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Edited Transcript of TWNK earnings conference call or presentation 6-Nov-19 9:30pm GMT

Q3 2019 Hostess Brands Inc Earnings Call

KANSAS CITY Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Hostess Brands Inc earnings conference call or presentation Wednesday, November 6, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew P. Callahan

Hostess Brands, Inc. - President, CEO & Director

* 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

* Pamela Kaufman

Morgan Stanley, Research Division - Senior Analyst

* Steven A. Strycula

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

* William Bates Chappell

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Katie M. Turner

ICR, LLC - MD

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Presentation

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Operator [1]

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Greetings. Welcome to Hostess Brands, Inc. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this conference is being recorded. I will now turn the conference over to your host, Katie Turner. Ms. Turner, you may begin.

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

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Thank you. Good afternoon and welcome to Hostess Brands Third Quarter Fiscal 2019 Earnings Conference Call. By now, everyone should have access to the earnings release period ended September 30, 2019, and 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 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 perspectives on the underlying growth trends of the business, and it has 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 thank you for joining us today. I'll begin our discussion with a brief overview of our third 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.

We continued our growth momentum during the third quarter, demonstrated by the strong 8.8% point-of-sale increase in our 118 basis point market share gain in our category, which is ahead of the Sweet Baked Goods category and total food. Impressively, this growth builds on our second quarter POS growth of 6.3%, again, significantly outpacing the 2% year-to-date growth of the category in total. This strong consumer-driven demand drove our 7.7% net revenue growth in the quarter. When we exclude the revenue attributable to the In-Store Bakery business we sold at the end of August, net revenue increased 9.2% in the quarter and 9.4% for the year-to-date.

Our financial results were driven by the broad-based strength of our product offering, including our core Hostess branded products and our new breakfast innovation, which helped to drive growth across our key retail sales channels. Importantly, our Hostess branded products drove 80% of the net revenue growth in the quarter. From a profit perspective, our adjusted EBITDA increased 19%, resulting in adjusted EBITDA margin of 21%. We generated another solid quarter of operating cash flow and combined with the proceeds from the sale of our In-Store Bakery business, reduced our leverage ratio to 3.5x. This quarter's excellent results led by profitable growth continued to support our long-term investment thesis to deliver financial results in the top quartile of our peer group. We remain confident that we will be able to continue this momentum in 2020 and beyond, driven by the capabilities we are building today, the strength of our iconic brand in the growing Sweet Baked Goods category and the favorable consumer trends in both snacking and breakfast.

In particular, a few third quarter highlights. Net revenue increased 7.7% to approximately $227 million. Donettes and CupCakes were revenue outperformers with continued strong distribution and merchandising support across multiple sales channels. Additionally, new Hostess branded Danishes fueled sales growth and our Dolly Madison branded products continued to post sales volume gains as we leveraged our acquired Cloverhill customer relationships.

Similar to prior quarters, this quarter's net revenue growth also benefited from our well-executed price increases that were sold into customers beginning in the fourth quarter of 2018, and have continued to sustain throughout 2019. As I mentioned last quarter, our team performed preventive maintenance and operational enhancements to a few of our bakery lines in Q3, which limited supply below our robust demand. Looking ahead, based on the strength of our year-to-date results and continued strong consumer demand momentum expected for the balance of the year, we are confident we will grow revenue well ahead of the category and continue to achieve our full year guidance.

We remain focused on our 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 throughout 2019 to strengthen this foundation. Our team is investing in our priority capabilities, and these investments are driving results. We are demonstrating that the right focus and capabilities, coupled with the breadth and depth of our portfolio can deliver strong results.

A few key highlights. First, grow our core. We continue to sharpen our analytical capabilities and insights, and this is fueling the success of our Hostess Partner Program. As a reminder, the Hostess Partner Program or HPP is Hostess' vehicle to drive profitable growth programs with our customers leveraging joint assets and insights to drive better performance for both the retailer and Hostess. These investments have led to improved distribution and shelf mix and supported the execution of our multi-faceted pricing. We will continue to build our fundamentals across the business, creating a strong platform for continued core and innovation growth. Early indications of the sell-in of our 2020 program have been positive and again, is reinforcing the strength of our brand and differentiated model to drive growth. We continued to see customers trade up in our Hostess Partnership Program, giving me confidence in our continued growth momentum throughout 2020.

