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Edited Transcript of TWNK earnings conference call or presentation 7-Aug-19 8:30pm GMT

Q2 2019 Hostess Brands Inc Earnings Call

KANSAS CITY Sep 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Hostess Brands Inc earnings conference call or presentation Wednesday, August 7, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew P. Callahan

Hostess Brands, Inc. - President, CEO & Director

* Katie M. Turner

ICR, LLC - MD

* Thomas Alan Peterson

Hostess Brands, Inc. - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Brian Patrick Holland

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* David Sterling Palmer

Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst

* Donald Delray McLee

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Jonathan Paul Braatz

Kansas City Capital Associates - Partner and Research Analyst

* Kenneth B. Goldman

JP Morgan Chase & Co, Research Division - Senior Analyst

* Pamela Kaufman

Morgan Stanley, Research Division - Senior Analyst

* Rebecca Scheuneman

Morningstar Inc., Research Division - Equity Analyst

* Robert Frederick Dickerson

Deutsche Bank AG, Research Division - Research Analyst

* Steven A. Strycula

UBS Investment Bank, Research Division - Director and Equity Research Analyst

* William Bates Chappell

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the Hostess Brands Inc. Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Katie Turner. Please proceed.

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Katie M. Turner, ICR, LLC - MD [2]

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Thank you. Good afternoon, and welcome to Hostess Brands' Second Quarter Fiscal 2019 Earnings Conference Call.

By now, everyone should have access to the earnings release for the period ended June 30, 2019 that went out this afternoon at approximately 4:05 p.m. Eastern time. The press release and updated investor presentation are available on Hostess' website at www.hostessbrands.com.

This call is being webcast and a replay will be available on the company's website.

Hostess would like to remind you that today's discussion will include a number of forward-looking statements. If you will refer to Hostess' earnings release as well as the company's most recent SEC filings, you will see a discussion of the factors that could cause the company's actual results to differ materially from these forward-looking statements. Please remember, the company undertakes no obligation to update or revise these forward-looking statements.

The company will make a number of references to non-GAAP financial measures. The company believes these measures provide investors with useful perspective on the underlying growth trends of the business and is included in its earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures.

And with that, I'd like to turn the call over to Hostess Brands' President and CEO, Andy Callahan.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [3]

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Thank you, Katie, and good afternoon and thanks for joining us today. I'll begin our discussion with a brief overview of our second quarter business highlights and provide an update on our pillars for growth. Then Tom Peterson, our CFO, will provide greater detail on our financial results and 2019 outlook. Finally, we'll be happy to take your questions.

I am really pleased with our team's execution against our pillars for growth during the second quarter of 2019. Our financial results were driven by the depth and breadth of our Sweet Baked Goods product offerings with broad-based strength across sales channels. As a result, we generated meaningful net revenue growth, increased market share and an improvement in our industry-leading profitability. In particular, a few key second half -- second quarter highlights. Net revenue increased 11.7% to approximately $241 million, our highest revenue quarter since relaunch. These results were driven primarily from increased sales of Hostess branded products with higher volume of both core and new products. Distribution and merchandising support improved in multiple sales channel with no more than 1/3 of our revenue growing from any one channel. We're also pleased with the solid Dolly Madison branded growth as we leverage our acquired Cloverhill customer relationships.

Net sales growth also benefited from our well-executed price increases that were sold into customers during the fourth quarter of 2018 and completed in Q1 of 2019. To put this in perspective, Q2's 11.7% revenue growth is on top of the strong Q1 growth resulting in a total first half revenue growth of 9.2%. Point of sale increased 6.3% and market share increased 81 basis points as compared to the prior year. Our market share continues to increase and is at a 5-year high at 19%.

Similar to our results in the first quarter, our net revenue growth of 11.7% outpaced our Nielsen tracked point of sale of 6.3%, reflecting the breadth and depth of our distribution and the quality of our execution. We had good merchandising execution during the quarter, particularly in our core Hostess branded products. We did experience a pull-forward of some shipments into Q2 this year to support July 4 merchandising, that we expect to contribute to Q3 point of sale. We have continued to experience very strong point of sale growth in the latest July Nielsen data. We proactively pulled forward our back-to-school merchandising support to better space our promotions throughout the year. As a result, we expect strong July point of sale to be partially offset in August.

