Hostess Brands, Inc. - Quarter Report: 2018 June (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10‑Q
(Mark One) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the three months ended June 30, 2018 | |
OR | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to |
Commission file number 001‑37540
![hostesslogoa35.jpg](https://www.sec.gov/Archives/edgar/data/0001644406/000164440618000035/hostesslogoa35.jpg)
HOSTESS BRANDS, INC.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 47‑4168492 (I.R.S. Employer Identification No.) |
1 East Armour Boulevard Kansas City, MO (Address of principal executive offices) | 64111 (Zip Code) |
(816) 701‑4600
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.:
Large accelerated filer x | Accelerated filer o | Non‑accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o | Emerging growth company o |
☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Act). Yes o No x
Shares of Class A common stock outstanding - 99,919,503 shares at August 6, 2018
Shares of Class B common stock outstanding - 30,255,184 shares at August 6, 2018
HOSTESS BRANDS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2018
INDEX
Page | ||
Item 1. | ||
Consolidated Balance Sheets (Unaudited) | ||
Consolidated Statements of Operations (Unaudited) | ||
Consolidated Statements of Comprehensive Income (Unaudited) | ||
Consolidated Statements of Stockholders’ Equity (Unaudited) | ||
Consolidated Statements of Cash Flows (Unaudited) | ||
Notes to Consolidated Financial Statements (Unaudited) | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. |
Cautionary Note Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”) contains statements reflecting our views about our future performance that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. All statements contained in this Quarterly Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. Statements that constitute forward-looking statements are generally identified through the inclusion of words such as “believes,” “expects,” “intends,” “estimates,” “projects,” “anticipates,” “will,” “plan,” “may,” “should,” or similar language. Statements addressing our future operating performance and statements addressing events and developments that we expect or anticipate will occur are also considered as forward-looking statements. All forward‑looking statements included herein are made only as of the date hereof. It is routine for our internal projections and expectations to change throughout the year, and any forward-looking statements based upon these projections or expectations may change prior to the end of the next quarter or year. Readers of this Quarterly Report are cautioned not to place undue reliance on any such forward-looking statements. As a result of a number of known and unknown risks and uncertainties, our actual results or performance may be materially different from those expressed or implied by these forward-looking statements. Risks and uncertainties are identified under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, as updated by subsequent filings. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these risk factors. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise. The discussion and analysis of our financial condition and results of operations included in Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Consolidated Financial Statements and related notes included in Item 1 of this Quarterly Report on Form 10-Q.
4
HOSTESS BRANDS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited, amounts in thousands, except shares and per share data)
June 30, | December 31, | |||||||
ASSETS | 2018 | 2017 | ||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 115,272 | $ | 135,701 | ||||
Accounts receivable, net | 110,470 | 101,012 | ||||||
Inventories | 38,191 | 34,345 | ||||||
Prepaids and other current assets | 11,276 | 7,970 | ||||||
Total current assets | 275,209 | 279,028 | ||||||
Property and equipment, net | 199,839 | 174,121 | ||||||
Intangible assets, net | 1,911,099 | 1,923,088 | ||||||
Goodwill | 578,345 | 579,446 | ||||||
Other assets, net | 18,137 | 10,592 | ||||||
Total assets | $ | 2,982,629 | $ | 2,966,275 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Long-term debt and capital lease obligation payable within one year | $ | 11,268 | $ | 11,268 | ||||
Tax receivable agreement payments payable within one year | 700 | 14,200 | ||||||
Accounts payable | 70,858 | 49,992 | ||||||
Customer trade allowances | 42,012 | 40,511 | ||||||
Accrued expenses and other current liabilities | 10,810 | 11,880 | ||||||
Total current liabilities | 135,648 | 127,851 | ||||||
Long-term debt and capital lease obligation | 982,328 | 987,920 | ||||||
Tax receivable agreement | 68,584 | 110,160 | ||||||
Deferred tax liability | 272,966 | 267,771 | ||||||
Total liabilities | 1,459,526 | 1,493,702 | ||||||
Commitments and Contingencies (Note 12) | ||||||||
Class A common stock, $0.0001 par value, 200,000,000 shares authorized, 99,919,503 and 99,791,245 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively | 10 | 10 | ||||||
Class B common stock, $0.0001 par value, 50,000,000 shares authorized, 30,255,184 and 30,319,564 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively | 3 | 3 | ||||||
Additional paid in capital | 923,502 | 920,723 | ||||||
Accumulated other comprehensive income | 4,177 | 1,318 | ||||||
Retained earnings | 251,593 | 208,279 | ||||||
Stockholders’ equity | 1,179,285 | 1,130,333 | ||||||
Non-controlling interest | 343,818 | 342,240 | ||||||
Total liabilities and stockholders’ equity | $ | 2,982,629 | $ | 2,966,275 |
See accompanying notes to the unaudited consolidated financial statements.
5
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except shares and per share data)
Three Months Ended | Six Months Ended | ||||||||||||||||
June 30, 2018 | June 30, 2017 | June 30, 2018 | June 30, 2017 | ||||||||||||||
Net revenue | $ | 215,849 | $ | 203,178 | $ | 424,592 | $ | 387,716 | |||||||||
Cost of goods sold | 148,992 | 114,734 | 286,494 | 219,976 | |||||||||||||
Gross profit | 66,857 | 88,444 | 138,098 | 167,740 | |||||||||||||
Operating costs and expenses: | |||||||||||||||||
Advertising and marketing | 8,938 | 8,111 | 17,808 | 15,433 | |||||||||||||
Selling expense | 7,751 | 8,700 | 15,139 | 16,812 | |||||||||||||
General and administrative | 11,185 | 15,739 | 25,746 | 28,921 | |||||||||||||
Amortization of customer relationships | 5,994 | 5,994 | 11,989 | 11,867 | |||||||||||||
Tax receivable agreement liability remeasurement | (1,752 | ) | — | (1,752 | ) | — | |||||||||||
Business combination transaction costs | — | — | 47 | — | |||||||||||||
Impairment of property and equipment | — | — | 1,417 | — | |||||||||||||
Related party expenses | 92 | 108 | 184 | 192 | |||||||||||||
Total operating costs and expenses | 32,208 | 38,652 | 70,578 | 73,225 | |||||||||||||
Operating income | 34,649 | 49,792 | 67,520 | 94,515 | |||||||||||||
Other expense (income): | |||||||||||||||||
Interest expense, net | 9,749 | 10,035 | 19,089 | 19,865 | |||||||||||||
Gain on buyout of tax receivable agreement | — | — | (12,372 | ) | — | ||||||||||||
Other expense | 86 | 239 | 169 | 953 | |||||||||||||
Total other expense | 9,835 | 10,274 | 6,886 | 20,818 | |||||||||||||
Income before income taxes | 24,814 | 39,518 | 60,634 | 73,697 | |||||||||||||
Income tax expense | 194 | 11,311 | 6,712 | 21,291 | |||||||||||||
Net income | 24,620 | 28,207 | 53,922 | 52,406 | |||||||||||||
Less: Net income attributable to the non-controlling interest | 5,337 | 9,377 | 10,799 | 17,744 | |||||||||||||
Net income attributable to Class A stockholders | $ | 19,283 | $ | 18,830 | $ | 43,123 | $ | 34,662 | |||||||||
Earnings per Class A share: | |||||||||||||||||
Basic | $ | 0.19 | $ | 0.19 | $ | 0.43 | $ | 0.35 | |||||||||
Diluted | $ | 0.18 | $ | 0.18 | $ | 0.41 | $ | 0.33 | |||||||||
Weighted-average shares outstanding: | |||||||||||||||||
Basic | 99,939,642 | 98,943,690 | 99,916,161 | 98,600,075 | |||||||||||||
Diluted | 104,773,094 | 107,184,341 | 104,911,474 | 106,004,898 |
See accompanying notes to the unaudited consolidated financial statements.
