Dean Foods Company Q2 2008 Earnings Call Transcript

| About: Dean Foods (DF)

Dean Foods Company (NYSE:DF)

Q2 2008 Earnings Call

August 6, 2008 9:30 am ET


Barry Sievert – Vice President of Investor Relations

Jack F. Callahan – Chief Financial Officer

Gregg L.Engles - Chairman and Chief Executive Officer


Farha Aslam - Stephens Inc.

Terry Bivens - JP Morgan

Alexia Howard – Sanford Bernstein

Eric Katzman - Deutsche Bank

Brian Scuderi for Jonathan Feeney - Wachovia Capital Markets

David Palmer - UBS

Christine McCracken - Cleveland Research Company

Eric Serotta - Merrill Lynch

Pi Aquino - Credit Suisse

Chris Kraul – Stifel Nicolas


Welcome to the Dean Foods Company second quarter earnings release conference call. (Operator Instructions) And now for opening remarks I will turn the call over to Vice President of Investor Relations, Barry Sievert.

Barry Sievert

Thanks for joining us for our second quarter 2008 conference call. We issued a press release this morning, which is available on our website at The release is also available on the SEC's website at Also available at the Dean Foods website today is a slide presentation which accompanies today's prepared remarks. A replay of today's call will be available on our website beginning this afternoon.

The consolidated earnings, operating income, and operating margin information that will be provided today are from continuing operations and have been adjusted to exclude the impact of discontinued operations, costs related to the recapitalization of the balance sheet, the expense related to facility closings and reorganizations, and non-recurring items in order to enable you to make meaningful evaluation of our operating performance between periods. The earnings release contains more detailed discussion of the reasons why these items are excluded from the consolidated results, along with the reconciliation between GAAP and adjusted earnings, as well as 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 others, disclosure of earnings targets, as well as expectations regarding our branding initiatives, expected cost savings, leverage ratios, and various other aspects of our business. These statements involve risks and uncertainties that may cause actual results to differ materially from the statements made on today's conference call. Information concerning those risks is contained in the company's periodic reports on Forms 10-K and 10-Q and in today's press release.

With those formalities out of the way, I will now turn the call over to Mr. Jack Callahan, our Chief Financial Officer, who will review our second quarter financial results. Following Mr. Callahan, Gregg Engles, our Chairman and CEO, will provide additional commentary on the second quarter and provide an update on our forward outlook. Following Mr. Engles' remarks, we will open the call for your questions.

Jack F. Callahan

The second quarter marks an important return to profit growth after a very challenging year that was marked by unprecedented commodity inflation. In the second quarter both consolidated operating income and earnings per share were above year-ago levels.

The significant highlights from the quarter include diluted adjusted earnings per share for the second quarter of $0.33, 10% higher than the second quarter a year ago. Now that we have lapped the recapitalization of the balance sheet that was completed at the start of the second quarter of 2007, you should expect strong year-over-year EPS growth through the remainder of the year.

Consolidated adjusted operating profit was 3% better than the second quarter of 2007, marking a return to year-over-year growth that we expect to accelerate over the back half of the year. Overall, this result reflects the progress we have made in managing the increases in commodity costs that began well over a year ago.

Cash flow from operations was again strong in the quarter, generating approximately $96.0 million in free cash flow from operations, excluding the impact of acquisitions. Over the last three quarters we have generated over $250.0 million in free cash flow before acquisitions. Overall, we are very pleased with the second quarter and the progress we are making in 2008.

Now, let me summarize the results by business segments. In DSD dairy, fluid milk volumes increased 1.1% over the year-ago period, compared to a fluid milk category that we estimate was down slightly in the quarter, based on USDA and federal milk marketing order data. This volume growth, combined with a tight focus on cost control in solid pricing execution, resulted in DSD operating profits of $154.0 million, 9% above year-ago levels.

Net sales for the WhiteWave Morningstar segment increased 10% to $652.0 million with strong sales growth across all of our key brands and in the Morningstar business. However, operating profit of $49.0 million was 12% below year-ago levels. While the majority of the branded portfolio did increase profitability in the quarter, this progress was offset primarily by the continued challenges in the Horizon Organic brand, modestly lower profitability at Morningstar related to commodity cost inflation, and to a lesser degree, to higher SG&A expense.

Now, let me review each segment in more detail and then discuss several corporate items. As I mentioned, DSD dairy fluid milk volumes outpaced the market, increasing 1.1% over year-ago levels against a backdrop of what we estimated to be a slightly negative category. Our volumes in the quarter benefited from the relatively low category elasticity and our recent acquisitions, allowing us to return to our historical pattern of increasing market share.

Dairy commodities in the second quarter continued to be volatile, with sharp month-to-month swings in prices. The Class I mover averaged $17.80 for the quarter, a 7% sequential decline but still approximately 10% above year-ago levels, with considerably higher in-quarter volatility. And like every other packaged food company, we have also been challenged by significant energy and other commodity-related inflation.

Overall, our DSD team performed extremely well in the face of these economic headwinds. Results in the quarter benefited from the reduction in workforce executed late last fall and a continue focus on driving out costs to increase productivity.

Additionally, shrink costs and contribution from excess cream sales were modestly positive on a year-over-year basis. These factors combined to deliver operating profit growth of 9% in the quarter to $154.0 million.

