Q2 2019 Earnings 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 Investor Relations and external communications.
Suzanne Rosenberg.
Please go ahead.
Thank you, Steve and good morning, everyone. Thanks for joining us on our second quarter 29 team earnings Conference call. This morning, we issued an earnings press release, which is available along with the slide presentation in the IR section on our website at <unk> Dot com.
A replay of today's call will be available on our website beginning this afternoon.
Before we begin I 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 are based on current expectations and projections and involve risks and uncertainties that may cause actual results to differ materially from our forward looking statements.
Information concerning those risks is contained in the companys filings with the FCC.
In addition, we will be discussing operating and financial results on an adjusted basis.
A reconciliation of these non-GAAP measures referenced during today's discussion to their most directly comparable GAAP measures can be found in today's earnings press release on our website.
Participating with me in the prepared section of today's call, our newly appointed President and CEO , Eric very gout and Jody Macedonia, Our Chief Financial Officer, Eric will start us off with an introduction 30 will then review our second quarter financial results before turning the call back over to Eric for other closing remarks, we will then open the call to your question.
Eric.
Thank you Suzanne good morning.
I was told many of our employees are listening in on the call I'd like to take the opportunity to say hi, and I'm looking forward to meeting all of you Deane is a great big beautiful business operating at a very challenging environment I can't wait to get the and growing again.
Dean Foods is one of the most prominent names in the dairy industry and I'm excited to join the company at this important juncture.
Nationally recognized brands and some of the best service in the industry. It is no coincidence that Dean foods has become one of America's largest dairy providers.
Well this business and the overall category of certainly face challenges I see tremendous opportunities ahead for the company.
Just a bit of background on me.
I've spent my career working in food beverage and consumer products industries, and I know the dairy space, particularly well many of my friends say I must have milk flowing through my veins.
I have more than 30 years of transformational leadership and operational experience at a broad range of Blue chip companies in the food beverage and consumer products industries, including expertise and food processing private label and branded along with contract manufacturing. Most recently I served as CEO of Gale foods, a large producer of dairy based beverage and food products were oversaw a transformational change and significant growth in the business.
Since I began in this role last week I've already had the opportunity to get to know many of our employees over the next several weeks I will be out on the road visiting our facilities and meeting many of our key customers suppliers and business partners I've already heard some of their views on the industry. The current environment and specifically Dean foods position.
These discussions have reinforced to me.
That there is significant potential in the business and I'm excited to hit the ground running as we work to continue transforming the business.
I would also like to note that the talented team we have in place has made for a smooth transition while laying the groundwork that will position our company for future success, while Dean Foods has a strong foundation of assets and brands. It's clear to me that we need to take a fresh look at the business and make changes that will allow us to succeed in today's competitive environment.
It's no secret that our industry environment continues to present challenges to our business.
And we must look for opportunities to accelerate our transformation to position Dean foods to win.
I look forward to working closely with the team to understand the processes and systems at work at Dean Foods, while it's still too early for me to comment on the specific actions and adjustments that we will need to make I am confident that we have a talented team in place to make decisions and execute plans that will create value for all of our stakeholders.
With that I will turn things over to Jodi to review our second quarter results.
Thank you, Eric and good morning, everyone and Eric welcome to the Dean Foods team I know I speak for the entire leadership team that we look forward to working with you.
Today, I'll walk us through the financial results as well as review the balance sheet and cash flow performance.
As we stated on our last quarterly call, we move past the inflection point in our business transformation in the fourth quarter of last year. Subsequently, we've made steady progress as we delivered sequential improvement in the first quarter of 2017 and now another quarter of sequential improvement in Q2 as anticipated adjusted second quarter results also included positive quarterly free cash flow.
Our adjusted operating results are gaining traction as we continue to execute our enterprise wide cost productivity program to address the de leverage we are experiencing from volume pressure and higher dairy commodity inflation.
In the second quarter total Dean foods volume was down significantly year over year, reflecting ongoing volume pressure, coupled with the overlap of certain customers exiting our system last year.
Volume decrease reflects an accelerated fluid milk category decline. The category is currently undergoing significant changes as consumers have more food and beverage options to choose from than ever before this leads to is dynamic retail and competitive landscape that we believe will continue to evolve.