At Hostess, we have a rich history of being able to grow through innovation. The growing Sweet Baked Goods category is highly impulsive and expandable. And the Hostess brand and sub-brands are highly relevant to consumers. We continue to demonstrate with consumers and customers that small changes in our traditional products, when executed well and grounded in a consumer need can have an outsized impact on growth. We use fun, high-demand flavor and form varieties and extensions, exciting usage-driven limited time offerings or LTOs to drive incrementality, increase buy rates among existing consumers and bring new consumers to the category. This was evidenced again this quarter as we continued to achieve meaningful revenue growth, driven by our recent innovation and LTOs.

We also took advantage of the Hostess' 100th birthday to launch the Hostess' Birthday Cupcake. This started as an LTO for our Sweetennial birthday event earlier in 2019 and has become a permanent item based on its very strong sales and positive consumer response. Hostess CupCakes are sold more than any other cupcake brand in the U.S. And now Birthday Cupcakes are the #2 flavor of the brand. We also have new innovation on the way with our Triple Chocolate Brownie. This is a highly differentiated consumer-preferred product that allows us to participate in and capture a disproportionate share of a $250 million-plus brownie subcategory that has grown 5.5% over the last year. We are excited about this new product launch and the incremental revenue, we believe it will generate in the future. In addition to indulgent snacking, we are applying the same proven playbook to breakfast, including donuts, pastries and muffins, we currently have a 17.8% share of the growing $3.5 billion breakfast subcategory, up 280 basis points from our share in 2017.

Over the past 52 weeks ended 9/28, Sweet Baked Goods breakfast is growing 2.6%. We continue to believe breakfast serves as a robust opportunity for our growth. Our meaningful expansion in breakfast is going (inaudible) is growing. As we have continued to unlock capabilities and innovation supported by the Cloverhill acquisition. For example, during the quarter, our Danish portfolio accounted for more than half of the total category's Danish growth. Another breakfast innovation launching in Q4 2019 is the Hostess Cream Cheese Coffee Cake. Our research indicates cream cheese is the #2 consumer preferred flavor alongside our successful Cinnamon Coffee Cake. Cream Cheese Coffee Cake will be a new flavor to the segment, and I expect it to be highly successful based on the initial response.

We also listen to consumers and developed a new package type for our market-leading Hostess Donette. This pack change creates a more portable and snackable Donette, extending them into a new usage occasion. Additionally, our research indicates that sweet products share of total morning occasions is increasing. Our early results support this data as the new Donette snack pack has been 70% incremental to the Hostess Donette shopper in stores where both products are present. That is really impressive. And I'm looking forward to expanding the distribution for our Donette Snack Pack in 2020.

The team is developing a very strong innovation pipeline that we are excited to bring the market in 2020. We are confident that the combination of the Hostess Brand and sub-brand's equity, large addressable market, our team's customer focus and our lean, agile and scalable model, work together to uniquely position Hostess to deliver sustainable, profitable growth in the future. Our team also continues to improve through agility and efficiency. We realized another quarter of meaningful benefit from the operational supply chain and price value programs that we implemented as part of our core initiatives and the integration of Cloverhill. I am thrilled that quite a few of you were able to see the Chicago Bakery at our Investor Day during the quarter to better understand the significant transformation our team executed.

The relocation of our primary distribution center from Illinois to Kansas is moving forward, on track with our expectations. We continue to expect the first shipments out of our new facility during the fourth quarter, and for this transition to be completed early in the first quarter of 2020. This is another important step in elevating our infrastructure for future profitable growth.

Our broad channel distribution is foundational to our top quartile growth ambition. To unlock this potential, we have built a unique, customized and tailored approach to how we win in every channel. Our team is taking data-driven actions that support the Hostess Partner Program to fuel efficient and profitable growth and the distribution agility we have enables us to execute with customers at scale.

