Hostess Brands, Inc. (TWNK) Q3 2018 Earnings Conference Call Transcript

Hostess Brands, Inc. (TWNK)
Q3 2018 Earnings Conference Call
Nov. 7, 2018 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Hostess Brands Inc. third-quarter 2018 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to the host, Ms.

Katie Turner. Please go ahead.

Katie Turner -- Investor Relations

Thank you. Good afternoon, and welcome to Hostess Brands third-quarter 2018 earnings conference call. By now, everyone should have access to the earnings release for the period ended September 30, 2018 that went out this afternoon at approximately 4:05 p.m. Eastern Time.

The press release and an 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 filing, you will see 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 trends of the business and has included in its earnings release, a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. And now, I'd like to turn the call over to Hostess Brands' President and CEO Andy Callahan.

Andy 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 touch on a few of our key priorities. Then Tom Peterson, our CFO, will provide greater detail on our financial results for the third quarter and then finally, we'll be happy to take your questions. As we outlined last quarter, we are focused on aligning our business and accelerating our growth, while working to recover inflation-driven cost increases.

We are executing what we said we would since the Q2 call. We are implementing our multifaceted pricing and merchandising plan, transforming the recently acquired Cloverhill business, launching our new Hostess-branded breakfast innovation into the market and continuing to collaborate with our key business partners to increase display and merchandising to drive incremental revenue growth. We are executing our proven and differentiated model that leverages our strong brands, consumer-relevant innovation and collaborative customer partnerships to drive Hostess' share growth and profitable category growth for our customers. I am confident these efforts will have a meaningful impact to our business performance moving forward.

Importantly, consumers continue to purchase Hostess at a rate ahead of the Sweet Baked Goods category, which is a strong foundation for long-term growth. Specifically, I'm excited to talk about our point of sale growth and how Hostess is driving this growth. For the third quarter, company point of sale increased 3.8% for the 13-week period ended September 29, led by the addition of the Cloverhill and Big Texas brands to our company base. Our market share was 18.9%, up 90 basis points.

We track six primarily channels, including grocery, convenience, mass, dollar, drug and club. During the third quarter, Hostess had organic point of sale growth of over 4% versus a year ago across all channels. Excluding the mass channel, these channels represents 70% -- 76% of tracked Sweet Baked Goods category. Specifically, point of sale within the convenience channel was up 4.6 for the quarter and share was up 190 basis points to 25.6%, which further solidifies our No.

1 share position in the largest channel within Sweet Baked Goods category. Point of sale within the grocery channel was up 3.9% and market share was up 50 basis points to 13.6%, driven by strong back-to-school program. And point of sale within dollar was up 4.5%. And point of sales within club channel were up over five times, while market share was up 13 points, driven by our acquired Cloverhill and Big Texas brands.

As previously discussed, our point of sale growth during the quarter across all of these channels is being muted by the lower performance in the mass channel, due to merchandising reduction. In analyzing our recent reductions, we learned more on the key drivers of growth for display. As just one example, we determined that our limited time offers and seasonal items are over 70% incremental to the category and Hostess when they're displayed correctly in the right mix and frequently replenished. This is just one insight of many we are leveraging to sharpen our execution and continue to drive growth across all of our channels.

We have good line of sight to sequential improvement in Hostess' display support in the fourth quarter and are moving in the right direction. Importantly, our overall point of sale and market share results illustrate that we are executing broadly across consumer need state, consumer segment and channels. We also understand that where customers partner and build Hostess, Hostess provides profitable category growth. Our team is incredibly focused on growth and consistently demonstrates it as evidenced by continued growth ahead of the category.

Now, turning to the third-quarter financial results. Net revenue increased $18.7 million to $211 million from the incremental net revenue provided by our recently acquired breakfast brands of Cloverhill and Big Texas and other acquired products. We continue to expect to have organic revenue growth above the Sweet Baked Goods category. Gross profit for the quarter was $60.4 million and adjusted gross profit was $64.1 million, an 18% reduction from the prime -- the prior year.

The primary drivers behind the decline were the shift in mix and revenue to include our Cloverhill business and lower revenue in the mass channel as previously discussed, as well as continued inflationary pressures. Based on the outlook for the remainder of 2018, we are now forecasting adjusted EBITDA of $185 million to $190 million for the full year. This is driven by the combination of lower revenue in the mass channel and higher transportation -- transformation cost, which are expected to continue into the fourth quarter of 2018. As we look at the specific drivers, we are making positive headway to mitigate them in the future and are confident that we have a meaningful improvement to EBITDA in 2019.

