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Executives

Shaun Mara - Chief Financial Officer and Executive Vice President

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

Barry Sievert - Vice President of Investor Relations

Analysts

Judy Hong - Goldman Sachs Group Inc.

Amit Sharma - BMO Capital Markets U.S.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

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

Adam Josephson - KeyBanc Capital Markets Inc.

Eric Katzman - Deutsche Bank AG

Christine McCracken - Cleveland Research Company

Farha Aslam - Stephens Inc.

Dean Foods (DF) Q2 2011 Earnings Call August 4, 2011 9:30 AM ET

Operator

Good morning, and welcome to the Dean Foods Company's Second Quarter 2011 Earnings Conference Call. Please note that today's call is being recorded and is also being broadcast live over the Internet on Dean Foods' corporate website. This broadcast is property of Dean Foods. Any redistribution, retransmission or rebroadcast of this call, in any form, without the expressed written consent of the company is strictly prohibited.

At this time, I would like to turn the call over for opening remarks to the Vice President of Investor Relations, Mr. Barry Sievert. Please go ahead, sir.

Barry Sievert

Thank you, Laura, and good morning, everyone. Thanks for joining us for our second quarter 2011 earnings conference call. We issued an earnings 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 litigation matters; 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 also would like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements will include, among other, disclosures 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 results, walking through the performance of the operating units and current business trends. Following Gregg, Shaun will offer additional comments on our financial results before turning the call back to Gregg for some additional commentary on the forward outlook and other closing comments. We will then open the call for 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. I understand that we have this morning's announcement just a bit of a hirsute environment for food analysts and investors this morning so we certainly appreciate you're all making the time to be on the call with us this morning.

In many ways, the second quarter of 2011 is a continuation of the trends that we've seen over the last several quarters. WhiteWave-Alpro, again, posted strong results and Fresh Dairy Direct-Morningstar continued to make progress towards profit stability against the backdrop of weak industry volumes. We continued to execute our plan to drive costs out of the business and progress in this area has been solid.

Overall, the quarter came in largely, as expected, with consolidated adjusted operating income of $114 million and adjusted diluted earnings per share of $0.18. Cash flow was solid and net debt and leverage continued to decline as expected.

Now let's look at each of the business segments in greater detail, starting with Fresh Dairy Direct-Morningstar. Improving trends in the retail price environment for our Fresh Dairy Direct-Morningstar business that began in the first quarter, continued in Q2. Large-format retailers, by and large, maintained the pricing gains they've made in gallon-sized milk and continued to back away from their deep discount strategy. Retail prices increased -- increases generally met or outpaced rising raw milk costs, and the average industry margin over milk was fairly consistent with first quarter levels.

While some of our regional brands remain well out of value, on average, rising private label pricing has reduced the retail price gap between private label and our regional brands. Our average price gap was nearly 30% in the year-ago quarter, but today is 20% on a blended basis across all original milk brands. These reduced gaps are helping to improve the relative performance of our brands in the category. On a like-for-like basis, which excludes the impact of new and lost business, regional brand volumes, again, outperformed private label in the quarter.

At the wholesale level, private label milk pricing generally continued to stabilize, albeit at historically low levels. However, given continued volume weakness across the industry, which deleverages both competitor processing facilities and our own, we once again experienced pockets of competitive pressure in the quarter.

With retail pricing that continues to stabilize and cost reductions on track, volume remains our largest concern. The continuing struggles of consumers at the lower end of the economic spectrum have been widely reported this earnings season. I can echo those comments as we see a clear evidence of continued weakness among this demographic across virtually, all categories in our conventional dairy business.

With widespread food and energy inflation stressing consumer pocketbooks, many Americans are finding areas to cut back even in consumer staples like dairy. We see the impact of this belt-tightening manifested in declining inter-month volumes that reflect the transfer payment and pay cycle. It is also apparent in the performance of customers that derive larger portions of their business from this consumer segment.

The fluid milk category has been on a multi-decade trend of flat to slightly declining volumes. This is the result of declining per capita consumption somewhat offset by population growth. As a result of the recession and rising inflation, however, we are now 2 years into accelerated category declines in fluid milk. Industrywide, fluid milk volumes are down 1.9% in the quarter, a steepening decline from prior periods and the worst quarterly decline since 2007. This is on top of the year-ago quarter that was down 1.5% for the industry. With the economy continuing to struggle and dairy commodity prices expected to remain high, we have little confidence that these volume declines will abate anytime soon. This makes our efforts to drive out costs and add new business all the more important. It also means that a disappointingly high level of our cost saves are being offset by the inevitable fixed cost deleverage we experienced as volume declines.

We offset some of the category weakness in the second quarter through the addition of new business. As a result, we gained share and outperformed the industry on a volume basis in the quarter. Unfortunately, this quarter's sharp erosion in category volumes, nonetheless, led our milk volumes to decline just over 1% despite our share gains.

Outside of fluid milk, most of the other dairy categories we participate in were also weak. Notably, the ice cream category was down nearly 5% on a volume basis at retail, roughly consistent with our own volume decline. Our food service ice cream mix business was also soft in the quarter. Other important categories, including sour cream and cottage cheese, were weak. When combined with the sale of our Yogurt business, this led to a Fresh Dairy Direct-Morningstar volume decline of 4% in the quarter. Soft volumes across FDD-Morningstar remains our biggest concern over the back half of the year.

