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Hostess Brands, Inc. (TWNK) Q3 2019 Earnings Call Transcript

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Hostess Brands, Inc. (NASDAQ: TWNK)
Q3 2019 Earnings Call
Nov 6, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings. Welcome to Hostess Brands Incorporated, Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. A question-and-answer session will follow the formal presentation. [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.

Katie Turner -- Vice President of Investor Relations

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 for the period ended September 30th, 2019 that went out this afternoon at approximately 4:00 PM or 5:00 PM 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 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 perspective on the underlying growth trend 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.

Andrew P. Callahan -- President and Chief Executive Officer

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 and 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 3.5 times.

This quarter's excellent results led by profitable growth continue 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 out-performers with continued strong distribution and merchandising support across multiple sales channels.

Additionally, new Hostess branded Danishes fueled sales growth and our Dolly Maddison branded products continue to post sales volume gains as we leveraged our acquired Clover Hill 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 five 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 multifaceted 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 selling of our 2020 program have been positive and again is reinforcing the strength of our brand and differentiated model to drive growth.

We continue to see customers trade up in our Hostess partnership program given the 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-brand -- 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, increased by rates among the existing consumers and bring new consumers to the category.

This was evidenced again this quarter as we continue to achieve meaningful revenue growth driven by our recent innovation and LTOs. We also took advantage of the Hostess' hundredth 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 US and now birthday cupcakes are the number two 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 sub-category 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 [Phonetic] expansion in breakfast is going [Technical Issues] was growing, as we have continued to unlock capabilities and innovation, supported by the Clover Hill acquisition.

For example, during the quarter, our Danish portfolio accounted for more than half of the total category's Danish growth [Phonetic]. Another breakfast innovation launching in Q4 2019 is the Hostess Cream Cheese Coffee Cake. Our research indicates cream cheese is the number two 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 listened to consumers and developed a new package type for our market-leading Hostess Donettes. This pack change creates a more portable and snack-able Donette extending them into a new use occasions [Phonetic]. Additionally, our research indicates that sweet product 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 to market in 2020. We are confident that the combination of the Hostess brand and sub-brand's equity in large addressable market, our teams customer focus and our lean, agile and scalable model worked 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 Clover Hill.

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 an 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 at 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 the 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 markets 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 and 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 continue 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.

Thomas Peterson -- Executive Vice President, Chief Financial Officer

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 non-controlling interests, 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 were $0.13 compared to $0.10 in 2018.

As of September, 30th, we had cash and cash equivalents of $266.9 million and net debt of $709 million. Our operating cash flow for the nine months ended September 30th 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 3.5 times, an improvement from 4 times 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 3.2 times to 3.4 times.

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 multifaceted 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 continues 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 the programs and the achievement of operating efficiencies. We anticipate ending the year with a net debt leverage ratio between 3.2 times and 3.4 times, 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.

Andrew P. Callahan -- President and Chief Executive Officer

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 remained confident about the profitable growth potential of Hostess Brands. We are operating a differentiated model and 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.

Questions and Answers:

Operator

[Operator Instructions]. Our first question is from Brian Holland, D.A. Davidson & Company. Please proceed with your question.

Brian Holland -- D.A. Davidson & Company -- Analyst

Thanks, good afternoon gentlemen. First question -- I am a little bit surprised by the lack of flow through given the magnitude of the topline beating the quarter. I understand some of the mix issues that you described. It -- I guess one, how did the gross margin come in compared to your plan for the quarter and is this just a cadence issued or maybe we step back on some of that from -- was that kind of some initial or seasonal promotion that may be steps [Phonetic] back 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?

Andrew P. Callahan -- President and Chief Executive Officer

Yeah, Brian. Let me take it first and then we can talk about Q4 and the gross margin. What happened in the quarter was our -- as you know, we had some line maintenance that we work on. We expected the revenue increase of that to 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 puts 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 sub-segments 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 as we could and it was really growth and demand driven. And that's hitting some of our product lines as well as transportation.

Thomas Peterson -- Executive Vice President, Chief Financial Officer

Okay. And to answer your Q4 EBITDA margin question, so that will have our highest gross and EBITDA margin percentage for the year.

Brian Holland -- D.A. Davidson & Company -- Analyst

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

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. Yeah, thanks for that, 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, yes, [Speech Overlap]

Brian Holland -- D.A. Davidson & Company -- Analyst

Okay, thanks. Understood. Appreciate the color. I'll leave it there. Thank you.

Andrew P. Callahan -- President and Chief Executive Officer

Thanks, Brian.

Thomas Peterson -- Executive Vice President, Chief Financial Officer

Thanks, Brian.

Operator

Our next question is from Pamela Kaufman, Morgan Stanley. Please proceed with your question.

Pamela Kaufman -- Morgan Stanley -- Analyst

Hi, good evening. 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.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. 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 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 [Phonetic] 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.

Pamela Kaufman -- Morgan Stanley -- Analyst

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 it could impact the outlook, like shipment timing or merchandising initiatives?

Andrew P. Callahan -- President and Chief Executive Officer

You know, the Q3 was -- it was really good. We pulled -- 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 a 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 2% is a tall feat.

But we feel really good about the programs, we feel good about the innovation coming in, and we expect that growth well ahead of the Sweet Baked Goods category.

Pamela Kaufman -- Morgan Stanley -- Analyst

Thanks. 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?

