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Dean Foods (NYSE:DF)

Q3 2012 Earnings Call

November 08, 2012 9:30 am ET

Executives

Barry Sievert - Vice President of Investor Relations

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

Gregg A. Tanner - Former Chief Supply Chain Officer and President of Fresh Dairy Direct

Shaun P. Mara - Chief Financial Officer and Executive Vice President

Analysts

Amit Sharma - BMO Capital Markets U.S.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Christine McCracken - Cleveland Research Company

Eric R. Katzman - Deutsche Bank AG, Research Division

Farha Aslam - Stephens Inc., Research Division

Gretchen Guo

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Operator

Good morning and welcome to the Dean Foods Company Third Quarter 2012 Earnings Conference Call. Please note that today's call is being recorded and is also being broadcast live over the Internet on the Dean Foods' corporate website. This broadcast is a property of Dean Foods. Any redistribution or retransmission or rebroadcast of this call in any form without the express written consent of the company is strictly prohibited.

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

Barry Sievert

Thank you, and good morning, everyone. Thanks for joining us on our Third Quarter Earnings Conference Call. This morning we issued our earnings press release, which is available on our website at deanfoods.com. The press release is also filed as an exhibit to Form 8-K, which is 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 costs and reorganizations, expenses related to asset write-downs, expenses related to litigation matters, goodwill impairments, IPO-related costs, gains or losses from the divestiture of assets and other nonrecurring 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 the 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 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, including the potential sale of Morningstar, any spin-off or other disposition of our remaining ownership interest in The WhiteWave Foods Company and the succession plans of our executive officers. 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 our earnings release.

Given the timing of the WhiteWave IPO, which was completed just over a week ago, the related management changes -- and the related management changes, today's call will be a bit different from our usual format. Participating with me in the prepared section of today's call are Gregg Engles, our Chairman; as well as Gregg Tanner, our CEO; and Shaun Mara, our Chief Financial Officer. Also joining us for the call today is Chris Bellairs, CFO of Fresh Dairy Direct, who will be assuming the role of CFO of Dean Foods following our year-end reporting cycle, allowing a smooth transition from Shaun.

Mr. Engles will start us off by providing an overview of total company and WhiteWave performance, followed by Mr. Tanner with a review of Fresh Dairy Direct and Morningstar results. Mr. Mara will then offer some additional perspective on our financial results before turning the call back to Gregg Engles for comments on the forward outlook and other closing remarks. We will then open the call for your questions.

With that, I will turn the call over to Gregg Engles for his opening remarks. Gregg?

Gregg L. Engles

Thank you, Barry, and good morning, everyone. We were pleased to be able to successfully complete the initial public offering of The WhiteWave Foods Company late last month, and I'm excited for the future prospects of both companies. We successfully raised $368 million in net proceeds in an offering that represented 13.3% of the economic interest in the WhiteWave Foods Company.

In addition, as part of the IPO process, WhiteWave established a $1.35 billion credit facility. Proceeds from WhiteWave's initial borrowings plus net IPO proceeds were used to retire $1.16 billion of Dean Foods' debt, including all of the 2014 term debt maturity lowering the overall leverage of the Dean business. We are also currently in the process of exploring a sale of the Morningstar business. The successful completion of a sale would serve to further leverage Dean Foods and significantly increase financial flexibility going forward.

While I will remain Chairman of Dean Foods until the WhiteWave spin-off, in connection with the IPO, I assumed the role of CEO of the WhiteWave Foods Company.

Gregg Tanner has assumed the role of CEO of Dean Foods. Gregg is a highly capable executive, and I am very confident that he is the right person to lead Dean Foods in the next phase of its development. His 30 years of broad experience at companies like Hershey, ConAgra and Quaker have brought significant value to Dean during the first 5 years of his tenure. In that time, he has led the transformation of our supply chain network and has been an instrumental leader in our broad cost-reduction agenda. Prior to his promotion to CEO, he served as the President of Fresh Dairy Direct and Chief Supply Chain Officer, where he drove the impressive return to growth the platform has experienced in 2012.

