Flowers Foods, Inc. (FLO) Q1 2018 Earnings Report, Transcript and Summary

Welcome to the Flowers Foods’ First Quarter 2018 Earnings Conference Call and Webcast. My name is Ellen, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to J.T. Rieck, Vice President, Investor Relations and Treasurer. Mr. Rieck, you may begin.

Thank you, Ellen, and good morning everyone. Our first quarter results were released yesterday evening, the earnings release and our updated investor presentation is posted in the investor section of the recently refreshed Flowers Foods’ website. Our 10-Q was filed with the SEC yesterday evening. Before we begin, please be aware that our presentation today may include forward-looking statements about our company’s performance. Although we believe those statements to be reasonable, they are subject to risks and uncertainties that could cause actual results to differ materially. In addition to matters we’ll discuss during the call, important factors relating to Flowers Foods business are fully detailed in our SEC filings. Okay, let’s get started. Participating on the call today, we have Allen Shiver, Flowers Foods’ President and Chief Executive Officer and Steve Kinsey, our Executive Vice President and Chief Financial Officer. After their prepared remarks, we’ll open the line up for questions. Allen, I’ll turn the call over to you.

Thank you, J.T. The first quarter was encouraging on several fronts and reflects the progress that we’re making on our strategic priorities to drive profitable growth and related costs. We’re achieving solid momentum and we have confidence, that we can reach said the goal that we set for fiscal 2018. As you know, over the past year, we’ve been working on project Centennial and we are executing on initiatives that increased our focus on the consumer, while removing complexity and costs from our business. Our goal is by 2021, we can drive sales growth of 3% to 4% and achieve EBITDA margins of 13% to 14%. The restructuring we began last year which will be completed in early 2019 has resulted in a more cost-effective, functional structure. Teams are now empowered to grow our core brands, improve productivity and capitalize on opportunities in underdeveloped geographies and underdeveloped product adjacencies. Working together in new and dynamic ways, our team will be executing with greater urgency and accountability on these strategic priorities. For the quarter, we delivered record sales and posted solid sales growth of 1.6%, which was ahead of our first quarter targets. Our portfolio of strong brands continues to outperform the packaged bread category even with the price increases we took early in the first quarter to recover significant input cost inflation. Adjusted earnings per share was $0.30 for the quarter, up 20% year-over-year. This trend is in line with the guidance we have given for the full year. We are pleased with the solid performance demonstrated by our core brands and our competitive marketplace. For the seventh straight quarter, our market share increased according to IRI, improving 0.6 share points to 15.8. These share gains were driven primarily by continued growth for Dave's Killer Bread and solid performance from our Nature's Own and our Wonder brands in the traditional Loaf segment. The revitalized brand teams we put in place last year have been executing on our strategic brand initiatives and there is now a solid innovation in marketing pipeline of new products that we have just began to introduce. In last April, we introduced the booming berry variety to our successful DKB bagel line. As you know the bakery category is large and there are significant segments like breakfast where we can show share growth with unique products. The breakfast segment is approximately $2 billion of retail and since launching DKB breakfast items last year, we've doubled our market share. At the start of the second quarter, we launched Nature's Own Perfectly crafted a line of artisan style bakery breads. It is delicious. A very special Loaf with thick slices, soft texture and distinctive packaging. This new line also has the better few attributes that are so important to consumers today. And for the summer grilling season our Wonder brand has partnered with USO for a Camo for the calls promotions. With unique packaging and thousands of special in-store product displays, we are proud to support the USO. These are just a few examples of new innovation and we have been pleased with how things have been progressing. Over the