What's next for Hostess Brands?

by L. Joshua Sosland
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IRVING, TEXAS — Less than two weeks from when labor unions are expected to decide whether or not to go along with the reorganization plan of Hostess Brands, Inc., Greg Rayburn, chief executive officer, offered a hopeful vision of the company’s future.

Hanging in the balance is whether the company will continue into the future as a going entity or will face imminent liquidation, Mr. Rayburn said in a Sept. 5 interview with Milling & Baking News. The discussion followed an earlier appearance on CNBC in which Mr. Rayburn described as “painful” an 8% wage concession sought from all Hostess employees.

In addition, the reorganization plan would require bondholders to lose about $100 million in claims. Hostess said professionals working on the case, including the lawyers and financial advisers for both the company and the union, have agreed to give up about $10 million in fees. Ripplewood Partners, the majority owner of the company, would lose its entire $150 million investment.

Hoping to emerge successfully from its bankruptcy, Hostess has final proposals before its unions, including the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union and the International Brotherhood of Teamsters. Mr. Rayburn said results from the votes were expected by Sept. 17.

If negotiations with its unions and other key steps are successful, Mr. Rayburn declared that Hostess will be on a path toward genuine success in coming years.

“What I want for Hostess is for it to be as strong a competitor as it can be, which I think is much more effective and strong than it has been in recent years,” he said. “I think it has tremendous upside, tremendous potential, but I want to see it do what I call generate its own oxygen. You’ve got to be profitable. You’ve got to make your own money. You’ve got to fund your own livelihood, and you’ve got to fund enough to make up for years of lack of investment. And those are the goals for this company, to have a plan that says we will have the funds to invest, we will make the investments. Sure, we might make mistakes along the way but I think there are a lot of opportunities for this business so that for a long time it will be around and be competitive.”

Hostess filed for bankruptcy protection in January 2012. It was the company’s second such filing in the last decade. Hostess (then Interstate Bakeries Corp.) filed for bankruptcy in September 2004 and emerged in February 2009.

Mr. Rayburn has been with Hostess for just over six months. His appointment as chief restructuring officer was announced Feb. 28, and he replaced Brian Driscoll as c.e.o. less than 10 days later. A partner at Kobi Partners L.L.C., Mr. Rayburn has more than 29 years of experience working with troubled businesses in their efforts to restructure. He is the sixth c.e.o. of Hostess over the last 10 years.

In the interview, Mr. Rayburn said his priority in recent days has been to explain to the company’s unions the rationale underpinning wage concessions and other elements of the Hostess reorganization plan.

“It has been difficult that’s for sure,” he said. “But I think we’ve made a lot of progress, and I’m just trying to get out to as many locations as I can to meet with the employees in person and talk to them about the proposal that’s in front of them and give them the facts and let them understand” what will happen depending on the vote outcome.

While he has extensive experience working with distressed companies, Mr. Rayburn said the fact Hostess is in bankruptcy for a second time sets his current engagement apart from earlier experiences, creating particularly acute challenges.

“This is more difficult because you’re effectively going back to an employee base that needed to make concessions that last time, and they’re back in the same place again,” Mr. Rayburn said. “I think that adds a significant amount of challenge to the process.”

That “challenge” has bubbled to the surface as Mr. Rayburn has traveled to meet with union representatives to discuss the reorganization plan.

“Our meetings have been good and productive,” he said. “But I think people are showing and you would rightfully expect that you are going to see a level of frustration. In some cases anger and disappointment at the package they are being asked to vote on and some of that stems from the fact as I said that this company has been through this process once. But I think people are also willing to hear the facts and prepare themselves to deal with the facts and make the best decisions that they can for themselves and then for the company.”

Asked to expand on what Hostess is seeking in the negotiations with its workers beyond the wage cuts, Mr. Rayburn put financial issues front and center.

“The two big buckets of change are really the wage concessions and also pension contribution adjustments,” he said. “Hostess’ history was that it was making $100 million dollars a year in pension contributions over half of which were going into multi-employer plans that were going to the benefit of people who never worked for Hostess. And so what we’ve tried to do is construct pension contributions that we can a) afford, and b) will be there when people retire and will be in relatively stable funds. So I think that’s what we’ve accomplished here. Those are the two big economic changes this time around versus the last bankruptcy, and I think those are key to making sure that the company actually has money to invest in its plants and its equipment.”

The emphasis in his comments on wages and pension contributions should not be interpreted to mean that contract negotiations have neglected important work rule issues that long have been sources of contention between Hostess and its unions, Mr. Rayburn said.

“We actually have dealt with that, and I think we’ve come up with a set of changes to the work rules, some distribution changes that will make us much more competitive,” he said. “That’s all part of this package. I just was kind of pointing out sort of the big two in terms of the way I think the membership looks at it because it’s personal to them when you talk about pay cuts and the pensions. But those work rule changes are all part of this proposal. I expect to see Hostess a lot stronger competitor.”

Asked for contingency plans in the event labor negotiations fail, Mr. Rayburn was unambiguous in describing what will transpire. Hostess as a company would, in a very short period of time, no longer exist, he said.

“We would liquidate, and we would sell whatever brands and assets we could,” he said. “There wouldn’t be a merger. There wouldn’t be a different transaction. I think if we don’t get a majority of the bakers’ and Teamsters unions voting yes to the ratification, we would immediately start the sale of assets and Hostess would shut down.”