For example, our differentiated execution of our limited time offering or LTO and seasonal displays represents a core capability that Hostess delivers on a large-scale to retailers nationally.

As I mentioned last quarter, we remain excited about the opening of a new test kitchen and consumer research center within our new corporate headquarters in Kansas during Q1 of 2020. This will expand capacity, increase agility and improve efficiency of the new product research and development.

We are cultivating talent and capabilities. For those of you at our Bakery Tour and investor meeting in September, you were able to meet many of the terrific leaders at Hostess in key areas of our business from sales and marketing, bakery operations, supply chain, R&D, quality, innovation and finance. Our team has the benefit of the iconic 100-year-old Hostess brand that is as relevant today as ever. We have been able to launch Hostess and our sub-brands under a contemporary business model, while making strategic investments in our capabilities to differentiate us within the sweet baked goods industry. We are part of a large, growing and addressable market, including indulgent snacking and breakfast in which there is ample room to grow.

At Hostess, we have a tested and proven playbook, and are continuing to grow the consumer customer analytics side of the business to more deeply fuel future growth. Specific to our consumer investments, the step-up of this capability is a logical sequence for Hostess as we build off of our strengthening customer and business fundamentals. We are well positioned to build upon our brand with our excellent operational capabilities and even sharper consumer-driven insights, which together, sets us up for our strong growth going into the future. We continue to leverage our strong cash flow to help fuel our growth, deleverage and support our capital needs ahead.

We're good stewards of cash. With our operating cash flow and proceeds from our ISB business, we continued to reduce the company's leverage ratio in Q3. We also refinanced and extended our term loan and revolving credit agreements at favorable terms, further solidifying our strong financial position for the future. From a capital allocation perspective, we will continue to use our cash to pursue a range of potential strategic options, including reinvesting in our business, deleveraging our balance sheet and pursuing potential strategic acquisitions, while effectively managing our capital structure.

I am very pleased with our business fundamentals, increasing core capabilities and broad-based growth we achieved in the third quarter and year-to-date. We have had excellent growth momentum in 2019, and based on the programs we have in place and the strong consumer demand for our products, we fully expect this profitable growth momentum to continue for 2020.

Now I'll turn it over to Tom to go through the financial details of the quarter.

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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 third quarter financial performance and other data from today's release. Net revenue for the quarter was $227.2 million, a 7.7% or $16.2 million increase from 2018's revenue, driven by strong distribution and merchandising support across our sales channels. We are confident in our ability to generate revenue growth well ahead of the sweet baked goods category and in the top quartile of our peers over the long term. Gross profit was $70.4 million and gross margin was 31%. Adjusted gross profit was $75.2 million or 33.1% of net revenue compared to 30.4% in 2018. Adjusted gross margin improved year-over-year from previously announced favorable pricing actions and increased sales volume, partially offset by a shift in product mix. We also benefited from operating cost efficiencies.

As we continue to develop opportunities to profitably grow our business, we are focused on adding incremental gross profit. At times, this might result in lower gross margin percentages as we invest in growth capabilities and build out areas such as value brands, which inherently have lower gross margins than the portfolio average. But importantly, meet the needs of a distinct consumer segment.

Our effective tax rate for the quarter was 22% compared to 18.9% in the prior year. The increase in the effective tax rate is due to the Class B share exchanges in the second and third quarters of 2019. Subsequent to these exchanges, less income is attributed to the noncontrolling interest, a pass-through entity for tax purposes. Net income was $10.7 million compared to $11.2 million in the prior period. The decline was primarily due to the costs related to the sale of ISB and debt refinancing. Adjusted net income increased $4.8 million or 32.9% to $19.2 million, and adjusted EPS was $0.13 compared to $0.10 in 2018.