next few quarters, we will have more new products come into market with clear points of difference and consumer appeal. One important point is that our new cross-functional operating structure allows our brand marketing efforts to be much more strategic. For example, these new product launches I just described are being executed around the marketing strategy that includes the 360-degree brand activation program to drive consumer awareness and trial. We now have the support of our field marketing teams to drive marketplace execution. Overall, we are confident this is a more focused and effective approach than we've used in the past. While we are growing in the fresh bakery category, we realize our cake business is not as profitable as it should be. As I mentioned on the last call, our cake team is focused on profitability and executing on the fundamentals. This team is streamlining the assortment, rationalizing price points, prioritizing innovation, rightsizing capacity and identifying investments to drive manufacturing efficiency. There is no quick fix but we will be aggressive in taking actions necessary to improve the financial performance of our snack cake business. The transition to our new organizational structural is one of the most powerful things that we are doing under Project Centennial. To put it simply, we have new energized teams that are cross-functionally on achieving our strategic priorities. The business units create strategies that maximize the value of their brands and business lines. Dedicated brand teams and field marketing groups work to drive profitable growth. Our Chief Marketing Officer and his team support the business units through consumer insights and research driven innovation. The sales team executes in the marketplace. Our retailer engagement has never been stronger at both the national and the local levels. Also, we now have a dedicated distributor enablement that is dramatically improve our partnership with the independent distributors. Order quality is improving. That is putting pressure products into the marketplace and helping distributors build their business. Our supply chain group also has been restructured to emphasize a greater focus on quality, continuous improvement, efficiencies and network optimization. Our bakeries are now headed up by leaders whose sole saw responsibilities are plan operations and product quality. In addition, the work we did last year on brand and market assortment has given us a clear long-term view of our capacity needs, which is valuable insight as we optimize our manufacturing and distribution networks. For the first time, we have a team completely focused on value creation, strategic growth and acquisitions. M&A remains a key component of our growth strategy. And our finance and technology functions are becoming more analytical and forward-looking. We have centralized and standardized processes and put more focus on reducing costs across the company. The benefits of our new organizational structure are already yielding results. We have recruited exceptional talent, who have brought us new capabilities and we promoted high performers from within. The fresh perspective that comes from these actions have been powerful and has made the entire company more focus. I am very proud of the Flowers team and how they’re adjusting to all of the changes that we’ve made over the past year. Looking ahead, in terms of our cross-functional priorities, our attention is on completing our organizational restructuring and accelerating our supply chain initiatives. We expect this to be significant drivers of cost savings and efficiencies. We are also evaluating a robust pipeline of M&A opportunities within the bakery food space. We recognize this is an area where we can drive significant value with acquisitions that build on our competitor strengths. However, we will continue to be disciplined in our process, mindful that valuations are high and we do have meaningful investment opportunities within our own operations. There is certainly a lot of good work going on, but I want to make this clear, we are not going to be satisfied until we achieve the long-term sales and margin goals. While we're making good progress on the cost savings initiative we identified through Centennial, we intend to stay aggressive and to make sure those savings are not lost through inflation or inefficiency in other parts of the business. Now I'll ask Steve to review the financials and provide our outlook for the rest of the year. Steve?

