Driscoll account blames labor, many other factors for Hostess woes

by L. Joshua Sosland
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NEW YORK — While burdensome obligations to multiemployer pension plans have cost Hostess Brands Inc. more than $100 million a year, the company has sustained losses exceeding $100 million in each of its two full years since emerging from bankruptcy in 2009.

The role of the company’s union obligations in its financial problems has been brought to the fore in recent statements and counter statements by Hostess and union representatives (see related story on Page 15). Hostess has attributed its woes “primarily to legacy pension and medical benefit obligations and restrictive work rules.” Secondarily, the company cited the economic downturn and a more difficult competitive landscape.

Calling the company’s assertions “offensive,” Frank Hurt, president of the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union, said Hostess “is in dire financial shape because of a string of failed business decisions made by a series of ineffective executives who have been running this company for the past decade.”

A filing with the United States Bankruptcy Court, Southern District of New York, by Brian J. Driscoll, president and chief executive officer of Hostess, paints a more complicated picture of the difficulties facing the baking company.

The “Affidavit of Brian J. Driscoll in Support of First Day Motions” does indeed draw a picture of “crippling” pension obligations that cover not only Hostess employees but also former baking employees of companies no longer in business. The affidavit also offers examples of workforce rules the company said puts Hostess at a significant competitive disadvantage.

Still, the affidavit attributes the company’s lack of competitiveness to factors extending far beyond issues of labor relations. Additionally, it suggests the company came out of bankruptcy in 2009 with far too much debt to succeed going forward, a factor omitted in the company’s bankruptcy announcement.
The lengthy affidavit offers a detailed look at Hostess and what precipitated the company’s return to bankruptcy. In the first two years since exiting from bankruptcy, Hostess sustained an aggregate loss totaling $479 million (a figure that includes $132 million in special write-off charges).

Setting the stage for the narrative, Mr. Driscoll described Hostess’s industry environment as one of “high levels of competition and related pricing pressures, thin operating margins and competitors with more sophisticated technology and significant cost advantages.”

He said Hostess’s competition employs work forces that either are not unionized or are only partly unionized. The difference allows other bakers to operate with “significantly less burdensome operating restrictions and overall cost structures,” he said.

Because of its long-standing unionized workforce, Hostess has significant legacy costs, mostly as pension and medical benefit obligations that its competitors “do not share,” he said.

Of the company’s 19,000 employees, 83% of union members subject to 372 collective bargaining agreements, Mr. Driscoll said. Of these, 92% are members of the International Brotherhood of
Teamsters or the Bakery, Confectionery, Tobacco Workers and Grain Milers International Union.
“Because their workforce is heavily unionized, the debtors (Hostess) also participate in 40 multiemployer pension plans, which, by law, exist only where one or more employers each contribute to a pension plan pursuant to one or more collectively-bargained agreements,” Mr. Driscoll said. “The debtors’ cash contribution obligations to these plans go beyond amounts attributable to the retirement benefits of the debtors’ own workforce; they also encompass the contributions attributable to the retirement benefits of the workforces of other employers who have ceased to exist or have otherwise withdrawn from the plans. By statute, the plans are structured to place the financial burdens of all of the plan’s retirees upon those remaining companies that have active union employees. Over the last several decades, the number of companies and the active employee base supporting these pension plans have shrunk significantly, thus increasing the burden on the companies, such as Hostess, that remain.”

As of Dec. 10, 2011, Hostess had assets of about $1 billion and liabilities of about $1.4 billion. The latter figure does not include contingent liabilities such as the multiemployer pension obligation. The company had $592 million in long-term debt outstanding plus another $225 million in convertible notes.

In the company’s first year out of bankruptcy, the period ended May 29, 2010, Hostess sustained a loss of $138 million. In the year that followed, the company’s loss widened to $341 million, including $132 million in the write-off of “deferred debt issuance costs and debt discount.”

Explaining the deteriorating fi-nancial performance, Mr. Driscoll said the cash pension contributions associated with the multiemployer plans are about $103 million (the filing also estimated the monthly cost for the plans at about $8 million ($96 million)). Hostess said it stopped paying into the plan in August.
The company also has annual retiree medical obligations that are far smaller, at about $1.4 million.