In recent years. The overall category has declined about 2% annually and in Q2, we saw an acceleration of this trend.
The dairy category continues to be pressured by very low retail price points on private label milk, while at the same time accelerated dairy commodity inflation is putting additional pressure on margins.
In Q2 class, one raw milk costs were up approximately 12% versus year ago, and up 6% versus Q1.
We are now projecting class one raw milk cost inflation in Q3, the increase 19% versus prior year significantly higher than we originally anticipated.
Earlier in the year, we implemented net pricing actions to help offset some of the pension.
Moving forward, we will continue to explore other initiatives, including product mix opportunities to further mitigate inflationary pressure.
Let's spend a minute on what's happening in the retail environment.
Retailer private label margin over milk is the key industry metric looks at the average retail price private label milk.
The per gallon class one cost of milk. The difference between these two pricing is the margin dollars available to cover retailer and processor cost to generate profit.
As retailers continue to invest in private label milk to drive foot traffic the retailer margin private label margin over milk is contracted to a $1.26 in June matching a historic low.
As retailers continue to fund pricing promotions to drive traffic into their stores, they're draining their own profitability. As a result, we believe these margins are unsustainable and expect it to alleviate overtime.
Importantly, we believe this makes our brands even more important to the profit pool of our customers.
Keep in mind any change in raw milk costs will predominantly impact our branded business.
So, let's turn now to our Q2 adjusted results.
We reported $378 million and adjusted gross profit in Q2, a decline of 13% versus prior year, driven primarily by lower volume.
Impact of de leverage in higher dairy commodity inflation.
Below the gross profit line total company adjusted operating costs and expenses for the quarter increased by $8 million.
Within adjusted selling and distribution expenses decreased by $2 million, driven by lower marketing spend and the shift to digital advertising, which was partially offset by higher logistics costs associated with our network consolidation.
Our adjusted DNA costs in the second quarter were flat to Q1 and $9 million higher than year ago. The year over year increase primarily reflects professional fees associated with our plant consolidation efforts combined with employee related expenses.
During the second quarter, we executed a head count reduction and we'll begin to see the savings related to this initiative in the second half of this year.
In total we reported an adjusted operating loss of $27 million in the second quarter. While these results were down significantly year over year. It does reflect a 9 million sequential improvement from the first quarter of this year.
This marks the continuation of the sequential improvement we saw in our Q1 operating results versus Q4 of last year.
The company's second quarter adjusted loss per share was 36 cents.
On a sequential basis the loss per share narrowed from our results in Q1.
Turning now to free cash flow results the positive quarterly free cash flow generated in the second quarter, primarily reflects strong working capital improvement while inventory was down on sequential basis, we anticipate further reductions, particularly in ice cream as we move throughout the year like many of our competitors our ice cream business was negatively impacted by the cold and wet spring across the United States in the second quarter.
Full year capital expenditures remain on track with our expected range between 95 million and $110 million.
While second quarter results include positive free cash flow given our expectations for continued volume pressure and higher input costs. We now expect to be a net user of cash for full year 2019.
From a balance sheet perspective, we ended Q2 with net debt of $968 million.
This is $991 million in Q1, driven by working capital management.
As expected at the end of June we announced the successful increase in our borrowing base availability to $265 million under our senior secured revolving credit facility by completing post closing appraisal work.
This expansion increases our financial flexibility and further enhances our liquidity.
In addition, our existing $450 million accounts receivable securitization facility provides us with another source of flexible low cost access to capital together. These facilities provide us with the resources to continue to execute our priorities as we take meaningful actions to drive our plan forward and transform our company.
As of June Thirtyth, we reduced our revolver borrowings to $286 million, a $27 million reduction from Q1.
In conclusion, we're actively working to address current market conditions, while simultaneously moving forward on our strategic plan, where we continue to make improvements we expect our initiatives to accelerate during the second half of this year and we continue to reset our cost base.
Supply chain productivity to be more agile and cost efficient.
As we implement these initiatives, we will continue to focus on maintaining the highest levels of quality value and service that we deliver to our customers, which is paramount to our success.
