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Welcome to the TreeHouse Foods Second Quarter 2020 Conference Call. [Operator Instructions] Please note, this event is being recorded. At this time, I would like to turn the conference over to TreeHouse Foods for the reading of the safe harbor statement.
Good morning, and thanks for joining us today. Before we get started, I'd like to point out that we've posted the accompanying slides for our call today on our website at treehousefoods.com. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and can generally be identified by the use of words such as guidance, may, should, could, expects, seeks to, anticipates, plans, believes, estimates, approximately, nearly, intends, predicts, projects, potential, promises or continue or the negative of such terms and other comparable terminology.
These statements are only predictions. The outcome of the events described in these forward-looking statements are subject to known and unknown risks, uncertainties and other factors, including COVID-19 that may cause the company or its industry's actual results, levels of activity, performance or achievement to be materially different from any future results, levels of activity, performance or achievement expressed or implied by these forward-looking statements . TreeHouse's Form 10-K for the period ending December 31, 2019, TreeHouse's Form 10-K for the period ending March 31st, 2020, and other filings with the SEC discuss some of the risk factors that could contribute to these differences. You are cautioned not to unduly rely on such forward-looking statements, which speak only as of the date made when evaluating the information presented during this conference call. The company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein to reflect any change in expectations with regard thereto, or any other change in events, conditions or circumstances on which any statement is based.
For purposes of our discussion, our results and outlook are provided on a continuing operations basis, which excludes the impact of the Snacks division, which was sold last August and the ready-to-eat cereal business.
I would now like to turn the call over to our CEO and President, Mr. Steve Oakland.
Thank you, P.I. Good morning, everyone, and thank you for joining us today. Before I get into our performance and what we consider a very good quarter, let me spend a little time on the events of the last few months. Since we last spoke in May, 2020 has been marked by more than the COVID-19 pandemic. For me personally, the racial injustices and the events in the last couple of months stirred a wide range of emotions. What I can say for certain is that these injustices have no place in our society, and at TreeHouse, we have an opportunity to create change.
We have plants, offices and associates in the communities hit hardest by these events. In those places, we are on different cultures, races and genders, and we are better for it. We value each and every employee at TreeHouse. And it's more than what any one individual contributes to our business. It's about what we all collectively bring to build our culture. We've talked to you in the past about our TreeHouse values. And you can see those on Slide 3.
In particular, our values are better together, speak up and own it or helping guide the organization. We are putting much more thought into how we think, speak and act. We are engaging our employees by talking about unconscious bias and the power of inclusion and diversity. By doing so, we are further building our culture. I'm proud of the way our teams are embracing the importance of supporting each other and our communities. Our values have also been a key part of guiding our response through the pandemic. Hopefully, you've had a chance to go to our website and read about our COVID-19 response, which you can see on Slide 4, in the ways in which we are prioritizing employee safety, as we deliver high-quality food and beverages to serve our communities across the nation.
I'm very proud of how quickly we've adapted and how effective we become in this new environment. So I'd be remiss if I didn't start today by expressing my deep gratitude to our nearly 9,000 frontline employees across the company. These men and women are putting on masks everyday and coming to work in our plants and distribution centers so that we can do our part to serve the North American food supply.
I also want to recognize our employees who are working remotely, seamlessly supporting our back office. And those who are working to build and deepen connections with our customers. These are difficult times for everyone, and I truly appreciate your dedication and efforts. As I did last quarter, let me start by framing the macro environment.
We've updated Slide 5 for Q2, showing how at-home food consumption has fared in our categories overall versus private label for our 2 divisions. As you can see, while private label has grown nicely this year, the pace of that growth has lagged branded. And I wanted to give some context for that.
Following the March spike, when consumers rush to fill their pantries, we worked with our retail partners to prioritize higher velocity SKUs. This is a very complex exercise for private label, given the variety of formulations and packaging. While this limited assortment resulted in fewer choices on the shelves for consumers, it enabled us to run our plants more efficiently and provide retailers with more tonnage. I feel good about how we performed in Q2, and I continue to be encouraged by the strength of demand.
I wanted to address the topline here because as we said on our last employees as we are our plants. Our teams have been proactively monitoring COVID data in the counties and communities where we have manufacturing and distribution operations. As we all know, cases were on the rise in the Northeast and Midwest, early in the second quarter. In a number of instances, we made very conscious decisions to temporarily close certain locations so that we could take additional sanitation measures and keep our people safe.
This translated into underserved demand in certain categories in the second quarter, and Bill will give you more detail on that in a bit. In most cases, affected plants were down for a few days. However, we did have several plants that were down for a couple of weeks. This week, all 36 of our plants in North America and 2 plants in Italy, are up and running. Those of you who subscribe to syndicated data saw private label grow year-over-year, but at a rate below that of the overall category in May and June. Branded manufacturers were able to more quickly restore assortment on the shelf, realizing this benefit, which partially explains why private label lost a bit of share during that time.
As demand has stabilized, we have now restored over 80% of the SKUs we limited, most of which will be shipping by the end of August, and we think our current plant protocols allow us to improve our customer service levels going forward. In a few minutes, Bill will take you through our revenue by channel, giving you the opportunity to see our retail grocery business in the quarter that's actually much healthier than the syndicated data would have suggested.
On Slide 6, our EPS of $0.58 was $0.08 above the top end of our guidance range. Second quarter net sales of $1.04 billion, grew almost 4% on an organic basis, and our profitability was very strong. Adjusted EBITDA was up 13%, and adjusted EBITDA margin rose 110 basis points versus last year. Our results demonstrate not only the leverage we have in our P&L, but also that the structural changes we've made over the last several years have been tremendously beneficial in this new environment.