We also announced today that as part of the changes at Dean, Shaun Mara will be transitioning the CFO role over to Chris Bellairs in the coming months. Shaun has helped instill tight cost discipline at Dean and his leadership has been valuable in helping to lead the turnaround of the business. I am grateful for his service.

I am equally confident in Chris's ability in his new role as CFO. Chris has been groomed for this role during his time serving closely with Gregg Tanner as the CFO of Fresh Dairy Direct and the finance leader of our supply chain function. Gregg and Chris have surrounded themselves with a strong and capable management team, and I'm excited to see where they can take Dean Foods in the years to come.

We will also be transitioning leadership of our legal department over the coming months from Steve Kemps to Rachel Gonzalez. Rachel has served for 5 years as our Deputy General Counsel and has led much of the Fresh Dairy Direct and Dean Foods public company legal efforts over the past few years. Following the transition of responsibilities, Shaun and Steve will remain in consulting roles for several additional months.

Before I begin a discussion of Q3 results, as a point of clarification, I would like to remind you that the third quarter ended prior to the completion of the IPO. This is reflected in today's presentation of our reported results, which includes 100% of WhiteWave outpost third quarter results, consistent with previous earnings reports. Later in the call, Shaun will walk you through how our earnings will be reported on a go-forward basis.

So turning to the results, the solid momentum across the business continued in the third quarter, with each of our businesses posting strong growth. Operating income increased 25% at WhiteWave-Alpro, 32% at Fresh Dairy Direct and 54% at Morningstar. Consolidated adjusted operating income improved 35% to $145 million.

Adjusted diluted earnings per share of $0.33 was 83% above year-ago results. On a year-to-date basis, gross profit is up 6%. Adjusted operating income is up 38% and EPS has increased over 100%. The strong success of our business this year is the result of a focused set of agendas that maximize the strategic advantages of each business. As of the end of the third quarter, total Dean Foods leverage defined as net debt to EBITDA, stands at 3.71x, a decline from 3.96x at the end of Q2.

With that overview, let's look at each of the segments in a bit more detail. To start, I'll discuss WhiteWave-Alpro results. WhiteWave-Alpro's momentum continued in the third quarter. The powerful mix of on-trend categories, leading brands and highly effective innovation and marketing continued to deliver strong top and bottom line growth in the quarter. In total, third quarter WhiteWave-Alpro net sales grew 13% over the prior year to $598 million. This strong growth was led by our U.S. Plant-based Foods and Beverages platform.

Aligned with the long-term emerging consumer trends for healthy and sustainable products, the Plant-based Beverage category continued its strong growth in Q3. Over the past year, household penetration of Plant-based Beverages in the United States has grown by 200 basis points. The most recent 12-week data shows category growth of over 20%.

As the leading brand in the category, Silk is the main driver and beneficiary of these category dynamics. In the third quarter, Silk PureAlmond was once again the strongest performer in the platform, while Silk soy continued to stabilize on the strength of Silk Fruit&Protein. Additionally, Silk PureCoconut continues to perform well, broadening the appeal of the overall product set. Consistent with the first half of the year, the strong growth in Silk PureAlmond, PureCoconut and Fruit&Protein products resulted in Q3 North American Plant-based Food and Beverage net sales growth of over 20%.

Our European Plant-based Foods and Beverages platform also continued to perform well. Fresh drinks, including the rollout of our new almond and hazelnut beverages and yogurts, continued to post strong growth. Our core European markets of the U.K., Belgium, the Netherlands and Germany continue to generally outperform the southern part of the continent. On a constant currency basis, Alpro net sales increased high single digits in the quarter. With the impact of the stronger dollar, Alpro net sales declined low single digits in the quarter after currency conversion.

Turning to our Coffee Creamers and Beverages platform, the long-term trend towards increased coffee consumption continues to create a favorable category dynamic for this platform. And increasingly, consumers are choosing to whiten and flavor their coffee, adding variety and great taste to their coffee occasions.

