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Executives

Shaun Mara - Chief Financial Officer and Executive Vice President

Barry Sievert - Vice President of Investor Relations

Gregg Engles - Chairman, Chief Executive Officer and Chairman of Executive Committee

Analysts

Judy Hong - Goldman Sachs Group Inc.

Alexia Howard - Bernstein Research

Jonathan Feeney - Janney Montgomery Scott LLC

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Terry Bivens - JP Morgan Chase & Co

Eric Katzman - Deutsche Bank AG

Bryan Spillane - BofA Merrill Lynch

David Palmer - UBS Investment Bank

Dean Foods (DF) Q4 2010 Earnings Call February 16, 2011 9:30 AM ET

Operator

Good morning, and welcome to the Dean Foods Co. Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the call over for opening remarks to the Vice President of Investor Relations, Mr. Barry Sievert. Please go ahead, sir.

Barry Sievert

Thank you, Kim, and good morning, everyone. Thanks for joining us for our fourth quarter and full year 2010 earnings conference call. We issued an earnings release press release this morning, which is available on our website at deanfoods.com. The release is also filed as an exhibit to a Form 8-K available on the SEC's website at sec.gov. Also available during this call at the Dean Foods website is a slide presentation which accompanies today's prepared remarks. A replay of today's call, along with the slide presentation, will be available on our website beginning this afternoon.

The earnings per share, operating income and interest expense information that will be provided today are from continuing operations and have been adjusted to exclude the expenses related to facility closings and reorganizations, expenses related to closed and expected-to-close acquisitions, divestitures and other non-recurring items in order to enable you to make a 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 reconciliations between GAAP and adjusted earnings and between net cash flow from continuing operations and free cash flow from continuing operations.

We would also 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 other, 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 conference 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.

Participating with me in the prepared section of today's call are Gregg Engles, our Chairman and CEO; and Shaun Mara, our Chief Financial Officer. Gregg will start us off by providing a general review of the results, walking through the performance of the operating units and current business trends. Following Gregg, Shaun will offer additional comments on our financial performance before turning the call back to Gregg for some additional commentary on the forward outlook and other closing remarks. We will then open the call to your questions.

With that, I will turn the call over to Gregg for his opening remarks. Gregg?

Gregg Engles

Thank you, Barry, and good morning, everyone. 2010 was an exceptionally difficult year for Dean Foods. Throughout the year, our core dairy business was faced with highly promotional retail pricing, wholesale price pressure, weak consumer demand and volatile commodity prices. These pressures resulted in substantial operating income declines for the company, driven by results at Fresh Dairy Direct-Morningstar. The use of private label milk as a loss leader to drive store traffic has proven highly disruptive for the processing industry. With unusually low pricing on private label gallons, our regional brands were exposed to significantly wider retail price gaps versus private label. With the job's recession in full swing, cash-strapped consumers traded down to private label as a result. Moreover as retailers invested in cheap private labels, they pushed their suppliers for lower prices. As a result, processor margins on private label milk declined meaningfully. Industry-wide volume softness across the rest of our conventional dairy categories during the balance of the year exacerbated these issues.

While admittedly difficult to see in our financial results given the intense price pressures on our business, the $300 million cost reduction program which began in early 2009 has helped to partially offset the impact of these pressures. We lowered costs by $75 million in 2009 and an additional $100 million in 2010. In spite of these savings, we remained well behind the cost price squeeze throughout 2010. It's clear we must continue to drive harder against our cost savings initiatives to get ahead of the margin squeeze and begin restoring our profitability.

In contrast to the very difficult year at Fresh Dairy Direct-Morningstar, our WhiteWave-Alpro business had an exceptional year. Driven by strong innovation across the portfolio, excellent marketing campaigns and tight cost discipline, our WhiteWave business reported its best year ever, even before the positive impacts of our very successful Alpro acquisition. All of our key brands posted strong growth for the year. The business carries significant momentum into 2011, where we expect it to continue to build on a strong track record of growth on a full year basis.

Throughout these recent challenges, we have remained a profitable and competitively strong business. On a consolidated basis for the full year 2010, we reported $472 million of operating income, earnings of $0.80 per share and free cash flow of $224 million after capital expenditures of $302 million to support our cost reduction efforts.

Let's now look at results by business unit. Fresh Dairy Direct-Morningstar fourth quarter gross profits declined $42 million from the year-ago period, in line with the year-over-year impact we experienced in Q3. The raw milk to private label price gap remained depressed at $0.40 to $0.50 per gallon below 2008 levels. Wholesale pricing also did not improve during the quarter, and volumes softened. As a consequence, Fresh Dairy Direct-Morningstar operating profit was little changed from Q3.

We have, however, begun to see signs that the fluid milk category is stabilizing, albeit at historically low levels of probability. As retailers have taken early steps to reduce heavy private label promotions, our regional brand volume mix has begun to stabilize, and branded volumes outperformed the private label on a year-over-year basis in Q4. Moreover, private label wholesale prices appear to have stopped declining, although we have not yet seen them rise. Volume, however, remains weak, which we believe will limit upward price mobility. The net result is an industry that appears to be stabilizing, albeit at a price and profit level meaningfully below historical norms. To move forward in such an environment means that Dean must continue to optimize our network to offset volume weakness and drive efficiency to rebuild profits, which is the path that we are on.

As I mentioned, volumes remained weak across both the industry and the Fresh Dairy Direct-Morningstar portfolio. Dean fluid milk volumes declined 3% from a year ago compared to an estimated decline of 2% for the overall market. Total volumes at Fresh Dairy Direct-Morningstar, including all products, declined 5% in the quarter. This volume weakness deleverages our production facilities which somewhat offsets our cost reduction progress. In addition, for the first time in several years, our fluid milk volume performance was below our competitors in the quarter. We have lapped the year-over-year comparison of our most recent acquisitions in Wisconsin and California, which had boosted volume by one or two points. Moreover, our customer base has on balance underperformed their historical growth rates versus their peers, slowing our total volume.