6
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, amounts in thousands)
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2018 | June 30, 2017 | June 30, 2018 | June 30, 2017 | ||||||||||||
Net income | $ | 24,620 | $ | 28,207 | $ | 53,922 | $ | 52,406 | |||||||
Other comprehensive loss: | |||||||||||||||
Unrealized gain (loss) on interest rate swap contract designated as a cash flow hedge | 1,383 | (665 | ) | 5,121 | (665 | ) | |||||||||
Tax benefit (expense) | (292 | ) | 203 | (1,079 | ) | 203 | |||||||||
Comprehensive income | 25,711 | 27,745 | 57,964 | 51,944 | |||||||||||
Less: Comprehensive income attributed to non-controlling interest | 5,664 | 9,219 | 11,989 | 17,586 | |||||||||||
Comprehensive income attributed to Class A stockholders | $ | 20,047 | $ | 18,526 | $ | 45,975 | $ | 34,358 |
See accompanying notes to the unaudited consolidated financial statements.
7
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, amounts in thousands except share data)
Class A Voting Common Stock | Class B Voting Common Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income | Accumulated Losses / Retained Earnings | Total Stockholders’ Equity | Non-controlling Interest | |||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||
Balance–December 31, 2016 | 98,250,917 | $ | 10 | 31,704,988 | $ | 3 | $ | 912,824 | $ | — | $ | (15,618 | ) | $ | 897,219 | $ | 334,192 | ||||||||||||||||
Comprehensive income | — | — | — | — | — | (304 | ) | 34,662 | 34,358 | 17,586 | |||||||||||||||||||||||
Share-based compensation | 435,000 | — | — | — | 4,360 | — | — | 4,360 | — | ||||||||||||||||||||||||
Exchanges | 1,306,211 | — | (1,306,211 | ) | — | 12,609 | — | — | 12,609 | (12,609 | ) | ||||||||||||||||||||||
Distributions | — | — | — | — | — | — | — | — | (8,918 | ) | |||||||||||||||||||||||
Exercise of public warrants | 55 | — | — | — | 1 | — | — | 1 | — | ||||||||||||||||||||||||
Tax receivable agreement arising from exchanges, net of income taxes of $1,845 | — | — | — | — | (9,685 | ) | — | — | (9,685 | ) | — | ||||||||||||||||||||||
Balance–June 30, 2017 | 99,992,183 | $ | 10 | 30,398,777 | $ | 3 | $ | 920,109 | $ | (304 | ) | $ | 19,044 | $ | 938,862 | $ | 330,251 | ||||||||||||||||
Balance–December 31, 2017 | 99,791,245 | $ | 10 | 30,319,564 | $ | 3 | $ | 920,723 | $ | 1,318 | $ | 208,279 | $ | 1,130,333 | $ | 342,240 | |||||||||||||||||
Adoption of new accounting standards, net of income taxes of $83 | — | — | — | — | — | 7 | 191 | 198 | 85 | ||||||||||||||||||||||||
Comprehensive income | — | — | — | — | — | 2,852 | 43,123 | 45,975 | 11,989 | ||||||||||||||||||||||||
Share-based compensation, net of income taxes of $189 | 63,878 | — | — | — | 2,532 | — | — | 2,532 | — | ||||||||||||||||||||||||
Exchanges | 64,380 | — | (64,380 | ) | — | 1,033 | — | — | 1,033 | (1,033 | ) | ||||||||||||||||||||||
Distributions | — | — | — | — | — | — | — | — | (9,463 | ) | |||||||||||||||||||||||
Payment of taxes for employee stock awards | — | — | — | — | (436 | ) | — | — | (436 | ) | — | ||||||||||||||||||||||
Tax receivable agreement arising from exchanges, net of income taxes of $50 | — | — | — | — | (350 | ) | — | — | (350 | ) | — | ||||||||||||||||||||||
Balance–June 30, 2018 | 99,919,503 | $ | 10 | 30,255,184 | $ | 3 | $ | 923,502 | $ | 4,177 | $ | 251,593 | $ | 1,179,285 | $ | 343,818 |
See accompanying notes to the unaudited consolidated financial statements.
8
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
Six Months Ended | |||||||||
June 30, 2018 | June 30, 2017 | ||||||||
Operating activities | |||||||||
Net income | $ | 53,922 | $ | 52,406 | |||||
Depreciation and amortization | 20,648 | 18,854 | |||||||
Impairment of property and equipment | 1,417 | — | |||||||
Debt premium amortization | (541 | ) | (470 | ) | |||||
Tax receivable agreement remeasurement and gain on buyout | (14,124 | ) | — | ||||||
Stock-based compensation | 2,721 | 4,360 | |||||||
Non-cash gain on debt modification | — | (394 | ) | ||||||
Gain on sale/abandonment of property and equipment | — | (15 | ) | ||||||
Deferred taxes | 4,994 | 12,505 | |||||||
Change in operating assets and liabilities: | |||||||||
Accounts receivable | (8,458 | ) | (10,883 | ) | |||||
Inventories | 3,558 | (3,353 | ) | ||||||
Prepaids and other current assets | (1,643 | ) | (140 | ) | |||||
Accounts payable and accrued expenses | 17,187 | (6,418 | ) | ||||||
Customer trade allowances | 1,501 | 1,327 | |||||||
Net cash provided by operating activities | 81,182 | 67,779 | |||||||
Investing activities | |||||||||
Purchases of property and equipment | (19,836 | ) | (15,101 | ) | |||||
Acquisition of business | (23,910 | ) | — | ||||||
Proceeds from sale of assets | — | 54 | |||||||
Acquisition and development of software assets | (1,591 | ) | (859 | ) | |||||
Net cash used in investing activities | (45,337 | ) | (15,906 | ) | |||||
Financing activities | |||||||||
Repayments of long-term debt and capital lease obligation | (5,051 | ) | (2,570 | ) | |||||
Debt fees | — | (1,017 | ) | ||||||
Distributions to non-controlling interest | (9,463 | ) | (8,918 | ) | |||||
Tax payments related to issuance of shares to employees | (407 | ) | — | ||||||
Payments on tax receivable agreement | (41,353 | ) | — | ||||||
Proceeds from the exercise of warrants | — | 1 | |||||||
Net cash used in financing activities | (56,274 | ) | (12,504 | ) | |||||
Net increase (decrease) in cash and cash equivalents | (20,429 | ) | 39,369 | ||||||
Cash and cash equivalents at beginning of period | 135,701 | 26,855 | |||||||
Cash and cash equivalents at end of period | $ | 115,272 | $ | 66,224 |
Supplemental Disclosures of Cash Flow Information: | ||||||||||
Cash paid during the period for: | ||||||||||
Interest | $ | 20,358 | $ | 24,958 | ||||||
Taxes paid | $ | 3,959 | $ | 9,930 | ||||||
Supplemental disclosure of non-cash investing: | ||||||||||
Change in accrued capital expenditures | $ | 1,388 | $ | 123 |
See accompanying notes to the unaudited consolidated financial statements.
9
HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Hostess Brands, Inc. is a Delaware corporation headquartered in Kansas City, Missouri. The consolidated financial statements include the accounts of Hostess Brands, Inc. and its subsidiaries (collectively, the “Company”). The Company is a leading packaged food company focused on developing, manufacturing, marketing, selling and distributing fresh sweet baked goods in the United States.
The Company’s operations are conducted through indirect operating subsidiaries that are wholly-owned by Hostess Holdings, L.P. (“Hostess Holdings”), a direct subsidiary of Hostess Brands, Inc. The Company holds 100% of the general partnership interest in Hostess Holdings and a majority of the limited partnership interests therein and consolidates Hostess Holdings in the Company’s consolidated financial statements. The remaining limited partnership interests in Hostess Holdings are held by the holders of the outstanding shares of Class B common stock of Hostess Brands, Inc. These limited partnership interests in Hostess Holdings are reflected in our consolidated financial statements as a non-controlling interest.
