Hostess Brands Inc (TWNK) 2016 Q4 法說會逐字稿

Greetings and welcome to Hostess Brands fourth-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Katie Turner. Please go ahead.

Thank you. Good afternoon and welcome to Hostess Brands fourth-quarter and FY16 earnings conference call. By now everyone should have access to the earnings release for the period ending December 31, 2016 that went out this afternoon at approximately 4:05 PM Eastern Time. If you have not received the release, it is available on Hostess' website, www.hostessbrands.com. This call is being broadcast and a replay will be available on the Company's website. Hostess would like to remind you that today's discussion will include a number of forward-looking statements. If you will refer to Hostess' earnings as well as the Company's most recent SEC filings, you will see a discussion of factors that could cause the Company's actual results to differ materially from these projections. Please remember the Company undertakes no obligation to update or revise these forward-looking statements.

The Company will make a number of reference to non-GAAP financial measures. The Company believes these measures provide investors with useful perspectives on the underlying growth trends of the business and has included in its earning release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. In addition, Hostess has supplemented its earnings release with unaudited, pro forma combined information for the quarter and year ended December 31, 2016 giving it back to the November, 2016 business combination as if it had occurred on January 1, 2016. All references to the results for the quarter and year ended December 31, 2016 refer to such unaudited, pro forma combined results. Now, it's my pleasure to turn the call over to Hostess' CEO, Bill Toler.

Thank you, Katie. Good afternoon, everyone. We appreciate you joining us today. It's been an exciting year at Hostess. As most of you know, Hostess became publicly traded this past November. This is our first full-year earnings conference call as a public Company. I will begin today's discussion with a brief overview of the Company and the highlights of our growth initiatives. Afterwards, our CFO, Tom Peterson will provide greater detail on our fourth-quarter and full-year financial results as well as our outlook for FY17. Then, we will be glad to take the call and open it up for questions.

We had a strong finish to the year and are pleased to report solid momentum across our business. Before we get into the numbers, I would like to talk a little bit about our Company. Hostess has a 96-year-old history, a remarkable 90% brand awareness, and a strong, unique, emotional connection with consumers. These unique brand attributes give us the ability to drive category growth for our retailers.

As most of you know, our Executive Chairman, Dean Metropoulos, and Apollo acquired the Hostess brand and certain strategic assets out of bankruptcy liquidation in April, 2013. Since the relaunch, we have grown to $727.6 million in net revenues for full-year 2016 and $215.3 million in adjusted EBITDA for 2016. Per Nielsen, our market share of the sweet baked goods category has grown consistently since relaunch and is now at 16.7% for the 52-week period ending December 31, 2016. Much of this growth can be attributed to the investments we have made in the business. Including approximately $160 million to upgrade our manufacturing facility, implement new IT systems, enhance production efficiencies through the installation of automated baking and packaging lines. We've also switched to a direct to warehouse model -- distribution model that has paved new opportunities for us, expanding our distribution reach and making it easy for us to innovate across the whole spectrum.

To continue to expand our presence in sweet baked goods, we acquired Superior cake products in May, 2016. That expanded our platform into the in-store bakery, or as we call it ISB. Superior is our first entry into this $8 billion space, and we believe it offers significant growth potential. The category is currently growing around 4% annually which last year was faster than the center-of-the-store, sweet baked goods category. Superior's product line includes eclairs, black and white cookies, madeleines brownie bites, and creampuffs; all new products to Hostess. We plan to leverage our distribution model and resources so this primarily northeastern-centric Company can be rolled out across the country in conjunction with our launch of the new Hostess BAKE SHOP line into the in-store bakery.

Looking forward, we remain focused on our three main growth drivers. First, rebuilding our core business, next, innovating and extending our lines and third, moving into important white space categories.

On the first one, we are rebuilding our core and ensuring that Hostess maximizes its market share potential. To put it simply, we want more Hostess items in more stores. As the driver of category growth, we're working with retailers every day to expand our shelf space to equal our market share. And, as I've mentioned, we've had great success in expanding those core products into more stores in most of our channels.

