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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the three months ended
 
June 30, 2019
 
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-37540
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=13047880&doc=11
HOSTESS BRANDS, INC.
(Exact name of registrant as specified in its charter)
Delaware
47-4168492
(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)
1 East Armour Boulevard
64111
Kansas City,
MO
(Zip Code)
(Address of principal executive offices)
 
(816701‑4600
Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:
Title of each Class
Ticker Symbol
Name of each exchange on which registered
Class A Common Stock, Par Value of $0.0001 per share
TWNK
The Nasdaq Stock Market LLC
Warrants, each exercisable for a half share of Class A Common Stock
TWNKW
The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S‑T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.:
Large accelerated filer
Accelerated
filer 
Non‑accelerated 
filer 
Smaller reporting company 
Emerging growth company 
☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Act). Yes  No 
Shares of Class A common stock outstanding - 109,323,871 shares at August 6, 2019
Shares of Class B common stock outstanding - 20,999,784 shares at August 6, 2019



HOSTESS BRANDS, INC.
FORM 10-Q
For the Quarter Ended June 30, 2019

INDEX
 
 
Page
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.






Cautionary Note Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q contains statements reflecting our views about our future performance that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. All statements contained in this Quarterly Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. Statements that constitute forward-looking statements are generally identified through the inclusion of words such as “believes,” “expects,” “intends,” “estimates,” “projects,” “anticipates,” “will,” “plan,” “may,” “should,” or similar language. Statements addressing our future operating performance and statements addressing events and developments that we expect or anticipate will occur are also considered as forward-looking statements. All forward‑looking statements included herein are made only as of the date hereof. It is routine for our internal projections and expectations to change throughout the year, and any forward-looking statements based upon these projections or expectations may change prior to the end of the next quarter or year. Readers of this Quarterly Report are cautioned not to place undue reliance on any such forward-looking statements. As a result of a number of known and unknown risks and uncertainties, our actual results or performance may be materially different from those expressed or implied by these forward-looking statements. Risks and uncertainties are identified under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018, as updated by subsequent filings. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these risk factors. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise. The discussion and analysis of our financial condition and results of operations included in Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Consolidated Financial Statements and related notes included in Item 1 of this Quarterly Report.


3



HOSTESS BRANDS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited, amounts in thousands, except shares and per share data)

June 30,
 
 
December 31,
ASSETS
2019
 
 
2018

 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
$
189,284

 
 
$
146,377

Accounts receivable, net
128,187

 
 
105,679

Inventories
42,893

 
 
38,580

Prepaids and other current assets
10,285

 
 
8,806

Total current assets
370,649

 
 
299,442

Property and equipment, net
223,751

 
 
220,349

Intangible assets, net
1,889,221

 
 
1,901,215

Goodwill
574,645

 
 
575,645

Other assets, net
10,713

 
 
14,062

Total assets
$
3,068,979

 
 
$
3,010,713

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
Long-term debt and lease obligations payable within one year
$
13,206

 
 
$
11,268

Tax receivable agreement payments payable within one year
7,700

 
 
4,400

Accounts payable
72,161

 
 
65,288

Customer trade allowances
50,765

 
 
42,010

Accrued expenses and other current liabilities
23,100

 
 
18,137

Total current liabilities
166,932

 
 
141,103

Long-term debt and lease obligations
972,118

 
 
976,736

Tax receivable agreement
85,820

 
 
64,663

Deferred tax liability
273,575

 
 
277,954

Other long term liabilities
107

 
 

Total liabilities
1,498,552

 
 
1,460,456

 
 
 
 
 
Commitments and Contingencies (Note 11)

 
 

 
 
 
 
 
Class A common stock, $0.0001 par value, 200,000,000 shares authorized,109,323,871 and 100,046,392 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively
11

 
 
10

Class B common stock, $0.0001 par value, 50,000,000 shares authorized, 20,999,784 and 30,255,184 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively
2

 
 
3

Additional paid in capital
1,022,529

 
 
925,902

Accumulated other comprehensive income (loss)
(190
)
 
 
2,523

Retained earnings
303,974

 
 
271,365

Stockholders’ equity
1,326,326

 
 
1,199,803

Non-controlling interest
244,101

 
 
350,454

Total liabilities and stockholders’ equity
$
3,068,979

 
 
$
3,010,713

See accompanying notes to the unaudited consolidated financial statements.