On November 4, 2016 (the “Closing Date”), in a transaction referred to as the “Business Combination,” the Company, then known as Gores Holdings, Inc. (“Gores Holdings”), acquired a controlling interest in Hostess Holdings, an entity owned indirectly by C. Dean Metropoulos (the “Metropoulos Entities”) and certain equity funds managed by affiliates of Apollo Global Management, LLC (the “Apollo Funds”, and together with entities controlled by Mr. Metropoulos, the “Legacy Hostess Equityholders”).
Basis of Presentation
The consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited consolidated financial statements include all adjustments necessary for the fair presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented, all such adjustments were of a normal and recurring nature. The results of operations are not necessarily indicative of the results to be expected for the full fiscal year. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2017.
Mr. Metropoulos and the Metropoulos Entities hold their equity investment in the Company primarily through Class B limited partnership units in the Company’s subsidiary, Hostess Holdings (“Class B Units”) and an equal number of shares of the Company’s Class B common stock (“Class B Stock”). The Company’s Class B Stock has voting, but no economic rights, while Hostess Holdings’ Class B Units have economic, but no voting rights. Each Class B Unit, together with a share of Class B Stock held by the Metropoulos Entities, is exchangeable for a share of the Company’s Class A common stock (or at the option of the Company, the cash equivalent thereof). The interest of the Metropoulos Entities in Hostess Holdings’ Class B Units is reflected in the Company’s consolidated financial statements as a non-controlling interest.
The Company has two reportable segments: Sweet Baked Goods and In-Store Bakery. Previously, the Company’s reportable segments were Sweet Baked Goods and Other. A change in the Company’s internal reporting structure during the fourth quarter of 2017 caused the Company to reassess its reportable segments. Prior period segment disclosures have been reclassified to conform with the current period presentation.
10
Adoption of New Accounting Standards
On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), using the modified retrospective transition method. Under this method, results for reporting periods beginning January 1, 2018 are presented under Topic 606. Prior period amounts are not adjusted and continue to be reported in accordance with the historic accounting under Topic 605, with the cumulative effect of applying Topic 606 to prior period amounts recognized as an adjustment to opening retained earnings.The Company has elected to apply the new standard to contracts that are not complete as of January 1, 2018. Under this transition method, the Company deemed contracts to be not complete if, as of the date of transition, the Company had not fulfilled its performance obligations. The impact of the adoption of Topic 606 is further described in the Revenue Recognition section of this footnote.
On January 1, 2018, the Company adopted ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12). The adoption of this standard did not have a material impact on the consolidated financial statements.
In March 2018, the Company adopted ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, which updates the income tax accounting in U.S. GAAP to reflect the SEC’s interpretive guidance released on December 22, 2017, when the legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Reform”) was signed into law. Additional information regarding the adoption of this standard is contained in Note 10-Income Taxes.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its majority-owned or controlled subsidiaries (including those for which the Company is the primary beneficiary of a variable interest entity), collectively referred to as the Company. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and for the reported amounts of revenues and expenses during the reporting period. Management utilizes estimates, including, but not limited to, valuation and useful lives of tangible and intangible assets, reserves for trade and promotional allowances and valuation of expected future payments under the tax receivable agreement. Actual results could differ from these estimates.
Accounts Receivable
Accounts receivable represents amounts invoiced to customers for performance obligations which have been satisfied. As of June 30, 2018 and December 31, 2017, the Company’s accounts receivable were $110.5 million and $101.0 million, respectively, which have been reduced by an allowance for damages occurring during shipment, quality claims and doubtful accounts in the amount of $2.5 million and $2.1 million, respectively. In addition, there are customer trade allowances of $42.0 million and $40.5 million as of June 30, 2018 and December 31, 2017, respectively, in current liabilities in the consolidated balance sheets.
Inventories
Inventories are stated at the lower of cost or net-realizable value on a first-in first-out basis.
Abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) are expensed in the period they are incurred.
11
The components of inventories are as follows:
(In thousands) | June 30, 2018 | December 31, 2017 | |||||
Ingredients and packaging | $ | 16,892 | $ | 14,826 | |||
Finished goods | 19,823 | 15,471 | |||||
Inventory in transit to customers | 1,476 | 4,048 | |||||
$ | 38,191 | $ | 34,345 |
Impairment of Property and Equipment
For the six months ended June 30, 2018, the Company recorded an impairment loss of $1.4 million related to the planned disposition of certain production equipment before the end of its useful life. The measurement of this loss was based on Level 3 inputs within the fair value measurement hierarchy. The remaining net book value of the equipment is included in other assets, net on the consolidated balance sheet.
Software Costs
Included in the caption “other assets” in the consolidated balance sheets is capitalized software in the amount of $7.5 million and $7.3 million at June 30, 2018 and December 31, 2017, respectively. Capitalized software costs are amortized over their estimated useful life of five years commencing when such assets are ready for their intended use. Software amortization expense included in general and administrative was $0.8 million and $1.4 million for the three and six months ended June 30, 2018, respectively, compared to $0.6 million and $1.2 million for the three and six months ended June 30, 2017, respectively.
Revenue Recognition
Net revenue consists primarily of sales of packaged food products. The Company recognizes revenue when the obligations under the terms of its agreements with customers have been satisfied. The Company’s obligation is satisfied when control of the product is transferred to its customers along with the title, risk of loss and rewards of ownership. Depending on the arrangement with the customer, these criteria are met either at the time the product is shipped or when the product is received by such customer.
Customers are invoiced at the time of shipment or customer pickup based on credit terms established in accordance with industry practice. Invoices generally require payment within 30 days. Net revenue is recognized in an amount that reflects the consideration the Company expects to be entitled to in exchange for that product. Amounts billed to customers related to shipping and handling are classified as net revenue. A provision for payment discounts and other allowances is estimated based on the Company’s historical performance or specific terms with the customer. The Company generally does not accept product returns and provides these allowances for anticipated expired or damaged products.
Trade promotions, consisting primarily of customer pricing allowances, merchandising funds and consumer coupons, are offered through various programs to customers and consumers. A provision for estimated trade promotions is recorded as a reduction of revenue in the same period when the sale is recognized.
The Company also offers rebates based on purchase levels, product placement locations in retail stores and advertising placed by customers. The ultimate cost of these programs is dependent on certain factors such as actual purchase volumes or customer activities and is the subject of significant management estimates. The Company accounts for these programs as variable consideration and recognizes a reduction in revenue in the same period as the underlying program.
For product produced by third parties, management evaluates whether the Company is the principal (i.e., report revenue on a gross basis) or agent (i.e., report revenue on a net basis). Management has determined that it is the principal in all cases, since it establishes its own pricing for such product, generally assumes the credit risk for amounts billed to its customers, and often takes physical control of the product before it is shipped to customers.
The Company utilizes a practical expedient approach under Topic 606 and does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which the Company has the right to invoice for services performed.
12
See Note 4 - Segment Reporting to the Company’s consolidated financial statements for a disaggregation of net revenue.
The adoption of Topic 606 had no significant impact on the Company’s consolidated statement of operations for the three or six months ended June 30, 2018 or the consolidated balance sheet as of June 30, 2018.
