Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in Item 1A “Risk Factors” of this Annual Report on Form 10-K.
Overview
We are a leading sweet snacks company focused on developing, manufacturing, marketing, selling and distributing snack products in North America, providing a wide range of snack cakes, donuts, sweet rolls, breakfast pastries, cookies, snack pies and related products. As of December 31, 2021, we operate five baking facilities and utilize distribution centers and third-party warehouses to distribute our products. Our Direct-to-Warehouse product distribution system allows us to deliver to our customers’ warehouses. Our customers in turn distribute to their retail stores and/or distributors.
The Company has one reportable segment: Snacking. The Snacking segment consists of sweet baked goods, cookies, bread and buns that are sold under the Hostess®, Voortman®, Dolly Madison®, Cloverhill® and Big Texas® brands.
Hostess® is the second leading brand by market share within the Sweet Baked Goods (“SBG”) category, according to Nielsen U.S. total universe. For the 52-week period ended January 1, 2022 our branded SBG products’ (which include Hostess®, Dolly Madison®, Cloverhill®, and Big Texas®) market share was 21.3% per Nielsen’s U.S. SBG category data. Our Voortman® branded products include the #1 creme wafer and sugar-free cookie products within the larger Cookie category.
Principal Components of Operating Results
Net Revenue
We generate revenue through selling packaged snacks which include iconic products such as Donettes®, Twinkies®, CupCakes, Ding Dongs®, Zingers®, Danishes, Honey Buns and Coffee Cakes under the Hostess® group of brands, as well as cookies, wafers and sugar-free products under the Voortman® brand. We also sell products under the Dolly Madison®, Cloverhill® and Big Texas® brands along with private label products. Our product assortment is sold to customers’ warehouses and distribution centers by the case or in display-ready corrugate units. Retailers display and sell our products to the end consumer in single-serve, multi-pack or club-pack formats. We sell our products primarily to supermarket chains, national mass retailers and convenience and drug stores, along with a smaller portion of our product sales going to club stores, dollar stores, vending, and other retail outlets.
Our revenues are driven by average net price and total volume of products sold. Factors that impact unit pricing and sales volume include product mix, the cost of ingredients, promotional activities, industry capacity, new product initiatives and quality and consumer preferences. We do not keep a significant backlog of finished goods inventory, as our baked products are promptly shipped to our distribution centers after being produced and then distributed to customers.
Cost of Goods Sold
Cost of goods sold consists of ingredients, packaging, labor, energy, other production costs and warehousing and transportation costs including in-bound freight, inter-plant transportation and distribution of our products to customers. The cost of ingredients and packaging represent the majority of our total costs of goods sold. All costs that are incurred at the bakeries, including the depreciation of bakery facilities and equipment, are included in cost of goods sold. We do not allocate any corporate functions into cost of goods sold.
Our cost of ingredients consists principally of cooking oil, sugar, coatings and flour, which are subject to substantial price fluctuations, as is the cost of paper, corrugate, films and plastics used to package our products. The prices for raw materials are influenced by a number of factors, including the weather, crop production, transportation and processing costs, government regulation and policies and worldwide market supply and demand. We also rely on fuel products, such as natural gas, diesel, propane and electricity, to operate our bakeries and produce our products. Fluctuations in the prices of the raw materials or fuel products used in the production, packaging or transportation of our products affect the cost of products sold and our product pricing strategy. We utilize forward buying strategies through short-term and long-term advance purchase contracts to lock in prices for certain high-volume raw materials, packaged components and certain fuel inputs. Through these initiatives, we believe we are able to obtain competitive pricing.
Advertising and Marketing
Our advertising and marketing expenses include wire racks and corrugate displays delivered to customers to display our products off shelf, field marketing and merchandising services to reset and check our store inventory on a regular basis. We also invest in advertising campaigns, which include social media, print, online advertising, local promotional events, monthly agency fees and payroll costs.
Selling
Selling expenses primarily include sales management, sales employee related expenses, travel, and related expenses, as well as broker fees. We utilize brokers for sales support, including managing promotional activities and order processing.
General and Administrative
General and administrative expenses primarily include employee and related expenses for the accounting, finance, customer service, legal, human resources, corporate operations, research and development, purchasing, logistics and executive functions. Also included are professional service fees related to audit and tax, legal, outsourced information technology functions, transportation planning, headquarters and other office sites and insurance costs, as well as the depreciation and amortization of corporate assets.
Other Expenses
Other expenses primarily include interest paid on our term loan as well as the change in fair value of our liability-classified public and private placement warrants.
Non-Controlling Interest
During the year ended December 31, 2020, Mr. Metropoulos and the Metropoulos Entities held equity investment in us primarily through Class B limited partnership units in the Company’s subsidiary, Hostess Holdings (“Class B Units”), and an equal number of shares of the Company’s Class B common stock (“Class B Stock”). Our Class B Stock had voting, but no economic rights, while Hostess Holdings’ Class B Units had economic, but no voting rights. Each Class B Unit, together with a share of Class B Stock held by the Metropoulos Entities, was exchangeable for a share of the Company’s Class A common stock (or at the option of the Company, the cash equivalent thereof). The Company held 100% of the general partnership interest in Hostess Holdings. Subsequent to final exchange described below, the partnership was dissolved. The interest of the Metropoulos Entities in Hostess Holdings’ Class B Units prior to the final exchange is reflected in our consolidated financial statements as a non-controlling interest. The Metropoulos Entities have eliminated their ownership through a series of exchanges of shares of Class B Stock and Class B Units for an equal number of Class A shares. As part of the final exchange, we repurchased 0.4 million shares of Class A common stock from the Metropoulos Entities. The remaining shares were purchased by third parties. At December 31, 2020, there were no outstanding shares of Class B common stock.
Factors Impacting Recent Results
COVID-19
The acute and far-reaching impact of the COVID-19 pandemic and actions taken by governments to contain the spread of the virus have impacted our operations. During the first two quarters of 2020, as consumers prepared for extended stays at home, we experienced an increase in consumption, particularly in our multi-pack products sold through grocery and mass retailer channels. Conversely, during that same time frame, we experienced lower consumption of single-serve products, which are often consumed away from home. During the second half of 2020 and all of 2021, we have continued to experience strong demand in our multi-pack products, as well as an increase in our immediate consumption single-serve business as mobility increased. However, we cannot predict if these trends will sustain or reverse in future periods.
Since the start of the pandemic, our internal COVID-19 task force has monitored the rapidly evolving situation and implemented risk mitigation actions as deemed necessary. To date, we have not experienced significant disruptions to our supply chain and distribution network. However, it is possible that significant disruptions could still occur. Supply chain constraints seen elsewhere in the global economy due to availability of labor, transportation and raw materials could impact our ability to source ingredients and packaging for our bakeries or our ability to ship products to our customers. We continue to work closely with all of our vendors, distributors, contract manufacturers, and other external business partners to ensure availability of our products for our customers and consumers.
To protect our employees and ensure continuity of operations, we have implemented additional safety and sanitation measures in all of our facilities. We continue to follow protocols that are consistent with, or ahead of applicable local, state and federal guidelines. As many of our non-production team members, including sales, marketing and corporate employees, return to the office after working remotely for many months, we continue to monitor employee health and safety and adhere to evolving CDC guidelines while supporting our ability to bring products to consumers.
Despite the distribution of COVID-19 vaccines, uncertainty continues to exist regarding the pandemic and its impact on our business, including uncertainty related to, among other things, the duration of the pandemic, vaccine deployment and acceptance, new variants of COVID-19 and vaccine effectiveness for new variants, and the effect of actions to contain COVID-19 or treat its effect.
Under the provisions of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, we were able to defer the payment of $5.6 million of 2020 employer payroll taxes. Payments of $2.8 million continue to be deferred as of December 31, 2021. Apart from this deferral and their impact on the general economy, including the labor market and consumer demand, neither the CARES Act, the American Rescue Plan enacted in the first quarter of 2021, nor any other government program intended to address COVID-19 had any material impact on our consolidated financial statements for the years ended December 31, 2021 or 2020. We continue to monitor any effects that may result from the CARES Act and other stimulus programs.
Acquisition
On January 3, 2020, we completed the acquisition of all of the shares of the parent company of Voortman Cookies Limited (“Voortman”), a manufacturer of premium, branded wafers and cookies, including sugar-free products. By adding the Voortman® brand, we believe we have greater growth opportunities provided by a more diverse portfolio of brands and products. Our consolidated statements of operations include the operation of these assets from January 3, 2020 through December 31, 2021. In December 2020, we asserted claims for indemnification against the sellers under the terms of the Share Purchase Agreement pursuant to which we acquired Voortman for an aggregate of approximately $90 million Canadian Dollar (“CAD”) in damages arising out of alleged breaches by the sellers of certain representations, warranties and covenants contained in such agreement relating to periods prior to the closing of the acquisition. We have also submitted claims relating to these alleged breaches under the representation and warranty insurance policy we purchased in connection with the acquisition. Such insurance policy has a coverage limit of $42.5 million CAD. We have entered into an agreement with the sellers to toll the running of any applicable limitation period that may apply to our claim against them while we work through our claim with our insurers. Although we strongly believe that our claims are meritorious, no assurance can be given as to whether we will recover all, or any part, of the amounts for which we have made such claims. No gains or receivables have been recognized related to these claims as of December 31, 2021 or 2020.
Change in Fair Value of Warrant Liabilities
During the years ended December 31, 2021 and 2020, there were fluctuations in the market price of our publicly traded warrants. These fluctuations created significant gains and losses on the remeasurement of certain warrants which are recognized as liabilities measured at fair value on our consolidated balance sheets. These remeasurements are recognized as “change in fair value of warrant liabilities” within other expenses on our consolidated statements of operations.
Results of Operations
| | | | | | | | | | | | | | | |
| | | |
(In thousands, except per share data) | Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | | | |
Net revenue | $ | 1,142,036 | | | $ | 1,016,609 | | | | | |
| | | | | | | |
| | | | | | | |
Gross profit | 409,983 | | | 355,639 | | | | | |
As a % of net revenue | 35.9 | % | | 35.0 | % | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total operating costs and expenses | $ | 209,245 | | | $ | 220,329 | | | | | |
Operating income | 200,738 | | | 135,310 | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total other expense | 40,926 | | | 6,608 | | | | | |
| | | | | | | |
Income tax expense | 40,513 | | | 20,405 | | | | | |
Net income | 119,299 | | | 108,297 | | | | | |
| | | | | | | |
Net income attributable to Class A stockholders | $ | 119,299 | | | $ | 104,676 | | | | | |
| | | | | | | |
Earnings per Class A share: | | | | | | | |
Basic | $ | 0.91 | | | $ | 0.84 | | | | | |
Diluted | 0.86 | | | 0.51 | | | | | |
| | | | | | | |
Results for the Year Ended December 31, 2021 Compared to Results for the Year Ended December 31, 2020
Net Revenue
Net revenue for the year ended December 31, 2021 increased $125.4 million, or 12.3%, compared to the year ended December 31, 2020 with higher volumes accounting for approximately seven percentage points of the annual growth. Sweet baked goods revenue increased $105.1 million or 11.4% due to higher volume in Convenience, Grocery and Dollar channels, the benefit of pricing actions implemented in the second half of the year and continued momentum of single-serve products driving favorable product mix. Cookies net revenue increased $20.3 million or 21.1% due to distribution growth and lapping the initial Voortman slotting fees paid in 2020 to obtain space in customer warehouses.
Gross Profit
Gross profit was 35.9% of net revenue for the year ended December 31, 2021, an increase of 92 basis points from a gross margin of 35.0% for the year ended December 31, 2020. The increase in gross profit was driven primarily by higher volume, productivity initiatives, pricing actions, and favorable product mix, as well as lapping Voortman acquisition and facility transition costs and COVID-19 costs in the prior year. These benefits were partially offset by transportation and input cost inflation.
Operating Costs and Expenses
Operating costs and expenses for the year ended December 31, 2021 decreased by 5.0% from the year ended December 31, 2020. These costs decreased primarily due to lapping Voortman acquisition and integration costs and conversion of Voortman’s operations. Operating costs in 2020 also reflect an impairment expense related to the planned disposition of production equipment, resulting in a decrease in 2021. These decreases were partially offset by increased headcount, higher incentive compensation, additional investment in marketing spend and increased project consulting costs.
Operating Income
Operating income for the year ended December 31, 2021 was $200.7 million compared to $135.3 million for the year ended December 31, 2020. The increase in gross profit gains and lapping the Voortman acquisition and integration costs incurred in the prior year contributed to the higher operating income in the current year.
Other Expense
For the years ended December 31, 2021 and 2020, interest expense related to our term loan was $38.6 million and $41.8 million, respectively. Also during the years ended December 31, 2021 and 2020 we recognized a $0.6 million gain and a $39.9 million gain, respectively, on the fair value remeasurement of our liability-classified public and private placement warrants. During the year ended December 31, 2021 we also recognized an unrealized gain of $0.5 million compared to a loss of $1.8 million during the year ended December 31, 2020 related to the remeasurement of certain CAD denominated liabilities.
Income Taxes
Our effective tax rate was 25.4% for the year ended December 31, 2021 compared to 15.9% for the year ended December 31, 2020. The effective tax rates in both periods were impacted by non-taxable mark-to-market adjustments on our liability-classified warrants. Additionally, the effective tax rate for the year ended December 31, 2021 reflects a tax benefit related to revaluing our deferred tax liabilities due to a change in the estimated state tax rate, while the effective tax rate for the year ended December 31, 2020 reflects a portion of income which was allocated to the non-controlling interest, a pass-through entity for tax purposes.
Net Income
For the year ended December 31, 2021, net income was $119.3 million compared to $108.3 million for the year ended December 31, 2020. Excluding the $0.6 million gain and $39.9 million gain on remeasurement of warrant liabilities for the years ended December 31, 2021 and 2020, respectively, net income increased as a result of higher gross profits, lower operating costs and lower interest expense.