As of September 30, we had cash and cash equivalents of $266.9 million and net debt of $709 million. Our operating cash flow for the 9 months ended September 30 was $107.4 million. Our strong cash flows provide us with flexibility to pursue a range of potential strategic options, including reinvesting in the business, deleveraging our balance sheet and pursuing potential strategic acquisitions while effectively managing our capital structure. Our leverage ratio was 3.5x, an improvement from 4x last quarter, primarily due to the proceeds of the In-Store Bakery divestiture and improved operating results. We are on track to achieve our full year net leverage ratio of 3.2x to 3.4x.

For fiscal 2019, we are narrowing our net revenue and adjusted EBITDA outlook. We expect net revenue for the year to organically grow well above the Sweet Baked Goods category, driven by Hostess branded core and new product innovation, expanded distribution, improved merchandising and the execution of our multi-faceted pricing programs. We expect adjusted EBITDA to be in the range of $202 million to $208 million, even after adjusting for the $3 million ISB would have contributed, if not sold in Q3. As a reminder, we acquired our ISB business in 2016 for $51 million and sold it this quarter for $65 million. And including the earnings, we achieved a 38% return on investment. Also, our team continued to drive further efficiencies, and we expect our Q4 EBITDA margins to be the highest of the year. Adjusted EBITDA -- EPS is expected to be in the range of $0.58 to $0.61 after considering the $0.01 decrease for the sale of ISB. This increase is primarily driven by our strong demand, the execution of our price increase, merchandising programs and the achievement of operating efficiencies.

We anticipate ending the year with a net debt leverage ratio between 3.2x and 3.4x, driven by strong operating cash flows of $140 million to $150 million and the net proceeds from the sale of ISB, partially offset by our capital expenditures in the range of $30 million to $35 million. Our expected tax rate, excluding discrete items for 2019 will be 22% to 23%.

Now I'll turn it over to Andy for closing remarks.

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

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Thanks, Tom. We demonstrated another quarter of strong consumer-driven demand, broad-based channel growth and building capabilities we will continue to leverage. That is why, moving forward, we remain confident about the profitable growth potential of Hostess Brands. We are operating a differentiated model in a growing category. Across the team, we are working together to further advance our high performance-based culture to consistently win with all stakeholders. Our investments in enhanced capabilities and the continued development of our innovation pipeline will continue to lead to net revenue growth well ahead of the Sweet Baked Goods category. We will continue to drive strong long-term financial performance in the top quartile of our peers. Our strategy, our execution, our robust cash flow and our strong balance sheet will create value for our shareholders for many years to come.

And 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) Our first question is from Brian Holland, D.A. Davidson & Company.

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Brian Patrick Holland, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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First question, I'm a little bit surprised by the lack of flow-through, given the magnitude of the top line beat in the quarter. I understand some of the mix issues that you described, I guess, one, how did the gross margin come in compared to your plan for the quarter? And is this just a cadence issue to maybe we step back on some of that -- was that kind of some initial or seasonal promotion that maybe steps back in a little bit. I know, Tom, you mentioned at the end that EBITDA contribution would be highest in the fourth quarter. If you could maybe help us understand that?

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

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Yes, Brian, let me take it first, and then we can talk about Q4 on the gross margin. What happened in the quarter was our -- as you know, we had some line maintenance that we worked on. The -- we expect that the revenue increase of that could be greater than it was. The demand continued to be extremely high, which is really good news. The Hostess consumers are highly loyal. To be able to meet that demand, it's -- the substitutability of Hostess went to some other lines, which put some pressure on those other lines. And we invested in -- mostly in transportation and some of the ability around our other line capability to be able to meet the demand higher than we anticipated, moving across some of the other categories that we weren't or subsegments that we weren't investing in the maintenance. So that increased costs to keep the demand going we didn't anticipate and you saw that come through in Q3. So we supported the demand as best we could, and it was really growth and demand driven. And that's hitting some of our product lines as well as transportation.

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

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And to answer your Q4 EBITDA margin question. So that we'll have our highest gross and EBITDA margin percentage for the year.

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Brian Patrick Holland, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [5]

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Okay. And then the operating cash guide, it's adjusted down, at least each of the past 2 quarters that I can see, modestly. I don't mean to nitpick because it's clearly still strong cash generation. But I mean, is this just tied to what we just discussed? Or is there anything else that kind of weighing on that expected cash from operations?