We're reacting to volume weakness in the business in two ways. First, we're targeting selected pieces of new business. We will see some of this come online late in the first quarter and expect our share performance to begin to improve in Q2. Second, we plan to accelerate our network optimization to offset this volume deleverage. Our accelerated efforts, including the closure of a production facility announced late last month and future network optimization moves, should begin to drive up asset utilization as we head into the back half of 2011.

During the fourth quarter, the Class I Mover averaged $16.93 per hundredweight, up 8% sequentially from the third quarter and a 30% increase over the fourth quarter of 2009. The Class II butterfat price fell in both November and December from its peak in September to average $2.17 per pound in the quarter. Our Class II business benefited as prices fell through most of the fourth quarter. Prices have surged higher again early this year however, which will have a significant negative impact in Q1 on our portfolio of butterfat-rich Class II products.

The continued gross margin pressures on the business more than offset continued progress against cost reduction initiatives to drive segment operating profit well below year-ago levels at $114 million for the fourth quarter.

These continued challenges reinforce the importance of our cost reduction strategy, a strategy to rebuild our profitability and drive returns for our shareholders. The future for Dean is about doing more with less: fewer facilities, fewer trucks, fewer people, and as a result, lower cost per unit. In Fresh Dairy Direct-Morningstar, this is our clear near-term focus. To that end, in 2010, we reduced total headcount at Fresh Dairy Direct-Morningstar by nearly 1,400 positions or 6% of total segment headcount, the result of our concerted efforts to reduce cost across distribution, conversion and procurement. Our team's efforts to reduce costs resulted in a slight decrease in 2010 conversion and distribution cost per gallon, excluding fuel, despite normal inflationary pressures and the deleveraging effect of lower volumes.

As we've talked about previously, we are expanding and accelerating these efforts in additional areas, like the G&A cost reduction initiative we recently announced, which is expected to result in at least $30 million in additional run rate savings by the end of 2011.

We continue to be aligned to the company on this priority with a number of initiatives focused on permanently reducing structural cost, to stabilize and then rebuild the profitability of Fresh Dairy Direct-Morningstar. We're putting particular emphasis on shorter-term projects, with lower capital requirements and quick paybacks to help ensure delivery of the 2011 plan.

In contrast to the pressures at Fresh Dairy Direct-Morningstar, fourth quarter results at WhiteWave-Alpro reflect continued success in this high-performing segment. Fourth quarter sales grew 7% over prior year to $527 million, the single highest sales quarter in the history of the segment. Strong sales growth occurred across all of our key product lines.

Horizon Organic milk posted especially strong growth, with net sales nearly 20% higher than the fourth quarter of 2009. Continued innovation in products and packaging and solid marketing drove strong growth and expanded market share for the brand. Our branded creamers business also performed well on the strength of category growth and a pipeline of consumer-preferred innovations. Net sales for creamers in total increased in the low double digits for the quarter. And within creamers, International Delight sales increased in the mid-teens, and Land O'Lakes sales increased mid-single digits.

Driven by the strong performance of our Silk PureAlmond product, Silk net sales grew in the high single digits during the quarter. The launch and rollout of Silk PureAlmond continues to be highly successful. We are very pleased with this extension into the broader plant-based beverage category. Following on the success of PureAlmond, we recently introduced our new Silk PureCoconut product. PureCoconut was launched in Q4 and is entering expanded distribution now with excellent early results.

Alpro net sales increased low single digits on a constant currency basis and declined mid-single digits after currency translation, closing out a very successful 2010. Alpro operating margins continue to expand and are well ahead of our expectations when we acquired the business in mid-2009. We are very pleased with the performance of our Alpro operations.

For the quarter, strong top line performance drove 14% segment operating income growth at WhiteWave-Alpro to $50 million. Overall, our branded business had an outstanding 2010, and we expect the segment to continue to build on its successful track record in 2011.

With that review of the business units, I'll now turn the call over to Shaun to discuss some corporate items. Shaun?

Shaun Mara

Thanks, Gregg. Good morning, everyone. I'll take a few minutes now to walk through the consolidated financial performance for the quarter, starting with the P&L and gross profit. At the top of the page, you see our consolidated Q4 gross profit declined 6% from a year ago to $757 million, with stronger WhiteWave-Alpro results more than offset by weakness at the Fresh Dairy Direct-Morningstar segment. Below the gross profit line, total company operating expenses decreased $8 million or 1% from the year-ago period. And looking at the individual line items, we see distribution costs up 1% in total. Within this, continued benefits from improved technology at Fresh Dairy Direct-Morningstar have reduced total distribution headcount by over 480 positions in 2010.

In addition, better routing and efficiencies drove an annual reduction in the amount of fuel used by more than 2 million gallons. However, in the quarter, this progress at Fresh Dairy Direct-Morningstar was offset by 15% higher diesel fuel prices as well as higher resupply and warehousing expense of WhiteWave. The increased costs at WhiteWave were driven by strong volume growth across the portfolio that left the business temporarily capacity-constraint. All this contributed to a 1% increase in consolidated distribution costs for the period.

Selling and marketing costs in the quarter were 5% lower on a year-over-year basis due principally to lower overall advertising expenses. And across G&A, costs were 5% below year-ago levels, driven by lower employee incentive compensation expense. All told, total operating expenses declined 1% from the year-ago period. And as we have said previously, driving operating cost leverage continues to be the primary area of focus going forward and a key to offsetting the margin pressures in the business.

Below the operating income line, interest expense increased $6 million from the year-ago period. The increase is the result of higher average interest rates related to the amendment and extension of our senior credit facilities which was completed in the middle of 2010. Also impacting interest costs for the quarter was a $400 million senior note issuance in late Q4. The impact of these items was partially offset by lower average debt balances and the expiration of some interest rate hedges. Net income of $27 million resulted in fourth quarter adjusted diluted earnings per share of $0.15.

