10-Q. We expect these sales to continue throughout fiscal 2014 and into fiscal 2015. Also, we recorded carrying costs, including depreciation, associated with all of the acquired plants and depots of approximately $4.5 million and $11.2 million during the twelve and twenty-eight weeks ended July 12, 2014, respectively, in our Condensed Consolidated Statements of Income. • Opening of the Henderson, Nevada Plant - During the fourth quarter of fiscal 2013, we opened the bread line at a plant that was acquired as a part of the Acquired Hostess Bread Assets. We also opened the bun line during the second quarter of fiscal 2014. This plant increased our capacity for the California market. • Opening of the Modesto, California Bread Line - During the first quarter of fiscal 2014, we added a bread line at a plant we acquired in fiscal 2013 that originally produced only buns. This new line increases our capacity for the California market. • Opening of the Knoxville, Tennessee Plant - During the second quarter of fiscal 2014, we opened another plant that was acquired as a part of the Acquired Hostess Bread Assets. This plant operates a single bread line and increases our capacity in Tennessee, Kentucky, and Ohio. We anticipate adding a bun line in the future at this plant. • Amendment to the Credit Facility and Term Loan - On February 14, 2014, we announced that we amended our existing senior unsecured revolving loan facility previously amended and restated on May 20, 2011 and the term loan agreement dated April 5, 2013. The amendment to the senior unsecured revolving loan facility reduced the applicable interest rate and extended the maturity date to February 14, 2019. The amendment to the term loan agreement reduced the applicable interest rate. • Plant Held For Sale - During the second quarter of fiscal 2014, we decided to sell certain assets at our Ft. Worth, Texas, tortilla facility (the "disposal group"). We expect the sale to close during the third quarter of fiscal 2014. The carrying value of these assets is $7.5 million and is presented in "Assets Held for Sale" as of July 12, 2014 because the disposal group met the requirements for held for sale classification on the balance sheet date. Assets not part of the disposal group have either been transferred to other plants or will be scrapped shortly after closing. We recognized an impairment loss on goodwill of $2.6 million and an additional impairment loss of $1.9 million for the scrapped assets during the twelve weeks ended July 12, 2014. These impairments are recorded on the Condensed Consolidated Statements of Income in the line item "Impairment of assets". 31 -------------------------------------------------------------------------------- Table of Contents • Amendment to the Accounts Receivable Securitization facility - On August 7, 2014, the company amended the facility. The amendment (i) increased the revolving commitments under the facility to $200.0 million (ii) extended the term one year and (iii) made certain other conforming changes. 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, institutions, or vending machines. The company has 47 bakeries in 16 states that produce a wide range of breads, buns, rolls, and snack cakes. These products are marketed fresh to more than 79% of the U.S. population or are sold fresh and frozen nationally. Segments and Delivery Methods The company has two business segments that reflect its two distinct methods of delivering products to market. Direct Store Delivery ("DSD") segment products are delivered fresh to customers through a network of independent distributors who are incentivized to grow sales and to build equity in their distributorships. Our DSD segment reaches 79% of the U.S. population with fresh bakery foods. The warehouse segment ships fresh and frozen products to customers' warehouses nationwide. Customers then distribute these products to their depots, stores, or restaurants. Flowers' bakeries fall into either the DSD segment or warehouse segment depending on the primary method of delivery used to sell their products. The DSD segment operates a highly involved system of reciprocal baking whereby each bakery has an assigned production mission to produce certain items for its own market as well as for other DSD segment bakeries' markets. 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 DSD segment bakery has a full complement of fresh products for its independent distributors to provide to their retail and foodservice customers. The company has invested significant capital in its bakeries for several decades to develop efficient production processes, use technology effectively, provide consistently excellent quality, and offer a good working environment for team members. During the twenty-eight weeks ended July 12, 2014, we had capital expenditures of $45.0 million. 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 are engaged 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 teams 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. The Nature's Own line-up now offers varieties with higher fiber and omega-3. On July 19, 2013 the company completed the acquisition of the Acquired Hostess Bread Assets. In September 2013, the Wonder, Merita, Home Pride, and Butternut brands, which had been off the market since Hostess ceased operations in November 2012, were re-introduced into the market by the company. The brands were returned to markets where they were available before the company acquired the brands within our DSD segment market in the Northeast, East, South, Southwest, and Western parts of the United States. The acquired Nature's Pride brand has not been re-introduced to the market and we are still considering the future of this brand. Snack cakes have been part of the company's product offerings since at least the early 1920s. In more recent years, snack cakes have been developed and introduced under several brands, such as Blue Bird and Mrs. Freshley's. On May 20, 2011, the company acquired Tasty Baking Co. ("Tasty") and its extensive line of Tastykake branded snack cakes. The Tastykake brand added an iconic snack cake brand to our brand portfolio. Since the acquisition of Tasty, we have expanded the distribution of the Tastykake products into our core markets. We expect to continue to expand the Tastykake brand into any additional markets we enter over the next several years. 32-------------------------------------------------------------------------------- Table of Contents In 2014 we re-branded the Cobblestone Mill brand to the Cobblestone Bread Company brand. We have twelve core items and regional favorites at introduction. This brand includes restaurant and sandwich shop inspired breads and rolls. We completed the roll-out to the full market in July 2014. 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 bakeries and, after detailed analysis, acquiring companies and properties that add value to the company. We believe this strategy has resulted in consistent and sustainable growth that will continue to build value for our shareholders. The company is also committed to maintaining a collaborative, in-house information technology team that meets all of our bakeries' needs and maximizes efficiencies. 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. We regularly articulate our core business strategies to the investment community and internally to our team members, including long-term (five-year) goals. Compensation and bonus programs are linked to the company's short and 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 both a short- and long-term goal for our most senior management team and aligns their interests with those of shareholders. We believe our highly automated bakeries, with teams that focus on quality, bake products that meet consumers' needs. We strive to maintain and exceed service levels for our customers, consumers, and suppliers. The design of our delivery systems and segments permits us to allocate management time and resources to meet marketplace expectations. Competition and risks In January 2012, Hostess filed for bankruptcy. By the end of 2012, Hostess, which had been in bankruptcy for six of the last nine years, ceased production and announced it would liquidate. At that time, Hostess immediately stopped production and sold out their remaining inventory. Hostess discontinued serving their customers by late November 2012. These events impacted the industry as Hostess sales shifted to other providers to meet marketplace needs. These providers included Flowers, Grupo Bimbo (with Sara Lee, Arnolds, Thomas, and Entenmann's brands), Campbell Soup Company (with the Pepperidge Farm brand), McKee Foods Corporation (Little Debbie and Drake's) and smaller regional bakeries, retailer-owned bakeries, and store brands. The Hostess cake products were re-introduced into the market in July 2013 by a new and separate company formed by the outside investment group of Apollo Global Management and C. Dean Metropoulous & Co. that purchased the Hostess cake brands. Sales are principally affected by pricing, quality, brand recognition, new product introductions, product line extensions, marketing, and service. Sales for the second quarter of fiscal 2014 decreased 2.3% from the second quarter of fiscal 2013. This decrease was primarily due to declining volumes in the warehouse segment caused by the re-introduction of the Hostess cake products. While we expect sales to grow, we cannot guarantee the level of such growth considering the current economic environment and competitive landscape in the baking industry. The baking industry will continue to see market fluctuations in the near-term as companies compete for market position in the wake of the Hostess liquidation. 