Growth Plans Turned Sour at Knudsen

On a warm day in late January, executives from four large dairy cooperatives gathered for an unusual meeting at the austere Los Angeles headquarters of Knudsen Foods, the biggest dairy operation in the West.

Knudsen Chairman Ted D. Nelson said the company had some cash-flow problems, according to several people who attended the meeting. But Knudsen had no intention of filing for bankruptcy, he reportedly told the dairymen.

Nelson’s comments confirmed rumors of financial difficulties that had already led 22 dairy farmers to stop supplying 67-year-old Knudsen, whose dairy products have been familiar to generations of Southern Californians.

What happened next came as a surprise, recalled Richard Mullard, manager of the Los Angeles Mutual Dairymen, a cooperative.

“He said Knudsen is keeping its dairy business in California, Arizona and Nevada, but dairy properties in other states are on the block,” Mullard said.

Quietly Seeking Buyers

Others in the dairy industry now say that Knudsen may dispose of about one-third of its properties to help reduce a crushing $266.2-million debt.

Industry sources say Knudsen is quietly seeking a buyer for dairy properties in Missouri, Arkansas, Louisiana, Hawaii and Texas that it acquired when it purchased archrival Foremost Dairies last June. Knudsen also plans to sell its Globe Extracts flavorings business and its Hoagy’s Corner convenience store chain in the Pacific Northwest, the sources say.

For his part, Nelson is reluctant to publicly identify which assets are for sale. “Is everything we own outside California for sale? No. Do we have a for sale sign on some of it? Yes,” he said in an interview.

Any sale of these businesses would be a setback for Nelson and his two older half-brothers, who together control Winn Enterprises, a publicly traded trust that owns Knudsen.

The brothers, millionaires who made fortunes in health care and real estate, were determined to make Knudsen, which they purchased for $74.8 million in 1983, the first national dairy company.

A more philosophical Nelson now says: “Time has a way of changing our perspectives.”

Winn Suffered Loss

The gloomy Jan. 27 meeting with the dairymen, one of several held by Knudsen executives with customers and suppliers, came just six months after Knudsen had nearly tripled its size by acquiring San Francisco-based Foremost for $50.1 million.

Winn Enterprises had borrowed heavily to buy both Knudsen and Foremost, and it was now sorely pressed to make payments to banks and other creditors. Those payments included $16.5 million in interest charges for the third fiscal quarter alone, according to Winn’s report for the quarter ended Dec. 31, 1985.

That report also says that Winn lost $3.27 million in the first nine months of its fiscal year that ended March 31, compared to a profit of $6.13 million a year before. Sales fell to $951.9 million from $962.3 million in the nine-month period.

The quarterly report acknowledges that since at least September, Knudsen has been in violation of its loan agreements with its principal bank creditor, Citicorp Industrial Credit Bank. Nelson, in the interview, said efforts to refinance its debt have so far proved unsuccessful. Knudsen is also several months behind on payments due the former owners of Foremost.

Knudsen needed cash so badly last winter that one of the brothers--whom sources identify as Ted Nelson--personally guaranteed a portion of a new $10-million credit line. Nelson said he is trying to renew that loan, which expired March 17.

Nonetheless, the dairymen say they left the meeting last January somewhat relieved. A leaner Knudsen, they reasoned, would have no problem paying dairy farmers for raw milk.

Donald Olson, manager of Hi-Grade Milk Producers Assn. in Chino, wrote a letter to the members of his cooperative indicating that Knudsen’s problems were behind them. Mullard was so cheered that he purchased Winn Enterprises stock, which is traded on the American Stock Exchange.

“I felt better. I think we all did,” said Ruby Uliana, manager of Cal-Dari, a milk cooperative that supplies Knudsen in Modesto.

Despite the reassurance, however, Knudsen’s problems still seem far from over. Company officials acknowledge that a variety of factors, from backlash against its elimination of the Foremost brand name in Northern California to late deliveries of milk, caused the combined operations to lose $35 million of business since the merger.

Distributors Balk

Knudsen’s problems were compounded after a number of independent milk distributors near Modesto quit handling Knudsen products last winter. Three distributors told The Times that they took the action after suffering thousands of dollars in losses on milk that turned sour too soon.

Meanwhile, Knudsen’s giant milk-processing plant at 231 E. 23rd St. in Los Angeles failed a government sanitary inspection in January, according to a state official. The failure effectively barred Knudsen from shipping products out of state from that plant.

