HOSTESS BRANDS, INC. The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity and capital resources ofHostess Brands, Inc. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto included herein, and our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . The terms "our", "we," "us," and "Company" as used herein refer toHostess Brands, Inc. and its consolidated subsidiaries.
Overview
We are a leading sweet snacks company focused on developing, manufacturing, marketing, selling and distributing snacks in theU.S. under the Hostess® brands and inNorth America under the Voortman® brands. Our direct-to-warehouse ("DTW") product distribution system allows us to deliver to our customers' warehouses. Our customers in turn distribute to the retail stores. Hostess® is the second leading brand by market share within the Sweet Baked Goods (SBG) category, according to NielsenU.S. total universe. For the 13-week period endedOctober 1, 2022 , our branded SBG (which includes Hostess®, Dolly Madison®, Cloverhill® and Big Texas®) market share was 21.4% per Nielsen'sU.S. SBG category data.
Factors Impacting Recent Results
We believe volatility in certain aspects of the global supply chain have had a continued impact on our operations, including the cost and availability of labor, transportation and raw materials. Various macro factors, including, but not limited to, the COVID-19 pandemic, labor market trends, rising fuel and transportation costs, the conflict inUkraine , the Avian Influenza and overall elevated demand for goods, have led to fragility in the supply chain. We have attempted to mitigate the impact of these cost increases on our business, to the extent possible, by locking in prices on certain raw materials and through pricing actions implemented with customers in 2021 and 2022. Given the fragility of the global supply-chain environment, our ability to source raw materials for our production facilities or produce and ship products to meet the needs of our customers may be materially impacted. We continue to work closely with all of our vendors, distributors, contract manufacturers and other external business partners to maintain availability of our products for our customers and consumers. 19
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Operating Results
Three Months Ended Nine Months Ended
September 30, September 30, September 30,
(In thousands, except per share data) 2022 2021 September 30, 2022 2021
Net revenue $ 346,226 $ 287,969 $ 1,018,749 $ 844,875
Gross profit 115,421 98,979 343,745 299,604
As a % of net revenue 33.3 % 34.4 % 33.7 % 35.5 %
Operating costs and expenses 61,032 52,375 180,038 152,829
Operating income 54,389 46,604 163,707 146,775
Other expense (income) (21,645) 10,534 (2,309) 32,390
Income tax expense 9,765 9,878 34,713 31,614
Net income 66,269 26,192 131,303 82,771
Earnings per Class A share:
Basic $ 0.49 $ 0.20 $ 0.95 $ 0.63
Diluted $ 0.48 $ 0.19 $ 0.95 $ 0.60
Results of Operations
Net Revenue
Net revenue for the three months ended September 30, 2022 increased
$58.2 million , or 20.2%, compared to the three months ended September 30, 2021 .
Contribution from previously taken pricing actions and product mix provided
20.1% of the growth, while higher volumes accounted for 0.1% of the quarterly
growth. Compared to the same period last year, SBG net revenue increased
$48.5 million or 18.7%, while cookies net revenue increased $9.7 million or
33.2%.
Net revenue for the nine months ended September 30, 2022 increased
$173.8 million , or 20.6%, compared to the nine months ended September 30, 2021 .
Contribution from previously taken pricing actions and favorable product mix
provided nearly 14.8% of the growth, while higher volumes accounted for 5.8% of
the year-to-date growth. Compared to the same period last year, SBG net revenue
increased $148.1 million or 19.5%, while cookies net revenue increased $25.7
million or 29.9%.
Gross Profit
Gross profit increased 16.6% and was 33.3% of net revenue for the three months
ended September 30, 2022 , a decrease of 105 basis points from a gross margin of
34.4% for the three months ended September 30, 2021 . The decrease in gross
margin was due to inflation and inefficiencies caused by supply-chain fragility,
partially offset by favorable price/mix, including revenue growth management
initiatives, and productivity benefits. The increase in gross profit was
attributed to favorable price/mix.
Gross profit increased 14.7% and was 33.7% of net revenue for the nine months
ended September 30, 2022 , a decrease of 172 basis points from a gross margin of
35.5% for the nine months ended September 30, 2021 . The decrease in gross margin
was attributed to inflation and inefficiencies caused by supply-chain fragility,
partially offset by favorable price/mix, including revenue growth management
initiatives, and productivity benefits. Gross profit increased due to favorable
price/mix and higher volume.
Operating Costs and Expenses
Operating costs and expenses for the three months endedSeptember 30, 2022 were$61.0 million , compared to$52.4 million for the three months endedSeptember 30, 2021 . The increase was primarily attributed to higher investments in our workforce, depreciation expense and advertising expense. Operating costs and expenses for the nine months endedSeptember 30, 2022 were$180.0 million , compared to$152.8 million for the nine months endedSeptember 30, 2021 . The increase was primarily attributed to higher investments in our workforce as well as higher advertising expense and depreciation expense. 20 --------------------------------------------------------------------------------
Other Expense (Income)
Other income for the three months endedSeptember 30, 2022 was$21.6 million compared to expense of$10.5 million for the three months endedSeptember 30, 2021 . The increase in other income was primarily due to a gain from receipt of insurance proceeds of$33.0 million under the representation and warranty insurance policy purchased in connection with the Voortman acquisition. Interest expense on our term loan was$11.1 million and$9.6 million for the three months endedSeptember 30, 2022 and 2021, respectively. Other income for the nine months endedSeptember 30, 2022 was$2.3 million compared to expense of$32.4 million for the nine months endedSeptember 30, 2021 . The increase in other income was due to a gain from receipt of insurance proceeds of$33.0 million under the representation and warranty insurance policy purchased in connection with the Voortman acquisition as well as lapping costs related to certain corporate initiatives in the prior year period. Interest expense on our term loan was$30.2 million and$29.0 million for the nine months endedSeptember 30, 2022 and 2021, respectively.