Thank you, Allen and good morning, everyone. Let's start with the items affecting comparability in the quarter, which amounted to approximately $0.06 per share. The most significant items were project Centennial related consulting and restructuring cost of totaled $7.7 million. We also recorded a pension settlement charge of $4.7 million and IBP related legal settlement of $1.4 million and a multiemployer pension plan withdrawal cost of $2.3 million. Now turning to first quarter operating results. Total first quarter consolidated revenue increased 1.6%. Adjusting for the mixed manufacturing business, we divested early last year, sales increased 1.7% compared to the prior quarter. DSD segment revenue was up 1.6% in the first quarter driven primarily by strong sales of DKB partially offset by lower sales of traditional bakery items. Price mix increased 3.4% while volume decreased 1.8%. The majority of our price mix this quarter came from the growth of DKB and our overall sales mix. As discussed on prior calls, we did address the commodity inflation we are experiencing with pricing early in the quarter, which did help to offset the ingredient cost inflation. We remain focused on productivity initiatives to offset the other inflationary cost pressures we are experiencing. Warehouse segment revenue was up 2.2% in the quarter, excluding a 50 basis points decline associated with the mixed manufacturing business. Price mix decreased 3.6% while volume increased 5.8%. Most of this increase was driven by higher food service and store branded retail sales partially offset by lower sales in our warehouse organic business and contract manufacturing. Consolidated adjusting operating margin was 7.3% of revenue compared to 7.2% in the first quarter last year. Adjusting operating margin in our DSB segment was flat with the prior year. Sale increases due to improved price mix and lower SG&A cost were offset by lower manufacturing efficiencies as well as higher input cost and labor inflation. Also impacting the DSB segment adjusted EBIT was $2.5 million impairment of a note receivable from a non-IBP customer. Adjusted warehouse operating margin was down 80 basis points as a percent of sales impacted primarily by shift in mix from the higher margin branded bread items to lower margin cake and food service items and higher freight. These were offset somewhat by lower SG&A cost. Looking at our consolidated results. Gross margins declined 60 basis points as a percentage of sales due to higher outside purchases and ingredient cost as well as lower production efficiencies. As Allen mentioned, we are not satisfied with the reduced efficiencies and our supply chain team is focused on addressing the underperforming assets in order to improve gross margins. It’s important to note, the restructuring and costs programs we have been working on, have primarily benefited our SD&A functions. These programs were the primary driver of an 80-basis point decrease and our adjusted SD&A expenses. As we complete the restructuring and accelerate our multi-year supply chain optimization initiatives, we expect to improve overall manufacturing efficiencies and achieve our long-term EBITDA margin objective. Reflecting the net of higher production costs and lower SD&A as a percent of sales as well as the impact of the 2.5 million asset impairment net earlier, adjusted EBITDA margins decreased 20 basis points to 11%. GAAP earnings per share for the quarter was $0.24 per share excluding the items effecting comparability we mentioned earlier, adjusted EPS in the quarter was $0.30 per share up $0.05 compared to the prior year quarter. The effect of the new tax law accounted for approximately $0.04 of the increase and adjusted EPS. Now turning to cash flow. Cash flow continues to be strong, operating cash flow during the quarter was 97.1 million or up 15.2 million from the prior year. This increase was primarily due to lower Project Centennial related consulting costs and lower expected tax rate net of $10 million of voluntary pension contribution. Capital expenditures were 26.6 million in the quarter as compared to 17.5 million a year ago. We ended the quarter with 795.7 million in net debt. At quarter end, our net debt of trailing 12 months adjusted EBITDA was 1.8 times. Our financial position is strong. As of the quarter end, we had approximately 682 million of liquidity available at our credit facilities. For 2018, we continue to expect sales to be in the range of flat to up 1.6% and adjusted EPS to be in the range of $1.04 to $1.16 per share including the benefit of approximately $0.14 to $0.16 per share due to tax reform. Our forecast [before] top-line to be driven primarily by incremental volumes from DKB as well as from the brand group initiatives we have coming into the market during the second and third quarter. We encouraged by the performance of brand for the marketplace so far this year. But we do continue to see a competitive environment overall. We are pleased with the performance of DKB as this growth has served to offset softer volumes from our core branded items. This mix shift thus positively benefit sales, but overall, it’s generally neutral to margins, as DKB's margins are currently in line with overall corporate averages. We are on track with our cost saving initiatives. TGNF organization or redesign supply chain optimization. From these initiatives we are targeting approximately 38 million to 48 million of gross savings in 2018, which is incremental to the 32 million in growth savings we realized in 2017. A portion of these savings are being invested into incremental marketing innovation programs to drive brand growth. These incremental costs were primarily impact margins in the second and third quarter tracking the brand growth initiatives that Allen mentioned earlier. We continue to expect approximately 40 million of input cost inflation in 2018, which we have addressed to pricing actions and continue to focus on improving manufacturing efficiencies. We are seeing a tight labor market, which caused an increase turnover the bakery and contributes to the lower manufacturing efficiencies. Also keep in mind that outside purchases have increased to support the growth of Dave's Killer Bread, which has temporary pressured margins. And finally, like other companies, we are experiencing a tight trade environment, which offset the portion of the savings realized from the organizational restructuring. For 2018, we expect the full year tax rate of approximately 25% to 26%. We remain comfortable with our EPS guidance range which we believe appropriately balances the factors we are seeing in the marketplace and the progression of Project Centennial. The upper end of the range assumes a rational competitive environment, steady growth from DKB and solid performance from our new product introductions. The lower bound incorporates continued softness in the core brands, a competitive marketplace and further inflationary cost pressures. On balance, our financial performance so far this year is in line with our expectation. Our Q1 top-line performance was encouraging and we are pleased with the progress being made to reduce SG&A cost. As our detailed production costs are experiencing upward pressure and balanced state that we are addressing the increase in these costs. Overall, we've made progress with Project Centennial. The savings realized through our BGNS and the ongoing organizational restructuring have helped to offset the transitory factors impacting our gross margin. Long term there is a clear path to supply chain optimization to improve our production to supply chain, to improve our production cost structure and we are confident given our strategies to reduce SG&A that our supply chain initiatives will allow us to drive margin improvement in line with overall goals. Now I'll pass the call back to Allen.

