KC bakery facing new challenges in snack competition

KANSAS CITY, Mo. -- More than 70 years after Chicago-area bakery manager Jimmy Dewar made culinary history by creating the first Hostess Twinkie, the current maker of the famous tasty treat is struggling as competitors such as Krispy Kreme Doughnuts Inc. gobble up the snack cake industry's profits.

Less than a year ago, Interstate Bakeries Inc., the nation's largest wholesale baker, reported a $14 million increase in sales and a nearly threefold gain in first-quarter earnings.

Months later, however, the Kansas City-based baker reported a 45 percent drop in earnings as revenue fell flat. Snack cake sales had collapsed, company executives said, even as the costs -- for ingredients, energy and employee benefits -- rose.

Since then, Interstate Bakeries has continued to report dismal earnings. In April, the company announced its first quarterly loss since the late 1980s that was not fully attributable to one-time charges. And in July, as Interstate reported yet another quarterly loss, company executives said they would no longer issue earnings guidance and refused to dismiss the possibility that they may eliminate the dividend.

How can the company that makes such staples of the American diet as Hostess Twinkies and Wonder Bread find itself losing money? Analysts point to increased competition and rising costs.

"I think (Interstate's) snack cake business needs to be made more contemporary," said analyst John McMillin of Prudential Equity Group Inc. "That might require thinking out of the box. It's going to have to go beyond just putting chocolate on something."

Selling doughnuts, Twinkies and Ding Dongs has become harder, James Elsesser, Interstate's chief executive, said in a conference call with analysts in April in part because of "the Krispy Kreme phenomenon" -- people are giving up Interstate Bakeries' sweets for Krispy Kreme doughnuts. The Winston-Salem, N.C.-based company in May reported first quarter earnings of $13.1 million, a 47 percent increase over the same period the year before.

"Our cake business has lost both units and share as the Krispy Kreme phenomenon has affected the entire sweet goods industry," Elsesser said.

But analysts say Interstate's treats face increased competition from more than just Krispy Kreme. Store shelves have become crowded with candy bars, energy bars and miniature cookies and chips.

"It used to be their only competition was Little Debbie. Now they've got a host of snack alternatives," McMillin said.

Interstate makes products under the Hostess, Wonder Bread, Home Pride, Butternut, Merita, Drake's and Dolly Madison brand names.

It's not just that Interstate's sweet goods that have fallen out of favor. It's bread isn't doing so hot anymore, either.

Mitch Pinheiro of Janney Montgomery Scott in Philadelphia said Interstate failed to catch on to yet another market trend: the premium and super premium breads that have become popular with adults. While those breads cost only slightly more to make than ordinary bread, Pinheiro said, they are priced much higher.

"They're behind the competition," Pinheiro said. "And for the leading bread company in the country to have missed that trend is just inexcusable."

Company executives acknowledge the problems but say they're trying to find ways to fix them.

"The question is, how do we begin to sell products with greater appeal?" company spokesman Mark Dirkes said.

Interstate is trying to get into the premium bread market with its Home Pride and Grandma Emily's labels.

And it has introduced caramel Hostess Ho-Hos in the Northeast. So far, those results are impressive, increasing Interstate's "total Ho-Ho volume" in that area by nearly 50 percent, Dirkes said. But the product is still being tested, and it's unclear when and if caramel Ho-Hos might be available across the country.

The company also is looking at lowering prices and changing some of its packaging.

"Snack cake in particular is an impulse item," Elsesser told analysts July 14, "and we're trying to improve the odds that our product will be noticed and picked up."

Then there are the high costs Interstate has faced in recent quarters. The price for health care, energy and ingredients have gone up for everyone. But Interstate also has operational problems, Pinheiro said, including "an inefficient and high-cost distribution system."

The company is looking at those issues. The company plans to invest in technology that will allow it to know which routes and accounts are profitable.

Interstate officials also are deciding whether to eliminate bakeries and thrift stores, weeding out some marginal products, and consolidating some delivery routes.

"It's a very difficult environment out there," Elsesser said at the end of the July conference call, "and we have a lot of obstacles to overcome."

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On the Net:

Interstate Bakeries: www.corporate-ir.net/ireye/ir--site.zhtml?tickerIBC&script21 00

Hostess Twinkies: www.twinkies.com

Krispy Kreme: www.krispykreme.com