Commodity inflation also continued to post challenges to the business in Q2. The Class I Mover averaged $19.83 per hundredweight for the quarter, representing a 21% sequential increase from Q1. The Class I price increased each month during the quarter. Our team did a solid job dealing with these rising cost to protect gross margins. What we failed to do, however, is to fully recover the second quarter's higher fuel and energy prices, which led to higher distribution cost and lower operating income in the quarter.

The Class I Mover has continued to rise in both July and August, and is now approaching 2007's all-time high. These higher prices, when reflected at retail, will put additional downward pressure on category volumes. Looking ahead, we expect milk prices to rise through September and then flatten or slightly decline in Q4. Overall, however, as long as the dollar remains weak, which supports the continued export of dairy commodities, we expect prices to remain near historical highs across the dairy complex.

In addition to dairy inputs, packaging, materials and energy also remained significantly inflationary on a year-over-year basis, creating additional challenges for both our business and the industry.

In spite of the steep input inflation and soft volumes, FDD-Morningstar gross profit performance in the quarter was down only 1%. Effective pricing for dairy inputs and continued reduction in conversion costs drove $578 million of segment gross profit for the quarter.

In keeping with our stated priority to be the differentiated low-cost producer, we continued to drive costs out of the business in Q2. We have announced the closure of 2 production facilities, and more than a dozen distribution branches so far this year. This helps offset soft volumes and drives efficiency through higher asset utilization.

We have also taken action to significantly reduce headcount across the business. Total company headcount today is 6% below year-ago levels and down over 600 positions in this calendar year. We also continued to drive cost out of distribution, which has used 6% fewer gallons of diesel fuel through the first half of this year compared to 2010. Our procurement and continuous improvement efforts continue to pay dividends to the business.

We also made progress toward our goal of reducing our SG&A run rate by $60 million by year end. In Q2, these structural savings helped offset general category weakness but were more than offset by surging fuel, energy and input costs.

Second quarter operating profit for the segment was $116 million. These results were 21% below year-ago level but 4% above first quarter results. We continue to see FDD-Morningstar stabilize. But unless category volume improves, we will continue to see a disappointing percentage of our productivity devoted to offsetting fixed cost deleverage as opposed to benefiting the bottom line.

Let's now turn to our other operating segment, WhiteWave-Alpro, which once again delivered strong top and bottom line growth. Top line growth is being driven by strong category trends with the creamers, plant-based beverages and organic milk categories all continuing to expand. In total, second quarter net sales grew 12% over the prior year to $514 million.

The second quarter marks the sixth consecutive quarter that all of our key product segments have posted positive growth, driven by solid category trends and innovation across the product line. For the quarter, sales in our creamers business, which includes International Delight and Land O'Lakes, increased mid-teens. Horizon Organic milk continued to build on its recent strong growth, with net sales also increasing mid-teens in the second quarter on strong category dynamics and innovation-driven product differentiation.

Silk net sales grew in the mid-single-digits during the quarter with Silk PureAlmond and the rollout of Silk PureCoconut continue to bring new customers into the plant-based beverage category. Consumers are responding favorably to these better-for-you offerings. Alpro net sales increased low-single-digits on a constant-currency basis and mid-teens on a reported basis. Alpro sales growth has slowed slightly as the economic troubles across Southern Europe have impacted sales growth rate.

The continuation of solid volume trends, operating efficiencies and effective pricing to cover inflation was once again somewhat offset by increased distribution costs at WhiteWave. As we've said earlier, WhiteWave's production capacity issues are being addressed by investment in new manufacturing facility in Dallas, Texas, the first phase of which should begin production in late 2011. Despite this headwind, total segment operating income grew 14% at WhiteWave-Alpro to $47 million.

With that, I'll now turn the call over to Shaun for some additional commentary on the financials. Shaun?

Shaun Mara

Thanks, Gregg. Good morning, everyone. I'll take a few minutes now to walk through the consolidated financial performance in the quarter from a P&L, cash flow and debt perspective.

Starting with the P&L, consolidated gross profit was $760 million, $8 million above the year-ago quarter. Essentially flat Fresh Dairy Direct-Morningstar gross profit and 8% growth at WhiteWave-Alpro combined to drive the result. On a per gallon basis, this represents a 5% increase in consolidated gross profit from a year ago, highlighting effective cost control and improved pricing despite continued volume softness.

Within operating expenses, distribution expense stands out as a notable headwind in the quarter. In aggregate, distribution expense was $22 million or 6% above year-ago levels as higher fuel costs and increased expense at WhiteWave, driven by capacity constraints, more than offset progress in our cost reduction initiatives in this area.

Total SG&A cost increased 2% in the quarter, primarily due to higher incentive compensation expense.

As we discussed last quarter, an important metric we are using to internally gauge our progress with respect to our SG&A cost savings initiatives is SG&A expense minus incentive compensation and advertising expense. Using this metric, we are $8 million below year-ago levels and making strong progress against our goal to reduce our run rate by $60 million by year end. In fact, through Q2, our annualized run rate is already over $30 million below our year-ago levels. This strong momentum gives us a high level of confidence in achieving our goal.

