Hostess Brands, Inc., maker of the iconic Twinkie, announced yesterday that it would be closing and selling off assets due to a failure to come to an agreement with striking bakers. This announcement has prompted the usual amount of hand wringing and anti-union attacks in the media. However, lost in most of the stories and commentaries is how Hostess came to this point. It is a story of ongoing incompetence and greed.
A Brief Company History
Hostess Brands was founded in Kansas City in 1930 as Interstate Bakeries Corporation. The company grew over the next thirty years through a series of mergers and acquisitions, and in 1969 the company changed its name to Interstate Brands. In 1975 Interstate Brands was purchased by Data Processing Financial and General Corporation (DPF). DPF was a computer leasing company that had decided to change business models due to the IBM antitrust suit. While under DPF management the corporation continued to expand, acquiring more brands and investing substantial sums in plant expansion. After DPF finished the sale of its computer assets it changed the name of the company back to Interstate Baking in 1981. Expansion continued throughout the 1980′s and in 1987 management decided to change from a public to a private company, renaming it IBC Holdings.
Interstate Bakeries reemerged as a public company in 1991, and in 1995 it merged with Continental Brands. Thanks to the merger, Interstate was in control of two major bread lines: Butternut and Wonder. Due to the perishable nature of bread the company operated over 60 bakeries, so that none of their delivery trucks had to drive very far. After enzymes designed to extend the shelf life of bread appeared, the company hoped to turn the network of small bakeries into a more efficient operation consisting of a few large bakeries. Problems soon developed, as the new enzymes caused the bread to have a different texture and taste than what customers were used to. At about the same time the snack cake operation saw declining sales, which the company blamed on the popularity of new “low carb” diets such as the Atkins Diet.
2004: Bankruptcy #1
On September 22, 2004 Interstate Bakeries filed for Chapter 11 bankruptcy. While the company blamed declining sales on waning consumption of its various snack cakes, observers had a different opinion. Janet Adamy, writing in the Wall Street Journal on September 23, 2004, suggested the problem was largely to do with the failed experiment to extend shelf life:
When applied to bread, a new process sometimes produced loaves that were gummy and doughy. Reduced frequency of deliveries, one of the hoped-for benefits of the plan, meant retailers’ shelves could grow disheveled. Hopes that the program would save money through plant closings didn’t match Wall Street’s expectations.
Interstate CEO, James R. Elsesser, resigned and was replaced with Tony Alvarez, a restructuring expert. The company announced that it had received $200 million of “debtor in possession” financing from J.P. Morgan Chase to allow it to continue operations during restructuring. Alvarez insisted that “industry pressures” and not the failed attempt at extending the shelf life of its products was at the root of the company’s problems. Adamy disagreed, citing several contributing factors in her WSJ article:
The dark view of carbs in some popular diets certainly didn’t help. Yet this could hardly have been the whole story. A giant bread-making competitor of Interstate, Flowers Foods Inc., of Thomasville, Ga., has managed to post sales gains of about 5% in recent quarters, along with similarly robust earnings.
Interstate’s sales, meanwhile, were easing slightly in the roughly two years it was rolling out its extended-shelf-life program. Interstate had a loss of $25.8 million for the fiscal year ended May 29, compared with $69.8 million in profits two years earlier.
A heavy debt load — $748 million — has been one problem. The company said in June it would take a $40 million charge against earnings to boost its workers’ compensation fund, after higher costs in California and rising health-care expenses totaled more than expected for fiscal 2004. In July, Interstate said the Securities and Exchange Commission had begun an informal inquiry related to its workers’ compensation reserves.
Some analysts blamed former chairman Elsesser for the company’s problems, saying that Interstate should have concentrated on marketing and increased sales rather than cost cutting. Elsesser brought to Interstate a reputation for cost cutting from his time at Ralston Purina, and it was suggested in some quarters that he failed to spend enough time on product development. For example, Interstate did not introduce a high quality multi-grain bread–one of the industry’s hottest products–until spring 2004, which put it well behind its competition. During the bankruptcy period Interstate closed nine of its remaining 54 bakeries, as well as more than 300 “outlet” stores. It reduced its workforce from 32,000 to 22,000 employees.
2009: Reorganization and Givebacks
Interstate emerged from Chapter 11 in February 2009, announcing that it had put together financing to come out of bankruptcy as a stand alone company. According to a Business Courier article dated February 4, 2009
IBC had financing commitments from IBC Investors I LLC, an affiliate of private equity firm Ripplewood Holdings LLC, which was to provide $130 million of capital — $44.2 million for 4.42 million shares and $85.8 million in new fourth-lien convertible secured notes. Other commitments were for a $125 million revolving loan with General Electric Capital Corp. and GE Capital Markets Inc. and a $344 million term loan-secured credit facility with Silver Point Finance LLC and Monarch Master Funding Ltd.