Secondly, we're committed to innovation and line extensions to continue to excite our customers and consumers. Innovation for us is about flavors. It's about seasonal items, limited time offers, new ideas, shapes, packaging. In 2017, some of our new product launches you'll see in stores this year include cinnamon sugar crunch Donettes, white-cut fudge covered Ding Dongs, chocolate cake Twinkies, and, peanut butter. Peanut butter has always been the number-one flavor gap in our portfolio in all of our consumer surveys. And, now, we've developed a peanut butter Ho Ho and anticipate rolling out more peanut butter products throughout the year as well.

Our third area of growth is white space, identifying new areas for our distribution and innovation. We acquired Superior to enter the in-store bakery business which we view as a big opportunity given the category's strong growth profile. And, we have an exciting lineup of products slated for this spring, beginning with the Hostess BAKE SHOP. We're adding to the ISB line Hostess BAKE SHOP triple-dipped Ding Dongs and decorated Twinkies. We're launching a Hostess cupcake cookie which is a play on Superior's black-and-white cookie but with that famous Hostess squiggle.

The frozen aisle is another area of white space. We launched Deep Fried Twinkies last year. We will be adding additional items to the line this year as well. And, we partnered with Nestle for a licensing arrangement on ice cream. In schools, we're proud to say that our whole-grain muffins qualified for the smart snack program which makes for a great brand impression that kids can be buying Hostess products at school for years to come. This tactical innovation of converting our mini muffins into whole-grain muffins helped us take a declining business at retail to one with double-digit growth and fits well in the consumer trends.

Just last week, we announced the launch of Twinkies cappuccino in partnership with Kerry convenience in the C-store channel. This will be our first product in the hot-dispensed beverage category. Internationally, we're expanding our Dolly branded products in Canada and continue to see upside potential there. Our business is growing in Mexico and across the Caribbean as we use a number of distributors to further gain presence of Hostess items in stores. We've also made progress in e-commerce where we have a small but emerging business that works well for online retailers selling our products going through their warehouses. And, finally, in food service, we've partnered with McCain foods to help us with the selling and distribution of deep-fried frozen Twinkies as a food service product. We just started this in February and have been encouraged by the initial progress.

In summary, Hostess is off to a great start as a publicly traded Company with a strong finish to 2016, and we believe we are well-positioned to continue to grow over the next several years as we innovate and leverage both our iconic brand and infrastructure to take advantage of the opportunities that we see in our business. Now, I'll turn it to Tom for more details on the financials. Tom?

Thank you, Bill. I will now review our fourth-quarter financial performance and some other data from today's press release. For comparative purposes, we will review unaudited, pro forma combined financial statements for the quarter and year ended December 31, 2016 which presents our results as if the business combination had occurred as of January 1, 2016. Comparisons are to the actual 2015 fourth-quarter and full-year results of Hostess Holdings LP which are presented in our consolidated financial statements as predecessor. We believe this discussion provides helpful information on the performance of the Hostess business during those respective periods.

As we look at our pro forma financial and operating results for the fourth quarter, we are pleased with our improvements. We posted strong top line growth over the past year as we continued to build our core product shelf space and market share as well as introduce compelling product innovation. And, we have established the infrastructure that positions us to continue this growth and realize the operating leverage in our competitively advantaged business model.

Pro forma combined net revenue for the fourth quarter was $178.8 million, an increase of $31.8 million over the fourth-quarter of 2015. This represents a 21.6% increase year-over-year growth rate reflecting $10.2 million in top line contributions from Superior and an increase in cases sold as a result of product innovation including the launch of Suzy Q's and Sweet Shop Brownies. Excluding Superior, revenue increased 14.8% over the fourth quarter of 2015. We generated $77 million of pro forma combined gross profit in the fourth quarter of 2016, or 26% growth versus prior year. Gross margin was 43% of net revenue, up 150 basis points from the same quarter last year. We benefited from the higher case volume as well as decreases in egg prices from 2015 when the reduced availability of egg supplies led to record high ingredients prices. We view commodities as stable in 2017 and have covered most of our purchases for the year.