Our Coffee Creamers and Beverages platform is well positioned to capitalize on these long-term trends through continued brand innovation and building. Iced Coffee has been an important part of the growth story this year, and we continue to spend to support its rapid development. Much like the first 2 quarters of this year, our Coffee Creamers and Beverages platform posted net sales growth of over 20% in Q3.

Looking at our Premium Dairy platform, early in the year, we increased our pay price to our farmer partners to help offset rising feed costs. We also instituted a corresponding price increase at that time. Despite these factors, net sales growth continues to be solid. We see particularly strong performance in our innovative and differentiated single-serve and DHA omega-3 products. This strength helped deliver a mid-single-digit increase in Q3 net sales.

Consistent with the first half of the year, WhiteWave-Alpro Q3 volumes were up strongly. Net sales increased 13% to $598 million. We continue to invest in production capacity, innovation and brand building in Q3 to drive future growth, including increases in marketing, well ahead of our growth in sales.

Despite these investments, our tight cost management and volume leverage resulted in operating income growth of 25% to $64 million, and operating margins expanding to 10.7%, an increase of over 100 basis points year-over-year. We are very pleased with the positive momentum at our WhiteWave-Alpro segment, and look forward to the next phase of The WhiteWave Foods Company's evolution as an independent company.

I'll now turn the call over to Gregg Tanner to discuss the Q3 results at FDD and Morningstar. Gregg?

Gregg A. Tanner

Thank you, and good morning, everyone. Before I begin, I would like to thank Gregg for his strong leadership of Dean Foods over the last 2 decades. I'm confident that under his leadership, the WhiteWave Food Company will fulfill its potential as one of the premier food and beverage companies in the world. I'm honored and humbled by the opportunity to become the CEO of Dean Foods, and I'm excited about our future as the country's leading and largest dairy company.

I'm excited because this is a business with many unique advantages. We have significant scale, being 5x the size of our next largest competitor. We have a unique national footprint and one of the largest refrigerated direct store delivery networks in the country, giving us national reach and a local touch. I believe our network optimization and supply chain management efforts have made us one of the most efficient, profitable operators in the country, and we will continue to push that advantage going forward. And bar none, I strongly believe that our organization has the best talent in the entire industry, both in management and throughout the rest of the company.

I would also like to take a minute to thank our employees for their continued focus and commitment to Dean Foods. Our company has experienced great change over the past few months. But our team has stayed focused on our priorities, and that has translated into results that you're going -- you're seeing today. I feel very fortunate to be leading such a talented team, and we believe that our future success will be driven by leveraging our advantages toward our streamlined agenda of volume, price and cost. At the same time, we are uncompromising in our focus on quality of our products, the safety of our employees and the service we provide to our customers.

Our financial flexibility is vastly improved. Looking ahead, with a strong cash flow and return on invested capital focus, our financial strength should continue to improve. I believe we have a very strong foundation for Dean to drive significant shareholder value in the years to come.

Turning to Fresh Dairy Direct results for the third quarter, we continue to execute our plan. Starting with volumes. While the fluid milk category remained somewhat soft, our focus resulted in continued outperformance versus the industry. On an absolute basis, FDD volumes declined 2.2% versus the balance of the industry, that experienced a decline of over 3%. Excluding the impact of the divestiture of our Waukesha facility last year from this performance, our fluid milk volumes declined 1.4% in the quarter.

Absolute volume for the category in FDD was impacted by the quality of days in the third quarter. The USDA publishes an adjusted volume number and methodology that normalizes for quality of days. On this basis, the overall fluid milk market declined approximately 1.8% in the third quarter and the FDD fluid milk volume declined 1.1% before adjusting for the impact of Waukesha.

Adjusting this figure for the Waukesha divestiture, yields and adjusted FDD volume decline of less than 0.5%. In line with the continued softness across many of our other categories, volumes across much of the balance of our product portfolio continued to be a bit soft. Inclusive of cultured products, ice cream, juice, tea and water, total volumes, excluding Waukesha, declined approximately 2% from the year-ago period.

As we said last quarter, fluid milk costs are rising. We are focused on effectively pricing to cover this commodity inflation. From a base of $15.24 in June, the Class I Mover increased more than $2 per hundredweight through the third quarter, with prices rising each of the 3 months.