Additionally, we are currently performing preventive maintenance and operational enhancements to a few of our lines. This is part of our ongoing continuous improvement program. We currently expect that this will impact demand-driven revenue growth potentially by $5 million to $10 million in the third quarter. However, looking ahead, based on the strength of our year-to-date results and continued demand momentum expected for the balance of the year, we're confident in our ability to grow revenue well ahead of the category and continue to achieve our full year guidance.

We remain focused on our robust operational plan to drive sustainable, profitable growth in 2019 and beyond grounded in our 5 pillars. We made further progress and have taken important actions during the second quarter and year-to-date to execute on these pillars. We are investing in our fundamental capabilities and we'll continue to do so in Q3. These investments have helped us increasingly achieve growth across channels.

A few key highlights. Within growing the core, we continue to build our analytic capability and insights to drive the success of our Hostess Partner Program across both grocery and convenience. We talked extensively on previous calls about our investments in further understanding our elasticity, mix and incrementality. These investments have enabled strong execution of our distribution and shelf-mix programs and the focused execution of our multifaceted pricing action. We will continue to build our fundamentals across the business, creating a strong platform for continued growth and innovation.

As we grow through innovation, we remain pleased with the customer acceptance of the Hostess breakfast products and the incrementality of our innovation year-to-date versus the prior year period. In addition, we have had a ton of fun with the success of our Hostess birthday cupcakes as we celebrate 100 years of Hostess. This latest execution has further showcased the strength of our limited time offers or LTO programs at retail. Our successful execution of innovation and LTOs at scale highlights the advantages of our distribution model and strong brands, which results in both Hostess and category growth.

Moving forward in the second half of '19, as customers complete product resets, we expect continued innovation growth. Breakfast and indulgent premium snacking are growth platforms over the next few years. Our team is building out our pipeline of consumer-focused innovation to drive future profitable growth. Similar to our customer insight, I am confident that our investment in understanding our consumer and the strengthening of these fundamentals will help drive growth for Hostess and the category over the next several years.

We also continue to improve through agility and efficiency. The meaningful operational, supply chain and price value initiatives that we implemented and the integration and transformation of our Cloverhill acquisition are paying off. During the quarter, we were able to reduce our overall cost base by approximately 270 basis points through our bakery efficiency initiatives.

In addition, the relocation of our primary distribution center from Illinois to Kansas is moving ahead and on track with our expectation. We continue to expect this transition to be complete by the first quarter of 2020, which is an important step in elevating our infrastructure for future profitable growth. Upon completion, we expect to improve our customer service via taking miles out of our network and improving lane rates as well as support portfolio growth. We believe this further strengthens our category-differentiated direct-to-warehouse distribution system and core prebuilt pallet and shipper merchandising capabilities. Our ability to efficiently and effectively build pallet-ready displays, shippers and other merchandising forms fuels our LTOs and merchandising programs with retailers.

We are also excited to be opening a new test kitchen and consumer research center within our new corporate headquarters, which will expand our capacity and reduce the time and cost of new product research and development. The headquarters moving to Kansas will also result in future tax savings. We expect to continue to reinvest a significant portion of the savings achieved with the distribution center and headquarters move back into the business to further enhance our foundation and enable additional consumer-driven profitable growth.

We are cultivating talent capabilities. Under the leadership of our Chief Marketing Officer, Chad Lusk, and our Chief Operating Officer, Andy Jacobs, we are in the process of growing the consumer and customer analytics side of our business more deeply. Specific to our consumer investments, a step up of this capability is a logical sequence for Hostess as we build off our strengthening customer and business fundamentals.

We are well positioned to build upon our brand, operational and business fundamental capabilities with even sharper consumer-driven insights. The announcement of our Chicago office has generated a very positive response and has already enabled us to attract industry-leading talent and experience, quickly building on our existing strong talent base.

We will continue to leverage our strong cash flow to help fuel our growth, de-leverage and support our capital needs. Last week, we announced that Hostess has entered into a definitive agreement to sell our In-Store Bakery business to Sara Lee Frozen Bakery for $65 million in cash. We expect to use the net proceeds from the completion of the transaction to pursue a range of potential strategic options, including reinvesting in our business, de-leveraging our balance sheet and pursuing potential strategic acquisitions while effectively managing our capital structure.

Superior has been a high-performing business, and we believe it will continue to thrive in Sara Lee Frozen Bakery's portfolio as we focus our future investments on areas of our business that better leverage our core competencies and pillars for growth. I want to personally thank the Superior team for their contributions to the company and wish them well as they move forward under new ownership.