Pro forma combined SG&A expenses were $26.4 million, or 14.8% of revenue. This compares to $20.6 million, or 14% of revenue for the fourth-quarter of 2015. The increase in SG&A was primarily attributable to the increased investments in field marketing and merchandising, higher annual incentive compensation related to the improved operating performance of the Company, and expenses associated with the addition of Superior. We generated pro forma combined adjusted EBITDA of $52.9 million, or 29.6% of revenue compared to adjusted EBITDA of $42.1 million, or 28.7% of revenue for the fourth-quarter of 2015. Year-over-year growth in adjusted EBITDA was 25.4% driven by the increases in revenue and gross profit. Pro forma combined GAAP net income was $22 million, or $0.14 per fully diluted share compared to $17.2 million last year.

Briefly turning to our full-year results. Pro forma combined net revenue in 2016 was $727.6 million, an increase of 17.2% compared to net revenue of $620.8 million for 2015, due to $44 million from new product launches and $26.7 million in revenue contribution from the acquisition of Superior in May of 2016. Excluding Superior, revenue increased 12.9% over 2015. We generated pro forma combined gross profit of $316 million, or 43.4% of net revenue, compared to adjusted gross profit of $264.9 million, or 42.7% of net revenue. For 2015, excluding the impact of a one-time $2.6 million special employee incentive compensation payment, the improvement was driven by decreases in commodity costs and improved bakery costs.

Pro forma combined SG&A expenses for the year were $108.4 million, an increase of $15.4 million as compared to SG&A of $93 million for 2015. The increase in SG&A was primarily attributable to the impact of the business combination, the addition of Superior, planned expansion and field marketing, and increases in incentive compensation related to the performance of the business. Pro forma combined adjusted EBITDA increased 21% to $215.3 million, or 29.6% of net revenue, compared to adjusted EBITDA of $177.9 million, or 28.7% of net revenue for 2015. Our earnings release provides more detail on our EBITDA including a reconciliation to net income.

In addition, our earnings release includes an explanation of 2016 pro forma adjusted EBITDA compared to the projected 2016 adjusted EBITDA included in our proxy statement for the business combination. Pro forma combined GAAP net income was $82.4 million, or $0.54 per diluted share compared to $88.8 million for 2015 as operating gains were offset by the income tax provision for 2016. Our effective tax rate was 28.6%. Prior to the business combination, Hostess was not a taxpayer.

Turning now to the balance sheet. Net debt as of December 31, 2016 was $971.9 million. At year end, we had cash and cash equivalents of $26.9 million and approximately $97.2 million available for borrowing under our revolving line of credit. Our total leverage ratio as of December 31, 2016 was 4.51 times 2016 pro forma combined adjusted EBITDA of $215.3 million. We continue to expect this rate to come down over the next year given our consistent cash flow generation. From a capital allocation perspective, in addition to reducing our debt leverage ratio, we will continue to explore complementary tuck-in M&A in the fragmented ISB category as well as continue to make strategic investments to support our growth. In terms of our outlook for 2017, we are reaffirming our previously issued 2017 guidance of net revenue of $781 million and adjusted EBITDA of $235 million.

In summary, we finished 2016 with positive momentum across the business and are pleased with our operational and financial results. Looking ahead, we believe Hostess is well positioned to grow and enhance shareholder value through the execution of our strategic initiatives including further core distribution expansion, continued product innovation and line extension, as well as the pursuit of our white space opportunity. With that, we are available to take your questions.

(Operator Instructions)

Bill Chappell, SunTrust.

Thanks. Good afternoon. I am looking at the guidance. What does that imply for organic growth in the business -- I guess, taking out what you expect in contribution from Superior?

It's about 5.4% in total. And, we expect a little faster growth at Superior, but it's not a huge piece of the pie. Mid-5% kind of numbers.

How does that break out in terms of looking at -- do you expect the category to grow still 2% to 3% this year? Or, are there any changes?

Category has slowed a little bit in the last 24 weeks. Probably more in the 1% to 2% range category growth. Obviously, there's a lot of factors to that. It has slowed some so it may not be as robust as it was a couple of years ago. We expect it in that 1% to 2% range.