Interest expense increased $15 million from the year-ago period. The increase is the result of higher average interest rates, partially offset by lower average debt balances. For the full year, we continue to expect interest expense to be between $255 million and $260 million.

Net income of $32 million resulted in second quarter adjusted diluted earnings per share of $0.18.

Turning now to the cash flow and balance sheet. Net cash from continuing operations through the first 6 months of the year was $180 million. Year-to-date free cash flow is $61 million, which includes capital expenditures of $119 million. From a working capital standpoint, our net working capital investment was essentially flat for the quarter despite the significant increase in dairy commodities that Gregg mentioned. Even with these significant headwinds, we've been able to minimize working capital investment and have delivered a 1.2-day improvement in our cash conversion cycle as compared to Q2 of last year.

In addition, cash available for debt reduction was augmented by the receipt of $62 million tax refund, as well as the sale of 2 yogurt businesses. This was partially offset by the payment of $30 million for the settlement of the Vermont litigation. The net of all this was a $262 million reduction in our debt and brings our total outstanding net debt at quarter end to $3.7 billion.

Our quarter-end leverage ratio of funded debt-to-EBITDA, as defined by our credit agreements, declined to 4.95x versus 5.14x last quarter. We continue to expect to end the year below 4.75x after possibly stepping up modestly in Q3. With this, we expect to end the year more than a full turn below our maximum covenant of 5.75x.

I should note that with respect to the Tennessee litigation, we took a pretax charge of $131 million in the second quarter. This charge is added back, for covenant compliance purposes, under our credit agreement.

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

Gregg Engles

Thank you, Shaun. As we've said, at a high level, many of the trends that we've discussed in previous quarters continued. WhiteWave-Alpro continues to perform well with solid sales growth across the top line and operating leverage resulting in bottom line momentum. We continue to expect full year segment operating income to grow in the low- to mid-teens at WhiteWave-Alpro.

At Fresh Dairy Direct-Morningstar, costs continue to come out of the business across the supply chain as well as in core SG&A. Our teams are working to deal effectively with rising commodity costs.

Consistent with our previous comments, our biggest concern over the balance of the year continues to be volume weakness across conventional dairy categories, which has worsened in recent periods. Due to the heavy fixed-cost nature of our business, relatively small changes in volume drive meaningful lot changes in bottom line performance. We believe a recovery in volumes will not happen until the employment and picture improves, particularly among the less affluent who continue to struggle.

In the interim, our best course of action is to continue to drive structural costs out of the business to offset the deleveraging effects of soft volumes. Assuming relative price stability, the rate at which our cost saves fall to the bottom line will, in large measure, be driven by the rate of volume declines in the category.

Given current category performance, we expect the new business we added in Q2, a more stable pricing environment and our cost reduction initiatives to drive continued stabilization into the third and fourth quarter, with normal seasonality driving stronger performance in Q4. This, combined with expectations for continued solid growth from WhiteWave and Alpro, and the accumulating benefit of our SG&A cost reduction initiatives, should result in earnings consistent with, to a bit above, 2010 levels in the third quarter. We expect to return to year-over-year adjusted earnings per share growth in Q4.

More specifically, for the third quarter, we expect dilutive -- adjusted diluted earnings of between $0.12 and $0.17 per share. With this in mind, we reaffirm our previous full year guidance of between $0.67 and $0.75 per adjusted diluted share.

Many aspects of our business are slowly improving. Volume, however, continues to erode at a quickening pace. Despite this volume softness, we are confident that we are focused on the right areas to drive shareholder returns going forward.

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 comes from the line of Alexia Howard with Sanford Bernstein.

Alexia Howard - Sanford C. Bernstein & Co., Inc.

Two quick -- 2 questions. First of all, the Class I outlook, the way that you see it shaping up to this year, might we see some sort of moderation in the fourth quarter? And then as a link to that, is it possible that we might see an overhaul of the way that Class I milk price is stacked, as part of the fondue in 2012, that might reduce volatility? That's the first question on Class I milk. And then secondly, what are you seeing in the retailing environment? It seems to me that the issue now is more the consumers having to deal with these very high prices. But are you getting much pushback from the retailers if you pass the milk prices through?

