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Executives

Barry Sievert - Vice President, Investor Relations

Jack F. Callahan - Chief Financial Officer

Gregg L. Engles - Chairman and Chief Executive Officer

Analysts

Terry Bivens - J.P. Morgan

David Palmer - UBS

Eric Katzman – Deutsche Bank Securities

Farha Aslam – Stephens Inc.

Robert Moskow - Credit Suisse

Alexia Howard – Sanford Bernstein

Christine McCracken - Cleveland Research Company

Christopher Growe – Stifel Nicolaus

Dean Foods Company (DF) Q4 2008 Earnings Call February 11, 2009 9:30 AM ET

Operator

Good morning and welcome to the Dean Foods Company fourth quarter fiscal year 2008 earnings release conference call. Please note that today’s call is being recorded and is also being broadcast live over the Internet on the Dean Foods corporate website. This broadcast is the property of Dean Foods. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of the company is strictly prohibited. At this time, I would like to turn the call over for opening remarks to the Vice President of Investor Relations, Mr. Barry Sievert.

Barry Sievert

Good morning everyone. Thanks for joining us for our fourth quarter and year end 2008 conference call. We issued a press release this morning which is available on our website at www.deanfoods.com. The release is also available on the SEC’s website at SEC.gov. Also available at the Dean Foods website is a slide presentation which accompanies today’s prepared remarks. A reply of today’s call will be available on our website beginning this afternoon.

The consolidated earnings, operating income and operating margin information that will be provided today are from continuing operations and have been adjusted to exclude the impact of discontinued operations, costs related to the recapitalization of the balance sheet, the expenses related to facility closings and reorganizations, and non-recurring items in order to enable you to make meaningful evaluation of our operating performance between periods. The earnings release contains a more detailed discussion of the reasons why these items are excluded from the consolidated results, along with the reconciliation between GAAP and adjusted earnings, as well as between net cash flow from continuing operations and free cash flow from continuing operations. We also would like to advise you that all forward-looking statements made on today’s call are intended to fall within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements will include, among others, disclosure of earnings targets as well as expectations regarding our branding initiatives, expected cost savings, leverage ratios and various other aspects of our business. These statements involve risks and uncertainties that may cause actual results to differ materially from the statements made on today’s call. Information concerning those risks is contained in the company’s periodic reports on Forms 10-K and 10-Q and in today’s press release.

With those formalities out of the way, I will now turn the call over to Jack Callahan, our Chief Financial Officer, who will review the financial results from the fourth quarter and full year 2008, as well as comment on our forward outlook. Following Jack, Gregg Engles, our Chairman and CEO, will provide additional commentary on the performance of the business and give an update on our strategic initiatives. Following Gregg’s remarks we will open the call for your questions.

Jack F. Callahan

Good morning everyone. I will first discuss the overall performance for Dean Foods then review the performance of our two business segments, DSD Dairy and WhiteWave-MorningStar. I will close my remarks with a look at our very strong cash flow performance and comment on the outlook for 2009.

The fourth quarter demonstrates the remarkable resiliency of our business model as we’ve clearly completed the rebound from a very challenging year in 2007 to finish 2008 with the strongest quarterly adjusted operating income that the business has ever produced. Both WhiteWave-MorningStar and DSD Dairy contributed very strong results in the quarter.

Strong volume growth and execution are rapidly improving commodity environment and the accumulating benefits of our strategic initiatives in the DSD Dairy division drove their profits 31% above year-ago levels in the quarter.

Continued sales growth and tight expense control produced 14% profit growth at WhiteWave-MorningStar for the quarter.

Consolidated adjusted operating income for the quarter increased 27% over the fourth quarter of 2007 for a record $190.0 million, finishing the year in very strong fashion and positioning us for a fast start in 2009.

Below the line, interest leverage from declining debt balances, combined with our strong operating performance to drive adjusted diluted EPS growth of 70% in the quarter, despite the increased share count related to our $400.0 million equity offering earlier in 2008.

Interest expense in the quarter was $73.0 million, down nearly $16.0 million for the year-ago period as we continue to realize the benefits of our strong cash flow and related de-leveraging of the balance sheet.

Operating results improved throughout the year to produce full year adjusted operating income of $631.0 million, 7% above 2007 levels. The operational improvements we have made across the business, as well as strong branded growth combined with pricing execution, continued network rationalization, and the reduction in force implemented in the DSD Dairy segment in last 2007 all contributed to help drive our full year results well above year-ago levels.

Full year adjusted diluted earnings came in at $1.30 per share, 8% above 2007 levels. The equity offering in the first quarter of 2008 combined with our strong cash flow performance to materially reduce our overall debt.

Total interest expense for 2008 was $308.0 million, nearly $12.0 million below 2007 interest expense. The ongoing reduction in debt levels positions us well for continued EPS leverage in 2009.

Now I will discuss each of the business segments in a bit more detail. Let me start with DSD Dairy. DSD Dairy fluid milk volumes continue to outpace the overall market, increasing 2.8% over year-ago levels, aided by the acquisitions we completed this year. By comparison, based on USDA and federal milk marketing order data, the balance of the industry was down over 1% in the quarter.

For the full year, DSD Dairy’s fluid milk volumes were 1.5% ahead of 2007 results, compared to an overall milk market that was essentially flat. Over the course of 2008 we estimate that our market share in the fluid milk market expanded about a point to approximately 37%.

With such a strong quarter I can finally say that I’ve experienced both sides of the mountain, as the commodity volatility has been such a challenge to the business over the last two years worked in our favor in the fourth quarter. Dairy commodities declined significantly, particularly in December as butterfat and cheese prices declined materially.

The Class I milk price averaged $16.10 per hundred weight in the quarter, 23% below the $21.03 average in the fourth quarter of 2007. Class I prices have continued to trend lower so far in 2009, with February’s Class I mover set at $10.72 per hundred weight and expectations for additional decline in March.