The cumulative effect of the changes made to the Company’s consolidated January 1, 2018 balance sheet for the adoption of Topic 606 was as follows (in thousands):
Balance at December 31, 2017 | Adjustments Due to Topic 606 | Balance at January 1, 2018 | ||||||||||
Current assets: | ||||||||||||
Accounts receivable, net | $ | 101,012 | $ | 1,000 | $ | 102,012 | ||||||
Inventories | 34,345 | (531 | ) | 33,814 | ||||||||
Current liabilities: | ||||||||||||
Accounts payable | 49,992 | 103 | 50,095 | |||||||||
Long-term liabilities: | ||||||||||||
Deferred tax liability | 267,771 | 83 | 267,854 | |||||||||
Stockholders’ equity: | ||||||||||||
Retained earnings | 208,279 | 198 | 208,477 | |||||||||
Non-controlling interest | 342,240 | 85 | 342,325 |
The adjustments shown above are primarily attributed to a change in the criteria used to determine when the Company’s performance obligation is satisfied. Prior to the adoption of Topic 606, the Company’s performance obligation was satisfied when risk of loss related to the product transferred to the customer. After implementing Topic 606, the Company’s performance obligation is satisfied based on a set of criteria including the customer’s obligation to pay, physical possession, transfer of legal title, transfer of risk and rewards of ownership and the customer’s acceptance of the product. Depending on the arrangement with the customer, the application of this new criteria changed the timing of revenue recognition for certain contracts.
Concentrations
The Company has one customer that accounted for 10% or more of the Company’s total net revenue. The percentage of total net revenues for this customer is presented below by segment:
Three Months Ended | Six Months Ended | ||||||||||
(% of Consolidated Net Revenues) | June 30, 2018 | June 30, 2017 | June 30, 2018 | June 30, 2017 | |||||||
Sweet Baked Goods | 18.4 | % | 19.9 | % | 18.1 | % | 19.1 | % | |||
In-Store Bakery | 0.6 | 0.7 | 0.6 | 0.7 | |||||||
Total | 19.0 | % | 20.6 | % | 18.7 | % | 19.8 | % |
Collective Bargaining Agreements
As of June 30, 2018, approximately 46.3%, of the Company’s employees are covered by collective bargaining agreements, including 14.4% subject to collective bargaining agreements which will expire before December 31, 2018.
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Accounting Standards Issued but Not yet Adopted
In February 2016, ASU No. 2016-02, Leases (“ASU 2016-02”) was issued to improve financial reporting about leasing transactions. This standard requires a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by lease terms of more than 12 months. This standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on its consolidated financial position, results of operations and cash flows.
2. Aryzta Transaction
On February 1, 2018 (the “Purchase Date”), the Company acquired certain U.S. breakfast assets of Aryzta, LLC, including a bakery facility and certain brand names. The Company acquired the assets to expand its product portfolio and to gain previously outsourced manufacturing capabilities for its existing product portfolio. The assets acquired and liabilities assumed have preliminarily been determined to constitute a business and will be recorded at their estimated fair values as of the Purchase Date under the acquisition method of accounting.
Consideration for this acquisition included a $23.9 million cash payment. The Company is still finalizing the purchase price and the allocation of the purchase price to the individual assets acquired and liabilities assumed. The purchase price and allocation included in the June 30, 2018 consolidated balance sheet are based on management’s best estimate and are preliminary and subject to change. To assist management in the allocation, the Company has engaged a valuation specialist to prepare an appraisal. The Company will finalize the amounts recognized as the information necessary to complete the analysis is obtained.
The provisional amounts for the assets acquired and liabilities assumed as of the Purchase Date are as follows (in thousands):
Inventory | $ | 8,162 | |
Property and equipment | 16,838 | ||
Other liabilities | (1,090 | ) | |
Net assets acquired | $ | 23,910 |
Based on the preliminary assessment of the purchase allocation, no goodwill or other intangible assets have been recorded as a result of this transaction.
For the three and six months ended June 30, 2018, the Company incurred less than $0.1 million of expenses related to the acquisition. These expenses are classified as business combination transaction costs on the consolidated statement of operations.
For the three and six months ended June 30, 2018, the operations of the acquired assets provided net revenue of $20.8 million and $35.4 million, respectively, and negative gross profit of $6.3 million and $10.7 million, respectively. The negative gross profit does not reflect the allocation of shared costs incurred by the Company. Due to the nature of these costs, the Company determined it was impracticable to allocate to individual bakeries.
3. Property and Equipment
Property and equipment consists of the following:
(In thousands) | June 30, 2018 | December 31, 2017 | ||||||
Land and buildings | $ | 37,415 | $ | 32,088 | ||||
Machinery and equipment | 169,633 | 141,995 | ||||||
Construction in progress | 13,330 | 13,489 | ||||||
220,378 | 187,572 | |||||||
Less accumulated depreciation | (20,539 | ) | (13,451 | ) | ||||
$ | 199,839 | $ | 174,121 |
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Depreciation expense was $3.8 million and $7.2 million for the three and six months ended June 30, 2018, respectively, compared to $3.0 million and $5.8 million for the three and six months ended June 30, 2017, respectively.
4. Segment Reporting
The Company has two reportable segments: Sweet Baked Goods and In-Store Bakery. The Company’s Sweet Baked Goods segment consists of sweet baked goods that are sold under the Hostess® and Dolly Madison® brands, Hostess® branded bread and buns and frozen retail products. The operations attributed to assets acquired from Aryzta are included in the Sweet Baked Goods segment. The In-Store Bakery segment consists of Superior® and Hostess® branded products sold through the in-store bakery section of grocery and club stores.
We evaluate performance and allocate resources based on net revenue and gross profit. Information regarding the operations of these reportable segments is as follows:
(In thousands) | Three Months Ended June 30, 2018 | Three Months Ended June 30, 2017 | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 | |||||||||||
Net revenue: | |||||||||||||||
Sweet Baked Goods | $ | 204,237 | $ | 191,695 | $ | 403,529 | $ | 366,488 | |||||||
In-Store Bakery | 11,612 | 11,483 | 21,063 | 21,228 | |||||||||||
Net revenue | $ | 215,849 | $ | 203,178 | $ | 424,592 | $ | 387,716 | |||||||
Depreciation and amortization: | |||||||||||||||
Sweet Baked Goods | $ | 9,857 | $ | 8,899 | $ | 19,251 | $ | 17,522 | |||||||
In-Store Bakery | 700 | 689 | 1,397 | 1,332 | |||||||||||
Depreciation and amortization | $ | 10,557 | $ | 9,588 | $ | 20,648 | $ | 18,854 | |||||||
Gross profit: | |||||||||||||||
Sweet Baked Goods | $ | 64,359 | $ | 85,486 | $ | 133,797 | $ | 162,268 | |||||||
In-Store Bakery | 2,498 | 2,958 | 4,301 | 5,472 | |||||||||||
Gross profit | $ | 66,857 | $ | 88,444 | $ | 138,098 | $ | 167,740 | |||||||
Capital expenditures (1): | |||||||||||||||
Sweet Baked Goods | $ | 13,432 | $ | 7,662 | $ | 22,598 | $ | 15,645 | |||||||
In-Store Bakery | 164 | 167 | 217 | 438 | |||||||||||
Capital expenditures | $ | 13,596 | $ | 7,829 | $ | 22,815 | $ | 16,083 |
(1) | Capital expenditures consists of purchases of property and equipment and acquisition and development of software assets paid in cash or acquired through accounts payable during the three and six months ended June 30, 2018 and 2017. |
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Total assets by reportable segment are as follows:
(In thousands) | June 30, 2018 | December 31, 2017 | ||||||
Total segment assets: | ||||||||
Sweet Baked Goods | $ | 2,893,075 | $ | 2,884,642 | ||||
In-Store Bakery | 89,554 | 81,633 | ||||||
Total segment assets | $ | 2,982,629 | $ | 2,966,275 |
5. Intangible Assets
Intangible assets consist of the following:
(In thousands) | June 30, 2018 | December 31, 2017 | |||||
Intangible assets with indefinite lives (Trademarks and Trade Names) | $ | 1,408,848 | $ | 1,408,848 | |||
Intangible assets with definite lives (Customer Relationships) | 542,011 | 542,011 | |||||
Less accumulated amortization (Customer Relationships) | (39,760 | ) | (27,771 | ) | |||
Intangible assets, net | $ | 1,911,099 | $ | 1,923,088 |
Amortization expense was $6.0 million and $12.0 million for the three and six months ended June 30, 2018 and $6.0 million and $11.9 million for the three and six months ended June 30, 2017, respectively. The unamortized portion of customer relationships will be expensed over their remaining useful life, from 18 to 23 years. The weighted-average amortization period as of June 30, 2018 for customer relationships was 21.0 years.