This quarter, we began our annual strategic planning process. So before I turn it over to Bill, I wanted to share a bit of our thinking here. Back in February, we consolidated to 2 divisions from 3 in order to better align our business. Our strategy team has done a nice job of framing how we think about this as you see on Slide 7. At the base and as the foundation of everything we do are the pillars of our enterprise strategy: operational excellence, commercial excellence, portfolio optimization and people and talent.
At the top is our growth algorithm, which in a normalized environment, has not changed. As we think about the potential of our portfolio, and I talked about this a bit in the last call, our move to 2 divisions allows us to more closely align our customers' goals and strategies with how we think about, operate and sell our categories. Importantly, meal prep on the left will drive cash generation by optimizing its mix and simplifying the business while maintaining share.
Snacking and beverage on the other hand, represents an opportunity to grow the top line through innovation and distribution. Both businesses will continue their focus on our TMOS and Lean continuous improvement principles by segmenting our business and providing clearly defined goals and initiatives, we're in a much better position to manage our categories in a manner that aligns our efforts with how our customers think about them, and how they manage their private label strategy.
Our new 2-division structure has been serving us very well during the pandemic, and I believe our second quarter results and our outlook for the back half, which we're raising today are testament to that.
With that, let me turn it over to Bill to take you through the numbers and details of our improved outlook. I'll come back at the end to wrap up. Bill?
Thank you, Steve. Good morning, everyone, and thanks for joining us today. I hope this once again finds you well and enjoy your summer. Steve took you through the high-level results around net sales and profitability, but let me start by providing more detail.
Slide 8 provides our scorecard for the quarter. Given all the uncertainty we faced 3 months ago, our results were largely on track, and our profitability was strong. The net sales line for the quarter came in at $1.04 billion, which is about $10 million short of the bottom end of our guidance range and $30 million below the midpoint.
This is really driven by 3 things. First, the biggest driver was the unserved demand, as Steve talked about earlier. In the second quarter, we deliberately held back production in certain geographies in order to keep our employees safe and healthy. This impact was spread across a number of categories, namely dry dinners, creamers and pretzels. Broth, crackers and hot cereal are also challenged in the quarter.
Second, the pace of recovery for the food wafer home sector in Q2 was a bit slower than we anticipated, particularly within restaurants and institutions. And third, we had a couple of retailers whose order patterns were irregular due the actions they took around limiting foot traffic and shortened store hours. We also saw temporary closures as a result of protests around the country. This impact was seen primarily in red sauces, bars, preserves and dressings.
Adjusted EBITDA of $119 million is at the top end of our guidance range. Adjusted EPS of $0.58 was $0.08 above the top end of our guidance. About $0.03 of our beat was driven by tax as we were slightly conservative in our tax rate guidance, given the uncertainty of COVID on our business around expenses, channel mix and various tax implications due to the Cares Act. As we look ahead, we have a better sense of how these issues impact us in the second half. That said, there is a new round of Cares Act legislation that is pending and could have impact going forward.
Turning to Slide 9. You can see our P&L will show the division direct operating income grew just over 13.5% to $154.8 million versus last year. Division DOI margin improved 160 basis points versus the same period. I'm particularly pleased with the quality of our results this quarter, which reflects the strength of our business model and the fixed cost leverage as we add incremental volume.
Slide 10 will actually cross the adjusted EPS drive year-over-year from $0.40 last year at $0.58 this year. Volume and mix, including absorption, was $0.15 better than last year as our plants continue to work hard to replenish inventory drawdowns in the first quarter. Pricing net of commodity costs contributed $0.16 year-over-year, driven by favorability in warehousing and logistics. Operations was a negative $0.12 compared to last year. While our plants ran very well, the benefit was outweighed by a combination of higher employee expenses and negative variances due to temporary plant shutdowns caused by COVID-related interruptions.
Before going in any further, let me address COVID-19 related costs as we focus on keeping our central frontline employees safe. In the second quarter, we incurred a total of almost $30 million in COVID-related expenses. Of that, we treated approximately $20 million as onetime expense, which is included in the COVID line in our reconciliation table. This includes things such as third-party sanitation costs, temperature screening, PPE and supplemental pay. Those costs get netted against a $5 million benefit related to tax-driven by the Cares Act. The remaining almost $10 million in COVID costs such as overtime and staffing has been absorbed in our adjusted P&L. SG&A was a negative $0.03 versus last year as we accrued for higher variable incentive compensation expense, and that was mostly offset by favorable tax and other.
Turning now to Slide 11. You can see the top line growth by division, driven primarily by increased demand. Organic net sales for the Meal Prep division grew 1.8%, while Snacking and Beverages organic growth was 7%. On the right, we shared our quarterly net sales growth, which has turned the quarter from being negative last year to positive this year. We've been able to successfully service the higher demand, overcoming the carryover volume loss, which was significant.
Next, let's turn to Slide 12 and our second quarter revenue by channel. Here, you can see the results for the retail grocery channel was better than our overall reported results, posting growth in the double digits as a result of COVID demand. Meal Prep was the largest beneficiary of the increase in grocery demand, while Snacking and Beverages also posted solid improvement year-over-year. This has, in turn, driven positive absorption in our plants, and our operations are running full out in a number of categories.