The CME butterfat price, which is also important to our MorningStar business, fell dramatically through the fourth quarter, from $1.73 per pound in October to just over $1.20 in December, for an average of $1.52 in the quarter, still 14% above year ago levels, but 6% below the third quarter. CME butter prices collapsed in December to $1.20 per pound and have fallen further as we enter the new year to support levels in the $1.10 range with the U.S. government making significant purposes. Gregg will over a bit more insight into our current commodity outlook in just a few minutes.

The continued declines in energy and resin prices were as significant to the business as the movement of dairy commodities. Fuel, resin, natural gas and electricity all continued their decline that started in the third quarter. Overall, these declines in input costs, both dairy and oil related, contributed to a meaningful decline in DSD cost per gallon.

Strong volume growth and the favorable commodity environment contributed with the benefits of our strategic initiatives to deliver DSD operating income of $166.0 million, 31% above year-ago levels and the best quarterly result for the segment in company history.

Notably, the DSD results in the quarter were also 10% ahead of the very strong fourth quarter of 2006 before the commodity shock of 2007.

While most of the trends in the quarter were positive, I should note that like many other packaged goods companies, we saw a continued trade down from of our regionally branded products to private label as the economy deteriorated further. In most cases this is a trade between one Dean Foods product to another, albeit generally at a reduced margin.

We are uniquely positioned across the dairy case to provide customers both branded and private label products. This breadth of our product offering is a core strength of our business and helps us respond to shifting consumer preferences.

For the full year 2008 DSD Dairy operating profits increased 10% over 2007 to $591.0 million, despite a weak start to the year in the first quarter and an energy commodity environment that was quite challenging until the fourth quarter.

The $53.0 million increase in year-over-year DSD Dairy operating profits represents the recovery of almost three-fourths of the profits lost in 2007 when dairy commodities spiked. The accumulated benefits of our efforts to drive efficiency and productivity in DSD Dairy are becoming increasingly apparent.

Among other things, results are benefitting from the reduction in force completed in the fourth quarter of 2007, the benefits from the facility closures of the last two years, and a reduction in DSD routes. So in addition to favorable commodity tailwinds likely for the first half of 2009, we believe these strategic benefits will continue over the long term.

Now let me turn to WhiteWave-MorningStar. Total net sales in the fourth quarter increased 5% to $708.0 million. WhiteWave posted net sales that were 8% higher than the year-ago period at $420.0 million on a mix with increased pricing and higher volumes in our key brands.

Our portfolio of national brands in the WhiteWave portfolio continue to deliver strong sales growth but volumes did begin to slow a bit, driven by a softening economy.

Horizon Organic milk sales were up nearly 15% during the quarter, driven in large part by improved price realization. Across the category, both brand and the private label pricing increased in the quarter, however sales growth in the organic milk category clearly slowed in the fourth quarter as the price gap between organic and conventional milk opened to nearly two times. The category has declined from a growth rate north of 30% in early 2008 to below 105 by the end of the fourth quarter.

Silk sales increased in the mid-single digits in the fourth quarter as the category decelerated due in part to the troubled economy and the continued decline of a competitor’s brand. Additionally, Silk’s growth rate was specifically impacted by a strategic choice to exit an unprofitable relationship with a large food service customer.

As the only national player in the soy milk category, we will be focused on driving continued category growth in 2009. This focus will include several new product introductions as well as an updated health-benefit-focused marketing campaign.

In our coffee creamer business, International Delight net sales grew in the high single digits in the quarter. In addition to several new flavors we are currently launching exciting new packaging for International Delight. The updated packaging has the benefits of being consumer preferred and a lower cost with a reduced carbon footprint.

The new package has already been launched in Western states and will be rolling nationally over the coming weeks. Initial consumer response has been very positive as the new package shape is functionally easier to pour and very visually appealing. We will begin a national marketing effort in the second quarter.

LAND O' LAKES delivered low single-digit net sales growth in the quarter. Within this, the core Half & Half LAND O' LAKES business grew at a substantially higher rate as home consumption of coffee creamers remained strong.

At MorningStar strong yogurt, egg nog, and cottage cheese volumes were offset by the pass-through of sharply declining commodities, resulting in a net sales increase of 1.5% in the quarter to $288.0 million. Stronger retail results did offset some weakness in food service channels.

As a whole, the combined WhiteWave-MorningStar segment reported operating income of $69.0 million for the fourth quarter, 14% above year-ago results. Strong sales growth volume leverage and cost management at WhiteWave combined with favorable commodity trends at MorningStar to deliver strong profit growth in the quarter.

On a full year basis WhiteWave-MorningStar sales increased 10% to $2.65 billion. Strong brand performance at WhiteWave yielded 12% growth in net sales to $1.5 billion. Horizon Organic milk sales were up more than 20% on a full-year basis. Silk sales increased in low double digits as the brand increased its IRI-measured market share by over a point to 79% for the year. International Delight and LAND O' LAKES grew in the high and mid-single digits respectively in a very competitive but well positioned category. Solid growth in private label yogurt, specialty milk, and food service ice cream mix led to MorningStar net sales that were 8% higher for the year at $1.1 billion.

Looking ahead to 2009, we expect WhiteWave’s top line growth will dampen a bit as their brands experience slowing in their categories driven by economic conditions, as well as the decision to exit some non-core private label and food service businesses.

As I mentioned earlier, in 2009 we are rolling out the new packaging behind the International Delight. We are also bringing in an updated product line for Silk to the market, and launching select New Horizon and Rachel’s products. We expect these efforts, in addition to the launch of the Fruit Today product in a joint venture with Hero, to continue driving sales growth in 2009.