All of Interstate’s 423 union locals approved revised labor agreements in connection with the reorganization. In a press release new CEO Craig Jung said
I want to thank IBC’s employees for the sacrifices they have made and our union leaders for their commitment to our company and saving jobs. Their actions made possible the financing required to execute a business plan that will build competitive advantage and secure our company’s future.
Included in the financing deal was a provision that two executives affiliated with Ripplewood Holdings, John Cahill and Greg Murphy, get seats on Interstate’s board. Ripplewood officials announced that they were happy with the financing arrangement and that they intended to use the company’s snack cake lines as a starting point for future success. As of November 2, 2009, the company was renamed Hostess Brands. In June 2010 CEO Jung left the company and was replaced by Brian Driscoll, who had previously held top management positions at several other food producers, including Kraft and Nabisco.
2011: Bankruptcy #2
Rumors began in late 2011 that the company was again preparing a Chapter 11 filing. The New York Post reported on December 22 of last year that the main issue was union pension plans: The company was saying that it could not keep current on its $700 million loan and continue contributing to the plans. Hostess had been in violation of its union contracts since August 2011 by not making pension plan contributions. But the pension plan contributions were only part of the problem. Even with the savings realized by not adding its required contributions to the plan, the company was still short of money. Ripplewood officials stated that they would not invest more money in the company without significant union concessions. According to the Post article, a Hostess worker said
We understand that, should we pursue some form of legal action to require the company to live up to the terms of the contract, they may close, but we have come to believe that they will close anyway.
We believe the company is poorly managed and the only hope is a complete change in management.
As of the beginning of 2012, as reported in the Wall Street Journal, the company was carrying more than $860 million in debt and was facing a serious cash flow problem due to “high labor costs and rising prices for sugar, flour, and other ingredients.” Hostess also owed more than $50 million to vendors who wanted payments on a shortened time frame due to the financial troubles of the company. The WSJ article also reported that Hostess was finding it hard to attract consumers due to a lack of offerings in the whole grain and multi grain bread categories. Another problem for the baker was that it had historically kept prices high, which made it difficult to charge more for its products and still remain competitive as expenses rose. Hostess filed for Chapter 11 bankruptcy protection a second time on January 10, 2012.
Another Wall Street Journal story, from April 2 of this year, relates the sacrifices that Hostess employees had made due to the company’s first bankruptcy.
Luigi Peruzzi has been delivering Twinkies and Ding Dongs to gas stations and grocery stores in Detroit for 25 years. When his employer, Hostess Brands Inc., was in bankruptcy court in 2009, Mr. Peruzzi agreed to give up half his weekly base pay, going to $100 a week from about $209, forcing him to depend more on his commissions. The Hostess driver was told the sacrifices were needed to make the company thrive.
This past spring Hostess proposed a salary freeze for union workers that would save it an estimated $6.1 million a year through 2015–a proverbial “drop in the bucket” compared to the company’s overall debt burden. Unions balked at the freeze, noting that Hostess had “failed to innovate and pursued failing strategies.” Hostess’s Teamsters workers president Dennis Raymond observed that he wanted to be sure that “sacrifices are not made in vain again due to mismanagement.”
Pay Increases…For Some…As the Company Slowly Goes Under
As the company was asking for more givebacks from workers, a group of creditors said in court papers that the company “may have manipulated its executives’ salaries higher in the months leading up to its Chapter 11 filing,” again according to the WSJ. According to the creditors’ court filing, the following Hostess executives saw substantial salary increases in July 2011:
- Brian Driscoll, CEO, from around $750,000 to $2,550,000
- Gary Wandscheider, EVP, $500,000 to $900,000
- John Stewart, EVP, $400,000 to $700,000
- David Loeser, EVP, $375,000 to $656,256
- Kent Magill, EVP, $375,000 to $656,256
- Richard Seban, EVP, $375,00o to $656,256
- John Akeson, SVP, $300,000 to $480,000
- Steven Birgfeld, SVP, $240,000 to $360,000
- Martha Ross, SVP, $240,000 to $360,000
- Rob Kissick, SVP, $182,000 t0 $273,008
[Note: The WSJ article observes that some executives did not take the full raise.]
A Hostess spokesman, in reply to the creditors’ filing, responded that the executives’ salaries were increased at a routine compensation review “to align them with industry standards and because the executives were being asked to take on significant additional responsibilities associated with trying to restructure the company outside of bankruptcy proceedings.” All this while asking workers such as Mr. Peruzzi, a 47 year old father of three, who, according to the WSJ article grossed about $51,000 last year, to take further pay and benefit cuts.