Gregg Engles

Okay, let's -- let me take those -- I'll try and take those in order and if I get up-track, you can reel me back in. As to the milk price expectations going forward, increasingly, Alexia, really starting in 2007, our milk prices have begun to be set more by what's happening in the global market for dairy commodities than the domestic supply and demand balance in the United States, which was the traditional driver of milk price up until that point in time. What we have seen over the last 2 quarters, at least, is international prices, driven partly by the supply-demand balance globally, and partly by the decline in the value of the currency, pulling these milk prices consistently higher towards these very high, historically high levels. If you look out into the international market place and the forward international market place over the balance of the year, you could convince yourself that you would see prices abate somewhat in the back half. I think the real challenge that's emerging to that point of view today is what we're experiencing in terms of our U.S. weather right now, these very extreme temperatures and its effect on domestic supply. So it's a little bit of a cloudy picture right now, but in terms of what we can sort out of all of that noise, we believe these milk prices are going to stay high through the back half of the year. We'll be pleased if we get some abatement in Q4. We've built a small amount of abatement into our outlook, as we said in our prepared remarks, but not a lot of abatement in those prepared remarks, in our outlook. As to passing milk prices along, we've said this, probably, on every call that we've had going back for 15 years, but we're pretty effective at passing along the price of milk to our big customers. So most of these relationships are, either formally or informally, a formulaic relationship, where the price of milk gets calculated as it's announced and passed on to -- into the marketplace, certainly as it relates to private label products. And when you look at our gross margin line performance this quarter, you can see that we passed along the cost of milk, because what's in that gross margin line is the cost of raw materials and conversion. And so we recovered other than the normal friction that you have on the way up and on the way down. So we are encountering the friction as a negative way on the way up. We recovered the milk price increase. Now there are nuances around that, so our branded products, we pay attention both to the underlying inflation in the raw commodity but also price points that these branded products hit at retail. So although we start pushing up against the price point like $6 a gallon, which we are in some markets. We start to be more cautious about passing through all the raw milk commodity as it relates to our brands just because the negative implications of elasticity sometimes outweigh the cost recovery. So that inevitably happens as we pass through certain price points on the way up. At some point in time, the prices get so high, you have to take it anyway and you just move on but there's a little bit of a step function changes that relates to that. And then on our up-and-down the street price list-oriented business, there's not so much of a formulaic mechanism for passing price along, it's governed a little bit more by the up-and-down of the street competitive dynamics in the marketplace. But, again, just looking at broad measure at the gross profit line, we recovered increasing milk prices here. There's clearly, in the volume declines, a meaningful part of not only economic stress but also just elasticity in the marketplace. If you go back to 2007, before the economic crisis when milk prices spiked to this level, that's the quarters where we saw the highest percentage decline in the category ever at 2.1% in, I believe, in Q2 or Q3 of 2007. And that's just a function of sticker shock at the shelf. So there's a piece of that here too. Milk prices are getting higher than they've ever been, and consumers are naturally reacting to those very high prices as they confront it at the shelf. Finally, as to whether or not we're going to hit more or less volatility out of milk price reform, I've been going to Washington and we've been going to Washington for almost 20 years now, trying to argue for a more logical, more transparent, more manageable milk price environment and have yet to have anything that looks like success. Because these farm programs and dairy, they've been in place over 80 years, have constituents that they benefit and constituents that they don't. And moving this regulatory scheme confronts the hard political realities that you're going to be taking something away from somebody as you do so. The budget pressures that exist today, I think, create a somewhat better opportunity to move these programs. But frankly, what I read coming out of Washington and the positions that the parties just taken out, in this debate, specifically around milk, are not encouraging as it relates to significant reform of the system. So what we really hope to do is avoid it getting worse in the first instance, and there are proposals out there that would make it worse for us, including supply management proposals, which would enshrine, I think going forward, high prices. So we're working the issue hard. I don't think we should look at it as an opportunity to take a lot of volatility out of the system.

Operator

And our next question comes from the line of on Amit Sharma with BMO Capital Markets.

Amit Sharma - BMO Capital Markets U.S.

I just wanted to focus on the diesel fuel energy-related costs. Did I get it right that they were $22 million negative in the quarter?

Shaun Mara

Approximately, yes. A little less than that.

Amit Sharma - BMO Capital Markets U.S.

So going forward, are those costs something that you expect to recover as you're able to pass them through in the back half? Or is that -- is it nonrecoverable going forward?

Gregg Engles

I think it's -- I think, over time it tends to be recoverable because it hits everybody's margin in the industry and it gets reflected in their profitability and they ultimately seek to recover it from the market. It is less formulaic across the totality of the business than milk is. It is increasingly becoming formulaic with larger customers because they understand the impact it has on your business, but it is less so than milk. So it takes longer to recover than milk price does. So there's clearly a lagging effect changes in diesel fuel cost.

Amit Sharma - BMO Capital Markets U.S.

And that's something I want to know, we have heard other food manufacturers say that they are spacing lagging price increases that they're not able to recover so I just wanted to distinct in the 2. On the volume side, I mean, clearly weak volumes are deleveraging your fixed costs. But I just wanted to get a sense of, let's say your raw milk, wholesale milk spread remains stable. I mean, we saw improvement from first quarter, but let's say it remains stable, how much of a volume in decline can be offset by the $100 million cost saving coming through next year? Or in other words, how much volumes need to decline to completely offset the cost savings that are coming through?

Gregg Engles

Well, this -- like the analysis given in response to most of these questions on the call, this won't be complete enough for you to get to the right answer but it's the best we can do in a short period of time. If you look at it on average across all of our volume, keeping in mind that we have significant differences between private label, white milk and ice cream and all of our product line, we have closed to $1 per gallon contribution margin across our product portfolio. So the instantaneous cost, if you will, of declining volumes is you lose that $1 of contribution on average if your entire portfolio is contracting at the same rate. And that's -- it's not all -- you can variabilize those -- that contribution margin and take fixed cost out over time, but in the instantaneous case, it's hard to do. So if I'm only taking 950 gallons on a route instead of $1000 -- 1000 gallons, the cost of the route is the same. And my shipping in my plants, because this is spread like peanut butter across the portfolio, is the same on an instantaneous basis. So that should help you sort of dimensionalize what the impacts of negative volume are.