For the full year 2008 WhiteWave-MorningStar operating profits came in at $205.0 million, on par with 2007 results. This reflects the difficult commodity environment at MorningStar for much of the year and the investments we made in the organic milk category that have met operational improvement in the WhiteWave business.

For the year, WhiteWave profits were up slightly over 2007 levels and improved significantly in the fourth quarter as the drag from organic milk investments were significantly mitigated. MorningStar profits were a bit below year-ago results.

Looking ahead, we expect a return to profit growth in 2009 for WhiteWave-MorningStar, before the impact of the Fruit Today joint venture. As we mentioned on our call in November, we are investing approximately $0.06 per share behind the launch of the Fruit Today product. The Fruit Today product introduction is a joint venture with the Swiss Company, Hero.

Hero has been very successful with this fruit-based product in Europe and we are excited to be partnering with them to bring it to the U.S. market. This is a great new product platform for Dean that you will hear more about at our upcoming investor conference.

Now I would like to discuss the very strong cash flow performance and continued de-leveraging of the balance sheet. Demonstrating the resiliency of the Dean business model, full year free cash flow from operations was especially strong, totaling $462.0 million. Our strong operating results and improvements in working capital led to the best free cash flow year in our history and a powerful recovery from the commodity shock of 2007 and we continue to invest in the business, with close to $100.0 million of acquisitions in 2008 and capital expenditures that totaled $257.0 million for the year.

We expect strong cash performance to continue in 2009 even as we step up the investment behind our strategic initiatives. This increased investment includes for capital expenditures of up to $300.0 million in 2009.

As of December 31, 2008, total outstanding debt stood at just under $4.5 billion, $877.0 million lower than its peak level last year. Our leverage ratio of funded debt to EBITDA, as defined by our credit agreement, declined to 4.92 times at quarter end, more than a full turn below its year-ago level.

This is more than three-quarters of a turn below the 5.75 times maximum allowed under our current covenant and already below the year end 2009 covenant step down to 5.0 times.

Going forward, given the new financial landscape, we believe it is prudent to continue our focus on de-leveraging the balance sheet.

In 2009 we have just over $300.0 million of scheduled amortization and maturities. We plan to use free cash flow, combined with our borrowings under our $1.5 billion revolving credit facility to meet our schedule maturities over the coming year.

As of the end of the fourth quarter we had $1.3 billion available under our revolving credit facility and $140.0 million available under our receivables securitization. I would also like to note that during the quarter we made the choice to make market purchases of $77.0 million of our bonds due in 2009 at a nominal discount to par value.

In summary, we feel very good about our overall performance in the fourth quarter and a strong recovery of the business in 2008. We have significant momentum in our business as we enter 2009. For the first quarter we are off to a strong start and are expecting adjusted diluted earnings to be at least $0.38 per share. For the full year we are currently targeting at least $1.50 of adjusted earnings per share which is strong double-digit EPS growth.

While we have clear tailwinds due to favorable commodities at the moment, real concerns remain. We believe it is prudent to be conservative on our full year outlook due to the unpredictable commodity volatility, continuing competitive pressures, the extraordinarily troubled economy, unsettled credit markets, and increases in our pension expense of approximately $0.05 per share.

We will update you in more detail regarding 2009 and our longer-term outlook at our investor conference in two weeks.

With that, I would like to thank you for joining us today and turn the call over to Gregg Engles.

Gregg L. Engles

For Dean Foods 2008 was a year that clearly demonstrated the strength and resiliency of our business model. Both 2007 and 2008 were incredibly volatile from a commodities standpoint, with Class I milk averaging $18.00 in both years and organic milk experiencing a period of material excess supply and price discounting. Energy and resin inflation escalated in 2007 and peaked in the third quarter of 2008 before beginning its decline into the past fall and winter.

Still, in spite of this volatility, our results steadily improved during 2008 with the fourth quarter representing the best quarter in the company’s history on a number of fronts. I am very proud to say that over the course of these last two years our businesses have learned to better manage volatility and shown a great underlying strength.

From my perspective, 2008 was also a year of tremendous progress. The business overcame a slow start in the first quarter to post full year adjusted operating income growth of 7%, marking a solid rebound from 2007’s depressed results and returning the business to its historical long-term trend of mid- to high-single digit operating income growth.

Fluid milk volumes in the DSD Dairy segment grew 1.5% and full year segment profits increased 10%. Sales at WhiteWave-MorningStar were 10% higher than the year-ago period and segment profit was flat for the year but improved materially in the fourth quarter.

Free cash flow was the highest in our history at $462.0 million. Our strong cash flow, combined with our equity offering in February of 2008, led to debt reduction of $783.0 million during the year which significantly de-levered our balance sheet. Adjusted diluted earnings per share were 8% above 2007 results despite the dilution from our $400.0 million equity offering in the first quarter.

By many measures the fourth quarter of 2008 was the strongest in our history with consolidated adjusted operating income 27% above the depressed levels of Q4 2007. Both business units turned in solid performances, with DSD Dairy operating profit 31% above year-ago levels and WhiteWave-MorningStar operating profit up 14% in the quarter.

Consistent with the trends we were seeing as we exited Q3, commodities continued to be favorable in the fourth quarter, particularly energy-related commodities, which when combined with operational improvements across the business bolstered our financial results in the period.

All in all, we have a very solid year, despite a challenging environment. I am proud of the accomplishment of our business teams as they navigated the continued commodity volatility throughout 2008 to deliver improved results and build capability to sustain our performance over the next several years.

Heading into this new year, the dairy markets have declined sharply from the historically high levels we have seen over the last two years to historic lows. Export demand for U.S. commodities decreased materially in the second half of 2008. Oceania dairy production and exports, particularly in New Zealand, are increasing again. The European Union has reinstituted export subsidies for their farmers, supporting their production.