Mr. Driscoll laid out elements from a business plan he said management has developed and set the stage for long-term viability for Hostess. The plan is “premised upon achieving a competitive cost structure” and requires “systemic, dramatic change,” he said. Elements of the plan include:

Complete withdrawal from multi-employer pension plans;

Addressing legacy health and welfare costs to significantly reduce costs, bringing them in line with the competitive marketplace

Modifying existing collective bargaining agreements to relax work rules

Finding new capital investment to modernize and automate production and distribution operations; and

A significant reduction of debt and related expenses

Mr. Driscoll said Hostess has $860 million in debt outstanding in addition to its liabilities in connection with multiemployer pension plans.

“To effect the transformation changes required for their businesses, the debtors must negotiate with their lenders, unions and the trustees of the multiemployer pension plans,” Mr. Driscoll said.
He said negotiations with the unions began before the filing, adding that “liquidity pressures” forced the company to file for bankruptcy.

Taking a step back, the affidavit offers extensive background on the company, including a brief account of its history and more detailed developments leading up to the Jan. 12 bankruptcy filing.
Hostess operates 36 baking plants, 565 distribution centers, about 5,500 delivery routes and 570 bakery outlet stores throughout the United States.

Established in 1927 as Schulze Baking Co., the company was renamed Interstate Brands Corp. in 1937 with a merger with Western Bakeries Ltd. The company grew over the next 60 years through multiple acquisitions. Mr. Driscoll said the expansion gave the company a nationwide network of operations and well known brands but also left the company “with a matrix of assets and operations that were not well integrated or streamlined and that remained burdened with the legacy labor obligations of each of its predecessors.”

Seeds of trouble in ‘90s

Even though the company was the nation’s largest wholesale baking company in the 1990s, “the excess capacity, inefficiencies and cost burdens of its 54 bakeries, more than 1,000 distribution centers and 1,200 bakery outlets across the country were ultimately not sustainable.”

The problems culminated with a 2004 bankruptcy filing with the United States Bankruptcy Court for the Western District of Missouri. The protracted bankruptcy dragged on for 4½ years because of litigation with public shareholders, labor strife, management turnover and a failed sale process, Mr. Driscoll said. Key outcomes from the bankruptcy, he identified, were:

• A transition to a privately-held company from a publically-held one
• A highly leveraged capital structure
• A decision to retain legacy union pension obligations “in reliance on some labor savings and anticipated operational improvements.”

Still a major player in baking

Reviewing developments since the emergence from bankruptcy, Mr. Driscoll said Hostess remains one of the largest baking companies in the United States with annual sales of $2.5 billion, about 89% of which come from route sales. The company’s products are sold nearly coast-to-coast in about 175,000 different customer locations.

In purchasing ingred-ients and other inputs, Hostess has as much as $500,000 in raw materials in transport daily. Additionally, the company stores about $6.5 million of goods in warehouses and pays storage fees of about $102,000 monthly.

As of the filing date, Hostess estimated about $50 million to $60 million is outstanding in debts to vendors, mostly for goods and services.

The affidavit offered two examples of how the company’s collective bargaining agreements put Hostess at a competitive disadvantage.

“The debtors often provide both bread and cake products to an individual customer location,” Mr. Driscoll said. “The existing work rules require that, on many routes, separate trucks must deliver the bread and cake products to that single customer location. The work rules also require that, in some bakeries and distribution centers, a separate individual must be used to load the trucks (the debtors’ competitors have drivers who load their own trucks) and separate people must load either bread or cake on a truck.

“Finally, work rules require that, in some instances, even when a route representative is already visiting a customer location, that representative may not move products within that location; rather, a separate employee must visit the customer location to move products from the back room to the shelf. Often this ‘pull-up’ employee cannot move both bread and cake, and thus, two ‘pull-up’ employees must make this same trip.”

Debt of unsustainable levels

In addition to the union related issues, Mr. Driscoll said the $860 million of secured debt it has issued is not sustainable.