Thank you, Steve. In summary, we're pleased with our performance in the first quarter. It reflected the competitive strength of our core brands and the strategic initiatives in which we've been executing in connection with Project Centennial. Looking ahead, we will continue to work with urgency to maintain the momentum we have built to drive profitable growth, enhance ROIC and create value for our shareholders. Now let's open the line for your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And our first question is from Farha Aslam with Stephens.

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

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

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

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

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

Yes. It may be up slightly but we sell, it will continue to show good performance as well.

Our next question is Brett Hundley with The Vertical Group.

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

Generally, when you look at how the kind of the cadence of cost increases around overall input cost. Inflation in the first half is probably slightly higher than the back half. I want to say it overall significant but we are seeing higher inflation in the first half. So that’s our greater impact Q1 to Q2.

And Steve, if you can trying characterize this for me. Are Q1 and Q2 relatively similar or is one larger than the other there?

Over a percent of sales perspective probably similar Q2 may be slightly higher given where they were last year.

And then can you give me a sense of what percentage of DKB is being co-packed today versus in-house?

Yes. So primary thing being co-packed today what you think actually in the breakfast category. Most of the bread is being produced in house and a slight number of the portion of the volume that is being co-packed. So that really is around the breakfast items.

And then lastly for me, you guys talk to some momentum as it relates to production cost increases and that makes sense given all the variables that you talked about. I just wanted to revisit your gross savings target for 2018. The net impact from reinvestment and just try to get a sense of slack in the systems sot o speak. So, as you guys try and combat what seems to be some higher production costs increases, do you feel like you can rain in reinvestment spend at all, or are these higher production cost increases really just something that you and others have to eat over the near term in order to maintain your strategy and grow the overall category overtime. Thank you.

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

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

The next question is from Bill Chappell with SunTrust.

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

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

Just when you look specifically at brands we will get into that detail competitively. But overall, our brand and growth are still being driven by DKB, they are still exceeding some pressure depending on the segment of categories with certain brands, but white -- it was in the white bread category, Wonder continues to perform very well does Nature's Own butter bread. And then for the first time in several quarters we've actually seen our dollars in soft variety improved quarter-over-quarter. So that's very positive.

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

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

Thank you.

If you look at the pro rata you will be okay.

The next question is from Akshay Jagdale with Jefferies.

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

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

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

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

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

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

So generally, when you look at the guidance I'd say it is a range. And we thought about the factors that impact where you land within that range. Allen talked about, I'll talk about when you look on the gross margin line there are really three large buckets impacting the overall margin. Input cost which we believe we would address the pricing the labor market of the cost of our labor which we are addressing as Allen said with urgency. We've realized that we need to get that in line in order to accelerate the margin growth for the rest of the year. So, we are taking action and looking at the overall labor cost within production. And then with regard to outsource production. Again, some of that is beyond our control and you're talking about a lot of that growth in breakfast. So, we will continue to work on the margin profile on those items as well. And continue to drive overall margin improvement within the organic state.

So just to add, I mentioned earlier this whole supply chain optimization we're early in the process of generating savings from overall structure. But that as well is going to be our top priorities as we finish the year and it could generate significant results.

Thank you.

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

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

Yes. I would say that’s a reasonable estimate.

That’s pretty impressive. And thinking about other categories, where you don’t have significant penetration. Obviously, dinner bread rolls, you’re underrepresented there. Is that an area where DKB could play a view, I assume, you talked about that. But what are your thoughts?