We have made significant progress on all of our key priorities during the quarter and believe these steps will create a strong foundation for future profitable growth. I want to touch upon a few of these priorities we are focusing on in the second half of the year, including the transformation and integration of our Cloverhill acquisition, what we are doing to combat inflationary pressures and our path to new innovation. I'm excited with the progress across each area. Let me address the transformation of the recently acquired Cloverhill business first.

We acquired this business to accelerate our growth into the underpenetrated breakfast segment and add brands with meaningful presence in the value, vend and club channel. And it is doing just that. We are very excited that our penetration and expansion in the breakfast segment, fueled by this acquisition is being well-received and already contributing growth. In late September, we launched Hostess-branded Cinnamon Rolls, Danishes and Jumbo Donette multipacks and we expect to begin the sell-in of additional single-serve products later in the fourth quarter.

We are also leveraging our differentiated model as we roll out our new breakfast platform and it is especially gratifying to see the enthusiasm in some of the channels that previously could not meaningfully participate in the breakfast segment, because of distribution models and code life. We are now able to partner with all retailers with a national brand that will support with innovation and drive incremental growth for Hostess and for our customers. We knew the transformation of these operations wasn't going to be easy, but our team is up to the task and we're making great progress. Our third-quarter results reflect the expected margin pressure from product mix and operational costs associated with the transformation.

Our teams work tirelessly to stabilize and improve the operation since completing the acquisition in February. This includes reducing waste, improving unplanned downtime, as well as finalizing significant capital projects that are expected to be completed in the next few months and will be instrumental to create a much more efficient operation. The most meaningful part of the capital installation is well under way and on time. Importantly, we are executing these capital projects, while growing the acquired business and servicing our customers.

Our priority is to service our customers, while not sacrificing the long-term foundations for growth. This has sometimes resulted in short -- in then extra costs in the short-term, but never at the expense of the long-term potential. We are confident that Cloverhill Business and the launch of the Hostess-brand items will be a catalyst to our growth in the breakfast segment and we remain very confident about the accretive revenue and EBITDA opportunity this platform provides in 2019 and into the future, as we continue to build out the product set and expand distribution into other channels. Since the last call, we have sharpened our analytic and foundational knowledge on pricing and announced a multifaceted price increase and merchandising program, coupled with trade rate reductions on select product lines.

The pricing actions will impact both Hostess and Cloverhill brands. The announced program will mitigate the impact of transportation of raw material increases, while maintaining growth. Based on our latest discussion with customers, we fully expect this pricing action, depending on the channel, to flow into retail starting in late Q4 and early Q1. In addition, we concurrently adapted our very successful Hostess partnership program from C-store into our grocery channel and adjusted for the growth drivers unique to this channel.

We are emphasizing this -- we are emphasizing the approximate mix of products, including proactive evaluation of SKUs to optimize our portfolio and deliver increased profitability. We are excited about the rollout of Hostess' most valuable product set to fuel sales of our highest-margin, best-velocity SKUs. Our customer relationships are collaborative. At Hostess, we strive to be an indispensable partner to our customers and will work daily to achieve that.

They are increasingly asking us to partner with them on insight and I expect the progress we made this year across all channels to pay off in 2019. We are also actively evaluating ways to improve our operations to drive down cost and achieve efficiencies. All of these capabilities will be important, as we navigate through this inflationary environment. Now, let me turn to innovation.

Innovation will continue to be a growth catalyst for Hostess. We are focused on three key areas: innovating our core, premium innovation and innovation into adjacencies. Our core innovation emphasizes new flavors of iconic products to leverage the brand's power and expand the core. We believe Hostess is highly profitable for our customers supported by our brand strength and large lists on display.

We are also focusing our energy on premium innovation in an effort to attract new consumers at higher price points like we have done with our Bakery Petites premium snacking platform. We are excited to launch two new flavors of our Cake Delights, strawberry and caramel, in the fourth quarter as well as expand distribution of Bakery Petites into the club and dollar channels, as we continue to build out this platform. Lastly, we are working to expand the Hostess brand into new consumer segments to drive incremental growth, like we are doing with Hostess TOTALLY NUTTY peanut butter wafer bars and our new Hostess Danish, Jumbo Donettes and other new products. Bakery Petites and breakfast are key platforms for growth.

They are both highly incremental to our business and extendable. We are also continuously looking at potential strategic acquisitions as another path for new innovation. Going forward, Hostess will remain a leader in innovation, as we revitalize and disrupt underserved product categories. So in conclusion, over the past few months, we have strengthened our customer relationships.