And then, looking just at margins -- some of the expectation. Do you have major projects, or anything that we are looking out over the first half that's going to help improve those going forward? Or, are those more longer term.

It's more longer term. The big one would be, of course, the cake line for the next step function in growth which will probably be very late this year or early next year.

Okay. The recent automation -- I think of the cupcake line -- that's already in effect?

That was not in effect, Bill, in the fourth quarter this time. In the fourth quarter, that was not an effect. Really late in the fourth quarter, it was. So, we should see the impact of that this quarter.

Okay. Great. Last question for me in terms of new product launches, that's obviously a robust lift. Is that fairly front-end loaded? Or, excluding the seasonal stuff like Halloween or Christmas, is that in the market now? Or, should we see that over the next couple of months?

Yes, a little bit of both actually. We go out with single serve out in January. The major grocery retailer resets are in the spring. March and April is the primary period. So, not a lot of that is in the volume today. That we usually front-load the innovation into March and get the lion's share of the benefit through the year. There will be a second shot at that in September when a number of retailers will do a plug-and-play-type situation or pull and plug where you don't get as much shelf expansion, but you do get some new items on. But, it is primarily targeted around getting them out in March or April of the year.

Got it. Thanks so much.

Thank you, Bill.

Brian Holland, Consumer Edge Research

Thanks. Good afternoon, gentlemen. Quickly, on the C-store. Seeing slowing traffic, tough comps. You've got gas prices as a headwind. Bill, I know you and I have talked about the channel lapping a big lottery in the prior-year. Your points of distribution growth are exceeding your sales growth right now by a few bips. Any concerns about how long that continues? Or, do you have any insight into that by either talking to customers, et cetera? How long maybe that persists?

Yes, I think a part of that is that we are getting items onto the shelf, and they haven't built the trial and repeat yet. So, chocolate cake Twinkie, peanut butter Ho Ho, white fudge-covered Ding Dong, the TDPs, total distribution points, are out there, and they are getting -- we're seeing that increase. But, it takes a little longer for the trial and repeat to build the velocity underneath that.

Sure. Thanks for that. Back to the question about the guidance and then trying to think about some of the white space opportunities that you've spoken to. So, whether that's in-store bakery, [clubs], international, et cetera. Can you give us a sense how much of that is factored into your 2017 guidance that you provided here today? Specifically, on the top line? And, maybe how quickly we can attack some of these opportunities?

Yes. I would say it like this, Brian, that frankly most of the growth is core. And, we've got a number of white space initiatives coming out right now, and it's early in the year so it's hard to say which one of those -- whether it's the food service or international or ISB or frozen or all those. Which one is going to take off at what rate. While the $781 million certainly has some expectation around white space growth, a lot of that really comes from the core expansion, the new products on the core, and really driving the Hostess brand as it is today.

Got it. That's helpful. Talking specifically about the in-store bakery opportunity which you know I found to be interesting as I've talked to industry contacts. One -- forgive me if I missed this and you said this, have you started to roll that out? Is the Hostess BAKE SHOP active anywhere at this point? And, can you talk about the puts and takes with fully realizing that opportunity relative to where you are today? Maybe why you're bullish on the opportunity. Why you made this acquisition? The opportunity that you see and balancing that against are there complexities we should be thinking about as we model this in? And, I'm talking two, three, four years out.

Yes, let me give you parts of that, and then come back to me if I miss some of it. The Hostess BAKE SHOP is literally just starting. Literally, I think our first shipments on the cupcake cookie were in late February, early March. It's not material in any of the financials, but we are starting to get some exposure in the marketplace which is good. That's important for the future. Important for us to get that going. It is just starting. So, that's part one of it.