Earnings Per Share
Our earnings per Class A share was $0.91 (basic) and $0.86 (dilutive) for the year ended December 31, 2021, compared to $0.84 (basic) and $0.51 (dilutive) for the year ended December 31, 2020. The increase in basic and diluted earnings per share was due to the net income impacts noted above.
RECONCILIATION OF NON-GAAP FINANCIAL MEASURES
Adjusted net revenue, adjusted gross profit, adjusted gross margin, adjusted operating income, adjusted net income, adjusted net income margin, adjusted Class A net income, adjusted EBITDA, adjusted EBITDA margin, and adjusted EPS collectively referred to as “Non-GAAP Financial Measures,” are commonly used in our industry and should not be construed as an alternative to net revenue, gross profit, gross margin operating income, net income, net income margin, net income attributed to Class A stockholders or earnings per share as indicators of operating performance (as determined in accordance with GAAP). These Non-GAAP Financial Measures may not be comparable to similarly titled measures reported by other companies. We included these Non-GAAP Financial Measures because we believe the measures provide management and investors with additional information to measure the Company’s performance, estimate the Company’s value and evaluate the Company’s ability to service debt.
Non-GAAP Financial Measures are adjusted to exclude certain items that affect comparability. The adjustments are itemized in the tables below. You are encouraged to evaluate these adjustments and the reason we consider them appropriate for supplemental analysis. In evaluating adjustments, you should be aware that in the future the Company may incur expenses that are the same as or similar to some of the adjustments set forth below. The presentation of Non-GAAP Financial Measures should not be construed as an inference that future results will be unaffected by unusual or recurring items.
For example, we define adjusted EBITDA as net income adjusted to exclude (i) interest expense, net, (ii) depreciation and amortization (iii) income taxes and (iv) share-based compensation, as further adjusted to eliminate the impact of certain items that the Company does not consider indicative of its ongoing operating performance. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of the Company's results as reported under GAAP. For example, adjusted EBITDA:
•does not reflect the Company’s capital expenditures, future requirements for capital expenditures or contractual commitments;
•does not reflect changes in, or cash requirements for, the Company’s working capital needs;
•does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on the Company’s debt; and
•does not reflect payments related to income taxes, the tax receivable agreement or distributions to the non-controlling interest to reimburse its tax liability.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, 2021 |
($ and shares in thousands) | | | Gross Profit | | Gross Margin | | Operating Income | | Net Income | | Net Income Margin | | | | | Diluted EPS |
GAAP results | | | $ | 409,983 | | | 35.9 | % | | $ | 200,738 | | | $ | 119,299 | | | 10.4 | % | | | | | $ | 0.86 | |
Non-GAAP adjustments: | | | | | | | | | | | | | | | | |
Foreign currency remeasurement | | | — | | | — | | | — | | | (505) | | | — | | | | | | — | |
Project consulting costs (1) | | | — | | | — | | | 6,081 | | | 6,081 | | | 0.5 | | | | | | 0.04 | |
Change in fair value of warrant liabilities | | | — | | | — | | | — | | | (566) | | | — | | | | | | — | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Tax receivable agreement remeasurement | | | — | | | — | | | (1,409) | | | (1,409) | | | (0.1) | | | | | | (0.01) | |
Other (2) | | | 704 | | | 0.1 | | | 2,107 | | | 4,338 | | | 0.4 | | | | | | 0.03 | |
Remeasurement of tax liabilities | | | — | | | — | | | — | | | (3,357) | | | (0.3) | | | | | | (0.03) | |
Tax impact of adjustments | | | — | | | — | | | — | | | (1,871) | | | (0.2) | | | | | | (0.01) | |
| | | | | | | | | | | | | | | | |
Adjusted Non-GAAP results | | | $ | 410,687 | | | 36.0 | % | | $ | 207,517 | | | 122,010 | | | 10.7 | | | | | | $ | 0.88 | |
| | | | | | | | | | | | | | | | |
Income tax | | | | | | | | | 45,741 | | | 4.0 | | | | | | |
Interest expense | | | | | | | | | 39,762 | | | 3.5 | | | | | | |
Depreciation and amortization | | | | | | | | | 51,681 | | | 4.5 | | | | | | |
Share-based compensation | | | | | | | | | 9,585 | | | 0.8 | | | | | | |
Adjusted EBITDA | | | | | | | | | $ | 268,779 | | | 23.5 | % | | | | | |
(1) Project consulting costs are included within general and administrative on the consolidated statement of operations.
(2) Costs related to certain corporate initiatives, including $2.8 million of Voortman acquisition related costs. Of the total $4.3 million, $0.7 million is included in cost of goods sold, $1.4 million is included in general and administrative and $2.2 million is included in other non-operating expenses.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2020 |
($ and shares in thousands) | Net Revenue | | Gross Profit | | Gross Margin | | Operating Income | | Net Income | | Net Income Margin | | Class A Net Income | | | | Diluted EPS |
GAAP results | $ | 1,016,609 | | | $ | 355,639 | | | 35.0 | % | | $135,310 | | $108,297 | | 10.7% | | $104,676 | | | | $0.51 |
Non-GAAP adjustments: | | | | | | | | | | | | | | | | | |
Foreign currency remeasurement | — | | | — | | | — | | — | | | 2,065 | | | 0.2 | | 1,966 | | | | | 0.02 | |
Acquisition, disposal and integration related costs (1) | 6,821 | | | 7,963 | | | 0.5 | | 29,166 | | | 29,166 | | | 2.7 | | 27,569 | | | | | 0.22 | |
Facility transition costs (2) | — | | | 3,681 | | | 0.4 | | 5,710 | | | 5,710 | | | 0.6 | | 5,396 | | | | | 0.04 | |
Impairment of property and equipment | — | | | — | | | — | | 3,009 | | | 3,009 | | | 0.3 | | 2,909 | | | | | 0.02 | |
Tax receivable agreement remeasurement | — | | | — | | | — | | 760 | | | 760 | | | 0.1 | | 760 | | | | | — | |
COVID-19 costs (3) | — | | | 2,082 | | | 0.2 | | 2,388 | | | 2,388 | | | 0.2 | | 2,257 | | | | | 0.02 | |
Change in fair value of warrant liabilities | — | | | — | | | — | | — | | | (39,941) | | | (3.9) | | (39,941) | | | | | — | |
Other | — | | | — | | | — | | 100 | | | 1,766 | | | 0.2 | | 1,681 | | | | | 0.01 | |
Remeasurement of tax liabilities | — | | | — | | | — | | — | | | (455) | | | (0.1) | | (455) | | | | | — | |
Tax impact of adjustments | — | | | — | | | — | | — | | | (10,961) | | | (1.1) | | (10,961) | | | | | (0.09) | |
| | | | | | | | | | | | | | | | | |
Adjusted Non-GAAP results | $ | 1,023,430 | | | $ | 369,365 | | | 36.1 | % | | $ | 176,443 | | | 101,804 | | | 9.9 | | | $ | 95,857 | | | | | $ | 0.75 | |
| | | | | | | | | | | | | | | | | |
Income tax | | | | | | | | | 31,821 | | | 3.1 | | | | | | |
Interest expense | | | | | | | | | 42,826 | | | 4.2 | | | | | | |
Depreciation and amortization | | | | | | | | | 54,940 | | | 5.4 | | | | | | |
Share-based compensation | | | | | | | | | 8,671 | | | 0.9 | | | | | | |
Adjusted EBITDA | | | | | | | | | $ | 240,062 | | | 23.5 | % | | | | | | |
(1) Adjustments to net revenue represent initial slotting fees paid to customers to obtain space in customer warehouses for the Voortman transition. Adjustments to operating costs included $8.0 million of selling expense, $8.9 million of general and administrative expenses and $4.3 million of business combination transaction costs on the consolidated statement of operations.
(2) Facility transition costs are included in general and administrative expenses on the consolidated statement of operations.
(3) COVID-19 costs are included in cost of goods sold and general and administrative expenses on the consolidated statement of operations. Total COVID-19 non-GAAP adjustments primarily consist of costs of incremental cleaning and sanitation, personal protective equipment and employee bonuses in the first half of 2020.
Adjusted Net Revenue
There were no adjustments to net revenue for the year ended December 31, 2021. Net revenue increased $118.6 million, or 11.6%, compared to adjusted net revenue for the year ended December 31, 2020, with higher volumes accounting for approximately seven percentage points of the annual growth. Sweet baked goods net revenue increased $105.1 million or 11.4% due to higher volume in Convenience, Grocery and Dollar channels, the benefit of pricing actions implemented in the second half of the year and continued momentum of single-serve products driving favorable product mix. Cookies adjusted net revenue increased $13.5 million or 13.1% due to strong distribution growth in 2021, including introduction to the Convenience channel and pricing actions.
Adjusted Gross Margin
Adjusted gross margin was 36.0% for the year ended December 31, 2021, a decrease of 13 basis points from an adjusted gross margin of 36.1% for the year ended December 31, 2020. Adjusted gross margin was relatively flat in comparison to the prior year as transportation and input cost inflation was offset by productivity initiatives, pricing actions and favorable product mix.
Adjusted EBITDA
Adjusted EBITDA was $268.8 million for the year ended December 31, 2021, compared to $240.1 million for the year ended December 31, 2020. The improvement in adjusted EBITDA was driven by higher sales volume, productivity initiatives, pricing actions and the realization of Voortman cost synergies, partially offset by transportation and input cost inflation as well as increased headcount, higher incentive compensation and additional investment in marketing spend.
Adjusted EPS
Adjusted EPS was $0.88 for the year ended December 31, 2021, compared to $0.75 for the year ended December 31, 2020. The improvement in adjusted EPS was driven by strong adjusted EBITDA performance along with decreases in interest expense and depreciation and amortization, partially offset by the dilutive impact of settling the public and private warrants.
Liquidity and Capital Resources
Our primary sources of liquidity are from the cash and cash equivalents on the balance sheet, 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 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 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 and 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, our future capital expenditures and other cash requirements could be higher than we currently expect as a result of various factors, including any expansion of our business that we undertake, including acquisitions. 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 warrant liabilities, as of December 31, 2021 and 2020 of $17.9 million and $7.0 million, respectively. We have the ability to borrow under our Revolver to meet obligations as they come due. As of December 31, 2021, we had approximately $94.0 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 years ended December 31, 2021 and 2020 were $203.0 million and $159.2 million, respectively. The increase in operating cash flows was driven by an increase in net income after adjusting for non-cash items such as change in fair value of warrant liabilities, depreciation and amortization, share-based compensation and impairment and loss on sale of assets.
Cash Flows provided by and used in Investing Activities
Investing activities used $65.4 million and $374.3 million of cash for the years ended December 31, 2021 and 2020, respectively. During 2020, we funded $316.0 million of the net cash required to purchase Voortman from cash on hand and the proceeds from an incremental term loan on our existing credit facility. Cash used for the purchase of property and equipment reflects planned investments in our bakeries, including new production lines.
Cash Flows provided by and used in Financing Activities
Financing activities used $61.3 million of cash for the year ended December 31, 2021 and provided $103.2 million of cash for the year ended December 31, 2020. The net outflow for 2021 consisted of cash used to repurchase 3.3 million shares of our common stock under our existing securities repurchase authorization offset by cash inflows from the proceeds on exercise of employee stock options and proceeds from the exercise of public warrants prior to the amendment of the warrant agreement in July 2021. The net inflow in 2020 reflects proceeds from debt originated to fund the purchase of Voortman, offset by cash outflows related to the repurchase of 2.0 million warrants and 0.4 million shares from the Metropoulos Entities as part of the exchange of their last remaining Class B units in Hostess Holdings, LP and distributions to non-controlling interest, which was dissolved in Q4 2020. Both periods reflected similar activity on cash outflows related to scheduled payments under the tax receivable agreement and term loan.
Long-Term Debt
As of December 31, 2021, $1,091.6 million aggregate principal amount of our term loan and $6.0 million aggregate principal amount of letters of credit, reducing the amount available under the Revolver, were outstanding. See Note 15. Commitments and Contingencies to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for information regarding the letters of credit. We had no outstanding borrowings under our Revolver as of December 31, 2021. As of December 31, 2021, we were in compliance with all covenants under our term loan and the Revolver. The Revolver contains certain restrictive financial covenants. Based on our current and projected financial performance, we believe that we will comply with these covenants for the foreseeable future.
Critical Accounting Estimates
The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of judgment, estimates and assumptions. We make such subjective determinations after careful consideration of our historical performance, management’s experience, current economic trends and events and information from outside sources. Inherent in this process is the possibility that actual results could differ from these estimates and assumptions for any particular period.
Our significant accounting policies are detailed in Note 1. Summary of Significant Accounting Policies of the notes to our consolidated financial statements within Item 8. Critical accounting policies are defined as those policies that are reflective of significant judgments, estimates and uncertainties, which could potentially result in materially different results under different assumptions and conditions. The following is a summary of certain accounting estimates considered critical by management.
Trade and Consumer Promotion Programs
We offer various sales incentive programs to customers, such as feature price discounts, in-store display incentives, cooperative advertising programs and new product introduction fees. The mix between promotional programs, which are classified as reductions in revenue in the statements of operations, and advertising or other marketing activities, which are classified as marketing and selling expenses in the consolidated statements of operations, fluctuates between periods based on our overall marketing plans, and such fluctuations have an impact on revenues. These trade programs also require management to make estimates about the expected total cost of the programs and related allocations amongst participants (who might have different levels of incentives based on various program requirements). These estimates are inherently uncertain and are generally based on historical experience, adjusted for any new facts or circumstances that might impact the ultimate cost estimate for a particular program or programs.
Goodwill and Indefinite-lived Trade Names
When evaluating goodwill and indefinite-lived intangible assets for impairment under U.S. GAAP, we may first perform an assessment of qualitative factors to determine if the fair value of the reporting unit or the intangible asset is more likely than not greater than the carrying amount. Such qualitative factors include, but are not limited to, macro-economic conditions, market and industry conditions, cost considerations, competitive environment, share price fluctuations, overall financial performance and results of past impairment tests. Based on a review of the qualitative factors, if we determine it is not more likely than not that the fair value is less than the carrying value, we may bypass the quantitative impairment test. We also may elect not to perform the qualitative assessment for the reporting unit and perform a quantitative impairment test. For our 2021 and 2020 annual impairment testing, we elected to perform qualitative assessments for our reporting unit. No indicators of impairment were noted.