We have added more precision around pricing and flexibility to optimize our product portfolio to drive incremental sales. We are on track in the development of our current innovation platforms and accelerated our penetration into the breakfast segment through the integration and transformation of the Cloverhill Business. We have gained consumer, customer and market insights with enhanced tools and technology to inform our decision-making. And we have sharpened our capabilities as we build upon the experienced and talented team we have at Hostess.

As I look into 2019, our team is energized and confident that our strategic effort will deliver results. The fundamental strength of the Hostess brand across multiple sales channels, our merchandising strategies with both core products and compelling innovation, as well as our low-cost operating model, position us well to deliver sustainable results and value for our shareholders. Now, I'll turn it over to Tom, who's going to go through the details of the quarter.

Tom Peterson -- 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 $211 million, a 9.7% or $18.7 million increase from third-quarter 2017's revenue of $192.3 million. The Cloverhill business, which we acquired in the first quarter of 2018, contributed $18.9 million of incremental net revenue this quarter.

We also had growth in the small format, grocery and dollar channels, which was offset by lower net revenue within the mass channel. Excluding the impacts of the Cloverhill acquisition and the decline within the mass channel, our net organic revenue is up 2.3% as compared to the prior year. We generated $60.4 million of gross profit for the third quarter of 2018 and gross margin was 28.6%. Adjusted gross profit was $64.1 million or 30.4% of net revenue compared to $40.8 million in the third quarter of '17.

The decline in adjusted gross margin was primarily due to the shift in mix of revenue to include the non-branded Hostess products that were acquired with Cloverhill. This resulted in a 630 basis point lower adjusted gross margin. Also, we incurred higher transportation costs and other inflationary pressures, which resulted in a 330 basis point reduction. We continue to make significant progress to stabilize and improve the acquired breakfast operations.

However, there is more work to do to transform the Cloverhill business to a profitable operation. Significant capital projects are being completed in the next few months, which will be instrumental in improving the efficiency of the bakery operations. In addition, the company announced the multifaceted approach to pricing and merchandising in October of 2018, which will begin to be reflected in the market late in the fourth quarter. The pricing changes are expected to result in a 2% increase in the average list price with minimal impact in '18.

This does not include trade, bracket and weight adjustments, which we are also implementing. Our effective tax rate, including the impact of the noncontrolling interest was 18.9%, compared to 39% in the prior-year period. The decrease was primarily due to the lower federal statutory rate enacted by tax reform. Adjusted EPS was $0.10 per share, compared to $0.14 for the third quarter of 2017.

Excluding the impact of the losses as we transform and rebuild the Cloverhill business, adjusted EPS would have been $0.13 per share. Our operating cash flows for the nine months ended September 30 were $110 million, compared to $118 million for the same period last year. Our CAPEX for the first nine months of the year were $35 million, mainly for property and equipment to support the cake line in Columbus and investments we're making in the Cloverhill operation. We had cash and cash equivalents of $127.4 million and net debt with $859 million as of September 30.

Our leverage ratio was 4.46 times. In terms of our outlook for 2018, we continue to expect organic revenue to grow above the Sweet Baked Goods category average for the year and we expect revenue contributions from the acquired brands to be $70 million to $80 million for the year. From a profitability perspective, as Andy mentioned, we are updating our guidance and expect adjusted EBITDA to be in the range of $185 million to $190 million. This revised guidance reflects our year-to-date results and the expected results for the remainder of '18.

We narrowed our expected adjusted EPS to $0.52 to $0.55, which is the lower end of the previously guided range. Our expected tax rate for 2018 is approximately 20% to 21%, giving effect to the noncontrolling interest, a partnership for tax purposes. We anticipate ending the year with a debt leverage ratio between 4.5 times and 4.6 times. Now, I'll turn it over to Andy for his closing remarks.

Andy Callahan -- President and Chief Executive Officer

Thanks, Tom. In summary, we believe our core companies -- competencies will continue to differentiate us for success in an evolving marketplace. Hostess has strong brand equity, with both consumers and customers. There is no denying Hostess' iconic brand appeal with new classic treats.

We have an attractive low-cost model that enables us to go to market in unique ways and win. Our team consistently works collaboratively with customers on our core products and innovation to deliver strong, long-term partnerships. We have the ability to quickly bring complementary incremental innovative products in displays to the marketplace to build and expand new categories. And we are fortunate that Hostess have multiple paths for value creation and continued strong operating cash flow to support future organic and inorganic growth.

All of these differentiates us from the competition. We expect our core companies -- competencies to continue to help us drive growth above the category, increase profitability and value for shareholders. With that said, Tom and I are available for questions. 

Questions and Answers:

Operator

[Operator instructions] Today's first question will be from Brian Holland with Consumer Edge Research. Please go ahead.