Before I turn the call back to Eric I want to briefly touch on our strategic alternatives review, we are conducting a thorough and comprehensive review of opportunities to create value for Dean foods, our shareholders Our company and other stakeholders that said as previously stated we have not set a timetable for concluding the review we look forward to updating you after decisions are made.
With that I'll now turn the call back to Eric for closing remarks, We'll then open the call to questions Eric.
Thanks Jody.
In closing, we know the Dean foods can and must successfully transform itself and I know we have significant work to do to ensure that we deliver on our commitments to our customers and our stakeholders.
Im excited for what our team will accomplish together as we continue to position Dean foods for future growth and success.
Thank you in advance for your support.
As you know I've only been with the company for a little over a week and so I will defer the majority of your questions. Jody This time around.
With that I'll now turn the call over to the operator for QNX.
Thank you, Sir ladies and gentlemen, if you have a question at this time. Please press Star then one on your Touchtone telephone.
If your question has been answered all your wish to remove yourself from the queue. Please press the pound key.
We ask that you ask one question and one follow up to prevent any background noise. We ask that you. Please place your line on mute. Once your question has been stated.
Our first question comes from the line of Bryan Hunt of Wells Fargo Securities. Your line is open.
Thank you for your time this morning.
I was wondering if you could discuss what liquidity was as of quarter end or as of the period.
When you expanded the revolver two to 65.
You know.
We shared slides with you. This morning that shows what our revolver borrowings are but we'll have all of that information for you in the Q later today.
Okay, and and then a follow up can you discuss what the change in free to free cash flow negative for the year implies about the second half free cash flow are you still anticipating the second half to be.
Free cash flow positive just not to overcome the t. outflow in Q1.
Yes, yes for the second half we are anticipating positive free cash flow, but it can't overcome on our performance in the first half.
And then one more follow ups and something that you're talking about on the on the first question.
You know in the press.
Theres reports that you've sold garlic farms.
As well as a plant and hopefully, Illinois, F. those asset sales been reflected in the year to date asset sales numbers or are those pending.
Neither of those are true so no they havent been reported.
Okay. Thank you for your time I'll I'll get back in the queue.
Thank you. Our next question comes from the line of Ken Goldman.
JP Morgan.
Your line is open.
Hi, good morning, Thank you.
Jody I wanted to follow up on your commentary about retailers.
Im going to paraphrase, a little bit here, but you sort of talked about how they're not making enough money on milk right now and as a result, you expect them to potentially.
Change the way, they think about pricing and going to market with milk as as a loss leader. So again those are my words not yours, but.
That's the gist of it I think so my question is.
This has been going on for years been getting worse for years, it feels like to us anyway.
What evidence do you have the size that margins aren't great in the milk business that suggests that retailers will change and the reason I'm asking is.
So many of them seem content to use that as a loss leader, even though the margins on it are great because I'm not sure what necessarily change is actually.
You know it you know.
It's a combination of things with retail in margin over milk, reaching such as.
Historic lows, you know down at such levels that that.
We believe most retailers and this is predominantly related to private label by the way. This is not associated with the brand as part of the business.
You know those that are are.
Lowering their prices on on private label and keeping them so low to drive traffic.
If we don't believe its sustainable and if you look at the charts that we had shared with you.
Overtime, you can see that retailers do correspond and its cyclical in nature, they will choose something else to be a traffic driver.
Okay.
Thank you for that and then my follow up is you talked about.
Price gaps versus private label.
As we look at Nielsen data, it's it seems to suggest that price gaps for deans milk versus other branded milk have widened as well not not necessarily in your favor. So I was just wondering.
You know what your thoughts were on that and whether that's something that you may need to take steps to alleviate.
You know.
We do watch or price down it's an important metric that we look at in that price gaps really widened because private label.
Gone down not because of the branded price has gone up so we'll monitor that from time to time and make a choice will decisions.
Going forward.
Thank you.
Thank you. Our next question comes from Robert Moskow.
Of credit Suisse. Your question please.
Hi, Thanks.
Eric I had a question on I guess, you probably have seen.