If a quantitative test were to be utilized for our reporting unit, it would estimate the fair value of the reporting unit and compare it to its carrying value. To the extent the fair value was in excess of the carrying value, no impairment would be recognized. Otherwise, an impairment loss would be recognized for the amount that the carrying value of our reporting unit, including goodwill, exceeded its fair value. In performing the quantitative test of goodwill, fair value would be determined based on a calculation which would give consideration to an income approach utilizing the discounted cash flow method and the market approach using the market comparable and market transaction methods.
Our indefinite-lived intangible assets consist of trademarks and trade names. The $1,538.6 million balances at both December 31, 2021 and 2020, were recognized as part of the Hostess Business Combination and the Voortman and Cloverhill acquisitions. The trademarks and trade names are integral to the Company’s identity and are expected to contribute indefinitely to our corporate cash flows. Fair value for trademarks and trade names was determined using the income approach. The application of the income approach was premised on a royalty savings method, whereby the trademark and trade names are valued by reference to the amount of royalty income they could generate if they were licensed, in an arm’s-length transaction, to a third party. These assets have been assigned an indefinite life and therefore are not amortized but rather evaluated for impairment annually using the qualitative or quantitative methods similar to goodwill. For 2021 and 2020, we performed a qualitative test. No indicators of impairment were noted.
Changes in certain significant assumptions could have a significant impact on the estimated fair value, and therefore, a future impairment could result for a portion of goodwill or long-lived intangible assets.
Long-lived Assets
We review long-lived assets, including property and equipment and amortizable identifiable intangible assets (e.g. customer relationships), to assess recoverability from projected undiscounted cash flows whenever events or changes in facts and circumstances indicate that the carrying value of the assets may not be recoverable. When such events occur, we compare the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group to the carrying amount of the long-lived asset or asset group. The cash flows are based on our best estimate of future cash flows derived from the most recent business projections. If this comparison indicates there is an impairment, the carrying value of the asset is reduced to its estimated fair value. We also evaluate the amortization periods assigned to our intangible assets to determine whether events or changes in circumstances require a revised estimate of useful lives. We recorded impairment charges of $2.9 million for the year ended December 31, 2020. There were no impairment losses for the year ended December 31, 2021.
Business Combinations
We account for business acquisitions using the purchase method of accounting. Assets acquired, liabilities assumed, and non-controlling interests are recorded at their estimated fair values at the acquisition date. The excess of purchase price over fair value of the net assets acquired, including the amount assigned to identifiable intangible assets, is recorded as goodwill. Given the time it takes to obtain pertinent information to finalize the acquired company’s balance sheet, it may be multiple quarters before we are able to finalize those initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised.
New Accounting Pronouncements
Refer to Note 1. Summary of Significant Accounting Policies of the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information regarding recently issued accounting standards.
Item 8. Financial Statements and Supplementary Data
| | | | | |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS |
Audited Consolidated Financial Statements | |
Report of Independent Registered Public Accounting Firm | |
Consolidated Balance Sheets as of December 31, 2021 and 2020 | |
Consolidated Statements of Operations for the years ended December 31, 2021, 2020 and 2019 | |
Consolidated Statements of Comprehensive Income for the years ended December 31, 2021, 2020 and 2019 | |
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2021, 2020 and 2019 | |
Consolidated Statements of Cash Flows for the years ended December 31, 2021, 2020 and 2019 | |
Notes to Consolidated Financial Statements | |
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Hostess Brands, Inc.:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Hostess Brands, Inc. and subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of customer trade allowances
As discussed in Note 1 to the consolidated financial statements, the Company has recorded a provision for customer trade allowances, consisting primarily of pricing allowances and merchandising programs associated with sales to customers. The liability recorded for the estimated cost of these programs is dependent on factors such as the ultimate purchase volume activity, participation levels of customers, and the related settlement rates for these programs. The Company’s liability for customer trade allowances as of December 31, 2021 was $52.7 million.
We identified the evaluation of the customer trade allowance as a critical audit matter because of the higher degree of auditor judgment required to evaluate the Company’s estimates. This is due to uncertainty around the amount of settlements, which typically occur in a period subsequent to the related sales transactions, and in particular, the estimate of purchase volumes made by retailers from distributors.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s trade process at disaggregated levels. This included controls related to the Company’s trade spend trending and lookback analyses based on final settlement. We analyzed the liability by trade allowance type to identify unusual trends. We assessed the Company’s historical ability to accurately estimate its customer trade allowances by comparing historical estimates to final settlements. We compared a sample of settlements subsequent to period end to the amount previously recognized by the Company.
/s/ KPMG LLP
We have served as the Company’s auditor since 2013.
Kansas City, Missouri
March 1, 2022
HOSTESS BRANDS, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except shares)
| | | | | | | | | | | | | | |
| December 31, | | | December 31, |
ASSETS | 2021 | | | 2020 |
Current assets: | | | | |
Cash and cash equivalents | $ | 249,159 | | | | $ | 173,034 | |
Accounts receivable, net | 148,180 | | | | 125,550 | |
Inventories | 52,813 | | | | 49,348 | |
Prepaids and other current assets | 10,564 | | | | 21,614 | |
Total current assets | 460,716 | | | | 369,546 | |
Property and equipment, net | 335,305 | | | | 303,959 | |
Intangible assets, net | 1,944,392 | | | | 1,967,903 | |
Goodwill | 706,615 | | | | 706,615 | |
Other assets, net | 19,283 | | | | 17,446 | |
Total assets | $ | 3,466,311 | | | | $ | 3,365,469 | |
| | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
Current liabilities: | | | | |
Long-term debt and lease obligations payable within one year | $ | 14,170 | | | | $ | 13,811 | |
Tax receivable agreement obligations payable within one year | 11,600 | | | | 11,800 | |
Accounts payable | 68,104 | | | | 61,428 | |
Customer trade allowances | 52,746 | | | | 46,779 | |
Warrant liabilities | — | | | | 861 | |
Accrued expenses and other current liabilities | 47,009 | | | | 55,715 | |
Total current liabilities | 193,629 | | | | 190,394 | |
Long-term debt and lease obligations | 1,099,975 | | | | 1,113,037 | |
Tax receivable agreement obligations | 134,265 | | | | 144,744 | |
Deferred tax liability | 317,847 | | | | 295,009 | |
Other long-term liabilities | 1,605 | | | | 1,560 | |
Total liabilities | 1,747,321 | | | | 1,744,744 | |
Commitments and Contingencies (Note 15) | | | | |
Class A common stock, $0.0001 par value, 200,000,000 shares authorized, 142,031,329 shares issued and 138,278,573 shares outstanding as of December 31, 2021 and 130,791,908 shares issued and 130,347,464 shares outstanding as of December 31, 2020 | 14 | | | | 13 | |
| | | | |
Additional paid in capital | 1,303,254 | | | | 1,281,018 | |
Accumulated other comprehensive loss | (506) | | | | (10,407) | |
Retained earnings | 475,400 | | | | 356,101 | |
Treasury stock | (59,172) | | | | (6,000) | |
Stockholders’ equity | 1,718,990 | | | | 1,620,725 | |
| | | | |
Total liabilities and stockholders’ equity | $ | 3,466,311 | | | | $ | 3,365,469 | |
See accompanying notes to the consolidated financial statements.
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except shares and per share data) | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | | | | |
Net revenue | $ | 1,142,036 | | | $ | 1,016,609 | | | $ | 907,675 | | | | | | |
Cost of goods sold | 732,053 | | | 660,970 | | | 607,841 | | | | | | |
Gross profit | 409,983 | | | 355,639 | | | 299,834 | | | | | | |
| | | | | | | | | | |
Operating costs and expenses: | | | | | | | | | | |
Advertising and marketing | 51,683 | | | 45,724 | | | 39,775 | | | | | | |
Selling | 36,288 | | | 46,729 | | | 30,719 | | | | | | |
General and administrative | 99,173 | | | 92,860 | | | 69,423 | | | | | | |
Amortization of customer relationships | 23,510 | | | 26,510 | | | 23,377 | | | | | | |
Business combination transaction costs | — | | | 4,282 | | | 1,914 | | | | | | |
Tax receivable agreement remeasurement | (1,409) | | | 760 | | | 186 | | | | | | |
Gain on foreign currency contract | — | | | — | | | (7,128) | | | | | | |
Other operating expense | — | | | 3,464 | | | 5,472 | | | | | | |
Total operating costs and expenses | 209,245 | | | 220,329 | | | 163,738 | | | | | | |
Operating income | 200,738 | | | 135,310 | | | 136,096 | | | | | | |
Other (income) expense: | | | | | | | | | | |
Interest expense, net | 39,762 | | | 42,826 | | | 39,870 | | | | | | |
| | | | | | | | | | |
Change in fair value of warrant liabilities | (566) | | | (39,941) | | | 58,816 | | | | | | |
Other expense | 1,730 | | | 3,723 | | | 1,769 | | | | | | |
Total other expense | 40,926 | | | 6,608 | | | 100,455 | | | | | | |
Income before income taxes | 159,812 | | | 128,702 | | | 35,641 | | | | | | |
Income tax expense | 40,513 | | | 20,405 | | | 16,892 | | | | | | |
Net income | 119,299 | | | 108,297 | | | 18,749 | | | | | | |
Less: Net income attributable to the non-controlling interest | — | | | 3,621 | | | 14,450 | | | | | | |
Net income attributable to Class A stockholders | $ | 119,299 | | | $ | 104,676 | | | $ | 4,299 | | | | | | |
| | | | | | | | | | |
Earnings per Class A share: | | | | | | | | | | |
Basic | $ | 0.91 | | | $ | 0.84 | | | $ | 0.04 | | | | | | |
Diluted | $ | 0.86 | | | $ | 0.51 | | | $ | 0.04 | | | | | | |
Weighted-average shares outstanding: | | | | | | | | | | |
Basic | 131,571,733 | | | 124,927,535 | | | 110,540,264 | | | | | | |
Diluted | 138,198,176 | | | 127,723,488 | | | 111,005,689 | | | | | | |
See accompanying notes to the consolidated financial statements.
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | |
| Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | | | | |
Net income | $ | 119,299 | | | $ | 108,297 | | | $ | 18,749 | | | | | | |
Other comprehensive income: | | | | | | | | | | |
Unrealized gain (loss) on interest rate swaps and foreign currency contracts designated as cash flow hedges | 8,973 | | | (16,870) | | | (4,063) | | | | | | |
Reclassification into net income | 4,503 | | | 3,886 | | | (1,705) | | | | | | |
Income tax benefit (expense) | (3,575) | | | 3,421 | | | 1,222 | | | | | | |
Comprehensive income | 129,200 | | | 98,734 | | | 14,203 | | | | | | |
Less: Comprehensive income attributed to non-controlling interest | — | | | 2,749 | | | 13,292 | | | | | | |
Comprehensive income attributed to Class A stockholders | $ | 129,200 | | | $ | 95,985 | | | $ | 911 | | | | | | |
See accompanying notes to the consolidated financial statements.
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Class A Voting Common Stock | | Class B Voting Common Stock | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Losses) | | Retained Earnings | | Treasury Stock | | Total Stockholders’ Equity | | Non-controlling Interest |
| Shares | | Amount | | Shares | | Amount | | | | | | | | Shares | | Amount | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Balance–December 31, 2018 | 100,046 | | | $ | 10 | | | 30,256 | | | $ | 3 | | | $ | 897,652 | | | $ | 2,523 | | | $ | 247,126 | | | — | | | $ | — | | | $ | 1,147,314 | | | $ | 350,454 | |
Comprehensive income | — | | | — | | | — | | | — | | | — | | | (3,388) | | | 4,299 | | | — | | | — | | | 911 | | | 13,292 | |
Share-based compensation, net of income taxes of $1,354 | 209 | | | — | | | — | | | — | | | 7,877 | | | — | | | — | | | — | | | — | | | 7,877 | | | — | |
Exchanges | 21,845 | | | 2 | | | (21,845) | | | (2) | | | 262,547 | | | 109 | | | — | | | — | | | — | | | 262,656 | | | (262,656) | |
Distributions | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (6,658) | |
Exercise of employee stock options | 7 | | | — | | | — | | | — | | | 23 | | | — | | | — | | | — | | | — | | | 23 | | | — | |
Payment of taxes for employee stock awards | — | | | — | | | — | | | — | | | (1,431) | | | — | | | — | | | — | | | — | | | (1,431) | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
Tax receivable agreement arising from exchanges, net of income taxes of $28,817 | — | | | — | | | — | | | — | | | (42,863) | | | — | | | — | | | — | | | — | | | (42,863) | | | — | |
Balance–December 31, 2019 | 122,107 | | | 12 | | | 8,411 | | | 1 | | | 1,123,805 | | | (756) | | | 251,425 | | | — | | | — | | | 1,374,487 | | | 94,432 | |
Comprehensive income | — | | | — | | | — | | | — | | | — | | | (8,691) | | | 104,676 | | | — | | | — | | | 95,985 | | | 2,749 | |
Share-based compensation, including income taxes of $2,167 | 223 | | | — | | | — | | | — | | | 10,838 | | | — | | | — | | | — | | | — | | | 10,838 | | | — | |
Exchanges | 8,411 | | | 1 | | | (8,411) | | | (1) | | | 94,719 | | | (960) | | | — | | | — | | | — | | | 93,759 | | | (93,759) | |
Distributions | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | (3,422) | |
Exercise of employee stock options and warrants | 50 | | | — | | | — | | | — | | | 690 | | | — | | | — | | | — | | | — | | | 690 | | | — | |
Payment of taxes for employee stock awards | — | | | — | | | — | | | — | | | (1,440) | | | — | | | — | | | — | | | — | | | (1,440) | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
Reclassification of public warrants | — | | | — | | | — | | | — | | | 68,503 | | | — | | | — | | | — | | | — | | | 68,503 | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
Repurchase of common stock | (444) | | | — | | | — | | | — | | | — | | | — | | | — | | | 444 | | | (6,000) | | | (6,000) | | | — | |
Tax receivable agreement arising from exchanges, net of income taxes of $11,818 | — | | | — | | | — | | | — | | | (16,097) | | | — | | | — | | | — | | | — | | | (16,097) | | | — | |
Balance-December 31, 2020 | 130,347 | | | 13 | | | — | | | $ | — | | | 1,281,018 | | | (10,407) | | | 356,101 | | | 444 | | | (6,000) | | | 1,620,725 | | | — | |
Comprehensive income (loss) | — | | | — | | | — | | | — | | | — | | | 9,901 | | | 119,299 | | | — | | | — | | | 129,200 | | | — | |
Share-based compensation | 224 | | | — | | | — | | | — | | | 9,585 | | | — | | | — | | | — | | | — | | | 9,585 | | | — | |
Exercise of employee stock options | 313 | | | — | | | — | | | — | | | 4,488 | | | — | | | — | | | — | | | — | | | 4,488 | | | — | |
Exercise of public warrants | 881 | | | — | | | — | | | — | | | 9,632 | | | — | | | — | | | — | | | — | | | 9,632 | | | — | |
Cashless exercise of public warrants, net of fees of $500 | 9,823 | | | 1 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 1 | | | — | |
Payment of taxes for employee stock awards | — | | | — | | | — | | | — | | | (1,767) | | | — | | | — | | | — | | | — | | | (1,767) | | | — | |
Reclassification of warrants | — | | | — | | | — | | | — | | | 298 | | | — | | | — | | | — | | | — | | | 298 | | | — | |
Repurchase of common stock | (3,309) | | | — | | | — | | | — | | | — | | | — | | | — | | | 3,309 | | | (53,172) | | | (53,172) | | | — | |
Balance-December 31, 2021 | 138,279 | | | $ | 14 | | | — | | | $ | — | | | $ | 1,303,254 | | | $ | (506) | | | $ | 475,400 | | | 3,753 | | | $ | (59,172) | | | $ | 1,718,990 | | | $ | — | |
See accompanying notes to the consolidated financial statements.
