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Half a Loaf At Giant Baker, Freshness Project Takes Sour Turn

Interstate's Drive to Extend Shelf Life Has Problems;
Now, a Chapter 11 Filing Disarray in Wonder Bread Rack

JANET ADAMY / Wall Street Journal 23sep04

 

KANSAS CITY, Mo. -- In recent months, Interstate Bakeries Corp. blamed its growing difficulties on low-carbohydrate dieting. That made some sense, considering that Interstate makes carbs as celebrated as Wonder Bread, Twinkies and Ding-Dongs. And some other food giants, like General Mills, were blaming the fad, too.

But there was also a problem unique to Interstate, the nation's largest baker: a fumbled quest for a formula to make baked goods last longer.

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.

Dividing The Dough

US supermarket sales of top branded breads in the 52 weeks preceding July 18.* Interstate Bakeries brands are in blue.

* Many of these brands also make breads for private labels. For the same time period, private-label breads generated $1.42 billion in sales.
source: Information Resources

Three years after it launched its ballyhooed effort to extend the shelf life of its baked goods, Interstate yesterday filed for Chapter 11 bankruptcy protection. Its chairman and chief executive, James R. Elsesser, resigned. Tony Alvarez, a restructuring expert, will succeed him. Interstate said it had obtained $200 million of "debtor in possession" financing from J.P. Morgan Chase & Co. to enable it keep making bread and cakes while it reorganizes.

Interstate "has some of the most recognizable and popular baked breads and sweet goods brands in the nation," said Mr. Alvarez. In an interview, the new CEO stated that industry pressures, not troubles with the effort to stretch out breads' and cakes' shelf lives, forced the company into Chapter 11.

The bankruptcy filing was the low point in the nearly 75-year history of Twinkies and other Hostess and Dolly Madison brands. A staple in the lunch pails of generations, Hostess cakes and pies became a cultural icon. But as the Hostess brand was passed from one big company to another -- Continental Baking to ITT Corp. to Ralston Purina Co. to Interstate Bakeries, in 1995 -- it has suffered at times both from parent-company inattention and from ubiquitous fresh pastries. Meanwhile, Twinkies and white Wonder Bread seemed increasingly out of sync with health-conscious consumers.

Consumption of white bread, Interstate's flagship product, suffered as consumers shifted toward multigrain loaves. But Interstate was slow to jump on the multigrain trend. Meanwhile, the nation's growing concern about childhood obesity hurt sales of Hostess treats.

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.

Interstate has twice delayed filing the latest fiscal year's annual report with the SEC, attributing the delay to a glitch in a new computerized financial-reporting system that accounts for operating costs.

Yesterday, after the Chapter 11 filing, the company's stock plunged $1.22, or 37.3%, to $2.05 a share before trading was halted by the New York Stock Exchange. The shares had traded above $16 apiece six months ago.

About three years ago, company executives concluded they had found a formula that would revolutionize their processes and save big on costs. It was a way to double shelf life without losing taste or quality. But in rolling out newly long-lived Ho-Hos and Wonder Bread, they ran into a series of setbacks that hurt sales, ate into profits and turned off some customers. In an era when much of business is obsessed with cutting costs, the case shows how a plan that seems sure to yield coveted savings can have unintended consequences.

Company officials defend the shelf-life program. "I think it's been a plus," says Mark Dirkes, senior vice president of marketing. In a sharply different view, a suit filed on behalf of shareholders in a federal court in Missouri last year contends that Interstate officials failed to disclose the significant problems that resulted from the program. A spokeswoman for Interstate declined to comment on the suit.

The shelf-life program began when company food technicians decided to deconstruct a crumb cake that seemed to stay fresh forever. Examining its recipe, the researchers found the cake included an ideal amount of a gum whose role was to keep it extra-moist. With great caution, they decided to try adding more of that ingredient to Zingers, a Dolly Madison cake. "One of the scariest things in the food business is to change your recipe," says Mr. Dirkes.

The new Zingers tasted fine. So the company added more gum to Hostess Twinkies and the rest of its line of snack cakes. Suddenly the cakes, which used to last on store shelves for as few as seven days, could stay there at least two weeks.

Stale Stock
Interstate Bakeries (IBC) shares

The implications were huge: Interstate could reduce waste. That meant it should be able to close some plants. And it could cut the frequency of deliveries.

A big question was whether the technology could be applied to bread, which makes up more than half of the company's sales. It had always had a shelf life of only about three days, far less than cakes.

Bread proved far more complicated. The gum didn't mix well with it. An early attempt to create a longer-lived loaf burned out the motor of a bread-dough mixer.