Brian Holland -- Consumer Edge Research -- Analyst

Yeah, thanks. Good evening. I appreciate all the color in your prepared remarks, but if -- and forgive me if I'm asking you to be repetitive, but just trying to sort of flesh out, with respect to some of the transformation and rebuild investments that you talked about with respect to Cloverhill. What changed from last quarter or what did you identify? I mean, is this a structurally high -- because you seemed to be committed still toward the long-term plan.

So is this an acceleration of investments, whether that's to meet demand or opportunity? Or there's just a structurally higher cost here that we need to be maybe sensitive about as we think about the opportunity going forward?

Andy Callahan -- President and Chief Executive Officer

No, Brian. They are -- there's -- this is a wonderful acquisition, the Cloverhill business that we acquired. The strategic underpinnings of why we bought it remain and as we get the capital employed, which is right on schedule right now, as soon as we do that, we will see EBITDA positive and we're highly confident that this is going to be a highly accretive growth engine for us in '19 and beyond, both in revenue and EBITDA. As we look through the transformation phases here, there's three components that we're really doing.

We're managing the core business of what we bought and that has investment within the core lines and the efficiencies that go with that, think about ingredient loss and waste and all that stuff on lines, that really were not to Hostess' standards, and we have high standards, but we're still servicing our customers doing that. We're launching the breakfast platform with -- under the Hostess branding, which, as I mentioned, is being highly accepted by our customers and we have a lot of enthusiasm behind -- for that. And we're -- at the same time we're doing that, we're investing the capital to elevate the capabilities of this and really give a platform for long-term launch. So within that, the end state is very clear and I'm very confident of that.

The road through that, as we manage all of those priorities all at once, which the team is doing a terrific job, is a little bit windy sometimes. So absolutely no change in my confidence going forward. That's why the team is doing a great job and the capital is on schedule. And I expect to come out of '18 with that completed and behind us and really a tremendous tail engine and growth platform moving forward.

Brian Holland -- Consumer Edge Research -- Analyst

Right, thanks. That's helpful. So then, as we think about flowing that through to the guidance here, my take here is that sort of legacy or core Hostess, if you will, less the acquisition, that seems like it was largely in plan, maybe a little bit softer revenue. Is that fair that the majority of this guidance revision is tied to those transformation and rebuild costs that you outlined?

Andy Callahan -- President and Chief Executive Officer

I'd say that's true just on -- and those are transitory, just in the short-term, doesn't as we -- it doesn't change anything for '19. And we did see a little bit. We talked about just the merchandising in one channel as that comes back a little bit, so the combination of those. But the core Hostess business, as we saw the growth and the share growth, we said, is fundamentally very good.

We have great momentum. And I expect to move into '19, as we get all engines firing, to be -- I'm very confident about that, the line of sight that I see.

Brian Holland -- Consumer Edge Research -- Analyst

OK, and last one for me. Just -- you talked about the price increase at the end of Q4, but you're also -- you've talked a lot about sight lines to improve display and merchandising. I would imagine, especially in your category, that demand elasticity is more sensitive to sort of any volatility in display, merchandising, trade spend, however you want to define it, than sort of a list price increase. Is that fair? So do you -- are you less concerned about demand elasticity on a price increase that maybe you would be on any change in merchandising like what we saw this year -- early this year with Walmart?

Andy Callahan -- President and Chief Executive Officer

Well, we're not going to comment across any of the specifics. But the team has -- did tremendous analysis across multiple channels, multiple product form, the elasticities across each of them. And as we analyze those, what we did is we implemented our cost recovery model that included all of those factors, different channel, different product lines, different merchandising programs, mix, display activity, to ensure that we could recover what we needed to at the same time that we were managing growth. But your answer is right, they're not all the same.

Brian Holland -- Consumer Edge Research -- Analyst

Fair enough. Thank you. Best of luck.

Operator

Next question will be from Michael Gallo with CL King. Please go ahead.

Michael Gallo -- C.L. King -- Analyst

Yeah, good morning. A couple of questions. Tom, how -- what do you expect the EBITDA loss would be for Cloverhill this year? I know you've given a range in the past, but what should we think about in terms of -- what do you have embedded with the number?

Tom Peterson -- Chief Financial Officer

Yeah. We gave a range when we guided originally. And as we've said, it lost just under $5 million this quarter, which we disclosed, but we haven't disclosed the year.

Michael Gallo -- C.L. King -- Analyst

OK. But I think, I would put you somewhere around $15 million-ish of losses for the year? I think, we're still...