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. Well, if you look across, so I don't know which ones you've had. But if you look at, I know we 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 five of our six 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 are certainly some that's driven by distribution growth. But it varies by depending on the channel. Remember, we leverage -- also leveraged the Clover Hill acquisition, so we gained some new customers that were able to take that and not just grow Clover Hill, 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 are 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.

Pamela Kaufman -- Morgan Stanley -- Analyst

Thank you.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. Thanks, Pam.

Operator

Our next question is from Steven Strycula, UBS. Please proceed with your question.

Steven Strycula -- UBS Inc. -- Analyst

Hi, good afternoon. A few quick questions from me. Just to go back to the line maintenance piece to make sure I understand this properly. So there was 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 may be like if you net it all together, you know some perfect clean math, or maybe it was 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 that's making easier year over year comparing the third quarter of next year?

Thomas Peterson -- Executive Vice President, Chief Financial Officer

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

Steven Strycula -- UBS Inc. -- Analyst

Okay. And then for the Clover Hill 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 be $20 million, $25 million contribution by end of next year. I just wanted to kind of get a little bit of a goalpost update as to kind of how we're tracking for end of '19, so that investors can think about the incrementality of the piece coming in next year, meaning, are we halfway there, meaning like we're back to like $5 million of EBITDA going to $20 million $25 million, any type of context would be helpful.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. Hey, 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 have segment 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 ahead, it was in my prepared remarks, the launch of the 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 in 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 Clover Hill brand or 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.

Steven Strycula -- UBS Inc. -- Analyst

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 is accomplishing in the metrics this year, we're lapping some really tough compares. So the number one question I get from investors, how do we think about lapping such a strong revenue performance here this year? Do you think that the planograms that may break your way can still help you guys net grow next year? Thanks.

Andrew P. Callahan -- President and Chief Executive Officer

Thanks, 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 anytime you're growing at 9%. I think it's pretty straightforward to say that the lap is tougher. I expect us to continue to grow.

Operator

Our next question is from David Palmer, Evercore ISI. Please proceed with your question.

David Palmer -- Evercore ISI -- Analyst

Thanks. Good evening guys. I was wondering if you 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. So you mentioned some negative impact from mix. I suppose that was somewhat the high donuts mix, you've said that one, that's an oldie but a goodie. And then also, you mentioned the production line switch over and I guess there is some pricing rolling off. I don't know the -- perhaps you can remind us of the timing and magnitude of that. But any gives and takes about this, this last quarter and how we should be thinking about gross margin trends going forward would be helpful.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah, David, let me take a stab, and then Tom will way back -- way 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 some sub-category line to the value streams across plants that they don't normally work across. So that -- that was a cost that we incurred and then we continue 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 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, or not the regular donut 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 majority of that and will be fully lapped in Q2 of 2020.

David Palmer -- Evercore ISI -- Analyst

I guess just on that line maintenance impact or the negative impact, and also that mix impact, can you give any sort of sense about how big of an impact that might have been to gross margins? I presume those are -- they are the two main headwinds.

Andrew P. Callahan -- President and Chief Executive Officer

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

David Palmer -- Evercore ISI -- Analyst

Okay. We'll take it offline, but, thank you.

Operator

Our next question is from Bill Chappell, SunTrust Robinson Humphrey. Please proceed with your question.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

Thanks. Just -- Andy, if you have 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, to [Phonetic] know if you see a more of a rising tide or if you're really going to have to continue to carry the torch going into next year.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah, 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 is a lot of room for growth for us and our competition. We live in a breakfast -- majority in breakfast and in indulgent 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 is a lot of room to grow. We see that now, we see some of our competition with actually very strong point of sale and channels and we're still also growing point of sale and chair in those channels.

And we're well positioned to capitalize on those. I believe with the right innovation grounded in consumer, with the right execution and we can do that very well with our model that we can continue to drive that growth. So 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 than any competition. So we're able to leverage and bring ideas to consumers across. So the real -- the real broad answer and sorry to make it a long is, I really do believe that Sweet Baked Goods the way it's defined analytically which is different than the way a consumer defines it. They just want a sweet snack, which is a much broader case or much broader addressable market. I believe we will have 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 last several quarters.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

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

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. 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, you know, 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 its size, mix, portfolio, straight out pricing. We did that this time in multifaceted [Phonetic] 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 cost. I feel good about the work that they've done there. So I think we're in a good, we're in a good spot. But we're always looking at it, Bill. So we're ready to respond.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

Great. Thank you.

Andrew P. Callahan -- President and Chief Executive Officer

Yeah. Thank you, Bill.

Thomas Peterson -- Executive Vice President, Chief Financial Officer

Thanks Bill.

Operator

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

Andrew P. Callahan -- President and Chief Executive Officer

Well, thanks everybody. 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.

Operator

[Operator Closing Remarks].

Duration: 43 minutes

Call participants:

Katie Turner -- Vice President of Investor Relations

Andrew P. Callahan -- President and Chief Executive Officer

Thomas Peterson -- Executive Vice President, Chief Financial Officer

Brian Holland -- D.A. Davidson & Company -- Analyst

Pamela Kaufman -- Morgan Stanley -- Analyst

Steven Strycula -- UBS Inc. -- Analyst

David Palmer -- Evercore ISI -- Analyst

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

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