The company sought the help of Innovative Cereal Systems, an Oregon company that specializes in mixing freshness-enhancing enzymes for bakeries. Enzymes bind water molecules to the bread, making it softer and slowing the process of going stale.

Innovative Cereal was convinced it had the right formula for extending the life of bread -- a recipe that didn't include the gum inside Zingers. But Interstate wasn't its only client. The whole bakery industry was seeking to prolong shelf life. Sara Lee Corp., another large bread maker, was also working with Innovative Cereal.

Interstate experimented with the Innovative Cereal formula and determined that it worked in Wonder Bread, the nation's top-selling brand. In 2001, Interstate began shipping Wonder loaves that could stay soft and fresh for seven days, more than twice as long as before.

Company officials saw the rollout as clearing the way for a huge cost-cutting program. Bread always had been so perishable that the company had operated more than 60 bakeries, so no truck had to drive very far. Now, executives envisioned shutting plants right and left, and reducing deliveries by 10%.

Officers told Wall Street the program would permit cost cutting like never before. "Our extended-shelf-life program will continue to play a significant role in cost control, with the added benefit of improved quality and availability of our products," said Charles Sullivan, former chairman and chief executive, three years ago.

Almost from the start, problems arose. At some bakeries, the recipe just didn't work well. But the loaves were delivered to stores nonetheless.

Mitchell Pinheiro, a food analyst with Janney Montgomery Scott, says he was touring an Atlanta supermarket in June 2003 when he noticed that Interstate's Merita bread looked gummy and doughy. "It was so heavy that the sides weren't able to support the weight," Mr. Pinheiro says. He questioned a delivery driver, who, he recalls, thought the bread never should have made it to store shelves.

Quality was especially a problem in the company's Southeast division. Sales there were off 25% by April 2003, according to David C. Nelson, a food-industry analyst at Credit Suisse First Boston.

Consumers started complaining on Twinkies.org, a Web site not affiliated with Interstate. "I've been eating Merita bread for decades," but "the taste seems to have changed," an anonymous consumer wrote in a posting in 2003. Wrote another: "Whatever has happened or is happening we do not like it and have gone to another brand."

Competitors noticed, too. "They had a formula on white bread that all the consumers I had ever been associated with loved. It was hard as hell to beat," says Doug Wimberly, president of ButterKrust Bakeries in Lakeland, Fla. But "somebody decided this other alternative was a better route.... I think it was a huge mistake." Mr. Wimberly says his sales began increasing.

Even in some places where the bread tasted fine, problems arose from reduced delivery schedules. One job of drivers is to straighten out stores' shelves. Drivers who visited as often as once a day always made sure the product looked fresh and well-arranged. But now, days would pass between visits, especially to small stores. So the Interstate Bakeries offerings could look picked over and sometimes crushed. The company acknowledged it had cut service too deeply and began adding back driver routes.

At Open Pantry Food Marts in Madison, Wis., the Interstate Bakeries shelves have often looked messy and the shelves sometimes empty. "They look sort of C-quality," says Robert Buhler, chief executive of the 42-store chain.

The promise of plant closures was part of the appeal of the shelf-life program. The closing of a plant in Grand Rapids, Mich., for instance, means the stores it served now receive their bread from a plant in Toledo, Ohio. But such closings have proved more difficult than expected. About three years into the rollout of extended-life Wonder Bread, Interstate Bakeries has managed to close only about a half-dozen plants, leaving 54 remaining facilities.

The company declines to say why. Some speculate that the higher cost of fuel today has made long-distance delivery less economical. Whatever the reason, the difficulty of closing plants clearly is weighing on the company. In its bankruptcy announcement, Interstate cited the cost of excess capacity as a significant reason for its financial woes.

Some analysts said the extended-shelf-life program could still save significant money if managed right, but that the company's highest priority ought to be improved marketing and increased sales, rather than cost cutting. Some suggested that Mr. Elsesser, a renowned cost-cutter at Ralston Purina before he joined Interstate in 2002, simply failed to focus on building the brands and creating new products. Not until this spring, for instance, did Interstate introduce a premium-brand multigrain bread, the bread industry's hottest product. Mr. Elsesser declined to comment.

Might the shelf life just have been stretched too much in some cases? Competitor Flowers Foods is using the same freshness-retaining enzymes as Interstate but pulls the loaves off the shelf after four days, just one day longer than before. "On the seventh day it may be 'fresh,' but it may have been moved around by store personnel. It may look shelf-worn," says Jimmy Woodward, Flowers' chief financial officer.

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