6. Derivative Financial Instruments and Fair Value Measurements

Derivative Financial Instruments

Interest Rates — We have interest rate swap agreements in place that have been designated as cash flow hedges against variable interest rate exposure on a portion of our debt, with the objective of minimizing the impact of interest rate fluctuations and stabilizing cash flows. These swap agreements provide hedges for interest on our senior secured credit facility by fixing the LIBOR component of interest rates specified in the senior secured credit facility at the interest rates noted below until the indicated expiration dates of these interest rate swap agreements.

The following table summarizes our various interest rate agreements in effect as of March 31, 2012:


Fixed Interest Rates	Expiration Date	Notional Amounts
		(In millions)
0.415% to 0.418%(1)	December 31, 2012	$	500
1.60% to 1.84%	December 31, 2013		800
2.75% to 2.84%	March 31, 2016		200
2.70% to 3.17%	March 31, 2017		650

(1)

In September 2011, we entered into forward-starting interest rate swap agreements with an effective date of December 30, 2011. The notional amounts of the swap agreements decreased by $400 million on March 30, 2012 and the remaining notional amounts shown in the table above expire on December 31, 2012.

These swaps are recorded as an asset or liability on our unaudited Condensed Consolidated Balance Sheets at fair value, with an offset to other comprehensive income to the extent the hedge is effective. Derivative gains and losses included in accumulated other comprehensive income are reclassified into earnings as the underlying hedged forecasted transaction occurs. Any ineffectiveness in our hedges is recorded as an adjustment to interest expense. There was no hedge ineffectiveness during the three months ended March 31, 2012 and 2011.

We are exposed to market risk under these arrangements due to the possibility of interest rates on our senior secured credit facility rising above the fixed rates in our interest rate swap agreements. Credit risk under these arrangements is believed to be remote as the counterparties to our interest rate swap agreements are major financial institutions; however, if any of the counterparties to our hedging arrangements become unable to fulfill their obligation to us, we may lose the financial benefits of these arrangements.

Commodities — We are exposed to commodity price fluctuations, including milk, organic and non-genetically modified ("non-GMO") soybeans, butterfat, sweeteners and other commodity costs used in the manufacturing, packaging and distribution of our products, such as, natural gas, resin and diesel fuel. To secure adequate supplies of materials and bring greater stability to the cost of ingredients and their related manufacturing, packaging and distribution, we routinely enter into forward purchase contracts and other purchase arrangements with suppliers. Under the forward purchase contracts, we commit to purchasing agreed-upon quantities of ingredients and commodities at agreed-upon prices at specified future dates. The outstanding purchase commitment for these commodities at any point in time typically ranges from one month's to one year's anticipated requirements, depending on the ingredient or commodity. These contracts are considered normal purchases.

In addition to entering into forward purchase contracts, from time to time we may purchase over-the-counter contracts from our qualified banking partners or enter into exchange-traded commodity futures contracts for raw materials that are ingredients of our products or components of such ingredients. Certain of the contracts offset the risk of increases in our commodity costs and are designated as cash flow hedges when appropriate. Additionally, from time to time we enter into derivative contracts with approved counterparties that are designated as hedging instruments against the risk of changes in the fair value of a portion of our butter inventory. These contracts are marked to market at each reporting period and any resulting gains or losses on the derivative instruments, as well as the offsetting gains or losses on the hedged item attributable to the hedged risk, are recognized in earnings in the same period. There was no material hedge ineffectiveness related to our commodities contracts designated as hedging instruments during the three months ended March 31, 2012 and 2011.

Other contracts may be executed related to certain customer pricing arrangements. We have not designated such contracts as hedging instruments; therefore, the contracts are marked to market at each reporting period, and a derivative asset or liability is recorded on our balance sheet.

A summary of our open commodities contracts recorded at fair value in our unaudited Condensed Consolidated Balance Sheets at March 31, 2012 and December 31, 2011 is included in the table below.

Although we may utilize forward purchase contracts and other instruments to mitigate the risks related to commodity price fluctuation, such strategies do not fully mitigate commodity price risk. Adverse movements in commodity prices over the terms of the contracts or instruments could decrease the economic benefits we derive from these strategies.

Foreign Currency — Sales in foreign countries, as well as certain expenses related to those sales, are transacted in currencies other than our reporting currency, the U.S. dollar. Our foreign currency exchange rate risk is primarily limited to the euro and the British pound. We may, from time to time, employ derivative financial instruments to manage our exposure to fluctuations in foreign currency rates or enter into forward currency exchange contracts to hedge our net investment and intercompany payable or receivable balances in foreign operations. Additionally, in anticipation of repatriating approximately €55 million from our foreign operations, we entered into a forward contract to purchase $70 million, to be delivered in the second quarter of 2012, to mitigate potential currency fluctuations as we take steps to mobilize the funds. This derivative instrument was not designated as a hedging instrument, and changes in fair value of the instrument are recognized immediately in other operating (income) expense in our unaudited Condensed Consolidated Statements of Operations. See the table below for a summary of the foreign currency related financial instruments outstanding at March 31, 2012 and December 31, 2011.