Turning now to the cash flow. We see that our cash flow remains strong. Net cash from continuing operations for the full year was $526 million, with free cash flow of $224 million after $302 million of net capital expenditures. We continue to generate free cash flow and pay down debt through aggressively managing working capital, as evidenced by our four-day improvement in our cash conversion cycle. Year-over-year, net operating working capital declined $28 million despite Class I milk and Class II butterfat prices averaging 30% and 50% higher, respectively, on a year-over-year basis.

Total outstanding net debt at quarter end stood at just under $4 billion, down approximately $8 million from Q3 and approximately $208 million on a full year basis. As expected, our leverage ratio of funded debt to EBITDA as defined by our credit agreements stepped up a bit this quarter despite our continued debt reduction. This was due to the impact of our reduced EBITDA in Q4 2010 versus Q4 2009.

Lastly, turning to the balance sheet. During the fourth quarter, we amended our credit agreements to allow for additional flexibility under our leverage covenants and reduced some of our short-term debt via the issuance of $400 million of eight-year senior unsecured notes in the middle of December. This better aligns our debt maturity profile with the expected returns on some of our longer-term capital projects. Our maximum total leverage covenant is now 5.75x our total funded debt to EBITDA as calculated per our credit agreements. This compares to our actual year-end total leverage ratio of 5.13x. Our covenant remains at 5.75x until March of 2012 when it steps down to 5.5x. It remains at that level until March 2013 before stepping down another quarter of a turn.

We continue to maintain strong liquidity with approximately $1.4 billion of availability under our AR securitization and revolving credit facilities as of year-end. We have plans in place to modestly increase capital spending in 2011. But we will balance the implementation of these plans against our goal of maintaining adequate flexibility under our covenants. We expect our total leverage to step up over the near term before beginning to fall again as we close out the year.

With that, I will turn the call back to Gregg for some commentary on the forward outlook before opening the call for your questions.

Gregg Engles

Thank you, Shaun. As I noted in my opening remarks, 2010 was an extraordinarily turbulent year for Dean Foods and the dairy processing industry. In light of that turbulence, we withdrew our full year guidance early last year. While we do not see meaningfully better industry conditions in 2011, we do see more stability returning to important aspects of our business, albeit stability at levels that imply our lower earnings in FDD-Morningstar going forward. We will therefore reinstitute annual guidance with this call.

Before I give you our guidance for Q1 and the year however, I'd like to recap some of the broad themes that will drive the outlook we're giving. First, to understand our ingoing 2011 position, we need to adjust 2010 results for higher interest expense from our new capital structure and the pro forma effect of selling our two yogurt operations.

Two 2010 events will raise our 2011 interest expense. First, we amended and extended our credit facility midyear, which increased our interest cost. Second, in mid-December, we issued $400 million in eight-year senior notes, and repaid nearer term but lower interest rate bank debt. Net-net, for the full year 2011, interest expense should be approximately $265 million versus $236 million in 2010. The difference represents approximately $0.10 per share less earnings in 2011 due to higher interest expense.

Late in 2010, we also entered into agreements to sell our two yogurt operations. We expect those transactions to generate about $180 million in gross proceeds and about $120 million to $125 million in proceeds net of tax. We plan to use those proceeds to reduce outstanding debt and clean up near-term maturities, which will reduce our interest expense by approximately $2 million. However, the disposed businesses generated approximately $20 million in annual operating profit that is now gone from our P&L. Net-net, these transactions are important strategically to allow us to focus on our core business but are expected to be dilutive in 2011 by $0.06 per share. We expect to eliminate that dilution in 2012 as we get stranded costs associated with the yogurt unit out of our business, but that will not affect 2011. The result of these two items is that we exit 2010 with a base business that is producing an estimated $0.64 per share in earnings, not the $0.80 we just reported.

Using this as a base, let me turn to the items that will drive our 2011 earnings progression. First, the consensus view of the dairy commodity outlook in 2011 is effectively a mirror image of what the industry believed three months ago. On our last call, we expressed the view that milk prices would fall throughout the first half of the year before climbing back to current levels by year-end. Since then, however, prices have shot higher driven by global demand and poor weather in Australia and New Zealand. We now expect dairy commodity prices to climb throughout the first half before flattening out or declining slightly in Q3 and Q4. We expect a rather dramatic move up in dairy prices during Q1 and early Q2, which we have already experienced in butter. This inversion of the commodity outlook will clearly present a drag on Q1 and Q2 earnings and will push earnings out of the first half and into the back half of the year compared to our thinking last fall.

Second, the price concessions and brand erosion that drove our reduced 2010 earnings occurred primarily from late Q1 through early Q3. We won't lap that lower margin structure until Q3, which will make for very tough first half comparisons.

Third, because overall 2010 performance was materially below our plan, we underpaid our 2010 bonus targets. Our 2011 plan reflects the new marketplace realities. And if we deliver that plan, we will pay at target. This higher level of incentive compensation is expected to be a drag on the business throughout 2011.

Finally, the fluid milk category finished the year with volumes down 2.5% in Q4 and has started 2011 soft. The asset deleverage of soft volumes negates some of the impact of our cost reduction efforts, and makes it harder to take those savings to the bottom line.

On the plus side, we have a robust cost reduction effort underway, which we expect to deliver $125 million in productivity this year. We're looking for opportunities to boost those efforts near-term. We are working to offset both commodity and non-commodity inflation through a combination of cost reduction and price realization. That said, we are clearly behind commodity inflation in Q1 given the rapid rise in prices. In order to mitigate soft category volumes, we have won new business that should come online in Q2 and Q3.