Retailer pricing of fluid milk pulled back modestly in the quarter to produce a private label margin over milk of $1.64 compared to $1.74 in Q2. Despite this pullback, pricing remained at levels we view as healthy. But we are watching it closely. We do not anticipate a return to the deep discounting seen in 2009 and 2010. In fluid milk, I'm proud of the job our sales team did to ensure that we efficiently pass these costs through and limited the negative impacts of rising commodity costs.

In ice cream and cultured products, which represent about 12% of our volume, the pass-through was less efficient and our pricing fell behind as Class II milk cost also rose significantly throughout the quarter.

Class II butterfat increased from $1.49 per pound in June to over $2 per pound in September. We continue to work to enhance our pricing protocols and risk management strategies to better insulate this part of the business from commodity volatility. This will be an area of enhanced emphasis going forward.

Overall, gross profit per gallon remained above year-ago levels. And I'm generally pleased with the pricing performance in the quarter, but also recognize that we still have considerable work to do. We will continue to be challenged by inflationary cost pressures in the fourth quarter, and we expect our teams to maintain a similar level of focused pricing discipline.

Looking at Q4, milk prices will continue to rise. The Class I Mover in October was $18.88, and the November Class I price has been set at $20.70 per hundredweight. December is likely to be a bit higher than November, resulting in a Q4 average price that is over 20% higher than Q3. We expect prices to peak in Q4 and begin to modestly decline in the first quarter of next year.

Cost containment continues to be a key component to driving our success in an area where we think we have significant capability advantages over our competitors and plenty of additional opportunities. This is a key point to remember when considering our ability to navigate challenging commodity environments today versus previous cycles.

Comparing our FDD and corporate cost structure in the third quarter of 2010 versus third quarter of 2012, demonstrates the solid cost-reduction progress we've made over the past 2 years. FDD and the corporate structural fixed cost and interest expense were $70 million lower in Q3 2012 than they were just 2 years ago or between $250 million and $300 million lower on an annualized run rate basis.

And we continue to focus on cost reductions and debt reduction through a strong cash flow emphasis and strategic actions like the IPO of WhiteWave and potential sale of our Morningstar business. And in Q3, we continued to make progress against our cost focus. FDD costs of product processing decreased 1% and SG&A declined 13% from the year-ago period. We also realized a 4% decline in fuel usage as we continue to drive routing efficiency and a 6% reduction in milk case purchases as we focus on better tracking and recovery.

Continuing our cost reduction efforts, we just announced the closure of our Bangor, Maine facility. Decisions to close facilities are never easy, but the dynamics of our industry require that we continue to work to lower our fixed cost. This action will increase our efficiency in the upper Northeast and improve our competitiveness in that region.

Despite challenging category volume and commodity trends, our success in driving our focused agenda of volume, price and cost resulted in continued strong growth and profitability. Q3 Fresh Dairy Direct gross profit was $504 million, roughly flat with year-ago results, although at 3% improvement in gross profit per gallon from year-ago levels.

Disciplined cost management leveraged our gross profit performance into $100 million of adjusted operating income, a 32% increase over the year-ago period. While we still have significant opportunity to drive value across our 3 focus areas of volume, price and cost, I'm pleased with the progress in the quarter against the challenging commodity and consumption environment. Q4 presents continued challenges. However, looking ahead, I expect we will continue to improve our ability to navigate both favorable and challenging environments.

Turning to Morningstar, this business continues to perform well. With strong volume and profit growth driven by innovative products, close customer partnerships and a disciplined cost-focused culture, total Morningstar volumes increased 6% in the third quarter, primarily driven by strong sales of the ESL creamers and milk, ice cream mix and iced coffee.

Our away-from-home business, which accounts for 2/3 of total Morningstar volumes, continued to be a main driver of our growth. Volumes in this channel increased in the mid-teens. Solid volume growth, offset by pass-through of more favorable dairy commodities versus last year, resulted in Morningstar's net sales of $338 million, down 3% from year-ago quarter. Positive mix shift, strong cost control and pricing discipline drove a 27% increase in segment gross profits to $61 million.

