KANSAS CITY — A marked product mix shift away from higher margin single-serve products at Hostess Brands, Inc. over the past two months is likely to reverse as stay-at-home orders expire, Brian Purcell, the company’s chief financial officer, said. A tilt in product mix toward multipacks is one of several dramatic shifts Hostess executives described in a May 8 conference call with investment analysts.
Hostess net income in the first quarter ended March 31 was $2.64 million, equal to 2¢ per share on the common stock, down sharply from $21.13 million, or 21¢ per share, in the first quarter last year. Sales were $243.49 million, up 9% from $222.74 million. The net income decline was attributed to acquisition costs associated from Voortman Cookies Ltd. Net sales were up 14%, excluding the divested in-store bakery business. Hostess said Voortman accounted for 8.1 points of the adjusted sales growth with other sweet baked foods generating 6.3 points of growth.
Adjusted EBITDA of $51 million was up 6% from a year earlier, excluding the in-store baking business, and beat an anticipated single-digit decline. Hostess said the improved profitability reflected higher volume and better-than-expected Voortman performance, offset partly by increased distribution and labor costs.
Mr. Purcell said sales, excluding the divested in-store business, were tracking up 5% in the quarter through February, spiked 12% in March and then were up 4% in April, demonstrating the “pantry loading and subsequent decline.” He said the temporary surge contributed two to three points to the company’s revenue growth in the first quarter.
Of concern, he said the company’s higher-margin single-serve business has been down 10% to 15% over the last few weeks while sales of multi-packs have increased 15%.
“We believe a large portion of this shift in product mix reflects the temporary change in consumer shopping habits during stay-at-home orders, which has resulted in less store traffic in our highly developed c-store channel and increased pantry stock with other channels,” Mr. Purcell said. “We are optimistic that this shift will begin to reverse as stay-at-home orders lift, and there is an increase in convenience support traffic this summer as more people may drive versus fly.”
He cautioned that his crystal ball on how buying patterns will shift in coming months is anything but perfect.
“The timing and extent of the COVID-19 impacts on consumer behaviors in the near term is uncertain,” he said.
Andrew Callahan, chief executive officer, said Hostess facilities have remained operational during the pandemic but not without extraordinary effort. Initiatives include incremental sanitation breaks and cleaning protocols above “already robust traditional sanitation protocols.”
“We have installed additional sanitation stations within the bakeries, provided temperature and health survey readings at every facility in our network, provided base coverage for all employees, installed safety glass, plexiglass and dividers at critical locations on the lines and break facilities and modified production schedules to support distancing and eliminate density,” he said.
Hostess has paid associates for COVID-19 testing, provided supplemental pay benefits and extended leave-of-absence job protection, Mr. Callahan said. How the company has been affected has not been uniform from one plant to the next.
“Each of our facilities has been impacted differently based on the mix of demand, local variations and policies and the degree of COVID-19 impact in the community,” he said. “For example, our Chicago facilities lines are physically closer together and require more people as compared to our highly automated Emporia (Kansas) bakery, resulting in more impactful changes to our operating procedures and modifications to the facility to ensure the safety of our employees. We are continuing to modify our manufacturing, supply chain and merchandising priorities to respond to the changing market dynamics.”
Like many food companies, Hostess has prioritized key stock-keeping units and is working with retailers to minimize out-of-stocks while also adjusting the timing and nature of trade programs.
“We’re also making adjustments to our marketing programs to increase our e-commerce footprint, capture consumers digitally, during planning and best target anticipated consumer changes,” he said. “The changes we have made to this point are meaningful and implemented quickly to appropriately address the changing needs of our business, the timing and magnitude of change for the next phase is uncertain.”
In addition to the shift between single-serve and multi-packs, a jump in e-commerce sales represents another change since the start of the pandemic.
Mr. Callahan said e-commerce sales had been running at about 2% of the company’s overall sales and have jumped.
“We’ve seen that spike more at some retailers than others,” he said, quadrupling in some instances.
“We’re looking at reinforcing some of the marketing efforts around their intercepting consumers, around the planning timing of where they shop,” he said. “So that’s going very well.”
Convenience store business has been an area of weakness for some packaged foods companies, but Mr. Callahan said the pandemic is likely to leave Hostess stronger in c-stores than before the outbreak.
“We’re not missing the opportunity as we’re stronger in c-stores,” he said. “There’s some positives here as well. Some of our c-store customers are doing less around fresh bakery and more packaged. So the areas that used to be fresh donuts and pick-and-mix are now prepackaged. We’re expanding our shelf sets during the time because we’re there — where maybe some other suppliers are not there.
“The impact is more related to impulse purchase and single-serve. So as a matter of fact, even though the channel in c-store is down, we still see relatively strong and growing performance in our bread business, for example, and our bun business as well as our donut business in that channel.”
Mr. Callahan said household penetration for Hostess has climbed two percentage points over the last four weeks, “which I feel great about.”
During the call, Mr. Callahan described “significant” progress in the integration of Voortman into Hostess, a process he called complex and made more complicated by the COVID-19 pandemic.
Mr. Callahan credited a go-forward team he said is successfully transitioning Voortman to the Hostess warehouse distribution model from a direct-store delivery model.
“Voortman results were performing ahead of plan before the benefit of the COVID-19 stock up in March,” Mr. Callahan said. “The Voortman integration is going very well. We executed key integration activities, including transitioning Voortman’s distribution model, which remains on track as US shipments under the warehouse model were successfully executed in April. Importantly, Voortman is accretive to adjusted EBITDA in Q1 and generated solid point-of-sale growth, up 9.4% during the quarter, further solidifying our optimism for the future profitable growth potential of Wortman when fully integrated.”
He said the company has lowered its projection for transition costs associated with Voortman to a range between $25 million and $30 million, down from the previous forecast of $30 million to $35 million.
Hostess has withdrawn financial guidance for the balance of the year, but Mr. Purcell said the stepped-up safety measures implemented in recent weeks will result in higher costs during the second quarter.
Still, he struck an upbeat tone.
“Voortman EBITDA contribution is expected to improve meaningfully in the second half of the year as we begin to realize synergies and drive incremental revenue with our proven Hostess model,” he said. “Despite the temporary uncertainty created by COVID-19, we remain confident in our underlying business fundamentals, which support our ability to achieve our long-term financial objectives, including organic revenue growth, adjusted EBITDA margins and free cash flow conversion in the top quartile of our free cash flow conversion in the top quartile of our peers.”