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 anticipate that our commodity costs will remain volatile in 2014. 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. 33-------------------------------------------------------------------------------- Table of Contents 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 28, 2013. 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 28, 2013, 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 28, 2013. 34-------------------------------------------------------------------------------- Table of Contents 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 July 12, 2014 and July 13, 2013, are set forth below (dollars in thousands): For the Twelve Weeks Ended Percentage of Sales Increase (Decrease) July 12, 2014 July 13, 2013 July 12, 2014 July 13, 2013 Dollars % Sales DSD segment $ 740,951 $ 740,709 84.5 82.5 $ 242 0.0 Warehouse segment 136,427 157,444 15.5 17.5 (21,017 ) (13.3 ) Total $ 877,378 $ 898,153 100.0 100.0 $ (20,775 ) (2.3 ) Materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately below) DSD segment(1) $ 359,442 $ 356,078 48.5 48.1 $ 3,364 0.9 Warehouse segment (1) 98,577 115,536 72.3 73.4 (16,959 ) (14.7 ) Total $ 458,019 $ 471,614 52.2 52.5 $ (13,595 ) (2.9 ) Selling, distribution and administrative expenses DSD segment (1) $ 288,120 $ 286,616 38.9 38.7 $ 1,504 0.5 Warehouse segment(1) 20,866 22,712 15.3 14.4 (1,846 ) (8.1 ) Corporate(2) 10,596 16,618 - - (6,022 ) (36.2 ) Total $ 319,582 $ 325,946 36.4 36.3 $ (6,364 ) (2.0 ) Impairment of assets DSD segment(1) $ 4,489 $ - 0.6 - $ 4,489 NM Warehouse segment(1) - - - - - - Corporate(2) - - - - - - Total $ 4,489 $ - 0.5 - $ 4,489 NM Depreciation and amortization DSD segment(1) $ 26,487 $ 22,082 3.6 3.0 $ 4,405 19.9 Warehouse segment(1) 3,524 3,529 2.6 2.2 (5 ) (0.1 ) Corporate(2) (104 ) 132 - - (236 ) NM Total $ 29,907 $ 25,743 3.4 2.9 $ 4,164 16.2 Income from operations DSD segment(1) $ 62,413 $ 75,933 8.4 10.3 $ (13,520 ) (17.8 ) Warehouse segment(1) 13,460 15,667 9.9 10.0 (2,207 ) (14.1 ) Corporate(2) (10,492 ) (16,750 ) - - 6,258 37.4 Total $ 65,381 $ 74,850 7.5 8.3 $ (9,469 ) (12.7 ) Interest expense, net $ 1,734 $ 2,700 0.2 0.3 $ (966 ) (35.8 ) Income taxes $ 21,583 $ 25,690 2.5 2.9 $ (4,107 ) (16.0 ) Net income $ 42,064 $ 46,460 4.8 5.2 $ (4,396 ) (9.5 ) 1. As a percentage of revenue within the reporting segment. 2. The corporate segment has no revenues. NM. Not meaningful. 35 -------------------------------------------------------------------------------- Table of Contents Results of operations, expressed as a percentage of sales and the dollar and percentage change from period to period, for the twenty-eight week periods ended July 12, 2014 and July 13, 2013, are set forth below (dollars in thousands): For the Twenty-Eight Weeks Ended Percentage of Sales Increase (Decrease) July 12, 2014 July 13, 2013 July 12, 2014 July 13, 2013 Dollars % Sales DSD segment $ 1,709,916 $ 1,663,471 83.9 82.0 $ 46,445 2.8 Warehouse segment 327,222 365,492 16.1 18.0 (38,270 ) (10.5 ) Total $ 2,037,138 $ 2,028,963 100.0 100.0 $ 8,175 0.4 Materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately below) DSD segment(1) $ 812,353 $ 786,433 47.5 47.3 $ 25,920 3.3 Warehouse segment(1) 241,543 270,479 73.8 74.0 (28,936 ) (10.7 ) Total $ 1,053,896 $ 1,056,912 51.7 52.1 $ (3,016 ) (0.3 ) Selling, distribution and administrative expenses DSD segment(1) $ 672,608 $ 648,446 39.3 39.0 $ 24,162 3.7 Warehouse segment(1) 49,930 52,556 15.3 14.4 (2,626 ) (5.0 ) Corporate(2) 23,434 36,383 - - (12,949 ) (35.6 ) Total $ 745,972 $ 737,385 36.6 36.3 $ 8,587 1.2 Impairment of assets DSD segment(1) $ 4,489 $ - 0.3 - $ 4,489 NM Warehouse segment(1) - - - - - - Corporate(2) - - - - - - Total $ 4,489 $ - 0.2 - $ 4,489 NM Depreciation and amortization DSD segment(1) $ 61,271 $ 51,234 3.6 3.1 $ 10,037 19.6 Warehouse segment(1) 8,180 8,387 2.5 2.3 (207 ) (2.5 ) Corporate(2) (252 ) 311 - - (563 ) NM Total $ 69,199 $ 59,932 3.4 3.0 $ 9,267 15.5 Gain on acquisition DSD segment(1) $ - $ 50,071 - 3.0 $ (50,071 ) NM Warehouse segment(1) - - - - - - Corporate(2) - - - - - - Total $ - $ 50,071 - 2.5 $ (50,071 ) NM Income from operations DSD segment(1) $ 159,195 $ 227,429 9.3 13.7 $ (68,234 ) (30.0 ) Warehouse segment(1) 27,569 34,070 8.4 9.3 (6,501 ) (19.1 ) Corporate(2) (23,182 ) (36,694 ) - - 13,512 36.8 Total $ 163,582 $ 224,805 8.0 11.1 $ (61,223 ) (27.2 ) Interest expense, net $ 4,906 $ 7,255 0.2 0.4 $ (2,349 ) (32.4 ) Income taxes $ 55,546 $ 59,064 2.7 2.9 $ (3,518 ) (6.0 ) Net income $ 103,130 $ 158,486 5.1 7.8 $ (55,356 ) (34.9 ) 1. As a percentage of revenue within the reporting segment. 2. The corporate segment has no revenues. NM. Not meaningful. 36 -------------------------------------------------------------------------------- Table of Contents CONSOLIDATED AND SEGMENT RESULTS TWELVE WEEKS ENDED JULY 12, 2014 COMPARED TO TWELVE WEEKS ENDED JULY 13, 2013 Consolidated Sales. For the For the Twelve Weeks Ended Twelve Weeks Ended July 12, 2014 July 13, 2013 Sales category $ % $ % % Decrease (Amounts in (Amounts in thousands) thousands) Branded Retail $ 490,751 55.9 % $ 491,459 54.7 % (0.1 )% Store Branded Retail 147,932 16.9 160,450 17.9 (7.8 )% Non-Retail and Other 238,695 27.2 246,244 27.4 (3.1 )% Total $ 877,378 100.0 % $ 898,153 100.0 % (2.3 )% The 2.3% decrease in sales was generally attributable to the following: Favorable Percentage Point Change in Sales Attributed to: (Unfavorable) Pricing/Mix 0.6 % Volume (2.9 )% Total Percentage Change in Sales (2.3 )% Sales category discussion The favorable pricing/mix was due to a shift in mix from lower priced cake items and store branded bread and rolls to higher priced branded bread and rolls, partially offset by a competitive pricing environment. We continue to experience heavy promotional activity in the branded category. Volume declines were primarily driven by decreases in our cake business and to a lesser extent store branded bread and rolls and foodservice. The re-introduction of the Hostess cake products negatively impacted both branded and store branded cake. The slight decrease in branded retail sales was due to volume declines in branded cake and pricing declines, mostly offset by volume gains from the Acquired Hostess Bread Assets and growth in our expansion markets (defined as new markets that we entered into in the last five years). The decrease in store branded retail sales was due to significant volume decreases in almost all categories with the largest decline in store branded cake. Non-retail and other sales, which include contract manufacturing, vending and foodservice, decreased mainly due to pricing/mix and volume decreases in foodservice sales. Direct-Store-Delivery Sales. For the For the Twelve Weeks Ended Twelve Weeks Ended July 12, 2014 July 13, 2013 % Increase Sales Category $ % $ % (Decrease) (Amounts in (Amounts in thousands) thousands) Branded Retail $ 460,163 62.1 % $ 457,349 61.7 % 0.6 % Store Branded Retail 120,772 16.3 126,817 17.1 (4.8 )% Non-Retail and Other 160,016 21.6 156,543 21.2 2.2 % Total $ 740,951 100.0 % $ 740,709 100.0 % 0.0 % Sales were unchanged due to the following: Favorable Percentage Point Change in Sales Attributed to: (Unfavorable) Pricing/Mix (0.3 )% Volume 0.3 % Total Percentage Change in Sales 0.0 % 37 -------------------------------------------------------------------------------- Table of Contents Sales category discussion