KANSAS CITY — The selective reopening of the US economy has given Hostess a peek into what kind of recovery may be expected for its business as people return  to work, and the indications appear positive, said Andrew P. Callahan, president and chief executive officer of Hostess Brands, Inc., Kansas City.

In a June 17 colloquy with David Palmer, senior managing director of Evercore ISI, Mr. Callahan offered an update on Hostess’ performance in the midst of the coronavirus (COVID-19) pandemic, gave a status report on the integration of the Voortman Cookies Ltd. business acquired for $320 million in January, and shared insights on several COVID-related matters, including surprisingly persistent tightness in the US labor market and how the company has slowed its pace of new product introductions. Part of the 2010 Evercore ISI Virtual Consumer & Retail Summit, the discussion also included Brian T. Purcell, executive vice president and chief financial officer of Hostess.

“It’s unmistakable that when they opened up and consumers are getting back to work, we’re seeing sales bounce back right away,” Mr. Callahan said.

Similarly, he said the Hostess warehouse distribution model will give the company a chance to gain share in coming weeks and months. He said benefits of the model stand out in servicing smaller customers in general, and convenience stores and dollar stores in particular.

“If you think about it, we compete with some manufacturers who are                  DSD (direct-store delivery),” he said. “When (the pandemic hit) the DSD, in order to service demand, went to the largest stores. There were some stores that felt not as serviced. … that’s proven to be an opportunity for us. I actually think that in some of these channels we will come out stronger relative to distribution, relative to assortment because we’re there all along. We’re servicing our distributors. We’re servicing our customers even when business was weak, and we expect that to be a positive for us. Consumers are driving on vacation, they’re not flying places. They’re driving back to work, maybe taking less mass transit. I think all that is a positive.”

From a historical perspective as well as measured specifically by what is occurring in the marketplace at present, Hostess is well positioned for this moment in time, Mr. Callahan said.

“This brand historically does very well in booming economies and declining economies,” he said.

Powerful COVID-related trends identified by Hostess management during the first-quarter earnings call in May included a shift in consumer purchases toward multi-packs and away from higher-margin single-serve. Sales of the latter products were down between 10% and 15%.

Since then, multi-pack sales have enjoyed strong, even stronger growth, and single-serve business has shown signs of recovery, Mr. Callahan said.

“Our c-store channel which is not a 100% but the majority of our single-serve business has seen steady and consistent improvement since I would say the middle of April,” he said. “We see consumers coming back. We see take away coming back, and we also see our distributors who had pulled back purchases to preserve cash in the short term, filling back inventories and consumption growing.”

Mr. Callahan offered other reasons beyond distribution for the company to be upbeat about its positioning when the pandemic wanes. In particular, he cited the higher household penetration achieved in recent months, a two percentage point gain, and improvement in repeat purchases. While overall sales in convenience stores and other lagging segments have been down, the company’s business has not declined as much as the overall category, and certain products, including bagged Donettes, have seen sales gains.

“I feel really good about us coming out of this stronger than when we went in,” Mr. Callahan said. 

Mr. Palmer posed a number of questions around reasons investors may be wary of investing in Hostess, including the reduced management involvement and the reduced investment of C. Dean Metropoulos, chairman of Hostess. Mr. Callahan said Mr. Metropoulos remains chairman and serves as a mentor to Mr. Callahan as well as other Hostess leadership, particularly around mergers and acquisitions.

“I think Dean would support this — he’s a great mentor, but we have a terrific management team I’m fortunate to have surrounding me that are running this company,” Mr. Callahan said.

Acquisitions bring integration risk, and given the growing significance acquisitions are playing at Hostess, Mr. Palmer asked the executives to comment on how the investment community should view those kinds of risks at Hostess. Responding, Mr. Callahan said Hostess has a track record that should put those concerns to rest.

“I think the results speak a lot,” he said. “I think if you look back, we have many of our people, especially within the operations side and our finance who relaunched Hostess from nothing,” he said. “They have that experience. They bought the Superior on Main business and then we sold it for basically a 40% return. We turned around the Cloverhill business that was losing $50 million, and now are executing Voortman. Each time is another chapter and another refinement and another kind of learning to our integration playbook. We have partners that we’ve done it with, people that have been through it. I just couldn’t be more thrilled about the quality of the executions I’ve seen so far. We’re paranoid about making sure we look around the corner and see the next opportunity or the next problem that we avoid, but we’re able to do that.”

Looking forward, Mr. Callahan said further acquisition opportunities will emerge to “create value with really good and smart acquisitions.”

He said the investment community has been prone to criticizing management for being too conservative in M&A as well as too aggressive.

“Before we executed this one (Voortman), we heard ‘You can’t execute. You said you were going to have an M&A and you didn’t,’” he said. “Then we had too much cash. Then we execute the M&A and then our leverage is too high. But we’re focused on the long term. We’re going to do what we really do very well. We’ve sharpened our competencies over the time since we’ve been here to be able to even improve it, and I think it’s going to continue to be a strategy. We’re going to focus on perfection on Voortman. We are going to deleverage very quickly, and I think there are a lot of opportunities for us to create value out there and execute even more in the future.”

Mr. Purcell and Mr. Callahan used the Voortman acquisition as evidence of the company’s ability to successful integrate an acquisition.

The company is on track to generate up to $15 million in cost synergies over 12 to 18 months, Mr. Purcell said. Those will be harvested after the first quarter, which was before Hostess transitioned Voortman to a warehouse delivery model from DSD. Mr. Purcell said revenue from Voortman’s was artificially depressed during the quarter because “independent distributors were bleeding down their inventory” before the company transitioned to warehouse delivery.

That the Voortman business was basically break even in the first quarter also should be viewed as a considerable achievement, Mr. Purcell said.

