Hostess Brands Inc (TWNK) 2017 Q1 法說會逐字稿

Greetings and welcome to Hostess Brands first-quarter 2017 earnings conference call. (Operator Instructions). And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Rachel Perkins. Thank you, please go ahead.

Good afternoon and welcome to Hostess Brands' first-quarter fiscal 2017 earnings conference call. By now, everyone should have access to the earnings release for the period ended March 31, 2017, that went out this afternoon at approximately 4:05 PM Eastern Time. If you have not received the release, it is available on Hostess's website at 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's earnings release 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 references to non-GAAP financial measures. The Company believes these measures provide investors with useful perspective on the underlying growth trends of the business, and has included in its earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures.

In addition, Hostess has supplemented its earnings release with unaudited pro forma information for the quarter ended March 31, 2016, giving effect through November 2016 business combination as if it had occurred on January 1, 2016. All references to the results for the quarter ended March 31, 2016, refer to such unaudited, pro forma results.

Now I will turn the call over to Hostess's CEO, Bill Toler.

Thank you, Rachel. Good afternoon, everyone, and thank you for joining us today. I'll begin today's discussion with a brief overview of the first quarter and highlights of our business performance. Afterwards, our CFO, Tom Peterson, will provide greater detail on the first-quarter financial results, as well as reconfirm our outlook for fiscal 2017. Then we'll open up the call for questions.

I'm pleased to report another quarter of strong sales and earnings, with revenue growth up 15.2% to $184.5 million, and adjusted EBITDA up 13.3% to $54.5 million.

Our first-quarter performance is evidence of our continued success in launching new, innovative products; our continuing expansion of shelf space; and growth and points of distribution. We've also begun to penetrate white space channels. We're seeing good momentum in our Hostess sub-brands and strong consumer demand for our core products as we continue to drive category growth for our retailers.

Per Nielsen, our market share of the sweet baked goods category has grown consistently since relaunch, and is now at 17.1% for the 52-week period ending April 22, 2017, up 126 basis points from the prior year. Results were led by snack cakes, brownies, and Donettes, and I'm pleased to report that almost all major Hostess sub-brands posted market share gains. We expect to build on that as we will continue to grow faster than our categories.

We continue to increase the number of items in distribution; and those are driven by the convenience, drug, and grocery channels, behind improved execution and expanding core products into more stores.

Also importantly, in the 52 weeks ending April 22, 2017, Hostess achieved the number-one share position in C store, and of course we're also the market leader in the drug channel.

We have seen some slowdown in the overall category growth of sweet baked goods over the last 52 weeks. Category growth is slightly below 1%. We continue to believe the Hostess brand and our innovation pipeline will enable us to build market share and grow above the category.

One of the measures of our successful innovation is revenue generated from new products during the first year they're on the market. We sold substantially more from innovation in the first quarter of 2017 than in the same period last year, and benefited from the wraparound effect of Suzy Q and Hostess SweetShop brownies, as well as our early 2017 launches. Also, our seasonal offerings, our limited time offers, performed very well versus prior year in Q1 of 2017.

We've been encouraged by the retailer and consumer response to our new items. Donettes is our largest business, and we've [recently] launched cinnamon sugar crunch. We've also launched the first line extension on Ding Dongs, a 50-year-old brand that has historically only had one SKU. Now we have new white fudge covered Ding Dongs, and of course the traditional chocolate Ding Dongs. We're also doing an improved fudge-covered Twinkie and launching the Chocolate Cake Twinkie. Who doesn't love chocolate cake?

Peanut butter has been the number-one flavor gap in our portfolio for a number of years. So last year we converted our Indianapolis bakery to be able to handle peanut butter; and recently relaunched Peanut Butter Ho Hos, and we will release more of our classics with peanut butter in the future. We're expanding our coffee cake line with apple streusel and with our cupcakes offering, the Golden Cupcake.

Our white space efforts in distribution innovation are beginning to show traction. Since acquiring Superior on Main, our in-store bakery business, that business has grown 16%. And with the launch of Hostess Bake Shop, we've learned that ISB doesn't have the same predictable cadence for new items and merchandising as sweet baked goods. There's less discipline on the planograms, timings, and resets than it is in grocery, and our programming will take a little longer to take hold. That being said, we're pleased with early response to Hostess Bake Shop.