Overall, volume growth in our branded retail sales was offset by negative pricing/mix as well as volume declines in our store branded products. The increase in branded retail sales was due primarily to volume increases primarily from the Acquired Hostess Bread Assets and sales growth in our expansion markets. These increases were partially offset by heavy promotional activity in the quarter and decreases in branded cake due to the re-introduction of the Hostess cake items. Branded white bread had strong sales in the quarter while branded cake had much softer sales. The decrease in store branded retail was due to volume declines in almost all categories with the largest decline in store branded white bread due to a shift to branded product. The increase in non-retail and other sales was primarily due to positive pricing/mix. Warehouse Segment Sales. For the For the Twelve Weeks Ended Twelve Weeks Ended July 12, 2014 July 13, 2013 Sales Category $ % $ % % Decrease (Amounts in (Amounts in thousands) thousands)Branded Retail $ 30,588 22.4 % $ 34,110 21.7 % (10.3 )% Store Branded Retail 27,160 19.9 33,633 21.4 (19.2 )% Non-Retail and Other 78,679 57.7 89,701 56.9 (12.3 )% Total $ 136,427 100.0 % $ 157,444 100.0 % (13.3 )% The 13.3% decrease in sales was generally attributable to the following: Percentage Point Change in Sales Attributed to: (Unfavorable) Pricing/Mix (1.8 )% Volume (11.5 )% Total Percentage Change in Sales (13.3 )% Sales category discussion Overall, significant volume declines in all categories as well as decreases in pricing/mix in the non-retail category drove the decrease. The re-introduction of the Hostess cake items negatively impacted the warehouse segment. The decrease in branded retail was primarily the result of decreased branded snack cake volume, partially offset by price/mix increases. The decrease in store branded retail was primarily due to volume decreases in store branded cake. The decrease in non-retail and other sales, which include contract manufacturing, vending and foodservice, was due primarily to much lower foodservice and vending volume and to a lesser extent negative pricing/mix. Materials, Supplies, Labor and Other Production Costs (exclusive of depreciation and amortization shown separately). The table below presents the significant components of materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 26.1 % 26.8 % (0.7 )% Workforce-related costs 13.7 12.8 0.9 Packaging 4.6 4.5 0.1 Utilities 1.6 1.5 0.1 Other 6.2 6.9 (0.7 ) Total 52.2 % 52.5 % (0.3 )% 38 -------------------------------------------------------------------------------- Table of Contents Overall, the decrease was attributable to lower ingredient costs and lower sales of outside purchased product (sales with no associated ingredient cost) as a percent of sales, partially offset by the $2.5 million of carrying costs associated with the acquired Hostess facilities, lower production volumes for the warehouse segment and higher workforce-related costs. The cost of the outside purchases is included in the other line item component and was largely comprised of the Sara Lee California product purchases from BBU in the prior year. Ingredient costs decreased as a percent of sales largely due to lower prices for sweeteners, oils, cocoa and flour, partially offset by higher costs for other ingredients and decreases in outside purchased product (sales with no associated ingredient costs). Increases in workforce-related costs as a percent of sales primarily resulted from increased headcount associated with increased production lines, lower sales for the warehouse segment, less outside purchased product (sales with no associated workforce-related costs) and the acquired Hostess facilities carrying costs. The decrease in the other line item is primarily driven by much lower outside purchased product, partially offset by higher costs from the acquired Hostess facilities. Commodities, such as our baking ingredients, periodically experience price fluctuations, and, for that reason, we continually monitor the market for these commodities. The commodities market continues to be volatile. Ingredient prices trended lower in the first half of 2014 and are expected to be volatile the second half of the year. 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 enter into forward purchase agreements and other derivative financial instruments to manage the impact of such volatility in raw material prices. Any decrease in the availability of these agreements and instruments could increase the price of these raw materials and significantly affect our earnings. The table below presents the significant components of materials, supplies, labor and other production costs for the DSD segment (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 23.6 % 24.2 % (0.6 )% Workforce-related costs 12.1 11.3 0.8 Packaging 3.4 3.3 0.1 Utilities 1.6 1.4 0.2 Other 7.8 7.9 (0.1 ) Total 48.5 % 48.1 % 0.4 % The DSD's segment's decrease in ingredient costs as a percent of sales was largely due to lower prices for flour, sweeteners and oils and increased product purchases from the warehouse segment (sales with no associated ingredient costs), partially offset by higher prices in other ingredients and decreases in outside purchased product (sales with no associated ingredient costs). The cost of the outside purchased product is included in the other line item component and was largely comprised of the Sara Lee California product purchases from BBU in the prior year. Increases in workforce-related costs as a percent of sales primarily resulted from decreases in outside purchased product (sales with no associated workforce-related costs), increased headcount due to increased production lines and the acquired Hostess facilities carrying costs. The table below presents the significant components of materials, supplies, labor and other production costs for the warehouse segment (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 39.5 % 39.1 % 0.4 % Workforce-related costs 22.7 19.9 2.8 Packaging 11.2 9.8 1.4 Repairs and maintenance 2.4 2.4 - Utilities 1.9 1.7 0.2 Other (5.4 ) 0.5 (5.9 ) Total 72.3 % 73.4 % (1.1 )% 39 -------------------------------------------------------------------------------- Table of Contents The warehouse segment's increase in ingredient costs as a percent of sales was primarily attributed to increased sales to the DSD segment (ingredient costs with no associated sales), partially offset by lower prices for shortening, sweeteners, cocoa and flour. Sales to the DSD segment are included in the other line item component in the above table. Increases in workforce-related costs as a percent of sales are also attributable to increased sales to the DSD segment as well as overall volume declines. Packaging increased due to price increases and higher sales to the DSD segment (packaging costs with no associated sales). As discussed above, increased sales to the DSD segment, as well as improved manufacturing efficiencies resulted in the decrease in the other line item as a percentage of sales. Selling, Distribution and Administrative Expenses. The table below presents the significant components of selling, distribution and administrative expenses as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Workforce-related costs 17.0 % 17.3 % (0.3 )% Distributor distribution fees 13.8 12.3 1.5 Other 5.6 6.7 (1.1 ) Total 36.4 % 36.3 % 0.1 % The distributor distribution fees increased due to the continued conversion of the Lepage Bakeries, Inc. ("Lepage") and California routes to independent distributors, as well as the DSD segment comprising a larger percentage of consolidated sales. These increases were not completely offset by a decline in workforce-related costs due to ongoing costs associated with market expansions, the Lepage integration and lower sales for our warehouse segment. Prior year acquisition-related costs of $5.7 million associated with the Acquired Hostess Bread Assets primarily caused the decline in the other line item component. The table below presents the significant components of our DSD segment selling, distribution and administrative expenses as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Workforce-related costs 17.0 % 17.9 % (0.9 )% Distributor distribution fees 16.4 15.0 1.4 Other 5.5 5.8 (0.3 ) Total 38.9 % 38.7 % 0.2 % The decrease in workforce-related costs as a percentage of sales was attributable to the continued conversion to independent distributors for Lepage Bakeries, Inc. and California routes, partially offset by higher costs associated with expansion into new markets and the continuing Lepage integration. The distributor distribution fees increased due to the continued conversion to independent distributors discussed above. The table below presents the significant components of our warehouse segment selling, distribution and administrative expenses as a percent of sales: For the Twelve Weeks Ended Increase July 12, 2014 July 13, 2013 as a Line item component % of sales % of sales % of sales Workforce-related costs 8.8 % 8.7 % 0.1 % Freezer storage/rent 2.0 1.8 0.2 Distribution costs 0.8 0.8 - Other 3.7 3.1 0.6 Total 15.3 % 14.4 % 0.9 % Lower sales that spread fixed costs over a smaller sales base drove the overall increase in selling, distribution and administrative expenses as a percent of sales. 