4


HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, amounts in thousands, except shares and per share data)
 
Three Months Ended
 
Six Months Ended
 
June 30, 2019
 
 
June 30, 2018
 
June 30, 2019
 
 
June 30, 2018
 
 
 
 
 
 
 
 
 
 
Net revenue
$
241,060

 
 
$
215,849

 
$
463,798

 
 
$
424,592

Cost of goods sold
157,610

 
 
148,992

 
305,160

 
 
286,494

Gross profit
83,450

 
 
66,857

 
158,638

 
 
138,098

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
Advertising and marketing
10,696

 
 
8,938

 
19,559

 
 
17,808

Selling expense
8,310

 
 
7,751

 
16,830

 
 
15,139

General and administrative
19,276

 
 
11,185

 
36,747

 
 
25,746

Amortization of customer relationships
6,009

 
 
5,994

 
11,994

 
 
11,989

Other operating expense (income)
2,278

 
 
(1,660
)
 
517

 
 
(104
)
Total operating costs and expenses
46,569

 
 
32,208

 
85,647

 
 
70,578

Operating income
36,881

 
 
34,649

 
72,991

 
 
67,520

Other expense (income):
 
 
 
 
 
 
 
 
 
Interest expense, net
10,302

 
 
9,749

 
20,538

 
 
19,089

Gain on buyout of tax receivable agreement

 
 

 

 
 
(12,372
)
Other expense
846

 
 
86

 
1,286

 
 
169

Total other expense
11,148

 
 
9,835

 
21,824

 
 
6,886

Income before income taxes
25,733

 
 
24,814

 
51,167

 
 
60,634

Income tax expense
9,064

 
 
194

 
7,886

 
 
6,712

Net income
16,669

 
 
24,620

 
43,281

 
 
53,922

Less: Net income attributable to the non-controlling interest
5,186

 
 
5,337

 
10,672

 
 
10,799

Net income attributable to Class A stockholders
$
11,483

 
 
$
19,283

 
$
32,609

 
 
$
43,123

 
 
 
 
 
 
 
 
 
 
Earnings per Class A share:
 
 
 
 
 
 
 
 
 
Basic
$
0.11

 
 
$
0.19

 
$
0.32

 
 
$
0.43

Diluted
$
0.10

 
 
$
0.18

 
$
0.31

 
 
$
0.41

Weighted-average shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
105,072,322

 
 
99,939,642

 
102,618,951

 
 
99,916,161

Diluted
109,509,195

 
 
104,773,094

 
105,338,010

 
 
104,911,474




See accompanying notes to the unaudited consolidated financial statements.

5


HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, amounts in thousands)

 
Three Months Ended
 
Six Months Ended

June 30, 2019
 
June 30, 2018
 
June 30, 2019
 
June 30, 2018
 
 
 
 
 
 
 
 
Net income
$
16,669

 
$
24,620

 
$
43,281

 
$
53,922

Other comprehensive income (loss):
 
 
 
 

 
 
Unrealized gain (loss) on interest rate swap contract designated as a cash flow hedge
(3,006
)
 
1,383

 
(5,171
)
 
5,121

Tax benefit (expense)
636

 
(292
)
 
1,083

 
(1,079
)
Comprehensive income
14,299

 
25,711

 
39,193

 
57,964

Less: Comprehensive income attributed to non-controlling interest
4,605

 
5,664

 
9,589

 
11,989

Comprehensive income attributed to Class A stockholders
$
9,694

 
$
20,047

 
$
29,604

 
$
45,975



See accompanying notes to the unaudited consolidated financial statements.



6


HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, amounts in thousands except share data)
 
Class A Voting
Common Stock
 
Class B Voting
Common Stock
 
Additional
Paid-in Capital
 
Accumulated
Other Comprehensive Income (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Non-controlling
Interest

Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
Balance–December 31, 2017
99,791,245

 
$
10

 
30,319,564

 
$
3

 
$
920,723

 
$
1,318

 
$
208,279

 
$
1,130,333

 
$
342,240

Comprehensive income

 

 

 

 

 
2,082

 
23,841

 
25,923

 
6,331

Share-based compensation, including income taxes of $98
59,989

 

 

 

 
1,721

 

 

 
1,721

 

Adoption of new accounting standards, net of income taxes of $83

 

 

 

 

 
7

 
191

 
198

 
85

Exchanges
64,380

 

 
(64,380
)
 

 
1,033

 

 