We are building our business and our capabilities. As we move through 2019 and beyond, we will continue to improve and build upon our scalable infrastructure with an efficient operating model, differentiated capabilities that support collaborative customer partnerships, robust innovation and significant cash flow that I know sets us apart from our peers and positions us to win with consumers and our valued customers.

With the second half of 2019, we are confident about our opportunities for future growth. Our team, our strategy, our execution, when combined with our robust cash flow and strong balance sheet, will create value for shareholders for many years to come.

Now let me turn it over to Tom to go through the terrific quarter's detail.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [4]

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Thanks, Andy. I will now review our second quarter 2019 financial performance and other data from today's release. Net revenue for the quarter was $241.1 million, an 11.7% or $25.2 million increase from 2018's revenue driven by a combination of volume and price increases across multiple channels. We believe our record Q2 revenue performance will be our largest year-over-year growth of 2019.

Adjusted gross profit was $83.5 million or 34.6% of net revenue compared to 32.1% in the second quarter of 2018. From a margin standpoint, we are pleased that our adjusted gross profit margin was improved both sequentially and year-over-year as we offset continued inflationary pressures in ingredients, labor and packaging and other costs, offset by pricing actions and cost efficiencies in our operations. On average, we expect gross margins in the second half of 2019 to be at least as good as Q2.

Our effective tax rate was 35% compared to 0.8% in the prior year. Both periods had discrete income tax items impacting the rate. As a reminder, with the relocation of our distribution center and now our corporate headquarters to Kansas, we expect to receive significant future tax incentives and credits based on our ability to partner with the state of Kansas and local governments on the relocation.

Our adjusted EPS was $0.17 compared to $0.14 in the second quarter of prior year. We ended the quarter with cash and cash equivalents of $189.3 million and net debt of $790 million. Our operating cash flow for the 6 months ended June 30 was $74.1 million compared to $81.2 million for the prior year. For the quarter, our operating cash flow was $45.7 million or a 6.5% increase over prior year. We continue to expect 2019 cash flows to provide us with the flexibility to pursue a range of potential strategic options, including reinvesting in our business, de-leveraging our balance sheet and pursuing potential strategic acquisitions while effectively managing our structure.

Our leverage ratio, as of June 30, has improved to 4x. During 2019, we expect to improve overall leverage by 1.1 to 1.3x given our expected EBITDA growth and inherent cash flow generation, absent any significant business transactions, particularly given our recent announcement and anticipated proceeds from our planned In-Store Bakery divestiture and the reduced spend from the Cloverhill business transformation. We are on track to achieve our improved full year net leverage ratio of 3.2 to 3.4x.

To expand further on our planned ISB sale, you may recall in 2016, we acquired Superior for $51 million and grew net revenue and EBITDA by 30%. The purchase price and cumulative profit earned from the business reported in a 38% ROI. We anticipate the ISB sales to be approximately $0.03 dilutive to EPS on an annualized basis.

For fiscal '19, we are reiterating our net revenue and adjusted EBITDA outlook as well as improving our views on leverage despite the anticipated sale of our ISB business in the third quarter. We continue to expect net revenue for the year to continue to organically grow well above the Sweet Baked Goods category driven by Hostess branded core and new product innovation, expanded distribution and improving merchandise and execution over the course of the year and execution of our multifaceted pricing programs.

We expect adjusted EBITDA to be in the range of $200 million to $210 million driven by the revenue growth and achievement of our operating efficiencies. Despite the $0.01 dilution from the ISB sale, adjusted EPS is expected to continue to be in the range of $0.57 to $0.62 per share, primarily driven by the execution of the multifaceted pricing and merchandising program, and achievement of efficiencies.

We anticipate ending the year with net debt leverage ratio between 3.2 and 3.4x driven by strong operating cash flows of $145 million to $155 million and the expected proceeds from the ISB sale, partially offset by capital expenditures in the range of $30 million to $35 million. Our expected tax rate, excluding discrete items, is 21% to 22%.

Now, I'll turn it over to Andy for his final remarks.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [5]

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Thanks, Tom. We are very pleased with our business fundamentals, increasing core capability and the broad-based growth we achieved in the second quarter and year-to-date. Going forward, I remain confident about the growth potential we have for the balance of the year.

Across the team, we are working together to further advance our high-performance-based culture to consistently win with all stakeholders. These efforts will lead to growth well above the Sweet Baked Goods category and highly accretive revenue and profitability as we work to create value for all shareholders.

With that, Tom and I are available for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And with that, we go to our first question from the line of Rob Dickerson with Deutsche Bank.