At the same time, in the face of a global recession, dairy imports into China and Southeast Asia are stagnant or in decline. And here in the U.S., demand for cheese and other dairy commodities has softened.

Through the last two years of historically high prices, restaurants and food manufacturers have reformulated recipes to use less dairy in an effort to save costs. Those efforts are unlikely to be reversed quickly in response to falling dairy commodities.

Dairy consulting firm, Blimling and Associates, estimates that based on current supply and demand, there are between 350,000 and 500,000 excess dairy cows in the United States and storable commodity stocks are building. Non-fat dry milk, butter, and cheese prices have fallen to support levels with the U.S. government purchasing over 150,000 pounds of non-fat dry milk and about 2.0 million pounds of butter since the start of the fourth quarter.

Given the magnitude of the current oversupply, it appears that it will likely take some time for the market to correct. For the rest of this year most dairy economists are forecasting dairy commodity prices at the lower end of the historical range, with a generally increasing trend throughout most of the year, and a wide disparity of beliefs about the slope of the curve. We are generally in line with the average view for planning purposes for the balance of 2009.

While commodities certainly contributed to our strong financial results, more significantly for the long term, our performance is also a direct result of the hard work accomplished by our teams to drive efficiency and productivity. The accumulated benefits of the work we have accomplished to build the new Dean Foods are becoming more apparent in our financial results.

We have made significant progress reshaping the company. We are beginning to realize the benefits of a new focused management team and the skills they brought to Dean foods to reshape the broader business. In 2008 we completed our first detailed strategic growth plan, which will define our efforts to drive performance for years to come.

A number of us on the senior leadership team will discuss more about our strategic growth plan at our first Investor Day in New York on the 26th of this month. But let me spend a few minutes giving you a framework of our plan and where we believe the opportunities lie.

We operate in a category with many advantages. Consumer penetration is among the highest in the consumer packaged foods space. Nine out of ten households are milk consumers. Demand is consistent from year to year, highly inelastic prices exist in the category, and the category is relatively recession resistant. The category’s health and wellness credentials are strong. From a retailer perspective, the dairy case is a destination in the store and one of the most profitable categories in the supermarket, making it especially important to their strategies.

Historically however, our category has been highly fragmented and plagued with a lack of innovation, inefficiency and excess capacity. The emergence of Dean Foods was the first step towards reshaping the dairy category in the United States. Within the category, Dean Foods has a clear advantage as the market leader. We have unique and sizeable opportunities to drive increase efficiency, improved service, and innovate across the category, offering both consumers and retailers an improved product and service experience.

We are confident that as we execute against the opportunities we have identified, we will be able to continue, clearly differentiating ourselves with our customer partners and with consumers.

There are three core strategies of our strategic growth plan that we believe are essential to maximize our competitive advantage. First and foremost, our top priority over the near term is to drive to the lowest cost position in the industry. The conventional milk category has very high private label penetration. Winning in conventional milk requires lowering cost without sacrificing quality. This will be our clear focus over the next three to four years.

As the largest player in conventional milk, we have the opportunity to significantly lower our cost structure. To drive efficiency in our business, we can and will pursue strategies to lower our cost across the entire supply chain, from the farm to the fridge.

We have build plans to achieve these goals through optimizing our plant network, driving a disciplined culture of continuous improvement across our manufacturing base, refining our distribution methodologies to lower costs and improve service, and continuing to leverage our total spend base to achieve procurement savings.

In keeping with this strategy, in 2008 we closed four facilities. We continued to make progress in purchasing standardization and centralization and we saw increasing benefits from our back office initiative. Greg Tanner, our Chief Supply Chain Officer, will tell you more about how we will drive these efforts at the February event.

The second element in our plan is to strengthen our core franchises. To achieve this goal we must transform what has been a disparate collection of sales and distribution methods or models into a standardized, professional selling and delivery power house.

Improved routing technologies and sales standards have already allowed us to eliminate more than 250 delivery routes in 2008. One tangible result of this initiative was a 5% decrease in diesel fuel gallons used in 2008 versus 2007 on higher total product volume.

In addition, we significantly improved our pricing methodologies, with results that are becoming increasingly evident in our DSD Dairy results.

A result of strengthening our core franchise should be strong market share performance versus our competition in fluid milk. Under Harrald Kroeker’s leadership, we continued to win share from competitors in 2008 by better meeting our customers’ needs. In DSD Dairy we bolstered this with four strategic acquisitions during the year, adding to the strength of our network.

As we have mentioned before, the industry challenges of the last few years have caused on increasing number of competitors to consider exiting the business. Although processors are currently seeing some relief from commodity costs, the financial markets are causing challenges across the industry and as a result we continue to be very active in evaluating potential acquisition opportunities in this unique time in our industry.

In New York Harrald will discuss how we intend to further strengthen our core DSD Dairy operations and truly become a selling and delivery powerhouse.

You will also hear from Joe Scalzo, CEO of WhiteWave-MorningStar, about plans to leverage the branded business platform we have built at WhiteWave. Joe will describe how we intend to drive the growth and profitability of our strong, existing brands going forward and how we can and will leverage our branded business systems to launch new products, including the Fruit Today product launch later this year.

Our third strategic component is to build capabilities for the future. The dairy category has traditionally been fragmented with no single player possessing the R&D, manufacturing, or distribution capability to effectively innovate in a category. With the benefits of high household penetration and purchase frequency, the category’s value to retailers and strong health and wellness credentials, we think that the dairy and broader chilled case is ripe for innovation.

As the scale player in the industry, we look forward to leading growth and innovation in the chilled space through stepped-up investments in R&D and innovations and by optimizing our existing manufacturing and distribution capabilities.