 
1,033

 
(1,033
)
Distributions

 

 

 

 

 

 

 

 
(4,153
)
Payment of taxes for employee stock awards

 

 

 

 
(407
)
 

 

 
(407
)
 

Tax receivable agreement arising from exchanges, net of income taxes of $50

 

 

 

 
(350
)
 

 

 
(350
)
 

Balance–March 31, 2018
99,915,614

 
10

 
30,255,184

 
3

 
922,720

 
3,407

 
232,311

 
1,158,451

 
343,470

Comprehensive income

 

 

 

 

 
770

 
19,282

 
20,052

 
5,658

Share-based compensation, net of income taxes of $189
3,889

 

 

 

 
811

 

 

 
811

 

Distributions

 

 

 

 

 

 

 

 
(5,310
)
Payment of taxes for employee stock awards

 

 

 

 
(29
)
 

 

 
(29
)
 

Balance-June 30, 2018
99,919,503

 
$
10

 
30,255,184

 
$
3

 
$
923,502

 
$
4,177

 
$
251,593

 
$
1,179,285

 
$
343,818

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance–December 31, 2018
100,046,392

 
$
10

 
30,255,184

 
$
3

 
$
925,902

 
$
2,523

 
$
271,365

 
$
1,199,803

 
$
350,454

Comprehensive income (loss)

 

 

 

 

 
(1,216
)
 
21,126

 
19,910

 
4,984

Share-based compensation, net of income taxes of $613

 

 

 

 
1,668

 

 

 
1,668

 

Distributions

 

 

 

 

 

 

 

 
(457
)
Exercise of public warrants
50

 

 

 

 

 

 

 

 

Balance–March 31, 2019
100,046,442

 
10

 
30,255,184

 
3

 
927,570

 
1,307

 
292,491

 
1,221,381

 
354,981

Comprehensive income (loss)

 

 

 

 

 
(1,789
)
 
11,483

 
9,694

 
4,605

Share-based compensation, net of income taxes of $563
20,241

 

 

 

 
1,936

 

 

 
1,936

 

Distributions

 

 

 

 

 

 

 

 
(4,459
)
Exercise of employee stock options
1,788

 

 

 

 
23

 

 

 
23

 

Payment of taxes for employee stock awards

 

 

 

 
(124
)
 

 

 
(124
)
 

Exchanges
9,255,400

 
1

 
(9,255,400
)
 
(1
)
 
110,734

 
292

 

 
111,026

 
(111,026
)
Tax receivable agreement arising from exchanges, net of income taxes of $10,109

 

 

 

 
(17,610
)
 

 

 
(17,610
)
 

Balance-June 30, 2019
109,323,871


$
11


20,999,784

 
$
2

 
$
1,022,529

 
$
(190
)
 
$
303,974

 
$
1,326,326

 
$
244,101


See accompanying notes to the unaudited consolidated financial statements.

7


HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
 
 
 
Six Months Ended
 
 
 
June 30, 2019
 
June 30, 2018
Operating activities
 
 
 
 
Net income
$
43,281

 
$
53,922

 
Depreciation and amortization
21,939

 
20,648

 
Impairment of property, goodwill and intangibles
1,005

 
1,417

 
Debt premium amortization
(536
)
 
(541
)
 
Tax receivable agreement remeasurement and gain on buyout
(483
)
 
(14,124
)
 
Share-based compensation
4,780

 
2,721

 
Deferred taxes
5,637

 
4,994

 
Change in operating assets and liabilities, net of acquisitions:
 
 
 
 
 
Accounts receivable
(22,508
)
 
(8,458
)
 
 
Inventories
(4,313
)
 
3,558

 
 
Prepaids and other current assets
(1,661
)
 
(1,643
)
 
 
Accounts payable and accrued expenses
18,168

 
17,187

 
 
Customer trade allowances
8,755

 
1,501

 
Net cash provided by operating activities
74,064

 
81,182

 
 
 
 
 
 
Investing activities
 
 
 
 
Purchases of property and equipment
(15,398
)
 
(19,836
)
 
Acquisition of business, net of cash

 
(23,910
)
 
Acquisition and development of software assets
(2,907
)
 
(1,591
)
 
Net cash used in investing activities
(18,305
)
 
(45,337
)
 
 
 
 
 
 
Financing activities
 
 
 
 
Repayments of long-term debt and lease obligations
(5,056
)
 
(5,051
)
 