Because the company is competitively dis-advantaged and faced a worsening financial picture, Hostess in 2010 retained Goldman Sachs and J.P. Morgan to explore sale opportunities, Mr. Driscoll said. None emerged even after a wide range of potential buyers was contacted, including Grupo Bimbo, Flowers Foods, Hershey, J.M. Smucker, Kraft Foods Inc., Pepperidge Farm and B&G Foods. The investment banks “could not obtain any offers to purchase any portion of the debtors’ businesses.”

This failure prompted Hostess to restructure the company, leading to the creation of the current “turnaround plan,” Mr. Driscoll said.

He said elements aimed at reducing its payment obligations to the multiemployer plans are crucial.
“These and other initiatives are designed to bring the total compensation packages provided to the debtors’ union workforce in line with those of similarly skilled domestic workers,” Mr. Driscoll said.

Union negotiations will be needed to implement a revenue generating initiative, he said.

Central to boosting revenues is finding alternative ways to deliver product, a capacity restricted by current collective agreement packages. The agreements limit where and how route sales representatives are able to make deliveries.

Need access to dollar stores

Many customers expressly forbid delivery of product directly to customer store locations, the affidavit said. As a result, Hostess has been unable to enter “potentially profitable markets such as dollar stores, vending services and movie theaters,” the affidavit said. Mr. Driscoll said the company would like to outsource these stops to third-party distribution operators.

Ready to rollout new products

“The debtors have developed products based on their best-selling cake items that have a longer shelf life and can withstand freezing en route to customers over longer transportation hauls,” he said. “The formulation and regulatory process relating to these products is complete, but the products cannot be rolled out unless the debtors obtain certain modifications to their existing collective bargaining agreements.”

The affidavit includes details of the plan beyond renegotiation of labor contracts. Several important moves are needed to enhance the company’s operational efficiencies, including reducing excess capacity and making remaining capacity more efficient. Hostess plans to upgrade its aging vehicle fleet and improve its ability to manage inventory through tracking software at distribution centers.

Unprofitable bakery outlet stores need to be closed, and pricing strategies in this segment need to be reworked, Mr. Driscoll said. At the same time Hostess sees a need to build its administrative capabilities, the company also recognizes a need to take substantial steps to “reduce other costs associated with selling, general and administrative expenses.”

The plan also calls for boosted advertising and marketing budget.

While committed to pursuing its turnaround plan, Hostess said its ability to do so was compromised by a worsening liquidity crisis. The company had more than $115 million in cash in 2009, shortly after emerging from bankruptcy, a figure that was down to $82 million a year later. By May 2011, Hostess had only $35 million in cash and had $50 million against a line of credit. Mr. Driscoll estimated the company went through $250 million in cash from the bankruptcy emergence though the end of 2011.
Efforts to negotiate a settlement with union leaders “ramped up” in late 2010.

Teamsters vote barely final

Hostess management negotiated changes to the collected bargaining arrangement with Teamsters, but in May 2011, union members voted down the proposed modifications by a vote of 52% to 48%. In September, a revised proposal was presented to the Teamsters and at least eight in-person meetings have been held. Hostess met with the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union with detailed proposals presented a month later, Mr. Driscoll said. Multiple proposal revisions have been offered and numerous meetings with union representatives have been held, Mr. Driscoll said.
As liquidity tightened, the need to resolve the outstanding labor issues heightened, Mr. Driscoll said.

Finding hinges on concessions

“The debtors believed that (investors) might be willing to make additional investments into the business if certain labor concessions could be obtained and operational goals achieved,” he said.

Toward that end, Hostess was able to secure some additional financing but not enough to “solve the debtors’ fundamental liquidity problems, Mr. Driscoll said.

“Notwithstanding every effort to preserve cash, the debtors’ cash position continued to deteriorate,” he said. “Accordingly, after consultation with its advisors, the boards of directors of the debtors authorized them to commence these chapter 11 cases.”