Finally, we expect WhiteWave-Alpro to get off to a bit of a start slow start, primarily due to the calendar shift of Easter this year from the first to the second quarter. For the full year, however, we expect WhiteWave-Alpro to deliver low double-digit operating income growth again this year, offsetting some of the challenges in our Dairy business. Taking all of these factors into account, we expect full year earnings of $0.55 to $0.65 per share or flat to slightly down from 2010 as adjusted for interest and divestitures.

As you can tell from my full year commentary, we expect the first half of 2011 to be particularly difficult as we battle soft volumes and spiking commodities. However, as we lapped the most difficult challenges of 2010, as new business comes online and as our cost reduction efforts accelerate further, we expect results to strengthen in the back half and to exceed 2010 performance by Q4. Q1 is historically our weakest quarter. And we expect it will be without doubt the most difficult quarter of this year as we chase the unexpected spike in dairy commodity costs, suffer weak volumes and begin to accrue incentive compensation at normal rates.

All in, we expect first quarter earnings of around $0.05 per adjusted diluted share in the quarter. We expect our performance to improve throughout the quarter and throughout the year as we adjust for inflation, volume from new business flows into our system and the cost reduction initiatives continue to gain momentum.

As I said, we'll continue to focus on reducing costs in the business and expect to finish out our initial $300 million cost reduction program by achieving the final $125 million of savings in 2011. Our plans for 2011 call for progress to accelerate as we move throughout the year, particularly as our G&A cost reduction plans are implemented. As we've discussed before, the $300 million initial program is only the first step, and we'll continue to aggressively attack costs for the foreseeable future.

Capital expenditures are targeted at $325 million to $350 million for the year. The modest increase in spending is a result of adding additional capacity to support WhiteWave growth, as well as additional spending on larger network optimization projects that will drive considerable cost savings going forward. We expect the recent change in tax laws allowing for full depreciation of new capital to save us a material amount of cash taxes and drive additional debt reduction during the year.

In summary, wholesale fluid milk pricing for the industry and for Dean has been reset to lower levels. We believe the market environment and our underlying earnings are stabilizing. But several factors will continue to impact our earnings progression, particularly early in the year. Later in the year, we expect earnings to improve as continued cost savings progress, and WhiteWave-Alpro growth begins to outpace the headwinds we've recently faced.

With that, I'd like to thank you for joining us on the call today, and ask the operator to open the call for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Alexia Howard from Sanford Bernstein.

Alexia Howard - Bernstein Research

I think from the press release, you were saying that the retailers have basically stopped looking for further price concessions. Is that the case now? And if so, do you have a good visibility into what the competitive cost structures are in some of those smaller regions where you really are coming under a lot of profit pressure?

Gregg Engles

The heaviest portion of price renegotiation, as I mentioned, was in Q1 through Q3 of last year. As you can tell from our results, we and the rest of the industry took a very meaningful step down in overall pricing in the marketplace. And that activity has meaningfully abated as the -- what I would call the price renegotiation cycle really ended in the early part of the second half of last year. I would never come out and say there is not the potential of an additional round of price renegotiation downward. But the signs that we're seeing is that really there's a level of exhaustion in the industry with all of the changes that have taken place, but most particularly, net price realization. So you, in fact, see in the marketplace companies walking away from business at current price levels saying they just can't make it work at those price levels and you're starting to see maybe, well we've described it here as the stabilization of the price environment. When those activities take place, business is still moving because of the excess capacity in the industry. But at least from our point of view, there doesn't appear to be much more capacity to take price down in this industry. We feel like we're hitting a bottom in terms of what's possible in terms of price downward.

Alexia Howard - Bernstein Research

Is the issue here really just concentrated in a few regions where you perhaps don't have the cost advantage that you might have in areas where you're stronger? Could you say that we're doing fine in I don't know, 60%, 70% of the business, but it's 20% or 30% that's really challenging. Just to give us an idea of the extent of the problem.

Gregg Engles

What I would say is that the level of price renegotiation downward has been a little bit asymmetrical. But it's tended to be asymmetrical where margins were highest, right. So there are parts of the country where margins have long been pressured. And those parts of the country did not experience the same kind of margin erosion because I think to my earlier commentary to your question, Alexia, there is just not a lot of room to go down. There was a concerted effort to negotiate prices down to where margins were higher. And I think we've come close to reaching the level of exhaustion in those marketplaces as well.

Operator

Moving on, we'll hear from Bryan Spillane from Bank of America.

Bryan Spillane - BofA Merrill Lynch

Just a couple of questions around the working capital and cash flow. With milk costs rising sort of earlier in the year, and I suspect higher than what you were originally planning for 2011 when you were beginning to describe the environment I guess in the third quarter earnings call, will it be a greater pull on working capital in the first half of the year than you were expecting and maybe for the full year? And then I guess kind of connected to that, when you renegotiated the terms of your credit agreements, how different is the plan that you laid out for us today for 2011 versus what you talked through with the banks back in the fall? I guess what I'm trying to get it is just, you've got the covenant reset -- have you used up some of the flexibility to that covenant because of the spike in milk costs?

Gregg Engles

Let me address the working capital issue first. First of all, Tim Smith in our Treasury group has done an absolutely fantastic job as part of our transformation efforts as we have moved activities that relate to working capital, particularly our payable cycle out of the field and into a centralized location. As you'll see, as you dissect our cash flow statements, we made excellent progress on working capital, even in a commodity environment that grows meaningfully from beginning of year 2010 to end of year 2010. So that team has done a great job, and there is more progress to be made. So we are confident about our ability to continue to drive productivity into the working capital side of our business and to continue to make that a benefit to our cash flow going forward.