Amit Sharma - BMO Capital Markets U.S.

It certainly does. And my final question is on the branded premium, I mean, you indicated that the price gap have narrowed between private label and branded. So the fact that your branded margins have declined, is that just elasticity that you alluded to or is there more to it?

Gregg Engles

Well, I think what I said in response to Alexia's question is that, as the certain of our most premiumly-priced brands, we didn't necessarily push through all the price increases because of the price point at retail in Q2.

Operator

Our next question comes from the line of Farha Aslam with Stephens Inc.

Farha Aslam - Stephens Inc.

Just a quick question on where you think volumes are expected to go going forward. And third quarter, did you show us where you think kind of how volumes in FDD-Morningstar are expected to be?

Gregg Engles

Well, what I can tell you is what we've seen so far, which is volumes continue on this pretty significant soft trend that we saw in the first half of the year. So we're through effectively 1/3 of the quarter and volumes continued to be down sort of in the milk category, in that kind of 1% to 2% range. At retail, volumes are quite a bit softer than that. So if you go pull the IRI data on large-format retail, they're down 3.5%, 4%, 4.5%, 5%. So volumes are incredibly soft are retail. Now food service volumes, [indiscernible] volumes tend to be a little stickier so less of a decline in those channels but at retail, you can get at the numbers pretty easily.

Farha Aslam - Stephens Inc.

And on the fourth quarter, you're expecting a mitigation of the volume decline, is that really reflecting the fact that you're thinking you could have maybe some better pricing on the shelf because of the forward milk curve? Or do you...

Gregg Engles

No. Actually, I don't think in Q4, we are expecting a mitigation of the volume decline. I don't think we said that.

Farha Aslam - Stephens Inc.

Okay. So it's still going to be soft in the fourth quarter?

Gregg Engles

Yes. It's going to be soft because these prices are still going to be, in all likelihood, over $20 on the Class I Mover.

Farha Aslam - Stephens Inc.

Okay. And so in the third quarter, is third quarter earnings are coming in, in line with what you were thinking of or slightly lower? Because they're coming in slightly lower than what I was looking for. That makes the fourth quarter tough. So what gives you confidence in making your fourth quarter numbers?

Gregg Engles

Well the fourth quarter, typically, is just a seasonally very strong quarter. So first of all, for WhiteWave-Alpro, it's far and away their strongest quarter. So and the third quarter's really WhiteWave-Alpro's weakest quarter of the year. So you'll see a very significant step up in operating profitability in WhiteWave-Alpro from Q3 to Q4, which is really the biggest driver of the outperformance in between the 2 quarters among the platforms. And then the FDD-Morningstar business, while in terms of volumes, is not necessarily the strongest quarter, it's a good quarter in terms of mix. So with all the holidays in Q4, we skew more heavily toward creams, creamers and a higher value-added portfolio of product. And so it's just a better quarter. It's not being driven by the changes in the expectations around volume in liquid milk in Q4.

Operator

Our next question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

Gregg, I think you've talked about pockets of competitive pressure that you've started to see in the quarter just given the industry volume weakness. Can you just give us a little bit more color as to maybe regions or how widespread that situation is? And then just in terms of the -- given the volume weakness, what are you seeing in terms of the capacity in the industry?

Gregg Engles

Well, with respect to the level of competitive intensity, I think in general, I would characterize it as not different than Q2 and Q1. It's episodic, it's not concentrated in any particular region. When it raises its head, its impact is largely a function of the particular costumer or segment at issue and how much volume is associated with that customer. But it's not widespread and I'm hopeful it won't spread more broadly simply because I do think we're kind of at margin levels in the industry where there's just not a lot of opportunity to sell it for less. However, I think your question gets at the right issue which is how confident do you feel about that in an industry where over the past quarter, year-over-year, we created 2% more capacity than existed in 2010? And now we're well into the second year of these volume declines, and so overall capacity over that period is now up bordering on 3.5% or 4%. So the issue is, I think, it gets to your final part of your question, are we going to see that excess capacity manifest itself in pricing continuing to degrade or in capacity leading the industry? We're taking capacity out, frankly, as fast as we can get it out of the network. We're starting to see other people or hear that other people are considering taking capacity out of their networks as well. But most of these companies are private so they don't tend to announce it as clearly as we do. But we understand there's some plants closing in the Midwest. We've seen plants closed in the Southeast. We know that plants are being offered for sale in various parts of the country. If those sales processes don't result in transactions, you may well see those facilities close. So there is definitely a higher level of conversation and noise around capacity in the industry than has existed in the past because I think industry participants are beginning to come to the conclusion that some of these trends are less cyclical and more long-term trends than they might have thought when we entered into this period of decline beginning with the great recession. So I'm hopeful it comes out of capacity but I'm not going to make that call with it just to see the amount of confidence at this point in time.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then just -- I know it's a little bit too early but if we think about 2012, I mean, it sounds like this year, you have high inflation, both on the raw milk side and then some of the other packaging and fuel cost. You've got weaker volume that's also leading to operating deleveraging. And so that's eating into a lot of your cost savings. But in 2012, if we assume relatively stable cost environment, I mean, I guess the issue is just really on the volume side. But directionally, can we see more of the cost savings getting passed through next year versus this year if we assume that the costs are more stable?