Morningstar's commitment to cost control leveraged 6% volume growth and 27% gross profit growth into operating income that was 54% above the year-ago period at $31 million. We continue to be very pleased with the performance of the Morningstar business. As we have announced, we are in the midst of a process that could result in the sale of the Morningstar business. This is obviously a very desirable business. We expect we will make an announcement when and if we sign a definitive sale agreement.

In summary, all 3 of our operating segments posted strong results by focusing on their respective core strategies. We have strong momentum heading into the fourth quarter.

With that, I'll now turn it over to Shaun who will take you through the consolidated performance for the quarter. Shaun?

Shaun P. Mara

Thanks, Gregg. Good morning, everyone. Before I begin, I want to start by saying how much I've enjoyed working with the Dean team and with our investor base over the past 2 years. I am grateful for my time here. But with the changes in the business, I felt like it was the right time for me to move on. I will stay on through the year-end close to ensure a smooth transition and fully expect the handoff to Chris will be seamless.

Chris Bellairs is a seasoned financial executive with significant experience at Procter & Gamble, Pepsi, Iron Mountain and the U.S. Army. In his 4.5 years at Dean Foods, he has served as Gregg Tanner's long-time lieutenant and CFO roles of both supply chain and Fresh Dairy Direct. Chris is a strong and capable leader and has been instrumental in helping to steer the FDD business back to growth. Chris is well prepared to be the CFO of Dean Foods going forward.

Turning now to the results for the third quarter, all of our operating segments turned in strong results. And once again, we held corporate costs in check, resulting in 35% growth in operating income and 83% growth in EPS.

Consolidated gross profits increased 6%. Operating costs increased 1%, as strong cost control efforts were partially offset by increased advertising and higher incentive compensation expense. SG&A, excluding incentive compensation and advertising, declined $23 million or 12% in the quarter. On a year-to-date basis, these costs have declined $83 million from 2011.Q3 operating income of $145 million is 35% higher than the same period last year. Reduced debt balances and lower effective interest rates drove a $10 million decrease in interest expense, resulting in an 84% increase in net income and 83% increase in EPS.

Turning now to the cash flow and the balance sheet. We had a solid quarter of cash flow and debt reduction. Total net debt decreased by $111 million to $3.4 billion. Debt reduction was aided by proceeds of $56 million related to the sale of our minority interest in Consolidated Container Corporation. This sale triggered a tax liability of $90 million, which will be paid in the fourth quarter.

Through the first 9 months of the year, cash flow from operations totaled $354 million, capital spending totaled $163 million and free cash flow was $191 million. Also through the first 9 months of this year, net debt has declined $270 million. This, coupled with a strong EBITDA growth, drove our leverage ratio of net funded debt to EBITDA as defined by our credit agreements down to 3.71x at quarter end. This is more than 1.5 turns below or 5.5x in maximum covenant and 1 full turn below where the ratio stood a year ago. Including deleveraging from the IPO and the Q4 tax payment associated with the consolidated container sale, we now expect that total Dean Foods leverage ratio, as defined by our credit agreement and excluding the WhiteWave Foods Company, to be approximately 3.5x by year end.

In a minute, I will turn the call over to Gregg to take you through the forward outlook. However, before Gregg takes you through the guidance, I want to take a moment to explain 3 buckets of differences of how we report results post-IPO and more specifically, the impact on our guidance on a post-IPO basis. Importantly, you will see that at the end of the day, the adjustments do not change our overall EPS guidance for the year or for the fourth quarter. I want to make it clear that these adjustments on this page and the guidance Gregg will give reflect our expectations, including the WhiteWave-Alpro segment.

These adjustments reflect the 2 post-IPO months of the fourth quarter. Additionally, this guidance is not intended to be indicative of the results for the WhiteWave Foods Company on a separate stand-alone basis. The WhiteWave Foods Company will issue its own guidance later in the fourth quarter, following the expiration of the IPO quiet period.