Distributions to non-controlling interest
(4,916
)
 
(9,463
)
 
Tax payments related to issuance of shares to employees
(124
)
 
(407
)
 
Cash received from exercise of options
23

 

 
Payments on tax receivable agreement
(2,779
)
 
(41,353
)
 
Net cash used in financing activities
(12,852
)
 
(56,274
)
Net increase (decrease) in cash and cash equivalents
42,907

 
(20,429
)
Cash and cash equivalents at beginning of period
146,377

 
135,701

Cash and cash equivalents at end of period
$
189,284

 
$
115,272

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash paid during the period for:
 
 
 
 
Interest
$
22,472

 
$
20,358

 
Net taxes paid
$
1,815

 
$
3,959

Supplemental disclosure of non-cash investing:
 
 
 
 
Accrued capital expenditures
$
1,527

 
$
1,388

See accompanying notes to the unaudited consolidated financial statements.

8


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




1. Summary of Significant Accounting Policies
Description of Business

Hostess Brands, Inc. is a Delaware corporation headquartered in Kansas City, Missouri. The consolidated financial statements include the accounts of Hostess Brands, Inc. and its subsidiaries (collectively, the “Company”). The Company is a leading packaged food company focused on developing, manufacturing, marketing, selling and distributing fresh sweet baked goods in the United States.
The Company’s operations are conducted through indirect operating subsidiaries that are wholly-owned by Hostess Holdings, L.P. (“Hostess Holdings”), a direct subsidiary of Hostess Brands, Inc. Hostess Brands, Inc. holds 100% of the general partnership interest in Hostess Holdings and a majority of the limited partnership interests therein and consolidates Hostess Holdings in the Company’s consolidated financial statements. The remaining limited partnership interests in Hostess Holdings are held by the holders of the outstanding shares of Class B common stock of Hostess Brands, Inc. These limited partnership interests in Hostess Holdings are reflected in the consolidated financial statements as a non-controlling interest.

Basis of Presentation
The consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited consolidated financial statements include all adjustments necessary for the fair presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented, and all such adjustments were of a normal and recurring nature. The results of operations are not necessarily indicative of the results to be expected for the full fiscal year. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2018.

The Company has two reportable segments: Sweet Baked Goods and In-Store Bakery.
Adoption of New Accounting Standards

On January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases, along with the related ASUs 2018-01, 2018-10 and 2018-11 (collectively, “Topic 842”). Topic 842 requires a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by lease terms of more than 12 months. To adopt this standard, the Company utilized a modified retrospective transition method. Under this approach, the results for reporting periods beginning January 1, 2019 are presented under Topic 842. Prior period amounts are not adjusted and continue to be reported in accordance with the historic accounting standards. There was no cumulative effect of applying Topic 842 to the opening balance of retained earnings. The Company has elected to apply the practical expedients under Topic 842 which allow entities to not reassess the lease classification for expired or existing leases and to not reassess if expired or existing contracts contain leases under the Topic 842 definition. The Company has also elected to use hindsight when determining the lease term of existing leases. As a result of the adoption, on January 1, 2019, the Company recognized right of use assets of $8.2 million, offset by associated accumulated amortization of $5.2 million and corresponding lease liabilities of $3.0 million. The recognition of leases subsequent to the adoption of Topic 842 is further described in the Leases section of this footnote.

Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its majority-owned or controlled subsidiaries (including those for which the Company is the primary beneficiary of a variable interest entity). All intercompany balances and transactions have been eliminated in consolidation.    

9


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and for the reported amounts of revenues and expenses during the reporting period. Management utilizes estimates, including, but not limited to, valuation and useful lives of tangible and intangible assets, valuation of expected future payments under the tax receivable agreement, and reserves for trade and promotional allowances. Actual results could differ from these estimates.
Accounts Receivable
Accounts receivable represents amounts invoiced to customers for performance obligations which have been satisfied. As of June 30, 2019 and December 31, 2018, the Company’s accounts receivable were $128.2 million and $105.7 million, respectively, which have been reduced by an allowance for damages occurring during shipment, quality claims and doubtful accounts in the amount of $2.8 million and $2.6 million, respectively. In addition, there were customer trade allowances of $50.8 million and $42.0 million as of June 30, 2019 and December 31, 2018, respectively, in current liabilities in the consolidated balance sheets.
Inventories
Inventories are stated at the lower of cost or net-realizable value on a first-in first-out basis.
Abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) are expensed in the period they are incurred.
The components of inventories are as follows:
(In thousands)
June 30,
2019
 