Turning to the WhiteWave Morningstar segment, total net sales for the warehouse-delivered side of the business increased 10% to $652.0 million in the quarter. This included WhiteWave net sales that were 13% higher than the year-ago period, at $368.0 million.

Morningstar, which is our private-label, cultured, and extended-shelf-life dairy business, also experienced strong top-line growth in the quarter with net sales increasing 7% to $284.0 million. Highlights in the quarter for Morningstar include strong ice cream mix sales and a retail private-label yogurt business that is benefiting from some well received innovation in the probiotic area.

All of the key brands in the WhiteWave branded portfolio exhibited strong sales growth in the second quarter. Silk sales were up more than 10%, aided by increased marketing support and good results by our Plus line, particularly our DHA-enhanced product. Overall, Silk continues to expand its leadership position in the category.

International Delight net sales increased in the high single digits, even as its volume slowed a bit due to heightened competitive activity. Land O’ Lakes creamer products also grew net sales in the high single digits, primarily as a result of commodity-related price increases. Horizon Organic milk sales were nearly 30% higher than the year-ago period, driven by continued distribution expansion and innovation.

Given its impact on the portfolio, let me add a bit more color on Horizon Organic. The steep discounting of the past year related to the over-supply of raw organic milk is now over. In the quarter heightening supply across the industry resulted in increased realized sales prices. Prices were essentially on par with the first quarter of last year. However, these price increases have been more than offset by higher raw organic milk and other costs.

So far, as raw milk costs have risen substantially across the industry and the supply of milk has tightened, most branded competitors have responded by increasing their own prices. However, private-label pricing has lagged, widening the price gaps between branded and private-label offerings. The category remains highly competitive and we are carefully monitoring competitor and consumer reaction to our increased prices and the tightening overall milk supply.

Taken as a whole, the combined WhiteWave Morningstar segment is reporting operating income of $49.0 million for the second quarter, 9% ahead of the first quarter results, but still 12% below year-ago levels. In addition to organic milk, the segment was impacted in the quarter by significant inflation across a range of commodities including fuel, soybeans, and resin.

In spite of this cost inflation, the contribution margin for Silk and the branded creamer businesses continued to improve as we realized significant operational leverage in production and distribution over the last year. These improvements are overshadowed, however, by the delay in the recovery of Horizon profitability related to the significant organic milk cost inflation. In addition, Morningstar delivered lower profitability, due in part to cost inflation and the overall segment had modestly higher SG&A expense.

Now let me turn to several corporate items. Corporate expenses in the second quarter totaled $41.0 million, up slightly from year-ago results as we continue to balance tight cost controls with strategic investments in building our transformational capabilities. Through the first six months of the year, corporate costs are up approximately 1%. For the balance of the year we expect corporate expenses to increase a bit from year-ago levels as we layer in specific transformational capability and lap tougher year-over-year comparisons.

For the company as a whole, consolidated adjusted operating income was $162.0 million, a 3% increase over the second quarter of 2007. Interest expense came in at $76.5 million, down more than $12.0 million on an adjusted basis from the year-ago period as we begin to realize the benefits of our efforts to de-leverage the balance sheet.

Our current $3.25 billion portfolio of fixed-rate hedges has effectively protected our interest expense from sharp interest rate volatility this year. As of the end of the quarter approximately 87% of our debt was effectively fixed. The weighted average effective interest rate on our fixed-rate debt was approximately 6.43% as of the end of the second quarter. For the year we continue to expect interest expense to be around $315.0 million.

Adjusted diluted EPS for the quarter was $0.33, 10% above year-ago levels, as higher operating income and lower interest expense more than offset the increased share count related to our equity offering earlier this year.

Now let’s turn to cash flow. Before the impact of acquisition-related spending, free cash flow from operations contributed $96.0 million to debt pay-down in the quarter and $210.0 million year-to-date.

Capital spending through the first six months of the year was $106.0 million. Spending will ramp up as we enter the back half of the year and depending on certain supply chain and innovation of investments, could be approximately $275.0 million for the full year, a 10% increase from our previous guidance.

This successful cash flow growth, combined with our equity offering successfully concluded earlier this year, has significantly reduced overall debt levels. As of June 30, 2008, total outstanding debt stood at $4.7 billion, roughly $650.0 million lower than at its peak in the third quarter last year. Our key leverage ratio, funded debt to EBITDA as defined by our credit agreement, declined to 5.48x, significantly below the 6.25x maximum allowed under our covenant.

At year end this covenant will step down to 5.75x. At that time we expect our leverage ratio to be below 5.25x. As a result, we remain comfortable with regard to our financial covenants and we continue to focus on de-leveraging the balance sheet.

In closing, with Dean Foods returning to profit growth, I hope you agree we have made significant progress in managing through this highly-inflationary and competitive environment, which continues to pose some real challenges. Gregg will provide a bit more color on our forward outlook in just a moment.

With that, I would like to thank you for joining us today and turn the call over to Gregg Engles.

Gregg L. Engles

Overall, the business is executing well in this unprecedented, inflationary environment and our near-term results reflect this improvement. Perhaps more than any other packaged-food company, we have faced significant cost increases across a range of inputs for well over a year.