6. Accrued Expenses
Included in accrued expenses are the following:
(In thousands) | June 30, 2018 | December 31, 2017 | ||||||
Payroll, vacation and other compensation | $ | 6,330 | $ | 4,342 | ||||
Annual incentive bonuses | 1,136 | 4,259 | ||||||
Workers compensation reserve | 1,666 | 1,650 | ||||||
Self-insurance reserves | 1,338 | 1,192 | ||||||
Taxes | 99 | 99 | ||||||
Accrued interest | 241 | 338 | ||||||
$ | 10,810 | $ | 11,880 |
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7. Debt
A summary of the carrying value of the debt and the capital lease obligation is as follows:
(In thousands) | June 30, 2018 | December 31, 2017 | ||||||
Third First Lien Term Loan (4.2% as of June 30, 2018) | ||||||||
Principal | $ | 988,794 | $ | 993,762 | ||||
Unamortized debt premium and issuance costs | 4,315 | 4,857 | ||||||
993,109 | 998,619 | |||||||
Capital lease obligation (6.8%) | 487 | 569 | ||||||
Total debt and capital lease obligation | 993,596 | 999,188 | ||||||
Less: Amounts due within one year | (11,268 | ) | (11,268 | ) | ||||
Long-term portion | $ | 982,328 | $ | 987,920 |
At June 30, 2018, minimum debt repayments under the Third First Lien Term Loan are due as follows:
(In thousands) | |||
Remainder of 2018 | $ | 4,969 | |
2019 | 9,938 | ||
2020 | 9,938 | ||
2021 | 9,938 | ||
2022 | 954,011 |
8. Interest Rate Swap
To reduce the effect of interest rate fluctuations, the Company entered into an interest rate swap contract with a counter party to make a series of payments based on a fixed interest rate of 1.78% and receive a series of payments based on the greater of LIBOR or 0.75%. Both the fixed and floating payment streams are based on a notional amount of $500 million at the inception of the contract and will be reduced by $100 million each year of the five-year contract. As of June 30, 2018, the notional amount is $400 million. The Company entered into this transaction to reduce its exposure to changes in cash flows associated with its variable rate debt and has designated this derivative as a cash flow hedge. At June 30, 2018, the effective interest rate on the long-term debt hedged by this contract was 4.03%.
As of June 30, 2018 and December 31, 2017, the fair value of the interest rate swap contract of $8.0 million and $2.9 million was reported within other assets, net on the consolidated balance sheet. The fair value of the interest rate swap contract is measured on a recurring basis by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves (Level 2).
9. Earnings per Share
Basic earnings per share is calculated by dividing net income attributable to the Company’s Class A stockholders for the period by the weighted average number of Class A common shares outstanding for the period excluding non-vested restricted stock awards. In computing diluted earnings per share, basic earnings per share is adjusted for the assumed issuance of all applicable potentially dilutive share-based awards, including: public and private placement warrants, restricted stock awards, restricted stock units, and stock options.
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Below are basic and diluted net income per share:
Three Months Ended June 30, 2018 | Three Months Ended June 30, 2017 | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 | |||||||||||||
Numerator: | ||||||||||||||||
Net income attributable to Class A stockholders (in thousands) | $ | 19,283 | $ | 18,830 | $ | 43,123 | $ | 34,662 | ||||||||
Denominator: | ||||||||||||||||
Weighted-average Class A shares outstanding - basic | 99,939,642 | 98,943,690 | 99,916,161 | 98,600,075 | ||||||||||||
Dilutive effect of warrants | 4,668,452 | 8,144,735 | 4,856,923 | 7,371,050 | ||||||||||||
Dilutive effect of restricted stock and restricted stock units | 165,000 | 95,916 | 138,390 | 33,773 | ||||||||||||
Weighted-average shares outstanding - diluted | 104,773,094 | 107,184,341 | 104,911,474 | 106,004,898 | ||||||||||||
Net income per Class A share - basic | $ | 0.19 | $ | 0.19 | $ | 0.43 | $ | 0.35 | ||||||||
Net income per Class A share - diluted | $ | 0.18 | $ | 0.18 | $ | 0.41 | $ | 0.33 |
For the three and six months ended June 30, 2018 and 2017, stock options were excluded from the computation of diluted net income per share because the assumed proceeds from the awards’ exercise was greater than the average market price of the common shares.
10. Income Taxes
The Company is subject to U.S. federal, state and local taxes on its allocable portion of the income of Hostess Holdings, a partnership for U.S. federal and most applicable state and local taxes. As a partnership, Hostess Holdings is itself not subject to U.S. federal and certain state and local income taxes. The operations of Hostess Holdings include those of its C Corporation subsidiaries.
The income tax expense in the accompanying consolidated statement of operations is based on an estimate of the Company’s annual effective income tax rate and adjusted for discrete items, if any. The Company’s estimated annual effective tax rate based on annual projected earnings for the year ending December 31, 2018 is 20.4% prior to taking into account any discrete items. During the three and six months ended June 30, 2018, the Company recorded a discrete income tax benefit of $5.0 million related to a change in the Company’s estimated state tax rate. During the six months ended June 30, 2018, the Company also recorded a discrete income tax expense of $1.6 million related to the buyout of the tax receivable agreement entered into in connection with the Business Combination (the “Tax Receivable Agreement”).
At December 31, 2017, the Company recorded provisional amounts for the impact of re-measurement on its deferred taxes related to Tax Reform as set forth under SAB No. 118 guidance. Through June 30, 2018, no adjustments were made to the provisional amounts. These provisional amounts are subject to refinement during the measurement period under SAB 118.
11. Tax Receivable Agreement
On January 26, 2018, the Company entered into an agreement to terminate all future payments payable under the Tax Receivable Agreement to the Apollo Funds in exchange for a payment of $34.0 million (the “Buyout”). Subsequent to the Buyout, the Company will retain a greater portion of the future cash tax savings subject to the Tax Receivable
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Agreement. The Buyout did not affect the portion of the rights under the Tax Receivable Agreement payable to Metropoulos Entities, including those previously assigned by the Apollo Funds. If the Company enters into a definitive agreement on or before January 26, 2019 and that agreement results in a change in control (as defined in the Tax Receivable Agreement), the Company will be required to make an additional payment of $10.0 million to the Apollo Funds. As of June 30, 2018, no amounts have been paid and there are no amounts reflected in the consolidated financial statements related to the change in control provision, based on management’s estimate of the fair value of the potential obligation.
During the three and six months ended June 30, 2018, the Company recognized a gain on the remeasurement of the future expected payments under the Tax Receivable Agreement due to a change in the Company’s estimated state tax rate. As of June 30, 2018, the expected cash tax savings rate was 26.9%.
The following table summarizes activity related to the Tax Receivable Agreement for the six months ended June 30, 2018:
(In thousands) | ||||
Balance December 31, 2017 | $ | 124,360 | ||
Exchange of Class B units for Class A shares | 400 | |||
Reduction of future payments due to the Buyout | (46,371 | ) | ||
Remeasurement due to change in estimated state tax rate | (1,752 | ) | ||
Payments | (7,353 | ) | ||
Balance June 30, 2018 | $ | 69,284 |
As of June 30, 2018 the future expected payments under the Tax Receivable Agreement are as follows:
(In thousands) | |||
Remainder of 2018 | $ | 700 | |
2019 | 4,300 | ||
2020 | 4,300 | ||
2021 | 4,200 | ||
2022 | 4,200 | ||
Thereafter | 51,584 |
12. Commitments and Contingencies
Liabilities related to legal proceedings are recorded when it is probable that a liability has been incurred and the associated amount can be reasonably estimated. Where the estimated amount of loss is within a range of amounts and no amount within the range is a better estimate than any other amount, the minimum amount is accrued.
