May 9, 2017
Executives
Rachel Perkins - ICR Bill Toler - President and CEO Tom Peterson - EVP and CFO
Analysts
Bill Chappell - SunTrust Robinson Humphrey Brian Holland - Consumer Edge Research Michael Gallo - CL King John Braatz - Kansas City Capital Rob Dickerson - Deutsche Bank
Operator
Greetings and welcome to Hostess Brands First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode and a brief 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 Rachel Perkins.
Thank you. Please go ahead.
Rachel Perkins
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 ending March 31, 2017 that went out this afternoon at approximately 4:05 PM Eastern Time.
If you have not received the release, it's available on Hostess' 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' 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 references 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 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 combined information for the quarter ended March 31, 2016 giving effect to the 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'll turn the call over to Hostess' CEO, Bill Toler.
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 continuous success in launching new innovative products, our continuing expansion of shelf space and growth in points of distribution. We've also begun to penetrate white space channels.
We're seeing good momentum in our Hostess sub brand 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 in the April 22, 2017 up 126 basis points from the prior year.
Results were led by snack cakes, brownies and donuts 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 out of 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 were 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 innovations revenue generated from new products during the first year there on the market.
We sold substantially more from renovation in the first quarter of 2017 than in the same period last year and benefited from the wraparound effect of Suzy Q and Hostess Sweet Shop Brownies as well as our early 2017 launches. Also, our seasonal offerings are limited time offers performed very well versus prior-year in Q1 of 2017.
We've been encouraged by the retailer and consumer response for our new items. They're next to our largest business, regionally launched cinnamon sugar crunch.
We've also launched the first line extension on Ding Dongs a 50-year-old brand 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 build a handle peanut butter and recently we launched Peanut Butter Ho Hos and we'll 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 Cupcakes.
Our white space efforts and distribution, innovation are beginning to show traction, since acquiring Superior in May, our in-store bakery business, that business has grown 16% and with the launch of Hostess Bake Shop we learned that ISPs doesn’t have the same predictable cadence for new items that merchandising as sweet baked goods. There is less discipline on the timings and resets that it is grocery and our program will take a little longer to take hold.
That being said, we're pleased with the early response to Hostess Bake Shop. To better work in the ISB model, we've implemented a number of changes including integrated the ISB sales team with the Hostess package sales team and leverage our current existing customer relationships.
While we believe the Hostess, Brand can play well in the category to the Hostess Bake Shop, we're also playing off our cobranded products and have incremental innovation plan for later this year. In summary, our differentiated business model continues to drive growth and our overall market share across suite 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.
Tom Peterson
Thank you, Bill. I'll now review our first quarter financial performance and some other data from today's press release.
For comparative purposes, we'll review unaudited pro forma financial statements for the quarter ended March 31, 2016, which presents our result as just the business combination had occurred as of January 1, 2016. We believe this discussion provides helpful information on the comparative performance of Hostess on the Hostess business during this period.
As Bill indicated, we are pleased with our financial performance. We posted strong topline growth in the first quarter and we have 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 topline contributions from ISB and an increase in cases sold as a result of product innovation, including the launch of Chocolate Cake Twinkie, 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 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 with $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 time, trailing 12 month pro forma combined adjusted EBITDA of $221.7 million. This has 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 meaning 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 Sweet Bakers 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 $0.61 per Class A common shareholders. This is based on expected basic and diluted shares outstanding of approximately $98.7 and $106.8 million respectively.
We're anticipating income tax payment 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 extensions 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're available for questions.
Operator
Thank you, ladies and gentlemen. [Operator instructions] Our first question comes from the line of Bill Chappell with SunTrust.
Please go ahead with your questions.
Bill Chappell
Thanks. Good afternoon.
Bill Toler
Hey Bill. How are you?
Bill Chappell
Am handing in there. Bill just a little more commentary to what you're seeing in the category from just your growth in 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 pick up from your competitors in terms of innovation or promoting the category or are you expecting 1% growth for the category this year?
Bill Toler
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 as users traditionally are fairly weak period for, we see weekly POS numbers and while we don't talk in those terms, we see continued strong POS from our customers 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 shelves.
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 think it's expected to get back to that 3%, 4% level in the next few months.
Bill Chappell
Okay. And then just talking about the new distribution any -- as we've now gone through most of the resets, any major expansion did even the drug channel where you are on the c-store channel or even in food or is it fairly similar to what you look like three months ago?
Bill Toler
No, we had very good expansion in grocery at major mass customers and consistent expansion at c-store. So, feel pretty good there.
As you know our shares in drug have dropped a bit. One of a 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 working on -- working on trying to mitigate that with some merchandising ideas but the basic new items, the 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 through April and early May.