These pressures continued in the second quarter. For example, the second quarter Class I mover averaged $17.80, 10% above year-ago levels. Diesel fuel prices were up more than 50% over the second quarter of last year and resin prices were approximately 30% higher. Electricity, natural gas, soybeans and a variety of other inputs were also highly inflationary. In the face of these continued pressures, we are pleased to report a return to growth in the DSD dairy segment, and for Dean Foods as a whole.

At the same time, we continue to move forward on the larger long-term opportunity to transform Dean Foods. Let me comment on each of the business segments and provide you with an update on our longer-term strategies and our forward outlook.

First, let me begin by saying that I am proud of the job that our DSD dairy team has done through the first half of this year, and in particular in the second quarter. After the challenges of last year it’s clear that the unique attributes of our DSD dairy business and our focus on cost control and supply chain efficiency are having the desired effect.

First, one of the real benefits of operating in a category that is a true consumer staple is the relatively low elasticity of the category. Even as prices have risen substantially over the past year and a half, consumers have continued to make milk purchases and our volumes have remained relatively stable. Aided in part by our acquisitions this year, our second quarter volumes were up over 1% from prior year levels as we continue to build our share position.

Second, the industry system of monthly price adjustments gives us the opportunity to quickly adjust our prices to offset inflationary input costs. In 2007 we were effective at moving our prices to insulate us from the direct impacts of higher raw milk costs. However, we were challenged enough to move prices enough to cover indirect costs, including increases shrink costs and diminished contribution from excess cream sales.

Over the first half of this year excess cream sales have returned to more normal levels of profitability and shrink costs have become relatively neutral on a year-over-year basis as we begin to lap the dairy input cost inflation of 2007.

Additionally, our DSD dairy management team has worked to tighten our price change procedures and to improve the accuracy of our methodologies, resulting in a more effective pass-through of these costs. This allowed the DSD dairy segment to grow second quarter operating profit by $13.0 million, even as our costs increased more than $184.0 million over prior year.

Third, although the industry remains highly competitive, we firmly believe that we have long-term advantages that are unique to our company. We’ve just begun to tap our opportunity to drive supply chain productivity as we bring new levels of focus and functional expertise to bear on our manufacturing and distribution infrastructure.

We have a significant opportunity to remove excess capacity and drive asset utilization across our business and we are systematically beginning to do so. Late last fall we executed a workforce reduction in the DSD dairy segment that is benefiting results, and so far this year we’ve announced the closure of two DSD dairy facilities and one in Morningstar.

Our efforts are focused not only on people and plant productivity but also on driving efficiency in our DSD system as we employ improved routing technology and practices. Although these efforts are still in their early stages, they are already producing benefits. For example, through the first half of 2008 we used 4% fewer gallons of diesel fuel than in the same period last year, while delivering higher product volumes. This has helped somewhat soften the impact of dramatic cost increases for fuel.

These factors, combined with expectations for fairly benign shrink cost overlaps, and a more favorable excess cream sales contribution, give us confidence as we head into the back half of the year.

I would, however, give you one caveat to this improved outlook. As category pricing has risen steadily over the last year and as industry volume growth has stagnated, or turned to modes declines, we are beginning to see higher levels of price competition and higher resistance to pricing in certain areas of our business. Our industry is still plagued by a significant amount of excess capacity, which tends to rear its head as unsustainable competitive behavior, particularly in times of category dislocation. Our strategy will be to protect or grow our share position during these unsettled periods.

On the WhiteWave Morningstar side of the business, we continue to see strong net sales growth across the product line. Segment sales growth of 10% consisted of WhiteWave sales that were 13% higher in the quarter than the prior year and Morningstar sales that were up 7%. WhiteWave Morningstar continues to drive supply chain efficiency and Silk and the branded creamers are exhibiting strong profit growth, even in the face of commodity headwinds.

The redesign of our production and distribution network at WhiteWave has yielded significant efficiencies in these areas. Unfortunately, this progress is being offset by continued challenges in the Horizon brand. Although we have increased prices to year-ago levels, as the over-supply of organic milk has eased, the price increases have been mostly offset by higher raw milk and other costs. It is unclear when a recovery of profitability will occur in the Horizon Organic brand.

In addition to the progress in our financial performance for the company as a whole this quarter, we have also continued to make good progress against our transformational goals. We now have in place an excellent management team with a strong mix of dairy industry expertise and best-in-class functional experience to lead these efforts. This leadership team is clearly getting traction in its early efforts to create value as we navigate a volatile and inflationary environment.

As we work to improve near-term execution, our management team is also making good progress in mapping out our longer-term transformational strategy. We should conclude the first significant phase of our strategic planning process late this year and will have more to say about the results and implications for our continued transformation early in 2009.

Overall, we are cautiously optimistic about the back half of the year, despite the challenging commodity cost inflation we face. Our business teams are executing well. Back-half overlaps in the areas of shrink and excess cream sales should be favorable.

Hampering our confidence for the balance of the year, however, is a heightened level of competitive pressure we are seeing in certain areas of our business, as well as continued volatility in inflationary pressure across the cost spectrum.

Nonetheless, on balance we are confident our DSD dairy business segment will continue to perform well in the third and fourth quarters.

The majority of the WhiteWave Morningstar business also continues to perform well, but as discussed, the anticipated recovery in Horizon Organic is taking longer than we had hoped.