What Went Wrong
Critics point to a number of failures at Hostess. Again, according to the Wall Street Journal:
Hostess kept a lot of debt on its books—$774 million in secured obligations when it exited Chapter 11 the first time—and didn’t anticipate the depth of the recession or that commodity prices would spike, combining to crimp sales, according to court documents and people close to Hostess.
Hostess was slow to update old production systems and keep pace with competitors offering newer, healthier foods, in part because of its inability to invest.
Hostess posted an unaudited loss of about $341 million on roughly $2.5 billion in sales in the year ended last May. Though Americans are keen to talk about Twinkies—which have gained an aura of mythical, if kitschy, indestructibility—they seemed less interested in eating them. Unit sales of the snack were flat in the 52 weeks ending Feb. 19, according to SymphonyIRI Group, a Chicago-based market research firm.
To appeal to more health-conscious Americans, Hostess launched a line of whole-grain breads called Nature’s Pride that the company says has been selling well, but it is a small product line compared with rival offerings.
In February Hostess had asked the bankruptcy judge to approve a new compensation package for CEO Driscoll. Part of the proposed package provided for Driscoll to receive severance pay of up to $1.95 million should Hostess liquidate or should he be fired without cause, providing he honored a noncompete clause. This package was on top of the salary increase that Driscoll had received the previous July. In March of 2012 Driscoll resigned, and was replaced by Gregory Rayburn, a restructuring/turnaround specialist who had been with the company only nine days. In order to appease unions, who were reportedly upset with Driscoll’s compensation package, Rayburn cut the salaries of the top four executives to $1, to be restored at the beginning of the year.
In July, David Kaplan, writing on CNNMoney/Fortune.com observed:
But in truth there are no black hats or white knights in this tale. It’s about shades of gray, where obstinacy, miscalculation, and lousy luck connived to create corporate catastrophe. Almost none of the parties involved would speak on the record. Still, it’s clear from court documents and background interviews with a range of sources that practically nobody involved can shoot straight: The Teamsters remain stuck in a time warp, unwilling to sufficiently adapt in a competitive marketplace. The PE firm failed to turn Hostess around after taking it over. The hedgies can’t see beyond their internal rates of return. Et cetera, et cetera, et cetera.
The Beginning Of the End
Also in July, the New York Post reported that Hostess and the Teamsters were close to a deal. Under the terms of the proposed deal, the company would continue its contributions to the pension plans, and workers would agree to substantial pay and benefit cuts. The article quoted a Brooklyn Hostess delivery driver who said
“I am not taking another hit…I am making about $65,000. That is the same as I was making 10 years ago.”
He pointed to a Stroehmann’s bread truck driver delivering to the same supermarket who he said gets a guaranteed $300 a week — compared to his $195 — and earns much more in commissions.
This month the 6,600 Hostess employees who are members of the Bakery, Confectionery, Tobacco Workers and Grain Millers’ International Union voted to strike after the latest contract proposal from Hostess was rejected by 92% of its membership. Hostess management issued the following statement:
A widespread strike will cause Hostess brands to liquidate if we are unable to produce or deliver products. If that’s the case, the company will move promptly to lay off most of its 18,300-member workforce and focus on selling its assets to the highest bidders. We urge our employees to remain on the job to rebuild the company.
In response to the strike, Hostess announced on November 16 that it would be laying off most of its 18,500 employees and liquidating its assets. In order to do so, it will require the approval of U.S. Bankruptcy Court Judge Robert Drain. Consumers who may be fretting about the loss of their Twinkies, Ho Ho’s, Wonder Bread and other brands will probably not have to do without them for too long, as it is expected that other companies will be willing to purchase them from Hostess.
What We Learned
In recent days a variety of pundits and news sources have laid the blame for Hostess’s demise squarely at the feet of unions and their contracts. But a close examination reveals that were the workers to agree to work for free the company would probably not have survived; all the strike did was hasten the inevitable. Those on the right are quick to point to “greedy unions” in these situations, but it must be pointed out that in collective bargaining both sides come to an agreement that they believe that everyone can live with. Unions represent the wishes of their members, and it is only human nature to ask for as much as they can get in negotiations. Companies have the responsibility to share accurate financial information with the unions, and should draw a line in the sand when the unions ask for more than the company feels it can comfortably provide. No matter whether you are talking about a $50,000 a year employee or a $5,000,000 CEO, people get used to living on the salary they receive, and asking workers to give back substantial amounts of pay and benefits not once, but twice in a period of less than ten years while at the same time boosting executive salaries is not the way to achieve a good and peaceful relationship with labor.
Hostess workers were not asking for more; like many other workers in many similar situations in recent times they were merely trying to hold onto what they had. It was not the fault of the workers or their unions that Hostess suffered from years of inept management and failed ideas, but now their jobs are gone and they are left holding the blame.