At least the preliminary findings of the business review that's been going on for several months do you have any opinions on on what the conclusions of that review our.
Or any insights as to whether or not you might have to redo it I guess.
Based on on your perspective thanks.
For what I mentioned before Q and I started and then with the business a little over a week, so thats still something that we're assessing.
Okay.
And then another question for Jody.
The inflation in dairy it's up to $17 100 weight was 16 and it was 15 before that it's not that sharp of an increase in the past I would I would have thought that dean would just be able to increase price and.
That would that does prices would be increased at retail pretty quickly.
Has it become more difficult now to.
Cope with.
Ramp like that which.
Isn't that steep.
Well well first off I, just want to clarify the we do pass through the dairy commodity inflation on our private label business.
That's that's a business model that we operate on with respect to.
Retailers passing the pricing on that is their choice. We can't we do not have any input on what a retailer prices their milk at so that's their choice.
So you know it when its 19% quarter over quarter.
You know in a very steep increase in a time where volumes declining in the category that puts even more pressure on the margin.
Puts pressure on your branded margin you mean.
It puts pressure on the entire business right because when the category shrinking in total.
You know.
Everyone's going for a smaller pie.
But but you're raising price on private label. It is passing through and then the retailer decides just not to pass it through to the consumer So I guess theoretically half your business must be able to offset that inflation are you just saying that there is just less volume so it.
So therefore, its less less profitability net for Dean.
Yes, we're being impact by the volume decline.
Okay I'll leave it there thanks.
Thank you. Our next question comes from Rob Dickerson of Deutsche Bank. Your question. Please.
Hey, good morning, it's Matt fish fight on for Rob. Thanks for the question and congrats Eric.
Thank you Eric thinking about the present day Dean foods as the result of industry consolidation.
The value behind the idea of 15 years ago as we understand it.
That was the company could leverage scale and reduce regional overhead and advertising and marketing national brands, while supporting the countries.
Retailers and that model was supposed to help the company right out.
Plus cycles and periods of aggressive.
And competitor actions and totally appreciate what we can to dean for a week.
But since you've taken on this challenge in both personal and professional level at this stage of the story.
Very interested in learning your perspective on whether or not that national model still relevant today, what's maybe changed structurally that's causing that old model. The breakdown in your view, especially given your experience in the dairy industry.
And perhaps you know more about the lens that you'll be using to identify how that model can be further presume, presumably so that's yeah, there's upside to being a national fresh milk prices are more than just permitting a going concern.
Thanks.
For Jody too.
Yeah, so per the earlier comment clearly still assessing many things you you referenced.
Obviously in a business this size, there's huge advantages to scale the difficult position the industry's in right now is due to the declining category consumption.
What happens vis-a-vis that scale and your fixed cost base. So that's something that we continue to access to assess.
And clearly there's opportunities to grow the business I will refer to this as a target rich industry for private label and branded products.
And there is also more opportunities for cost reduction intelligent cost reduction within the business as well.
Okay, I appreciate that color and and Jody.
Well I guess.
Margin of 8.3% in Q2 is technically a sequential improvement from negative 0.2%.
One can you help us understand exactly what's improving sequentially and given that improvement can you help us better understand the reason behind the change to your cash flow outlook for the year, you mentioned volume pressure in cost inflation, but I feel like you know the volume pressure and cost inflation. It would have to change relative to how you thought three months ago and.
I mean, it doesn't really look too much different from our from our point of view. So any color you can give us on that and based on your current view of things will 2020 be a cash flow positive year figured I'd might they might be fair to ask since we're only about three and a half months away at this point. Thank you very much.
Okay. So I'm going to work in reverse so thank you Matt for your question. So I'm I'm not going to comment on 2020, it's too early to comment on that so far with respect to.
Our outlook change clearly.
You know what we are trying to clearly communicate to you all is that with that.
Accelerated category decline, we saw in Q.
Combined with the higher class, one very commodity inflation.
You know.
I think can comment into you know $17 a wasn't that much.
The class one.
Raw milk.
Hundred per hundred weight, it's the highest it's been since the beginning of 2015. So it is significant and it's changing our outlook from <unk> and impacting our cash flow forecast for balance of the year.