We remain focused on maintaining our leading brand position in the category, as we balance market share considerations against profitability in a very competitive market. On the whole, we are comfortable reiterating our guidance for 2008, adjusted diluted earnings of at least $1.20 per share, and for the third quarter we expect adjusted diluted EPS to be $0.26 to $0.31 per share.

With that, I would like to open up the call for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Farha Aslam with Stephens Inc.

Farha Aslam - Stephens Inc.

Could you detail for us the shrink and the comparison in the back half that you probably won’t experience again, this back half of 2009, and also the cream sales issue?

Gregg L. Engles

Let me give you a high-level commentary and then Jack may follow up with some numbers. Effectively where we are on shrink is we expect to be neutral with respect to shrink as it relates to the back half of 2007.

Maybe slightly advantaged if milk ends up being cheaper in the back half of 2008 than it was in 2007, but I guess the most important point there is we’re lapping these very difficult shrink overlaps and as we make progress across the rest of our business, I think it will support a return to higher levels of profit growth.

On the excess cream sales issue, you will recall that in the back half of 2007 the industry found itself in an unusual position where the price of powder was really driving the price of milk and the price of cream, or the price of butter fat, was relatively low.

Therefore, the price that we paid for the milk that ended up in cream, as compared to the value of that cream in the market place, was inverted with respect to its historical norms and the cost reduction, or the profitability, from those cream sales diminished, or were evaporated, in the back half of 2007.

2008, that situation has returned to normal. It is fat rather than skim, or powder, that is driving the price of milk and so the realization we are getting from our cream sales is returning to more normal levels, which is of course impacting our profitability in a favorable way.

Jack F. Callahan

Just to put some rough quantification around it as far as in the second quarter, the improved realization from cream sales probably contributed about 25% of the profit growth in the DSD dairy segment. And in just absolute dollars, we would expect that benefit to step up a bit in the third quarter, just given the incredibly challenging time we had in the third quarter of 2007. So, it will probably step up in the third quarter.

Farha Aslam - Stephens Inc.

My follow-up question involves your workforce and plant rationalization. How much do you expect that to save overall in 2008?

Gregg L. Engles

Well, the plant closures will really be more of a 2009 impact because they’re happening late in the year of 2008. So, you will see the charges associated with those come through the P&L in 2008 but the benefits really will be 2009 benefits.

The workforce reduction, I think we communicated this at the time of the reduction, had a net positive benefit on the order of $30.0 million or so in terms of reduced costs. And frankly, we’ve held that benefit as we’ve come into 2008, so the reduction in force was a very effective cost reduction move for us as we came into 2008.


Your next question comes from Terry Bivens with JP Morgan.

Terry Bivens - JP Morgan

The first question, you know, Gregg, cheese has clearly come down here, kind of in an unexpected fashion, but butter has gone up now to somewhere around $1.65, the last time I checked. Obviously that has helped the cream sales but my question is this. It seems to be a help now, but as we move, particularly into the holiday cooking season, etc., at what price level does higher butter costs begin to be a worry for us instead of the current benefit on the cream side?

Gregg L. Engles

It is a two-edged sword. We’ve got a business, particularly at Morningstar, that is a significant user of cream and that business is also seasonal and skewed toward the third and the fourth quarters.

So your point that higher fat costs have a drag on that business is an accurate one, it’s one of the things that makes us somewhat cautionary about the back half of the year.

We are, however, beneficiaries of the higher fat to the extent that we’re selling cream. So, sometimes we have benefits that offset it. But I think your point is basically a fair one, that in the back half of the year it’ll be at a minimum, less favorable than it has been in the most recent periods as we begin to use more fat for our seasonal businesses.

I will say that, at least in terms of what we’re seeing as it relates to fat today, we anticipate moves in the fat market in our pricing. And so unless the moves get dramatic, it doesn’t make us feel particularly uncomfortable about the back half.

Terry Bivens - JP Morgan

My follow-up would be this. I suppose you could argue yesterday the stock got a little bit ahead of itself. Today I suppose, judging from the way it’s behaving, there may have been some disappointment, you guys did not raise guidance for the year. You know, particularly as we look at cheese has obviously come down, which I guess at some point is going to have an effect on milk prices. We seem to be seeing some rollover in the oil prices, ditto natural gas.

So I guess the question would be, as you look into the second half, the decision not to raise guidance, is that more a function of the volatility that we’ve seen lately? Is it more a function of, I guess you guys are kind of congenitally conservative on your guidance, but if you could just kind of address that point a bit.

Gregg L. Engles

I think it’s a fair question. The last five days in the global commodity markets have been a good five days, so I will openly acknowledge that if the trends of the last five days hold, that will be good for us and will probably lead to better performance than we have communicated to you.

I think, however, it would be unreasonable to expect that we would bake five days worth of good news, in these unbelievably volatile commodity markets, where prices move up as fast as they have moved down over the last five days, into a commitment of better earnings over the back half of the year. We could wake up tomorrow morning, oil could go up $13, cheese moved down $0.26, it’s moved up just as fast in periods over the last 18 months.

So, we’re simply not going to take the bait of five days worth of good news and come and tell you that the risk of moves in the other direction have disappeared and we can commit to that flowing through to the bottom line. That would just not be a prudent path for us to follow. But your basic point that, if in fact these trends hold, that we should do better in the back half, I unequivocally agree with.

