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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
 
September 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
hostesslogob18.jpg
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 - 120,947,081 shares at November 5, 2019
Shares of Class B common stock outstanding - 9,455,184 shares at November 5, 2019



HOSTESS BRANDS, INC.
FORM 10-Q
For the Quarter Ended September 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 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.


3



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

September 30,
 
 
December 31,
ASSETS
2019
 
 
2018

 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
$
266,871

 
 
$
146,377

Accounts receivable, net
115,857

 
 
105,679

Inventories
38,582

 
 
38,580

Prepaids and other current assets
12,182

 
 
8,806

Total current assets
433,492

 
 
299,442

Property and equipment, net
227,114

 
 
220,349

Intangible assets, net
1,858,943

 
 
1,901,215

Goodwill
535,853

 
 
575,645

Other assets, net
11,376

 
 
14,062

Total assets
$
3,066,778

 
 
$
3,010,713

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
Long-term debt and lease obligations payable within one year
$
10,166

 
 
$
11,268

Tax receivable agreement payments payable within one year
10,700

 
 
4,400

Accounts payable
69,811

 
 
65,288

Customer trade allowances
44,593

 
 
42,010

Accrued expenses and other current liabilities
23,389

 
 
18,137

Total current liabilities
158,659

 
 
141,103

Long-term debt and lease obligations
972,838

 
 
976,736

Tax receivable agreement obligations
125,023

 
 
64,663

Deferred tax liability
252,986

 
 
277,954

Total liabilities
1,509,506

 
 
1,460,456

 
 
 
 
 
Commitments and Contingencies (Note 12)

 
 

 
 
 
 
 
Class A common stock, $0.0001 par value, 200,000,000 shares authorized,120,947,081 and 100,046,392 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively
12

 
 
10

Class B common stock, $0.0001 par value, 50,000,000 shares authorized, 9,455,184 and 30,255,184 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively
1

 
 
3

Additional paid in capital
1,140,126

 
 
925,902

Accumulated other comprehensive income (loss)
(687
)
 
 
2,523

Retained earnings
312,759

 
 
271,365

Stockholders’ equity
1,452,211

 
 
1,199,803

Non-controlling interest
105,061

 
 
350,454

Total liabilities and stockholders’ equity
$
3,066,778

 
 
$
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
 
Nine Months Ended
 
September 30,
2019
 
 
September 30,
2018
 
September 30,
2019
 
 
September 30,
2018
 
 
 
 
 
 
 
 
 
 
Net revenue
$
227,211

 
 
$
210,982

 
$
691,009

 
 
$
635,574

Cost of goods sold
156,791

 
 
150,604

 
461,951

 
 
437,098

Gross profit
70,420

 
 
60,378

 
229,058

 
 
198,476

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
Advertising and marketing
10,627

 
 
9,563

 
30,186

 
 
27,371

Selling expense
6,992

 
 
7,467

 
23,822

 
 
22,606

General and administrative
17,736

 
 
13,569

 
54,483

 
 
39,315

Amortization of customer relationships
5,755

 
 
5,994

 
17,749

 
 
17,983

Other operating expense (income)
5,739

 
 
92

 
6,256

 
 
(12
)
Total operating costs and expenses
46,849

 
 
36,685

 
132,496

 
 
107,263

Operating income
23,571

 
 
23,693

 
96,562

 
 
91,213

Other expense:
 
 
 
 
 
 
 
 
 
Interest expense, net
9,813

 
 
9,974

 
30,351

 
 
29,063

Gain on buyout of tax receivable agreement

 
 

 

 
 
(12,372
)
Other expense (income)

 
 
(36
)
 
1,286

 
 
133

Total other expense
9,813

 
 
9,938

 
31,637

 
 
16,824

Income before income taxes
13,758

 
 
13,755

 
64,925

 
 
74,389

Income tax expense
3,029

 
 
2,603

 
10,915

 
 
9,315

Net income
10,729

 
 
11,152

 
54,010

 
 
65,074

Less: Net income attributable to the non-controlling interest
1,944

 
 
3,211

 
12,615

 
 
14,010

Net income attributable to Class A stockholders
$
8,785

 
 