Over time we expect these efforts to improve our sales mix and margins. This, however, is a longer-term opportunity that we are just now laying the foundation to exploit. In the near and the intermediate term our primary focus will be to drive efficiency into the business.

So in summary, 2008, and the fourth quarter in particular, demonstrated that Dean’s basic operating model is strong, resilient, and improving. We enter 2009 well positioned for strong growth across the business with operational improvements, strategic initiatives, and favorable commodities boding well for the year ahead. As Jack said, we expect to earn at least $1.50 of adjusted EPS this year, even as we invest back into the business to drive future growth.

The first quarter is off to a strong start in this regard. If this favorable commodity environment continues, there is likely some upside to our full year outlook. But the remarkable input price volatility that we have experienced over the last two years, the very uncertain macroeconomic outlook, and the potential for heightened competitive intensity, make us unwilling to raise our guidance further at this early point in the year. We will, of course, update you as the year progresses.

Overall we are very excited about the direction of the business and I look forward to telling you more about it in a couple of weeks. With that, I would like to thank you for joining us on this morning’s call and for your interest in Dean Foods. We will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Terry Bivens - J.P. Morgan.

Terry Bivens - J.P. Morgan

Gregg, just a couple of quick questions on the DSD Dairy side. Volumes up 2.8, how much of that would you say is acquisitions?

Gregg L. Engles

Most of that was acquisitions in Q4. If you look at that historical chart you have seen that the business has oscillated from say flat to the category to up 1% to 1.5% versus the category. It seems to sort of be bouncing back. It’s a little episodic as share moves around in the category, then augmented by acquisitions. So as we have come into the first quarter of 2009 we seem to be moving forward in terms of organic share growth on top of the acquisition-driven growth but that seems to be an oscillating trend for us.

Terry Bivens - J.P. Morgan

And just in terms of looking at the margin there, it was up about 210 basis points in the fourth quarter, is it possible to separate at how much the trade down to private label may have held that margin growth back?

Jack F. Callahan

It really impacted a couple of reasons. It’s clearly still happening. Let me come back to you with a better view at our investor conference in two and a half weeks. I would prefer not to give out that one number in isolation, kind of given all the other moving parts in the P&L. Very volatile quarter.

Terry Bivens - J.P. Morgan

And it does look in Nielsen figures that the trade down from your branded to your private label is declining a bit, at least over the last four weeks. Is that your read as well? I know you have better numbers than I do there.

Jack F. Callahan

Frankly, it has jumped around a little bit. In some cases it has gotten better and in some cases it has gotten a tad worse. We do have a heck of a lot more focus on, right now, about managing that price gap of our branded products versus private label. But within a period rapidly declining prices, you really have to stay on that.

Operator

Your next question comes from David Palmer - UBS.

David Palmer - UBS

Gregg, just a big picture question and I don’t want to steal all your thunder from the analysts’ day that is coming up, but a couple of years ago you launched the vision of the new Dean and you brought a lot of capable people that have a lot of steam in the industry over to Dean with a vision of this company becoming better managed internally, generating cost savings and perhaps finding margin on the top line as well, both in WhiteWave and the DSD side, leveraging that distribution. When you think back to the original vision and where you thought you would be, kind of entering in the year three of the new Dean, so to speak, kind of get us up to speed as to what you might be disappointed in in terms of the time frame. Obviously there is so much noise in terms of the commodity that it’s tough for us to tell. What inflections points might you be reaching and where? And what are some of the successes that you think might have been masked by some severe commodity noise to date?

Gregg L. Engles

I think just to give you some top-line perspective, I think the thing that has been difficult to convey, both internally and externally, but particularly externally, is the sweeping magnitude of the change that had to take place at Dean and that is taking place at Dean.

So just to give you a few metrics around that, of my ten direct reports, nine of them are new to the company over the last three years. Were not in the business and have come from outside and one is in a new position over the last ten years. So there has been a complete revamping of the senior management team of the business and that has been necessary really to bring the appropriate experiences and skill sets to bear on the challenge at hand.

And the challenge at hand is, has been, a sweeping one. That, in the saying of it, implies that the opportunity at hand is a sweeping one as well, but it is a time-consuming effort to get at it. So we have 100 plants in our DSD Dairy system and five in our WhiteWave system. They all came from smaller, typically private companies. They were all managed in very different ways with different metrics and different approaches to the market and harmonizing that to be able to get at the efficiencies that the network offers, is a real challenge and a real opportunity.

So I’m not really disappointed. I always knew it would be a long and difficult challenge and I always felt and believed that the opportunity was large. I think the difference today is that, as you will see in February, the team is in place. We really put the last two pieces of the team in place in late 2007 and in early 2008 with supply chain and strategy, and the team is coming together, working very effectively as a team, and now beginning to drive the disciplines necessary to reshape the business down into the organization.

Now, that’s going to take some time, too, which is why we are talking about the time horizon that we will be talking about with you at the February meeting. But instead of putting the foundation in place, now we’re on the journey. We’re making progress period-over-period in re-architecting the business and you are seeing it in the results. So, we’re on our way and we’re very excited about it.

David Palmer - UBS

The reason I asked all that is really, the jury is still out as to whether Dean should be valued like a commodity company, or obviously transitioning from a roll-up story in the past, or perhaps something that can be transitioned to something better, as a quasi-brand company with a more flexible DSD system that has strategic value. All that stuff. You know that stuff that was mentioned a couple of years ago, I suppose you will revisit it, but that vision has grown a bit stale and any clarity as to the progress you’re talking about I think could be helpful to your stock.

Gregg L. Engles

Well, look, we’re going to make the case for the latter position but the one thing that we can’t do probably is make that transformation as fast as the investment community’s time horizon would like it to go. It is a longer-term transformation of the business. It’s going to take a lot of investment and the building of a lot of capabilities that don’t exist, or haven’t historically existed in the business and what we will make the case for at the end of February is that transformation in itself should deliver long-term, sustainable EPS and operating income growth during the course of the transformation itself. And at the point of arrival we would hope to be valued at a meaningful higher multiple.

