Flowers Foods Inc. (NYSE: FLO), the nation's second-largest producer and marketer of fresh packaged bakery foods, reported results for its 12-week second quarter ended July 12, 2014. 

Second quarter highlights:

Allen L. Shiver, president and chief executive officer, said, "Although the second quarter was challenging, we remain confident in our long-term growth strategies. We are particularly encouraged by the traction we are continuing to see in our new markets, where sales doubled since last year. We also are seeing strong sequential growth in our acquired bread brands. As a team, we are working to control those issues within our reach while maintaining a strong, flexible financial position to weather near-term challenges.

"Sales were lower in the quarter due primarily to high promotional activity across most food categories, Hostess' return to the market, and reduced sales of low-margin store brand and foodservice products. Sales of our branded breads, buns, and rolls in the DSD segment were up 3.1 percent, driven by the ongoing success of our acquired brands and Nature's Own, especially in new markets. Those increases were offset by lower sales of cake and store brand items in both segments. Hostess' further penetration into the cake market impacted our business by approximately $20.7 million in the quarter. Warehouse segment sales decreased due to the competitive dynamics in the cake and foodservice categories. We continue to strategically exit low margin business in both the foodservice and store brand categories to improve future earnings.

"Earnings for the quarter were lower than expected and slightly below last year's second quarter earnings, excluding the carrying costs and interest expense related to the Hostess acquisition and the impairment charge.  Higher costs for added production capacity, promotional allowances, and higher-than-normal returned products (stales), impacted the quarter's results. Product returns were impacted by new markets and promotional allowances. Gross margin improved slightly in the quarter despite those costs and the acquired facilities' carrying costs. This is an indication of Flowers Foods' underlying strengths," Shiver said. "Our manufacturing efficiencies and our Lepage operation continue to improve. Even though costs we've incurred over the past year for acquisitions, new markets, new production capacity, and new products negatively impacted first half results and our outlook for the year, our team remains confident that these investments will help us reach our long-term goals.

"Not including the asset impairment, the Leo's operation negatively impacted operating earnings in the quarter by $0.01 per share. We have exited the low-margin foodservice tortilla business at Leo's, and we are moving tortilla production equipment to another bakery to focus on opportunities for retail branded tortillas.  Additionally, we have entered into a contract to sell certain assets of the Leo's operation.  We expect the transaction to close in the third quarter. We are pleased to have a resolution to this issue, which has been a distraction from growth opportunities in other areas. The sale of Leo's is expected to improve earnings going forward."

Looking ahead, Shiver said, "Our revised guidance takes into account the expected impact of current competitive dynamics as well as the effect of costs we have incurred to expand our geographic footprint, add production capacity to serve expansion markets, and enhance the strength of our brands.  For the remainder of 2014, our team will focus on improving sales and earnings in our existing bakeries and in the markets we have entered.  Our success in new markets, the strength of our brands, the efficiencies of our bakeries, and the experience of our team give me confidence in the future of Flowers Foods. We are firm in our belief that over time Flowers Foods' team and our proven strategies will deliver growth in line with our long-term objectives."

Second quarter 2014 results   
For the 12-week second quarter of 2014, sales decreased 2.3 percent to $877.4 million. In last year's second quarter, sales were $898.2 million. This decrease was attributable to positive net price/mix of 0.6 percent and decreased volume of 2.9 percent. The positive price/mix was due primarily to a favorable mix shift from cake and store branded products to branded bread and rolls, partially offset by a competitive pricing environment.  Overall volume declines were driven primarily by decreases in the cake business and to a lesser extent decreases in store-branded bread and rolls and foodservice.

Net income for the quarter was $42.1 million, or $0.20 per diluted share, compared to last year's second quarter of $46.5 million, or $0.22 per diluted share. Adjusted for the asset impairment this quarter, net income per diluted share was $0.21, as compared to $0.24 in last year's second quarter, which was adjusted for acquisition-related costs.  Carrying costs for the acquired Hostess facilities and interest expense related to funding of the acquisition negatively affected EPS by$0.02 in the second quarter of this year.

Gross margin (excluding depreciation and amortization) as a percent of sales was 47.8 percent, up 30 basis points compared to 47.5 percent in last year's second quarter.  Decreased ingredient costs as a percent of sales drove the gross margin increase, as prices for several of our major ingredients were lower this year as compared to last year. Increased manufacturing efficiencies also contributed to the increase. Partially offsetting these positive items were carrying costs associated with the acquired Hostess facilities and start-up costs for the opening of new production lines.