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Robert Frederick Dickerson, Deutsche Bank AG, Research Division - Research Analyst [2]

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Great quarter, I guess. Two very easy questions. The first question is just with respect to the Q2 revenue growth result, and how maybe we should think about the back half, given I think you said $5 million to $10 million, maybe on the line transition shift, but then also pull forward of volume in the July data that we're seeing, which is obviously very impressive, off the 4th of July and back-to-school and then also off the sale In-Store Bakery. I guess one is, should we still think that net sales could maybe still grow in the back half kind of all-in? And then secondly, with respect to organic sales growth, 12% in Sweet Baked Goods for Q2, the data looks better, but there's some volume pulled forward. So maybe just some perspective as to kind of maybe what you think is kind of a right normalized rate. Are you growing more like 7%, 8% and kind of if you were to take away all the noise? And that's it.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [3]

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Thanks, Rob. Appreciate it. Just a headline. Absolutely, we expect to continue to grow and we're going to continue to grow ahead of the Sweet Baked Goods category in the back half coming off a very strong first half. With that being said, our all-in first half, as I said, was up 9.2%. Q2 was up 11.7%. Our Nielsen takeaway in July was really strong. And as you mentioned that's due -- that was partly due to great execution, but it's a little bit high because we moved merchandising up. We will have a little bit of this supply I talked about, but that's a little bit noise. So I would expect Q3 to not be as high of a growth rate, but still growing. And I would see very strong growth as we get back into Q4. So I feel -- like I talked about in previous quarters, I feel really good about our merchandising plans. I feel really good about the initiatives we put in place. We're already planning for thinking forward into 2020. So I feel really good about the future growth prospects.

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Operator [4]

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And our next question comes from the line of David Palmer with Evercore ISI.

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [5]

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Just a follow-up on that. I guess you have shipment timing as a potential noise factor. If you have an idea as to how much your all channel consumption may have differed from shipments in the quarter, that'd be helpful. And a sense of how much of a drag that specifically would be in the third quarter, that would be helpful. And also, you just mentioned the promotion merchandising timing is another thing, it's somewhat could be related. That will be interesting to hear about. And from your graph, it looks like club mass and collar where you're having outsize growth there. I guess my question would be, going forward, is there going to be perhaps a chance that the grocery channel can get in the game where some of these growth rates in some of the merchandising you're doing so far in those other channels?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [6]

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Yes. Thanks. I appreciate the question. So the -- there was a shipment year-on-year for a very strong July 4 merchandising that went into June. And we think that's about 200 basis points, potentially or so. So just to -- for that one. If you look at a total merchandising for back-to-school, it is a timing, July and August. If you look at total July and August, that merchandising would have been about the same, and that really helps us execute some of our investments, but also it helps sequence. We have a fairly robust merchandising program so it helps us sequence them throughout the full period. So that's on that.

It's absolutely true. So just on yours, I don't want to leave convenience out either. We've seen some really good growth within our small format as well. It's a great channel for us; that team's doing a great job. We're seeing it. Our grocery growth, it is growing. It's not growing as robustly as very strong growth in the others. And I feel good about the programs there, we continue to work a battle on grocery as well. It doesn't look as good of a performance when you compare it against some of the really, really strong performance. But we're working hard to accelerate grocery's growth as well.

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Operator [7]

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And our next question comes from the line of Brian Holland with D.A. Davidson.

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Brian Patrick Holland, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [8]

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So not to continue to beat on the top line here, on that topic, but I guess just to maybe sum up here. The merchandising, it wasn't a catalyst in Q1 or one that you highlighted but you've talked for a while, you've intimated you've got sightlines on getting some improvement there. And obviously, you're going to lap some headwinds to that regard in the second half. I appreciate the commentary with respect to kind of the shipment shift into Q2, the pull forward. But if -- we're just backing up here net-net, as we're looking at the second half of the year, thinking about what you're lapping along with the distribution, the innovation pipeline remains strong and you've got the merchandising.

And I'm wondering, where are we in the process of merchandising? Are we back to sort of a level that you think -- and I know it shifts at different periods -- but are you back to where you thought you would be? Or is there more low -- is there more opportunity for merchandising to grow? And then in that context, net-net, are we talking about more tailwind sequentially than headwinds as we look over the back half of the year versus what we've seen so far in the first half of the year? Is it fair to say that, more tailwinds than headwinds?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [9]

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I'm not sure about the tailwinds versus headwinds. We got very strong growth in Q2. Some of it was timing. We expect continued meaningful growth ahead of the Sweet Baked Goods category in the back half. Let me address one comment though. Our growth is driven not just by merchandising, it's driven by good fundamentals, execution of our partnership program, the team's focus on mix. We focused on executing a pricing action, which continues -- a lot of those continue through the back half of the year. Our broad-based merchandising activities that we've sold in across multiple channels, we have good line of sight to those. And I feel as confident as I talked about for the first half, I feel about -- in the second half as well.