Hopefully that covers the waterfront on that question.


Your next question comes from Alexia Howard with Sanford Bernstein.

Alexia Howard – Sanford Bernstein

Could I ask about your plans for pricing and marketing on the Horizon milk brand going forward? It seems to me that in this kind of weak consumer environment, we’re going to see some trade down to private label, particularly on higher-priced products like organic milk. So how do you feel about how hard you have to fight to maintain your share today versus preserving the profitability or returning to profitability on that segment?

Gregg L. Engles

This is a question that has been asked for several quarters now and to which I think we have given a consistent answer, although the longer it goes on, the more you have to continue to ask yourself the question.

This is a category that is continuing to grow volumes between 25% to 30%. So it’s a category that continues to have a lot of resonance with consumers, even though it’s high priced and even though we’re in difficult economic times. So that set of facts has led us to choose to defend our share in this environment because we believe that the category will be important to our overall dairy business, and increasingly important as time goes by.

However, it is taking longer for this category to move towards the levels of profitability that one would expect it to have than we would have hoped. So at this moment in time we are continuing to invest to maintain the health of our business in terms of volume and its position with consumers.

The other brands in the category appear to be doing the same thing, but we do see a strong move on the part of retailers to gain share by holding pricing on private label in this environment. And frankly, today, that’s the biggest constraint on profitability in the business, is widening price gaps between the brands and private label.

Based on our understanding of the business, it seems to us that the retail community is, frankly, investing heavily in private label share. Because given the dynamics of raw milk price and price levels for private label, it seems that it’s very difficult for them to be profitable at these levels. So how long that dynamic plays out is a question I wish I had a better answer to, I don’t. And today we continue to believe that maintaining our share of the category will be important for the overall profitability of our business, long term

Alexia Howard – Sanford Bernstein

And just as a quick follow-up, sticking with the private label trends but moving onto the DSD fluid milk business, how are trends going there in terms of private label, both in terms of pricing and share gains. What are you seeing in terms of consumer behavior and trading down?

Gregg L. Engles

We continue to see significant consumer trade-down from brands to private label. In fact, the trends show no signs of abating. And that continues to be a headwind for us in our DSD dairy business.


Your next question comes from Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank

A quick follow-up on Alexia’s question on the Horizon Organic business. Given the profitability trends, Jack, do you expect to have to take a re-assessed amortization and potentially take a charge against that business, given that it seems like the profit outlook just kind of hasn’t met up with expectations when the business was purchased.

Jack F. Callahan

Eric, that’s an exercise we tend to go through as part of our year-end look in terms of what’s on the balance sheet. Based on our understanding of the economics of the business, we still believe that people are going to make money across the industry and at some point in time more sustainable book pricing and input cost levels will emerge and we still believe over the long term this is going to be a nice profitable business and while we’re paying an investment now, we have a nice share base on which we hope to benefit for the long term.

Gregg L. Engles

And a very significantly growing base of volume.

Jack F. Callahan

So we’re obviously going to look at that carefully but I would not point to anything eminent on that issue.

Eric Katzman - Deutsche Bank

And switching a little bit, Gregg, to kind of bigger picture and some of the comments you made earlier. As I’ve observed the company over the years, all in, including corporate expense, when quarters are decent you tend to put up an EBIT of around $160.0 million. So not looking at the recapitalization and the impact of interest expense, it seems like that $160.0 million, you kind of recovered to that level this quarter despite the challenges in Horizon Organic.

I guess the question is, what takes that $160.0 million beyond the vagaries of input volatility, whether it’s favorable or not, what takes it to the next level? I assume it’s this big centralization effort and given all that you’ve looked at and the people you’ve hired, are you more optimistic, less optimistic, roughly in line with the numbers that I think you gave at Back-To-School or Cagney, maybe a year or two ago.

Gregg L. Engles

First of all, as to the overall level of profitability of the business, we had a very good quarter in Q2 of 2008. In fact, if you go back and look at our DSD group profitability, it was the best quarter in aggregate profitability that we’ve had since early 2006 and 2006 was a very, very strong year in our business.

So, again, you have to take the impact of the recapitalization out, in terms of the bottom line EPS number, but we had a very strong quarter of performance and, frankly, we feel good about where we are going into the back half of the year in that regard, with the exception of this heightened competitive level of activity, which, frankly, we just see in this industry from time to time, particularly when you get big significant shifts in the cost of the commodity and people scramble to re-establish their profit tools.

We are, I think, in terms of our underlying levels of performance, pleased with where we recover to and, frankly, how quickly we have recovered to this position. Taking it forward is, I think as you correctly assumed, is going to be a function of driving costs out of the system.

And my overall perspective on driving costs out of the system is the opportunity is every bit as big as I have historically believed it to be. And I do believe that, different than two years ago, we today have a leadership team in place capable of getting at the opportunity in a reasonable time horizon. As that team has got on the ground, learned the business, and, frankly, started to build the teams below them, which is essential to executing the plans that we’re developing today, the one change that I would have, or the one piece of better information I would say that we have today as a company is it’s probably going to be a more sustained, consistent effort that’s going to take a longer time horizon. It’s not going to be a big phase shift in one or two years.