Next, you can see on the orange bar that we pulled out the carryover wrap of loss distribution and pricing adjustments, which totaled about $80 million in Q2. Next is our Food Away From Home business, which declined approximately $40 million or 47% compared to last year. This was more than we've anticipated when we provided second quarter guidance. Food Away From Home as well as the Industrial Contract Manufacturing and Export business, each represent about 10% of TreeHouse revenue on an annual basis.
Slide 13 shows you our net debt position. Net debt at the end of the quarter was down to $1.8 billion, and our leverage ratio or net debt-to-EBITDA per our bank covenants and finished below 3.4x. Our balance sheet is strong, and we have sufficient liquidity. We generated positive free cash flow in Q2 of $29 million, which came in ahead of our expectations. We continue to focus on paying down debt and anticipate that we will finish the year with net debt of around $1.6 billion. We believe the right leverage ratio for our business is in the 3 to 3.5x range, and we would anticipate being in that range at year-end.
Turning now to our guidance on Slide 14. As Steve mentioned, we are raising our adjusted EPS guidance for the year to a range of $2.55 on the bottom end and $2.75 at the top. We anticipate sales for the year to be in the top half of our original guidance range of $4.1 billion to $4.4 billion. We've also raised our EBITDA outlook by $5 million to a range of $485 million to $515 million. Free cash flow is expected to finish the year at the top end of the range of $250 million to $300 million. We've also provided a number of the key line items.
A quick word about interest expense. Last quarter, we talked a bit about timing and delays in certain initiatives that were planned this year. Our debt structure is one such area. A number of you are aware that we have about $376 million of our 2022 notes that became callable earlier this year. Given the attractiveness of the debt markets prior to the pandemic crisis, we were evaluating various options for those 2022 notes. So when we provided our original guidance in February, the intent was to be opportunistic and refinance the bonds. The volatility in the market has settled a bit and the situation has evolved. So our guidance revisions takes that into account.
By this point, we continue to monitor the debt markets and see the high-yield market improving. We will continue to assess our options. We provided our Q3 guidance on Slide 15 and are anticipating sales of $1.04 billion to $1.08 billion, which contemplates the June temporary plant closures for pickles and refrigerated dough, as well as other categories such as dry dinners that continue to see demand greater than available supply. We expect adjusted EBITDA of $112 million to $127 million, and adjusted EPS of $0.55 to $0.65. We believe this guidance provides you a balanced perspective on the upcoming quarter that takes into account both the risks and opportunities.
Turning now to Slide 16. Back in May, we talked to you a lot about the interplay between these bars in the back half of the year. We considered the carryover loss business, new commercialization, COVID-related demand and the negative impact of Food Away From Home. This situation continues to be dynamic. But based on what we see today, we are raising our expectations for revenue in the back half to be flat to up 2% on a reported basis and up 2% to 4% on an organic basis. You will notice that we have combined the bar representing new business and COVID-related demand. So let me clarify what we anticipate here.
We continue to expect new business to outweigh any carryover losses in the second half, and our expectations for carryover loss has not changed. We're really proud of what our commercial teams have accomplished over the last several months given the virtual environment. While we do have a couple of new items that have been delayed into 2021, and some retailer plans are still evolving, we also have a number of successes to talk about.
On Slide 17, you can see some of the new items that we are commercializing. On the left are some of the new possible lentil items, gluten-free lentil-based pastas in various flavored varieties. On the right-hand side of the page, many of you may recognize our house brand, Rootstock, our newest first launched ready-to-drink coffee beverages. We're now selling our ready-to-drink beverages in new packaging formats, such as the glass [indiscernible] -style bottle, aluminum cans and nitro for cold brew. We're also now offering nonmilk creamers in [ aseptic ] carton format. The team's ability to drive innovation during this time is really encouraging.
Slide 18 is our free cash flow look. Given the increase in our earnings guidance, we are now comfortable guiding our 2020 free cash flow to the top end of the original range of $250 million to $300 million. Our expectation is that we will be cash flow negative in Q3 as we build inventories in preparation for our seasonal fourth quarter peak.
Before I turn over to Steve, I'll close by saying that I couldn't be more pleased with how our employees have come together this year, demonstrating our values like agility and commit to excellence. I'd like to echo my thanks to the entire TreeHouse organization. Your energy, commitment and contribution to our results continues to inspire me everyday. Steve?
Thanks, Bill. Similar to the way I started my remarks today, let me comment on the macro environment and then wrap up with my thoughts on how we are positioned to TreeHouse, which fuels my confidence and optimism about the future. This pandemic and the economic, political and frankly, cultural state of our nation continues to be something that we're all learning to navigate. While there's uncertainty, I come back to the underlying dynamics that support opportunity and growth for private label.
We've shared the 3 key themes on Slide 19 before, demographics, the economy and the retailer landscape. The first is demographics. We've all seen the data showing buying power is shifting away from boomers is on the rise for millennial and Gen Z consumers. Those generations are more supportive of and have a higher propensity to buy private label. Second, as you all know, the data suggests that the U.S. economy has been in a recession since March. Unemployment numbers peaked at just under 15%. Historically, recessions bode well for private label, though we have yet to see the total effect of these economic realities on the consumer.
At this point, we believe that the consumer has yet to feel the pinch. In light of the government's unprecedented stimulus, to date, we have not seen this recession translate into changes in consumer habits, including how we shop at the grocery store. And whether you want to believe in a U- or a V- or a W-shaped recovery, it's hard to forecast anything, but a recessionary tailwind for private label. I would argue that it's only a matter of time before we see the consequences of these trends.