HOSTESS BRANDS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands) | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | | | | |
Operating activities | | | | | | | | | | |
Net income | $ | 119,299 | | | $ | 108,297 | | | $ | 18,749 | | | | | | |
Depreciation and amortization | 51,681 | | | 54,940 | | | 43,334 | | | | | | |
Impairment and loss on sale of assets | — | | | 3,329 | | | 1,976 | | | | | | |
Non-cash loss on debt modification | — | | | — | | | 531 | | | | | | |
Debt discount (premium) amortization | 1,238 | | | 1,289 | | | (747) | | | | | | |
Tax receivable agreement remeasurement | (1,409) | | | 760 | | | 185 | | | | | | |
Change in fair value of warrant liabilities | (566) | | | (39,941) | | | 58,816 | | | | | | |
Non-cash fees on sale of business | — | | | — | | | 1,414 | | | | | | |
Unrealized loss (gain) on foreign currency | (503) | | | 2,061 | | | (7,128) | | | | | | |
Non-cash lease expense | 1,247 | | | 571 | | | — | | | | | | |
Share-based compensation | 9,585 | | | 8,671 | | | 9,231 | | | | | | |
| | | | | | | | | | |
Deferred taxes | 18,995 | | | 16,806 | | | 14,121 | | | | | | |
Change in operating assets and liabilities, net of acquisitions and dispositions: | | | | | | | | | | |
Accounts receivable | (22,728) | | | 4,434 | | | (2,570) | | | | | | |
Inventories | (3,465) | | | 5,824 | | | (12,477) | | | | | | |
Prepaids and other current assets | 9,876 | | | (5,301) | | | 265 | | | | | | |
Accounts payable and accrued expenses | 13,723 | | | 1,900 | | | 14,072 | | | | | | |
Customer trade allowances | 6,056 | | | (4,397) | | | 4,202 | | | | | | |
| | | | | | | | | | |
Net cash provided by operating activities | 203,029 | | | 159,243 | | | 143,974 | | | | | | |
| | | | | | | | | | |
Investing activities | | | | | | | | | | |
Purchases of property and equipment | (60,803) | | | (51,983) | | | (34,875) | | | | | | |
Acquisition of business, net of cash | — | | | (316,013) | | | — | | | | | | |
Proceeds from sale of business, net of cash | — | | | — | | | 63,345 | | | | | | |
| | | | | | | | | | |
Acquisition and development of software assets | (4,622) | | | (6,269) | | | (5,609) | | | | | | |
Net cash provided by (used in) investing activities | (65,425) | | | (374,265) | | | 22,861 | | | | | | |
Financing activities | | | | | | | | | | |
Repayments of long-term debt and financing lease obligations | (11,167) | | | (11,168) | | | (9,894) | | | | | | |
Proceeds from long-term debt origination, net of fees paid | — | | | 136,888 | | | — | | | | | | |
Debt refinancing costs | — | | | — | | | (7,433) | | | | | | |
Distributions to non-controlling interest | — | | | (3,422) | | | (6,658) | | | | | | |
Repurchase of warrants | — | | | (2,000) | | | — | | | | | | |
Repurchase of common stock | (53,172) | | | (6,000) | | | — | | | | | | |
Payment of taxes related to the net issuance of employee stock awards | (1,767) | | | (1,440) | | | (1,431) | | | | | | |
Payments on tax receivable agreement | (9,270) | | | (10,327) | | | (2,732) | | | | | | |
Cash received from exercise of options and warrants, net of fees | 14,121 | | | 690 | | | 23 | | | | | | |
Net cash provided by (used in) financing activities | (61,255) | | | 103,221 | | | (28,125) | | | | | | |
Effect of exchange rate changes on cash and cash equivalents | (224) | | | (252) | | | — | | | | | | |
Net increase (decrease) in cash and cash equivalents | 76,125 | | | (112,053) | | | 138,710 | | | | | | |
Cash and cash equivalents at beginning of period | 173,034 | | | 285,087 | | | 146,377 | | | | | | |
Cash and cash equivalents at end of period | $ | 249,159 | | | $ | 173,034 | | | $ | 285,087 | | | | | | |
| | | | | | | | | | |
Supplemental Disclosures of Cash Flow Information | | | | | | | | | | |
Interest paid | $ | 38,567 | | | $ | 41,776 | | | $ | 43,986 | | | | | | |
Taxes paid | $ | 12,081 | | | $ | 5,825 | | | $ | 1,840 | | | | | | |
Supplemental disclosure of non-cash investing | | | | | | | | | | |
Accrued capital expenditures | $ | 2,244 | | | $ | 4,718 | | | $ | 2,910 | | | | | | |
See accompanying notes to the consolidated financial statements.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Hostess Brands, Inc. is a Delaware corporation headquartered in Lenexa, Kansas. The consolidated financial statements include the accounts of Hostess Brands, Inc. and its subsidiaries (collectively, the “Company”). The Company is a leading sweet snacks company focused on developing, manufacturing, marketing, selling and distributing snacks in North America under the Hostess® and Voortman® brands. The Company produces a variety of new and classic treats including iconic Hostess® Donettes®, Twinkies®, CupCakes, Ding Dongs® and Zingers® as well as a variety of Voortman® cookies and wafers. The Hostess® brand dates back to 1919 when the Hostess® CupCake was introduced to the public, followed by Twinkies® in 1930.
Basis of Presentation
The Company’s operations are primarily conducted through its wholly-owned operating subsidiary, Hostess Brands, LLC (“HBLLC”) and its subsidiaries. Hostess Brands, Inc. is a holding company with no significant assets or operations other than cash and cash equivalents of $56.2 million and $40.4 million at December 31, 2021 and 2020, respectively, tax receivable agreement liability, investment in its subsidiaries and current and deferred income tax assets and liabilities related to its earnings from HBLLC. 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”). The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned, majority-owned or controlled subsidiaries, collectively referred to as the Company. All intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform with current period presentation.
The Company’s operating subsidiaries are wholly-owned by Hostess Holdings, a direct subsidiary of Hostess Brands, Inc. Prior to the final exchange of Class B stock (as described below), Hostess Brands, Inc. held 100% of the general partnership interest in Hostess Holdings and a majority of the limited partnership interests therein and consolidated Hostess Holdings in the Company’s consolidated financial statements. The remaining limited partnership interests in Hostess Holdings were held by the holders of Class B stock.
C. Dean Metropoulos and entities under his control (the “Metropoulos Entities”) held their equity investment in the Company primarily through Class B limited partnership units (“Class B Units”) in Hostess Holdings LP (“Hostess Holdings”) and an equal number of shares of the Company’s Class B common stock (“Class B Stock”). Each Class B Unit, together with a share of Class B Stock held by the Metropoulos Entities, was exchangeable for a share of the Company’s Class A common stock. The interest of the Class B Units was reflected in the consolidated financial statements as a non-controlling interest. During the year ended December 31, 2020, the Metropoulos Entities exchanged all of their remaining Class B Units and Class B Stock for Class A common stock. At December 31, 2021 and 2020, there were no outstanding Class B Units or Class B stock and there is no non-controlling interest reported on the December 31, 2021 or 2020 consolidated balance sheets.
Subsequent to the Metropoulos Entities’ final exchange of Class B Units, all subsidiaries, including Hostess Holdings are wholly owned by the Company.
Prior to the final exchange of Class B Units, the Company determined that Hostess Holdings, a limited partnership, was a variable interest entity (“VIE”) and that the Company was the primary beneficiary of the VIE. The Company determined that, due to its ownership of Hostess Holdings’ general partnership units, the Company had the power to direct all of the activities of Hostess Holdings, with no substantive kick-out rights or participating rights by the limited partners individually or as a group. Hostess Holdings constituted the majority of the assets of the Company.
The Company has one reportable segment: Snacking. For the year ended December 31, 2019, the Company had two reportable segments: Snacking and In-Store Bakery prior to the sale of its operations on August 30, 2019.
HOSTESS BRANDS, INC.
NOTES TO 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 was the primary beneficiary of a VIE), collectively referred to as the Company. All intercompany balances and transactions have been eliminated in consolidation.
Adoption of New Accounting Standards
On January 1, 2021, the Company adopted Accounting Standards Update (“ASU”), 2019-12 Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for certain income tax related items, including intraperiod tax allocations, deferred taxes related to foreign subsidiaries and step-up in tax basis of goodwill. The adoption of this standard did not have a material impact on the consolidated financial statements.
On January 1, 2020, the Company adopted ASU No. 2016-13 Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU requires entities to measure the impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. The adoption of this standard did not have a material impact on the 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, future cash tax savings rate, incremental borrowing rate and the allocation of the liability between short-term and long-term based on when the Company realizes certain tax attributes and reserves for trade and promotional allowances. Actual results could differ from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less when purchased as cash equivalents and records these at cost. Under the Company’s cash management system, checks that have been issued and are out of the control of the Company, but which have not cleared the bank by the balance sheet date, are reported as a reduction of cash.
Accounts Receivable
Accounts receivable represents amounts invoiced to customers for which the Company’s obligation to the customer has been satisfied. As of December 31, 2021 and 2020, the Company’s accounts receivable were $148.2 million and $125.6 million, respectively, which have been reduced by allowances for damages occurring during shipment, quality claims and doubtful accounts in the amount of $3.0 million and $3.5 million, respectively.
The allowance for doubtful accounts represents the Company’s estimate of expected credit losses related to trade receivables. To estimate the allowance for doubtful accounts, the Company leverages information on historical losses, current conditions, and reasonable and supportable forecasts of future conditions. Account balances are written off against the allowance when the Company deems the amount is uncollectible.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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) | December 31, 2021 | | December 31, 2020 |
Ingredients and packaging | $ | 22,607 | | | $ | 22,965 | |
Finished goods | 26,988 | | | 23,583 | |
Inventory in transit to customers | 3,218 | | | 2,800 | |
| $ | 52,813 | | | $ | 49,348 | |
Property and Equipment
Additions to property and equipment are recorded at cost and depreciated straight-line over estimated useful lives of 15 to 50 years for buildings and land improvements and 3 to 20 years for machinery and equipment. In order to maximize the efficiency of the Company’s operations and to operate the acquired equipment, occasionally the Company will remove and relocate equipment between bakeries. Such removal and relocation costs are expensed as incurred. Reinstallation costs are capitalized if the useful life is extended or the equipment is significantly improved. Otherwise, reinstallation costs are expensed as incurred. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments, which extend the useful lives of existing property and equipment, are capitalized and depreciated. Upon retirement or disposition of property and equipment, the capitalized cost and related accumulated depreciation are removed from the balance sheet and any resulting gain or loss is recognized in the consolidated statements of operations.
The Company assesses property, plant and equipment for impairment whenever events or changes in facts and circumstances indicate that the carrying amount of the asset may not be recoverable based on projected undiscounted cash flows. For the years ended December 31, 2020 and 2019, the Company recorded impairment losses of $2.9 million and $0.5 million, respectively, in the Snacking segment located within other operating expenses on the consolidated statements of operations. There were no impairment losses for the year ended December 31, 2021.
Software Costs
Costs associated with computer software projects during the preliminary project stage are expensed as incurred. Once management authorizes and commits to funding a project, appropriate application development stage costs are capitalized. Capitalization ceases when the project is substantially complete and the software is ready for its intended use. Upgrades and enhancements to software are capitalized when such enhancements are determined to provide additional functionality. Training and maintenance costs associated with software applications are expensed as incurred.