As additional information becomes available, the potential liabilities related to these matters are reassessed and the estimates revised, if necessary. These accrued liabilities are subject to change in the future based on new developments in each matter, or changes in circumstances, which could have a material effect on the Company’s financial condition and results of operations.
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13. Related Party Transactions
Under the terms of an employment agreement with the Company’s Executive Chairman, C. Dean Metropoulos, the Company is obligated to issue additional equity (in the form of either shares of Class A common stock of the Company, or Class B units of Hostess Holdings and equivalent shares of Class B common stock of the Company) to Mr. Metropoulos if certain EBITDA thresholds (as adjusted to reflect acquisitions) are met for the year ended December 31, 2018. Under this agreement, up to 2.75 million shares could be issued. As of June 30, 2018, the Company determined it was not probable that the EBITDA thresholds would be met.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity and capital resources of Hostess Brands, Inc. This discussion should be read in conjunction with our unaudited consolidated financial statements and notes thereto included herein, and our audited Annual Report on Form 10-K for the year ended December 31, 2017. The terms “our”, “we,” “us,” and “Company” as used herein refer to Hostess Brands, Inc. and its consolidated subsidiaries.
Overview
We are a leading United States packaged food company operating in two reportable segments: Sweet Baked Goods (“SBG”) and In-Store Bakery. We operate six bakeries and five distribution centers. Our direct-to-warehouse (“DTW”) product distribution system allows us to deliver to our customers’ warehouses. Our customers in turn distribute to the retail stores.
Hostess® is the second leading brand by market share within the SBG category, according to Nielsen U.S. total universe. For the 13-week period ended June 30, 2018, Hostess® brand market share was 17.5% per Nielsen’s U.S. SBG category data. We have a #1 leading market position within the two largest SBG Segments: Donut and Snack Cake. The Donut and Snack Cake Segments together account for 47.1% of the SBG category’s total dollar sales.
Factors Impacting Recent Results
Acquisition
On February 1, 2018, we acquired certain U.S. breakfast assets of Aryzta, LLC (Aryzta), primarily including a bakery facility, inventory, and the Big Texas and Cloverhill brand names (collectively referred to as the “Chicago Bakery”.) We acquired these assets to expand our product portfolio and to gain previously outsourced manufacturing capabilities for our existing product portfolio. Our consolidated statement of operations includes the operation of these assets from February 1, 2018 through June 30, 2018. We evaluated the impact of the Aryzta acquisition on our financial statements and concluded that the impact was not significant and did not require the inclusion of pro forma financial results assuming the acquisition had occurred on January 1, 2017.
Tax Receivable Agreement Buyout
On January 26, 2018, we entered into a transaction to terminate all future payments payable under the Tax Receivable Agreement to the Apollo Funds in exchange for a cash payment of $34.0 million, which was recognized as a financing outflow on the consolidated statement of cash flow. This transaction did not affect the portion of the rights under the Tax Receivable Agreement payable to Metropoulos Entities. We recognized a $12.4 million gain in the non-operating section of our consolidated statement of operations, which represented the difference between the $46.4 million carrying value of the portion of the Tax Receivable Agreement liability which was terminated and the $34.0 cash payment.
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Operating Results
Three Months Ended | Six Months Ended | |||||||||||||||
(In thousands, except shares and per share data) | June 30, 2018 | June 30, 2017 | June 30, 2018 | June 30, 2017 | ||||||||||||
Net revenue | $ | 215,849 | $ | 203,178 | $ | 424,592 | $ | 387,716 | ||||||||
Gross profit | 66,857 | 88,444 | 138,098 | 167,740 | ||||||||||||
As a % of net revenue | 31.0 | % | 43.5 | % | 32.5 | % | 43.3 | % | ||||||||
Operating costs and expenses | 32,208 | 38,652 | 70,578 | 73,225 | ||||||||||||
Operating income | 34,649 | 49,792 | 67,520 | 94,515 | ||||||||||||
As a % of net revenue | 16.1 | % | 24.5 | % | 15.9 | % | 24.4 | % | ||||||||
Other expense (income) | 9,835 | 10,274 | 6,886 | 20,818 | ||||||||||||
Income tax expense | 194 | 11,311 | 6,712 | 21,291 | ||||||||||||
Net income | 24,620 | 28,207 | 53,922 | 52,406 | ||||||||||||
Net income attributable to Class A shareholders | $ | 19,283 | $ | 18,830 | $ | 43,123 | $ | 34,662 | ||||||||
Earnings per Class A share: | ||||||||||||||||
Basic | $ | 0.19 | $ | 0.19 | $ | 0.43 | $ | 0.35 | ||||||||
Diluted | $ | 0.18 | $ | 0.18 | $ | 0.41 | $ | 0.33 | ||||||||
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Reconciliation of Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure commonly used in our industry and should not be construed as an alternative to net income as an indicator of operating performance or as an alternative to cash flow provided by operating activities as a measure of liquidity (each as determined in accordance with GAAP). This measure may not be comparable to similarly titled measures reported by other companies. We have included this measure because we believe it provides management and investors with additional information to measure our performance and liquidity, estimate our value and evaluate our ability to service debt.
We define adjusted EBITDA as net income adjusted to exclude (i) interest expense, net, (ii) depreciation and amortization, (iii) income taxes and (iv) as further adjusted to eliminate the impact of certain items that we do not consider indicative of our ongoing operating performance. These further adjustments are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments set forth below. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP. For example, adjusted EBITDA:
• | does not reflect our capital expenditures, future requirements for capital expenditures or contractual commitments; |
• | does not reflect changes in, or cash requirements for, our working capital needs; |
• | does not reflect the significant interest expenses, or the cash requirements necessary to service interest or principal payments, on our debt; and |
• | does not reflect payments related to income taxes, the Tax Receivable Agreement or distributions to the non-controlling interest to reimburse its tax liability. |
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Reconciliation of Adjusted EBITDA (Unaudited) | ||||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||||
(In thousands) | June 30, 2018 | June 30, 2017 | June 30, 2018 | June 30, 2017 | ||||||||||||||
Net income | $ | 24,620 | $ | 28,207 | $ | 53,922 | $ | 52,406 | ||||||||||
Non-GAAP adjustments: | ||||||||||||||||||
Income tax provision | 194 | 11,311 | 6,712 | 21,291 | ||||||||||||||
Interest expense, net | 9,749 | 10,035 | 19,089 | 19,865 | ||||||||||||||
Depreciation and amortization | 10,557 | 9,588 | 20,648 | 18,854 | ||||||||||||||
Share-based compensation | 1,098 | 3,839 | 2,721 | 4,360 | ||||||||||||||
Tax Receivable Agreement remeasurement and gain on buyout | (1,752 | ) | — | (14,124 | ) | — | ||||||||||||
Impairment of property and equipment | — | — | 1,417 | — | ||||||||||||||
Tax Reform bonuses | 602 | — | 1,585 | — | ||||||||||||||
Chicago bakery acquisition and integration costs | 1,817 | — | 1,864 | — | ||||||||||||||
Other | i. | 712 | 239 | 796 | 953 | |||||||||||||
Adjusted EBITDA | $ | 47,597 | $ | 63,219 | $ | 94,630 | $ | 117,729 |
i. | For the three and six months ended June 30, 2018, other expenses included transaction and other non-operating professional fees. For the three and six months ended June 30, 2017, other expense primarily included professional fees incurred related to the secondary public offering of common stock and the registration of certain privately held warrants offset by a gain recognized related to the modification of our long-term debt. |
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Results of Operations
Net Revenue
Net revenue for the three months ended June 30, 2018, increased 6.2%, or $12.7 million, compared to the three months ended June 30, 2017. The Chicago Bakery, which we acquired in the first quarter of 2018 to expand our breakfast product portfolio and manufacturing capabilities, contributed $20.8 million of net revenue which was partially offset by reduced Hostess® branded display volume and corresponding retail inventory reduction at one of our largest retail partners. We continued to gain market share in the Sweet Baked Goods (“SBG”) category with strong growth in sub-brands including Donettes® and Hostess Bakery Petites®. We gained 42 basis points of market share during the 13 weeks ended June 30, 2018 through strong performance in the convenience, food and club channels which contributed to our overall point of sale growth of 2.4% for the Hostess brand ahead of the total SBG category.