December 31,
2018
 

 

Ingredients and packaging
$
19,862

 
$
18,865

Finished goods
20,331

 
16,446

Inventory in transit to customers
2,700

 
3,269

 
$
42,893

 
$
38,580



Impairment of Property and Equipment

For the six months ended June 30, 2018, the Company recorded an impairment loss of $1.4 million related to the planned disposition of certain production equipment before the end of its useful life. This loss is included in other operating expenses on the consolidated statement of operations. The measurement of this loss was based on Level 3 inputs within the fair value measurement hierarchy.
Software Costs
Included in “Other assets, net” in the consolidated balance sheets is capitalized software in the amount of $10.2 million and $8.5 million at June 30, 2019 and December 31, 2018, respectively. Capitalized software costs are amortized over their estimated useful life of five years commencing when such assets are ready for their intended use. Software amortization expense included in general and administrative was $0.7 million and $1.4 million for the three and six months ended June 30, 2019, respectively, compared to $0.8 million and $1.4 million for the three and six months ended June 30, 2018, respectively.

10


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Concentrations
The Company has one customer (together with its affiliates) that accounted for 10% or more of the Company’s total net revenue. The percentage of total net revenues for this customer is presented below by segment:
 
Three Months Ended
 
Six Months Ended
(% of Consolidated Net Revenues) 
June 30, 2019
 
June 30, 2018
 
June 30, 2019
 
June 30, 2018
 

 

 
 
 
 
Sweet Baked Goods
23.3
%
 
18.4
%
 
23.5
%
 
18.1
%
In-Store Bakery
0.4
%
 
0.6
%
 
0.4
%
 
0.6
%
Total
23.7
%
 
19.0
%
 
23.9
%
 
18.7
%


Leases

Subsequent to its adoption of Topic 842, the Company recognizes a right of use asset and corresponding lease liability on the consolidated balance sheet for all lease transactions with terms of more than 12 months. Agreements are determined to contain a lease if they convey the use and control of an underlying physical asset. Based on the nature of the lease transaction, leases are either classified as financing or operating. Under both classifications, the right of use asset and liability are initially valued based on the present value of the future minimum lease payments using an effective borrowing rate at the inception of the lease. The Company determined the effective borrowing rate based on its expected incremental borrowing rate on collateralized debt. At June 30, 2019, the weighted average effective borrowing rates for outstanding financing and operating leases were 6.8% and 4.7%, respectively.
Under a financing lease, interest expense related to the lease liability is recognized over the lease term using an effective interest rate method and right of use assets are amortized straight-line over the term of the lease. Under an operating lease, minimum lease payments are expensed straight-line over the lease term, lease liabilities are amortized using an effective interest rate method and right of use assets are reduced based on the excess of the sum of the straight-line lease expense and the reduction of the lease liability over the actual lease payments. At June 30, 2019, the average remaining terms on both financing leases and operating leases were approximately one year.
Variable lease payments, such as taxes and insurance, are expensed as incurred. Expenses related to leases with original terms less than 12 months (short-term leases) are expensed as incurred. For all leases related to distribution, bakery and corporate facilities, the Company has elected not to separate non-lease components from lease components.
The table below shows the composition of lease expenses for the period subsequent to the adoption of Topic 842:
 
Three Months Ended
 
Six Months Ended
(In thousands)
June 30, 2019
 
June 30, 2019
Amortization of right of use asset, financing lease
$
56

 
$
100

Interest, financing lease
5

 
12

Operating lease expense
616

 
1,257

Short-term lease expense
282

 
682

Variable lease expense
189

 
377

 
$
1,148

 
$
2,428


At June 30, 2019, right of use assets related to both operating and financing leases are included in property and equipment, net on the consolidated balance sheet (see Note 2 Property and Equipment). As of June 30, 2019, lease liabilities for both operating and financing leases are included in the current and non-current portions of long-term debt and lease obligations on the consolidated balance sheet (see Note 6 Debt and Lease Obligations).