Today, our business, is in a much-more favorable place to be able to benefit than we've been in the past, especially with retailers' private label better-positioned versus previous recessions. And then third, the retailer landscape. On the right, you can see one of a number of charts from a recent consulting study. Retailers expect to allocate more shelf space to private label over the next 2 to 3 years. Private label is more profitable per unit for the retailer. And today, more than ever, retailers are looking forward and strategizing about how to further develop, action and grow their private label program, which brings me to where TreeHouse is today.
On Slide 20, I'll say it again, we are a much stronger organization today than we were a year ago. The work over the last 3 years has been difficult, and it's been time-consuming, but it has strengthened our foundation and optimized our network. Our operations team continues to do a phenomenal job. They're putting process and metrics in place to harmonize our operations, and they are in still a continuous improvement mindset in our plants.
Furthermore, the work over the past several months to keep our people safe has been nothing short of remarkable. That work has enabled us to build our commercial organization. I'd like to congratulate our commercial team who recently celebrated their 1-year anniversary. They've not only been selling the power of private brands and TreeHouse, but through the pandemic, have further strengthened our customer relationships.
So I'll close today similar to last quarter on people and talent. The last several months have both tested and challenged us. We've taken great pride in what we've accomplished at TreeHouse and where we're going. We want to thank each and every one of our employees for a job well done, and we will continue to put your health, safety and welfare first.
2020 is shaping up to be a year of very good results, and our higher guidance is a reflection of that. Our organization today has been built for this, and we remain confident that we are emerging a stronger, healthier TreeHouse.
With that, let's open the call up to questions.
[Operator Instructions] Your first question comes from the line of Chris Growe with Stifel.
Nice quarter there. I want to ask you, first of all, just want to understand for your second half expectations. What sort of at-home food consumption rates do you expect -- not to be so exact, but just do you expect this to continue through the year? Do you have a built up through the third quarter and then kind of or a normal condition in the fourth quarter? I'm just curious how your expectations are for at-home food consumption overall.
Yes. Chris, I think we'll see similar trends to what we see now. There's a lot of uncertainty as whether kids are going to go back-to-school. I know here in Illinois, that's bouncing back and forth, right? And this looks like more kids will be home than maybe we would have thought even a week ago. So I think we're expecting the rates that we see today to be stable through that period, and we're not seeing a recovery until into 2021. So to -- back to normal, I guess. So we're seeing what we see today through the rest of the year.
And then just to ask a second question, in relation to your supply chain, over operations. And it sounds like all your plants are operating today. Can you talk about like, I don't know, whether it's days or weeks, those were sort of closed to the quarter? And then given where you are today, are you able to pick up the share because of your supply chain now operating fully? Or is that where your competition is generally?
It's hard to speak to private label competition. But let me sort of reconstruct what we talked about as far as the plants being down. We all know that the last couple of weeks of April, we saw this big onslaught of volume -- or last couple of weeks of March, excuse me, and it rolled into April. So March and April were very strong. We came into May. We had new protocols. We started to see these cases spike in the Midwest and the Northeast. And quite frankly, that was all very new to us, right?
This was premask. This was -- pretty a lot of it, the protocol that we have today that we deem as standard. So we were conservative there. We closed plants. We did -- we brought in extra sanitation, we did all of those things, right? And I think if you look at the cases in our population compared to the data that we get on the industry, I think we did pretty well, keeping our people safe. But it did cost us some business, right? It cost us some volume.
Now I would tell you that June was a great month, right? And that in July and August, we've got protocols that I would argue in place that allow us to run through much of the stuff. We've got Plexiglass barriers, we've got masks, we've got all of those things. We've got people separated. So I think we're in a good place to operate and serve more the demand that we did in the second quarter, right? It'll be interesting about taking share, right, but it's really hard for private label to speak to your competitors there. I do think, as we said in the prepared remarks, that the brands got their assortment back quicker. I think you'll see private label's assortment come back over the next 4 to 6, 8 weeks. I think you'll see the assortment in a much better position. And I think that will help us.
Your next question comes from the line of Robert Moskow with Crédit Suisse.
A couple of questions. I'll get a follow-on what you just said, though, you said that only 80% of your [ SKUs ] are back? What is the volume hit to your business from the remaining 20% that aren't back?
No. It's 80% of the SKUs that we limited. So -- and that's a really complex number to figure out because in something like pasta, it would be less than something like maybe single-serve beverage pods or something. So we took a portion of the SKUs, the lower volume SKUs out, which really freed up capacity, that takes away changeovers. It takes away formula cleanups, all of those things so that we can provide more tonnage for those core weeks to get the retailer back in stock after that March-April rush.
Those -- we put about 80% of those SKUs back. Quite frankly, I don't think 100% of those SKUs will ever come back. I think the retailer and us, we will work together to determine, did we have stuff in the system that just didn't make sense? So I'm not thinking that, that last 20% -- and remember, that's 20% of just what we limited, will impact us at all long-term. In fact, I think it may, as you saw in the margin results, it may make us more effective, more efficient.
Okay. And then the second question. Your Slide 5 kind of points to what you're seeing for private label growth, and how it's lagging overall [ growth ]. If I look at it, it just seems to average out to maybe 3% [ net growth ] for private label overall, and then maybe 300 to 400 basis points below categories in which you participate. So am I correct that that's kind of how you're looking at your second half retail growth?