Will we get to the same percentage growth? It's not going to be as high as Q2 but I expect it to be continue to be very robust in the back half of the year. As far as, do I think we're at the peak? We're about where we expected to be. Andy Jacobs and his team are continuing to work with our customers to help grow their categories, and we think the best way to grow that is through building innovation and partnering with them to build great brands around Hostess. So we're in a continuous improvement mode when it comes to -- across our whole business and including merchandising. So that's the way we look at it.

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Brian Patrick Holland, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [10]

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Okay. Perfect. That's helpful color. Appreciate it. And Tom, did I hear you correct that you expect the gross margin in Q3 and Q4 to be at least as good as Q2? I just wanted to make sure I...

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [11]

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On average, they will be. As the back half, we always head back to school. And the merchandising programs we do in Q3 that always have -- Q3 is generally our lowest quarter of the year and then Q4 would (multiple speakers).

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [12]

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And that's just timing.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [13]

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That's just timing.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [14]

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The back half on average.

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Operator [15]

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And our next question comes from the line of Steven Strycula with UBS.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [16]

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Congratulations on a good quarter. So a quick question for Tom. Just midpoint to midpoint, before the divestiture, you were -- the midpoint was $205 million for EBITDA for the upcoming fiscal year. It looks like about $3 million of that will be haircut for getting rid of ISB. First of all, how are you going to report that? Is it going to be discontinued ops for the third quarter? And then how should investors think about the new midpoint of your guidance? Would you have raised this quarter if it weren't for the divestiture? And then I have a follow-up.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [17]

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Yes. Thanks, Steve. So we are not going to report it as a discontinued operation due to its size. And despite the sale of ISB, our EBITDA guidance is still $200 million to $210 million. Which by the math, would be the midpoint, would be $205 million.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [18]

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Okay. And then for the Chicago Bakery profitability, how should we think about that? You really didn't mention a lot of that on the call today. I imagine we'll hear about them more on September 10. But it is still tracking to profitability or to the goals that you outlined previously? And was that business profitable in the second quarter? I think it was close to breakeven, nominally profitable in the first quarter.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [19]

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Thanks, Steve. It was. Cloverhill business was profitable in the second quarter. We have -- and we didn't speak about it as much -- we have revenue pipelines and we have cost initiatives, and with those Cloverhill is on plan for meeting its cost initiatives.

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Operator [20]

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And our next question comes from the line of Ken Goldman with JPMorgan.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [21]

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A few for me, if I can. First, you mentioned tax incentives from the decision to stay within Kansas City. Can you help us understand when those kick in and how we think about the potential impact on your all-in tax rate?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [22]

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Sure. The primary tax incentives that Kansas gives start a year after the move. And those do not run through -- those credits do not run through the tax line.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [23]

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Got it. Okay. And you'll let us know down the road, roughly how big those are, though? I think it's important.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [24]

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Yes. Yes.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [25]

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Okay. And then the -- you mentioned the $5 million to $10 million affected by downtime maintenance. But that's a lot as a percentage of your quarterly sales. So two things. First, why is that figure so high, is there something unusual about the nature of the maintenance? And second, I think I heard you mention that this will affect demand-driven growth. I'm not sure how the downtime affects demand, so maybe I just heard that wrong. I just wanted to clarify that if we could.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [26]

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So just on the second piece, we expect to continue to grow. We are taking down a couple of lines for maintenance. So it may have been cute with words, but what I just expect, is we're growing a lot, we expect it to grow a lot. So we may be just modifying some of our ability to shift to meet the full demand for those couple of weeks. And then related to it, these lines are reviewed routinely. So there's never a good time. But it's about -- this is really -- think about a continuous improvement of quality for the long-term. So with the combination of upgrading some of the hardware and maintenance in areas and then the pulling apart and improving some of the lines, so the consistency of the output is consistent. So we have a clear line of sight to the work plan. I feel good about it. There's never a good time to do it. But that's why -- because it needs to get -- the lines need to be down and the maintenance needs to be done, so that's what we're doing.

