KANSAS CITY — While adjusted earnings in the fourth quarter of 2018 were flat, Andrew P. Callahan, president and chief executive officer of Hostess Brands L.L.C., expressed satisfaction with the final three months of the year.
“We are pleased with our solid finish to the year,” he said. “The team executed on our plan to advance our business in a dynamic operating environment. Our achievements have created a strong foundation for Hostess to build on in the future. We are excited to be celebrating Hostess’ 100-year anniversary and the iconic brand strength we bring to market with our entrepreneurial spirit, energy and enthusiasm. As we move forward into 2019, we are confident that our enhanced capabilities, strategic insights and capital investments will drive future innovation, sustainable growth and increased shareholder value.”
In early NASDAQ trading Feb. 28, the day after financial results were released, Hostess shares jumped 9%, to $12.39.
Net income at Hostess in the year ended Dec. 31, 2018, was $62,895,000, equal to 63c per share on the common stock, down 72% from $223,897,000, or $2.26 per share. Sales were $850,389,000, up 10% from $776,188,000 in 2017.
In the fourth quarter, net income was $11,830,000, or 12c per share, down sharply from $179,686,000, or $1.80, in the same quarter in 2017. Sales were $214,815,000, up 9% from $196,221,000.
Results in 2017 included a one-time tax gain of $163.1 million. The company said adjusted fourth-quarter earnings per share were about unchanged from the same period in 2017. The sales gain of $18.6 million in the fourth quarter of 2018 was more than entirely accounted for by a $20 million contribution from Cloverhill Bakery, acquired early in 2018.
Hostess said organic sales to mass merchandisers declined slightly while dollar, club, small format and grocery channels rose. Gross profits were $66.3 million, down 15% from $78.4 million. Gross margins fell to 32.6% from 42.3%. Contributing to the decline, Hostess said, were the “negligible margins” of the Cloverhill business.
The anticipation of better results from Cloverhill in 2019 is central to optimism about overall results. In a conference call with investment analysts Feb. 27, Mr. Callahan referenced the “integrated and transformed Cloverhill, which is fueling better access and capability in breakfast.”
“The Cloverhill business completed the installation of core capital improvements setting us up for accretive revenue and EBITDA growth for years to come, a great corporate milestone,” he said. “In 2019, we expect the Cloverhill business profitability to continue to improve as the year progresses.”
More broadly, he said Hostess is better positioned to participate in the promising snacks category with the company’s “iconic brands and loyal consumers.”
“To support this growth, Hostess has developed a scalable infrastructure with an efficient operating model, differentiated capabilities that support collaborative customer partnerships, robust innovation and significant cash flow that we believe sets us apart from our peers, and positions Hostess to create value for all stakeholders.”
The statement encompassed many of the five pillars he listed during the call as central to future growth — the company’s core business, innovation, agility and efficiency, the cultivation of talent and capabilities and leveraging the company’s strong cash flow.
He said Hostess is in the midst of a “proactive evaluation” of its stock-keeping units to optimize its portfolio, in line with consumer preference and to maximize growth.
Innovation opportunities include the breakfast category, where Hostess sees potential for a $100 million business as its “fair share.” Beyond breakfast, the company is focusing on premium products aimed at attracting newer consumers willing to buy products at higher price points.
“Hostess’ Totally Nutty peanut butter wafer bars and our new Hostess Danish are great examples of this,” he said. “We believe breakfast and premium innovations such as Bakery Petites are key platforms of growth over the next few years. They are both highly incremental to our business and expandable.”
At the same time, he said the company is exploring opportunities with its “value portfolio,” expecting to gain access to new channels through Cloverhill and utilizing the Dolly Madison brand.
Having made considerable progress with its Cloverhill business, Mr. Callahan said additional opportunities for heightened efficiency have been identified and will be pursued in 2019. Additionally, the company’s cash flow gives Hostess “the flexibility to pursue a range of strategic options.”
Gross profit of the Hostess Sweet Baked Goods segment was $66.3 million, or 32.6% of net revenue, which compared with $78.4 million, or 42.3% of net revenue in the previous year.
Gross profit of the In-Store Bakery segment was $2.5 million in 2018, versus $2.4 million the year before. Net revenue was $11.7 million, up 7% from $10.9 million in the fourth quarter. Gross margins narrowed to 21.3% from 22.4%, reflecting the effects of higher transportation costs.
“The company recognized impairment charges of $3.3 million to the goodwill and intangible assets within the In-Store Bakery reporting unit,” he said. “These charges reflect the impact of the decision to discontinue the Hostess Bake Shop product line as compared to expectations when the In-Store Bakery reporting unit was remeasured during the Hostess business combination. Based on the company’s impairment assessment, the fair value of the In-Store Bakery reporting unit continues to be well in excess of the initial cash purchase price of the Superior on Main business acquired in 2016.”
Capital improvements in the fourth quarter of 2018 are expected to boost efficiency and profitability in 2019, Hostess said.
Higher inflationary pressures, including increasing customer allowances, were blamed for an overall narrowing by 320 basis points in adjusted gross margins in the fourth quarter.
“The company is implementing multi-faceted pricing actions along with bakery efficiency programs to partially offset inflation while maintaining the company’s growth potential,” Hostess said.
Hostess executives earlier in the year said prices would be raised and were asked by analysts about timing and perhaps challenges experienced effecting price increases. Mr. Callahan said the company has done its research and was confident.
“As we’ve mentioned, we did a lot of research on the analytics and elasticities across our portfolio,” he said. “We priced the balance of recovery of the inflation and margin, but while maintaining growth. And therefore, we did price across select areas of the portfolio, mostly around single-serve, and then took other initiatives related to rolling out our Hostess Partnership Program, some downsizing and some other initiatives across the rest of the portfolio. So most of the list price increasing was within the single-serve and some areas within our value channel.”
For 2019, Hostess projected “revenue growth well above the sweet baked foods category, predicting that innovation in breakfast products, other core products, expanded distribution and improved merchandising execution will help. EBITDA guidance in the new year is $200 million to $210 million, up 7% to 13% from 2018, “driven by strong operating cash flows.” Earnings per share are forecast to grow 6% to 15% in 2019.