And then I guess the follow-on is, if the retailers are emphasizing the thick brands more aggressively because their supply chains are able to adapt quicker, what makes you feel comfortable that this will eventually shift over to more space for private label? Can we just have to wait for direct payments to consumers to kind of phase out and -- or do we have to wait for the retailers to kind of get their breath and have time to make changes to their shelves? It sounds like this is more like what might happen rather than what's going to happen for private label is my concern.
Sure. Sure. I would tell you that the data that you see in IRI or in Nielsen is really consumer data. I mean the retailer has an impact on that latest consumer data. And with the consumer, with all the stimulus in the consumers' hands, with the availability of brands that consumers were able to buy brands, right? The complexity of private label, the work-through that we talked about, I think affected our share. If you think about pasta, if there's a particular kind of pasta and the brands get it back quicker, they get 100% of share of that item until we get it back, right?
So I think there's some mechanic full stuff here. I think the consumer was, quite frankly, as I said in my prepared remarks, not -- has not felt the pinch of this yet. But I think if you think about where the retailer is, and the message that I hear from the retailer is one thing COVID has pulled forward is the e-commerce impact on their business, right?
Whether it be click-and-collect, whether it be home and -- whether it be Instacart, whether it be home delivery, all of which are much more expensive venues for them. So as they look to how they recover, how they accomplish, how they manage in this new world, where they're going to have a higher share of e-com. And their business, private label is got to be a key part of it. They have to find a way to margin up their business to pay for those extra costs. So it may take them some time. I think the reason we combine the chart where we reconstruct and we show the COVID impact versus new business, the reason we combine those two is because of the interplay between those two. If COVID demand softens and the retailer has more time to execute on initiatives, we'll see the initiative bar go up. If quite frankly, if we see COVID demand increase over the next few months, they'll have less time to do that. So I think there's a direct interplay there. But my comments on where I think private label will go are -- I think they're strategic, and I think the retailer will not have a choice going forward. So I'm not sure it's a what we wish would happen, I think it's what we think will happen. The hard part's going to be to define the timing.
Your next question comes from the line of David Driscoll with DD Research.
So I just wanted to go over the COVID impact . And just to make sure I understand something and really the -- where I'm going with this is how to think through next year but I think you put in your slide is that the COVID cost was an impact of $0.25 to your adjustments from GAAP earnings to your adjusted earnings. So you exclude that $0.25 impact from continuing operations.
However, the benefit for COVID is in the revenues. So if I do include the COVID costs, EPS would actually have been down year-over-year. And what I'm trying to contemplate, the first point is, is COVID actually a benefit to the company in the quarter? I don't think it is because I think EPS would have been down. But really where I want to go with this is into next year that as COVID fades, then presumably, you would eliminate all of these extra COVID costs. And so maybe the way we think about a lot of other packaging companies is that they're going to be seeing very tough comps next year. But I don't maybe think that's the case for you given just the mathematics of what we're seeing in the quarter. Can you respond to that?
Sure, Dave. This is Bill. Hope you and your family are well during these uncertain times. How we think about COVID is just really 2 pieces. First and foremost, we've been consistent at applying our policy of adjusted earnings so that you can great transparency into ongoing results versus onetime in nature results. And you would note even in this quarter as well as last quarter, we had some positive tax items that were one-time in nature that we excluded as well. So to your point about puts and takes, you know they're right in terms of what we excluded in terms of earnings. But as you think about kind of the P&L overall, the majority of the costs related to production shutdowns, those costs are included in our adjusted results. We would think that if there is no COVID, that result is better because of it.
But to your point, we do get incremental volume. There's incremental expenses. Some of these new things around sanitation and just social distancing and space, there'll be ongoing costs that will go forward. As we go into next year, we'll lay out for you pretty cleanly what the margin profile looks like in a post-COVID world. But until then, we do a good job. We think of excluding things that are just onetime in nature. And when you look at our adjusted earnings, you just see a really good feel for the trend.
David, one thing I would say, you do capture one important point. I know some of the peers in the grocery business have had higher top line numbers than us. So we will not have a steep until the lap next year is maybe some of our competitors. But there's also one thing -- one benefit that is going to carry into next year. And that's the improvements in our balance sheet. And this volume and this operating efficiency has allowed us to pull forward the improvements in our leverage ratios that we were working on. So the fact that we will hit our target leverage ratios in the fourth quarter, I think is a significant pull forward that's going to allow us flexibility as we go forward. So I think we'll have a slightly, slightly less steep slope decline. We'll have a slope decline, let's be clear but not as steep as many in the industry. But we'll do it from a much stronger balance sheet, and from a balance sheet that will give us more options than we would have thought we would have rolling into 2010.
And just one follow-up on this. Would you expect the $20 million of COVID costs you experienced in the second quarter that were excluded, would that -- I thought the expenditure continued Q3 and Q4 or was it unusually high in 2Q, and that figure begins to face because you've got your Plexiglass barriers in place, and we don't need another one? How does that work?
I would think that who knows exactly how the environment -- what will happen. And as Steve has mentioned many times, we'll do all that we can to keep our employees safe and healthy. That we do anticipate ongoing costs related to screening and there we've got some wage things, et cetera. So that will probably continue, Dave, to your point. So I would not expect until there were some step down in the COVID world that those costs would moderate. Our anticipation is that, that will be [ varied ] somewhere for us for the balance of the year.
Your next question comes from the line of Rob Dickerson with Jefferies.