To better work in the ISB model, we have implemented a number of changes, including integrated the ISB sales team with the Hostess packaged sales team, and leverage our current existing customer relationships. While we believe the Hostess brand can play well in the category through the Hostess Bake Shop, we're also planning to offer co-branded products, and have incremental innovation planned for later this year.

In summary, our differentiated business model continues to drive growth and our overall market share across sweet baked goods and in-store bakery product categories. We're excited about our initiatives to introduce innovative new products and to expand core shelf space and points of distribution, and look forward to updating you on those throughout 2017.

Now I'll turn it over to Tom.

Thank you, Bill. I will now review our first-quarter financial performance and some other data from today's press release. For comparative purposes, we will review unaudited pro forma financial statements for the quarter ended March 31, 2016, which presents our results as if the business combination had occurred as of January 1, 2016. We believe this discussion provides helpful information on the comparative performance on the Hostess business during this period.

As Bill indicated, we are pleased with our financial performance. We posted strong top-line growth in the first quarter. And we have the innovation, marketing, sales and distribution, and manufacturing infrastructure that positions us to continue to grow.

Net revenue for the first quarter was $184.5 million, an increase of $24.3 million over pro forma first-quarter 2016 revenue of $160.2 million. This represents a 15.2% year-over-year growth rate, reflecting $9.7 million in top-line contributions from ISB and an increase in cases sold as a result of product innovation, including the launch of Chocolate Cake Twinkies, Golden Cupcakes, and White Fudge Ding Dongs, along with expanded distribution. Excluding in-store bakery, revenue increased 9.1% over the first quarter of 2016.

We generated $79.3 million in gross profit in the first quarter of 2017 or a 13.2% growth year over year. Gross margin was 43% of revenue, down 70 basis points from the same quarter last year as a result of the shift in product mix to include ISB.

With respect to the mix between segments, our lower gross margin other segment increased from 3.4% to 8.7% of the overall business due largely to the addition of Superior.

SG&A expenses, including advertising, were $28.6 million or 15.5% of revenue. This compares to $23.6 million or 14.7% of revenue for the first quarter of 2016. The increase in SG&A was primarily attributed to increased professional services expense, the addition of Superior's operations, and higher non-cash share-based compensation.

We generated adjusted EBITDA of $54.5 million or 29.5% of revenue compared to adjusted EBITDA of $48.1 million or 30% of revenue for the pro forma first quarter of 2016. The year-over-year growth in adjusted EBITDA was 13.3%, driven by the increase in revenue and gross profit. As a percentage of revenue, the year-over-year decrease in adjusted EBITDA margin was due to the shift in the product mix to include ISB.

Our effective tax rate for the first quarter was 29.2% compared to a pro forma effective tax rate of 28.5% for last year. GAAP net income was $24.2 million or $0.15 per fully diluted share compared to $12.3 million or $0.08 per fully diluted share on a pro forma basis for the same quarter last year.

Turning now to the balance sheet, net debt as of March 31 was $950.6 million and we had cash and cash equivalents of $45.7 million and approximately $97.2 million available for borrowing under our revolving line of credit.

Our total leverage ratio as of March 31, 2017, was 4.29 times; trailing 12-month pro forma combined adjusted EBITDA of $221.7 million. This is improved from 4.51 times at the end of 2016. And excluding cash used for future acquisitions, we expect this rate to continue to come down over the next year, given our consistent cash flow generation.

Our CapEx for the quarter was $4.5 million, mainly for property and equipment to support our strategic growth initiatives and productivity improvements. We anticipate approximately $30 million to $40 million in CapEx for the full year.

In terms of our outlook for 2017, we continue to expect revenue to grow above the sweet baked goods category, and are reaffirming our previously issued 2017 guidance of net revenue of $781 million and adjusted EBITDA of $235 million.

We currently anticipate net income of $98 million for 2017, of which $33 million is expected to be allocated to the holders of the noncontrolling interest. The remaining $65 million is expected to result in basic EPS of $0.66 and diluted EPS of $0.61 for Class A common shareholders. This is based on expected basic and diluted shares outstanding of approximately 98.7 million and 106.8 million, respectively.

We are anticipating income tax payments of $39 million to $42 million to cover the Company's federal and state income tax, as well as reimburse the holders of the noncontrolling interest for their tax [liability].

In summary, we are off to a great start in 2017 and are well positioned to continue to deliver strong, solid revenue and earnings growth as we continue to expand our core distribution, introduce innovative new products and line extension, and pursue white space opportunities. And we will continue to explore complementary, tuck-in M&A opportunities in snacks and the fragmented ISB category.