11


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



2.    Property and Equipment
Property and equipment consists of the following:
(In thousands)
June 30, 2019
 
 
December 31, 2018
 
 
 
 
 
Land and buildings
$
43,552

 
 
$
47,418

Right of use assets, operating
9,082

 
 

Right of use assets, financing
1,568

 
 

Machinery and equipment
205,859

 
 
194,830

Construction in progress
6,426

 
 
6,059

 
266,487

 
 
248,307

Less accumulated depreciation and amortization
(42,736
)
 
 
(27,958
)
 
$
223,751

 
 
$
220,349



Depreciation and amortization expense was $4.3 million and $8.6 million for the three and six months ended June 30, 2019, compared to $3.8 million and $7.2 million for the three and six months ended June 30, 2018.
3.    Segment Reporting
The Company has two reportable segments: Sweet Baked Goods and In-Store Bakery. The Company’s Sweet Baked Goods segment consists of fresh and frozen baked goods and bread products that are sold under the Hostess®, Dolly Madison®, Cloverhill® and Big Texas® brands. The In-Store Bakery segment consists primarily of Superior on Main® branded and private label products sold through the in-store bakery section of grocery and club stores.

12


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The Company evaluates performance and allocates resources based on net revenue and gross profit. Information regarding the operations of these reportable segments is as follows:
 
Three Months Ended
 
Six Months Ended
(In thousands)
June 30, 2019
 
June 30, 2018
 
June 30, 2019
 
June 30, 2018
 

 

 
 
 
 
  Net revenue:
 
 
 
 
 
 
 
Sweet Baked Goods
$
229,273

 
$
204,237

 
$
442,151

 
$
403,529

In-Store Bakery
11,787

 
11,612

 
21,647

 
21,063

Net revenue
$
241,060

 
$
215,849

 
$
463,798

 
$
424,592

 
 
 
 
 
 
 
 
Depreciation and amortization:
 
 
 
 
 
 
 
Sweet Baked Goods
$
10,380

 
$
9,857

 
$
20,562

 
$
19,251

In-Store Bakery
680

 
700

 
1,377

 
1,397

Depreciation and amortization
$
11,060

 
$
10,557

 
$
21,939

 
$
20,648

 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
Sweet Baked Goods
$
80,925

 
$
64,359

 
$
154,069

 
$
133,797

In-Store Bakery
2,525

 
2,498

 
4,569

 
4,301

Gross profit
$
83,450

 
$
66,857

 
$
158,638

 
$
138,098

 
 
 
 
 
 
 
 
  Capital expenditures (1):
 
 
 
 
 
 
 
Sweet Baked Goods
$
7,516

 
$
13,432

 
$
11,778

 
$
22,598

In-Store Bakery
28

 
164

 
180

 
217

Capital expenditures
$
7,544

 
$
13,596

 
$
11,958

 
$
22,815

(1)
Capital expenditures consists of purchases of property and equipment and acquisition and development of software assets paid in cash or acquired through accounts payable. From December 31, 2018 to June 30, 2019, capital expenditures in accounts payable decreased by $6.4 million. From December 31, 2017 to June 30, 2018 capital expenditures in accounts payable increased by $1.4 million.

Total assets by reportable segment are as follows:
(In thousands)
June 30,
2019
 
 
December 31,
2018


 
 

Total segment assets:
 
 
 
 
Sweet Baked Goods
$
2,981,878

 
 
$
2,924,333

In-Store Bakery
87,101

 
 
86,380

Total segment assets
$
3,068,979

 
 
$
3,010,713




13


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


4.    Goodwill and Intangible Assets
During the three months ended June 30, 2019, the Company recognized an impairment charge of $1.0 million in other operating expense on the consolidated statement of operations related to the In-Store Bakery reporting unit. This charge reflects a change in certain market assumptions since the last time the reporting unit was valued in the fourth quarter of 2018 (Level 1 input). Goodwill activity is presented below by reportable segment:
(In thousands)
Sweet Baked Goods
 
In Store Bakery
 
Total
 
 
 
 
 
 
Balance as of December 31, 2018
$
535,853

 
$
39,792

 
$
575,645

Impairment

 
(1,000
)
 
(1,000
)
Balance as of June 30, 2019
$
535,853

 
$
38,792

 
$
574,645


Intangible assets consist of the following:
(In thousands)
June 30,
 2019
 
December 31,
2018
 
 
 
 
Intangible assets with indefinite lives (Trademarks and Trade Names)
$
1,410,497

 
$
1,410,497

Intangible assets with definite lives (Customer Relationships)
543,148

 
543,120

Less accumulated amortization (Customer Relationships)
(63,824
)
 