Great. Just a question on the back half from margins. And there seems like your organic sales growth expectations are out for the back half. It sounds like you're a part of that. Hopefully, there's some tailwinds from the macro backdrop. But that said, when we see the margin as much as it was in Q2, that we see where the sales are now expected to be in the back half, total year guide for EBITDA is up, I think, what, $5 million. So maybe just some color as to kind of what could get that EBITDA up even more and sustain potentially higher than expected -- higher than guided margin forecast.
Thank you for your question. This is Bill. I'll address part of it, and then maybe Steve can add on a bit more color here. But to your point, we were very pleased with the middle of our P&L this quarter. The structural to work we've done at TreeHouse over the past several years has really given us a strong foundation, and it really allows us to successfully ramp up the production during this time period. Steve mentioned in the script, we were built for this. And our operations team is doing a fantastic job.
You saw the margins really improve sequentially from Q1 to Q2 as well as over a year ago. I would expect that we will have similar margins of the Q2 exit rate in Q3. And Q4 is our larger quarter and most profitable. So I think we have accounted for -- we think we've accounted for incremental volume and net leverage. We also are anticipating, again, we are running in a COVID environment, and we have to anticipate some costs related to that as well. So I mean that showed through as much as you would have thought but the idea of the efficiency of the P&L is something we think will continue.
Yes. I guess the thing that will be, whether it's up or down, would be do we have shutdowns? And what are the magnitude of those? Are they greater than what we've anticipated in this forecast? So if we're able to run better than that and we are able to run more than that, then we'll probably be a little better. If it's a little softer than that, it will have a negative impact. But we think we've covered ourselves in this and -- but only time will tell. I mean at the beginning of -- when we talked to you in May, things changed an awful lot in the next 6 weeks. So we think we have a much better handle on it. We think we have much better protocols on our plants. So there are much less risk than they were maybe 3 months ago. So that would be -- and I think if the volume -- if things do shut down, if we see states reshut down obviously another volume spike would be beneficial to us.
Okay. Super. And then just a quick follow-up. Just on your comments around the retailers looking to offset some of the potential increased expenses given heightened online penetration and maybe looking to private label to support some of that profitability hit offset. Is that something that you sit down with the resellers now and you're thinking about 2021 and you say, "Okay, well, we kind of lagged a little bit this year in big brands", but given your expenses, we were really looking to kind of push these orders. Then as we think about '21, the assumption that we could see making the kind of push into an extent would be that private label, especially given the macro backdrop would really be accelerating in the next year given the comp, right?
So obviously you're not going to talk about '21 guidance with a lot of uncertainty. But I'd be thinking if it all is lining up to be fairly positive and you have to use their comps, then it would, in theory, imply that your top line growth, at least next year, should be better than we would have expected pre-COVID.
Yes. I think there's that potential. I mean, I think the questions we got earlier today about the costs -- the COVID costs that are going to go away for us are probably true, right? The new world is going to have less. We're not sure exactly how much less, but less of what we're expensing now. I'm not sure the retailer has that, right? If you think about how much this is pulled forward, this is consumer behavior that's been pulled forward, what I think they believe and we believe is permanently.
So they're going to have to deal with these ongoing costs. And that's where private label really comes in, is how do they improve the margins from the center of the store, private label does that. So yes, we are having those dialogues now. Now that we're not sitting down with them. They're all virtual obviously. And so we just had -- the FMI just did their big business conference suites virtually and those are the kinds of conversations we're having with the retailers at the more senior level. So they're trying to think about how they move forward. Now they still have themselves very much in today, right, to be fair. They're trying to have their nose on the grindstone and a couple of eyes on the horizon, but they've got some -- they still are trying to figure out how much impact are they going to have through the holiday season, one is Thanksgiving, those kinds of things. So I think it will be a little while before they have a chance to really lift their head and focus on '21.
Your next question comes from the line of Ken Goldman with JPMorgan.
I wanted to follow-up on your commentary. I don't think you used the word surprised necessarily, but surprised a little bit that in a recessionary environment, private label is not doing better. It also seems to me that the price gaps widened between store brands and manufacturer brands. What's the risk?
What are you hearing from your customers about them saying, "You know what, if consumers aren't going to buy private label in volume right now, maybe we should just take our prices up in an even better margin on private label", which wouldn't necessarily be great for you going forward. So I'm just trying to -- if I were a retailer, I would think, at least, think about that to try and get some extra margin out of my store brands. So just curious if you're hearing anything along those lines as those price gaps have widened and it hasn't necessarily driven tonnage up?
Ken, I think that the retailer is really well aware that those price gaps are, if you look at the data, that gives you the IRI data, depending on which slice of it or Nielsen data you look at, it's really lack of trade spend from the brands, right? And so that, that in fact, I think probably frustrates the retailer more than make some think that they should raise private label pricing. So we've been in a very stable price environment, right? Commodities have been very stable. So private label margins are good at the numbers that they're at now.
I think there's probably mixed thoughts on the branded trade spend. I mean places where they can't get product, they obviously don't want to promote. But I think the other places, they do. So I think they realized that those things will come back to normal whenever things -- whatever normal is going to look like. So I think they're looking much further out than that. I've not had one of the conversations I've had with the senior folks that retailers talk about raising prices. I hear a more talk about how do they improve their margins, right?
So -- and that's your volume of mix and those kinds of things, right? They haven't had a lot of time to do big resets. I think Rob asked that question. It's expensive, it's time-consuming, and it's a lot of labor in a store for the large national guys to move sets around. The smaller guys are doing it. The regional guys are doing it. But the big guys, it's a lot of expense and a lot of time and people and that's just not something they've wanted to do in the current environment. So I think that will happen afterwards after we start to see this and whenever that is.