This is a multi-year program, as we’ve been communicating for the last few quarters, that is going to pay out over a number of years. The part about that that I like is that I believe that we’re entering a period of sustained, meaningful profit growth by virtue of transforming the way that we go about this business, that will play out over an extended period of time.

But the opportunity is every bit as big as we have believed it be and, frankly, as we bring a more sustained effort at understanding the opportunity and scoping it, we are finding places where we hadn’t even anticipated where we think we have the opportunity to grow profitability in our business.

So, in terms of our long-term outlook, we’re very encouraged by our prospects. It’s going to take a lot of work, it’s going to take a meaningful amount of investment, it’s going to take a significant period of time for it all to play out, but we like the hand that we have.


Your next question comes from Brian Scuderi for Jonathan Feeney with Wachovia.

Brian Scuderi for Jonathan Feeney - Wachovia Capital Markets

Quickly touching on Alexia’s question earlier, since it seems to be a core of focus for the segment, could you give us an idea of how your market shares trended in the quarter for Horizon?

Gregg L. Engles

It ranges around 40%.

Brian Scuderi for Jonathan Feeney - Wachovia Capital Markets

I’m looking at Slide 6 and I’m wondering if some of the volume growth in DSD would be attributed to a pick up in food-at-home consumption, in your opinion, and did acquisitions have a notable impact to that number at all?

Jack F. Callahan

As you may remember, we did complete three acquisitions earlier in the year and they did contribute to that volume growth. Without the benefit of the acquisitions, we were still gaining share but our growth was flattish. Still better than the category but then the acquisitions added about another point of growth.

Gregg L. Engles

To the food-at-home and foodservice point, there clearly is a shift of consumption, particularly from the casual dining segment, to at-home consumption. We, I think, are about equally penetrated in both of those categories. So to the extent it helps us it would be only because people consume more dairy at home rather than their having a different locations for their meals. That may be true but I don’t think you can probably find it in the numbers.


Your next question comes from David Palmer with UBS>

David Palmer - UBS

I have kind of a soft question on the price gaps between conventional milk and organic and the switching that you think may be going on there. You know, I think I’ve seen that hormones were the number one thing that organic milk consumers were looking to avoid, and this was a year or two ago survey that I say this in, and I see now that many conventional milk brands are reminding us that they are hormone-free on the label. I’m wondering whether you think consumers, at certain price gaps, are feeling more free to trade down or feeling perhaps from an attribute perspective that they can kind of get what they want from conventional milk more today than maybe yesterday.

Gregg L. Engles

I think to some degree the horse is kind of out of the barn on what organic stands for. So, in the beginning, the early stages of development of the category, I think it was a lot about hormones. I think hormones are still important but I also think that organic has come to stand for more.

It’s come to stand for a more earth-friendly form of agriculture, it’s come to stand for animal welfare, it’s come to stand for no pesticides and fertilizers. It’s come to stand for a life style, to some degree. And so sort of the belated recognition on the part of the conventional milk industry, that consumers would prefer to have their milk with less externally-introduced hormones in the animals, hasn’t really changed the dynamic.

So what, at least today, continues to govern the growth of the organic category, frankly, seems to be overall level of price, so there’s only a certain sub-set of consumers that are candidates, given the price level, and the amount of supply. So the industry, for the last several years, has sold all that it can produce. That continues to be the case today. The available supply is being sold.

And so if there is a trade away from organic, sort of those people who are struggling to afford it, we don’t see it in the numbers because there’s not enough supply anyway.

Intuitively, your argue makes sense, I won’t say that it doesn’t. So hormones are clearly an important factor in the overall construct of what the organic consumer is looking for, but it’s not one that we can see in the data today.

David Palmer - UBS

Secondly, you talked about the private labels, supermarkets, it feels like they might be trying to demonstrate value. We’re hearing a lot about channel migration that’s going on to Walmart and certainly Whole Foods showed some major slowing down with its comments. Basically, are we talking about many of these chains trying to use private label milk as their way to show the high frequency purchase value and that’s essentially the big dynamic that’s going on right now, that certain chains are really using this as a loss leader to get the basket ring that they want and the traffic frequency that they want?

Gregg L. Engles

I think certainly that is happening. Retailers are so varied in their strategies that I think it’s hard to pigeon-hole it in terms of any one strategy. So, Safeway is very intent on building the O brands, I think not so much from a value perspective as from an overall store image perspective. They’re kind of targeting a higher end demographic than some of the other chains, but they clearly are pushing their private-label organic offerings significantly. You’ve got other chains that are pursuing more of the value positioning that you described.

But a lot of them are finding reasons to invest behind their private labels, across both across the conventional and the organic spectrum. And clearly that is, at least as long as the consumer is under the kind of pressure the consumer is under in America, that’s going to change the dynamic of every food category out there.

And we’re feeling the effects of it, no question about it. Both in the conventional and the organic sector.


Your next question comes from Christine McCracken with Cleveland Research.

Christine McCracken - Cleveland Research Company

I wanted to clarify one point. On the shift from branded to private label, you’re not at this point seeing any significant shifts from organic to conventional, is that right?

Gregg L. Engles

Again, not that we can see in the data. Pretty much the organic supply is being sold.

Jack F. Callahan

And the consumer work we’ve done, from the segmentation that was done in organic, the Horizon Organic consumer really is not making that trade-off. And it’s going back to Gregg’s earlier point, more looking at holistic benefits. It’s not just about hormones, as yet.