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

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Yes, Brian, it's -- the last quarter's reduction was due to the sale of ISB and the cash flow that we adjusted out. And then this quarter was due to the refinance, which we opportunistically did this quarter to get some good rates and extend the term loan. So we (inaudible).

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Operator [7]

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Our next question is from Pamela Kaufman, Morgan Stanley.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [8]

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I wanted to see if you could quantify what the top line impact was from line maintenance during the quarter? I think last quarter, you said that it would be about a $5 million to $10 million impact?

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

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Yes. Thanks, Pamela. It's definitely on the low range of that. We continue to see the demand across the entire portfolio. We see the consumers being very loyal. We had an estimate on the substitutability across different sub-brands, and that was higher than we anticipated. So it's clearly on the low end. The amount of shipment impact was about that, but the increase across some of the other lines, driven by the strong consumer demand offset it. So the impact was a little bit difficult to quantify because you can't precisely say how much of the consumers went across versus how much was just a continued momentum of our -- a very strong growth prior to the investment, but it's definitely on the low end of that.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [10]

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Okay, that's helpful. And then, I guess, how should we think about the sustainability of the top line growth into Q4? Are there any unique dynamics that could impact the outlook like shipment timing or merchandising initiatives?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [11]

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The Q3, it was really good. We -- if you remember, we also pulled back-to-school a little bit earlier, we expected an offset. And that was really good. And then I just talked about the Q3. We expect continued Q4 growth well ahead of the Sweet Baked Goods category. We do -- we are lapping a little bit better performance year ago, but we expect the underlying consumer demand to continue the momentum. We expect a good Q4 relative to growth. Sustaining 9-plus in a category that's growing, too, is a tall feat, that we feel really good about the programs. We feel good about the innovation coming in, and we expect growth well ahead of the Sweet Baked Goods category.

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Pamela Kaufman, Morgan Stanley, Research Division - Senior Analyst [12]

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And then just on the growth by channel. Obviously, you're seeing very strong growth in dollar, club and mass. How much of the growth is coming from expanding your distribution points within those channels versus accelerating velocities? I'm just trying to get a sense for how sustainable that might be into next year?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [13]

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Yes. Well, if you look across -- I don't know, which ones you've had. But if you look at -- I know we've put out our presentation, our investor presentation. That's filed online as well. We have a chart that talks about each quarter, and you're exactly right. You can see across 5 of our 6 we're growing share. And we're growing extremely well. What you're looking at is we invested in data. If you go back to the pillars, we invested in data in certain channels. We invested in the Hostess Partnership Program in certain channels and then we refined our merchandising mix and how we executed that across. The majority of our growth or a lot of our growth is due to product mix and also improved merchandising, but there's certainly some that's driven by distribution growth, but it varies by -- depending on the channel. Remember, we leverage -- also leveraged the Cloverhill acquisition so we gained some new customers that we're able to take that and not just grow Cloverhill, but also combine that with our existing portfolio to drive growth.

So I would say it's a combination of different things. Our dollar growth is heavily driven by mix. We're gaining distribution and mix improvements in grocery. Convenience is driven by a combination of both. So it varies across the board. And the reason why it varies is because we have programs based on our data and analytics that drive both our distribution and the quality of our -- both events and our mix within each customer.

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Operator [14]

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Our next question is from Steven Strycula, UBS.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [15]

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Few quick questions for me. Just to go back to the line maintenance piece just to make sure I understand this properly. So there is definitely a revenue component to it and then a little bit of a cost overrun component to it as well, I believe. Tom, would it be fair to say that maybe like if you net it all together, there's no perfect clean math, but maybe just like a $2 million drag to EBITDA? And if so, is it something like that, if I understand it, pops back up in the fourth quarter, like it's a net positive? Or does that make an easier year-over-year compare in the third quarter of next year?