We’re very excited about the growth of Dave’s Killer Bread, it’s really important that you don’t over extend the brand, we have to make sure that the brand is present in categories that appropriate for the positioning of the brand. We do agree that there are other opportunities within the retail space. We continue to look at the bakery daily opportunities that are out there and whether that’s Dave’s Killer Bread or other brands we see other opportunities to grow the topline.

And then peak share was still down a scooch from last year. But it looks like it’s inflected in the last 2 quarters and is moving a little higher. Is that tasty cake sort of -- you’ve finding a floor or growing again or can you speak to how tasty cake is performing in the market. I assume that at some point, the incursions from hostess and others would probably slow?

I mean, overall, when you look at the cake category and you still think kind of stabilize and when you look at from a brand perspective we continue to see, I’d say, its decent gains or improvement from a share perspective. Tasty cake is, I would say it’s holding its own in the marketplace. This has freshly have had some improvement to the warehouse distribution with couple of retailers has been very strong in vending, which is a measured in IRI. So, I’d say overall, tasty cake is doing well with a larger perspective of stronger margin in the fresh give the economic play with the category. And we still feel like there is some wide space for tasty cake. So, we’re still pleased we have the brand.

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

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

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

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

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

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

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

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

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

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

Well with regard to the overall capacity, that is part of the planning. And it would just take time to get production in place. So, we are looking at production opportunities around breakfast and traditional DKB item, which is not there yet.

I'm just trying -- I understand perhaps the growth was faster than what you [indiscernible] that's why you had to go out. Or was it all just part of the plan?

Yeah, I mean the brand continues to be to performed very nicely. So, I don't want to say it's not pacing well, but probably thought it could do, but it is growing at a nice pace. And we do need to catch up from a production perspective.

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

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

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

I wanted to focus, again, if I could on the gross margin line. It would appear to me that for the midpoint of your guidance to be achievable you would need at least modest gross margin expansion over the balance of the year unless SD&A is going to be even lower than what I’m modeling right now. So, when you think about your 3 buckets again. If I just -- I understand and appreciate the focus that you have on each of those components. But just wondering timing. First on the pricing, was there a phase in such that all the pricing was in place in Q1. So maybe you get a little bit of that or many now you’re fully in place as we go Q2 through the balance of the year. So maybe that’s a little more of offset than it was in Q1. And then the other two buckets, again you’ve going into great detail about what the issues are and your attention to address them. But I’m just curious how soon you think that can flow through such that we can see gross margins improve over the balance of the year. And then just within that. Can we expect gross margins to improve versus 2017 and 2018?

Yes. More broadly, I would say, when you look at the pricing initiatives, there was a phasing in early in the first quarter, they’ll be a slight impact coming into Q2. But I’d say generally, everything was there for most of the -- for the full quarter of the first quarter. And again, when you look at the initiatives around some of the costs impact in Q1. As Allen said, we’re being fairly aggressive with trying to accelerate some of those. Because, we know, we’ve got to get the gross margin back in line and take some of these costs out. So, when you look at all year 2018 gross margin we are presenting the margin, there will be some margin improvement now.

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

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

Our next question is from Rob Dickerson with Deutsche Bank.

Hi good morning. It's Matt on for Rob. Thanks for the question, following up on the outsourced production. How quickly do your incremental cost typically disappear from a after decision to insource your volume was made, and how easier and how much investment is needed to convert your existing capacity to organic or new product types.

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

Perfect. And on the timing for the supply chain optimization. Just want to understand first if the initiatives that are stepping you'll eventually be giving more detail on when the time is right or we will learn more about that after it's done and its reflecting results. And second if you expect to see any benefits from the network optimization piece in 2018? Thanks.

Yeah with regard to the production capacity for competitive reasons we will do that more close to the events. It would be probably similar to what we did with Tuscaloosa where we converted a plant. We wouldn't want to talk about that, it's too far advanced. And then the second part of the question. Could you repeat that please?

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

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

Okay. So, there is some benefit.

Yeah there will be some benefits yes.

Okay, cool. Thanks.

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