40 -------------------------------------------------------------------------------- Table of Contents Impairment of assets. Refer to the discussion in the "Overview" section above. Depreciation and Amortization. Depreciation and amortization expense increased primarily as a result of the Acquired Hostess Bread Assets and the acquisition of certain assets related to a bun line in Modesto, California and their bread line added earlier this year. The DSD segment's depreciation and amortization expense increased primarily due to the Acquired Hostess Bread Assets and the acquisition of certain assets related to a bun line in Modesto, California and their bread line added earlier this year. The warehouse segment's depreciation and amortization expense was consistent with the second quarter of fiscal 2013. Income from Operations. The table below summarizes the percentage change in income from operations by segment: Favorable (Unfavorable) Income from operations Percentage DSD segment (17.8 )% Warehouse segment (14.1 ) Unallocated corporate 37.4 Consolidated (12.7 )% The unfavorable decrease in the DSD segment income was driven by the asset impairment charge of $4.5 million, the carrying costs of $4.5 million related to the acquired Hostess facilities, as well as increased promotional activity quarter over quarter. The unfavorable decrease in the warehouse segment income from operations was primarily due to significant sales decreases as discussed above. The favorable change in unallocated corporate expenses was primarily due to the prior year acquisition costs associated with the Acquired Hostess Bread Assets in 2013 and higher pension income in the second quarter of fiscal 2014 compared to the second quarter of 2013. Net Interest Expense. The decrease was related to higher interest income in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 due to the increase in distributor notes receivables outstanding. Income Taxes. The effective tax rate for the second quarter of fiscal 2014 was 33.9% compared to 35.6% in the second quarter of the prior year. The decrease in the rate is due to positive discrete items in the current quarter for state tax benefits and incentives. 41 -------------------------------------------------------------------------------- Table of Contents TWENTY-EIGHT WEEKS ENDED JULY 12, 2014 COMPARED TO TWENTY-EIGHT WEEKS ENDED JULY 13, 2013 Consolidated Sales. For the For the Twenty-Eight Weeks Ended Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 % Increase Sales category $ % $ % (Decrease) (Amounts in (Amounts in thousands) thousands) Branded Retail $ 1,138,551 55.9 % $ 1,102,848 54.3 % 3.2 % Store Branded Retail 337,298 16.6 353,644 17.4 (4.6 )% Non-Retail and Other 561,289 27.5 572,471 28.3 (2.0 )% Total $ 2,037,138 100.0 % $ 2,028,963 100.0 % 0.4 % The 0.4% increase in sales was generally attributable to the following: Favorable Percentage Point Change in Sales Attributed to: (Unfavorable) Pricing/Mix 1.9 % Volume (2.2 )% Acquisition 0.7 % Total Percentage Change in Sales 0.4 % Sales category discussion Across all categories, we experienced favorable pricing/mix largely due to a shift from lower margin cake items to higher margin bread and rolls. Overall, volume declines were driven by decreases in our cake business, partially offset by increases in our branded bread and rolls largely due to the re-introduction of the Acquired Hostess Bread Assets, growth in our expansion markets and to a lesser extent the Sara Lee California acquisition. The re-introduction of the Hostess cake brands negatively impacted our cake sales. The increase in branded retail sales was due primarily to volume increases resulting from the Acquired Hostess Bread Assets and growth in our expansion markets, partially offset by volume declines in branded cake and heavy promotional activity. The decrease in store branded retail sales was due primarily to volume decreases in store branded cake, and to a lesser extent bread and rolls. The decrease in non-retail and other sales, which include contract manufacturing, vending and foodservice, was largely due to volume decreases in vending and institutional sales, partially offset by positive pricing/mix. Direct-Store-Delivery Sales. For the For the Twenty-Eight Weeks Ended Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 % Increase Sales category $ % $ % (Decrease) (Amounts in (Amounts in thousands) thousands) Branded Retail $ 1,067,606 62.4 % $ 1,022,439 61.5 % 4.4 % Store Branded Retail 268,068 15.7 271,284 16.3 (1.2 )% Non-Retail and Other 374,242 21.9 369,748 22.2 1.2 % Total $ 1,709,916 100.0 % $ 1,663,471 100.0 % 2.8 % 42 -------------------------------------------------------------------------------- Table of Contents The 2.8% increase in sales was generally attributable to the following: Percentage Point Change in Sales Attributed to: Favorable Pricing/Mix 0.6 % Volume 1.4 % Acquisition 0.8 % Total Percentage Change in Sales 2.8 % Sales category discussion Overall, sales increased due to volume increases resulting from the re-introduction of the Acquired Hostess Bread Assets, growth in our expansion markets and to a lesser extent, the Sara Lee California acquisition. The increase in branded retail sales was due primarily to significant volume increases, the Sara Lee California acquisition and a shift in mix from store branded to branded products, partially offset by declines in pricing/mix. Branded white bread contributed the most growth. We continue to experience heavy promotional activity within the category. The decrease in store branded retail was due to volume declines, partially offset by positive pricing/mix. The increase in non-retail and other sales was due to positive pricing/mix, partially offset by volume decreases in institutional sales. Warehouse Segment Sales. For the For the Twenty-Eight Weeks Ended Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 Sales category $ % $ % % Decrease (Amounts in (Amounts in thousands) thousands) Branded Retail $ 70,945 21.7 % $ 80,409 22.0 % (11.8 )% Store Branded Retail 69,230 21.2 82,360 22.5 (15.9 )% Non-Retail and Other 187,047 57.1 202,723 55.5 (7.7 )% Total $ 327,222 100.0 % $ 365,492 100.0 % (10.5 )% The 10.5% decrease in sales was generally attributable to the following: Favorable Percentage Point Change in Sales Attributed to: (Unfavorable) Pricing/Mix 0.7 % Volume (11.2 )% Total Percentage Change in Sales (10.5 )% Sales category discussion Volume declined in all categories largely due to decreases in our cake business associated with the re-introduction of the Hostess cake brands in the second half of fiscal 2013. Branded and store branded retail decreased due to volume declines in cake, partially offset by positive pricing/mix. The decrease in non-retail and other sales, which include contract manufacturing, vending and foodservice, was due primarily to lower vending volume and price/mix and volume decreases in foodservice. 