In terms of the numbers. As it relates to working capital from period to period, clearly, we expected milk prices to go down in the first half as we told you on the call last quarter and up in the back. That looks like it's going to be reversed. It's going to be up in the front half and down in the back. So from a seasonality perspective, that will impact our quarter-to-quarter working capital performance as receivable values go up in the first half as opposed to down and payable values do the same thing. But our ending expectations for milk prices are still about what they were in the third quarter call. So on a full year basis, we wouldn't expect to see any impact on working capital versus our plan in prior periods. The plan that we gave you today, the guidance that we gave you is effectively the guidance that we used and the plan that we used from an annual perspective with the banks in renegotiating our covenants. So the year ending expectation against our plan and against our leverage levels with the bank is unchanged by the guidance that we're giving you today and is in line with what we told the banks. Again, similar to my commentary on working capital, however, the quarter-to-quarter seasonalization is a little bit different. So we are facing rising commodities and some earnings headwinds in the first half that we expect to be reversed with the change in the commodity cycle in the back half. So period-to-period, our leverage expectations around Q2 and Q3 are slightly higher than they were with respect to the banks and our presentation to them in renegotiating our deal. But we renegotiated this deal to give ourselves plenty of coverage, and we believe here today, with the plan and the guidance both for Q1 and the year that we've given you, that we have plenty of coverage.

Bryan Spillane - BofA Merrill Lynch

I'm assuming you'll need to draw down more from the revolver in order to fund working capital in the next couple of quarters. There's no conditions related to that that we'd have to think about in terms of your borrowing costs being pushed up higher than what your guidance is. There's plenty of room to draw down on the revolver in order to fund your working capital.

Gregg Engles

No, as Shaun mentioned to you in his remarks, we've got $1.4 billion of availability. All of that's available to us and it's available to us on the terms that have always applied under our credit facility as we renegotiated it in Q2 of last year.

Bryan Spillane - BofA Merrill Lynch

Just from listening to the commentary that the key is that milk costs actually moderate the back half of the year. If that doesn't happen, that's where there could be some challenges to the plan that you presented to the banks.

Gregg Engles

That is an important element in our outlook, is the timing of milk. But really, the key driver of our algorithm is our ability to take cost out of the system. Our ability to take cost out of the system and our ability to price for inflation. Those will be the two determinants of our success under this plan. We have a great deal of confidence in our plans to take costs out of the system. We're highly confident we'll deliver those. It's a continuum of the process that we started in 2009. We track it very carefully. We've got clearly identified initiatives that are the continuation of initiatives that we've been implementing for the last two years. So we believe very firmly we'll deliver against cost. And in fact, we're stepping up our efforts to take cost out of the business in the near term. And we'll be talking about that with you, I'm sure, on our next quarterly call.

However, the issue really is our ability to price for inflation as we come into a more highly inflationary period. And here, I'm not really so much talking about the Class I Mover. Again, the passthrough of the Class I Mover is a highly durable and highly refined process that's been ongoing in this industry for 70 years. But we live in an inflationary environment across the spectrum of our inputs, including non-dairy inputs, and we're going to have to be able to recapture that in price because you're not going to be able to offset all of that in terms of cost reduction in the near term.

Shaun Mara

Bryan, one build on the working capital, just to elaborate on some performance for 2010. We had those headwinds in 2010 as well in terms of dairy commodities with Class I going up 30% and Class II up 50%. Despite that, we're able to take out $20 million in working capital and improve the cash conversion cycle by four days. So we made progress in that and we continue to see that as an opportunity for us going forward.

Operator

Our next question today is from Judy Hong from Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

Following up on Bryan's question about milk costs in the back half, I'm just wondering why you think that the prices will flatten out or even decline in the back half given that you've got grain costs that are really elevated and historically that has led to herb [ph] reduction and reduced milk supply and thus higher prices. I understand that there is a passthrough mechanism, and that you may be able to offset higher costs with some pricing, but just wondering why, from a cost perspective, you'd think that that should moderate in the back half?

Gregg Engles

The rise in milk prices is caused by two things, as I mentioned. One is rising global demand. We don't have increased takeaway in the U.S. of all milk consumption, so milk consumption is moving from the U.S. and a lot of other places into the developing world. And prices have a constraining effect on demand. So as prices are moving up meaningfully and there is elasticity in the global demand for the product, so it will find some level of stability. Secondly is that important parts -- while the U.S. is a grain-driven dairy market, some of the most important markets out there are grass-fed markets, particularly New Zealand, in terms of supply in the global marketplaces. So they're really more weather driven by whether they get adequate moisture in order to support healthy amounts of feed for their cattle because they feed in pasture on grass. So they're not constrained by the same sort of input costs that American farmers are, and they're really the most important determinant of what global dairy prices are going to be. And finally, while input costs are clearly going up for American farmers, we're seeing prices rise early to compensate for that. So on balance, what we're seeing, at least in terms of what we believe in terms of the U.S. marketplace, is while things aren't getting a lot better for farmers with these price rises, they're holding their own by and large with respect to input cost across the spectrum. So we don't see a meaningful pullback in supply in the back half, given our new expectations about price levels. Now if we were talking about milk going to $14, which is what we thought was going to happen a quarter ago, we'd be having an entirely different conversation. But milk's going to $19 or $20 over the next two months. So these farmers are going to -- they're passing along much more instantaneously in this cycle the rise in input cost that they are experiencing today. So look, I will absolutely concede that the global dairy analytic community doesn't have a very good record of forecasting milk prices. Because three months ago, there was a high level of consensus that what we were going to experience was declining milk prices in the first half and rising milk prices in the back. The forecast that we've baked into our guidance and into our planning as a company is, again, really today's current consensus. And frankly, we're on the more pessimistic side of current consensus today around U.S. dairy prices. But we think it's prudent to be pessimistic today. Could this analytic community be wrong again about dairy prices in a volatile commodity world? Absolutely, they could.

Judy Hong - Goldman Sachs Group Inc.