With that, we are available for questions.

(Operator Instructions). Bill Chappell, SunTrust.

Bill, just a little bit more commentary, what you're seeing in the category. I guess from looking at your growth and the category growth, it seems like everyone else is in slight decline. Is that the right way to look at it? And maybe what's your outlook as we move into the peak season? Do you expect there to be a pickup from your competitors in terms of innovation or promoting the category? Or are you expecting 1% growth for the category this year?

I think the category is going to get a little bit better. I think the late Easter probably has it muted just a touch for the year, because Easter is traditionally a fairly weak period for it. We see weekly POS numbers, and while we don't talk in those terms, we see continued strong POS from our big customers. So that's encouraging, both in terms of our performance, and also I think the category is going to come back a bit.

There's not a big wave of innovation from our competition that we have seen. Our innovation is just hitting the shelf. So I would say that the category should strengthen some, but I don't think it's going to go up to that 4% level or so. I think it's going to get a little stronger than it has been, but I don't expect it to get back to that 3%, 4% level in the next few months.

Okay. And then just talking about new distribution, any -- as we've now gone through most of the resets, any major expansions? Be it even the drug channel, be it where you are on the C store channel, or even in food? Or is it fairly similar to what you looked like three months ago?

Now, we've had very good expansion in grocery at major mass customers and consistent expansion in C stores. So, feel pretty good there. As you know, our shares in drug have dropped a bit.

One of the leading drug retailers has moved our entire category to a different part of the store. And consumers are adjusting to whether they can find the product over there or not. So that's caused a bit of a drop in our drug channel business. That's been something we're working on; we're working on trying to mitigate that with some merchandising ideas.

But the basic new items and new stores expansion that we would expect in grocery and mass and C store has gone very well. And that's just playing through into the stores, literally right here in the last couple of weeks of April into early May.

Okay. And then last one for me, just -- any changed outlook on commodities? I know you are fairly locked in for this year, but any relief as we go versus your original expectations?

No. Pretty much as it has been for a few months, and been a pretty favorable story. And like you say, we're pretty well protected for 2017 and are working now to get into 2018, as well, and we are into 2018 as well.

Got it. Thanks so much.

Brian Holland, Consumer Edge Research.

So, the first question, just want to understand on the in-store bakery and the commentary there -- and I think you've been pretty consistent in that commentary, both on- and off-line, about the complexities of getting the product in the store and the execution.

Just curious, at this stage how that's performing relative to your expectations. Is there any sort of caution here that, maybe relative to at least your 2017 plans, that maybe -- and perhaps this is why we're holding guide, as I also appreciate it's only Q1. Is there a way to frame how that's coming versus your expectations? Just any commentary there.

Remember, ISB as a total in our business is still less than 6%, so any number there is not going to really move the whole needle that greatly. Now, we do have nice growth planned there. And as I said, we've grown it 16% since we acquired it. The innovation that we put out in Q1 is starting to get some traction. But again, that's sort of small items on a small business, so it's going to take a while to gain that.

Much like in grocery, when you have your spring reset and then your fall reset and everybody acts in unison, that doesn't happen in ISB; primarily because it's a retailer-controlled category with about 70% of the products being private label or owned brand products. So they aren't really looking for the refresh or the reset on such a regular basis.

So it's not really going to affect the 2017 number. Look, we still play in a big category over there. We've got some very unique and interesting ideas going forward that we think can add value there. And the business is doing fine. It's doing fine, but we always want a little more.

Great. That's helpful. Thinking about just innovation on hold for your business this year; and if I recall it was -- contributed something like 7% to your growth in 2016. And I think the cupcakes, Suzy Q's, and Deep Fried Frozen Twinkies were among the larger ones. As you think about the wave of new products this year, obviously a lot of that is -- it's unique to what you introduced last year.

Is there an expectation about what that could contribute relative to what we saw in 2016? Is there any expectation we could see something along the line of 7%? Or do you think the overlap with the new product introduction this year, whether it's line extensions, et cetera, might limit that contribution? Is there a way to think about that or how do you frame it?

Here's how we feel about it. The 2017 innovation I think is probably fundamentally stronger items than the 2016 innovation. The difference is that 2016 innovation was very incremental and different and outside of our current categories. As you said, Deep Fried Twinkie, where we'd never played before; brownies, we've never played before. Products that were really -- Suzy Q, an icon, we were bringing back. And now this year we got Chocolate Cake Twinkie, Peanut Butter Ho Ho, white fudge covered Ding Dongs.