Okay. And then for my follow-up, what can you tell us about the status of the cereal business? I imagine a lot of things are on hold right now, but any additional color there would be helpful.
Yes. We rekicked off that process. There's a tremendous amount of interest in that business. It has benefited from the current environment. So if anything, it's that -- it's as attractive or more attractive than it was when we started the first time. So we don't have anything to announce, but we would expect that process to run. We're starting to see those kinds of deals go through. We're starting to see people do plant tours, people do due diligence. You can -- people are much more comfortable with a Zoom management presentation than they might have been 6 months ago. So I think that process will run over the near term, and we'll have something to you as soon as we can.
Your next question comes from the line of Bill Chappell with Truist Securities.
Yes. Just want to double check on the kind of the outlook for remainder of the year, kind of 1% to 2% organic growth. I'm just -- maybe I missed it, but what are you kind of expecting for the category growth in terms of assumed still people are at home, schools are still going virtually. It would seem like the category will be pretty robust. So I'm just trying to pair that out with your kind of 1% to 2% outlook.
Sure. Well, hopefully, the deconstruction, maybe I'll give some of this to Bill here. But hopefully, what we want to build to deconstruct the business a little bit. Our grocery business is up nicely, right? And so the balance in our business in normal times will help us in this COVID time, there's a little bit of a headwind, not as much as folks with the larger food source business. But we expect our grocery business to be up similarly to what it's been up to date. You talk about? Yes. So Bill?
Yes. Sure, Bill. I think the -- just to clarify, a key point here. Our 1% to 2% is our long-term top line growth algorithm. For H2, our view in our script and in the deck, I think I said that the expected H2 organic growth will be 2% to 4%. So we think we'll be up in the second half. To Steve's point, we think the categories that will drive that growth.
Got it. I mean, I'm just trying to understand, do you expect the categories to be up 2% to 4%, you're in line with the categories? Or you -- can you -- can you catch up and grow faster?
Well, I think that's going to depend on awful lot on what happens with the consumer. And I think as we know everyday, there's debate on stimulus on will it be $600, will it be $400? What will it be? Will it be another $1200? So I think it's really hard for us to say. Should that stall and should the consumer start to feel more the pinch, I would assume we get a little more of that. If not, I think we'll get what we guided to.
Got it. And then last one for me. Just any updated thoughts on kind of the commodity outlook as everything is certainly moving around of these past few months and just kind of how that positions you for '21?
Yes. I think right now, the current environment is relatively balanced. We think we expect a bit of a low single digit pressure of inflation for the balance of the year. You see that in some of the key ingredients that we use, things like sugar, wheat, coffee, resins used in packaging. Obviously oil has been -- has seen downward pressure, and that's been helpful.
However, we're pretty well-hedged in that space. So again, we think it's not much to say on our commodities at this point, and we are looking, again, towards the 2021 planning time frame as well.
Your next question comes from the line of Carla Casella with JPMorgan.
My question relates to input costs as well, but more on the transportation and logistics side. If you just could give us a sense of whether you're seeing a tick up as seeing 3 open and there's more demand across the industries for your transportation logistics cost?
Carla, this is Bill. It's -- we've had a really good performance there in freight. If you go back to even this time last year, we put an RFP process, and we've done a really good job of managing that. And so it's a bit of a tough lap for us in terms of some incremental benefit we're lapping from a year ago. However, this incremental volume that we're seeing, it goes through our warehousing places as well. And so we absorbed that overhead pretty strongly. So in the quarter, we had a good performance in our pricing net of commodities, and a lot of that is driven by the work we've done on freight. And then obviously the volume pull-through in the warehouse and distribution network.
Your next question comes from the line of Jonathan Feeney with Consumer Edge.
Just one question for me. When I look at you apparently undershipping -- you've undershipping takeaway. You've talked about supply chain, how cautious you were, and that all makes a ton of sense. But I think for a long time, there's been an element here of trying to focus your business on the most profitable customers.
And I think partly, you're getting a -- all right, you already mentioned that some of these SKUs went away and won't come back. But is there any element of you trying to just focus your assets on the most profitable customers. And while demand is strongly be taking this opportunity to get pricing and margin across your supply base as opposed to you shipping all of the product that you possibly could. How much of this has been proactive? And will that continue?
I would say there's been a real effort to work with the customer on what's the most important SKUs for both of us, right? So I wouldn't say that we totally optimized the right margin mix by category customer. I would suggest, though, that all the work we've done, all the team of work we've done, all the money we've spent on our plants was really designed.
When we talk about -- we say we were built for this, well, there's organic growth in private label and we plan to get it through normal commercial being starting in the end of the second quarter into the third and the fourth quarter, right? So that was simply pull forward. So what you've seen is all of the effort that we've done and all the money we've spent and what organic volume does or what volume does to that business, right, if it makes it more profitable.
Now simplifying the SKU mix, doing that is sort of -- is the strategy of the Meal Prep side of our business, and their performance has really -- you've seen that performance pull forward because, quite frankly, the COVID thing helped to supply that strategy. So we are working in the side of the store, specifically in the Meal Prep division with the retailer on what SKU should come back and what SKU shouldn't, right?
And so we'll work very collaborative with the retailer, we'll find the right mix, what's the most effective mix for both of us. So I wouldn't say that we're managing it down on the customer. I think we're managing it with the customer. There isn't a customer out there that's not trying to get their mix appropriate, right?