The second question just relating to your first quarter guidance; obviously you called out some of the negative factors that affect the first half of the year. But just wondering if you can sort of bridge why the first quarter is particularly pretty weak. You got last year sort of $0.23 as a base number. I guess that will come down based on interest and the divestiture, so I'm just wondering if you could kind of bridge the difference.

Gregg Engles

Let me try and bridge it to two different quarters. Let me try and bridge it to Q1 of 2010, and then let me try and bridge it to Q4 of 2010, so year-over-year and sequentially. Bridging it to Q1 of 2010, the biggest drivers of the negative comparisons are that the vast majority of price concessions happened in Q2 and Q3 of last year. So we're lapping a much lower level of net price realization, Q1 of 2011 to Q1 of 2010. So the things that drove our quarter-to-quarter sequential decline in earnings last year are continuing to drive sequential decline in Q1 of this year, plus the continuing erosion of our brands. I'd put all of that into the bucket of net price. The second element would be the full burden of the negative interest comparison will exist in Q1 versus Q1 of last year. Because of our underperformance in Q1 last year, we're going to accrue incentive compensation at a lower level in Q1 than we will Q1 of 2010 versus Q1 of 2011. And then at least one, maybe two of the yogurt divestitures will be out of the Q1 of 2011 versus Q1 of 2010. And then the other things that I cited, soft volumes, those are applicable as well. So I think Q1 of 2010, there's just an awful lot that's different from Q1 of 2011, but the biggest difference by far, the macro environment in the category. In the walk forward from Q4 to Q1, the differences that you are going to see are interest, which is on the order of $0.01 to $0.02, yogurt which is out, which is on the order of $0.01. There is about between $0.02 and $0.03 of difference just in the seasonality of the WhiteWave business in particular, given its holiday orientation and very strong skew of Q4 seasonality. So you're just going to see, in the normal quarterly progression of that business, a step back on the order of $0.03 in terms of the seasonality of quarters. And then the one particularly large one-off event, if you will, is the spike in the first 10 days of January of butterfat prices, which as you may or may not recall, we get advanced notice of Class I prices, of the liquid milk price, and we're able to pass that on in our formulas. But the fat price is sort of a daily market. We don't get advanced pricing notice of what happens in our Class II inputs or heavy fat products. So we had the price of butter go up on the order of 20% over a two-day period in January. And we experienced those increased costs with absolutely no ability to price for them. So in my prepared commentary, I think I made the point that we're simply behind the spike in fat pricing in Class II prices in Q1, and I'm not going to be able to recover that until I get farther into the year. So those are really the differences.

Shaun Mara

The other Q4 to Q1 aspect that Gregg pointed out from Q1 to Q1 as well is this reloading of the incentive accruals. That's a big hit from Q4 of 2010 to Q1 of 2011.

Operator

Our next question today is from Chris Growe from Stifel, Nicolaus.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Shaun, could you characterize the incentive accruals, what that could mean? Is there a quarterly flow like, for example, in the fourth quarter, I guess it was cut a little bit. Is there a bigger fourth quarter hit in 2011, or maybe the full year hit if you could just talk about that?

Shaun Mara

I think if you go back to the beginning of last year in Q1, I think we recognized that the performance for the year was going to be less than we thought. So we had an adjustment in Q1. So I think it was relatively consistent throughout the year in terms of the reduction and then what's being put back this year. I think order of magnitude, you're probably talking about $0.03 or $0.04 per quarter of incremental costs that will be out there in 2011 versus 2010 as we look at the year.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Gregg, you were giving a response to Bryan's question earlier about some of the important factors for 2011, so the keys to your guidance and your plan. One of the things that you did not highlight in that list was the volume performance. And that's something that's concerning me, just given the fixed cost deleveraging, that's no secret. I just wondered if you could speak to that, and I guess the risks around volume to the year, especially as input costs go higher, and seeing the volume performance this quarter was a little concerning given the market share loss.

Gregg Engles

Volume is a risk and is an issue in the category and in our business. Let me talk a little bit about the drivers of volume. What, in a large measure, is driving our volume today is the share and growth performance of our customers. So customer share is not -- in other words, the processor portfolio of customers is not moving particularly much. It's pretty stable, but we happen to have a customer portfolio today, and you guys can find our top 10 customers if you go into our filings, that is underperforming at a minimum its historical comp performance, and in some cases, meaningfully underperforming its peer group. So we are experiencing some volume deleverage as a result of the fact that our particular customer set is underperforming its historical performance. And we need that customer set to perform reasonably well in 2011 to meet our volume plan, right. We're not counting on wholesale aversions to the mean for that customer set. But we need to see less erosion of volume from our underlying customers' share in the marketplace. So that is a risk to the business. We too, I think what's a startling number of people out of our business last year, we took 6% of our workforce out of the FDD-Morningstar business. And much of the benefit of that that would've otherwise flowed to the bottom line, got absorbed in lower volumes across the business. So we're slightly ahead of it, but not nearly as far ahead of it as we could be had our volumes held up.

The second issue that I think is of concern to the entire industry is that we saw the category in Q4 down 2.5%. So you've got rising milk prices that have come off real lows in 2009 and have risen to sort of the upper edges of normal and will probably push beyond that in 2010. And you're seeing some elasticity of that, maybe more elasticity than you normally would, given the high level of structural underemployment that exists in the country and the all-family nature of this business. So I'm selling to everybody milk products and about 20% of everybody is struggling with their ability to spend at the grocery store and everywhere else in the country. So we have a soft volume environment which is why every time we have one of these calls, we're talking about accelerating our efforts to take cost and take unused capacity out of our network.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Is the new business that you have coming online, is that a meaningful benefit to the company starting late in Q1? And I know who a lot of your big customers are. Is this becoming more of a channel issue? Is it moving to a dollar store, that kind of thing? Is that what's driving underperformance of your customers?

Gregg Engles

Ask me the first question again?

Christopher Growe - Stifel, Nicolaus & Co., Inc.