Part two is why ISB is at the core of your question. We think of it like this that Hostess from the consumer perspective has the permission to win and the right to play in sweet baked goods categories all around the store. Whether they are in our traditional aisle in our fresh aisle that we are in. Whether it's in the in-store bakery. Whether it might be in frozen. The Hostess brand certainly has the shoulders and has the strength to play in all those areas. In-store bakery, again, being larger than our packaged products also growing faster than our packaged products gives us a great place to take that Hostess brand and also potentially make products on our assets that we could take over there under the Superior brand or under other brands. So, it really gives us that leverage about where the brand can go in the store. Where consumers expect and want to see Hostess and where they give us the permission to win, and in-store bakery is right at the top of that list.

Perfect. Thanks. Last one, and then, I will hop back into queue. Looking at the gross margin, I know there is a lot to reconcile here with the pro forma so I'm not sure if this actually holds. It looks like gross margin might have missed [me] by about 50 basis points in Q4. I'm more concerned as we look out to 2017. The closer you get back to pre- or legacy Hostess levels from a share and distribution standpoint and thinking about your competitors who are ceding back that share to you. Do you think -- how much harder do you think the last few points of share or distribution will be to pick up? Not just from getting the placement on the shelves but maybe promoting against your competitors who want to preserve a net share gain from while you were dark. Is there anything you're seeing in the trade, or any concern that you might have to lean a little more heavily against the brand in the next 12 months relative to maybe the last 3 years?

Gross margins were up 150 basis point year-on-year so I'm not sure where you're getting the miss there. We thought there was a very strong performance on that front. Back to the competitive question. Look, every share point you have to work for. There is nothing easy or hard about any of them. I don't know that it's going to get any more difficult as we go forward. I think that's up to how well we do our job of leading and innovating. And, if we keep bringing differentiated products like peanut butter, like brownies, like white fudge covered, like chocolate cake Twinkie into the marketplace, we're going to continue to gain share. That's how it's played out over the last 3.5 years and how we think it can play out going forward. Competition has fought us. They've innovated as well. They've helped drive some of the growth that way. But, frankly, the Hostess products are doing well with consumers, and we're pleased with the outcome of our innovation and our efforts to broaden our distribution and continue to grow.

Thank you. Appreciate it.

Thanks, Brian.

Michael Gallo, CL King.

Hello, good afternoon. Congratulations on a strong finish to the year.

Thanks, Mike.

My question is just to dig in on the composition of the growth for 2017. It seems like you don't have a lot expected on innovation in terms of driving the growth in terms of at least what's embedded. I was wondering if you can speak to what you are seeing in terms of receptivity in the market. What are the more exciting areas that you think could drive some upside. I was also wondering if you can give us an update on your plans for entering into the food service business? Thanks.

Yes. Sure. The growth is going to come from those three legs of the stool. Rebuilding the core, more items in more stores, innovation, and white space. They bleed a little bit, right. The innovation, like peanut butter Twinkie drives more items in more stores so it keeps both building and broadening the base. We've gotten very good response from retailers on a number of initiatives so far. Chocolate cake Twinkie has been the fastest out of the gates. The first time the Twinkie icon has been put in a chocolate cake so that has been well received, and the velocities has been encouraging on that. Getting into peanut butter where our competition has been for a while is giving us some real momentum there as well. White fudge covered Ding Dong -- simply put, that's one of our best, fastest-growing brands into the first line extension on that. So, those are meaningful innovations that are going into the stores. And, meaningful ones that customers are receiving well, and we think will continue to provide nice growth through the year and beyond.

And then, on food service?

Yes, sorry. Food service. Food service has been a slower channel for us. And, that's generally the way food service operates. I've been in that business for a long time, and what's happened is we've partnered with McCain. McCain, of course, the big potato and appetizer Company. They want to get further into desserts. They actually help us in co-pack. We make the Twinkie ourselves. They co-pack and turn it into a fried Twinkie. And then, their very large sales force reps it and sells it into distribution. So, it goes into Cisco and US and ultimately out to retailers and restaurants and restaurant chains who use it. So, that business -- obviously, about 50% of all food is consumed in restaurants so we're continuing to build that presence there. We think it's going to be a nice business for us, but it's going take time to build and we're off to a good start. But, it is going take some time.

Thanks very much.

Thank you.

Rob Dickerson, Deutsche Bank.