Jan Wessell, a spokeswoman for the state Department of Agriculture, said milk plants don’t often fail sanitary inspections, which the state performs under contract for the U.S. Food and Drug Administration. She said Knudsen scored 63 out of a possible 100, below the passing grade of 85.

Although the problems were corrected a month later, and Knudsen was able to resume shipments from the plant to Nevada, dairy industry sources say the failure may have hurt Knudsen’s image.

Knudsen’s troubles couldn’t have come at a worse time. Although California is now awash in milk, a federal herd reduction program is expected to significantly reduce the state’s raw milk supply.

At the same time, Golden California Cheese Co., which operates the world’s largest cheese plant in Corona, is offering premiums to lure dairy farmers. When the cheese plant reaches capacity later this year, it will consume nearly 20% of the raw milk produced in Southern California.

May Pay Premiums

No one in the industry expects a milk shortage, because raw milk supplies are expected to remain plentiful north of the Tehachapis. But dairy industry sources believe that the raw milk market in Southern California may become more competitive than ever and that milk processors such as Knudsen, which is losing 10% of its milk supply this year, may soon be forced to pay premiums for milk.

Jerseymaid, a Los Angeles dairy company, briefly paid a premium to dairy farmers earlier this year but canceled the offer after raw milk supplies proved adequate.

“We’ll do what we have to do to remain competitive and maintain our supplies,” said Roger Kirkpatrick, a former Winn Enterprises executive who recently became Knudsen’s chief executive.

Nelson, who replaced his half-brother, Dee R. Bangerter, as chairman last December, is confident that Knudsen can recover. “Our problems are history,” he said. “You’ll see.”

Clearly, there is some cause for optimism. Knudsen enjoys an enviable position in the California marketplace, where it sells more milk, cottage cheese and buttermilk than anyone else. Many consumers are Knudsen customers without realizing it, as the dairy company also sells milk under the Albertson’s, Alpha Beta, Hughes and Stater Bros. supermarket labels.

The loss of raw milk supplies isn’t expected to hurt Knudsen too badly, as the company can make less powdered milk and butter, low-profit items that it sells to the federal government through the Commodity Credit Corp. Last year, the government paid Knudsen and Foremost $128.5 million for those commodities, providing about 10% of the companies’ combined revenue.

Have Midas Touch

Then there is the brothers’ Midas touch for turning losing enterprises into winners. Nelson, Bangerter and his twin, Lee R. Bangerter, started building their fortune with Care Enterprises, which began with one Anaheim nursing home and is now the nation’s fourth-largest nursing home chain, with revenue of $238.5 million last year.

In the 1970s they diversified, acquiring Builders Investment Group, a real estate investment trust that lent money for hotel and home construction mainly in the Southwest and Puerto Rico.

Nelson, associates said, makes a point of telling suppliers and customers that his family has never welshed on its debts. “He told us that they never went bankrupt and that they usually improved the companies they bought,” said Mullard, recalling comments that Nelson made during his meeting with the dairy executives.

The brothers did escape one brush with disaster. When interest rates rose in the mid-1970s, the real estate market collapsed. By 1979, Builders Investment Group had defaulted on its loans and began a program of selling its properties to its creditors.

By March, 1981, the trust had repaid its lenders. It had sold real estate holdings with a book value of $300.6 million to creditors in return for $68.9 million in cash and cancellation of $359.2 million in debt.

Two years ago, Winn Enterprises (Builders Investment Group changed its name in 1983) agreed to issue 611,564 common shares to settle a 1977 lawsuit brought by unhappy real estate investors. The settlement was not large; based on Winn Enterprises’ share price at the time, it was worth about $1.1 million.

How Knudsen, with $1 billion in sales last year, ran into financial trouble so quickly after the Foremost merger isn’t entirely clear.

Dairy industry sources say the two large dairy companies were combined during the summer, the season when milk demand normally drops and dairy companies experience their worst cash squeeze.

Underestimated Challenge

Nelson said he and Knudsen’s other top executives “underestimated the size of the challenge.” He said no one knew how much cash it would take to run the combined organizations, and Knudsen’s best guesses proved too low.

“The fact that the $10 million (in additional credit) was needed indicates that,” said Nelson, who added that the company had suffered more operating inefficiencies than expected.