Income Taxes
Our effective tax rate for the three months endedSeptember 30, 2022 was 12.8% compared to 27.4% for the three months endedSeptember 30, 2021 . The effective tax rate for the three months endedSeptember 30, 2022 , was impacted favorably by the$33.0 million non-taxable gain related to receipt of proceeds under the representation and warranty insurance policy. Additionally, the effective tax rate for the three months endedSeptember 30, 2022 reflects a tax benefit related to revaluing our deferred tax liabilities due to a change in the estimated state tax rate. Our effective tax rate for the nine months endedSeptember 30, 2022 was 20.9% compared to 27.6% for the nine months endedSeptember 30, 2021 . The effective tax rate for the nine months endedSeptember 30, 2022 was impacted favorably by the$33.0 million non-taxable gain related to receipt of proceeds under the representation and warranty insurance policy. Additionally, the effective tax rate for the nine months endedSeptember 30, 2022 reflects a tax benefit related to revaluing our deferred tax liabilities due to a change in the estimated state tax rate.
Liquidity and Capital Resources
Our primary sources of liquidity are from cash on hand, future cash flow
generated from operations, and availability under our revolving credit agreement
("Revolver"). We believe that cash flows from operations and the current cash
and cash equivalents and short-term investments on the balance sheet will be
sufficient to satisfy the anticipated cash requirements associated with our
existing operations for at least the next 12 months. Our future cash
requirements include, but are not limited to, the purchase commitments for
certain raw materials and packaging used in our production process, scheduled
rent on leased facilities, scheduled debt service payments on our term loan,
settlements on related interest rate swap contracts, payments on our tax
receivable agreement, settlements on our outstanding foreign currency contracts
and outstanding purchase orders on capital projects.
Our ability to generate sufficient cash from our operating activities depends on
our future performance, which is subject to general economic, political,
financial, competitive and other factors beyond our control. In addition, future
cash requirements could be higher than we currently expect as a result of
various factors, including any expansion of our business that we undertake, such
as acquisitions or bringing new production facilities on line. We consider all
highly liquid investments purchased with an original maturity of three months or
less to be cash equivalents.
We had working capital, excluding cash and short-term investments, as of
September 30, 2022 and December 31, 2021 of $31.7 million and $17.9 million ,
respectively. We have the ability to borrow under the Revolver to meet
obligations as they come due. As of September 30, 2022 , we had approximately
$93.9 million available for borrowing, net of letters of credit, under our
Revolver.
Cash Flows from Operating Activities
Cash flows provided by operating activities for the nine months endedSeptember 30, 2022 and 2021 were$164.2 million and$147.6 million , respectively. Operating cash flow benefited from current year improvement in profitability, including the insurance proceeds of$33.0 million , partially offset by an increase in tax payments and an increase in working capital. 21 --------------------------------------------------------------------------------
Cash Flows from Investing Activities
Investing activities used$105.7 million and$36.7 million of cash for the nine months endedSeptember 30, 2022 and 2021, respectively. OnFebruary 22, 2022 , we purchased a facility inArkadelphia, Arkansas for a total purchase price of$11.5 million . Additional capital expenditures were incurred on this project during the nine months endedSeptember 30, 2022 , and we expect elevated capital expenditures due to this project throughout the remainder of 2022. Additionally, during the nine months endedSeptember 30, 2022 , we invested in short-term marketable securities of$62.9 million and received proceeds from maturity of short-term marketable securities of$21.0 million .
Cash Flows from Financing Activities
Financing activities used$114.8 million and$55.7 million for the nine months endedSeptember 30, 2022 and 2021. The net outflow in the current-year period consisted of cash used to repurchase 4.2 million shares of our common stock under existing securities repurchase authorizations, as well as scheduled payments under the tax receivable agreement and term loan. The net outflow in the prior-year period reflects proceeds on exercise of employee stock options and proceeds from the exercise of public warrants, offset by cash used to repurchase 3.1 million shares of our common stock under existing securities repurchase authorizations and scheduled payments under the tax receivable agreement and term loan.
Long-Term Debt
As ofSeptember 30, 2022 ,$1,083.2 million aggregate principal amount of the term loan was outstanding and letters of credit worth up to$6.1 million aggregate principal amount were available, reducing the amount available under the Revolver. We had no outstanding borrowings under our Revolver as ofSeptember 30, 2022 , with a remaining borrowing capacity of$93.9 million . As ofSeptember 30, 2022 , we were in compliance with the covenants under the term loan and the Revolver.
Contractual Obligations, Commitments and Contingencies
There were no material changes, outside the ordinary course of business, in our outstanding contractual obligations from those disclosed within "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . During the three months endedSeptember 30, 2022 , we received the proceeds from the agreement with the insurers of the representation and warranty insurance policy related to the acquisition of Voortman and recognized as a gain of$33.0 million in other expense (income) on our condensed consolidated statement of operations.
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