Tom Peterson -- Chief Financial Officer

Yeah, we're still within the acquisition economics range. We expect it to still be within that.

Michael Gallo -- C.L. King -- Analyst

Right. And I guess, when I think about, again, you seem pretty excited about this once you get through the transitory cost. I know, you said within a few months. So I guess, do you think you'll have the vast majority of this wrapped up by the end of the year? Or do you think some of it could spill over into the first quarter?

Tom Peterson -- Chief Financial Officer

Yeah, Mike. We believe we'll have the capital deployed by the end of the year, a little bit of fine-tuning around that, but we're going to -- into '19, it'll be off and running.

Michael Gallo -- C.L. King -- Analyst

OK. And is there anything that you've seen now that you've had some time here? Is there anything you see -- you've seen about the acquisition that makes you think it's going to be harder to get to the long-term target or it's really just a function of moving the pig through the python and once you get through this transition that you're just as excited or there's nothing different about the opportunity?

Andy Callahan -- President and Chief Executive Officer

Let me answer that, this -- I am probably more excited about the opportunity than we were when we acquired it. There's no reason not to. But it's given us a wonderful brand. It's given us access to the breakfast platform.

Remember, we bought this business for $15 million, and we -- the inventory offset from that, we quickly made it to lose less money and as we get all the capital invested this year, we're going to be off and running with the platform that gave us penetration into -- with new brands, penetration into new channels that we didn't have, and a head start on launching the Hostess brand into the breakfast segment, which has given us new channels and a whole new incremental growth platform. There's no reason not to feel good about that. And I'm confident we're moving into '19 with great momentum when we get the capital deployed.

Michael Gallo -- C.L. King -- Analyst

OK, great. That's helpful. And then just final question, just on the kind of the core business. Andy, one of the things we've kind of noticed since your mass business came under pressure, you seem to be performing a lot better in the non-mass channels and it's pretty good growth.

I know, you alluded to some sequentially improve display space. Obviously, when Hostess does well, it would seem the category tends to do well. So I'm wondering if ultimately, this might end up being good if you can regain some of the shelf space back and kind of have a sharper focus in other channels, but could you give us any visibility into sort of that progress and getting display space back? I mean, is it modest? Is it just new product driven? Or you think you can kind of get the mass customers to see the real benefit of having to have a bigger growth channel? Thanks.

Andy Callahan -- President and Chief Executive Officer

Well, one of the things -- thank you for that question. And you're absolutely right. When we execute our model with our brand in the right forms, we've demonstrated that we can drive growth. And when it's not executed, then growth doesn't come both for us and for the category.

And so our focus is to -- when things are down to make sure we learn from it, and that was the example I brought up in the prepared remarks. Our limited time offers are consumer focused, they're insights, they're occasion driven, they're meaningful, they leverage our brand. And when we get them on display, they're 70% incremental, they're an extra purchase. When we have single serve in the right part of the store, at the right price and it's displayed, it's incremental to our business, when we display it the right way.

So we understand our business and our brands and we know how to drive growth for the customers and the categories, and I'm confident that we'll work -- to collaboratively work with all of our customers and improve that meaningfully going forward.

Michael Gallo -- C.L. King -- Analyst

Thank you.

Operator

Next question will be from Bill Chappell with SunTrust. Please go ahead.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

Thanks. Good afternoon. Just wanted some clarification, and maybe you've covered this. So on Cloverhill, prior, Andy, to you coming the thought was it would lose $15 million to $20 million this year and could make $25 million of EBITDA next year.

So are you saying that's still a possible number, just not necessarily that we're on the train to do that all in 2019? Or is that not even a possible number? I'm just trying to understand how I should be looking at the profitability.

Tom Peterson -- Chief Financial Officer

Yeah, so while we're not guiding for '19, we did, I believe, when we disclosed it, that was 2020s EBITDA target. We well be EBITDA accretive in 2019 but that was '20s target.

Andy Callahan -- President and Chief Executive Officer

Yeah and we're not guiding to '19, but I think, the premise of your question is we feel very confident about '19 at/or above the acquisition economics.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

OK. And then in looking at Cloverhill's impact this quarter, is there a way to kind of break out -- I mean, from my understanding, last year, Cloverhill was not -- it was barely running and that not only created out of stocks for Cloverhill products but also, I think, for some of the products that it supplied to Hostess on a co-pack agreement. So are -- does this represent kind of back to normal in terms of sales from Cloverhill, both through Cloverhill brands and Hostess brands? Or is there still further market share or, I guess, sales to be recovered?