So that’s the case we’ll make. It will be up to the investment community to assess that case and evaluate the time horizon that we believe is a respectable time horizon to do that against the time horizon that the investment community wants to invest against. And I think that will be the tail of the tape, but we are going to lay out for you what we believe the investment community can, and should, hold us accountable to in terms of performance and progress in the business.

Operator

Your next question comes from Eric Katzman – Deutsche Bank Securities.

Eric Katzman – Deutsche Bank Securities

Regarding the production of dairy commodities, what are the risks here that we see significant dairy herd liquidation and therefore more volatility on the upside to pricing than the market may expect right now?

Gregg L. Engles

There is some risk to that. The basic maxims, I think, hold, that high prices begat low prices and low prices begat high prices and the higher they get the more quickly they go low and the lower they get the more quickly they go high. So we have gone from very high prices to very low prices. There will be a microeconomic response on farms all around the country to that.

And the curve over the last five years has never been as smooth and as gentle as people have projected it to be. So there is a risk of a snap-back.

Jack F. Callahan

And we know there are some discussions out there about a herd calling but, at least over the near term, the magnitude of at least where the over-supply appears to be based on the size we talked earlier, it’s going to take a while for that really to get sorted out. We would prefer to be in an environment, the pricing where it’s going in March is not sustainable over the long term, so it’s going to come back, and we would prefer a less volatile environment but that’s not the one we live in right now.

Gregg L. Engles

And I do think there is one corollary to the axiom, this time maybe that the broad swings in volatility have tended to happen in rising or relatively stable economic times. Here, in addition to oversupply, you also are seeing demand continue to erode and that may prohibit the snap back from being as quick or as high as it might otherwise have been.

Eric Katzman – Deutsche Bank Securities

Another question, if I may. It’s something I have been asking of other companies. How much, although it’s a little bit difficult, given the pass-through mechanism that you have on the core fluid milk business, but if you try to estimate around the rest of the business over the last few years, how much cost inflation have you absorbed cumulatively versus how much have you priced through. Maybe this is more of an issue for WhiteWave.

Gregg L. Engles

Clearly we have ongoing efforts to drive productivity in the business that are in essence reflected as offsetting rises in wages and other input costs as opposed to all flowing through to the bottom line. So every year we have got to go get a meaningful amount of productivity or price to offset rising input costs.

I don’t think we are prepared to quantify that for you on today’s call, but just know it happens, as it does in every business.

Jack F. Callahan

Your focus here on WhiteWave is very relevant. That business has seen, up until very recently, sustained commodity inflation across soybeans, clearly organic milk, as we have talked repeatedly, packaging, etc. So, yes, we have seen significant inflation, have passed along some of that in-price into the marketplace. What is changing the environment there right now is some of that inflation appears to be moderating, if not backing off. So it will be interesting to see how we evolve our pricing strategies going forward.

Eric Katzman – Deutsche Bank Securities

I guess that’s the point, and then I’ll let it go. But for example, it seems like the bulk of the companies had roughly 20% to 25% cumulative cost inflation over the last three or four years and they maybe have priced against that to the tune of high single digits. So there is this big gap. You know, the retailers want the benefit of that, but the flip side of the commodities, but the manufacturer is saying we didn’t price up nearly to inflation so what are you talking about.

So I guess to the extent that you could provide some numbers that maybe would give comfort that you didn’t price equal to inflation and therefore you are less likely to have to give it back would be helpful.

Operator

Your next question comes from Farha Aslam – Stephens Inc.

Farha Aslam – Stephens Inc.

You pointed to 2006 when you were discussing results for the quarter. If you had to compare your company overall to 2006, what are your volume assumptions and handling capabilities given you have made four acquisitions last year?

Gregg L. Engles

How much larger is the business from the volume?

Farha Aslam – Stephens Inc.

Yes. Let’s focus on the DSD Dairy for a second.

Jack F. Callahan

DSD Dairy this year grew about 1.5%. 2007 was roughly a flattish year, based on the declines that we say, particularly in the third quarter of 2007. So I would say where we landed in volumes in DSD Dairy in 2006 were up 1.5% to 2% thereabouts. In terms of volume. Which is the right metric to use because in the midst of that you have had sales moving all around because of the volatility, particularly in the Class I milk price. So volume is the appropriate metric to focus on.

Farha Aslam – Stephens Inc.

And if you had to talk about your efficiency today versus 2006, how would you characterize it?

Gregg L. Engles

Improving. Incrementally better.

Farha Aslam – Stephens Inc.

Would you say there is a material increase, because in 2006 you produced EBIT margins in the DSD Dairy group of 7.6%. I’m trying to figure out what today would allow you to get there or what would hinder you from getting there.

Jack F. Callahan

2006 was a much more benign commodity period. But the things I could point to that we have accomplished in the 2008 performance is Gregg mentioned that we are starting to drive real productivity in the routes in terms of the use of less gallons. The other thing I would point to is if you just look at year-over-year, some of our people-related costs have certainly slowed in terms of their growth rate, relative to what we were seeing 2006 to 2007, due to the greater focus we have on overall headcount productivity. So you can start to look at the elements of a line and see clear progress in what we have accomplished in 2008 and are consistent with the plans we want to keep going for 2009.

So are we better capable today to actually go manage controllable costs? Absolutely. But we still have a long way to go to really optimize that opportunity.

Farha Aslam – Stephens Inc.

When you look at your dairy resin fuel and energy costs versus how they factor through in your formulas, is it just sort of that’s the cost and then it factors in over the next three months, six months? How are your formulas different today than they might have been in 2006?

