KANSAS CITY – The second-quarter market share of Hostess Brands, Inc. rose by 120 basis points from a year earlier, more than double the company’s targeted share gains, said William D. Toler, president and chief executive officer.
In an Aug. 8 conference call, Mr. Toler said while the market share expansion was a great positive relative to the company’s goal of 50 points of share gain per year, the overall sweet goods category was down 1.6% year-to-date, principally because of weaker convenience store business and softness in many grocery categories.
Overall sales at Hostess in the second quarter were boosted by new products, including Chocolate Cake Twinkies, White Fudge Ding Dongs and Golden Cupcakes. Mr. Toler said sales of Twinkies, Ding Dongs, Ho Hos and coffee cake all grew by double-digits in the second quarter. Adjusted net income was modestly higher during the quarter.
Hostess net income in the second quarter ended June 30 was $18,830,000, equal to 19c per share on the common stock, compared with $28,620,000 of income for the predecessor company in the second quarter of 2016. Sales were $203,178,000, up 6% from $192,343,000 in second-quarter sales last year. The predecessor figures refer to results of Hostess Holdings L.P. before its November 2016 acquisition by Gores Holdings, Inc. (the combined business was subsequently renamed Hostess Brands, Inc.).
Pro forma net income for Hostess in the second quarter was $28,207,000, equal to 19c per share on the common stock, up 29% from pro forma net income of $21,927,000, or 15c per share, in the second quarter of 2016.
Profits in the second quarter of 2016 were reduced by $4 million in charges associated with a Hostess voluntary product recall initiated last summer. The loss was recovered in the third quarter of 2016. Second-quarter profits in 2017 were also boosted versus the year before by lower interest payments, revenue growth and gross profit growth (though gross profit margins were under some pressure).
Adjusted EBITDA in the second quarter was $63.2 million, up 8% from $58.7 million in the second quarter last year. The EBITDA margin was 31.1% of revenue, up from 30.5% the year before.
In the conference call, Mr. Toler said the Chocolate Cake Twinkie “frankly has been the biggest success of the year.” Peanut Butter Twinkies, recently introduced in certain markets, also have been a success with good promise ahead, he said.
“Overall core is kind of flattish, which is terrific when you’re growing as much innovation as we are,” he said.
In addition to the new products, sales growth during the second quarter came from the company’s whitespace efforts, principally the Hostess In-Store Bakery segment, which contributed $4.7 million of growth because of the acquisition of Superior and in-store bakery product innovation. Food Service sales and International also were positives.
In the call, Mr. Toler described the quarterly results largely as in-line with expectations, noting that at the start of the year Hostess in its guidance had forecast strong growth in the first and fourth quarters of the year with slower growth in the middle quarters.
“We are pleased with our continued ability to gain market share, achieve mid-single digit net sales growth and drive profitability in a challenging retail environment, particularly as we cycled very strong results in the prior-year period,” Mr. Toler said of overall results. “Our second quarter results were driven by new product initiatives and growing traction of whitespace opportunities, led by in-store bakery, food service and international channel expansion. We are on track to achieve our annual revenue and adjusted EBITDA outlook.”
Investors were not as sanguine about the Hostess results. In Nasdaq trading Aug. 9, Hostess shares fell $1.37, or 9%, to close at $13.74.
Second-quarter gross margins were pressured by the inclusion of in-store bakery business in 2017 and because of growth in multi-pack and club-pack product sales as a percentage of total sales growth.
Mr. Toler said in-store bakery business was gaining momentum thanks to the company’s new Hostess Bake Shop subcategory.
“We’re gaining distribution in western geography and started to fill out the national footprint in the new large retailers,” he said. “A great example includes our recently added handheld pies, and our Donettes are now being sold in a large tub in the club stores around the country.”
During the call, Mr. Toler expanded on the company’s in-store bakery business prospects and conceded that Hostess, while viewing the market as attractive, has experienced a learning curve as it navigates the opportunity. He expressed hope that the business will grow double-digits in 2018, 2019 and 2020 as the company’s footprint expands.
“As we've mentioned on other calls, we like the business a lot,” he said. “Hostess makes a lot of sense over there. But we’re also learning a lot about the category dynamics. We’ve just brought in the handheld pie execution with four times the fruit into a couple of retailers, and that’s gone very well. We’re looking at some other cake analogs to go into.”
Progress also is being made in food service, Mr. Toler said. The company in January said it was partnering with McCain USA Foodservice, Lisle, Ill., initially with frozen deep-fried Twinkies.
Mr. Toler said thanks to the partnership, the company is making headway in quick-service restaurants, stadiums and amusement parks with the deep-fried Twinkies.
“We think that is probably the best place for it long term,” he said.
International business expanded during the quarter thanks to the launch of the Dolly Madison brand in Canada, a new product launch in Mexico and expansion in the United Kingdom, Mr. Toler said.
Taken together, these three channels (in-store, food service and international) are growing and significant Mr. Toler said. In the second quarter, the group accounted for 17% of volume, up from 11% in the second quarter of 2016.
“None of them individually is going to move the needle by itself,” he said. “But each one is picking up $1 million here and $1 million there per quarter. Then you’ve got three or four of those, and all of a sudden, that’s a nice part of your growth.”
Updating its 2017 guidance, Hostess said its sales will continue to grow faster than the sweet baked foods category for the year. The company reaffirmed its forecast of $781 million in sales and $235 million in adjusted EBITDA. Net income of $96 million is forecast for the year, down $2 million from its previous outlook issued in May.
Changes in a state tax law (Illinois) will cause the company’s income tax expense to rise $2.5 million to $3 million in the third quarter, Hostess said. The amount payable under a tax receivable agreement will result in an additional expense of $1.5 million to $2 million.
Longer term, Hostess remains interested in acquisitions, Mr. Toler said. The company is focusing on areas that allow the company to leverage its warehouse model; that expands the company’s baking capabilities, including further into in-store baking or toward appropriate adjacent categories; or a target that would allow Hostess to build into a greater snacking platform.
In the six months ended June 30, net income was $34,662,000, versus $46,229000 in the first half of last year for the predecessor company. Sales were $387,716,000, up 10% from $352,560,000.
Year-to-date pro forma net income was $52,406,000, or 35c per share, up 53% from $34,185,000, or 23c.