Capitalized software is included in other assets in the consolidated balance sheets in the amount of $14.7 million at both December 31, 2021 and 2020. Capitalized software costs are amortized over their estimated useful life of up to five years commencing when such assets are ready for their intended use. Software amortization expense included in general and administrative expense in the consolidated statements of operations was $4.7 million, $5.3 million and $2.7 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Goodwill and Intangible Assets
For the years ended December 31, 2021 and 2020, the goodwill balance of $706.6 million represents the excess of the amount the Company paid for the acquisition of Hostess Holdings from the Metropoulos Entities and other former equity holders in a 2016 transaction and the acquisition of Voortman in 2020 over the fair values of the assets acquired and liabilities assumed. The resulting goodwill was allocated to the Snacking reportable segment.
Goodwill by reporting unit is tested for impairment annually by either performing a qualitative evaluation or a quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company may
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
elect not to perform the qualitative assessment for some or all reporting units and perform a quantitative impairment test.
The Company’s indefinite-lived intangible assets consist of trademarks and trade names. The $1,538.6 million balance at both December 31, 2021 and 2020, was recognized as part of the 2016 acquisition of Hostess Holdings, the 2018 acquisition of the Cloverhill Business and the 2020 acquisition of Voortman. The trademarks and trade names are integral to the Company’s identity and are expected to contribute indefinitely to its corporate cash flows. Fair value for trademarks and trade names was determined using the income approach, which is considered to be Level 3 within the fair value hierarchy. The application of the income approach was premised on a royalty savings method, whereby the trademark and trade names are valued by reference to the amount of royalty income they could generate if they were licensed, in an arm’s-length transaction, to a third party. These assets have been assigned an indefinite life and therefore are not amortized but rather evaluated for impairment annually using the qualitative or quantitative methods, similar to goodwill. For the quantitative assessment, the valuation of trademarks and trade names are determined using the relief from royalty method. Significant assumptions used in this method include future trends in sales, a royalty rate and a discount rate to be applied to the forecasted revenue stream.
For the 2021 and 2020 annual impairment tests of goodwill and indefinite-lived intangible assets, the Company elected to perform the qualitative test. No indicators of impairment were noted. During the year ended December 31, 2019, the Company recognized an impairment charge of $1.0 million to the In-Store Bakery goodwill and intangibles. See Note 7. Goodwill and Intangible Assets for more information on impairment charges.
Also, the Company has finite-lived intangible assets, net of accumulated amortization, of $405.8 million and $429.3 million on December 31, 2021 and 2020 respectively, consisting of customer relationships that were recognized as part of the Hostess Holdings, Voortman and Cloverhill acquisitions. For customer relationships, the application of the income approach (Level 3) was premised on an excess earnings method, whereby the customer relationships are valued by the earnings expected to be generated from those customers after other capital charges. Finite-lived intangible assets are being amortized on a straight-line basis over the estimated remaining useful lives of the assets, from 3 to 18 years. The weighted-average amortization period as of December 31, 2021 for customer relationships was 17.7 years.
The Company assesses finite-lived intangible assets for impairment whenever events or changes in facts and circumstances indicate that the carrying amount of the asset may not be recoverable based on projected undiscounted cash flows, similar to property, plant and equipment. There were no impairment losses for the years ended December 31, 2021, 2020 and 2019.
Reserves for Self-Insurance Benefits
The Company’s employee health plan is self-insured up to a stop-loss amount of $0.3 million for each participant per plan year. In addition, the Company maintains insurance programs covering its exposure to workers’ compensation. Such programs include the retention of certain levels of risks and costs through high deductibles and other risk retention strategies. Included in the accrued expenses in the consolidated balance sheets is a reserve for healthcare claims in the amount of approximately $1.9 million and $2.2 million at December 31, 2021 and 2020, respectively, and a reserve for workers’ compensation claims of $3.1 million and $2.9 million at December 31, 2021 and 2020, respectively.
Leases
The Company recognizes a right of use asset and corresponding lease liability on the consolidated balance sheets 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 December 31, 2021, 2020 and 2019, the weighted average effective borrowing rate for outstanding operating leases was 3.6%, 3.6% and 4.4%, respectively.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 December 31, 2021, 2020 and 2019, the weighted average remaining terms on operating leases were approximately seven, eight and six years, respectively.
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.
At December 31, 2021, right of use assets related to operating leases are included in property and equipment, net on the consolidated balance sheets (see Note 5. Property and Equipment). Lease liabilities for operating leases are included in the current and non-current portions of long-term debt and lease obligations on the consolidated balance sheets (see Note 10. Debt).
Revenue Recognition
Net revenue consists primarily of sales of packaged food products. The Company recognizes revenue when the performance obligations under the terms of its agreements with customers have been satisfied. The Company’s obligation is satisfied when control of the product is transferred to its customers along with the title, risk of loss and rewards of ownership. Depending on the arrangement with the customer, these criteria are met either at the time the product is shipped or when the product is received by such customer.
Customers are invoiced at the time of shipment or customer pickup based on credit terms established in accordance with industry practice. Invoices generally require payment within 30 days. As a result, revenue is not adjusted for the effects of a significant financing component. Net revenue is recognized in an amount that reflects the consideration the Company expects to be entitled to in exchange for that product. Amounts billed to customers related to shipping and handling are classified as net revenue and accounted for as fulfillment activities, rather than separate performance obligations. The Company generally does not accept product returns and provides these allowances for anticipated expired or damaged products.
Trade promotions, consisting primarily of customer pricing allowances and merchandising funds are offered through various programs to customers. A provision for estimated trade promotions is recorded as a reduction of revenue in the same period when the sale is recognized, with the liability for these allowances included within customer trade allowances on the consolidated balance sheets. Differences between estimated and actual reductions to the transaction price are recognized as a change in estimate in a subsequent period.
The Company also offers rebates based on purchase levels, products carried in retail stores and customers’ promotional activity. The ultimate cost of these programs is dependent on various factors such as actual purchase volumes or promotional performance and is the subject of significant management estimates. Assumptions included in the development of these estimates are primarily based on historical performance adjusted for current trends. The Company regularly reviews these assumptions and related estimates. The Company accounts for these programs as variable consideration and recognizes a reduction in revenue in the same period as the underlying program. Our recorded liability for allowances is included within customer trade allowances on the consolidated balance sheets.
For product produced by third parties, management evaluates whether the Company is the principal (i.e., report revenue on a gross basis) or agent (i.e., report revenue on a net basis). Management has determined that it is the principal in all cases, since it establishes its own pricing for such product, assumes the credit risk for amounts billed to its customers, and often takes physical control of the product before it is shipped to customers.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables disaggregate revenue by geographical market and category:
| | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
(In thousands) | Sweet Baked Goods | | | | Cookies | | Total |
United States | $ | 1,025,541 | | | | | $ | 98,797 | | | $ | 1,124,338 | |
Canada | — | | | | | 17,698 | | | 17,698 | |
| $ | 1,025,541 | | | | | $ | 116,495 | | | $ | 1,142,036 | |
| | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2020 |
(In thousands) | Sweet Baked Goods | | | | Cookies | | Total |
United States | $ | 920,388 | | | | | $ | 77,692 | | | $ | 998,080 | |
Canada | — | | | | | 18,529 | | | 18,529 | |
| $ | 920,388 | | | | | $ | 96,221 | | | $ | 1,016,609 | |
| | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2019 |
(In thousands) | Sweet Baked Goods | | In-Store Bakery | | | | Total |
United States | $ | 878,973 | | | $ | 28,702 | | | | | $ | 907,675 | |
Canada | — | | | — | | | | | — | |
| $ | 878,973 | | | $ | 28,702 | | | | | $ | 907,675 | |
The Company has one customer 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:
| | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | | | | |
Snacking | 18.9 | % | | 20.2 | % | | 23.3 | % | | | | | |
In-Store Bakery | — | % | | — | % | | 0.3 | % | | | | | |
Total | 18.9 | % | | 20.2 | % | | 23.6 | % | | | | | |
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense included in advertising and marketing in the consolidated statements of operations was $9.5 million, $6.2 million and $4.1 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Foreign Currency Remeasurement
Certain Voortman sales and production related costs are denominated in the Canadian dollar (“CAD”). CAD transactions have been remeasured into U.S. dollars (“USD”) on the consolidated statements of operations using the average exchange rate for the reporting period. Balances expected to be settled in CAD have been remeasured into USD on the consolidated balance sheets using the exchange rate at the end of the period. During the year ended December 31, 2021 and 2020 the Company recognized a gain on remeasurement of $0.5 million and losses of $1.8 million, respectively, reported within other expense on the consolidated statements of operations.
Equity Compensation
The grant date fair values of stock options are valued using the Black-Scholes option-pricing model, including a simplified method to estimate the number of periods to exercise date (i.e., the expected option term). Management has determined that the equity plan has not been in place for a sufficient amount of time to estimate the post vesting exercise behavior. Therefore, it will continue to use this simplified method until such time as it has sufficient history to provide a reasonable basis to estimate the expected term. Forfeitures are recognized as a reduction of expense as incurred.
For awards which have market conditions, compensation expense is calculated based on the number of shares expected to vest after assessing the probability that the performance or market criteria will be met. For market-based awards, probability is not reassessed and compensation expense is not remeasured subsequent to the initial assessment on the grant date.
Shares issued for option exercises, restricted stock units and other stock-based awards may be either authorized but unissued shares or shares of treasury stock.
Collective Bargaining Agreements
As of December 31, 2021, approximately 44%, of the Company’s employees are covered by collective bargaining agreements. Two of these agreements expire before December 31, 2022.
Employee Benefit Plans
The Company provides several benefit plans for employees depending upon employee eligibility. The Company has a health care plan, a defined contribution retirement plan (401(k)), company-sponsored life insurance, and other benefit plans. For the defined contribution retirement plan, the Company matches a percentage of employee contributions up to a specified amount. For the years ended December 31, 2021, 2020 and 2019, contributions to the defined contribution retirement plan were $2.4 million, $2.0 million and $1.8 million, respectively.
The Company offers an annual incentive plan based upon annual operating targets. Final payout is approved by the Board of Directors or a committee thereof. As of December 31, 2021 and 2020 there was $21.2 million and $14.2 million accrued for this plan, respectively.
Income Taxes
The Company is subject to U.S. federal, state and local income taxes as well as Canadian income tax on certain subsidiaries.
Prior to the final exchange of Class B Units, the Company owned a controlling interest in Hostess Holdings, which was treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, Hostess Holdings was not directly subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by Hostess Holdings was passed through to and included in the taxable income or loss of its partners, including the Company.
The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additionally, the impact of changes in the enacted tax rates and laws on deferred taxes, if any, is reflected in the financial statements in the period of enactment.
The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs (see Note 14. Income Taxes).
Derivatives
At December 31, 2020 and 2019, the Company had outstanding public and private placement warrants which were originated in the 2015 initial public offering of a special purpose acquisition company (“SPAC”), which subsequently acquired Hostess Holdings in 2016 in a transaction that resulted in the Company becoming the parent company of Hostess Holdings. Due to certain provisions in the warrant agreement, the Company concluded that certain warrants do not meet the criteria to be classified in stockholders’ equity. In periods in which the public and private warrants meet the definition of a liability-classified derivative under Accounting Standards Codification (“ASC”) 815, the Company recognized these warrants within current liabilities on the consolidated balance sheets at fair value, with subsequent changes in fair value recognized in the consolidated statements of operations at each reporting date. The warrants expired on November 4, 2021 and are no longer outstanding.
The Company has entered into interest rate swap contracts to mitigate its exposure to changes in the variable interest rate on its long-term debt. The Company has also entered into Canadian Dollar (CAD) purchase contracts to mitigate its exposure to foreign currency exchange rates on its CAD denominated production costs. Both interest rate swap contracts and CAD purchase contracts are designated as cash flow hedges. Changes in the fair value of these instruments are recognized in accumulated other comprehensive income in the consolidated balance sheets and reclassified into earnings in the period in which the hedged transaction affects earnings. Hedging ineffectiveness, if any, is recognized as a component of interest expense for interest rate swap contracts and costs of goods sold for CAD purchase contracts in the consolidated statements of operations. Payments made under the interest rate swap contracts are included in the supplemental disclosure of interest paid in the consolidated statements of cash flows.
The Company also used a CAD purchase contract to mitigate the impact of foreign currency exchange rates on its January 2020 purchase of Voortman. This contract was settled during the year ended December 31, 2020 and did not qualify as a cash flow hedge.
See Note 11. Derivative Instruments for more information on our derivative instruments.
Fair Value Measurements
The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the best extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
•Level 1 inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
•Level 2 inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
•Level 3 inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
New Accounting Pronouncements
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides practical expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The expedients and exceptions provided by the amendments in this update apply only to contracts, hedging relationships, and other transactions that reference the London Inter-Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued as a result of reference rate reform. These amendments are not applicable to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022. ASU No. 2020-04 is effective as of March 12, 2020 through December 31, 2022 and may be applied to contract modifications and hedging relationships from the beginning of an interim period that includes or is subsequent to March 12, 2020. The Company is evaluating the impact the new standard will have on the consolidated financial statements and related disclosures but does not anticipate a material impact.
2. Business Combinations and Divestitures
Voortman Acquisition
On January 3, 2020, the Company completed the acquisition of all of the shares of the parent company of Voortman, a manufacturer of premium, branded wafers as well as sugar-free and specialty cookies for approximately $328.7 million ($427.0 million CAD), reflecting final working capital and other closing statement adjustments.
Net cash outflow related to the purchase price during the year ended December 31, 2020 was $316.0 million. This net cash outflow reflects a non-cash gain on a related foreign currency contract of $6.9 million, cash acquired of $1.6 million and an outstanding liability as of December 31, 2020 for certain purchase price adjustments of $4.2 million. As of December 31, 2021 the outstanding liability for certain purchase price adjustments was $4.3 million.
The acquisition of Voortman diversifies and expands the Company’s product offerings and manufacturing capabilities in the adjacent Cookie category. The acquisition also leverages the Company’s customer reach and lean and agile business model. The Company expects to realize additional benefits of scale via sharing established, efficient infrastructure and strengthening collaborative retail partnerships in the United States and Canada.