Gregg Engles

It -- I'm really -- I'm not trying to avoid answering your question with specificity but I just want to -- let me just start by going back and refer you to our comments in the prepared remarks. I think how much of our savings falls through to the bottom line will be inversely and linearly correlated with what happens to our volume. So I think the underlying predicate of your question is, should the cost environment stabilize, will volume stabilize? Then therefore, will you be able to take more cost to the bottom line? And I just don't know the answer that question. Typically, in the past, if you had seen milk rise to $20 a hundredweight and stay there, as you've got 2, 3, 4 quarters into that new price environment, you would see some bounce back of the negative elasticity of the initial move up because consumers become habituated to the higher price level and they go back to their old consumption patterns, because consumption patterns are hard to change over time. What I don't know is whether that historical paradigm holds in the context of 9% in increasing unemployment, very little income growth and lots of uncertainty around the direction of the economy. So it's impossible for us to parse out how much of this quarter is virtually 2% decline the category was associated with price elasticity and how much of it is associated with the economic distress. And so it's a little bit hard to call as to what happens with volume. I can say this with absolute certainty, we're going to like it better than this environment if it just stops going up. And if it turns around and starts going down, at least, for a while, we're going to like it a lot better than this environment.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then the new business that you won, is -- first of all, can you quantify how much that was? And then, are there any other new businesses that could potentially give you some boost in the volume going forward?

Gregg Engles

Yes. Look, we said earlier on in this year that we have picked up about 55 million gallons of new business. That new business is performing quite well. So we're actually seeing volumes run higher than that. The flip side of that is we see our core business softer in terms of comp volumes period-to-period, which leads to, as I said on the call, the disappointing result that with the volume we've taken, we're still down in terms of milk gallons 1% year-over-year. We frankly had expected to be up in this period or at least flat. And I used the disappointing word a couple of times in my commentary. While we delivered an in-line quarter, I thought coming into the quarter that we could do better. And I continue to believe that we can do better, but again, the fulcrum around doing better is going to be volume. So we see the category as a whole softer than what we called. The share gain in a declining category, as you all have pointed out to me and you all know is a bit of a 2-edged sword. But we have to keep volume in our system. So we continue to look for areas where we can gain new volume in a way that is beneficial to our P&L.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then just finally on the WhiteWave-Alpro, so given that your leverage has come down a bit, any update to thinking in terms of potentially unlocking the value of that business? I know you guys went through the review in October of last year but just in terms of how you're thinking about that option at this point?

Gregg Engles

Yes, look. I think what we said early this year and late last year, we understand the value unlocking potential of disaggregating our portfolio. We understand that really clearly, and we understand the benefit of our shareholders of doing that. We've got to get to a position where we can do it in a way that in fact, unlocks value. And we still have some hurdles to overcome in terms of getting there. So really no update with respect to that other than to reiterate that we are mindful of the value creation opportunity for our shareholders. And we continue to try and move the business and its positioning to a logical place where that can be accomplished should, at that time, it continue to present value creation opportunities.

Operator

Our next question comes from the line of Chris Growe with Stifel, Nicolaus.

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

I had 2 questions for you. The first one is just, I want to ask a little bit more about the -- I think you said that it early on, I may have missed it, but the branded volume was better than private label volume in the quarter. Was that correct for you?

Gregg Engles

On a relative basis, yes.

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

Yes, okay. Okay, so it was down still, is your point. It's just better than what it was in private label?

Gregg Engles

Yes.

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

Okay. We did notice generally, branded volumes in the milk category weakening throughout the quarter. I think you also indicated that you didn't necessarily pass along all the pricing. So I'm trying to understand how you were different from the category? Did you -- because you didn't pass along as much pricing, your branded volumes were better than the category as well, would you say that?

Gregg Engles

Not necessarily. I think the point that I would make about the branded part of this fluid -- conventional fluid milk category is that, it is completely regional in terms of its geographic dynamics and is very different from marketplace to marketplace. So to sort of generalize about what happened to industry branded volumes, I think, is not particularly illuminating of what's really happening in the category. So in parts of our portfolio, where we have relatively more premium-priced bands, we struggle more than we did in places where our brands are priced much closer to private labels. So there's a little bit of a complicated mix dynamic happening in our own branded portfolio. I think that our behavior, with respect to brands across the category, is probably not that different from other players' behavior with respect to brands. They're all mindful of price points, and we're in sort of uncharted waters here, again, in terms of the absolute cost of milk out of stores. So I don't have the data handy in front of me but I would guess that our behavior is not a heck of a lot different. The other thing that I'd point out is that, when we talk about branded volume, there is also a -- there's a real channel element that goes on here. Because in the small-format channel, virtually, all of our sales are branded because the velocities just aren't high enough to support the cost of additional brand in the private label. And those are channels that are taking share from large format. So if you look at the dollar channel, to some extent, the drug channel, you'll see that -- and certainly the food service channel which is almost all branded, those categories are performing better than retail, which is putting a bit of a -- more of a foreign under our branded volume than you would see by just looking at IRI.