The first question was -- I'm trying to understand, the new business that you have coming online, is it meaningful enough to help swing your market share here?

Gregg Engles

Yes, it is. It's a meaningful amount of volume, and it's broadening our customer base. It's an important step. And it is part of that, the tapestry, if you will, of what's happening in the underlying category and our belief that we're nearing a bottom in terms of volume. So you're seeing the marketplace say, I can't do it at this price anymore. So you're seeing volume starting to move, and we're so far the beneficiary of some of those important moves. We're encouraged by our share trends. We are concerned about overall volume weakness in the category.

Now your second question around channel issues. We do extremely well in the channels that are doing well. So we have a ubiquitous plant network and a ubiquitous distribution system. That is a great advantage in serving all channels, including the dollar store channel and the drug channel and places where you're seeing some share growth in the marketplace. So we're pleased with our performance there. But again, you got a category that was down in volume, in liquid milk 2.5% in Q4. And you've got within each of the channels, you have some puts and takes. But large-format grocery is one of the softest overall channels out there. So within large format, you've got puts and takes as to who the winners are on a relative basis that is somewhat different than what it has been in the past.

Operator

Moving on, we'll take a question from Terry Bivens from JPMorgan.

Terry Bivens - JP Morgan Chase & Co

If you do look at the profit pool, I know you guys broke it out, I think just looking at private label, we were looking at more or less all retail milk pricing less the raw milk cost, which is a crude measure. But it has perked up. And if you look in the syndicated data, there also appears to be pricing in the dairy case. So the question I have is, are you getting any of that incremental margin from the higher prices from the retailers?

Gregg Engles

There are two pieces to it, as you alluded to in your question, Terry. There is the brand piece and there is the private label, the wholesale pricing around private labels. We didn't talk a lot about the brand price mix here because it's become less of an issue as we do see retailers trying to take prices up off the bottom, both to recapture rising commodity costs, and also because as we've been saying for a couple of quarters, it doesn't appear that this deep discounting strategy is moving grocery share around. And therefore, it's an unproductive investment on their part. So we actually saw brand volumes grow in Q4, and we saw stronger brand pricing. So that is a benefit to us that we're experiencing in our business, and that we hope continues. We are still well below in terms of the overall price level between private labels at retail and milk prices. We're still below historical norms, well below them. But it has stopped going down. In fact, it appears like it's ticking up. We hope it's not a dead cat bounce but that it continues to move up, and we're encouraged by that. And our brand volumes have -- the first derivative has gone positive, right. They are, at a minimum declining at a lower rate and in some cases growing, in terms of brand volumes. That's a positive for us. The pricing as between us and our private label customers, however, I would characterize it again as I did in my prepared remarks, we see it stabilizing. We don't see a lot of appetite around continued concessions. But that's going to be stickier. In fact, there is more excess capacity today than there was last quarter because the volume in the category was down 2.5% in Q4. And that is going to constrain the ability to restore pricing in that private label arena. And some of these agreements have longer terms than just at-will terms. So it's going to endure for a while.

Terry Bivens - JP Morgan Chase & Co

On an aggregate fluid milk basis for Dean, you're telling me, I think, that you are beginning to capture a little price on the branded side. Is that the correct interpretation?

Gregg Engles

Yes.

Jonathan Feeney - Janney Montgomery Scott LLC

Just secondly, one [indiscernible]. Way back with WhiteWave, I think you were pretty optimistic about what the margin structure might look like as this thing was built out. And I heard the comment this morning that advertising was down a little bit. Where do you think margins can eventually settle out for WhiteWave when you've fully burdened it with marketing?

Gregg Engles

I would say it's fully burdened with marketing. Yes, it's fully burdened with marketing. We're investing in this business at conventional CPG rates. Now what will move the margin around in this business -- there's always some period-to-period fluctuations. We invested very heavily in marketing against this business in Q4 of last year above normal because we were launching and driving Silk PureAlmond. And we were really driving behind our success in CoffeeHouse Inspirations in the International Delight business.

So if you go back and you look at marketing Q4 '09 versus Q4 '08, you will see a big step-up at WhiteWave. So it's really lapping those two sort of discrete events that put WhiteWave marketing at Q4 at pretty normalized levels. But we are not underfeeding the WhiteWave business at all in terms of marketing. Margin structure, you saw our margin structure I think at 9.5% in Q4. Again, I would point you to the fact that Horizon Organic, while it's a fantastic brand, grew volumes 19% in Q4, has a significantly lower margin structure than the rest of the business. The rest of this business has a fantastic, best-in-class CPG margin structure.

Operator

Our next question today is from Eric Katzman from Deutsche Bank.

Eric Katzman - Deutsche Bank AG

My question may be a little bit longer-term focus. But given your point about the cost savings being critical, that's probably a worthwhile place to start. I think you said CapEx is going to be running $300 million, call it $325 million, and I thought initially it was looking like $400 million, and that I think you had said that some major projects were going to be deferred a bit. But I thought that the next wave of cost savings was kind of a function of CapEx and not so much, let's say, more of operating period-to-period savings. But it really had to do with bringing the cost structure down through new plants. So can you give us a better sense of that, and then also can you give us a sense as to the $125 million? How much of that is gross versus kind of net savings because that's been a point of contention over the last couple of years?

Gregg Engles

There is no question about the fact that in our current circumstances, we're trimming around the edges a little bit on capital. We're going to make sure we've got a comfortable amount of push in under our bank deal as we start to restore profitability here. We're making some choices around capital that are definitely taking it down a little bit from what we've been talking about one, two, three, four quarters ago. We're still on the transformation plan. But we're being a little bit more choiceful about emphasizing things that are nearer in as opposed to farther out, and we're slowing it down a little bit.