For the quarter, selling, distribution, and administrative (SD&A) costs as a percent of sales were 36.4 percent, up 10 basis points from 36.3 percent of sales in the second quarter of 2013. Distributor fees and costs associated with new market expansion were the primary drivers of the increase. Acquisition-related costs of $5.7 million negatively impacted SD&A as a percent of sales by 60 basis points during the second quarter of 2013. 

Depreciation and amortization expenses as a percent of sales for the quarter increased 50 basis points compared to last year's second quarter. This increase was due primarily to the acquired Hostess assets. Net interest expense decreased for the quarter compared to last year's second quarter primarily due to increased interest income associated with an increase in outstanding distributor notes receivable. The effective tax rate for the quarter was 33.9 percent compared to 35.6 percent in last year's second quarter. This decrease is due to positive discrete items in the quarter for state tax benefits and incentives.

EBIT was $65.4 million, or 7.5 percent of sales, compared to last year's second quarter of $74.9 million, or 8.3 percent of sales. Adjusted for the asset impairment this quarter, EBIT was $69.9 million, or 8.0 percent of sales, compared to last year's second quarter of $80.5 million, or 9.0 percent of sales, adjusted for acquisition-related costs incurred. During the second quarter of this year, carrying costs of $4.5 million related to the acquired Hostess facilities negatively affected EBIT margin by 50 basis points.

EBITDA was $95.3 million, or 10.9 percent of sales, compared to last year's second quarter of $100.6 million, or 11.2 percent of sales. Adjusted for the asset impairment this quarter, EBITDA was $99.8 million, or 11.4 percent of sales, compared to last year's second quarter of $106.3 million, or 11.8 percent of sales adjusted for acquisition-related costs incurred last year. During the second quarter of this year, carrying costs of $2.5 million related to the acquired Hostess facilities negatively affected EBITDA margin by 30 basis points.

Segment results 
The segment results reflect shifting the company's tortilla operation from the warehouse segment to the DSD segment at the beginning of 2014. For comparison purposes, prior year information has been recast to reflect this change.

DSD (84 percent of Q2 sales): During the quarter, the company's DSD sales were relatively flat as compared to the prior year quarter, reflecting volume gains of 0.3 percent and negative net price/mix of 0.3 percent. The volume increase was primarily the result of increases in the branded white bread and branded buns and rolls categories, partially offset by decreases in branded cake and store brand products, primarily white and variety breads and buns and rolls. Sales of branded breads, buns, and rolls increased by 3.1 percent, offset by lower sales of cake and store brand items. The negative net price/mix was primarily driven by a competitive pricing environment, partially offset by a shift in mix from store brand to branded bread and rolls.

Income from operations for the DSD segment was $62.4 million, or 8.4 percent of sales, compared to last year's second quarter of $75.9 million, or 10.3 percent of sales. Adjusted for the asset impairment this quarter, income from operations was $66.9 million, or 9.0 percent of sales. During the second quarter of this year, carrying costs of$4.5 million related to the acquired Hostess facilities negatively affected income from operations margin by 60 basis points. Increased promotional activity also negatively impacted DSD's income from operations.

Warehouse (16 percent of Q2 sales): Sales through warehouse delivery decreased 13.3 percent, reflecting volume decreases of 11.5 percent and negative net price/mix of 1.8 percent. The volume decreases were the result of decreases in branded and store brand cake, foodservice and vending. The negative net price/mix was driven by the foodservice category.

Income from operations for the warehouse segment was $13.5 million, or 9.9 percent of sales for the quarter compared to $15.7 million, or 10.0 percent of sales in last year's second quarter. This decrease was due primarily to a decline in sales volumes.

Cash flow
During the second quarter, cash flow from operating activities was $51.1 million.  The company paid down its debt by $14.8 million in the quarter and $95.9 millionduring the first half of the year. The company invested $21.4 million in capital improvements and paid dividends of $25.3 million to shareholders during the quarter. The company did not acquire any of its shares of common stock during the quarter. The company has acquired 59.0 million shares of its common stock under its 67.5 million share repurchase plan since the inception of the plan.

Outlook for 2014
The company gave revised guidance for fiscal 2014. Sales for the year are now expected to be in the range of $3.88 billion to $3.94 billion, an increase of 3.5 percent to 5.0 percent over 2013. Adjusted earnings per share for the company's 53-week 2014, excluding the asset impairment, are now expected to be in the range of $0.92 to $0.98, reflecting growth of 1.1 percent to 7.7 percent over last year's adjusted results.  Previously, guidance was for 2014 sales of $3.976 billion to $4.126 billion, or 6.0 percent to 10.0 percent increase, and earnings per share of $0.98 to $1.05, reflecting growth of 7.7 percent to 15.4 percent.  Capital expenditures for 2014 are forecasted to be from $95.0 million to $100.0 million.