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Kenneth B. Goldman, JP Morgan Chase & Co, Research Division - Senior Analyst [27]

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Okay. And then one last one for me. I wanted to get a sense of your appetite for stock buybacks on a higher level. Obviously, you still want to prioritize reinvestment and debt paydown, you mentioned M&A. But you could make an argument that given your growth, your stock's not terribly expensive on a cash basis. So is an increased buyback just too far down the priority list today? Or if your stock doesn't move much higher, clearly you have a -- someone who has been a fairly willing seller over the last few months. Just curious if that's an increasingly attractive use of cash for you? Or it's just off the table right now?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [28]

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Well, as we've said multiple times. First of all, we like to -- as Tom mentioned, we're really deleveraging very fast. So we like our position. And we also like our optionality. We continue to think that the best use of cash is either to invest in the business; look at M&A, we'll be very disciplined about that. And if not, continue to delever at this point. So I feel good about our cash position. With that being said also, every quarter and every meeting, we look at our cash option. So it's a continuous process.

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Operator [29]

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And our next question comes from the line of Pam Kaufman with Morgan Stanley.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [30]

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Congrats on the quarter. You mentioned that the cash flow in the quarter was impacted by timing of customer receipts. Can you elaborate on that? And also, what's contributing to your outlook for lower cash from operations this year? Is it mostly the divestiture? Or are there other factors driving that?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [31]

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Yes. Sure. Thanks, Pam. We mentioned the cash box in the first quarter, which did drive some of the improvement in the second quarter. And our DSOs are doing well right now. And then on the decrease, that is primarily from the divestiture.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [32]

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Okay. And then secondly -- and just on the innovation pipeline, can you give an update on your planned innovation for the back half of the year?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [33]

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Sure. We feel -- first of all, we feel really good about breakfast coming in. Our LTOs have been doing extremely well. We'll continue to expand our birthday cupcake. We've come out with some snack pack Donettes, which continue to drive well. We're looking at a new Brownie innovation, that's coming out. We feel great about that. We're also looking at -- accelerating on some of the TOTALLY NUTTY work. We're working on expanding some reliable capacity on that, that's coming online pretty soon and we expect that to expand very well. And then really -- as I mentioned in my prepared remarks as well, I'm also really excited about some of the investments we have in sight and some of the platform concepts that I've seen Chad work on. Not quite ready for prime time, but I feel like our innovation pipeline is really growing as well and the execution of what you're doing is coming along really well.

What's great about the brand, just related to innovation, a lot of it is about expanding usage within the need state, but also a lot of it is really leveraging our great brand and consumer affinity and small changes make up a huge difference. When we went to a more convenient snack pack in Donette, really excited about the traction around that. We came out with some new Zingers and really excited about how that's accelerated and driving that business growth. So our innovation year-on-year has contributed significantly, and I feel good about that continuing in the back half.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [34]

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Great. And just one more question, if -- you discussed executing on your price increase and completing that in Q1. And it's evident in the Nielsen data that there are price increases occurring throughout the portfolio, but on an overall basis, pricing is somewhat flat. So what's contributing to the declines in some of the categories where you're not taking pricing and is there an opportunity to reverse that?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [35]

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So there's a couple of things going on. I'm not exactly sure of the data that you're looking at, so we can take that off-line. I'm more than happy to fill it. But let me maybe comment on a couple of things. The pricing -- the multifaceted pricing action that we took was across the board. We did some downsizing on items and kept it. We looked at some mix and then we surgically, based on the analysis we did, priced within certain items and channels where we felt the elasticity or the price to value could handle it. That's really executed the way we expected and is contributing to the business in Q2. What you may be seeing is also mix. We've driven into some value businesses with the Cloverhill acquisition that you may see within the mix. They're by definition at a lower revenue rate. And we're doing a nice job of executing those across channels, whether it's club, within value smaller-format stores or within vent. And that's been doing well for our business and there may be some mix at play there, but I'm more than happy to take it offline and expand it. The headline is, I'm pleased with the execution and the analysis we did upfront on the pricing action.