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Thomas Alan Peterson, Hostess Brands, Inc. - Executive VP, CFO & Treasurer [16]

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We would certainly have an easier third quarter next year compare. We took that into account in our guide for the fourth quarter that would be our best margin quarter of the year, but it's not going to improve that much. It will just be better than -- Q2 was our best quarter, so better than Q2.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [17]

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Okay. And then for the Cloverhill or Chicago Bakery facility. Can you help us understand like how that's tracking in terms of the contribution? When you first did the deal and a few quarters after, you said it's going to $20 million, $25 million contribution by end of next year. I just want to kind of get a little bit of a goalpost update as to kind of how we're tracking for end of '19, so investors can think about the incrementality of the piece coming in next year. Are we like halfway there, meaning, like we're back to like $5 million of EBITDA and we're going to $20 million or $25 million? Any type of context would be helpful.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [18]

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Yes, Steve, I'll take that really quick. We're -- the headline is we're on track. We're positive. We continue to improve profitability. And remember, we have -- we've segmented as opposed to just one stand-alone business. We completely integrated that business. Our revenue growth is on track. We launched breakfast. Breakfast is growing. I had those in my prepared remarks, the launch of Danishes. Jumbo Donettes, are going extremely well and our cost initiatives are on track. So we fully -- we're on track as we look here at Q3. We'll be on track in '19. And our forward-looking vision is to achieve those targets that we have gave when we announced the integration. What's a great surprise, or not surprise because the team worked hard for it, but what is terrific upside is our ability to be able to leverage the customer partnerships that we had to grow even business. So it's not just coming from the Cloverhill brand, where the big Texas brand. Our growth is coming across Hostess branded products in multiple channels as well. So it's on track to achieve our targets.

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Steven A. Strycula, UBS Investment Bank, Research Division - Director and Equity Research Analyst [19]

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Okay. And then as a quick follow-up to that, Andy. In your prepared remarks, you did mention that you had a positive early read on the 2020 planogram sets. As you think about the innovation and what your sales team's accomplishing and the metrics this year, we're lapping some really tough compares. The #1 question I get from investors is how do we think about lapping such a strong revenue performance year this year. Do you think that the planograms that may break your way can still help you guys net grow next year?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [20]

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I appreciate that question. The headline is, I anticipate we continue to grow. Now as we get into years, we're always making choices because we're in a sustainable growth model, so if we have -- we trade-off profitability questions for growth or if the investment is too high. But as I sit here, and once again, it's not just the planograms. My prepared comments were meant to say that our total Hostess Partnership Program discussions are going very well and based on those, we're seeing a good opportunity to continue that growth. But I'm not ready to guide 2020, but I see certainly a tougher lap any time you are growing at 9%. I think it's pretty straightforward to say that the lap is tougher. I expect us to continue to grow.

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Operator [21]

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Our next question is from David Palmer, Evercore ISI.

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [22]

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I was wondering if we could talk a little bit more about gross margins in the quarter. And then how we should think about those trends going forward, some gives and takes. I see you mentioned some negative impact from mix. I suppose that was somewhat the high Donettes mix. You said that one is an oldie but a goodie. And then also, you mentioned the production line switchover? And I guess there's some pricing rolling off. I don't know if perhaps you can remind us of the timing and magnitude of that. But any gives and takes about this last quarter and how we should be thinking about gross margin trends going forward would be helpful.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [23]

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Yes, David, let me take a stab, and then Tom will weigh back in. We did have some higher cost to meet the demand that happened concurrent to the line maintenance we had. So we've had investments in transportation. We had investments of running lines and actually moving subcategory line to the value streams across plants that they don't normally work across. So that was a cost that we incurred and then we continued to invest in the sustainable business. We expect those margins to improve as we go through Q4 and then be improved going forward.

I think if I remember, Tom's comment related to, and just bounce back to me if you think I missed this, but -- so there's some products that we have that inherently have a lower gross margin, but they're almost 100% incremental to our portfolio. So they add absolute profit to our line. We are growing some of those a little bit faster than our base business. And there is, therefore, a natural just mathematical gross margin percentage change. We did see some of that mostly some from our breakfast portfolio that's not Donettes, but, well, or not the regular Donette line. So that's not what the talk was, but the Jumbo Donettes.