Christine McCracken - Cleveland Research Company

Just looking at the supply-demand balance today, you know, we had a big increase in feed costs during the quarter and obviously the organic milk producer is being squeezed like the conventional milk producer. Can you talk about if you saw any significant supply issues on the organic milk side during the quarter, if you feel comfortable with your supply arrangements, if you’ve seen any kind of change there.

Gregg L. Engles

I would say that the overall dynamic, in terms of the seasonality of this business, is different in organic than it is in conventional. So, there’s a high-pasture requirement for organic animals. And in the second quarter, they’re all out on pasture. So, the feed issue is not a big issue in Q2. It will become a big issue in Q4 and Q4 and, frankly, that’s where we expect to see supply growth in organic meaningful slow.

So I expect to see supplies tighter and the dynamic of this category change as we move into Q3 and Q4.

Christine McCracken - Cleveland Research Company

That essentially could be when the private-label organic players could be forced, at that point, to increase prices. Is that fair?

Gregg L. Engles

I think that you will see their costs go up meaningfully as we go into Q3 and Q4. I don’t know what kind of contractual relationships they have and how long they may be locked on a given price level, but clearly costs will go up and the overall level of pricing for the raw commodity is going to go up in Q3 and Q4.


Your next question comes from Eric Serotta with Merrill Lynch.

Eric Serotta - Merrill Lynch

Just wanted to fully beat this horse dead on the Horizon Organic side in terms of profitability. More broadly you have been pursuing a strategy of defending market share at the expense of profitability for now 2 ½ years or so. Given the category is experiencing such robust growth rates and given the growing importance of private-label organic to retailers, even before these uncertain economic times, could you give us some insight into your thinking as to why it wouldn’t make more sense to perhaps cede a little bit of market share to competitors for the benefit of profitability? Is it the economics of producing the milk, in terms of the Frupac or your contractual purchases or is it more of a strategic view as to maintaining share, and why?

Jack F. Callahan

One point of clarification before we talk about the strategic element. It has really only been one year that we’ve invested behind the Horizon Organic. You may remember, WhiteWave had pretty strong profit growth in the first quarter of 2007. We started to make this investment, started to ramp up in the second quarter of 2007. So we’re just now beginning to lap that as given the over-supply last year.

Eric Serotta - Merrill Lynch

It seemed that before you invested, before 2007, I believe it was 2006, you invested a significant amount in a period of under-supply of organic milk and not fully pricing for the surging raw organic milk costs. So that’s what I refer to in the 2 ½ years.

Jack F. Callahan

In 2006 the WhiteWave segment posted 20% profit growth. So it had a solid year and in that year Horizon made its fair contribution to that overall profit growth. What really led to this investment was really this incredibly unusual over-supply that came together around the second quarter of last year.

And then we made the choice at that time to really go and to defend our share position, which, over the year, has worked. It really has solidified our share. The other branded competitors are now at price parity to us and we’re trying to solidify that branded position.

On a go forward basis we’re going to continue to monitor this. We don’t want to sell off share to make a quarter when it may take a quarter or two for the overall economics of the industry to sort of catch up. And that’s why we’re staying on top of it and watch it very carefully.

Gregg L. Engles

I think the question has been asked several times, and I’ll just reiterate, I guess the high-level answer and maybe give you a little bit more detail behind it.

But the category volumes here are growing 25%. This segment of the category is going to be a meaningful part of the overall dairy business. We have a share that is commensurate with our overall share in the industry and we think it is important that we continue to participate in this rapidly growing segment of the category, at least commensurate with our overall share of the category.

So at some point in time, this thing is going to revert to a level of profitability that at least looks as good as the conventional category. And if we under-invest in our share or the growth, we will suffer at that point in time.

So, now the longer it goes on, the more you have to ask the question. We continue to ask the question of ourselves. But that’s the position we’ve taken over the last year and that’s where we still are.

I will give you some of the nuances here, also. This is a business, that because of the growth rates and the unique nature of supply, that you have to plan for your expected volumes well out into the future. So we’ve got to get the industry, or our supply base, to put more cows on the ground that are organic to produce the volume that we expect out of our share of the category going forward.

And that’s an investment you make years in advance of the milk showing up. So at some level you’re kind of trapped in a longer-cycle planning exercise here where you’re making commitments for milk that once it arrives, you also need to sell. It becomes expensive not to sell it. So if we were going to cede share, we would start to planning to do that well in advance of it happening because we have to start cutting back on future supply growth. It’s got some complexity to it.

Eric Serotta - Merrill Lynch

In terms of your third quarter guidance, I see that it is down sequentially from the second quarter, still very nice year-over-year growth, but could you give us some insight why the third quarter should be down sequentially? It seems that raw milk, conventional milk prices, are probably tracking within the realm of flattish, not looking for any major spikes there. I know that there is some seasonality with the fourth quarter being particularly strong, but I don’t remember historically the third quarter being historically weak in terms of volumes. Could you just clarify that?

Gregg L. Engles

Let me give you a high-level and maybe then dog down a little bit deeper. Typically the second quarter is our strongest quarter of the year. Ice cream business is spooling up, schools are still in session so milk volumes are probably their highest of any quarter during the year. You’ve got Easter, typically, so our Morningstar and branded business tends to do really well because there’s a holiday embedded in that.