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Operator [36]

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And our next question will come from the line of Bill Chappell of SunTrust.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [37]

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This might be an odd question, but are you getting the benefits from moving to Kansas City, Missouri, or Kansas City, Kansas?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [38]

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So we're currently in Kansas City at Missouri and we're moving to Kansas, the state of Kansas, we're moving over. Yes.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [39]

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And then in terms of -- just going back to the ISB, kind of a little more on your thoughts there in terms of -- I understand it was one where you probably would've needed to make more acquisitions to be of scale and size. But was this -- just trying to understand the genesis of the process. Did you decided 6 months ago, let's move out and did an auction? Or did someone come to you and say, Hey, this will be more valuable to us or -- and how -- and what does that say, just about the space? It just doesn't fit with kind of what you originally thought would be a good fit, but that core.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [40]

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So first of all, the ISB business we had, the team we had was absolutely terrific. They did a great job. We've grown the business since we bought it. We grew profit. We grew revenue, as Tom mentioned in his prepared remarks. What we looked at -- and I've commented on this several times, Bill -- is our best use of cash are ones that we determined build on where we're scaled and what we're really good at. And that is building brand, collaborating with customers to build their category, leveraging our consolidated centralized warehouse distribution model and building just delighting consumers in the need state that we have within breakfast and indulgent snack.

The ISB business, although great, our assessment was for it to continue to grow even beyond where we were, we would need to invest in cash and scale it to the same level that we had because it goes through a different distribution system, it's sold into a different part of the store. It has some different products. It's not branded. We looked at bringing the Hostess brand there and it wasn't as successful. So when we consolidate all those, we felt that the focus on our core business where we have tremendous opportunity and I'm really excited about, as is the team, that focus was better and that the ISB business, the great business that, that team has built, would thrive under someone who would be ready to invest in it, and that's what Sara Lee is willing to do.

So I think it was a win-win. The team performed it. They integrated it terrifically, they built it terrifically. And then when it didn't fit with -- when we tried to Hostess-brand it, it didn't fit, we made the fast decision to put it into an ownership that we thought could grow it and give the business a great -- it is a great business, it's probably -- maybe one of the greatest in that space, but for us it was about focus.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [41]

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Got it. And then just one other. In terms of kind of health of the overall Sweet Baked Goods category, I mean it seems like it's fairly stable to grow it. But with regards to your market share, should we expect another step forward? I mean in the past, it was kind of thought of maybe one day you could get back to that 23% share, prebankruptcy, and then that was no longer talked about for a while. And now you're getting back to 5-year highs, should we expect, especially as you move into breakfast and other items, that 23% is attainable?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [42]

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My expectation, I know, our team says, is continue to grow share. But I'd like to shift too. We're not just looking at our category, we're looking at our consumer frame of reference and saying, when they're looking for indulgent snacking and we're looking for breakfast solutions, we compete in a much larger pool that way. And we believe our Sweet Baked Goods offering have attributes and certain -- and our brands have a lot of elements that we think can grow our share of that broader need state and that's a lot bigger pie. And when we continue to do that, continue to execute and build off of our great customer fundamentals, I think that we can continue to grow.

So yes, I think we've grown on almost an average over the last year about a share point a year. We expect to continue to grow. Some of the reasons we weren't back to some of the levels is there's a lot of advantage we have, not some of the products weren't -- as we couldn't deliver the consumer to the standards that we expect out of Hostess and some of the product forms. But we're building very profitably of where we have an advantage and we're going to continue to do that.

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Operator [43]

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And our next question comes from the line of John Braatz with Kansas City Capital.

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Jonathan Paul Braatz, Kansas City Capital Associates - Partner and Research Analyst [44]

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Andy, you spoke a little bit about the new facility in Kansas opening up next year. Can you talk a little bit about how much of a needle mover that can be, maybe both on the cost side and your ability to better serve that customer -- the customers, grab market share? What are your expectations that, that new facility can deliver? And then secondly, are there going to be any startup costs associated with that, that we might see later this year or early next year?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [45]

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There is some capital costs. We included that and that's within our capital, there's no extra capital associated with that. But there is some relatively modest capital cost. The -- so let me explain what this does. We've historically had our R&D center since the relaunch, we've had our team in a separate building with one of our partners. It's been cumbersome to kind of collaborate, coordinate across, sometimes it's just not as hard. We don't have a 100% access to the equipment and facilities we need and, therefore, we do a lot more in our actual full scaled up facilities. And therefore, the ability to be able to do that or to bench top samples or to run sales samples and all of those things are more expensive, they take more time. So the ability to colocate it makes us -- which we are and we pride ourselves, makes us much faster, makes us much nimble, makes us look at the breadth of -- enables us to look at a breadth of ideas a lot faster. So our R&D team can really do faster prototyping and testing and other things related to our products. So I'm real excited about our ability to be able to do that. It's not necessarily unique that a company of our stature would have that, but it will be new to us and we've been highly successful without it, and I expect us to drive momentum and the ability to innovate with it. So that's kind of the idea.