$
7,941

 
$
41,395

 
 
$
51,064

 
 
 
 
 
 
 
 
 
 
Earnings per Class A share:
 
 
 
 
 
 
 
 
 
Basic
$
0.08

 
 
$
0.08

 
$
0.39

 
 
$
0.51

Diluted
$
0.07

 
 
$
0.08

 
$
0.37

 
 
$
0.49

Weighted-average shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
115,196,195

 
 
99,958,244

 
106,904,733

 
 
99,931,167

Diluted
121,122,895

 
 
102,963,080

 
110,804,367

 
 
104,299,251




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
 
Nine Months Ended

September 30, 2019
 
September 30, 2018
 
September 30, 2019
 
September 30, 2018
 
 
 
 
 
 
 
 
Net income
$
10,729

 
$
11,152

 
$
54,010

 
$
65,074

Other comprehensive income (loss):
 
 
 
 

 
 
Unrealized gain (loss) on interest rate swap contract designated as a cash flow hedge
(741
)
 
460

 
(5,912
)
 
5,581

Tax benefit (expense)
172

 
(97
)
 
1,255

 
(1,175
)
Comprehensive income
10,160

 
11,515

 
49,353

 
69,480

Less: Comprehensive income attributed to non-controlling interest
1,858

 
3,318

 
11,447

 
15,308

Comprehensive income attributed to Class A stockholders
$
8,302

 
$
8,197

 
$
37,906

 
$
54,172



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
 
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 $287
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

Comprehensive income

 

 

 

 

 
256

 
7,941

 
8,197

 
3,318

Share-based compensation, net of income taxes of $537

 

 

 

 
979

 

 

 
979

 

Distributions

 

 

 

 

 

 

 

 
(70
)
Balance-September 30, 2018
99,919,503

 
$
10

 
30,255,184

 
$
3

 
$
924,481

 
$
4,433

 
$
259,534

 
$
1,188,461

 
$
347,066


See accompanying notes to the unaudited consolidated financial statements.



















7


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, 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

Comprehensive income (loss)

 

 

 

 

 
(483
)
 
8,785

 
8,302

 
1,858

Share-based compensation, net of income taxes of $228
78,610

 

 

 

 
2,149

 

 

 
2,149

 

Distributions

 

 

 

 

 

 

 

 
(1,743
)
Payment of taxes for employee stock awards

 

 

 

 
(483
)
 

 

 
(483
)
 

Exchanges
11,544,600

 
1

 
(11,544,600
)
 
(1
)
 
139,169

 
(14
)
 

 
139,155

 
(139,155
)
Tax receivable agreement arising from exchanges, net of income taxes of $17,185

 

 

 

 
(23,238
)
 

 

 
(23,238
)
 

Balance-September 30, 2019
120,947,081

 
$
12

 
9,455,184

 
$
1

 
$
1,140,126

 
$
(687
)
 
$
312,759

 
$
1,452,211

 
$
105,061


See accompanying notes to the unaudited consolidated financial statements.


8


HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, amounts in thousands)
 
 
 
Nine Months Ended
 
 
 
September 30, 2019
 
September 30, 2018
Operating activities
 
 
 
 
Net income
$
54,010

 
$
65,074

 
Depreciation and amortization
32,678

 
31,370

 
Impairment of property, goodwill and intangibles
1,005

 
1,417

 
Debt premium amortization
(803
)
 
(810
)
 
Tax receivable agreement remeasurement and gain on buyout
1,296

 
(14,124
)
 
Non-cash fees on disposal of assets
1,414

 

 
Share-based compensation
7,157

 
4,237

 
Deferred taxes
9,519

 
7,929

 
Loss on sale of assets
471

 
1

 
Change in operating assets and liabilities, net of acquisitions and dispositions:
 
 
 
 
 
Accounts receivable
(13,536
)
 
(5,451
)
 
 
Inventories
(3,451
)
 
4,670

 
 
Prepaids and other current assets
(3,793
)
 
(2,407
)
 
 
Accounts payable and accrued expenses
18,305

 
20,759

 
 
Customer trade allowances
3,080

 
(2,794
)
 