Hostess gets go-ahead for DIP financing; union leader lashes out at management

IRVING, TEXAS — Hostess Brands Inc., which filed for bankruptcy protection on Jan. 11, said it has received authority from the U.S. Bankruptcy Court for the Southern District of New York to enter into a $75 million debtor-in-possession (DIP) financing facility and access $35 million of it until a hearing scheduled for Jan. 26 for further approval for the DIP. The financing will allow Hostess to continue routine operations while undertaking a comprehensive financial and operational restructuring.

The financing is being provided by a group of the company’s existing first-lien lenders, led by Silver Point Capital, L.P.

Additionally, Judge Robert D. Drain also authorized the continuation of wages for employees without interruption and maintenance of all customer programs, among other things.

“The motions granted today will ensure that Hostess continues its operations without any disruptions so that its products will remain available and on store shelves everywhere,” said Brian Driscoll, president and chief executive officer. “With the access to the DIP financing, Hostess will continue to provide wages and benefits to our employees and payments to suppliers going forward.”

The bankruptcy court said Hostess was focused on completing a successful reorganization and not on selling all or portions of the company.

“The company is strongly committed to continuing its good faith bargaining with its unions, and we remain hopeful that we can reach a consensual agreement on the terms of our labor contracts before filing 1113 and 1114 motions,” Mr. Driscoll said.

Expressing hope that Hostess Brands Inc. will survive in the wake of the recent bankruptcy filing, the leader of a principal union representing baking employees issued a strongly worded statement countering assertions the company’s financial problems are due to “union contracts and pension and health benefits obligations.”

“I find it deeply offensive and highly disingenuous for the company to claim that its financial woes are the result of its union contracts and pension and health benefits obligations,” said Frank Hurt, president of the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union. “We contend that the company is in dire financial shape because of a string of failed business decisions made by a series of ineffective executives who have been running this company for the past decade.”

According to the B.C.T.G.M., the union represents about 5,000 Hostess workers.

Announcing the bankruptcy filing, Hostess said its “current cost structure is not competitive, primarily due to legacy pension and medical benefit obligations and restrictive work rules.” The company expressed the hope it will emerge from bankruptcy with “competitive employee benefit plans.”

According to the B.C.T.G.M., the union has been “working with Hostess for months to identify an amenable resolution that would address the company’s financial difficulties.”

“Throughout this process, the company has never provided the union with a legitimate proposal that could be taken to the membership for consideration,” he said.

Mr. Hurt expressed great concerns about the jobs at Hostess at risk and the well being of union members working at Hostess.

“We had hoped that the company would emerge from the last restructuring stronger and more competitive,” he said. “Our members sacrificed a great deal to try and save the company the last time.
“The B.C.T.G.M. has contracts with dozens of baking companies across the country, including Bimbo Bakeries USA, the nation’s largest and most successful. The vast majority of those companies are doing just fine because they have experienced baking industry professionals managing them.”

Mr. Hurt took particular issue as highly misleading “the company’s portrayal in the media of its pension obligation problems.”

“Hostess Brands had been a longstanding participant in the industry’s Taft-Hartley multiemployer pension fund,” the union said. “The nearly $1 billion the company refers to is its withdrawal liability. Every participant in a Taft-Hartley fund has withdrawal liability, which ensures that beneficiaries will receive negotiated pension benefits if a company leaves the fund.

“The contributions Hostess had paid into the fund were negotiated through the collective bargaining process and are part of an overall economic compensation package. Pension benefits that retirees receive each month are paid by the fund and not the individual companies.”

Ultimately, Mr. Hurt expressed the hope solutions will be found.

“We remain hopeful that solutions can be found to ensure the permanent continuation of Hostess Brands,” he said. “We will work with the stakeholders throughout the process to find a solution that protects the interests of our members and helps enable the company to remain a viable business entity.”

Top management at Hostess Brands Inc. as listed in the affidavit includes:
 Brian J. Driscoll, president and chief executive officer

 David A. Loeser, executive vice-president of human resources

 Kent B. Magill, executive vice-president, general counsel and corporate secretary

 Richard C. Seban, executive vice-president and chief marketing officer

 John O. Stewart, executive vice-president and chief financial officer

 Gary K. Wandschneider, executive vice-president of operations.

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