“We were running two networks, and we didn’t really harvest any cost synergies in Q1,” he said.

Before the company stopped giving guidance, management had projected $90 million in revenue from Voortman and $20 million in EBITDA this year.

“We feel great about those numbers that we talked about previously in terms of how the integration is going in terms of how the synergies are going,” Mr. Purcell said. “We said the contribution was going to be roughly two-thirds back-half driven from a revenue standpoint and even more so from a profit standpoint as we realize those synergies.”

By 2022, the company believes Voortman’s EBITDA could reach $40 million.

Mr. Callahan was, if anything, even more upbeat about the success of the Voortman business performance, emphasizing the complexity of the integration.

“I see nothing right now that would leave me to believe that we are not at or above those numbers,” he said. “I think everybody is going to be happy as we get through 2020 on the execution of Voortman.”

He said the success Hostess has enjoyed transitioning the distribution system of Voortman stands in stark contrast to the experience of other prominent packaged foods companies.

“The CPG companies that are transitioning from DSD to warehouse are littered with down 20%,” Mr. Callahan said. “We’ll be close to flat this quarter if not above that while killing 40%, 45% of the SKUs (stock-keeping units), aligning a national food distribution base around, moving from a DSD to our warehouse model. And we built a business underneath the brand in the distribution. We had to redo all the packaging. We needed to have it ship-tested. We needed to change all the mill specs. We needed to change it into the IT system, connect it to all the national retailers, get the buyers to understand the category, get them to repurchase, change all the shelf tags get a cost aligned up get the shipper, I mean it is a magnitude, it’s amazing in the way the team executed that. It’s is awesome and we now shifted to Canada, and they’ve executed perfectly as well. We’re now moving to growth mode.”

Targets for growth for Voortman include what Mr. Callahan called “cracks in distribution,” including selling into convenience stores, and the development of products for club stores.

At a higher level, Hostess is exploring ways to capitalize on the two different consumer sets between the Hostess and Voortman categories, the mix between snack cake and cookie assets and the mix of manufacturing capabilities.

“We acquired some cookie capability that I think has a lot of opportunity and is under leveraged,” Mr. Callahan said. “Remember we’re the No. 1 wafer. We’re also the No. 1 sugar-free cookie.”

He said the company is testing to see what would have the greatest consumer appeal and potential incrementality for Hostess.

“We’re prioritizing those opportunities, but I certainly see some good revenue opportunities in front of us,” he said.

While the media steadily focuses on health and wellness as a major, unstoppable trend, Mr. Callahan said warnings that the sweet goods category will be undone by such trends consistently are shown to be unfounded.

“I have heard that comment since the day I walked in the door about two years ago,” he said of supposed increased attention devoted to health and wellness. “If you look at the way the consumers are behaving, they’re snacking more, and within those snacking they’re snacking on sweets and indulgence more frequently. It doesn’t mean they’re consuming absolutely more sweets, but when they do consume it, they want something that they enjoy.  Those trends are continuing. That’s been continuous since I started, and I believe that there’s opportunities for more consumers who are looking at eating more frequently during the day and looking for one of those six or seven occasions just to be treat me, comfort me or get into other occasions.”

Amid these trends, Hostess has the opportunity to meet “other need states,” Mr. Callahan said. “I also believe related to Hostess specifically there are some other need states maybe multi-occasions or otherwise that we don’t compete in but our product fits perfectly. So I hear that often, and I know the headlines always want to be health and wellness. I’m a little bit of a behavioralist as well as an attitudinalist, and the data that would support that there’s a good bit of runway and a large demand pool for Hostess to continue to grow.”

With unemployment rates at the highest levels since the Great Depression, baking executives had hoped an easing of the chronically tight labor market would represent a silver lining. To date, those hopes have yet to be realized, Mr. Callahan said.

“Despite the really high unemployment, labor is not as accessible as it should be for us,” he said. “All of this government support, which I completely understand and I think it’s needed especially for some segments, it has created an interesting short-term tension around labor around some of our plants. As we get through this summer I expect that to flip, and labor will be much more accessible but it is a little bit of a short-term crunch.” 

The coronavirus pandemic has prompted Hostess to delay new product introductions but has not halted innovation efforts at the company, Mr. Callahan said.

He was upbeat describing platforms that in some case will represent subtle differences with existing product and in other cases will be more “meaningfully different” targeting new eating occasions/needs for consumers.

“We have (an introduction) we were planning to make it a little bit sooner,” Mr. Callahan said. “Frankly we delayed it for two reasons. One is we had some modifications in the plants during the COVID. It was only essential personnel in the plants. We made a very conscious decision to say ‘Let’s hold off all unnecessary engineering work as we just deal with keeping the plants open.’ I’ve no regrets about that because our consumption is going to be really strong.

“I think the platform is more refined than it was before. I believe our insights and our learnings on these platforms is ahead. We are going to start selling these in the market in ’21.”

Even before his arrival, Hostess had product innovation/marketing playbook Mr. Callahan said has been and remains effective.

“I’m highly encouraged about our opportunities and continue to expand our usage and consumer base through innovation as we continue to pull the levers that were very successful for us on the LTOs and line extensions that are very good as we move into the back half of the year,” he said. “I don’t think that our limited-time-offer programming that ties to usage are seasonally relevant or tied into culturally relevant icons or movies get enough credit. The team before me, the marketing team led by Andy Jacobs built that model, and it’s absolutely brilliant. It is highly incremental and highly relevant. It is tied to usage, tied to displays. We are going to continue to do that very well in the line extensions. I feel good about our lineup as we move into ‘20 it’s a little bit more focused given the situation relative to space, and ’21 its going to be absolutely terrific.”