It's not trying to optimize and take SKUs out that don't make sense. So it's not a -- it's not an us-versus-them thing. It's really a we-thing. We can work with them on that. On exactly what you're talking about, they have the same goals we did.
Your next question comes from the line of Jon Andersen with William Blair.
So my question is around the guidance on the second half. We came in this quarter, a little bit shy of the sales guidance range for the reasons that you cited but bumped the full year outlook on sales and which implies, as you played out a couple of times, organic growth of 2% to 4% in the second half.
That's a step-up from what you had previously forecast for the second half, which I think was a modest decline. Just wondering if you can highlight the one, two or three things that give you confidence or gave you the confidence to raise your second half expectations on the top line because what happened in the second quarter, whether it be underserving demand because of plants being down or the regular retailer order patterns wouldn't necessarily provide that confidence. So if you could talk a little bit more about that, that will be helpful.
Sure. We missed our -- we missed the midpoint of our guidance by like $30 million, the bottom of the range by $10 million. It doesn't take long. When you shut a plant down for 2 weeks, it doesn't take long to burn up $10 million in potential shipments, right? So -- and we weren't going to make the trade-off, right? We were not going to put people at risk for $10 million in top line, right?
So that was an easy decision. I think we feel better about the protocols in our plants. If you think about how much more mature, all of us, all the manufacturers in the food business are, 4 months into this thing, 5 months into this thing, when you think about it from when we started.
We feel like our plants will run through things that we would have shut them down for early in the second quarter, right, because we have the protocols in place. And we'll run through those and feel really good about that our people are safe, right? And our product is safe. So I just think we're in a much more mature position a few months in than we were then.
I think we also have visibility to -- that we'll have COVID demand in the back half. And I think when we first talked about this, if you think about 3 months back, we were all talking about opening our offices in September, right, or August.
Our offices won't open until next year, right? So if you think about the changes in what we all know, I'm assuming you all thought you'd be back at your office for this conference call, right? And now we won't. So I think we just have a better look and what the demand signal is going to be, and we have a better protocol on how to run to serve that demand signal than we did just a few months ago.
Okay. And then the second question is on the 80% of the SKUs that you paired back on -- that are now coming back, what's the time frame for those, that 80% to get back on shelf and I guess, then my question is, with the benefit of the return of those SKUs and then perhaps maybe the consumer feeling some of the impacts of this recession, which is very unusual, to your point, because of all of the stimulus.
Do you think we -- as you look out to the second half, maybe later second half of the year, that private label share gains will be restored, that we'll start to see private label share tick up as opposed to what we've seen in the past couple of months?
Jon, I would just say that there's no question that when you take away the niche items and brand comes back and they're the only offering in that niche category, they get 100% of the share. So now they are, by definition, niche items. So can that help us a little bit? I think it can. I think it's really going to determine the consumer behavior and when the recessionary pinch really hits the consumer is when we have that biggest opportunity, right?
So and I think it's just too hard to guide, right? So I feel good about what we guided. I feel that we can run the product that we need to make that all happen. That's obviously everybody's guidance is barring any kind of enormous impact of COVID. But we feel like what we put out -- put forward is the right number for what we know now so.
Our final question comes from the line of Bryan Spillane with Bank of America Merrill Lynch.
So just 2 quick ones for me. The first one is just simply -- just want to make sure I understood this. Had you had those plants that were shut down running through the quarter you would have sold more, right? I mean, just simplistically in terms of just contextualizing the revenue mix, it really came down to -- it wasn't that the demand wasn't there, you just couldn't produce enough because you had to close the plants down.
That is exactly the case. Yes. Our service levels were several points below where they should have been. They would have been down. Look, after that April and March, April pull, they would have been down a little bit anyways because right everybody's inventory got hit pretty hard. But we were 3 or 4 points.
And if you take that on $1 billion, 3, 4, 5 points probably of good health service lower than we should have been in that period. That's really the $30 million or more that we would have shipped had we had the product.
Okay. And then second one, just with the shift to -- with the bigger shift to online purchases, how does that affect the merchandising of private label? Because you're not -- the consumer is not standing in front of the shelf, being able to see a different price point offerings for pasta, right? So are you having to do anything different? Or would the retailers do something different to make sure that if they're looking at it, the private label option comes up and they can see that price comparison. I'm just trying to understand, I guess, what's underneath my question is, does the shift to e-commerce either help or hurt the private label proposition, especially at that point of sale?
Sure. I would tell you that we have to build new skills in the commercial organization in my comments, I said we gave, it's only a year old, right? We did it in July a year ago. And so one of the things we built there was an experienced e-com team. And we brought people in that understand how to help the retailer do that.
We manufacture our partners' brands, right? We're their partner in that. They're the marketers in 99% of the cases of those brands. And so we have to help them have the tools to market it. And then in e-com, maybe in some cases, we have to help them learn how to do that appropriately, how to help them do that. The big guys understand it really well, right? Obviously the pure-play folks understand it really well. We're trying to build an e-com team that can provide those resources. And typically, it's content, it's photography, it's that kind of stuff, right? To make it easy for them and so we're building a team of experienced folks to help them do that. I would say to date, private label is underrepresented in e-com, and that provides an opportunity going forward.
I would now like to turn the conference over to Steve Oakland for any additional or closing remarks.
Well, I would just like to thank you all today. I know it's a busy day. There's a number of calls today. So I'm sure we'll have a chance to speak to many of you personally, and I wish you a great day, and thanks again for being with us.
Thank you for participating in today's conference call. You may now disconnect your lines at this time.