Given the frequency with which unexpected disruptions, such as gluten-free dieting or a severe drought, have hit the baking industry in recent years, Mr. Rayburn said conservative sales and cost forecasts in generating its reorganization plan were crucial.

“I think that this plan does address that, and I think that in my experience you have to be very careful year one after an exit,” he said. “You know, the way our concessions are designed with the 8% cut in year one, then they sort of creep back up after, that is really tailored to that concept that you have to give yourself a lot of margin for error. I think in our case, the lenders who are willing to exit this company and the union leadership and the management team want to make sure that whatever proposal we’re putting out for ratification or whatever our path is going to be, that there is very little likelihood of a return to
bankruptcy. I think that would be devastating. So I think that we are not projecting pie in the sky sales or new sales or new products. None of that is part of our plan. All of that would be upside to us. I think we’ve taken very conservative views on commodity prices and baked that into the plan as well. So I’m very comfortable that we can achieve and execute the plan and have success without inordinate risk.”

Even if the company successfully completes negotiations with its unions, emergence from bankruptcy likely will require Hostess to divest parts of its business, Mr. Rayburn said.

“Part of our exit strategy and part of the way we are going to fund our success is to do an asset sale,” he said. “We are in discussions regarding an asset sale with actually different buyers right now so I can’t really give you any details on that. But I think that once we have better clarity as to what that will be and what the timing is then we have more insight into capacity rationalization.”

In recent weeks Mr. Rayburn has indicated Hostess may sell its Merita baking business in the Southeast. Hostess acquired the business in 1987 from American Bakeries. At the time, the division was known as one of America’s most profitable.

A post-bankruptcy Hostess in 2012 would be in a very different position from when it first sought creditor protection in 2004. The company is no longer the largest baking company in the United States or even second largest. Mr. Rayburn said the degree to which the business has held up while in bankruptcy bodes well for how the business will fare afterward.

“We’ve had sort of everything and the kitchen sink thrown at us during the course of this bankruptcy and our sales have held up very well,” he said. “We have a very strong sales platform of products with sales around $2.5 billion a year, and I think that needs to be viewed as a platform for further product differentiation and brand extension and that’s going to go hand in hand with different distribution channels and methods. So you’re going to see, I think Hostess has a pretty strong competitive path going forward on the basis of that and that platform I think is pretty sound at the demand level. We sell lots of Twinkies, Ding Dongs, Ho Hos and Wonder Bread and Drake cakes and Dolly Madison. Our customer base is also very supportive of our survival because they need more suppliers rather than fewer, particularly in a consolidating industry.”

Asked about declines in unit volume sales that have hit Hostess (and other bakers), Mr. Rayburn acknowledged the company has had issues in keeping current with new product trends. Ultimately, though, he defended the company’s overall sales performance.

“I think where Hostess has probably underperformed is I don’t think it’s done enough brand extension and new product development,” he said. “So you’ve got a great base of products, but I don’t think we’ve put enough emphasis on R.&D. spend. So part of this plan is to sort of double our R.&D. spend to get it focused at issues like that and I think that is all opportunity for us.

“I think the demand has been very good, and I’ve been very pleased with the way sales have held up. And I’ve done this for a lot of different companies and a lot of different industries and typically you would not expect revenues to be as stable as ours have been in the face of a lot of strike talk, bankruptcy talk, commodity price increases and everything else you could name. I think we’re seeing good customer demand, we see it at the retail level and we certainly see it at the end customer level.

“I think the opportunity for us is to create off of that platform and create new products that will be more top of mind because they’re new for that customer base to try.”

Asked to dip a bit deeper into trends in baking such as whole wheat and gluten-free dieting, Mr. Rayburn declined to offer much elaboration.

“We have (whole) wheat line extensions now that have been a big part of the plan that we’ve put together in terms of our business plan,” he said. “We probably were late trend-wise on that, but I think that is something in which we have very good products in that space now. I don’t want to get too far into gluten-free because I really don’t want to talk about our strategies in a lot of detail.”

Mr. Rayburn did offer observations on the impact of the summer’s drought and resultant surging flour prices.

“I think all the players in the business are going to some extent going to have to take pricing,” he said. “When you have corn that’s up to current levels and you have wheat where it is, whether or not you’re hedged, I think at some point you’ll see the industry react taking pricing.”

Finding a permanent chief executive officer is toward the top of the list for steps to be taken by the company during its first 100 days after bankruptcy, Mr. Rayburn said.

“We’ve actually started a process of defining a profile and looking at search firms to go down the path of looking for a permanent c.e.o.,” Mr. Rayburn said. “Everything sort of has to start at the top. So I’ve told the company and the unions that I’ll stay in whatever capacity they would like for as long as it takes to make sure that the train doesn’t go off the tracks. I think we have a profile for candidates, and we’re going to push through that process. I think we want to get that person on board so that they can also be part of defining that first 100 days.”

Regarding his own involvement, Mr. Rayburn emphasized a commitment to stay as long as needed to help the company exit bankruptcy but also suggested the period he will remain with the company will not be very long.

“I don’t ever have an end date on the engagements that I do, and I’ve stayed at companies for half years before,” he said. “I have agreed to stay in whatever capacity and whatever both parties and interests prefer, because it’s in my best interests to make sure that Hostess is successful for the long haul.”
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