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

That's very helpful. I want to ask around diesel and resin costs and the effect those are having on your profitability. The question I had is that, do you anticipate pricing up to those in the second half of the year? Or your more cautionary comments on volume reflective of a cost increase you just, maybe, can't price fully to?

Gregg Engles

Yes. Look, I would say that we are trying to recover all of our inflation-imposed costs out of the marketplace because I mean, you don't have to look much farther than our operating unit profit margins to understand the need to do so in this category. And we don't have, unlike the branded food players, we don't have other line items in the P&L that are strong levers we can pull to maintain profitability in a declining-volume environment. So we need to recover inflation out of the marketplace. The flip side of it is sometimes, that's easier to say than it is to do. I would refer you on the fuel complex back to my earlier comments, which are recovery of non-milk input tends to lag the recovery of milk inputs in a rising inflation environment. But we are out there in an effort to do so in the marketplace, and I think the whole industry is under a similar source of pressures to recover it out of the marketplace.

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

Yes. And I certainly heard that point. My question just really revolved around how the volume weakness plays into that, and I think you've sort of answered that just that it can be a challenge in some markets and -- to get that pricing through itself.

Gregg Engles

Yes. But volume weakness makes all pricing more difficult. Whether it's for input inflation or just pricing generally.

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

Okay. If I could just guess one more follow-up and that'd be, in the third quarter, do you expect the FDD-Morningstar division to grow in profitability year-over-year?

Gregg Engles

I think that it will be in the same neighborhood of profitability than it was last year. I would call it flat to slightly down in terms of expected operating income in FDD-Morningstar in Q3 versus Q2 of last year.

Operator

Our next question comes from the line of Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank AG

I guess 2 questions, Gregg. With the first one is, I mean, I guess every company is dealing with the struggles of the macro environment and a tough consumer. But other companies have at least, theoretically, the ability to drive consumption via new products, advertising, what-have-you. Is there anything that Dean can do -- obviously, I'm not talking about WhiteWave because that's more kind of a traditional CPG business. But like, are you working with the retailers to try to drive consumption in the categories? Or is there anything that can be done in that regard? Or is it basically just completely a function of the macro economy and that's kind of what you have to live with?

Gregg Engles

Well, first of all, as to your commentary around CPG companies and the distinction between WhiteWave and FDD-Morningstar is apt. It's an appropriate distinction. You can see we are driving volumes, positive gross margins, significant P&L leverage in WhiteWave because it does have a lot more levers to pull, right? It has a significant advertising budget, it's got an ongoing pipeline of innovation, it's in categories, frankly, where our customer is doing better economically, on average, than the fluid milk category. And it is -- it's just a more resilient business in this type of environment than the FDD-Morningstar portfolio of businesses. In terms of what has been tried over the course of this recession, I think it does point to over the short -- to the short to intermediate term, the conclusion that we are really at the whim of what's happening in the broader macro environment. So we have been, in the last 4 quarters, from an incredibly highly promotional environment where retailers were selling milk out of store at significantly less than their cost to historically high cost, over this period of time. And frankly, in neither circumstance was there -- were there positive volumes in the category. So we've been incredibly promotional as an industry, right, vertically connected all the way through the retailers. And so price, apparently, is not going to be a significant driver here. In terms of innovation, there's lots of innovation happening in the broader milk category, but frankly it's all happening in places like WhiteWave because the purpose of the innovation is to tell the consumer that there are benefits to be had and convince them that they should be prepared to pay for them. And that requires products at higher price points and higher margins than exist in the liquid milk category. So if you look at dairy and dairy-related beverages, part of the problem in volume, over time, with liquid milk has been the success of what we're doing at WhiteWave. And so the growth of the plant-based beverage category, the shift from conventional to organic and then the shift within organic to more value added parts of that business. And then within broader dairy, there's also a meaningful shift of consumption, I think, from milk to the yogurt category. So innovation is hard in multi-serve, all-family products, and that difficulty is compounded by the regulatory environment in milk that has very strict standards of identity. So when you start altering this product, you stop being able to call it milk under the federal regulatory regime that exists today. Now I think that's incredibly outmoded, it's medieval in its thinking, but it's the thinking that persists today. And so until those sorts of things change, I think that what you're going to see is that innovation will continue to take place, and in all likelihood, it will continue to put pressure on volumes in the traditional conventional liquid milk segment.

Eric Katzman - Deutsche Bank AG

Okay, that's helpful. And then my second question, somewhat I guess unrelated, but can you just give a sense in terms of how you see both -- this year is probably pretty clear in terms of CapEx, D&A, interest -- I think you mentioned interest expense but what -- can you give us some guidance as to those 3 things for 2012? I'm just trying to get a sense as to kind of the nonoperating things and how those kind of lay out both this year and maybe just a little bit of guidance in terms of next year?