Tom Peterson -- Chief Financial Officer

Yeah, so from a -- what Hostess is going to operate of the assets we bought, which includes the Cloverhill and Big Texas brands, that's kind of the base reset is the almost $20 million this quarter. But the business and the product forms did a lot more than that. And we believe we can both grow those two brands in the value and vend segments of the market. But we can also launch, we're launching the Hostess-branded multipacks, additional single-serve items, and then strengthening our single-serve items that were already made that did impact this last year.

So each of the three of those, we're building around each of those three as platforms to breakfast.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

OK, so but there is more room or is Cloverhill at kind of running at normal revenue capacity?

Andy Callahan -- President and Chief Executive Officer

No, there's no more room to grow.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

OK, got it. And then last, just any update on freight as it relates to your guidance? I mean, I think you had seen kind of the worst of it over the summer, and I didn't know if it's gotten any worse versus your expectation and especially as we go into '19 or if you feel like it's, I guess, stabilized or you have your arms around that?

Tom Peterson -- Chief Financial Officer

Yeah. I think, we captured it, previously it hit our expectations. It does continue to rise, and we continue to watch it, and we're certainly trying to figure out where it will be in '19, like everybody else is. But it would probably at our expectation, but obviously, a lot higher than it was last year.

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

Got it. Thanks so much.

Andy Callahan -- President and Chief Executive Officer

Thanks, Bill.

Operator

Next quarter will be from Pamela Kaufman with Morgan Stanley. Please go ahead.

Pamela Kaufman -- Morgan Stanley -- Analyst

Hi. Thanks for the question. I have a couple of questions. First, I wanted to ask about how your customers are responding to your plans to increase prices? And how should we think about the effective price increase, once you implement your trade promotion and packaging adjustments that you mentioned?

Andy Callahan -- President and Chief Executive Officer

So the customers are having, generally, very good discussions across it. As I said, it's multi-faceted, includes the list price, bracket pricing, we're adjusting the weights on some. We've adjusted the merchandising program. So there's been an overwhelming positive and collaborative response to it.

I feel very confident when it rolls through in Q4, and it will come through in the first half of next year. As we disclosed in the prepared remarks, the net list price was 2%, but when you combine all of those, it will be above 2%. We're not ready to really disclose that, that will be, obviously, incorporated into our 2019 plan, but it'll be more than 2%.

Pamela Kaufman -- Morgan Stanley -- Analyst

OK, thanks. And also, I guess, how should we think about how much more opportunity there is for further distribution expansion? It seems like it's been very strong in specific channels like convenience but softer in mass and drug. So what do you see, as the opportunity for further distribution growth? And what is the mix impact from -- or the profit mix impact from seeing faster growth in convenience versus other channels?

Andy Callahan -- President and Chief Executive Officer

So let me address the first one. There's upside, and I get emails every day across our channels, where we're looking at the distribution growth opportunity, C-store is one, different distributors to access consumers in different ways. As we talk about the Cloverhill acquisition, given this access to value and leveraging our strong sales force and distribution network to be able to penetrate that. Our innovation, which goes into new segments, as I mentioned in the prepared remarks, with breakfast, gives us the opportunity that really bring a compelling solution to customers and drive incremental distribution, because it's incremental to them.

So our model's working and our team's tremendously focused on growth. So they're some of the ways to look at it. Now when you talked about margins, specifically, I'm not going to address margins across channels, but what I will say is, for example, with breakfast at Cloverhill, we mentioned that we know that it'll be, as a percentage-wise, margin dilutive, but we're really focused on incremental EBITDA contribution. So we're not going to sacrifice growth to protect margins.

We will focus on EBITDA growth and make sure that it's accretive and incremental to our bottom line. That's the way we look at it. Team's incredibly focused on it and doing it. You are right, the growth around in the short term, around some channels not growing as much as they were.

But we're focused on innovation and opportunities for increment down to our customers, and that will drive distribution as well.

Pamela Kaufman -- Morgan Stanley -- Analyst

OK, thanks. And just lastly, what is your current appetite for additional acquisitions? Are you seeing any attractive opportunities at the moment? And how comfortable are you with pursuing further acquisitions, given where your leverage is?

Tom Peterson -- Chief Financial Officer

So we continue to -- we see a number of different things and continue to believe the best use of our strong cash flow is acquisitions. We do understand that in the short term, there's some pressure on our leverage as we have a significant, as we said, we will have a significant EBITDA turnaround in 2019, and that will alleviate some of the leverage pressures. We continue to believe in acquisitions as in the forefront of our strategic pillars for the business and hope to put them together pretty quick.

Pamela Kaufman -- Morgan Stanley -- Analyst

OK, thank you.

Operator

Next question will be from Steve Strycula with UBS. Please go ahead.