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Operator [46]

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And our next question comes from the line of Donald McLee with Berenberg.

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Donald Delray McLee, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [47]

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Just to go back to your distribution and merchandise support actions you talked about earlier, how much of that was isolated to the quarter? And maybe are there -- or are there more sustainable measures that you can replicate for the remainder of the year, that will support similar volume strength?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [48]

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Okay. So thanks. We have a good line of sight to our total program for the year. And as I said before, part of it is the good -- the broad-based merchandising we've seen. A lot of it are pricing actions and some of it are just fundamentals related to mix and customers. So there are some components there. I would think about our back half continuing to grow, continue to grow well above the Sweet Baked Goods category.

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Operator [49]

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And our last question comes from the line of Steven Strycula with UBS.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [50]

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Just had a quick follow-up. Been getting a lot of questions and just want to make sure that we kind of set the record straight on what to expect for Q3. Tom, the In-Store Bakery, are we going to have much of a revenue contribution, if at all, in the third quarter? And then the fact that Andy was saying that should still expect some growth in the quarter. Is that on an absolute dollar basis or is that more for just, call it, the surviving operations that are not being divested? That maybe that part should grow like maybe in a low single-digit range? Clarification would be great.

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [51]

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Yes. Thanks, Steve. We are still going to grow on an absolute basis. And we will grow organically, obviously, with the adjustment for ISB. We expect to have revenue for a couple of months of the quarter. We expect to close in the third quarter, towards the end of it. But we will -- we still continue to expect to grow ahead of the Sweet Baked Goods category.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [52]

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Okay. Great. And then strategically you guys continue to do well in convenience. I know that's a higher-margin channel. Can you speak about that channel specifically? How is the warehouse model different than the DSD model? Do you actually view warehouse as a relative competitive strength in that channel versus DSD? Because I know that you have some competition that would also like to have a piece of that pie, but it seems like you guys continue to gain share there.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [53]

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Yes. Thank you. Yes. I do believe the warehouse model has unlocked the distribution network. We've given them a category. They have terrific relations with our customer. I got to give credit to our team, under Scott Ward's leadership. They do a terrific job. But we do execute it very well. We have great distributor partners and great relationships with the C-store. We do think it's an advantage to be able to access the breadth of distribution at C-stores. No -- there's no Sweet Baked Goods business that has the breadth of distribution that we have across all channels. And that includes C-store as well. When you have high velocity, smaller stores, our warehouse model is highly advantaged. But we're not content with just having the distribution model. We continue to invest in analytics to fuel our Hostess partnership program, to make sure that we are optimizing the mix, we're pricing to value and we're driving the breadth of the distribution in the market that warrant it.

So a lot of those fundamentals that you don't see, that the team is executing in C, are driving the growth. Just -- and that's a foundation that's terrific to build on with consumer programs as well as the innovation. So the last piece, I'd say, is we can really effectively and efficiently, through our centralized distribution, drive merchandising toppers on the shelves or racks within those stores very efficiently. So we do have a great model. But more importantly, the team is executing really well. And we're not content. We're continuing to fuel it with new analytics and insights.

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Operator [54]

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And we actually have one question in the queue at this time with Rebecca Scheuneman with MorningStar.

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Rebecca Scheuneman, Morningstar Inc., Research Division - Equity Analyst [55]

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Yes. Congratulations on a great quarter. So I'm sorry to beat a dead horse here with the revenue line, but just kind of a -- Tom, looking at it, as the 6% growth that we saw in the point of sale, is it reasonable to think that, that's kind of the run rate that we can expect to be sustained throughout the second half? Or was there something unique about the second quarter that drove that above trend?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [56]

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We don't -- we typically don't guide to the POS. I would look to continue to grow at the 6% POS we saw in the second half. We actually stepped up in July, if you look at the data. We expect that to step down in August because that was timing of the back-to-school. But we expect the continued growth well above the Sweet Baked Goods category in the back half. I feel good about our merchandising programs. It's driven by more than just our merchandising, it's driven by our mix fundamentals, multiple channels as well as the merchandising. So...

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Operator [57]

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With no other questions in the queue at this time, I would like to turn the call back over to management for any closing remarks.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [58]

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Thank you. And I appreciate all the questions. Q2 was a terrific quarter. We closed strong in the quarter. We continue to invest in our business, and I expect continued growth for now and for years to come. So thanks for your interest in Hostess, and everybody, have a great afternoon.

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Operator [59]

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Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and we thank all of you for your participation.