Gregg Engles

Yes. I can give you a preliminary look because we're not finished with our plans for 2012. We're several months ahead of being finalized on our plans. But directionally, I think you can say all 3 of those items, and you can adjust interest expense for the amount of debt paydown that we've guided you to this year so incremental -- incrementally lower interest expense in 2012 versus 2011. I think you can take the CapEx number and just copy it over one cell in your model. It's going to be -- it may be slightly down but basically, we're on a path of investing to take cost out of the business. And to take cost out of the business, it requires investment to close facilities, and of course, we're expanding capacity at WhiteWave. So not quantum differences in capital spending going forward, and therefore, depreciation will step up to reflect the capital that we were spending this year, just very modestly and continue to grow very modestly out into the future as our CapEx slightly exceeds our depreciation. So not big changes in the outlook for those nonoperating items in 2012.

Operator

Our next question comes from the line of Christine McCracken with Cleveland Research.

Christine McCracken - Cleveland Research Company

Gregg, just as a follow-up on the earlier question related to the impact to the hot weather on U.S. production. If you're looking for lower volumes here, at least, in the near term, wouldn't that exacerbate the overcapacity issues and the cost pressures on fluid milk?

Gregg Engles

Well, look, if price goes up, elasticity is going to move volumes down. So again, I think we've made those remarks in our prepared comments that higher milk prices will exacerbate some of the volume trends in the category. Clearly, some of what was happening in Q2 was price elasticity.

Christine McCracken - Cleveland Research Company

All right. In ice cream as well, you think that on the hotter weather, maybe, people would need a little more ice cream, right? Are you seeing kind of the same push back in ice cream or is it more a function of mix?

Gregg Engles

First of all, if you go back and just look at volume trends, the milk volume trends at retail are eye-opening in terms of the negative volumes. The volume's less negative in milk than it is in the broader ready-to-eat cereal category, it's less negative than it is in the lunch meat, it's less negative than it is in a bunch of other categories, right? So the volume trends here are consistent with what we see in broader consumption across the food industry at retail. Now as I've said in response to Eric's question, these other categories have more P&L levers to pull but in terms of volume, they're not doing any better than the liquid milk category is, by and large. So when you get to ice cream, you see ice cream is down more than milk at retail. Part of that is because ice cream is expensive. I think the heat is helping on a very temporary basis, but ice cream is expensive. And so when you've got consumers that are struggling economically, they tend to trim at the edges first in terms of the more discretionary indulgent items, and they tend to move back towards core items at a later pace. So I think it's really instructive to look at what's happening in the ice cream mix business, in the quick-serve restaurant area. The QSRs, McDonald's, some of the other guys are doing very well in terms of their overall comps because it's good value. But within their menu, you see shifts that reflect what's happening with the consumer. So their ice cream sales are not as robust as their sales are in other parts of the store, and they've done a great job of introducing menu items like this frozen strawberry lemonade that don't have any dairy in them because of the high cost of dairy. And so people are trading down to lower price point indulgences or cutting indulgences out everywhere you look across the consumer landscape. So we see that a retail ice cream is soft. We're going to get a little bump because of the heat but the basic driver there is, I think, the consumers' cut back.

Operator

Our final question comes from the line of Akshay Jagdale with KeyBanc.

Adam Josephson - KeyBanc Capital Markets Inc.

This is Adam Josephson in for Akshay. I'm sorry if I missed this earlier but last year, in the conventional milk category, sales of whole milk declined, by far, the most substantially, while in recent months, sales of all types of milk have been declining, including fairly steep declines in skimmed milk. What do you make of this trend, if anything?

Gregg Engles

I think the decline of whole milk vis-a-vis the rest of the category, is a long-term secular decline, part of it, as people move to lower-fat product. So I think that underlies the broader category trends. Within that, this is aggregated. It's a little bit tough but I think there's some demographic trends in there. Certain parts of the population have tended to over-index on the consumption of whole milk, particularly the Hispanic demographic and other folks at the lower income part of the spectrum because these products are lined-priced in many grocery stores so you get 120 calories out of whole milk and maybe 140 calories and you get 80 or 90 calories out of skimmed. So if you're trying to caloric bang for your buck, you tend to buy higher fat products, whole milk as opposed to skimmed. And the first people to get really hit here were people at the lower income part of the demographic, and they have cut back disproportionately on whole, I think you saw that in 2009. I think -- or 2010. As the recession has lingered and it has bit more deeply, I think you see everybody just cutting back a little bit. So that's why spreading through the other fat levels would be my guess. The other thing that's happening 2010 versus 2011 is milk prices are just much higher on an absolute basis at retail so that's driving negative elasticity everywhere. So that's my best stab at it.

Adam Josephson - KeyBanc Capital Markets Inc.

And one last one, to what extent do you think the growth in organic soy on the milk, et cetera, is coming at the expense of conventional milk?

Gregg Engles

A lot of it. A lot of it’s substitution. So I got 3 little kids at home. My house is filled with Horizon Organic. If it wasn't, it would be filled with my local regional brand. So in many cases, as it relates to organic milk, it's probably a direct substitute. The other plant-based beverages are, I think, highly, highly substitutable. Probably not perfectly so because, I think, we're drawing consumers into the category would've been consumers for dairy milk but a lot of people are just switching.

Gregg Engles

Well, operator, we'll wrap up with questions with that last question. Thank you, all, for joining us on the call this morning. We appreciate your continued interest in Dean Foods, and we're going to look forward to talking to you again following the third quarter.

Operator

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.

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