You know so it's a combination of the volume decline that we're experiencing and with the category to secure deterioration, where we are we're assuming that we'll continue.
We're also seeing that.
The higher input costs are changing or outcome.
But let's let's not forget we are actively addressing these.
These negative factors with.
A significant cost productivity program and we do expect that to ramp up in the second half of this year. We spent a lot of time in the second quarter designing a program that we that we are working on and to support our second quarter second half initiative and so we fully expect that to improve.
The performance in the second half.
I may have missed your first point, Matt so, but if you if you want to re ask that that's fine.
Just wondering again with the sequential improvement really was okay that yep sure times are improving relative to last quarter and the quarter before that.
You know, we we Didnt have you know significant improvement from some of our cost productivity initiatives that we initiated at the beginning of the year. You know we continue to see it is you know our plant consolidation.
Efforts are behind us. So we saw improvement in our manufacturing operations, we saw improvement from some of our productivity initiatives that improved our net revenue.
Performance you know as I spoke about on the last call me had a new trade promotion system that we had just Uh huh.
Implemented at the beginning of this year and we're seeing some of the benefits of that read through as well as our procurement spending efforts.
I had been driving significant productivity is reminder, last year Dean foods set up a non procurement team here based in Dallas with its focus on driving productivity in the non the nondairy aspects of the business of packaging.
Other raw materials like resin and and they've been very effective and were pleased with the result.
[noise].
Hi, Thanks for the color I'll pass it on.
Thank you. Our next question comes from Amit Sharma of BMO capital. Your question. Please.
Hi, good morning, everyone.
Good morning.
Judy.
If I didn't Miss here, you said category was down 2% to flow new kinda give is down 2% in the <unk> well is that right.
It's actually down further than that it's been trending down for the last couple of years that down 2%. It was down more like three on a U.S. Yang.
And.
And is your is dean foods share, including brand and private label is that trending down as well, so your volume declines or faster than the category.
You know what it is it's much harder we never quote private label share that's a much harder number to get that but our branded business for Dairypure is holding share both on a volume basis and on a dollar basis.
Okay. Okay.
And then from a cost perspective, DNA was up 9 million in the quarter can you talk about that like how would you guys hired and.
Well not profitability is down so aggressively.
Yes, So I mentioned that you know, perhaps if you listened on our Q1 call. We had said that we were going to engage a third party.
Firm to help us with.
Addressing some of the plant consolidation efforts that needed to take place and so in Q2. We are DNA was impacted by the professional services associated with those efforts as well as additional.
Employee related expenses.
So expect that to go down in the back half time as these are these changes.
Yes, yes, and I also and as you may have yes in June we did a a head count reduction here.
And we do expect to see benefits of that read through the PML in the second half of this year.
Got it and then just one for Eric.
All right I understand completely the only been here for a week. So when I ask you questions here, but if you look back and go onto your career like what are some of the learnings that you can bring forward I couldn't help being food, especially in an environment that we are in today.
Yeah.
In a nutshell basically on the commodity side of the business you need to be an efficient productive low cost provider certainly vis-a-vis your competitors.
And that.
We need to move swiftly and intelligently with growth projects, whether it's related to cost reduction or growth related to new products on both the private label side.
As well as the branded side.
And how long do you think it takes to formulate or implement a strategy like that.
Not long.
Okay. That's good.
I look forward to hearing more from you on that then.
Thank you.
Thank you. Our next question comes from John Baumgartner of Wells Fargo. Your line is open.
Good morning, Thanks for the question.
You know Eric when we look at this business. It seems that replacement value, maybe you know pretty well above Dean's public market valuation, but you Dean's also been considering strategic alternatives for a while now without any takers.
Even at this valuation so I hear the argument on scale, but we've also seen a 10 year contraction in profit margin. So even though you are new to the company I'm really curious what your industrial experience and initial impressions may be you know that lead you to think where the market has it wrong.
Yeah I mean.
There's overcapacity industry. That's clear so you will see capacity overtime coming out well short of a growth starting again in the category.
And scale to some degree as it can be a double edged sword as youre growing in a large category you get a lot of benefits fits from it.