Steve Strycula -- UBS -- Analyst

Hi. Good afternoon. Can you hear me?

Andy Callahan -- President and Chief Executive Officer

We hear you loud and clear. Thank you.

Steve Strycula -- UBS -- Analyst

Perfect. So a question for Andy, wanted to -- I think at the end of the first quarter call -- maybe it was the second quarter call, you did mention that some of the mass channel retailer negotiations were under way, and that you're hoping to secure more distribution space for the back half of calendar '18. Did that go to plan? Because when we're looking at the release today, it did seem that the mass channel was still a ways to -- that would be my first question, as to like, what went your way or what maybe didn't?

Andy Callahan -- President and Chief Executive Officer

Yeah, the -- sorry, I don't comment on any specific customer but specifically, we're continuing -- we think we have a growth model that works. Sequentially, we have seen more display. As I talked about the learnings, which is really good that we have a great precision, we continue to learn about how this would make displays drive the most incrementality and the biggest lift. So those are some of the things that we're continuing the learning.

We're never satisfied when it comes to growth. So we wanted more growth. We continue to collaborate. And I expect that to continue to improve, and I expect meaningful improvement as we get into '19.

Steve Strycula -- UBS -- Analyst

OK. And for the pricing piece that you are mentioning earlier, that 2% list pricing, is that for the total Hostess portfolio or total company portfolio, rather? Or is it off there just like select pieces of the portfolio?

Andy Callahan -- President and Chief Executive Officer

That's an average list price across our entire portfolio.

Steve Strycula -- UBS -- Analyst

OK, very helpful. And then my last question would be around the different puts and takes for EBITDA as we think forward for next year, now looking for explicit guidance on exact new merit. But you mentioned that the Chicago Bakery flexed from a drag this year to positive. How should we think about the base business for Hostess? You have about 2% plus coming through on pricing.

Are there any other puts and takes that we should think about? Clearly, inflation's still an issue, but are there anything else that investors should keep top of mind as we think about the base business heading into next year from what you know today? Thank you.

Tom Peterson -- Chief Financial Officer

Yeah. We're not giving guidance for '19 yet. We'll do that with our annual report that comes out in February, and that's all we can say about that right now.

Andy Callahan -- President and Chief Executive Officer

But you -- that's all we're going to say, but I think you're heading it right. We're addressing the current issues that will pay dividends in '19, and they're transitory. We're going to -- the transformation of Cloverhill is on track. We're implementing the pricing actions across the board, and those discussions are I feel confident about that, and we're working collaboratively across all of our customers.

And I feel good about that, and that's all within the backdrop of demonstrated growth across five of our six channels today. I feel really good about that and the innovation that's going to propel that.

Steve Strycula -- UBS -- Analyst

OK. Quick question, a follow-up for Tom. Tom, I think, year to date, the gross margins in the base business for the releases are down around 400 basis points. Is a lot of this just one time in nature? Can you help us think through what is kind of structural reset, because of where freight rates have gone to and freight rates are going to be a pressure going forward? And how much are truly transitory issues in the base business that can may be won back over the next 12 to 18 months?

Tom Peterson -- Chief Financial Officer

Yeah. As we talked about, the quarter had 330 basis points inflation. We are mitigating a significant portion of that from the price increase, but we're not going to -- we're not going to compromise the growth model of the business to gain back our margin. This isn't -- again, this isn't a margin business for us.

This is -- we're focused on total EBITDA dollars and we look at incremental opportunities around that, and that was part of how we came at the multi-faceted pricing aspect. We didn't just do an across-the-board price increase. We did a very strategic structural analysis of various options, and we're also looking at various options within our distribution network to make sure we are the lowest-cost operator within Sweet Baked Goods. So there's a number of things we're going at, but we're not going to guide to a margin.

Andy Callahan -- President and Chief Executive Officer

And apologies if I misspoke. The inflation is here to stay, we believe, the transportation and some of the other costs. So we're addressing with this.

Operator

Next question will be from Rob Dickerson with Deutsche Bank. Please go ahead.

Rob Dickerson -- Deutsche Bank -- Analyst

Great. Thank you. So I guess, my first question is just around the incremental pricing coming next year and kind of comment to me on gross margin. It sounds like it's you're, obviously, looking for incremental EBITDA dollars, not imagine the business per se for margin.