As of March 31, 2012 and December 31, 2011, our derivatives recorded at fair value in our unaudited Condensed Consolidated Balance Sheets consisted of the following:


	Derivative Assets				Derivative Liabilities
	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011
	(In thousands)
Derivatives Designated as Hedging Instruments
Interest rate swap contracts — current(1)	$	—	$	—	$	34,570	$	38,260
Interest rate swap contracts — noncurrent(2)		—		—		58,814		64,037
Commodities contracts — current(1)		767		93		2,962		2,346
Foreign currency contracts — current(1)		196		411		—		—
Derivatives not Designated as Hedging Instruments
Commodities contracts — current(1)		6,721		2,006		5,996		1,530
Foreign currency contracts — current(1)		—		—		2,939		—

Total derivatives	$	7,684	$	2,510	$	105,281	$	106,173

(1)	Derivative assets and liabilities that have settlement dates equal to or less than 12 months from the respective balance sheet date were included in other current assets and accounts payable and accrued expenses, respectively, in our unaudited Condensed Consolidated Balance Sheets.

(2)	Derivative assets and liabilities that have settlement dates greater than 12 months from the respective balance sheet date were included in identifiable intangible and other assets, net and other long-term liabilities, respectively, in our unaudited Condensed Consolidated Balance Sheets.

Gains and losses on derivatives designated as cash flow hedges reclassified from accumulated other comprehensive income into income for the three months ended March 31, 2012 and 2011 were:


	March 31, 2012		March 31, 2011
	(In thousands)
Losses on interest rate swap contracts(1)	$	13,996	$	17,040
(Gains)/Losses on commodities contracts(2)		1,136		(1,052	)
Losses on foreign currency contracts(3)		17		—

(1)	Recorded in interest expense in our unaudited Condensed Consolidated Statements of Operations.

(2)	Recorded in distribution expense or cost of sales, depending on commodity type, in our unaudited Condensed Consolidated Statements of Operations.

(3)	Recorded in cost of sales in our unaudited Condensed Consolidated Statements of Operations.

Based on current interest rates, commodity prices and exchange rates, we estimate that $34.6 million of hedging activity related to our interest rate swaps, $3.4 million of hedging activity related to our commodities contracts and $0.2 million of hedging activity related to our foreign currency contracts will be reclassified from accumulated other comprehensive income into income within the next 12 months.

Fair Value Measurements

Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering assumptions, we follow a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

•

Level 1 — Quoted prices for identical instruments in active markets.

•

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations, in which all significant inputs are observable in active markets.

•

Level 3 — Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

A summary of our derivative assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 is as follows (in thousands):


	Fair Value as of March 31, 2012		Level 1		Level 2		Level 3
Liability — Interest rate swap contracts	$	93,384	$	—	$	93,384	$	—
Asset — Commodities contracts		7,489		—		7,489		—
Liability — Commodities contracts		8,958		—		8,958		—
Asset — Foreign currency contracts		196		—		196		—
Liability — Foreign currency contracts		2,939		—		2,939		—

A summary of our derivative assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 is as follows (in thousands):


	Fair Value as of December 31, 2011		Level 1		Level 2		Level 3
Liability — Interest rate swap contracts	$	102,297	$	—	$	102,297	$	—
Asset — Commodities contracts		2,099		—		2,099		—
Liability — Commodities contracts		3,876		—		3,876		—
Asset – Foreign currency contracts		411		—		411		—

The fair value of our interest rate swaps is determined based on the notional amounts of the swaps and the forward LIBOR curve relative to the fixed interest rates under the swap agreements. The fair value of our commodities contracts is based on the quantities and fixed prices under the agreements and quoted forward commodity prices. The fair value of our foreign currency contracts is based on the notional amounts and rates under the contracts and observable market forward exchange rates. We classify these instruments in Level 2 because quoted market prices can be corroborated utilizing observable benchmark market rates at commonly quoted intervals, observable current and forward commodity market prices on active exchanges, and observable market transactions of spot currency rates and forward currency prices. We did not significantly change our valuation techniques from prior periods.

Due to their near-term maturities, the carrying amounts of accounts receivable and accounts payable are considered equivalent to fair value. In addition, because the interest rates on our senior secured credit facility and certain other debt are variable, their fair values approximate their carrying values.

The fair values of our Dean Foods Company senior notes and subsidiary senior notes were determined based on quoted market prices obtained through an external pricing source which derives its price valuations from daily marketplace transactions, with adjustments to reflect the spreads of benchmark bonds, credit risk and certain other variables. We have determined these fair values to be Level 2 measurements as all significant inputs into the quotes provided by our pricing source are observable in active markets. The following table presents the carrying value and fair value of our senior and subsidiary senior notes at March 31, 2012 and December 31, 2011:


	March 31, 2012				December 31, 2011
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(In thousands)
Subsidiary senior notes due 2017	$	129,543	$	140,935	$	129,117	$	136,853
Dean Foods Company senior notes due 2016		499,010		513,750		498,959		493,750
Dean Foods Company senior notes due 2018		400,000		440,000		400,000		426,000