Net cash provided by operating activities
107,352

 
109,871

 
 
 
 
 
 
Investing activities
 
 
 
 
Purchases of property and equipment
(28,421
)
 
(32,886
)
 
Acquisition of business, net of cash

 
(23,910
)
 
Proceeds from sale of business, net of cash
63,353

 

 
Acquisition and development of software assets
(4,298
)
 
(2,480
)
 
Net cash used provided by (used in) investing activities
30,634

 
(59,276
)
 
 
 
 
 
 
Financing activities
 
 
 
 
Repayments of long-term debt and lease obligations
(7,470
)
 
(7,578
)
 
Distributions to non-controlling interest
(6,659
)
 
(9,533
)
 
Tax payments related to issuance of shares to employees
(607
)
 
(436
)
 
Cash received from exercise of options
23

 

 
Payments on tax receivable agreement
(2,779
)
 
(41,353
)
 
Net cash used in financing activities
(17,492
)
 
(58,900
)
Net increase (decrease) in cash and cash equivalents
120,494

 
(8,305
)
Cash and cash equivalents at beginning of period
146,377

 
135,701

Cash and cash equivalents at end of period
$
266,871

 
$
127,396

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash paid during the period for:
 
 
 
 
Interest
$
33,602

 
$
30,972

 
Net taxes paid
$
2,416

 
$
4,092

Supplemental disclosure of non-cash investing:
 
 
 
 
Accrued capital expenditures
$
1,468

 
$
(59
)
See accompanying notes to the unaudited consolidated financial statements.

9


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. The Company sold its In-Store Bakery operations on August 30, 2019.
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.


10


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


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.    
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 September 30, 2019 and December 31, 2018, the Company’s accounts receivable were $115.9 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 $2.7 million and $2.6 million, respectively. In addition, there were customer trade allowances of $44.6 million and $42.0 million as of September 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)
September 30,
2019
 
December 31,
2018
 

 

Ingredients and packaging
$
19,527

 
$
18,865

Finished goods
16,654

 
16,446

Inventory in transit to customers
2,401

 
3,269

 
$
38,582

 
$
38,580



Impairment of Property and Equipment

For the nine months ended September 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.

11


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


Software Costs
Included in “Other assets, net” in the consolidated balance sheets is capitalized software in the amount of $10.9 million and $8.5 million at September 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 $2.1 million for the three and nine months ended September 30, 2019, respectively, compared to $0.6 million and $2.0 million for the three and nine months ended September 30, 2018, respectively.
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
 
Nine Months Ended
(% of Consolidated Net Revenues) 
September 30, 2019
 
September 30, 2018
 
September 30, 2019
 
September 30, 2018
 

 

 
 
 
 
Sweet Baked Goods
22.3
%
 
20.0
%
 
23.0
%
 
18.7
%
In-Store Bakery
0.3
%
 
0.5
%
 
0.5
%
 
0.6
%
Total
22.6
%
 
20.5
%
 
23.5
%
 
19.3
%


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 September 30, 2019, the weighted average effective borrowing rates for outstanding operating leases was 4.5%.
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 September 30, 2019, the average remaining terms on 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.

12


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


The table below shows the composition of lease expenses for the period subsequent to the adoption of Topic 842:
 
Three Months Ended
 
Nine Months Ended
(In thousands)
September 30, 2019
 
September 30, 2019
Amortization of right of use asset, financing lease
$
33

 
$
133

Interest, financing lease
4

 
16

Operating lease expense
752

 
2,009

Short-term lease expense
202

 
884

Variable lease expense
188

 
565

 
$
1,179

 
$
3,607


At September 30, 2019, right of use assets related to operating leases are included in property and equipment, net on the consolidated balance sheet (see Note 3. Property and Equipment). As of September 30, 2019, the Company has no outstanding financing leases. Lease liabilities for operating leases are included in the current and non-current portions of long-term debt and lease on the consolidated balance sheet (see Note 7. Debt and Lease Obligations).
2. Divestiture of In-Store Bakery Operations

On August 30, 2019, the Company sold its In-Store Bakery operations, including relevant trademarks and licensing agreements, to an unrelated party. The operations included products that were primarily sold in the in-store bakery section of U.S. retail channels.The Company divested the operations to provide more focus on future investment in areas of its business that better leverage its core competencies.