As to its impact on our ability to take out cost, clearly at some point in time, because we're slowing down the capital spend, it will slow down the cost takeout. However, the big capital projects, the sort of dairy-of-the-future type of project, they were long-term investment projects that had no meaningful benefit on cost reduction until you get out until the 2013 period, right, because it's going to take 2011 and 2012 to build them. So these will not affect our near end cost takeout. So the $125 million this year is a finishing of the $300 million program, which started in 2009 that was not heavily capital intensive. It's more operating intensive. And what we're telling you is we're going to double down more on those sorts of things, around G&A takeout and around operating our business more effectively and more lean, and we're slowing down a little bit the transformational capital. That's an accurate assessment. But that will not start to affect our algorithm until you get out to that 2013 period, and we've never given you that algorithm.

So you asked me a second question. The second question was what is gross and net? If you mean what is gross and net in the sense of what do I have to actually spend in order to deliver the $125 million in savings, I can give you that number pretty easily. So in our 2012 plan, we would spend on the order of $20 million of expense to deliver the $125 million of savings. And that would be additional headcount or consulting or severance and restructuring, those sorts of things, to deliver the gross $125 million, so a net $100 million, rough numbers. If the question is how does that $100 million flow through to the bottom line, that's a much tougher question. Because what it ultimately says -- what you're ultimately asking is, how are you going to do in terms of price in recovering company-wide inflation, whether that's milk commodity, dairy commodity, non-dairy commodity, wages, all of those things? And I don't think it's meaningful for me to try and boil all of those factors down into the $125 million of cost saving number. We're looking at them separately, how much price are we going to get, how much inflation are we going to suffer. And we need to be measuring our performance on those metrics without muddying them up by dumping all of the net-net of that into our cost savings number.

Operator

And we'll go next to David Palmer with UBS.

David Palmer - UBS Investment Bank

The yogurt businesses, why sell them now? What was the rationale there?

Gregg Engles

The underlying strategic rationale was that these were businesses that we were either going to have to invest in, and that runs the gamut of investment from capital to R&D to sales and organizational capacity, or we were going to see them continually erode in terms of their performance over time. The second strategic imperative is that we have an enormous amount of work going on here to try and rationalize our core business, which is our liquid milk business and associated products like half-and-half whipping cream, cottage cheese, sour cream that are sort of traditionally associated with the liquid milk business.

Yogurt has always been an afterthought in this business, and we did not have a strategic position in yogurt. So our choice was either keep it in the portfolio and invest. We made the judgment that we're not in a good position to do that, given everything else we've got going on in our business, or frankly respond to what were pretty compelling approaches by the ultimate buyers of those products and be able to exit the business today at strategic multiples. So we got extraordinarily good prices for these businesses today. So we were able to simplify our portfolio, narrow the scope of our investment activities and our management bandwidth, reduce our total indebtedness, slightly reduce our leverage and frankly, remove downward performance exposure in the future from our business.

David Palmer - UBS Investment Bank

Productivity savings, how much year-over-year productivity savings did you have last year in 2010? And how much in terms of year-over-year savings are you anticipating for 2011? And then also, you mentioned that Class I could get to $19, $20 in the next couple of months in one of your answers earlier. Is that what your guidance is based on?

Gregg Engles

Yes, that is what our guidance is based on. Our guidance is based on Class I milk going up into the low 20s, high 19. It bounces around. Before this, we get a forecast basically every week. It's constantly evolving. But our guidance is based on the view that this goes up to around $20.

David Palmer - UBS Investment Bank

Productivity savings last year and this year?

Gregg Engles

Productivity savings last year, we tracked $100 million in productivity savings. There is $125 million in productivity savings in this plan plus a separate discrete bucket of G&A savings that is $30 million run rate by the end of the year but I think in plan is, what, $18 million, something like that?

Shaun Mara

I'd say $15 million.

Gregg Engles

$15 million in plan this year.

Operator

And it looks like we have time for one more question today. That will come from Jonathan Feeney from Janney Montgomery Scott.

Jonathan Feeney - Janney Montgomery Scott LLC

So a two-part question, the first would be, I know I've asked this before. But then again industry capacity utilization it would appear to me keeps reaching new lower levels with these volumes. So I guess what -- do we understand enough about maybe the competitive landscape in aggregate that you got into, in answer to Alexia's question, the varying levels of profit. Where do we sort of reach a hard kick point in total operating profit where we're going to start to see headlines that major competitors of yours are closing in some markets, would be the first part of my question. And failing that, second part would be, is there a point where you look at your bottom eight or 10 performing dairies and say, well, we're not getting that great of a return here, and there's significant working capital and of course CapEx needs, et cetera. Do you take that leadership step and try to get industry capacity utilization kind of back to levels that supported mid-cycle EBITDA for you guys in the past?

Gregg Engles

As to the second part of your question, absolutely, we do it every year. We closed, what, four plants? In '09 last year, we closed one facility. We've already announced the closure of a milk plant this year which will be offline by the end of Q1. So absolutely, we are taking capacity out of our network in order to drive up asset utilization and efficiency and drive profitability in our business every day. Absolutely, we are all over that.

In terms of how it plays out for everybody else, I don't have visibility into what their plans are around their asset networks. But I do know this, they are all struggling with the same issues that we're struggling with. They have to be struggling with the same issues that we're struggling with. And there are the occasional plant closures out there. But I will tell you, we are far and away the most proactive company in the industry in terms of rationalizing our own network. We are all over it. And to the extent we're spending capital, to go back to Eric Katzman's question, some of these larger capital projects, they are to take out multiple facilities, consolidate multiple facilities into larger, more effective, lower cost operations. So we are going to right-size our network for our volume around which we can make an adequate return.

Thank you all for joining us on the call today. We appreciate your level of interest in our business and the work that you do to understand our company, and we look forward to seeing you at CAGNY. Thank you.

Operator

That does conclude our conference call today. Thank you all for your participation.

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