The first quarter is our weakest quarter of the year. The third is our second weakest quarter, and the fourth quarter is typically our strongest quarter of the year. So that’s how our business seasonalizes. At a high level. If you go back and look at our quarters I think you’ll find that to be true. Second quarter being the strongest quarter of the year.

The second point I would make is our original guidance for Q2 was $0.26 to $0.31, which is where we’re guiding for Q3 to start out. At the time that we put our forecast together for Q3, you know you’re looking at July, which has the largest milk price increase of the year, of close to $3.00 per hundred-weight from June to July. Those are difficult periods of time. And taking us to price levels that look like 2007. In fact, almost exactly on top of the 2007 price level.

And as we looked at the quarter originally it appeared that while August was going to trade down, September was going to trade back up. We still don’t know where September is going to be, what the milk price does in September I think will influence how we feel about the overall quarter. And we were going into fuel prices of over $140 per barrel.

So, look, the commodity environment here will have a meaningful impact on our Q3 performance but we’re not ready to declare victory yet and say that Q3 is effectively going to be sequentially better, given the seasonality than Q2, which is typically, in a steady-state environment, our strongest quarter.

So we’ll just have to see how it plays out. But, that hopefully gives you a little insight into how we’re thinking about the quarters.


Your next question comes from Pi Aquino with Credit Suisse.

Pi Aquino - Credit Suisse

Two dairy group questions. Can you give us a little more color, I think you talked about pricing resistance at the retail level and category dislocation. I’m assuming you mean the competitors are undercutting to be able to fill up the volume in their plants. Can you just give us some more color on that, anecdotally maybe?

Gregg L. Engles

We’re a year into this, right? Or five quarters, maybe. Starting five quarters ago we started meaningfully raising price, as an industry we had to do that. And the volume started trailing off. Volume, both in terms of branded volume switching to private label and overall category volumes moving from growing 1% to 2% to being down 1%, 2%, in some quarters even close to 3%.

So on balance for an industry or a player in the industry with excess capacity, that’s a pretty bad algorithm. And at some point in time, as volumes erode, people do exactly what you suggested, they try and fill the hole with volume and the way you fill the hole with volume is you try and do it with price.

So, I think we’re coming into the period that you typically see in these environments where you start to see more of that. You have to layer on top of that a retail environment in which the basic consumer is under stress and people with value strategies are winning, vis-à-vis those who don’t have value strategy. So you see everybody trying to get to a value strategy.

So, yeah, we’re coming into a period where we’re going to see heightened levels of competitive pressure in the category.

Pi Aquino - Credit Suisse

And on dairy, I think you mentioned you had a $184.0 million increase year-over-year on the cost side. Can you give us a better breakdown on how that breaks out, maybe between fluid milk versus resin and fuel?

Gregg L. Engles

Yes, probably.

Jack F. Callahan

Obviously you have the big increase year-on-year, 10% in year-on-year change in the Class I price of milk. But just to have some other significant increases, versus year and the second quarter, resin costs were up well over $10.0 million. Diesel fuel was up 25%. It’s not just milk that we’re dealing with here and it’s balancing particularly across, the energy and fuel-related segment has been sort of the other big inflationary item that we’ve been working through as we’ve gone through the year, just as about any other packaged-goods company.

Pi Aquino - Credit Suisse

As you take a look at the rest of the WhiteWave business, things seem to be clipping along at a fairly good pace for Silk and ID and so forth. What do the WhiteWave margins look like ex-Horizon? Roughly.

Gregg L. Engles

I think we can fairly say we’ve gotten to sort of that classic CPG set of margins in the rest of WhiteWave. We’re very proud of our branded business and it’s profitability.


Your final question comes from Chris Kraul with Stifel Nicolas.

Chris Kraul – Stifel Nicolas

I just had two follow-ups. The first one, Gregg, a bit of a big picture question. Is relative to the transformation and the cost savings coming out of this program. I guess what I’d be curious about is just what would be like the peak year for the cost saving from this program, would it be a year from now, 2009? Or we talking more like 2 or 3 years before you get into that kind of sustained level of cost savings?

Gregg L. Engles

I’m not prepared to give you the answer to that yet. As I mentioned in my prepared remarks, we’re in the middle of our first real in-depth strategic planning process around this transformation. Our intent is to have an investor day in the first quarter of next year where we begin to answer some of the questions like the one you just asked.

I think I would say it’s not going to be 2009. It’s out in the future, although we will see real progress in 2009.

Chris Kraul – Stifel Nicolas

You talked about the excess capacity and the price challenges there. It sounds like it’s hitting more, or as much, on private label as on the branded side. Is that the case?

Gregg L. Engles

Yes, you always get this in difficult periods in the industry. If your cost structure is under pressure and you have excess capacity in the plant, people are trying to spread their fixed costs over more volume. So, this is the industry seeking to move volume around to the advantage of one play or another in order to in a more advantaged way cover their fixed costs.

Thank you all for joining us on the call this morning. We are pleased to have returned to growth in the second quarter of the year and look forward to accelerated growth in the back half. We thank you for your interest in Dean Foods as a company and for joining us on the call and we look forward to talking to you again in November.

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