Related to pricing, we're continuing to look at our programs and invest in data. We began selling that through last year, and we saw the majority of the impact accelerate through in Q1 of 2019. So as we get into Q1 of 2020, we will lap the majority of that and will be fully lapped in Q2 of 2020.

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [24]

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I guess, just on that line maintenance impact or the negative impact, and also that mix impact, do you get any sort of sense about how big of an impact that might have been to gross margins? I mean I presume those are the 2 main headwinds,

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [25]

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Let us -- it was the majority of the impact, I guess, would be the way I would answer that.

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Operator [26]

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Our next question is from Bill Chappell, SunTrust Robinson Humphrey.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [27]

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Just, Andy, can you give a little bit of thoughts on the overall health of the category, what you're seeing in terms of pricing and also innovation or from some of your competitors. Because it seems like this year, you're kind of carrying the torch last year. Bimbo carried the torch. Didn't know if you see more of a rising tide, or if you're really going to have to continue to carry the torch going into next year?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [28]

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Yes. No, thanks, Bill. Well, there's a couple of headlines I'll say on that is -- one is, I like our category because I believe from a consumer standpoint, there's a lot of room for growth for us and our competition. We live in breakfast, majority in breakfast and in indulge and snacking, and both of those are growing. We're highly convenient. We're highly indulgent, we're highly impulsive. And therefore, just more broadly on the category perspective, I believe there's a lot of room to grow.

We see that now. We see some of our competition with actually very strong point-of-sale in channels, and we're still also growing point-of-sale share in those channels. And we're well positioned to capitalize on those. I believe with the right innovation grounded in consumer, the right execution and we can do that very well with our model, that we can continue to drive that growth, who we plan, and we're working on plans to build on top of the very strong growth in '19 now, to Steve's earlier question.

To build on that, if you recall from Investor Day, our distribution spans across all channels. So we have a 92% ACV when considered all channels, which is 12 points higher than the next closest in any competition. So we're able to leverage that and bring ideas to consumers across.

So the real broad answer, I'm sorry to make it a long -- is I really do believe that Sweet Bake Goods, the way it's defined analytically, which is different than the way a consumer defines it. They just want to sweet snack, which is a much broader case, a much broader addressable market. I believe we will -- a lot of runway to grow. And that's why we are seeing growth at food or above food, depending on the quarter. And I think with our execution, that's why you're able to see us consistently grow well ahead of the Sweet Baked Goods category over the last several quarters.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [29]

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Got it. And just as a follow-up, any thoughts on pricing next year? And with regards to higher labor cost or labor scarcity and how that may affect you?

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [30]

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Yes. Well, as you know, we have -- we're always looking at cost programs. We have pipelines. We have pipelines of innovation. We have pipelines of efficiency programs. We're adjusting some of our network, as I talked, which is on track, which should make us more efficient, which will -- that will help us both on a profit but also help us fuel the right investments to drive our growth.

We are always looking at efficiencies of our portfolio, whether it's size, mix, portfolio, straight out pricing. We did that this time in multi-faceted and we revisit that all the time. So it's too early to say or announce anything. We're not seeing as much total inflation as we've historically seen.

Our team and our procurement team does a nice job of being forward above variable input ingredient costs. I feel good about the work that they've done there. So I think we're in a good spot, but we're always looking at it, Bill, so we're ready to respond.

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Operator [31]

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This concludes the question-and-answer session. And now we will now turn the floor back over to management for closing remarks.

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Andrew P. Callahan, Hostess Brands, Inc. - President, CEO & Director [32]

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Well, thanks, everybody. I appreciate your interest in Hostess. We feel good about our Q3 results, and we feel good about where we're going into Q4. Our strategy, our execution, our cash flow and our strong balance sheet. We really believe will create value for our shareholders for years to come.

So I appreciate your interest. And with that, we'll -- I'll send it back to the operator.

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Operator [33]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.