43 -------------------------------------------------------------------------------- Table of Contents Materials, Supplies, Labor and Other Production Costs (exclusive of depreciation and amortization shown separately). The table below presents the significant components of materials, supplies, labor and other production costs (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twenty-Eight Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 25.9 % 27.1 % (1.2 )% Workforce-related costs 13.5 12.8 0.7 Packaging 4.6 4.5 0.1 Utilities 1.6 1.4 0.2 Other 6.1 6.3 (0.2 ) Total 51.7 % 52.1 % (0.4 )% Overall, the decrease was attributable to lower ingredient costs as a percent of sales, partially offset by the $6.5 million of carrying costs, excluding depreciation, associated with the acquired Hostess facilities, lower production volumes for the warehouse segment and higher workforce-related costs. Ingredient costs decreased as a percent of sales largely due to lower prices for sweeteners, oils and flour, partially offset by higher costs for other ingredients and decreases in outside purchases of product (sales with no associated ingredient costs). This outside purchased product is included in the other line item above. Increases in workforce-related costs as a percent of sales primarily resulted from increased headcount due to the addition of production lines, lower sales for the warehouse segment, the acquired Hostess facilities carrying costs and decreases in outside purchases of product (sales with no associated workforce-related costs). Commodities, such as our baking ingredients, periodically experience price fluctuations, and, for that reason, we continually monitor the market for these commodities. The commodities market continues to be volatile. Ingredient prices decreased in the first half of the year but are expected to be volatile through 2014. 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 enter into forward purchase agreements and other derivative financial instruments to manage the impact of such volatility in raw material prices. Any decrease in the availability of these agreements and instruments could increase the price of these raw materials and significantly affect our earnings. The table below presents the significant components of materials, supplies, labor and other production costs for the DSD segment (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twenty-Eight Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 23.5 % 24.3 % (0.8 )% Workforce-related costs 11.9 11.3 0.6 Packaging 3.4 3.4 - Utilities 1.6 1.4 0.2 Other 7.1 6.9 0.2 Total 47.5 % 47.3 % 0.2 % The DSD segment's decrease in ingredient costs as a percent of sales was attributable to lower pricing on sweeteners, oil and flour, partially offset by decreases in sales of outside purchased products (sales with no associated ingredient costs) and higher prices in other ingredients. Workforce-related costs increased as a percent of sales primarily due to the acquired Hostess facilities carrying costs, decreased outside purchased product (sales with no associated workforce-related costs) and increased headcount due to the addition of production lines. 44 -------------------------------------------------------------------------------- Table of Contents The table below presents the significant components of materials, supplies, labor and other production costs for the warehouse segment (exclusive of depreciation and amortization shown separately) as a percent of sales: For the Twenty-Eight Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Ingredients 38.6 % 39.8 % (1.2 )% Workforce-related costs 22.1 19.9 2.2 Packaging 10.9 9.8 1.1 Utilities 1.8 1.6 0.2 Other 0.4 2.9 (2.5 ) Total 73.8 % 74.0 % (0.2 )% The warehouse segment's decrease in ingredients as a percent of sales was primarily attributed to lower ingredient pricing and increases in sales of outside purchased products (sales with no associated ingredient costs), partially offset by increased sales to the DSD segment, both of which are included in the other line item in the table above. The decreases in sales volume and increased sales to the DSD segment increased workforce-related costs as a percent of sales. The increase in packaging was due primarily to price increases and increased sales to the DSD segment (packaging costs with no associated sales). Selling, Distribution and Administrative Expenses. The table below presents the significant components of selling, distribution and administrative expenses as a percent of sales: For the Twenty-Eight Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Workforce-related costs 17.5 % 17.7 % (0.2 )% Distributor distribution fees 13.6 12.4 1.2 Other 5.5 6.2 (0.7 ) Total 36.6 % 36.3 % 0.3 % The distributor distribution fees increased due to the continued conversion of the Lepage and California routes to independent distributors, as well as the DSD segment comprising a larger percentage of consolidated sales. These increases were not completely offset by a decline in workforce-related costs due to ongoing costs associated with market expansions, the Lepage integration and lower sales for the warehouse segment. Prior year acquisition-related costs of $10.3 million associated with the Acquired Hostess Bread Assets caused the decline in the other line item component. The table below presents the significant components of our DSD segment selling, distribution and administrative expenses as a percent of sales: For the Twenty-Eight Weeks Ended Increase July 12, 2014 July 13, 2013 (Decrease) as a Line item component % of sales % of sales % of sales Workforce-related costs 17.6 % 18.1 % (0.5 )% Distributor distribution fees 16.2 15.1 1.1 Other 5.5 5.8 (0.3 ) Total 39.3 % 39.0 % 0.3 % 45 -------------------------------------------------------------------------------- Table of Contents The decrease in workforce-related costs was attributable to the continued conversion to independent distributors for Lepage products and the California market, partially offset by higher costs associated with expansion into new markets and the continuing Lepage integration. The distributor distribution fees increased due to the continued conversion to independent distributors. The table below presents the significant components of our warehouse segment selling, distribution and administrative expenses as a percent of sales: For the Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 Increase as a Line item component % of sales % of sales % of sales Workforce-related costs 8.9 % 8.6 % 0.3 % Freezer storage/rent 2.0 1.7 0.3 Distribution costs 0.8 0.8 - Other 3.6 3.3 0.3 Total 15.3 % 14.4 % 0.9 % The overall increase in selling, distribution and administrative expenses was primarily driven by lower sales which spread the costs over the costs over a smaller sales base. Impairment of assets. Refer to the discussion in the "Overview" section above. Depreciation and Amortization. Depreciation and amortization expense increased primarily as a result of the Acquired Hostess Bread Assets and the acquisition of certain assets related to a bun line in Modesto, California and their bread line added earlier this year. The DSD segment's depreciation and amortization expense increased primarily due to the Acquired Hostess Bread Assets and the acquisition of certain assets related to a bun line in Modesto, California and their bread line added earlier this year. The warehouse segment's depreciation and amortization expense was consistent with the comparable second quarter of fiscal 2013. Gain on acquisition. On October 26, 2012 the company announced that the DOJ approved an agreement under which the company will acquire certain assets and trademark licenses from BBU. The cash used to acquire these assets was approximately $50.0 million. The company received (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. The California acquisition closed on February 23, 2013. We financed this transaction with cash on hand and available holdings. We believe the California acquisition resulted in a bargain purchase because 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. Income From Operations. The table below summarizes the percentage change in income from operations by segment: Favorable (Unfavorable) Income from operations Percentage DSD segment (30.0 )% Warehouse segment (19.1 ) Unallocated corporate 36.8 Consolidated (27.2 )% The unfavorable decrease in the DSD segment income from operations was largely attributable to the gain on acquisition recorded for the Sara Lee California acquisition in fiscal 2013 as discussed above. The gain on acquisition accounted for 22.0% of the DSD segment decrease in operating income. Excluding the gain on acquisition, the decrease was 9.3% which was driven by the $11.2 million of carrying costs associated with the acquired Hostess facilities, the $4.5 million asset impairment charge discussed in the "Overview" above, and the Lepage integration costs, partially offset by lower ingredient costs. The unfavorable decrease in the warehouse segment income from operations was primarily due to sales decreases which were driven by volume declines as discussed above, partially offset by lower ingredient costs. The favorable decrease in unallocated corporate expenses was primarily due to the prior year acquisition costs associated with the Acquired Hostess Assets and the Sara Lee California acquisition in fiscal 2013 and higher pension income in fiscal 2014 as compared to the prior year. 46 -------------------------------------------------------------------------------- Table of Contents Net Interest Expense. The change was related to higher interest income related to the increase in distributor notes receivables outstanding. Income Taxes. The effective tax rate for the twenty-eight weeks ended July 12, 2014 and July 13, 2013 was 35.0% and 27.1%, respectively. The increase in the current period's rate was driven by the gain on acquisition in the prior year, which was recorded net of deferred taxes as a component of income before income taxes in the first quarter of fiscal 2013. The gain was treated as a permanent, discrete item in the tax provision, and favorably impacts the prior year to date rate by approximately 8%. LIQUIDITY AND CAPITAL RESOURCES: Liquidity represents our ability to generate sufficient cash flows from operating activities to meet our obligations and commitments as well as our ability to obtain appropriate financing and convert into cash those assets that are no longer required to meet existing strategic and financing objectives. Therefore, liquidity cannot be considered separately from capital resources that consist primarily of current and potentially available funds for use in achieving long-range business objectives. Currently, the company's liquidity needs arise primarily from working capital requirements, capital expenditures, pension contributions and obligated debt payments. The company's strategy for use of its cash flow includes paying dividends to shareholders, making acquisitions, growing internally and repurchasing shares of its common stock, when appropriate. We believe we have access to available funds to meet our short and long-term capital requirements. Cash Flows The company leases certain property and equipment under various operating and capital lease arrangements. Most of the operating leases provide the company with the option, after the initial lease term, either to purchase the property at the then fair value or renew its lease at the then fair value. The capital leases provide the company with the option to purchase the property at a fixed price at the end of the lease term. The company believes the use of leases as a financing alternative places the company in a more favorable position to fulfill its long-term strategy for the use of its cash flow. See Note 11, Debt, Lease and Other Commitments, of Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for fiscal year ended December 28, 2013 for detailed financial information regarding the company's lease arrangements. Flowers' cash and cash equivalents were $8.5 million at July 12, 2014 and at December 28, 2013. The cash and cash equivalents were derived from the activities presented in the table below (amounts in thousands): For the Twenty-Eight Weeks Ended Cash flow component July 12, 2014 July 13, 2013 Change Cash flows provided by operating activities $ 172,911 $ 175,602 $ (2,691 ) Cash disbursed for investing activities (30,888 ) (114,847 ) 83,959 Cash provided by financing activities (142,021 ) (61,973 ) (80,048 ) Total change in cash $ 2 $ (1,218 ) $ 1,220 47 -------------------------------------------------------------------------------- Table of Contents Cash Flows Provided by Operating Activities. Net cash provided by operating activities consisted of the following items for non-cash adjustments to net income (amounts in thousands): For the Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 Change Depreciation and amortization $ 69,199 $ 59,932 $ 9,267 Impairment of assets 4,489 - 4,489 Gain on acquisition - (50,071 ) 50,071 Stock-based compensation 10,474 9,690 784 Loss reclassified from accumulated other comprehensive income to net income 5,578 12,040 (6,462 ) Deferred income taxes 8,913 (4,595 ) 13,508 Provision for inventory obsolescence 754 851 (97 ) Bad debt expense (allowance for accounts receivable) 2,585 3,262 (677 ) Pension and postretirement plans income (5,411 ) (1,099 ) (4,312 ) Other non-cash items (1,453 ) (1,308 ) (145 ) Net non-cash adjustment to net income $ 95,128 $ 28,702 $ 66,426 Net cash used for working capital requirements and pension contributions consisted of the following items (amounts in thousands): For the Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 ChangeChanges in accounts receivable, net $ (17,047 ) $ (12,279 ) $ (4,768 ) Changes in inventories, net 1,950 (5,893 ) 7,843 Changes in hedging activities, net (466 ) (27,869 ) 27,403 Changes in other assets, net (11,228 ) 4,190 (15,418 ) Changes in accounts payable, net (2,121 ) 7,914 (10,035 ) Changes in other accrued liabilities, net 8,594 24,894 (16,300 ) Qualified pension plan contributions (5,029 ) (2,543 ) (2,486 ) Net changes in working capital and pension contributions $ (25,347 ) $ (11,586 ) $ (13,761 ) The change in depreciation and amortization was primarily due to the Acquired Hostess Bread Assets. Depreciation and amortization increased $4.7 million for these assets. The change in stock-based compensation was primarily because the stock appreciation rights generated expense of $1.5 million in the twenty-eight weeks ended July 13, 2013 and income of $0.1 million during the twenty-eight weeks ended July 12, 2014. In addition, our Performance-Contingent Return on Invested Capital Shares issued to employees increased expense by $1.5 million as a result of a change to our expectation of the amount of shares that will vest for these performance condition awards. The bad debt expense decreased because of write-downs for a specific customer that occurred in the first quarter of fiscal 2013. The pension and postretirement plan income increased from fiscal 2013 to fiscal 2014 due to the performance of the plan's assets during fiscal 2013. Other non-cash items include non-cash interest expense for the amortization of debt discounts and deferred financing costs and gains or losses on the sale of assets. The changes in accounts receivable and inventories are described above and are due to the timing of receipts. Hedging activities change from market movements that affect the fair value and required collateral of positions and the timing and recognition of deferred gains or losses. The other assets and accrued liabilities changes are from changes in income tax receivable balances, deferred tax liabilities, accrued interest and accrued employee costs (including accrued compensation for our formula driven, performance-based cash bonus program). The company's derivative instruments contained no credit-risk-related contingent features at December 28, 2013. As of July 12, 2014 and December 28, 2013, the company had $18.9 million and $16.9 million, respectively, recorded in other current assets representing collateral from or with counterparties for hedged positions. During 2014, in addition to the $5.0 million contributed in the first quarter, the company expects to contribute $7.8 million to our qualified pension plans and expects to pay an additional $0.2 million in nonqualified pension benefits from corporate assets. The expected contributions to qualified pension plans represent the estimated minimum pension contributions required under ERISA and the Patient Protection Act as well as discretionary contributions to avoid benefit restrictions. The company believes its cash flow and balance sheet will allow it to fund future pension needs without adversely affecting the business strategy of the company. 48 -------------------------------------------------------------------------------- Table of Contents During the first quarter of fiscal 2014, the company paid $24.7 million, including our share of employment taxes and deferred compensation contributions, relating to its formula-driven, performance-based cash bonus program. We paid $23.7 million during the first quarter of 2013 for the performance-based cash bonus program earned during fiscal 2012. Cash Flows Disbursed for Investing Activities. The table below presents net cash disbursed for investing activities for the twenty-eight weeks ended July 12, 2014 and July 13, 2013 (amounts in thousands): For the Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 Change Purchase of property, plant, and equipment $ (45,008 ) $ (46,335 ) $ 1,327 Repurchase of independent distributor territories (12,772 ) (26,947 ) 14,175 Principal payments from notes receivable 12,217 11,254 963 Acquisition of businesses, net of cash acquired - (50,129 ) 50,129 Proceeds from sales of distribution territories - 14,039 (14,039 ) Deposit paid for potential acquisition - (18,000 ) 18,000 Contingently refundable consideration 7,500 - 7,500 Proceeds from sale of property, plant and equipment 7,175 1,271 5,904 Net cash disbursed for investing activities $ (30,888 ) $ (114,847 ) $ 83,959 Net cash disbursed for investing activities included the Sara Lee California acquisition of $50.0 million in the first quarter of fiscal 2013. In contrast, there were no acquisitions or acquisition-related costs during the twenty-eight weeks ended July 12, 2014. The change in the contingently refundable consideration includes the $7.5 million receipt in 2014 on the Sara Lee California holdback. Capital expenditures for the DSD and warehouse segments were $41.4 million and $2.0 million, respectively. The company currently estimates capital expenditures of approximately $95.0 million to $100.0 million on a consolidated basis during fiscal 2014. The change in the distributor territories repurchased and the principal payments on notes receivable are due to the Sara Lee California acquisition distributor territory roll-out in the first quarter of fiscal 2013. 