During the year ended December 31, 2020, working capital and other adjustments of $4.7 million were made to goodwill. Included in other non-current liabilities in the table below is a $1.3 million liability for pre-acquisition uncertain tax positions. The opening balance sheet was offset by a non-current receivable balance of $1.3 million representing expected recovery through indemnifications.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the final purchase price allocation:
| | | | | |
(In thousands) | |
Cash | $ | 1,639 | |
Accounts receivable | 24,848 | |
Inventory | 7,564 | |
Income tax receivable | 7,522 | |
Other current assets | 420 | |
Property and equipment | 32,028 | |
Customer relationships (1) | 11,100 | |
Trade names (2) | 130,000 | |
Goodwill (3) | 170,762 | |
Other non-current assets | 1,320 | |
Accounts payable and accrued expenses | (6,172) | |
Customer trade allowances | (5,428) | |
Lease liabilities | (6,420) | |
Deferred taxes | (39,149) | |
Other non-current liabilities | (1,320) | |
Assets acquired and liabilities assumed | $ | 328,714 | |
(1) Customer relationships were valued through application of the income approach (Level 3). Under this approach, revenue, operating expenses and other costs associated with existing customers were estimated in order to derive cash flows attributable to the existing customer relationships. The resulting cash flows were then discounted to present value to arrive at the fair value of existing customer relationships as of the valuation date. The estimated useful lives by operating segment ranging from one to eight years represent the approximate point in the projection period in which a majority of the assets’ cash flows are expected to be realized based on assumed attrition rates.
(2) The trade names were valued through application of the income approach (level 3), involving the estimation of likely future sales and an appropriate royalty rate. The trade name and trademarks are estimated to have indefinite useful lives as the Company expects a market participant would use the trade name and trademarks in perpetuity based on their historical strength and consumer recognition.
(3) Goodwill represents the excess of the consideration transferred over the fair values of the assets acquired and liabilities assumed. It is primarily attributable to synergies and intangible assets such as assembled workforce which are not separately recognizable.
During the years ended December 31, 2020 and 2019, the Company incurred $4.3 million and $1.9 million, respectively, of expenses related to this acquisition. These expenses are classified as business combination transaction costs on the consolidated statements of operations.
The following unaudited pro forma combined financial information presents the Company’s results as though the acquisition of Voortman had occurred at January 1, 2019. The unaudited pro forma consolidated financial information has been prepared using the acquisition method of accounting in accordance with U.S. GAAP:
| | | | | | | | | | | |
| Twelve Months Ended |
(In thousands) | December 31, 2020 | | December 31, 2019 |
| (unaudited, pro forma) |
Net revenue | $ | 1,016,609 | | | $ | 1,007,140 | |
Net income | 108,297 | | | 11,612 | |
In-Store Bakery Divestiture
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.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 year ended December 31, 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 statements of operations.
3. Exit Costs
Subsequent to the Company’s acquisition of Voortman, activities were initiated to transition Voortman’s distribution model to the Company’s direct-to-warehouse distribution model. The Company incurred costs to exit Voortman’s direct-store-delivery model, including severance and contract termination costs related to third-party distributor and leasing relationships. Total costs were $12.9 million through completion of the transition in 2020. During the year ended December 31, 2020, contract termination costs of $8.3 million were recognized in selling expense on the consolidated statement of operations and $4.6 million of severance costs were recognized within general and administrative expenses on the consolidated statement of operations.
Reserves for these activities are reported within accrued expenses on the consolidated balance sheets and had the following activity during the year ended December 31, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | |
(In thousands) | | Severance | | Contract Termination | | Total |
Charges recorded | | $ | 4,632 | | | $ | 8,278 | | | $ | 12,910 | |
Payments made | | (4,063) | | | (7,913) | | | (11,976) | |
Impact of change in exchange rates on CAD denominated liability | | (33) | | | (365) | | | (398) | |
Reserve balance as of December 31, 2020 | | 536 | | | — | | | 536 | |
Payments made | | (536) | | | — | | | (536) | |
Reserve balance as of December 31, 2021 | | $ | — | | | $ | — | | | $ | — | |
4. Stock-Based Compensation
The Hostess Brands, Inc. 2016 Equity Incentive Plan (the “2016 Plan”) provides for the granting of various equity-based incentive awards to members of the Board of Directors of the Company, employees and service providers to the Company. The types of equity-based awards that may be granted under the 2016 Plan include: stock options, stock appreciation rights (SARs), restricted stock, restricted stock units (RSUs), and other stock-based awards. There are 7,150,000 registered shares of Class A common stock reserved for issuance under the 2016 Plan. All awards issued under the 2016 Plan may only be settled in shares of Class A common stock. As of December 31, 2021, 2,128,990 shares remained available for issuance under the 2016 Plan.
Share-based compensation expense totaled approximately $9.6 million, $8.7 million and $9.2 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Restricted Stock Units (“RSUs”)
The fair value of RSU awards is calculated based on the closing market price of the Company’s Class A common stock on the date of grant. Compensation expense is recognized straight-line over the requisite service period of the awards, ranging from one to three years.
The vesting of certain RSU awards is contingent upon the Company’s Class A common stock achieving a certain total stockholder return (“TSR”) in relation to a group of its peers, measured over a three year period. Depending on the actual performance over the measurement period, an award recipient has the opportunity to receive up to 200% of the granted awards. At December 31, 2021, 2020 and 2019, there were 359,388, 411,549, and 319,657 RSU awards with TSR performance conditions outstanding, respectively.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Upon an employee’s termination, certain RSU awards provide that unvested awards will be forfeited and the shares of common stock underlying such awards will become available for issuance under the 2016 Plan. Other RSU awards provide for accelerated vesting upon an employee’s termination under certain circumstances.
The following table summarizes the activity of the Company’s unvested RSUs: | | | | | | | | | | | |
| Restricted Stock Units | | Weighted Average Grant Date Fair Value |
Unvested as of December 31, 2019 | 904,135 | | | $ | 12.99 | |
Total Granted | 628,801 | | | 12.99 | |
Forfeited | (198,677) | | | 12.17 | |
Vested(1) | (285,991) | | | 14.54 | |
Unvested as of December 31, 2020 | 1,048,268 | | | $ | 13.95 | |
Total Granted | 953,256 | | | 14.78 | |
Forfeited | (394,859) | | | 14.62 | |
Vested (2) | (467,138) | | | 13.60 | |
Unvested as of December 31, 2021 | 1,139,527 | | | $ | 14.62 | |
(1) Includes 78,728 shares withheld to satisfy $1.1 million of employee tax obligations upon vesting.
(2) Includes 92,440 shares withheld to satisfy $1.7 million of employee tax obligations upon vesting.
As of December 31, 2021 there was $9.6 million of total unrecognized compensation cost, related to non-vested RSUs granted under the 2016 Plan; that cost is expected to be recognized over a weighted average remaining period of approximately 1.8 years. As of December 31, 2021 there were no awards outstanding for which it was not probable that the performance conditions would be met.
For the years ended December 31, 2021, 2020 and 2019, $7.9 million, $6.3 million and $7.2 million, respectively, of compensation expense related to the RSUs was recognized within general and administrative expenses on the consolidated statements of operations.
Stock Options
The following table includes the significant inputs used to determine the fair value of options issued under the 2016 plan.
| | | | | | |
| | Year Ended December 31, 2020 |
Expected volatility (1) | | 26.3% |
Expected dividend yield (2) | | —% |
Expected option term (3) | | 6.00 years |
Risk-free rate (4) | | 1.6% |
(1)The expected volatility assumption was calculated based on a peer group analysis of stock price volatility with a look back period based on the expected term and ending on the grant date.
(2)From its inception through December 31, 2021, the Company has not paid any dividends on its common stock. As of the stock option grant date, it was assumed that no dividends would be paid on common stock over the term of the stock options. Option holders have no right to dividends prior to the exercise of the options.
(3)The Company utilized the simplified method to determine the expected term of the stock options since the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term.
(4)The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant which corresponds to the expected term of the stock options.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The stock options vest in equal annual installments on varying dates through 2022. The maximum term under the grant agreement is ten years. As of December 31, 2021, there was $0.9 million of total unrecognized compensation cost related to non-vested stock options outstanding under the 2016 Plan; that cost is expected to be recognized over the vesting periods. For the years ended December 31, 2021, 2020 and 2019, there was $1.7 million, $2.4 million and $2.0 million, respectively, of expense related to the stock options recognized within general and administrative costs on the consolidated statements of operations. The weighted average grant-date fair value of options granted in the years ended December 31, 2020 and 2019 was $4.04, and $3.76, respectively.
The following table summarizes the activity of the Company’s unvested stock options:
| | | | | | | | | | | | | | | | | | | | | | | |
| Number of Options | | Weighted Average Remaining Contractual Life (years) | | Weighted Average Exercise Price | | Aggregate Intrinsic Value |
Outstanding as of December 31, 2019 | 1,717,671 | | | 8.35 | | $ | 13.35 | | | |
Granted | 703,329 | | | — | | | 13.69 | | | |
Exercised | (44,257) | | | — | | | 11.35 | | | $ | 50,424 | |
Forfeited | (305,628) | | | — | | | 13.93 | | | |
Outstanding as of December 31, 2020 | 2,071,115 | | | 7.95 | | $ | 13.43 | | | |
Exercisable as of December 31, 2020 | 787,671 | | | 7.01 | | $ | 14.20 | | | |
| | | | | | | |
Exercised | (312,067) | | | — | | | 13.29 | | | 949,237 | |
Forfeited | (297,163) | | | — | | | 14.42 | | | |
Outstanding as of December 31, 2021 | 1,461,885 | | | 6.98 | | $ | 13.26 | | | 10,467,312 | |
Exercisable as of December 31, 2021 | 882,042 | | | 6.55 | | $ | 13.43 | | | 6,161,144 | |
5. Property and Equipment
Property and equipment consists of the following:
| | | | | | | | | | | |
(In thousands) | December 31, 2021 | | December 31, 2020 |
| | | |
Land and buildings | $ | 70,692 | | | $ | 59,774 | |
Right of use assets - operating | 32,192 | | | 31,354 | |
Machinery and equipment | 299,071 | | | 255,821 | |
Construction in progress | 26,027 | | | 25,041 | |
| 427,982 | | | 371,990 | |
Less accumulated depreciation | (92,677) | | | (68,031) | |
| $ | 335,305 | | | $ | 303,959 | |
Depreciation expense was $23.5 million, $23.1 million and $17.2 million for the years ended December 31, 2021, 2020, 2019, respectively.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Segment Reporting
For the years ended December 31, 2021 and 2020, the Company had one reportable segment: Snacking. For the year ended December 31, 2019, the Company had two reportable segments: Snacking and In-Store Bakery. The Company’s Snacking segment consists of sweet baked goods, cookies, wafers and bread products that are sold under the Hostess®, Voortman®, Dolly Madison®, Cloverhill® and Big Texas® brands. The In-Store Bakery segment consisted 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.
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:
| | | | | | | | | | | | | | | | | | | |
(In thousands) | Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | |
| | | | | | | |
Net revenue: | | | | | | | |
Snacking | $ | 1,142,036 | | | $ | 1,016,609 | | | $ | 878,973 | | | |
In-Store Bakery | — | | | — | | | 28,702 | | | |
Net revenue | $ | 1,142,036 | | | $ | 1,016,609 | | | $ | 907,675 | | | |
| | | | | | | |
Depreciation and amortization (1): | | | | | | | |
Snacking | $ | 51,681 | | | $ | 54,940 | | | $ | 41,732 | | | |
In-Store Bakery | — | | | — | | | 1,602 | | | |
Depreciation and amortization | $ | 51,681 | | | $ | 54,940 | | | $ | 43,334 | | | |
| | | | | | | |
Gross profit: | | | | | | | |
Snacking | $ | 409,983 | | | $ | 355,639 | | | $ | 293,648 | | | |
In-Store Bakery | — | | | — | | | 6,186 | | | |
Gross profit | $ | 409,983 | | | $ | 355,639 | | | $ | 299,834 | | | |
| | | | | | | |
Capital expenditures (2): | | | | | | | |
Snacking | $ | 62,951 | | | $ | 58,953 | | | $ | 35,354 | | | |
In-Store Bakery | — | | | — | | | 182 | | | |
Capital expenditures | $ | 62,951 | | | $ | 58,953 | | | $ | 35,536 | | | |
(1)Depreciation and amortization include charges to net income classified as costs of goods sold and general and administrative expenses on the consolidated statements of operations.
(2)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 years presented, total assets on the consolidated balance sheets are entirely attributed to the Snacking segment.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Goodwill and Intangible Assets
Goodwill and intangible assets as of December 31, 2021 and 2020 were recognized as part of the Hostess Business Combination and the Voortman and Cloverhill Business acquisitions.
During the year ended December 31, 2019, the Company recognized an impairment charge of $1.0 million related to its In-Store Bakery reporting unit, within other operating expense on the consolidated statement of operations. During the year ended December 31, 2019, the Company divested its In-Store Bakery segment (see Note 2. Business Combinations and Divestitures). Goodwill activity is presented below for the Snacking reportable segment:
| | | | | | | | | |
(In thousands) | Snacking | | | | |
| | | | | |
| | | | | |
| | | | | |
Balance as of December 31, 2019 | $ | 535,853 | | | | | |
Acquisition of Voortman | 170,762 | | | | | |
| | | | | |
| | | | | |
Balance as of December 31, 2020 and 2021 | $ | 706,615 | | | | | |
| | | | | |
| | | | | |
Intangible assets consist of the following:
| | | | | | | | | | | |
(In thousands) | December 31, 2021 | | December 31, 2020 |
Intangible assets with indefinite lives (Trademarks and Trade Names) | $ | 1,538,631 | | | $ | 1,538,631 | |
Intangible assets with definite lives (Customer Relationships) | 526,813 | | | 526,813 | |
Less accumulated amortization (Customer Relationships) | (121,052) | | | (97,541) | |
| | | |
Intangible assets, net | $ | 1,944,392 | | | $ | 1,967,903 | |
The Company recognized additional trade names and customer relationships intangible assets during the year ended December 31, 2020 related to the acquisition of Voortman. See Note 2. Business Combinations and Divestitures for additional details.