Gregg L. Engles

Well, first of all I think we have a much more time-bound acquisition of data and reflection of changing prices in our pricing models. So historically if you looked at things like packaging, resin, and even fuel, you did not get a lot of period-to-period volatility in those input costs and therefore you didn’t get a lot of focus and attention around pricing, it was all around the dairy commodity. Today that is radically changed. All of these inputs are highly volatile, they’re all important, and we focus on all of them in a much more time-sensitive way in terms of how we reflect them in our pricing.

We change prices monthly here and you’re getting a lot more things baked into the monthly price algorithm than you used to get baked into the monthly price algorithm. I think that’s the biggest difference.

Jack F. Callahan

And the other thing I would add is that the industry remains incredibly competitive and if we have a decline in resin many of our competitors do too, and that’s going to get reflected in the marketplace fairly efficiently and fairly quickly.

Farha Aslam – Stephens Inc.

And if I had to put it into context, kind of on a pie chart of cost of goods sold, could you just quantify how important the skim prices versus butterfat versus fuel versus energy and resin?

Jack F. Callahan

Could we maybe reserve that? Could we reserve that for the more holistic discussion we’ll have at the investor conference, just to give you a sense of the cost components? Rather than try to pick off a few factoids, I would rather try to give you a more complete picture that’s comprehensive.

Gregg L. Engles

Or do it offline. It’s getting to be very detailed and it’s not going to be the same for every piece of our business.

Operator

Your next question comes from Robert Moskow - Credit Suisse.

Robert Moskow - Credit Suisse

You said that you want to move towards becoming the low-cost provider in the space and I’m sure there is a lot of opportunity in the DSD routes to continue to be more efficient and consolidate purchasing activity. So two questions. How do you benchmark yourself against competition? Where do you think you are today? Are you the high-cost provider today or are you right in line?

And then secondly, you have some talented people there back at corporate but there is a lot of corporate expense running through your income statement, and to what extent does that hinder your ability to become the low-cost provider?

Gregg L. Engles

I would say today that we are the low-cost provider in the marketplace. Of course, we have 200 competitors so I don’t think I would tell you that every plant we have is lower cost than any other plant in the industry, but on balance, we’re the low-cost provider.

That is being driven primarily today, I would say, through our scale in purchasing and acquisition costs and the progress that we have made, primarily on the distribution and selling side of the business. I think when you get to the plant level, given the fact that we have operated this business historically in a highly decentralized way, without maybe necessarily the most up to date science around manufacturing practices, that we have meaningful opportunities in manufacturing, and in distribution and selling as well, to continue to drive significant amount of costs out of the system.

So when we say we want to drive to the lowest cost position in the industry, what we are really talking about is driving to a position that the rest of the industry can’t get to, that is a sustainable, competitive advantage in the marketplace. I think that is apropos of the corporate cost aspect of this. You just can’t do that without making the investments in the right kind of capabilities at the center to drive those kinds of programs throughout the business because they are much more highly sophisticated than what exists in our company today and what I believe exists in the rest of the industry. And it is a process that is ongoing, it’s not a one-time exercise. It’s a process of continuous evolution of the model to a more refined, lower cost structure.

So yes, there is a natural G&A component that goes along with building those capabilities and it is absolutely essential to getting to that low-cost position. I think the great advantage that we have is that we can leverage that investment over a $12.0 billion business. No one else in this space can come even close to that. So the level of investment required to develop those capabilities is not going to be smaller if you de-scale your business. So the opportunity that we have to separate ourselves permanently from the rest of the industry requires that we make these investments.

Robert Moskow - Credit Suisse

So should we expect corporate expense to be up again another $12.0 million or so in 2009? It’s been up $10.0 million or $12.0 million year for the last two years. Is it going to go up again?

Gregg L. Engles

It will continue to go up as we continue to build capability.

Jack F. Callahan

And I think that range of increase you’re talking about is reasonable for right now, I just would add, though, to Gregg’s comments, is we are getting hit with a pretty big increase in pension expense due obviously to overall market performance. I don’t think we’re alone there. We are lucky that we have largely a frozen plan but part of that does flow through corporate and of that $10.0 million to $12.0 million you suggested, I would say pension expense that we take at corporate is about half that.

There are also some other things that are impacting corporate performance right now also.

Operator

Your next question comes from Alexia Howard – Sanford Bernstein.

Alexia Howard – Sanford Bernstein

On Horizon Organic milk, that’s obviously been a bit of a headache in terms of profit headwinds for the last 18 months or so. It seems as though from the press release it’s no longer the problem that it has been. Can you talk about where that is right now and are we actually getting it back into profit territory and how much more improvement is there there?

Gregg L. Engles

Well, let me just ground you in the math of sequential earnings comparisons. We’re not talking about it anymore because it’s not getting worse. That’s a lot different from it getting better. It is slightly better, but no, it is not back in the positive territory, and yes, there is still meaningful room for improvement.

And by the way, Alexia, you will be receiving a check for $1,000 from us because everybody around the table had $100 in the pot as to who was going to ask the first Horizon Organic questions. And you win the prize.

Alexia Howard – Sanford Bernstein

Thank you very much. And then, just more of a longer term question about the joint venture deal on Fruit Today. It seems as though you’ve got a very valuable and quite unique refrigerated distribution asset here. Definitely sort of interested about the idea that you are now going to do a joint venture deal to try to get different product, higher margin product, through that system. Can I just ask how you are thinking about the ways of getting it back? Pulling a brand new unknown product over from Europe is one way to do it, maybe searching out higher margin regional brands over here and scaling them across might be another way to do it. Is this just the tip of the iceberg, or how are you thinking about that opportunity going forward?