But in a shrinking category you have to take costs out accordingly.
And yeah.
On the are you from a from a strategic review perspective, I really can't talk about that at this time.
Okay Fair enough I mean, Jody just I'm just wondering if you could put a little bit more detail today. The enterprise savings program, we haven't really had a real granular update on that in a while can you quantify the savings to date and B, how much remains and maybe the phasing from here.
Oh, you know.
What I can tell you is is the cost productivity efforts or what you see reading through the you know we are where we are making progress and it hasn't been.
Articulated in detail because we're the only public dairy company. So we're not going to share our program Oh on calls like this but we've been at executing our programs up and down the piano you know a as I mentioned on a previous question, we've seen benefits from being able to get better returns on entre promotions, we have seen benefits from our procurement initiatives we have.
Made tremendous progress on our plant consolidation and have returned to performance levels pre consolidation. So we feel good about that.
And I'll have more to go.
Okay. Thanks for your time.
[noise].
Thank you our next question comes from.
Chris Growe of Stifel. Your line is open.
Hi, good morning.
Good morning.
Hi, I just had a couple of we'll see follow on questions I wanted to ask first of all.
With higher milk prices.
Is that do you believe that's going to take this focus on private label and do you believe it forces higher prices at retail at some point that gap just can't be absorbed by the retailers. Obviously I don't we're not looking for the exact date and time, but just trying to understand is this the sort of the recipe for improving the pricing dynamic at retail.
You know historically.
No retailers respond to the higher prices at some point and we would expect that that would happen again. This business is cyclical if you look back on the chart that we shared on our webcast that would validate that.
But we can't comment and to win.
[laughter].
And then I just had a question about.
The volume declines for the category.
With prices going higher if anything for the branded milk you believe that's going to weaken the volume outlook for the business.
The recent category trends that we're seeing is really a a shift in how consumers are shopping and what they're buying it particularly in Q2, we saw some of the volume shift to water.
You know so you know more choices than ever before you know whether it's sustainable you know we'd like to think that the consumers you know would really see the value I mean, there's great value right now in the private label in particular for their shoppers.
To grow that category.
Okay. Thank you and just one quick follow if I could you talked about the cash availability.
That you have available to the company.
If you go through the revolver are there any debt covenants you to be aware of I'm, just wondering of the <unk>.
Being cash flow negative for the year of stocks that outlook.
You know.
No not really I think you know all of those details are provided for you in the queue. The new revolver provides us with tremendous amount of flexibility, we need and removes many of the covenants that we had previously.
And the cash flow negative does not it does not affect any way for you or Chris.
Not from a covenant standpoint now.
Thank you our next our final question comes from the line of Ken Goldman of JP Morgan.
Your line is open.
Hi, just a quick follow up for me.
Joe you spent very little of the company spent very little on Capex as a percentage of sales really over the last decade or more.
At least compared to most food companies and the consistent message we get from people in the industry is that yeah. Dean has some great plans, but it also has some that maybe are a little less efficient so.
I just wanted to follow up on your comment about improvements up and down the personnel I appreciate those but I wanted to understand.
Do you need to invest really meaningfully in some of its facilities to become a I guess, a consistent low cost producer or kind of across the board or in your view is that not something that's being strongly considered right now.
You know I think the the Capex plan that we have we said it was going to be between 95 and $110 million, we spend about anywhere from 55% to 65% of that on maintenance capital we need to keep in mind that you know we've been spending around that hondros $120 million range for the last.
Several years, but we have 21 fewer plant than we did in 2013, so there's not a need for as much capital.
So and also I think you have to well I can appreciate that the metric as a percent of net sales is valid for most companies with the impact of the commodity pricing impacting net revenue for us it's not as valley.
Okay. Thank you.
You're welcome.
Thank you at this time I'd like to turn the call over to CEO , Eric bearing gifts for closing remarks, Sir.
With that I'd like to thank you again for your interest and we're looking forward to speaking with you next quarter. Thanks very much.
Thank you Sir and thank you, ladies and gentlemen that does conclude today's conference. Thank you for your participation and have a wonderful day you may disconnect. Your lines at this time.
Oh.