But that said, market sometimes reacts to 1,000 basis point decline in gross margin. So I just -- I'm thinking, if everything that you've said in the next -- for next year, you have the pricing, when let's say, Cloverhill laps, and hopefully, gets better with increased distribution, the base sounds to be, you're saying it's strong or there should be these material improvements. Then if freight and the other cost inflation, for sake of argument, essentially stays the same, I mean, it sounds like as you kind of look forward, right, that the expectation is very broad. It's not guidance, it's that, logically, the gross margin would be increasing off of a kind of a very kind of tough 2018, at least, once you get to the back half of next year.

Is that fair? Is that how you think about it as you plan the strategy for next year?

Andy Callahan -- President and Chief Executive Officer

I think, that's how we think about it. We have a -- the transition and the inflation have impact this year without the solutions fully implemented. So the transformation of the Cloverhill business will be complete in the beginning of next year, and we'll be implementing pricing actions that will partially cover that inflation, while continuing to grow in large innovation expense, so that is the way we think about it.

Rob Dickerson -- Deutsche Bank -- Analyst

OK. And then just in terms of the conversation around display and kind of what's happened in the mass channel, it sounds like things have gotten a little bit better, and it sounds like the expectation is for it to continue to get better or hopefully, it will get better. Is that just really just driven by everything you've said around the strength of the Hostess Brand or the positioning of the category, the category growth with Hostess and Hostess is on display, and so on and so forth. And therefore, there's been maybe some share loss in mass and mass is coming back and saying, OK, while this might take a while as we reset our planogram or think about our overall assortment mix in the store into next year.

But hey, we got you, because we realize that we kind of messed up, so to speak, and we're going to work with you to kind of -- maybe not get back to where you were, but to get better. So just kind of a general comment from your end.

Andy Callahan -- President and Chief Executive Officer

Well, general comment is, in general, is you mentioned the data would support that when Hostess grows, the category grows. And we work collaboratively across all of our customers to -- there's no got you on our part. We want to be an indispensable partner to our customers. And we want to bring them solutions to profitably grow, and that's what we do.

That's what we do. They're our customers, we work with them across the board. We want them to grow. And we're making tremendous progress on that.

And I'm confident, as we go into 2019, we're going to see that in the results.

Rob Dickerson -- Deutsche Bank -- Analyst

OK. And then just one more. In terms of -- I've heard you say before, try to leverage the distribution network and the advantage you have in snacks, so it's a broader question, a lot of your competitors run on DSD. You don't.

We're all aware of it. Is that -- as you say -- we think about acquisition, hopefully, we get something soon, is there -- what is the ad -- what is the competitive advantage that you might have not just in the base Hostess, but overall within the aisle with the warehouse model that could provide you some advantage in terms of leveraging that network into other players or other brands? Thanks.

Andy Callahan -- President and Chief Executive Officer

Well, I think, that's a great question. So we need to be really good at what we're really good at. And our model -- our warehouse model allows us to do things for both smaller format stores as well as large box stores, in a meaningful way with the Hostess brand. So for smaller format, with our long-code-life warehouse model, we're able to get more points of distribution, grow them, bring segments and categories to customers and distributors they weren't unable to participate in a meaningful way.

They're our greatest champions out there, who are unlocking their ability to be able to grow their business and grow it with a real meaningful 99% awareness brand. And that's working. You see that working then we're continuing to innovate and feel that. Within large retailers, we're also able to bring innovation, one.

But then we're able to bring large merchandising events with consumer-relevant ideas around specific occasions with usage and merchandise and bring innovation in a category that hasn't been that way before. So we have advantages on both ends, and we activate them across the board, across all of our -- in our entire network across every channel, and we bring all this innovation to everybody, and it works for everybody, and we bring solutions to customers across every channel that works best for them.

Rob Dickerson -- Deutsche Bank -- Analyst

OK, great. Thank you.

Operator

At this time, this will conclude today's question-and-answer session. We'll turn the conference back over to management for any closing remarks.

Andy Callahan -- President and Chief Executive Officer

No, we're just really confident about our opportunities going forward. Our team is focused on growth. We're focused on transforming the current business. It's been a transition year, but we're really confident that the work we're doing now will continue to pay off and grow in the future.

So I appreciate your interest in Hostess. I appreciate your time today. Thank you.

Operator

[Operator signoff]

Duration: 57 minutes

Call Participants:

Katie Turner -- Investor Relations

Andy Callahan -- President and Chief Executive Officer

Tom Peterson -- Chief Financial Officer

Brian Holland -- Consumer Edge Research -- Analyst

Michael Gallo -- C.L. King -- Analyst

Bill Chappell -- SunTrust Robinson Humphrey -- Analyst

Pamela Kaufman -- Morgan Stanley -- Analyst

Steve Strycula -- UBS -- Analyst

Rob Dickerson -- Deutsche Bank -- Analyst

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