They are a little closer in, so the risk of course is maybe they are a little more cannibalistic. But they are also highly desired product forms, whether it's peanut butter, the number-one gap we've had; Chocolate Cake Twinkie, which has been a big win so far. So it's always that question of incrementality versus just growth.

And then of course we've got year two of the 2016 numbers, which you're right; your 7% is exactly right. They did $44 million last year. You get the pipeline one-time benefits. You're not going to lap and get that again.

And so those are the things we're working through. And we're going to learn that a lot in Q2 as we are now moving up against the lap of Q2, which is the largest quarter in the Company's history, last year's second quarter. And so we've got this year's items working against what we did last year.

Okay, got it. Thanks. And last one for me, and forgive me if you addressed it earlier in the call, but a little bit of heightened sensitivity last week in response to the scanner data. Any commentary there about whether the lag in picking up those SKUs and how that might be impacting your growth?

I don't know what you can see beyond just the scanner data and what you're hearing and seeing in the trades, and maybe magnitude of impact on that consumption data.

As you know, we only buy one of the services, so we get all the detail around Nielsen. We only get sound bites and snippets on IRI from different sources. But the biggest difference was IRI cut off a week earlier, the week before Easter, versus Nielsen. So in our Nielsen numbers, which were lower, it affects -- it had that week of slower sales in Easter, which is totally expected. In IRI, it did not, so I think that's the biggest difference. Much, much different than a data problem or anything of that. That was not the case. The case was really the timing difference of when the two different sources cut off.

Okay, got it. Thanks. Best of luck.

Michael Gallo, CL King.

My question: you've done -- you've had a lot of success going into a lot of adjacencies, whether it be Deep Fried Twinkies, et cetera. I guess the one area where it still seems like you have a hole in the product portfolio and the category would be cookies. So is that an area that you might pursue either through organic or M&A? Or is that an area that's not on the table or the drawing board for the foreseeable future?

No, that's a good call on your part. It's the single biggest product segment we don't compete in today within sweet baked goods. And interestingly, it's a big product segment in ISB as well. We're moving into ISB with cupcake cookies, so we're starting to play over there a bit.

But in the aisle, or sweet baked goods aisle, we have not yet found the right solution for -- whether to buy our way in, innovate our way in, or what really is the Hostess answer for that. But you're right; it's a place that certainly the consumer would expect us to play, and we certainly have an interest. We just have to develop the right product analogue to do that.

Okay, thank you.

Jon Braatz, Kansas City Capital.

Bill, you talked a little bit about incremental gains versus maybe -- as opposed to some cannibalistic -- cannibalism on some of the new product introductions. What have you seen so far in some of the new products? Can you give us an early read on the incremental gains you might be seeing on some of the new products?

Yes, there's two things. First of all, when you say gain, I oftentimes think of that as items in a store and shelf position. Those have been pretty clean. We're gaining the second Ho Ho; we're gaining the second Ding Dong; we're gaining the new Twinkie around Chocolate Cake Twinkies. So those are incremental space that will show up as new product gains, new product space.

The question comes in is terms of the incrementality. Does a Ho Ho user buy their regular Ho Ho and their peanut butter? Or do they switch, or -- because we've never had peanut butter, that brings in a whole new user we haven't seen.

Early days, where we've had these in the single serve on some of the big single serve racks in a large mass customer, we're seeing very good movement on Peanut Butter Ho Hos and we're seeing very good movement on the Chocolate Cake Twinkie. And so those are -- and they've shown themselves so far to be pretty incremental.

It's early days. We don't have a lot of data that -- it's more anecdotal at this point. But we are encouraged that these new flavor forms or these new flavor analogues are bringing new consumers and driving what we hope will be some sustained growth here.

Bill, I saw the other day -- I was at Costco, and I saw that you had Twinkies and Chocolate Cake Twinkies. There was an endcap. How difficult is it to become a permanent vendor, let's say, to Costco? I know you've done some work in there, but (technical difficulty) seemed it's more transitory than permanent. But what does it take?

Yes, I've been selling to Costco for a lot of years. And I will tell you, I always think of everything as a rotation. It's 8-week or 12-week or 13-week rotation. It's a holiday rotation or a back-to-school type rotation. And generally there are a lot of permanent items at Costco, for sure. But I also think they like to keep things fresh. They like the treasure hunt mentality.