Indeed, Knudsen has been bedeviled with production difficulties, according to those familiar with the company. During the nine months that ended Dec. 31, the company lost $1.83 million on merger-related “operating inefficiencies, product losses and administrative costs,” according to its Dec. 31 quarterly report.

For instance, Foremost and Knudsen milk crates were different sizes and so couldn’t be securely stacked in delivery trucks for shipment, according to dairymen. As a result, the company had to buy hundreds of new milk crates, they said.

Even last winter’s supermarket strike in Southern California, which forced supermarket chains that normally process their own milk to turn to Knudsen, worked against the company. Overtime pay consumed the extra profits, as Knudsen’s main plant in Los Angeles operated 24 hours a day, every day, to supply Southern California supermarkets with milk.

Kirkpatrick, Knudsen’s chief executive, blames the “stress” that the plant experienced during that time for its failure to pass the federal sanitary inspection on Jan. 13.

Inspectors found, among other things, dirty valves and yogurt-filling tubes, a filthy loading dock, dirty conveyor belts and a messy dumpster area, state Agriculture Department spokeswoman Wessell said.

Shifted Production

But, by most accounts, Knudsen’s bottled milk plant in Modesto experienced even worse problems. Shortly after buying Foremost, Knudsen closed Foremost milk plants in Sacramento and Fresno and fired 400 workers to slash production costs. Most of the milk production from the closed plants was shifted to Modesto, which was soon floating in milk.

“It was like trying to get a gallon of milk into a pint bottle,” said one dairyman who sold milk to Knudsen. Milk volume doubled and, as a result, dairymen faced long waits in line outside the plant to unload raw milk from their trucks.

Equipment breakdowns became more frequent, causing late milk deliveries to convenience stores and supermarkets, said Kenneth Bruner, business representative of Teamsters Local 386, which represents the Modesto workers.

Knudsen’s executives say they hoped to smooth Modesto’s production problems by eliminating the Foremost label, because each time a label is changed, production comes to a halt. Loyal Foremost customers became upset, however, and some switched to another local brand.

Crystal Creamery in Sacramento and Foster Farms in Modesto are believed to have benefited from Knudsen’s woes, each picking up about $2.5 million in sales, according to sources close to the situation.

Several milk distributors, most of whom declined to be identified, said some milk from Knudsen’s Modesto plant did not stay fresh as long as it should have.

“The milk would not last past the code date and sometimes wouldn’t even last to the code date,” said Frank Dutra, an Atwater distributor who now distributes milk for a Knudsen competitor.

Took Loss on Milk

The date stamped on a milk carton is the last day on which it can be sold, but, if properly refrigerated, it is required to stay fresh for at least 10 more days. Dutra said he removed Knudsen milk from his customers’ dairy cases before the code date and took a loss on the milk rather than lose customers due to complaints about sour milk.

Top Knudsen executives interviewed said they had no firsthand knowledge of product quality problems at Modesto, although Kirkpatrick said he had “heard something about it” second hand. Knudsen recently installed a second conveyor belt at Modesto to move milk more quickly through the plant.

“We believe this should eliminate any quality problems we may have had,” Kirkpatrick said.

Knudsen’s difficulties have understandably strained the normally amicable relationship among the brothers, according to associates. Nelson said his brother Dee Bangerter willingly stepped aside and even nominated him as chairman at a Winn Enterprises board of trustees meeting last December.

The three brothers, who together own 55% of Winn, are trustees. “My brother (Dee) supports me,” Nelson said.

Bangerter, an accountant whom associates describe as a quiet numbers whiz, declined to discuss his role at Knudsen. “They are both fine men,” said Paul R. Kouri, a trustee who said Nelson’s skills as a negotiator were needed. “He is much better at getting along with people, with making friends.”

Put Brakes on Growth

Nelson, who brought in Kirkpatrick as chief executive--a position Bangerter had held--has put the brakes on Knudsen’s growth. Under Bangerter, Knudsen had targeted 24 states for expansion and had planned to double the size of its Hoagy’s Corner convenience store chain.

Nelson, who formerly ran Winn’s Salt Lake City-based Mountain West Savings & Loan unit, says growth is now much less important at Knudsen.

“My goal is to continue the tradition started by Tom Knudsen,” said Nelson, referring to the Danish immigrant who founded Knudsen in 1919 and gave it the slogan “The Very Best.” “If we never grew again, that would be less important to me than whether or not this company was perceived as the very best.”