Bill Chappell
Okay. And then last one for me just any change outlook on commodities?
I know you're fairly locked in for this year, but any relief as we go versus your original expectation?
Bill Toler
No, pretty much as it has been for a few months and has been pretty favorable story and like you say, we're pretty well protected for 2017 and are working now to get into '18 as well and we are into '18 as well.
Bill Chappell
Got it. Thanks so much.
Bill Toler
Thank you.
Operator
Thank you. Our next question comes from the line of Brian Holland with Consumer Edge Research.
Please go ahead with your question.
Brian Holland
Thanks. Good afternoon, gentlemen.
Bill Toler
Hey Brian.
Brian Holland
So first question, just want to understand on the instore bakery and the commentary there and I think you've been pretty consistent on the commentary where offline about the complexities of getting the product in the store and the execution. Just curious I guess at this stage, how that's performing relative to your expectations?
Is there any sort of cost in here that may be relative to your '17 plan that maybe as perhaps this is why we're holding guidance I also presume it's only Q1? Is there a way to point how that's coming versus your expectation, just any commentary there?
Bill Toler
Remember ISB is a total in our business still less than 6% right. So, any number there is not going to really move the whole needle that greatly.
Now we do have nice growth plan there and as I said, we grunted 16% since we acquired 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 kind of acts in unison, it doesn't happen in ISB, primarily because it's a retailer control category with about 70% of the products being private label or our own 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 and 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.
Brian Holland
Great. That's helpful, thinking about this innovation on whole for your business this year and if I recall it was distributed something like 7% to your growth in '15 I think the CupCakes and growth were among the larger ones.
As you think about the ways of new products this year, obviously a lot of that is unique to what you introduced last year. Is there an expectation about what that could contribute relative to what we saw in '16?
Is there any expectation we could do something on the line of 7% or do you think the overlap with the new product introduction this year whether it's line extension etcetera might limit that contribution? Is there a way to think about that and how do you sort of break that down?
Bill Toler
Here's how we feel about, the '17 innovation I think is probably fundamentally stronger items than the '16 innovation. The difference is the '16 innovation was very incremental and different and outside of our current categories right.
As you said Deep Fried Twinkies where we never played before, Brownies we never played before. Products that were really is Suzy Q and Icon we were bringing back and now this year we get Chocolate Cake Twinkie, Peanut Butter Ho Ho, white fudge covered Ding Dong, they're little closer in, so the rest of course is maybe a little more cannibalistic, but they're also highly desired product forms whether it's peanut butter, the number one gap we've had, Chocolate Cake Twinkie, which has a big win so far.
So, it's always that question of incrementality versus just growth right and of course again a year or two of the 2016 numbers which you're right, your 7% is exactly right, it is $44 million last year. We get the pipeline onetime benefit, so you're not allowed to get that again and so those are things we're working through and we're going to learn that a lot in Q2 as we're 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.
Brian Holland
Thanks. Last one for me and forgive me if you addressed this earlier in the call, a little bit of sensitivity last week in response to the scanner data, any commentary there about whether the lag in picking up those skews 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 trade and maybe magnitude of impact on that consumption data?
Bill Toler
Yes, and as you know we only buy one of the services. So, we get all the detail around Nielsen.
We only get kind of stand by some snippets on IRI from different sources. The biggest difference was IRI cut off a week earlier, the week before Easter versus Nielsen.
So, when our Nielsen numbers which were lower in effect it had that week of slower sales in Easter, which is totally expected and IRI did not. So, I think that's the biggest difference much different than a data problem or anything like that, that was not the case.
The case was really the timing difference of when the two different sources cut off.
Brian Holland
Okay. Got it.
Thanks. Best of luck.
Bill Toler
Thank you. Thanks Brian.
Operator
Our next question is coming from the line of Michael Gallo with CL King. Please go ahead with your questions/
Michael Gallo
Hi. Good afternoon.
Bill Toler
Hey Michael.
Michael Gallo
My question, you've done, you've had a lot of success going to a lot of adjacencies whether it be Deep Fried Twinkies etcetera. 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 for the joint or the foreseeable future?
Bill Toler
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 and ISB as well.
We're moving into ISB with cupcake cookies, so we're starting to play over there a bit, but in the IR sweet baked goods, we have not yet found the right solution for whether to buy our way in and 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 analogs do that.
Michael Gallo
Okay. Thank you.
Bill Toler
Thanks Michael.
Operator
Our next question is coming from the line of John Braatz with Kansas City Capital. Please go ahead with your question.
John Braatz
Good afternoon, Bill, Tom?
Bill Toler
Hey John, how are you?
Tom Peterson
Hey John.
John Braatz
Bill, you talked a little bit about incremental gains versus maybe as opposed to some cannibalism of 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?