Amortization expense was $23.5 million, $26.5 million and $23.4 million for the years ended December 31, 2021, 2020 and 2019 respectively.
Future expected amortization expense is as follows:
| | | | | |
(In thousands) | |
2022 | $ | 23,512 | |
2023 | 23,512 | |
2024 | 23,512 | |
2025 | 22,751 | |
2026 | 22,751 | |
2027 and thereafter | 289,723 | |
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Accrued Expenses
Included in accrued expenses are the following:
| | | | | | | | | | | | | | |
(In thousands) | December 31, 2021 | | | December 31, 2020 |
| | | | |
Incentive compensation | $ | 21,172 | | | | $ | 16,199 | |
Payroll, vacation and other compensation | 7,791 | | | | 9,886 | |
Accrued interest | 4,828 | | | | 4,815 | |
Interest rate and foreign currency contracts | 2,042 | | | | 13,694 | |
Other | 11,176 | | | | 11,121 | |
| | | | |
| | | | |
| $ | 47,009 | | | | $ | 55,715 | |
9. Tax Receivable Agreement
Concurrent with the Hostess Business Combination, the Company entered into a tax receivable agreement that generally provides for the payment by the Company to the legacy equity holders of Hostess Holdings of 85% of the net cash savings, if any, in U.S. federal, state and local income taxes that the Company realizes (or is deemed to realize in certain circumstances) in periods after the closing of the business combination (which periods may extend, unless the tax receivable agreement is terminated early in accordance with its terms, for more than 15 years following any exchange of Class B Units of Hostess Holdings for shares of the Company’s Class A common stock or the cash equivalent thereof) as a result of (i) certain increases in tax basis resulting from the 2016 acquisition; (ii) certain tax attributes of Hostess Holdings and its subsidiaries existing prior to the 2016 acquisition and prior to subsequent exchanges of Class B Units; (iii) certain increases in tax basis resulting from exchanges of Class B Units; (iv) imputed interest deemed to be paid by the Company as a result of payments it makes under the tax receivable agreement; and (v) certain increases in tax basis resulting from payments the Company makes under the tax receivable agreement. The Company will retain the benefit of the remaining 15% of these cash savings. Certain payments under the tax receivable agreement will be made to the Metropoulos Entities in accordance with specified percentages, regardless of the source of the applicable tax attribute. The Company recognizes a liability on the consolidated balance sheet based on the undiscounted estimated future payments under the tax receivable agreement. Significant inputs used to estimate the future expected payments include a 26.2% cash tax savings rate.
The following table summarizes activity related to the tax receivable agreement obligations:
| | | | | | | | |
(In thousands) | | |
| | |
| | |
| | |
| | |
| | |
Balance December 31, 2019 | | $ | 138,196 | |
Exchange of Class B units for Class A shares | | 27,915 | |
Remeasurement due to tax law change | | 610 | |
Remeasurement due to change in estimated state tax rate | | 150 | |
Payments | | (10,327) | |
Balance December 31, 2020 | | $ | 156,544 | |
Remeasurement due to change in estimated state tax rate | | (1,409) | |
Payments | | (9,270) | |
Balance December 31, 2021 | | $ | 145,865 | |
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2021 the future expected payments under the tax receivable agreement are as follows:
| | | | | |
(In thousands) | |
2022 | $ | 11,600 | |
2023 | 10,300 | |
2024 | 10,100 | |
2025 | 9,400 | |
2026 | 9,600 | |
Thereafter | 94,865 | |
10. Debt
On January 3, 2020, the Company originated a $140.0 million incremental term loan through an amendment to its existing credit agreement. The Company received proceeds of $136.9 million, net of fees incurred of $3.1 million. The proceeds, together with cash on hand, financed the purchase of Voortman (see Note 2. Business Combinations and Divestitures). The terms, conditions and covenants applicable to the incremental term loan are the same as the terms, conditions and covenants applicable to the Fourth Term Loan, defined below. The term loan requires quarterly payments of interest at a rate of the greater of the applicable LIBOR or 0.75% per annum plus a margin of 2.25% per annum and principal payments at a rate of 0.25% of the aggregate principal balance per quarter with the remaining principal amount due upon maturity on August 3, 2025.
A term loan was originated on October 1, 2019 through an amendment to an existing credit agreement held by the Company’s subsidiary, Hostess Brands, LLC (referred to as the “Fourth Term Loan”). It requires quarterly payments of interest at a rate of the greater of the applicable LIBOR or 0.75% per annum (“New LIBOR Floor”) plus a margin of 2.25% per annum and principal at a rate of 0.25% of the aggregate principal balance with the remaining principal amount due upon maturity on August 3, 2025. The Fourth Term Loan is secured by substantially all of Hostess Brands, LLC’s present and future assets.
The Fourth Term Loan refinanced the remaining balance of $976.4 million on the Third New First Lien Term Loan (“Third Term Loan”) through a non-cash refinancing transaction. The Third Term Loan was originated through an amendment to an existing credit agreement held by Hostess Brands, LLC on November 20, 2017 and required quarterly payments of interest at a rate equal to the New LIBOR Floor plus a margin of 2.50% per annum and principal at a rate of 0.25% of the aggregate principal balance.
A summary of the carrying value of the debt and the lease obligations is as follows:
| | | | | | | | | | | | | | |
(In thousands) | December 31, 2021 | | | December 31, 2020 |
Term loan (3.0% as of December 31, 2021) | | | | |
Principal | $ | 1,091,596 | | | | $ | 1,102,763 | |
Unamortized debt premiums, discounts and issuance costs | (3,679) | | | | (4,917) | |
| 1,087,917 | | | | 1,097,846 | |
Lease obligations | 26,228 | | | | 29,002 | |
Total debt and lease obligations | 1,114,145 | | | | 1,126,848 | |
Less: Amounts due within one year | (14,170) | | | | (13,811) | |
Long-term portion | $ | 1,099,975 | | | | $ | 1,113,037 | |
At December 31, 2021 and 2020, the approximate fair value of the Company’s aggregate term loan balance was $1,090.2 million and $1,109.3 million, respectively. The fair value is calculated using current interest rates and pricing from financial institutions (Level 2 inputs).
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2021, minimum debt repayments under the Fourth Term Loan are due as follows:
| | | | | |
(In thousands) | |
2022 | $ | 11,167 | |
2023 | 11,167 | |
2024 | 11,167 | |
2025 | 1,058,095 | |
Revolving Credit Facility
On October 1, 2019, Hostess Brands, LLC amended its Revolving Credit Agreement (the “Revolver”), providing for borrowings up to $100.0 million, a stated maturity date of August 3, 2024 and secured by liens on substantially all of Hostess Brands, LLC’s present and future assets, including accounts receivable and inventories, as defined in the Revolver. The Revolver is ranked equally with the Fourth Term Loan in regards to secured liens. The Revolver has an annual commitment fee on the unused portion of between 0.375% and 0.50% annually based upon the unused percentage. Interest on borrowings under the Revolver is, at Hostess Brands, LLC’s option, either the applicable LIBOR plus a margin of 2.25% per annum or the base rate plus a margin of 1.25% per annum.
Prior to the amendment, the Revolver originated on August 3, 2015 had interest on borrowings at Hostess Brands, LLC’s option, of either the applicable LIBOR plus a margin of between 3.00% and 3.50% per annum or the base rate plus a margin of 2.00% to 2.50% per annum.
The Company had no outstanding borrowings under the Revolver as of December 31, 2021 or 2020. See Note 15. Commitments and Contingencies for information regarding the letters of credit, which reduce the amount available for borrowing under the Revolver. The Revolver contains certain restrictive financial covenants. As of December 31, 2021, the Company was in compliance with these covenants.
11. Derivative Instruments
Warrants
As part of its initial public offering in 2015, the Company issued public and private placement warrants. Each warrant entitled its holder to purchase one-half of one share of Class A common stock at an exercise price of $5.75 per half share, to be exercised only for a whole number of shares of Class A common stock. As of December 31, 2021 there were no public or private placement warrants outstanding. As of December 31, 2020, 53,936,776 public warrants and 541,658 private placement warrants were outstanding.
In July 2021, the agreement governing the Company’s public and private placement warrants was amended. Subsequent to the amendment, the exercise price for all outstanding warrants was payable through a “cashless exercise” with a premium of $0.25 added to the valuation price of each share for purposes of calculating the number of shares issuable upon exercise of the warrants. Subsequent to this amendment, 51,595,844 warrants were exercised on a cashless basis, resulting in the issuance of 9,822,909 shares of the Company’s Class A common stock. All remaining warrants expired on November 4, 2021.
The warrant agreement contained a tender offer provision that when paired with a two-class equity structure caused all warrants to be precluded from equity classification. Subsequent to the collapse of the two-class structure in November 2020 when all remaining Class B shares were exchanged for Class A shares, the tender offer provision no longer precluded the public warrants from being equity-classified. As a result, the $68.5 million liability related to the public warrants was reclassified to equity in November 2020. There were provisions specific to the private warrants which caused them to continue to be liability classified subsequent to the exchange, through their final expiration in November 2021. The fair value of the warrants is measured on a recurring basis by comparison to available market information. The value of each public warrant up until they were no longer classified as liabilities was based on the public trading price of the warrant (Level 1 fair value measurement). The fair value of each private warrant was evaluated and determined to be substantially the same as that of a public warrant and therefore considered to be a Level 2 fair value measurement. Gains and losses related to the warrants are reflected in the change in fair value of warrant liabilities in the consolidated statements of operations.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest Rate Swaps
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% in addition to term loan margin of 2.25% 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 are reduced by $100 million each year of the five-year contract. As of December 31, 2021, the notional amount was $100 million. 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 December 31, 2021, the interest on the Company’s variable rate debt hedged by this contract is effectively fixed at 4.03%.
In 2020, the Company entered into additional five-year interest rate swap contracts to further reduce the effect of interest rate fluctuations on its variable-rate debt. The notional value of these contracts was $500 million. Under the terms of the contracts, the Company makes quarterly payments based on fixed interest rates ranging from 1.11% to 1.64% in addition to term loan margin of 2.25% and receives quarterly payments based on the greater of LIBOR or 0.75%. The Company has designated these contracts as cash flow hedges. At December 31, 2021, the interest on the Company's variable rate debt hedged by these contracts is effectively fixed at rates ranging from 3.36% to 3.89%.
In February 2022, the Company entered into a three-year interest rate swap contract with a notional value of $200 million to further reduce the effect of interest rate fluctuations on its variable-rate term loan. Under the terms of the contract, the Company will make quarterly payments based on a fixed interest rate of 2.06% in addition to term loan margin of 2.25% and receive quarterly payments based on the greater of LIBOR or 0.75%.
Foreign Currency Contracts
To reduce the effect of fluctuations in CAD denominated expenses relative to their U.S. dollar equivalents originating from its Canadian operations, the Company entered into CAD purchase contracts during the years ended December 31, 2021 and 2020. The contracts that remain outstanding at December 31, 2021 provide for the Company to sell a total of $12.4 million USD for $15.5 million of CAD at varying defined settlement dates through the end of 2022. The Company has designated these contracts as cash flow hedges.
In connection with the agreement to purchase Voortman as described in Note 2. Business Combinations and Divestitures, the Company entered into a deal-contingent foreign currency contract to hedge the $440 million CAD forecasted purchase price and a portion of the subsequent expected conversion costs. The contract was settled in cash following the completion of the purchase on January 3, 2020.
A summary of the fair value of foreign currency and interest rate contracts is as follows:
| | | | | | | | | | | | | | |
(In thousands) | | December 31, 2021 | | December 31, 2020 |
Asset derivatives | Location | | | |
Interest rate swap contracts (1) | Other non-current assets | $ | 1,803 | | | $ | — | |
| | | | |
Liability derivatives | Location | | | |
| | | | |
Interest rate swap contracts (1) | Accrued expenses | $ | 1,798 | | | $ | 13,688 | |
Foreign currency contracts (2) | Accrued expenses | 244 | | | 6 | |
| | $ | 2,042 | | | $ | 13,694 | |
(1) The fair values of interest rate swap contracts are 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 observed market interest rate curves (Level 2).
(2) The fair values of foreign currency contracts are measured on a recurring basis by comparison to available market information on similar contracts (Level 2).
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the gains and losses related to foreign currency and interest rate contracts in the consolidated statements of operations is as follows:
| | | | | | | | | | | | | | | | | | | | |
(In thousands) | | Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 |
| | | | | | |
Gain (loss) on derivative contracts designated as cash flow hedges | Location | | | | | |
Interest rate swap contracts | Interest expense, net | $ | (4,563) | | | $ | (3,886) | | | $ | 1,705 | |
Foreign currency contracts | Cost of goods sold | 60 | | | — | | | — | |
| | $ | (4,503) | | | $ | (3,886) | | | $ | 1,705 | |
| | | | | | |
Gain (loss) on other derivative contracts | Location | | | | | |
Foreign currency contracts | Gain on foreign currency contract | $ | — | | | $ | — | | | $ | 7,128 | |
Foreign currency contracts | Other expense | — | | | (274) | | | — | |
| | $ | — | | | $ | (274) | | | $ | 7,128 | |
For interest rate swap contracts, unrealized expense recognized in accumulated other comprehensive income as of December 31, 2021 of $3.5 million is expected to be reclassified into interest expense through December 31, 2022.
For foreign currency contracts, unrealized expense recognized in accumulated other comprehensive income as of December 31, 2021 of $0.2 million is expected to be reclassified into cost of goods sold through December 31, 2022.
12. Equity
The Company’s authorized common stock consists of three classes: 200,000,000 shares of Class A common stock, 50,000,000 shares of Class B Stock, and 10,000,000 shares of Class F common stock (none of which were issued and outstanding at December 31, 2021 or 2020). As of December 31, 2021 there were 142,031,329 shares of Class A common stock issued, 138,278,573 shares of Class A common stock outstanding and 3,752,756 shares of treasury stock. As of December 31, 2020 there were 130,791,908 shares of Class A common stock issued, 130,347,464 shares of Class A common stock outstanding and 444,444 shares of treasury stock. As of December 31, 2021 and 2020 there were no shares of Class B Stock issued or outstanding.