(51,802
)
Less accumulated impairment charges (Trademarks and Trade Names)
(600
)
 
(600
)
Intangible assets, net
$
1,889,221

 
$
1,901,215


Amortization expense was $6.0 million and $12.0 million for the three and six months ended June 30, 2019, respectively and $6.0 million and $12.0 million for the three and six months ended June 30, 2018, respectively. The unamortized portion of customer relationships will be expensed over their remaining useful lives, from 18 to 23 years. The weighted-average amortization period as of June 30, 2019 for customer relationships was 20.0 years.
5.    Accrued Expenses and Other Current Liabilities
Included in accrued expenses and other current liabilities are the following:
(In thousands)
June 30,
 2019
 
 
December 31,
2018
 
 
 
 
 
Payroll, vacation and other compensation
$
6,969

 
 
$
6,104

Incentive compensation
6,539

 
 
3,261

Accrued interest
4,974

 
 
4,849

Workers compensation reserve
2,743

 
 
1,866

Self-insurance reserves
1,772

 
 
1,646

Current income taxes payable
103

 
 
411

 
$
23,100

 
 
$
18,137




14


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



6. Debt and Lease Obligations
A summary of the carrying value of the debt and lease obligations is as follows:
(In thousands)
June 30,
2019
 
 
December 31,
2018
Third Term Loan (4.8% as of June 30, 2019)
 
 
 
 
Principal
$
978,856

 
 
$
983,825

Unamortized debt premium and issuance costs
3,242

 
 
3,778

Total Third Term Loan
982,098

 
 
987,603

Financing lease obligations
314

 
 
401

Operating lease obligations
2,912

 
 

Total debt and lease obligations
985,324

 
 
988,004

Less: Current portion of long term debt and lease obligations
(13,206
)
 
 
(11,268
)
Long-term portion
$
972,118

 
 
$
976,736


    


7. Interest Rate Swap

To reduce the effect of interest rate fluctuations, the Company entered into an interest rate swap contract with a counter party to make a series of payments based on a fixed interest rate of 1.78% and receive a series of payments based on the greater of LIBOR or 0.75%. Both the fixed and floating payment streams are based on a notional amount of $500 million at the inception of the contract and will be reduced by $100 million each year of the five-year contract. As of June 30, 2019 and June 30, 2018, the notional amount is $300 million and $400 million, respectively. The Company entered into this transaction to reduce its exposure to changes in cash flows associated with its variable rate debt and has designated this derivative as a cash flow hedge. At June 30, 2019, the effective interest rate on the long-term debt hedged by this contract was 4.03%.
As of June 30, 2019 the fair value of the interest rate swap contract of $0.1 million is reported within other long Term liabilities on the consolidated balance sheet. As of December 31, 2018 the fair value of the interest rate swap contract of $5.1 million was reported within other assets, net on the consolidated balance sheet.The fair value of the interest rate swap contract is measured on a recurring basis by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates (forward curves) derived from observable market interest rate curves (Level 2).

8. Earnings per Share

Basic earnings per share is calculated by dividing net income attributable to the Company’s Class A stockholders for the period by the weighted average number of shares of Class A common stock outstanding for the period excluding non-vested restricted stock awards. In computing diluted earnings per share, basic earnings per share is adjusted for the assumed issuance of all applicable potentially dilutive share-based awards including public and private placement warrants, restricted stock units and stock options.


15


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Below are basic and diluted net income per share:
 
 
Three Months Ended
 
Six Months Ended

 
June 30, 2019
 
June 30, 2018
 
June 30, 2019
 
June 30, 2018
Numerator:
 
 
 
 
 
 
 
 
Net income attributable to Class A stockholders (in thousands)
 
$
11,483

 
$
19,283

 
$
32,609

 
$
43,123

Denominator:
 
 
 
 
 
 
 
 
Weighted-average Class A shares outstanding - basic
 
105,072,322

 
99,939,642

 
102,618,951

 
99,916,161

Dilutive effect of warrants
 
4,002,135

 
4,668,452

 
2,363,537

 
4,856,923

Dilutive effect of restricted stock units
 
434,738

 
165,000

 
355,522

 
138,390

Weighted-average shares outstanding - diluted
 
109,509,195

 
104,773,094

 
105,338,010

 
104,911,474

 
 
 
 
 
 
 
 
 
Net income per Class A share - basic
 
$
0.11

 
$
0.19

 
$
0.32

 
$
0.43