Thank you very much. A couple questions. The first question pertains to gross margin. I think you said the gross margin expansion Q4 was driven primarily by commodity cost decreases, but it looks like implied organic sales were up 14%. The first question is just why wasn't there more gross margin lift? 150 basis points is great. I'm just trying to get my head around why that top line growth wouldn't push up more?

Right. Thanks for the question. Mix is the reason. We sold more and saw higher growth rates in our bagged donuts versus our single serve and multi-packs. And, that drove down margins a little bit between the mix of the products, and that offset some of our growth -- the leverage that you would have expected.

Fair enough. Just to follow up on that question. The 14% organic for the quarter, I think it's around -- you said 13% for the year. You're guiding to around mid-5%. Is the step down on that -- I think it was pretty well telegraphed before today. It looks like it's pretty much in line. Things look positive 5%-plus organic still is growth tough to find in CPG in general these days. But, is the step-down from 2016 to 2017 -- is that driven partially because of a deceleration of your distribution gains? And then, a little bit off of a step-down in the category growth rate? Or, is there something else there that we should be aware of? Thank you.

No, a little bit of it is category. But, bigger than that, the business is getting larger and so these double-digit laps are not going to happen like they have been the last few quarters. So, it's really about the scale of the business, and there's also these white space initiatives that are still very early in their development. We are not yet far enough along to know which ones are going to take and which ones are going to be the biggest drivers of growth. It's a number we feel good about and a number we put out there a few months ago, and we are reaffirming it today. But, yes, it's just a much bigger business now that's lapping a lot of momentum and a lot of gains. And, the category has slowed a touch.

Super. Just a few quick housekeeping items. On the diluted share count, it looks like it's around $100 million diluted. [Basic] $98 million, that's for the Class A. It sounds like in the past couple months at least there has been discussion around this $130 million [total] fully diluted ex-warrants. The number that is listed excludes the Class B. Just one, how should I think about that? And then, as a follow-up to that, it looks like in the 10-K, there is a little bit more detail on the exercising constraints of the warrant. So, it looks like you actually can't exercise the warrants until the stock reaches the $24 per share. I just wanted to clarify, what should the marketplace be using for a diluted shares outstanding figure count? And then, any color on that $24 per share exercise schedule?

Sure. Thanks. It's a little of how you look at the numerator and denominator. Our net income includes all shares. But then, if you look at net income to common shareholders, that excludes the B shares. The B shares are held by Mr. Metropoulis and his family entities. And, those are the shares that don't count within EPS because EPS is calculated against net income to common shareholders not all shareholders. So, it just reduces that to the $98 million share count. So, if you were to look at net income to all shareholders, you would use the $130 million. If you are looking at net income to common shareholders, use the $98 million. [$250 million] from year end is the accurate number.

Okay. (multiple speakers)

And, the exercise price on the warrants is for the public warrants to this point. We cannot strike those until $24.

Okay. And, last two quick ones. Again, in the 10-K, it looks like you said $30 million to $40 million investment for further consolidation of production lines and expanding capacity. Is that your implied CapEx guidance for the year? Or, is that -- ?

That is our CapEx guidance for the year. What's included in there is some movement of some assets, but primarily, the first portion of a new cake line that we believe we need to have in place for 2018 based on our growth rates.

Great. Last simple one. It looks like implied tax rate for 2017 is similar to Q4 around this 28.5%. Is that, one, right? And then, two, why is that different than the 38% number that you talked about before?

Right. That is the tax rate for Hostess Brands, Inc. That's their booked tax rate. But, that is 75% of the income of the Company. The B shares don't count. That's the difference between it and the 38%. The B shares are taxed separately.

Got it. But, for the Class A to common, we should be using the 28.5%. Yes, Class A to common, you'll get it. The [booked] income tax rate will be 28.5% Great. Thanks a lot.

Thanks, Rob.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to management for closing remarks.

Thank you very much. We appreciate the questions and your involvement and interest in Hostess. And, wish everyone a good day. Thank you.

This concludes today's conference. You may disconnect your lines. Thank you for your participation.