The Company received proceeds from the divestiture of $65.0 million prior to transaction expenses and subject to certain post-closing adjustments. In connection with the sale, during the three and nine months ended 2019, the Company recognized transaction expenses of $2.1 million and a loss on disposal of $0.3 million within other operating expenses on the consolidated statement of operations.

3.    Property and Equipment
Property and equipment consists of the following:
(In thousands)
September 30,
2019
 
 
December 31, 2018
 
 
 
 
 
Land and buildings
$
44,401

 
 
$
47,418

Right of use assets, operating
10,374

 
 

Machinery and equipment
203,507

 
 
194,830

Construction in progress
13,791

 
 
6,059

 
272,073

 
 
248,307

Less accumulated depreciation and amortization
(44,959
)
 
 
(27,958
)
 
$
227,114

 
 
$
220,349



Depreciation and amortization expense was $4.3 million and $12.9 million for the three and nine months ended September 30, 2019, respectively, compared to $4.1 million and $11.3 million for the three and nine months ended September 30, 2018, respectively.

13


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


4.    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. The Company divested its In-Store Bakery operations on August 30, 2019. (See Note 2. Divestiture of In-Store Bakery Operations).
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
 
Nine Months Ended
(In thousands)
September 30, 2019
 
September 30, 2018
 
September 30, 2019
 
September 30, 2018
 

 

 
 
 
 
  Net revenue:
 
 
 
 
 
 
 
Sweet Baked Goods
$
220,156

 
$
201,693

 
$
662,307

 
$
605,223

In-Store Bakery
7,055

 
9,289

 
28,702

 
30,351

Net revenue
$
227,211

 
$
210,982

 
$
691,009

 
$
635,574

 
 
 
 
 
 
 
 
Depreciation and amortization:
 
 
 
 
 
 
 
Sweet Baked Goods
$
10,514

 
$
10,020

 
$
31,076

 
$
29,270

In-Store Bakery
224

 
703

 
1,602

 
2,100

Depreciation and amortization
$
10,738

 
$
10,723

 
$
32,678

 
$
31,370

 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
Sweet Baked Goods
$
68,804

 
$
58,886

 
$
222,872

 
$
192,683

In-Store Bakery
1,616

 
1,492

 
6,186

 
5,793

Gross profit
$
70,420

 
$
60,378

 
$
229,058

 
$
198,476

 
 
 
 
 
 
 
 
  Capital expenditures (1):
 
 
 
 
 
 
 
Sweet Baked Goods
$
14,284

 
$
12,378

 
$
26,062

 
$
34,975

In-Store Bakery
2

 
114

 
182

 
332

Capital expenditures
$
14,286

 
$
12,492

 
$
26,244

 
$
35,307

(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. For the nine months ended September 30, 2019, capital expenditures in accounts payable decreased by $6.4 million. For the nine months ended September 30, 2018, capital expenditures in accounts payable decreased by $0.3 million.

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


 
 

Total segment assets:
 
 
 
 
Sweet Baked Goods
$
3,066,778

 
 
$
2,924,333

In-Store Bakery

 
 
86,380

Total segment assets
$
3,066,778

 
 
$
3,010,713



14


HOSTESS BRANDS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



After the August 30, 2019 divestiture of the In-Store Bakery operations, the Company retained no assets related to the In-Store Bakery segment.

5.    Goodwill and Intangible Assets
In the second quarter of 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). In the third quarter of 2019, the Company divested its In-Store Bakery reporting unit (See Note 2. Divestiture of In-Store Bakery Operations). 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
)
Divestiture

 
(38,792
)
 
(38,792
)
Balance as of September 30, 2019
$
535,853

 
$

 
$
535,853


Intangible assets consist of the following:
(In thousands)
September 30,
 2019
 
December 31,
2018
 
 
 
 
Intangible assets with indefinite lives (Trademarks and Trade Names)
$
1,408,631

 
$
1,410,497

Intangible assets with definite lives (Customer Relationships)
515,712

 
543,120