So I really think of everything as being rotational. And so, for an item to come in, it's great. It probably will go out and other things will come in; maybe not right after it, but certainly in the next season or the next event.

So that whole business for us has been largely rotational. You'll see a lot of companies that operate that way, particularly in snacks, which is a very crowded space for the club, and they have very limited SKUs of course in that format.

Okay. All right, thank you very much.

Rob Dickerson, Deutsche Bank.

First question is just around your comments on ISB. I think you said it seemed like there was maybe a less disciplined planogram or structure in that part of the store. And it sounds like that was kind of in general across the retailers. So I was just -- any color you have as to why you think that's the case, how that affects your planning? Is there less optimization potential in that part of the store? Or do you see this as maybe a way to outsize the opportunity versus your prior expectations? Thanks.

Yes, I think the -- first of all, the fragmentation in the category still suggests there's a great roll-up opportunity for us, or for anybody. There's somebody to [do], right? There's plenty of people to consider that to roll in the segmentation and categories.

Part of the mindset of how they run ISB is they want it to be, much like a Costco, kind of a treasure hunt. They want you to walk over there and fumble through the cupcakes and the donuts, and the cookies and the brownies, and -- it's not like walking down the aisle. It's much more of a I-baked-it-just-for-you experience. And it -- by definition, it isn't as organized.

And while that's a little uncomfortable for us traditionalists who like things organized by brand and SKU, it's a little bit of how the ISB does operate. And each store has more latitude in an ISB context than a -- let's say, going into a Publix. Each Publix bakery manager can make a choice on, yes, I'll carry this product or not that product. In the center of the store, it's pretty much driven by headquarter-authorized planograms.

So, it's different; it's very winnable. And the idea is to bring unique products that work within the retailers' plan. It's a huge category that is still growing. It's over $8 billion in sales, and it's growing 5% or so. So every year, there's $400 million of new behavior over there that we can go get.

So it's still very winnable. We just want to be very up front with folks in how we talk about it, that it has a little different executional cadence than some of the other categories we worked in.

Okay, cool. And then I think you mentioned before that some of the major grocery resets usually occur around that March-April period. The plan was to push the innovation into that period; and, therefore, you get the payback throughout the majority of the year.

So I'm just curious, where there any -- was there any kind of major learnings that you experienced through this March-April period? And maybe there was a bit of deceleration that we've seen within overall retail or -- I'm just curious, given the current environment and given this was we just got through or kind of sort of getting through -- toward the end of this reset period, what did you learn?

Yes, I think, first of all for retail broadly, and this is just more of a one-off comment, I think it's been a pretty tough quarter in Q1. I think we're very pleased at Hostess with our continued share and top-line and bottom-line progress, but I don't think retail overall had a very good quarter. I think it did come back a bit in April with Easter being in the month, and some other things going on there. But I think overall it has been a -- let's call it a slower start to the year for broader retail.

For us, it was very much right down the middle in terms of what we did and what we expected, and what we got. Now we just got to see it play out with consumers to see the demand on the new products, the amount of incrementality of the new products; and all that plays through.

But no real surprises or no real differentiation from this year versus others in terms of center of the store, planogram timing, and all the stuff you were asking about.

Okay, great. And then lastly, just more of a housekeeping. It looks like -- if I look at your total operating expenses, it seems like the lion's share of the increase year-over-year was really driven by the administrative line. And I know a piece of that is obviously Superior. But you did call out, in the release, professional -- the professional services and brokerage costs.

I'm just curious if you could provide some color as to what's driving that. Is that just the -- kind of like a potentially an overall bump off of some incentive comp? Or how should we think about that?

Yes, the primary item was the cost of the first public 10-K, and just getting that done in a more complex tax return and tax structure that drove a significant portion of the G&A increase, along with those that you mentioned and non-cash share-based comp that started the grants were issued in late March.

Okay. But if we look at that line, is that on a percent of sales basis, is that maybe more of a normalized rate? (multiple speakers)

Yes, I think so, yes. For this year, yes.

Okay, great. All right, thanks a lot. I'll pass it on.

Thank you. This concludes our question-and-answer session. I'd like to turn the floor back to management for closing comments.

Thank you, everyone. Appreciate your interest in Hostess, and look forward to speaking with you soon. Take care.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.