Bill Toler
Yeah there are two things. First of all, when you say gained, I oftentimes think of that as items in our store and shalf position.
Those been pretty clean right. We're gaining the second Ho Ho.
We're gaining the second Ding Dong or 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 terms of the incrementality right. There is a Ho Ho user buy their regular Ho Ho and their peanut butter or to 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 a single serve on some of the big single server 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 Choco Cake Twinkies 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 is more anecdotal at this point, but we are encouraged that these new flavor forms, that these new flavor analogs are bringing new consumers and driving what we hope will be some sustained growth there.
John Braatz
Bill, I saw the other day, I was in Costco and I saw you Twinkies and Chocolate Cake Twinkies over there, how difficult is it to become sort of a permanent vendor let's say to Costco. I know you've done some work in there, but that seemed it's more transitory than permanent, but what does it take?
Bill Toler
Yeah, I been selling to Costco for a lot of years and I'll tell you always think of everything as a rotation right. It's a 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 in Costco for sure. But I also think they like to keep things fresh.
They like the treasure mentality. So, I really think of everything as being rotational and so for an item to come in, it's great and it probably will go out and other things will come in maybe not right after, but certainly in the next season or next event.
So that whole business for us has been largely rotational and you'll see a lot of companies that operate that way, particularly in snacks which is a very crowded space for the club and have very limited SKUs of course in that format.
John Braatz
Okay. All right.
Thank you very much.
Operator
Our next question is coming from the line of Rob Dickerson with Deutsche Bank. Please proceed with your question.
Rob Dickerson
Thank you very much. How are you?
Bill Toler
Great.
Rob Dickerson
All right. First question is just around your comments on ISB.
I think you said speed that you said it's seems like there is maybe like a less disciplined planogram structure in that part of the store and it sounds like that was kind of in general across the retailers. So just any color you have as to why you think that's the case?
How that affects your planning? Is there less optimization the potential in that part of the store or do you kind of -- do you see this as may be way to outsize the opportunity versus your prior expectations, thanks?
Bill Toler
Yeah, I think first of all the fragmentation category still suggest there is a great roll-off opportunity for us or for anybody somebody it's true. There is plenty of people to consider to roll in the segmentation and categories.
Part of the mindset of how they run ISB is they wanted to be much like the Costco, kind of treasure. They want you to walk over there and fumble through the cupcakes and the doughnuts and the cookies and the brownies and sort of it's not like walking down the aisle.
It's much more of a I think it's just for you experience and by definition it is sometimes organized and while it's little uncomfortable for us traditional who like things organized by Brandon SKU that's a little bit of how the ISB does operate and each store has more latitude in ISB context then let's say going into a public 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 authorize planogram. So, it's different, it's very winnable and the idea is to bring unique products that work within the retailer's plan and it's a huge category, it's so growing.
It's over $8 billion in sales and it's growing 5% or so that it's 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 upfront with folks and how we talk about it that it has a little different executional cadence than some the other categories they worked in.
Rob Dickerson
Okay. Cool and then I think you mentioned before that is some of the major grocery resets you incur on that March April period plan for the pushed innovation into that period and therefore you get the payback throughout the majority of the year.
So, I am just curious were there any -- was there any kind of major learnings that you experienced through this March-April and maybe there is that deceleration that we've seen within overall retailer or I'm just curious given the current environment and given this was we just got -- getting through toward the end of this reset period, what did you learn?
Bill Toler
Yeah, 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 as Hostess of our continued share and topline 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 kind of all that plays through. But no real surprises or no real differentiation from this year versus others in terms of the store planogram timing all the stuff you're asking about.
Rob Dickerson
Okay. Great and then lastly, just more of a housekeeping, it looks like just, if I look at your total operating expenses, it seems like the lion's share of the of the increase year-over-year was really driven by the administrative line and I know piece of that is obvious superior, but you did call out in the release of the professional services, brokerage cost, I am just curious if you could provide some color as to what's driving that?
Is that just the kind of like potentially an overall bump off of some incentive comp or kind of how should we think about that?
Bill Toler
Yeah, the primary item the cost of the first public 10K 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 in non-cash share-based comp that started the grants were issued in late March.
Rob Dickerson
Okay. But if we look at that line, is that on a percent of sales basis, is that more of a normalized rate or…
Bill Toler
Yeah, I think so yes for this year, yeah.
Rob Dickerson
Okay. Great.
All right. Thanks a lot.
I'll pass it on.
Bill Toler
Thanks Rob.
Operator
Thank you. This concludes our question-and-answer session.
I would like to turn the floor back to management for closing comments.
Bill Toler
Thank everyone. Appreciate your interest in Hostess and look forward to speaking with you soon.
Take care.
Operator
Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.