Net revenue for the six months ended June 30, 2018, increased 9.5% or $36.9 million, compared to the six months ended June 30, 2017. The Chicago Bakery contributed $35.4 million of net revenue. The remaining increase was due to growth from current and prior year product innovations partially offset by reduced Hostess® branded display volume and corresponding retail inventory reduction at one of our largest retail partners. For the 26 weeks ended June 30, 2018, we gained 77 basis points of market share and 4.3% of point of sale growth.
Gross Profit
Gross profit was 31.0% of net revenue for the three months ended June 30, 2018, compared to 43.5% for the three months ended June 30, 2017. The decline was primarily attributed to a combination of the shift in mix of revenue to include Chicago non-Hostess® branded products, which are currently unprofitable, and the continued efforts to transform the recently acquired Chicago Bakery which collectively resulted in 709 basis points lower margin. Over the short term, we continue to invest in converting the operations and processes to be more streamlined and efficient. We believe these investments will provide the solid infrastructure necessary to deliver profitable future growth in the breakfast subcategory. Also contributing to the lower gross profit were higher transportation costs and other inflationary pressures, which resulted in a 447 basis point decrease in gross margin and lower overhead absorption due to decreased production volume.
Gross profit was 32.5% of net revenue for the six months ended June 30, 2018, compared to 43.3% for the six months ended June 30, 2017. The decline was primarily attributed to a combination of the shift in mix of revenue to include Chicago non-Hostess® branded products, which are currently unprofitable, and the continued efforts to transform the recently acquired Chicago Bakery which collectively resulted in 630 basis points lower margin. Also contributing to lower gross profit were higher transportation costs and other inflationary pressures, which resulted in a 353 basis point decrease in gross margin as well as bonuses paid to hourly employees as a result of the projected benefits of Tax Reform and lower overhead absorption due to decreased production volume.
Operating Expenses
Operating costs for the three months ended June 30, 2018 decreased 16.6% from the three months ended June 30, 2017. The decrease was attributed to lower corporate incentive arrangements as well as a $1.8 million gain on the remeasurement of the Tax Receivable Agreement resulting from a change in our estimated state tax rate based upon adjustments to our state apportionment factors.
Operating costs for the six months ended June 30, 2018 decreased 3.6% from the six months ended June 30, 2017. The decrease was attributed to lower corporate incentive arrangements and professional fees along with the $1.8 million gain on the remeasurement of the Tax Receivable Agreement partially offset by an impairment loss of $1.4 million related to the planned disposition of certain production equipment before the end of its useful life and increased display rack deployment in support of revenue growth.
Other Expense
For the three months ended June 30, 2018 and June 30, 2017, other expense primarily consisted of $10.1 million and $10.0 million, respectively, of interest expense related to our Third First Lien Term Loan.
For the six months ended June 30, 2018 and June 30, 2017, interest expense related to our Third First Lien Term Loan was $19.6 million and $19.8 million, respectively. Also, during the six months ended June 30, 2018, we recognized a $12.4 million gain related to the buy-out of the tax receivable agreement.
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Income Taxes
Our effective tax rate was 0.8% for the three months ended June 30, 2018 compared to 28.6% for the three months ended June 30, 2017. The decrease in our effective tax rate was primarily attributed to a discrete tax benefit of $5.0 million resulting from a change in our estimated state tax rate based upon adjustments to our state apportionment factors. The lower federal statutory rate enacted by Tax Reform also decreased our effective tax rate.
Our effective tax rate was 11.1% for the six months ended June 30, 2018 compared to 28.9% for the six months ended June 30, 2017. The decrease in our effective tax rate was primarily attributed to the lower federal statutory rate enacted by Tax Reform, the tax impact of the gain on the buyout of the Tax Receivable Agreement, as well as the change in our estimated state apportionment.
Adjusted EBITDA
Adjusted EBITDA for the three months ended June 30, 2018 was $47.6 million, or 22.1% of net revenue compared to $63.2 million, or 31.1% of net revenue for the three months ended June 30, 2017. The decrease in adjusted EBITDA was primarily attributed to losses generated by the Chicago Bakery as well as higher transportation costs and other inflationary pressures. The decrease in adjusted EBITDA was also impacted by reduced Hostess® branded display and inventory volume at one of our largest retail partners.
Adjusted EBITDA for the six months ended June 30, 2018 was $94.6 million, or 22.3% of net revenues compared to $117.7 million, or 30.4% of net revenue for the six months ended June 30, 2017. The decrease in adjusted EBITDA was primarily attributed to the losses generated by the Chicago Bakery and higher transportation costs and other inflationary pressures The decrease in adjusted EBITDA was also impacted by reduced Hostess® branded display and inventory volume at one of our largest retail partners as well as bonuses paid to hourly employees as a result of the projected benefits of Tax Reform.
Segments
We have two reportable segments: Sweet Baked Goods and In-Store Bakery. Sweet Baked Goods consists of sweet baked goods that are sold under the Hostess® and Dolly Madison® brands, Hostess® branded bread and buns, and frozen retail. The In-Store Bakery segment consists of products, including Superior on Main® and Hostess® branded products sold through the in-store bakery section of grocery and club stores.
We evaluate performance and allocate resources based on net revenue and gross profit. Information regarding the operations of these reportable segments is as follows:
Unaudited Segment Financial Data | ||||||||||||||||
(In thousands) | Three Months Ended June 30, 2018 | Three Months Ended June 30, 2017 | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 | ||||||||||||
Net revenue: | ||||||||||||||||
Sweet Baked Goods | $ | 204,237 | $ | 191,695 | $ | 403,529 | $ | 366,488 | ||||||||
In-Store Bakery | 11,612 | 11,483 | 21,063 | 21,228 | ||||||||||||
Net revenue | $ | 215,849 | $ | 203,178 | $ | 424,592 | $ | 387,716 | ||||||||
Gross profit: | ||||||||||||||||
Sweet Baked Goods | $ | 64,359 | $ | 85,486 | $ | 133,797 | $ | 162,268 | ||||||||
In-Store Bakery | 2,498 | 2,958 | 4,301 | 5,472 | ||||||||||||
Gross profit | $ | 66,857 | $ | 88,444 | $ | 138,098 | $ | 167,740 | ||||||||
Sweet Baked Goods net revenue for the three months ended June 30, 2018 increased $12.5 million, or 6.5% from the three months ended June 30, 2017. The operations of the Chicago Bakery contributed $20.8 million of net revenue. The revenue increase was partially offset by reduced Hostess® branded display volume and corresponding retail inventory reduction at one of our largest retail partners.
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Sweet Baked Goods net revenue for the six months ended June 30, 2018 increased $37.0 million, or 10.1% from the six months ended June 30, 2017. The Chicago Bakery contributed $35.4 million of the increase in net revenue. The remaining increase was driven primarily by continued growth from current and prior year product innovations partially offset by reduced Hostess® branded display volume and corresponding retail inventory reduction at one of our largest retail partners.