Gregg L. Engles

We hope that it’s the tip of the iceberg. So Robert asked, I think, a very appropriate question about investment in costs at the corporate center and many of those costs are, as I said, directed at lowering our cost structure. I would say the majority of those costs today are invested at lowering our cost structure.

But a meaningful, a not insignificant amount of those costs, are also being invested against things that you don’t see at all today. So meaningful investments in a group that is targeting innovation in our space, which we define as this chilled case space. So seeking out opportunities to acquire smaller scale products and scale them, yes, that’s a legitimate approach.

Also extending our existing brand platforms with line extensions or new products under those brand umbrellas. We’re doing those things or investigating those things. And looking at potential new brand platforms that we can then extend, or build upon, in the refrigerated case. So the obligation that we have to our shareholders over the long term is to generate ongoing earnings growth. That’s not going to happen over the long term with cost saves alone.

So, we’ve got a great cost-save opportunities for a number of years here, but we are laying the foundation, making the investments to sustain both top line and earnings growth going forward, and that’s going to have to come from organic growth, and there is a meaningful investment against that effort that is beginning to develop at Dean Foods.

Jack F. Callahan

I would just add one thing specifically about Hero to broaden Gregg’s comments, is while we are going to look broadly for ideas, Hero specifically, we see there are more opportunities there than just this one Fruit Today product that we are going to be launching this year. What really impressed us with them as partners was their deep expertise in fruit, which we thought was a nice complement to the skills we have at WhiteWave. So we see a path to additional products through that JV over the long term.

Operator

Your next question comes from Christine McCracken - Cleveland Research Company.

Christine McCracken - Cleveland Research Company

On your decision to exit the Starbuck’s relationship, is that a function of the structure of the deal that you made with them or was it something more specific to the channel or the brand that didn’t work?

Gregg L. Engles

Ultimately, it’s the structure of the deal. So this was a product that we don’t manufacture in-house, so there is no leverage in the supply chain. It’s this aseptic product that we co-packed externally. I think the brand-building attributes of being associated with Starbucks, we had reaped the benefit of that from our presence in Starbucks over time. And at some point in time a product that you don’t manufacture, that doesn’t leverage your system, and that you break even at best on, or lose money on, there’s just a time to stop doing those sorts of things. So we reached that position and they’ve gone a different direction in terms of sourcing their soy milk for their lattes in their stores.

Christine McCracken - Cleveland Research Company

That was a relatively small business so it shouldn’t have any material impact on sales or margins.

Gregg L. Engles

It will be a little headwind in terms of sales growth as we go into 2009 but it will have a positive effect on margins.

Christine McCracken - Cleveland Research Company

On that herd reduction, that probably will happen, timing is somewhat questionable. Is there any risk to your plants from insufficient milk supplies if, for example, there is a greater than expected cull in a certain part of the country?

Gregg L. Engles

No. We have this class pricing. Class I milk gets a higher price than milk for any other use so they would have to reduce the herd by 80% before we would run out of Class I milk.

Operator

Your next question comes from Christopher Growe – Stifel Nicolaus.

Christopher Growe – Stifel Nicolaus

If you had $18.00 milk in 2007 and $18.00 in 2008, and I know it’s an annual average and there is a lot of up and down in that time, but your dollar profits for DSD Dairy were up like $50.0 million. Is there anything to the reduced shrink or cost savings that have truly taken hold and helping drive that dollar profit higher or is it more about the oscillations in the price?

Gregg L. Engles

No, there are very clear cost savings that are flowing through the P&L. So we had a meaningful reduction in force that we got the benefit of for all of 2008. We are getting traction on some of our significant efforts to reduce costs, particularly in distribution where we had significant benefits 2008 versus 2007. I think we are much more keen in terms of our knowledge about pricing and I think that’s an ongoing discipline that will serve us well over time.

So I would say that, yes, the way that commodities laid down over the two years, particularly late 2008, certainly contributed to the relative out-performance. I mean 2008 versus 2007, but a meaningful part of it is improvement in the underlying operations of our business.

Christopher Growe – Stifel Nicolaus

You mentioned more aggressive competition in the milk business in the DSD Dairy. In this environment is that more about how quickly declining costs get passed along or is more about there’s more than the declining cost getting passed along to try and gain share from you.

Gregg L. Engles

That game is always going on. And it comes and goes. So as you come out of an extraordinarily difficult period, like we experienced through say August 2008, different competitors are going to play it different ways. Some people just need to make some money because they haven’t made money for a long period of time and sometimes competitive intensity can abate, other competitors are going to try and refill their volume pipe and they may get more aggressive. So the competitive intensity in the marketplace ebbs and flows, but when you get into any significant change in the price range of the commodity, either up or down, this industry, like many other industries, can go into heightened levels of competitive intensity that erode industry-wide margins. So we are just always mindful of that.

Jack F. Callahan

And given the favorability we saw in the fourth quarter, that’s likely to continue into 2009. We fully anticipate this to be a very competitive time. We anticipate that and that’s considered in our forward outlook.

Gregg L. Engles

We also are just in a difficult economic period so there’s a lot of backward pressure from our customers and their consumers on prices.

Christopher Growe – Stifel Nicolaus

Do you expect volumes for Silk and Horizon to be up in 2009? I don’t want to get into your exact details, but would that be a reasonable expectation for 2009?

Gregg L. Engles

They will be up. Silk will be up. Horizon will probably be up. But the growth rates will moderate very significantly. On volume.

Operator

There are no further questions in the queue.

Barry Sievert

Thank you all for joining us on the call this morning. We are pleased with the results of the fourth quarter and a solid full year performance in the face of volatile commodity and financial markets. We look forward to seeing many of you at our Investor Day in New York on February 26 and if you would like to attend, please call our Investor Relations department at 214-303-3438.

Operator

This concludes today’s conference call.

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Source: Dean Foods Company Q4 2008 Earnings Call Transcript
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