49 -------------------------------------------------------------------------------- Table of Contents Cash Flows Disbursed for/Provided by Financing Activities. The table below presents net cash provided by financing activities for the twenty-eight weeks ended July 13, 2013 and July 14, 2012, respectively (amounts in thousands): For the Twenty-Eight Weeks Ended July 12, 2014 July 13, 2013 Change Dividends paid $ (49,271 ) $ (45,919 ) $ (3,352 ) Exercise of stock options, including windfall tax benefit 11,958 15,277 (3,319 ) Payments for financing fees (564 ) (1,351 ) 787 Stock repurchases (9,459 ) (3,790 ) (5,669 ) Change in bank overdrafts 1,252 (2,323 ) 3,575 Net debt and capital lease obligations payments (95,937 ) (23,815 ) (72,122 ) Other financing activities - (52 ) 52 Net cash provided by financing activities $ (142,021 ) $ (61,973 ) $ (80,048 ) Our dividend payout increased 6.7% beginning with the dividend paid on June 18, 2014 when compared to the dividend paid on June 19, 2013. The compound annual growth rate for our dividend payout rate from fiscal 2009 to fiscal 2013 was 11.0%. While there are no requirements to increase the dividend payout, we have shown a recent historical trend to do so. Should this trend continue in the future we will have additional working capital needs to meet these expected payouts. Stock option exercises and the associated tax windfall benefit increased slightly. As of July 12, 2014 there were nonqualified stock option grants of 7,476,898 shares that were exercisable. These have a remaining contractual life of approximately 2.44 years and a weighted average exercise price of $10.90 per share. At this time, we expect that these shares will be exercised before the contractual term expires and they may provide an increase to the cash provided by financing activities. Stock repurchase decisions are made based on our stock price, our belief of relative value, and our cash projections at any given time. Payments for debt issuance costs and financing fees increased because we incurred fees of $0.6 million for amending the unsecured credit facility and new term loan on February 14, 2014. The change in bank overdraft was a function of our cash receipts at the end of our fiscal 2013. Our cash objective is to minimize cash on hand by using the credit facility described below. The net debt obligations decreased primarily because we made payments on our new term loan and unsecured credit facility. At this time we do not anticipate an issue with meeting this obligation. The credit facility is variable rate debt, as described below. In periods of rising interest rates the cost of using the credit facility will become more expensive and increase our interest expense. The stated interest rate of the senior notes will not change. Therefore, draw downs on the credit facility provide us the greatest direct exposure to rising rates. In addition, if interest rates do increase it will make the cost of raising funds more expensive. Considering our current debt obligations, an environment of rising rates could materially affect our Condensed Consolidated Statements of Income. Additional liquidity items are discussed below for context. Accounts Receivable Securitization Facility, New Term Loan, Senior Notes, and Credit Facility Accounts Receivable Securitization Facility. On July 17, 2013, the company entered into an accounts receivable securitization facility (the "facility"). On August 7, 2014, the company amended the facility. The amendment (i) increased the revolving commitments under the facility to $200.0 million (ii) extended the term one year and (iii) made certain other conforming changes. The facility originally provided 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 representations and warranties, affirmative and negative covenants, and events of default. As of July 12, 2014 and December 28, 2013, the company had $90.0 million and $150.0 million, respectively, outstanding under the facility. As of July 12, 2014 and December 28, 2013, the company was in compliance with all restrictive financial covenants under the facility. Optional principal repayments may be made at anytime without premium or penalty. Interest is due two days after our reporting periods end in arrears on the outstanding borrowings and is computed as the cost of funds rate plus an applicable margin of 70 basis points. An unused fee of 25 basis points is applicable on the unused commitment at each reporting period. The company paid financing costs of $0.8 million in connection with the facility, which are being amortized over the life of the facility. 50-------------------------------------------------------------------------------- Table of Contents New Term Loan. We entered into a senior unsecured delayed-draw term facility (the "new term loan") on April 5, 2013 with a commitment of up to $300.0 million to partially finance the pending acquisition of the Acquired Hostess Bread Assets and pay acquisition-related costs and expenses. The company drew down the full amount of the new term loan on July 18, 2013 (the borrowing date) to complete the Acquired Hostess Bread Assets acquisition as disclosed in Note 4, Acquisitions. On February 14, 2014, we entered into the first amendment to the credit agreement for the new term loan. The new term loan amortizes in quarterly installments based on the annual percentages in the table below. The first payment was due and payable on June 30, 2013 (the last business day of the first calendar quarter ending after the borrowing date), quarterly payments are due on the last business day of each successive calendar quarter and all remaining outstanding principal is due and payable on the fifth anniversary of the borrowing date. Anniversary Year Percent of Principal Due 1 5 % 2 10 % 3 10 % 4 35 % 5 40 % The February 14, 2014 amendment favorably reduced the interest rates described below from those entered into originally on April 5, 2013. Voluntary prepayments on the new term loan may be made without premium or penalty. Interest is due quarterly in arrears on any outstanding borrowings at a customary Eurodollar rate or the base rate plus applicable margin. The applicable margin ranges from 0.00% to 1.25% for base rate loans and from 1.00% to 2.25% for Eurodollar loans, and is based on the company's leverage ratio. Interest on base rate loans is payable quarterly in arrears on the last business day of each calendar quarter. Interest on Eurodollar loans is payable in arrears at the end of the interest period and every three months in the case of interest periods in excess of three months. The company paid financing costs of $1.7 million in connection with the new term loan, which are being amortized over the life of the new term loan. A commitment fee of 20 basis points on the daily undrawn portion of the lenders' commitments commenced on May 1, 2013 and continued until the borrowing date, when the company borrowed the available $300.0 million for the Acquired Hostess Bread Assets acquisition. The new term loan is subject to customary restrictive covenants, including certain limitations on liens and significant acquisitions and financial covenants regarding minimum interest coverage ratio and maximum leverage ratio. The February 14, 2014 amendment cost $0.3 million and will be amortized over the remaining term. As of July 12, 2014 and December 28, 2013, the company was in compliance with all restrictive covenants under the new term loan. Senior Notes. On April 3, 2012, the company issued $400.0 million of senior notes. The company pays semiannual