Sweet Baked Goods gross profit for the three months ended June 30, 2018 was 31.5% of net revenue, compared to 44.6% of net revenue for the three months ended June 30, 2017. The decline was primarily attributed to the currently unprofitable products and higher costs resulting from the integration of the Chicago Bakery and higher transportation costs and other inflationary pressures.
Sweet Baked Goods gross profit for the six months ended June 30, 2018 was 33.2% of net revenue for the six months ended June 30, 2018, compared to 44.3% of net revenue for the six months ended June 30, 2017. The decrease in gross margin was primarily attributed to the currently unprofitable products and higher costs resulting from the integration of the Chicago Bakery, higher transportation costs and other inflationary pressures and bonuses paid to hourly employees as a result of the projected benefits of newly enacted tax legislation.
In-Store Bakery net revenue for the three months ended June 30, 2018 increased 1.1% from the three months ended June 30, 2017. In-Store Bakery gross profit for the three months ended June 30, 2018 was 21.5% of net revenue compared to 25.8% for the three months ended June 30, 2017. The decrease in gross profit was attributed to a shift in product and channel mix. Gross margin was further affected by higher transportation costs.
In-Store Bakery net revenue for the six months ended June 30, 2018 decreased 0.8% from the six months ended June 30, 2017. In-Store Bakery gross profit for the six months ended June 30, 2018 was 20.4% of net revenue compared to 25.8% for the six months ended June 30, 2017. The decrease in revenue and gross profit was attributed to a shift in product and channel mix. Gross margin was further affected by higher transportation costs and other inflationary pressures and bonuses paid to hourly employees as a result of the projected benefits of newly enacted tax legislation.
Liquidity and Capital Resources
Our primary sources of liquidity are from cash on hand, future cash flow generated from operations, and availability under our revolving credit agreement (“Revolver”). We believe that cash flows from operations and the current cash and cash equivalents on the balance sheet will be sufficient to satisfy the anticipated cash requirements associated with our existing operations for at least the next 12 months. Our ability to generate sufficient cash from our operating activities depends on our future performance, which is subject to general economic, political, financial, competitive and other factors beyond our control. In addition, our future capital expenditures and other cash requirements could be higher than we currently expect as a result of various factors, including any expansion of our business that we undertake, including acquisitions. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
We had working capital, excluding cash, as of June 30, 2018 and December 31, 2017 of $24.3 million and $15.5 million, respectively. We have the ability to borrow under our Revolver to meet obligations as they come due. As of June 30, 2018, we had approximately $96.9 million available for borrowing, net of letters of credit, under our Revolver.
Cash Flows from Operating Activities
Cash flows provided by operating activities for the six months ended June 30, 2018 were $81.2 million and for the six months ended June 30, 2017 were $67.8 million. The increase in cash flows provided by operating activities was primarily attributed to the timing of vendor payments and customer receipts as well as lower income tax payments.
Cash Flows from Investing Activities
Cash flows used in investing activities for the six months ended June 30, 2018 and 2017 were $45.3 million and $15.9 million, respectively. Cash outflows from investing activities increased in 2018 due to the acquisition of the Chicago Bakery, as well as an increase in capital expenditures.
Our property and equipment capital expenditures primarily consisted of strategic growth initiatives and productivity improvements. Cash outflows for the purchase of property and equipment for the six months ended June 30, 2018 increased from the same period last year due to additional expenditures to support a new cake line in our Columbus, Georgia bakery and investments in the operations of the Chicago Bakery.
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Cash Flows from Financing Activities
Cash flows used in financing activities were $56.3 million for the six months ended June 30, 2018 and $12.5 million for the six months ended June 30, 2017. The increase is primarily due to the $34.0 million payment to buy out a portion of the Tax Receivable Agreement, as well as a payment to the remaining counterparty of $7.4 million related to 2017 cash tax savings. We also paid distributions to the non-controlling interest, a partnership for income tax purposes, to cover income tax payments.
Long-Term Debt
We had no outstanding borrowings under our Revolver as of June 30, 2018.
As of June 30, 2018, $988.8 million aggregate principal amount of the Third First Lien Term Loan and $3.1 million aggregate principal amount of letters of credit, reducing the amount available under the Revolver, were outstanding. As of June 30, 2018, the Company was in compliance with the covenants under the Third First Lien Term Loan and the Revolver.
Contractual Obligations and Commitments
With the exception of the Tax Receivable Agreement (as discussed in Note 11 to the consolidated financial statements, “Tax Receivable Agreement”), there were no material changes, outside the ordinary course of business, in our outstanding contractual obligations from those disclosed within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2017.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to interest rate market risk.
Market risk on variable-rate financial instruments
Our Third First Lien Term Loan and Revolver each bear interest on outstanding borrowings thereunder at variable interest rates. The rate in effect at June 30, 2018 for the outstanding Third First Lien Term Loan was a LIBOR-based rate of 4.23% per annum. At June 30, 2018, the subsidiary borrower had an aggregate principal balance of $988.8 million outstanding under the Third First Lien Term Loan. At June 30, 2018, the subsidiary borrower had $96.9 million available for borrowing, net of letters of credit of $3.1 million, under our Revolver. Increases in market interest rates would cause interest expense to increase and earnings before income taxes to decrease.
To manage the risk related to our variable rate debt, we have entered into an interest rate swap contract with a counter party to make a series of payments based on a fixed interest rate of 1.78% and receive a series of payments based on the greater of LIBOR or 0.75%. Both the fixed and floating payment streams are based on a notional amount of $500 million at the inception of the contract and will be reduced by $100 million each year of the five year contract.
The change in interest expense and earnings before income taxes resulting from a change in market interest rates would be dependent upon the weighted average outstanding borrowings and the portion of those borrowings that are hedged by our swap contract during the reporting period following an increase in market interest rates. An increase or decrease in applicable interest rates of 1% would result in an increase or decrease in interest payable of approximately $1.5 million and $2.8 million for the three and six months ended June 30, 2018, respectively, after accounting for the impact of our swap contract.
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Item 4. | Controls and Procedures |
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e)) under the Securities and Exchange Act of 1934, as amended (the Exchange Act)) as of June 30, 2018, the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2018 to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that information relating to the Company is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
During the three months ended June 30, 2018, there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
Item 1. Legal Proceedings
We are involved in lawsuits, claims and proceedings arising in the ordinary course of business. These matters involve personnel and employment issues, personal injury, contract and other proceedings arising in the ordinary course of business. Although we do not expect the outcome of these proceedings to have a material adverse effect on our financial condition or results of operations, litigation is inherently unpredictable. Therefore, we could incur judgments or enter into settlements or claims that could materially impact our results.
Item 1A. Risk Factors
Our risk factors are set forth in the “Risk Factors” section of our Annual Report on Form 10-K filed on February 28, 2018 (the “Form 10-K”). Except as disclosed below, there have been no material changes to our risk factors since the filing of the Form 10-K.
A portion of our workforce belongs to unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages could cause our business to suffer.
Approximately 46.3% of our employees, as of June 30, 2018, are covered by collective bargaining agreements and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions could occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms, which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our business, financial condition or operating results. The terms and conditions of existing, renegotiated or new collective bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
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Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits
Exhibit No. | Description | |||
10.1 | ||||
10.2 | ||||
10.3 | ||||
31.1 | ||||
31.2 | ||||
32.1 | ||||
32.2 | ||||
101.INS | XBRL Instance Document | |||
101.SCH | XBRL Taxonomy Extension Schema Document | |||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Kansas City, Missouri on August 7, 2018.
HOSTESS BRANDS, INC. | |
By | /s/ Thomas Peterson |
Thomas Peterson Executive Vice President, Chief Financial Officer |