Shares of Class A common stock and Class B Stock have identical voting rights. However, shares of Class B Stock do not participate in earnings or dividends of the Company. During the year ended December 31, 2020, all remaining outstanding Class B Units were exchanged for Class A common Stock. Ownership of shares of Class B Stock was restricted to owners of Class B Units in Hostess Holdings. Class B Units in Hostess Holdings could be exchanged (together with the cancellation of an equivalent number of shares of Class B Stock) by the holders thereof for, at the election of the Company, shares of Class A common stock or the cash equivalent of such shares.
During the year ended December 31, 2020, the Company’s Board of Directors approved a securities repurchase program of up to $100 million of the Company’s outstanding securities. As of December 31, 2021, $38.9 million remained available for use under this program.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. 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 Class A common shares outstanding for the period excluding non-vested restricted stock awards. In computing dilutive 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, RSUs, restricted stock awards, and stock options.
Below are basic and diluted earnings per share: | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | |
Numerator: (in thousands) | | | | | | | |
Net income attributable to Class A stockholders - basic | $ | 119,299 | | | $ | 104,676 | | | $ | 4,299 | | | |
Impact of change in fair value of warrant liabilities | (566) | | | (39,941) | | | — | | | |
Numerator for diluted earnings per share | $ | 118,733 | | | $ | 64,735 | | | $ | 4,299 | | | |
Denominator: | | | | | | | |
Weighted-average Class A shares outstanding - basic (excluding non-vested restricted stock awards) | 131,571,733 | | | 124,927,535 | | | 110,540,264 | | | |
Dilutive effect of warrants | 5,841,062 | | | 2,525,863 | | | — | | | |
Dilutive effect of RSUs | 588,250 | | | 270,090 | | | 465,425 | | | |
Dilutive effect of stock options | 197,131 | | | — | | | — | | | |
Weighted-average shares outstanding - diluted | 138,198,176 | | | 127,723,488 | | | 111,005,689 | | | |
Earnings per Class A share - basic | $ | 0.91 | | | $ | 0.84 | | | $ | 0.04 | | | |
Earnings per Class A share - dilutive | $ | 0.86 | | | $ | 0.51 | | | $ | 0.04 | | | |
| | | | | | | |
For warrants that are liability-classified, during periods when the impact is dilutive, the Company assumes share settlement of the instruments as of the beginning of the reporting period and adjusts the numerator to remove the change in fair value of the warrant liability and adjusts the denominator to include the dilutive shares calculated using the treasury stock method.
Stock options that were excluded from the computation of diluted weighted average shares, because their effect was anti-dilutive were 2,010, 477,923 and 365,551 for the years ended December 31, 2021, 2020 and 2019, respectively.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Income Taxes
The income tax expense (benefit) consisted of the following:
| | | | | | | | | | | | | | | |
(In thousands) | | Year Ended December 31, 2021 | Year Ended December 31, 2020 | Year Ended December 31, 2019 | |
Current tax expense | | | | | |
Federal | | $ | 17,430 | | $ | 2,120 | | $ | 1,724 | | |
State and local | | 4,088 | | 1,479 | | 1,047 | | |
| | | | | |
Total Current | | 21,518 | | 3,599 | | 2,771 | | |
| | | | | |
Deferred tax expense (benefit) | | | | | |
Federal | | 13,509 | | 17,204 | | 14,859 | | |
State and local | | 3,077 | | 3,750 | | (738) | | |
Foreign | | 2,409 | | (4,148) | | — | | |
Total Deferred | | 18,995 | | 16,806 | | 14,121 | | |
Income tax expense, net | | $ | 40,513 | | $ | 20,405 | | $ | 16,892 | | |
Income (loss) before income taxes consists of the following:
| | | | | | | | | | | | | | | |
(In thousands) | | Year Ended December 31, 2021 | Year Ended December 31, 2020 | Year Ended December 31, 2019 | |
Earnings before income taxes | | | | | |
United States | | $ | 149,360 | | $ | 144,075 | | $ | 35,641 | | |
Foreign | | 10,452 | | (15,373) | | — | | |
Income before income taxes | | $ | 159,812 | | $ | 128,702 | | $ | 35,641 | | |
For the years ended December 31, 2021, 2020, and 2019, the effective income tax rate differs from the federal statutory income tax rate as explained below:
| | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2021 | | Year Ended December 31, 2020 | | Year Ended December 31, 2019 | | |
U.S. federal statutory income tax rate | | 21.0 | % | | 21.0 | % | | 21.0 | % | | |
| | | | | | | | |
Change in fair value of warrant liabilities | | (0.1) | | | (6.5) | | | 34.7 | | | |
State and local income taxes, net of federal benefit | | 5.6 | | | 2.8 | | | 12.3 | | | |
Income attributable to non-controlling interest | | — | | | (0.6) | | | (8.5) | | | |
Foreign rate differential | | 0.3 | | | (0.6) | | | — | | | |
Change in state tax rate | | (1.9) | | | 0.6 | | | (12.8) | | | |
Tax law change | | — | | | (0.8) | | | — | | | |
| | | | | | | | |
Other | | 0.5 | | | — | | | 0.7 | | | |
Effective income tax rate | | 25.4 | % | | 15.9 | % | | 47.4 | % | | |
Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the accompanying consolidated balance sheets. These temporary differences result in taxable or deductible amounts in future years.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Details of the Company’s deferred tax assets and liabilities are summarized as follows:
| | | | | | | | | | | | | | | | |
(In thousands) | | As of December 31, 2021 | | As of December 31, 2020 | | |
Deferred tax assets | | | | | | |
Imputed interest | | $ | 6,478 | | | $ | 6,744 | | | |
Tax credits | | 3,011 | | | 4,582 | | | |
Derivative instruments | | — | | | 3,495 | | | |
Net operating loss carryforwards | | — | | | 2,601 | | | |
Accrued liabilities | | 7,080 | | | 4,870 | | | |
Stock-based compensation | | 3,588 | | | 3,449 | | | |
Other | | 5,367 | | | 4,443 | | | |
Total deferred tax assets | | 25,524 | | | 30,184 | | | |
| | | | | | |
Deferred tax liabilities | | | | | | |
| | | | | | |
Goodwill and intangible assets | | (291,024) | | | (277,563) | | | |
Property and equipment | | (51,272) | | | (46,732) | | | |
Other | | (1,075) | | | (898) | | | |
Total deferred tax liabilities | | (343,371) | | | (325,193) | | | |
| | | | | | |
Total deferred tax assets and liabilities | | $ | (317,847) | | | $ | (295,009) | | | |
The recognition of deferred tax assets is based on management’s belief that it is more likely than not that the tax benefits associated with temporary differences, net operating loss carryforwards and tax credits will be utilized. The Company assesses the recoverability of the deferred tax assets on an ongoing basis. In making this assessment, the Company considers all positive and negative evidence, and all potential sources of taxable income including scheduled reversals of deferred tax liabilities, tax-planning strategies, projected future taxable income and recent financial performance.
At December 31, 2021 and 2020, Hostess had gross state credit carryforwards of $3.8 million and $5.8 million respectively. The carryforwards relate primarily to Kansas High Performance Incentive Program credits and will expire in years 2027 and 2036 if not utilized.
At December 31, 2021 and 2020 the Company had $3.1 million and $12.3 million, respectively, of current income taxes receivable included in prepaids and other current assets on the consolidated balance sheet.
The global intangible low-taxed income (“GILTI”) provisions require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. The Company is electing to account for GILTI tax in the period in which it is incurred.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company recognizes in the consolidated financial statements the benefit of a tax position only if the impact is more likely than not of being sustained on audit based on the technical merits of the position. As of both December 31, 2021 and 2020, the Company had $1.6 million of gross unrecognized tax benefits, which would have a net $1.6 million impact on the effective tax rate, if recognized. The following is a reconciliation of the beginning and ending amount of unrecognized tax benefits:
| | | | | | | | | | |
(In thousands) | | | | |
Balance at January 1, 2020 | | $ | — | | | |
Additions for tax positions acquired | | 1,320 | | | |
Additions for tax positions of current year | | 240 | | | |
Balance at December 31, 2020 | | 1,560 | | | |
Additions for tax positions established during prior periods | | 45 | | | |
| | | | |
Balance at December 31, 2021 | | $ | 1,605 | | | |
Interest and penalties related to income tax liabilities, if incurred, are included in income tax expense in the consolidated statements.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions, and certain subsidiaries in Canada. For federal and state tax purposes, the Company and its subsidiaries are generally subject to examination for three years after the income tax returns are filed. As such, U.S. federal and state income tax returns filed for periods since 2017 remain open for examination by tax authorities. In Canada, tax returns are subject to examination for four years after the notice of assessment is issued. Canadian tax returns filed for periods since 2016 remain open for examination.
The Company believes that its foreign subsidiaries have invested or will invest any undistributed earnings indefinitely, or the earnings will be remitted in a tax-neutral transaction, and, therefore, does not provide deferred taxes on the cumulative undistributed earnings of our foreign subsidiaries.
15. Commitments and Contingencies
Accruals and the Potential Effect of Litigation
From time to time, the Company is subject to lawsuits, claims and proceedings arising in the ordinary course of business. These matters may involve personnel and employment issues, personal injury, contracts and other proceedings. Based upon information presently known, the Company does not believe that the ultimate resolution of such matters will have a material effect on the Company’s financial position, although the final resolution of such matters could have a material effect on its results of operations or cash flows in the period of resolution.
Liabilities related to legal proceedings are recorded when it is probable that a liability has been incurred and the associated amount can be reasonably estimated. Where the estimated amount of loss is within a range of amounts and no amount within the range is a better estimate than any other amount, the low end of the range is accrued. As additional information becomes available, the potential liabilities related to these matters are reassessed and the estimates revised, if necessary. These accrued liabilities are subject to change in the future based on new developments in each matter, or changes in circumstances, which could have a material effect on the Company’s financial condition and results of operations.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Lease Commitments
Operating Leases
As of December 31, 2021 the Company has leases outstanding for certain office spaces, Burlington, Ontario bakery and primary distribution center under noncancellable operating lease arrangements. The future minimum lease payments under these agreements as of December 31, 2021 are shown below.
| | | | | |
(In thousands) | |
2022 | $ | 4,813 | |
2023 | 4,467 | |
2024 | 5,102 | |
2025 | 5,257 | |
2026 | 2,735 | |
Thereafter | 6,890 | |
Total lease payments | 29,264 | |
Reconciling impact from discounting | (3,036) | |
Total lease liabilities | $ | 26,228 | |
Financing Leases
The Company entered into a bond-lease agreement with the Development Authority of Columbus, Georgia on December 1, 2013, which was amended in December, 2016. The bond-lease transaction required the Company to exchange its property to the taxing jurisdiction for tax-exempt bonds issued in the name of the Company not to exceed $18 million. As the issuer and holder of the bonds, the Company is not required to make lease payments. On December 16, 2013, the Company received an ad valorem tax agreement from the Columbus, Georgia Board of Tax Assessors granting tax abatement for the real and personal property located at the Company’s Columbus, Georgia bakery through 2023. The Company has elected to use the right of offset under ASC 210-20 to net the asset and the liability.
HOSTESS BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below shows the composition of lease expenses for the period:
| | | | | | | | | | | |
(In thousands) | Year Ended December 31, 2021 | Year Ended December 31, 2020 | Year Ended December 31, 2019 |
Reduction of right of use asset, financing lease | $ | — | | $ | — | | $ | 133 | |
Interest, financing lease | — | | — | | 16 | |
Operating lease expense | 6,420 | | 5,722 | | 3,070 | |
Short-term lease expense | 1,945 | | 2,633 | | 968 | |
Variable lease expense | 1,450 | | 1,763 | | 1,076 | |
| $ | 9,815 | | $ | 10,118 | | $ | 5,263 | |
For short-term leases, the Company records rent expense in its consolidated statements of operations on a straight-line basis over the lease term. Variable lease payments, which primarily include taxes, insurance and common area maintenance, are expensed as incurred. Lease expenses are classified as operating activities within the consolidated statements of cash flows. During the year ended December 31, 2020, the Company amended the existing lease for its Burlington, Ontario bakery. The amendment extended the lease term through October 2030 and provided for two five-year extensions, at the Company’s option. During the year ended December 31, 2019, the Company entered into a lease agreement for its new distribution center in Edgerton, Kansas. The agreement has a base term of six and a half years with two five year extensions. The right of use asset and lease liability were calculated using the six and a half year term.
Contractual Commitments
The Company is a party to various long-term arrangements through advance purchase contracts to lock in prices for certain high-volume raw materials and packaging components for normal product production requirements. These advance purchase arrangements are contractual agreements and can only be canceled with a termination penalty that is based upon the current market price of the commodity at the time of cancellation. These agreements qualify for the “normal purchase” exception under accounting standards; and the purchases under these contracts are included as a component of cost of goods sold.
Contractual commitments were as follows:
| | | | | | | | | | | |
(In thousands) | Total Committed | Commitments within 1 year | Commitments beyond 1 year |
Ingredients | $ | 102,610 | | $ | 92,955 | | $ | 9,655 | |
Packaging | 89,906 | | 89,906 | | — | |
During the year ended December 31, 2021, the Company entered into a real estate purchase agreement to acquire a facility in Arkadelphia, Arkansas for a total purchase price of $11.5 million. The transaction closed on February 22, 2022. The facility will become the Company’s sixth bakery in North America upon completion of capital investments to install production lines and other necessary improvements needed to make the facility operational.
Letters of Credit
The Company is a party to Letter of Credit arrangements to provide for the issuance of standby letters of credit in the amount of $6.0 million and $5.5 million for the years ended 2021 and 2020, respectively. The arrangements support the collateral requirements for insurance. The Letters of Credit are 100% secured through our Revolver.