interest on the notes on each April 1 and October 1, beginning on October 1, 2012, and the notes will mature on April 1, 2022. The notes bear interest at 4.375% per annum. On any date prior to January 1, 2022, the company may redeem some or all of the notes at a price equal to the greater of (1) 100% of the principal amount of the notes redeemed and (2) a "make-whole" amount plus, in each case, accrued and unpaid interest. The make-whole amount is equal to the sum of the present values of the remaining scheduled payments of principal thereof (not including any interest accrued thereon to, but not including, the date of redemption), discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the treasury rate (as defined in the agreement), plus 35 basis points, plus in each case, unpaid interest accrued thereon to, but not including, the date of redemption. At any time on or after January 1, 2022, the company may redeem some or all of the notes at a price equal to 100% of the principal amount of the notes redeemed plus accrued and unpaid interest. If the company experiences a "change of control triggering event" (which involves a change of control of the company and related rating of the notes below investment grade), it is required to offer to purchase the notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest thereon unless the company exercised its option to redeem the notes in whole. The notes are also subject to customary restrictive covenants, including certain limitations on liens and sale and leaseback transactions. As of July 12, 2014 and December 28, 2013, the company was in compliance with all restrictive covenants under the notes. The face value of the notes is $400.0 million and the current discount on the notes is $0.7 million. The company paid issuance costs (including underwriting fees and legal fees) for issuing the notes of $3.9 million. The issuance costs and the debt discount are being amortized to interest expense over the term of the notes. Credit Facility. On February 14, 2014, the company amended its senior unsecured credit facility (the "credit facility") to provide for a less restrictive leverage ratio and certain more favorable covenant terms, to extend the term to February 14, 2019, to update the existing agreement to address changes in law, and to include applicable conforming changes in light of the new term loan. Our most recent previous amendment to the credit facility was on April 5, 2013. The credit facility is a five-year, $500.0 million senior unsecured revolving loan facility. The credit facility contains a provision that permits Flowers to request up to $200.0 million in additional revolving commitments, for a total of up to $700.0 million, subject to the satisfaction of certain conditions. Proceeds from 51 -------------------------------------------------------------------------------- Table of Contents the credit facility may be used for working capital and general corporate purposes, including capital expenditures, acquisition financing, refinancing of indebtedness, dividends and share repurchases. The credit facility includes certain customary restrictions, which, among other things, require maintenance of financial covenants and limit encumbrance of assets and creation of indebtedness. Restrictive financial covenants include such ratios as a minimum interest coverage ratio and a maximum leverage ratio. The company believes that, given its current cash position, its cash flow from operating activities and its available credit capacity, it can comply with the current terms of the amended credit facility and can meet presently foreseeable financial requirements. As of July 12, 2014 and December 28, 2013, the company was in compliance with all restrictive financial covenants under the credit facility. Interest is due quarterly in arrears on any outstanding borrowings at a customary Eurodollar rate or the base rate plus applicable margin. The underlying rate is defined as rates offered in the interbank Eurodollar market, or the higher of the prime lending rate or the federal funds rate plus 0.40%, with a floor rate defined by the one-month interbank Eurodollar market rate plus 1.00%. The applicable margin ranges from 0.0% to 0.95% for base rate loans and from 0.95% to 1.95% for Eurodollar loans. In addition, a facility fee ranging from 0.05% to 0.30% is due quarterly on all commitments under the credit facility. Both the interest margin and the facility fee are based on the company's leverage ratio. The company paid additional financing costs of $0.3 million in connection with the February 14, 2014 amendment of the credit facility, which, in addition to the remaining balance of the original $1.6 million in financing costs, is being amortized over the life of the credit facility. There were $19.8 million and $44.2 million in outstanding borrowings under the credit facility at July 12, 2014 and December 28, 2013, respectively. The highest outstanding daily balance during the twenty-eight weeks ended July 12, 2014 was $62.1 million and the lowest outstanding balance was $0.0 million. Amounts outstanding under the credit facility vary daily. Changes in the gross borrowings and repayments can be caused by cash flow activity from operations, capital expenditures, acquisitions, dividends, share repurchases, and tax payments, as well as derivative transactions which are part of the company's overall risk management strategy as discussed in Note 7, Derivative Financial Instruments. For the twenty-eight weeks ended July 12, 2014, the company borrowed $649.2 million in revolving borrowings under the credit facility and repaid $673.6 million in revolving borrowings. The amount available under the credit facility is reduced by $15.4 million for letters of credit. On July 12, 2014, the company had $464.8 million available under its credit facility for working capital and general corporate purposes. Credit Ratings. Currently, the company's credit ratings by Fitch Ratings, Moody's Investors Service, and Standard & Poor's are BBB, Baa2, and BBB-, respectively. Changes in the company's credit ratings do not trigger a change in the company's available borrowings or costs under the facility, new term loan, senior notes, and credit facility, but could affect future credit availability and cost. Uses of Cash On May 21, 2014, the Board of Directors declared a dividend of $0.12 per share on the company's common stock that was paid on June 18, 2014 to shareholders of record on June 4, 2014. This dividend payment was $25.1 million. On February 14, 2014, the Board of Directors declared a dividend of $0.1125 per share on the company's common stock that was paid on March 14, 2014 to shareholders of record on February 28, 2014. This dividend payment was $23.5 million. Our Board of Directors has approved a plan that authorizes share repurchases of up to 67.5 million shares of the company's common stock. Under the plan, the company may repurchase its common stock in open market or privately negotiated transactions at such times and at such prices as determined to be in the company's best interest. These purchases may be commenced or suspended without prior notice depending on then-existing business or market conditions and other factors. During the first quarter of fiscal 2014, 464,610 shares, at a cost of $9.5 million of the company's common stock were purchased under the plan. No shares were repurchased during our second quarter of fiscal 2014. From the inception of the plan through July 12, 2014, 59.0 million shares, at a cost of $467.8 million, have been purchased. During the twenty-eight weeks ended July 12, 2014, the company paid $24.7 million, including our share of employment taxes, in performance-based cash awards under the company's bonus plan. During the twenty-eight weeks ended July 12, 2014, the company contributed $5.0 million to our qualified pension plans. We expect to contribute an additional $7.8 million to these plans during the remainder of fiscal 2014. Accounting Pronouncements Not Yet Adopted In May 2014, the FASB issued guidance for recognizing revenue in contracts with customers. This guidance requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. There are five steps outlined in the guidance to achieve this core principle. The company is still analyzing the potential impact of this guidance on the company's consolidated financial statements. This guidance will be effective for our fiscal 2017 which begins on January 1, 2017. 52 -------------------------------------------------------------------------------- Table of Contents |