The first adjustment you will see reflects changes made to the business relationships across our 3 segments in preparation for the IPO to change from a cost-plus, cross-segment pricing methodology to agreements that reflect what we believe to be more market pricing. For the 2 months of Q4 post-IPO, we estimate this change will shift $4 million to $6 million of operating income from WhiteWave-Alpro to Fresh Dairy Direct and Morningstar with no impact to total Dean Foods.

Second, as a result of the IPO, a significant amount of Dean Foods' corporate costs will shift to the WhiteWave-Alpro segment. This represents long-term incentive compensation costs that were previously held in Dean Foods corporate G&A, as well as additional G&A costs to the WhiteWave Foods Company as a result of being an independent public company. We expect these additional costs to reduce WhiteWave-Alpro's Q4 operating income by $8 million to $10 million. This will be offset by $6 million to $8 million of reduced corporate costs at the remaining Dean Foods, resulting in an incremental $1 million to $2 million of cost for total Dean Foods.

Third, because Dean Foods will remain the majority owner of the WhiteWave Foods Company, its results will be consolidated in the Dean Food results, with a below the line adjustment to back out the unowned minority. We anticipate a $3 million to $5 million minority interest adjustment in the fourth quarter.

Additionally, I would note that interest expense at WhiteWave-Alpro related to new borrowings will result in approximately $4 million of Q4 interest expense at WhiteWave-Alpro. At Dean, debt reduction resulting from the $1.16 billion payment from WhiteWave-Alpro is expected to reduce Q4 interest expense to approximately $45 million excluding the WhiteWave-Alpro interest expense, bringing total fully consolidated Q4 Dean Foods interest expense to approximately $49 million.

Going forward, Dean and the WhiteWave Foods Company will issue separate earnings releases and hold separate conference calls with the investment community.

With that explanation of the changes to our guidance related to the IPO, I will turn it over to Gregg who will take you through the forward outlook. Gregg?

Gregg L. Engles

Thanks, Shaun. Due to the quiet period around the IPO, my comments will be limited primarily to Dean Foods, but including the WhiteWave-Alpro segment. I would also note that the guidance for WhiteWave-Alpro is not intended to be indicative of the anticipated performance of our expectations for the WhiteWave Foods Company on a separate stand-alone reporting basis. The WhiteWave Foods Company management expects to communicate expectations for their business following the expiration of the quiet period later in the fourth quarter.

First, on a pre-IPO basis, looking at how we saw the year playing out by business segment when we spoke to you last quarter versus where we see it now, you can see our expectations have risen across the business. For the WhiteWave-Alpro segment, we said we expected strong momentum to continue in the back half of the year. Third quarter results were strong, and we expect continued momentum in Q4, resulting in full year WhiteWave-Alpro segment operating income growth of around 20%.

At Fresh Dairy Direct, last quarter, we said we expected mid- to high-teens full year operating income growth. We expect the upside from Q3 to more than offset the impact of higher-than-expected commodity costs and any hurricane impacts in Q4. So while we continue to expect Q4 FDD operating income to be down on a year-over-year basis, we have increased our full-year expectations for operating income to grow in the high teens to 20%. Q3's outperformance has provided a bit of breathing room against this target, as we navigate a more challenging commodity environment in Q4, giving us confidence in our ability to hit our full year segment operating income target.

And at Morningstar, strong growth across the business has continued, and we are increasing our expectations for full year operating income growth accordingly. We now expect Morningstar operating income to be above year-ago levels by an amount in the mid-20%s, reflecting expectations for continued momentum to finish out the year.

So on an apples-to-apples basis, we're increasing our full year guidance for the performance of each of our business segments and for our consolidated results. On a fully consolidated basis, we expect operating income growth of mid- to high-20%s for the full year, resulting in full year earnings per share of between $1.27 and $1.32, or $0.27 to $0.32 in the fourth quarter. This full year guidance compares to our previous guidance of $1.18 to $1.28 per share that we issued in August. Overall, the various IPO-related adjustments will create some minor shifts between segments, but as Shaun noted, will not affect our EPS guidance, which remains $1.27 to $1.32 per share, both before and after the IPO-related adjustment that Shaun just discussed.

In summary, this is a momentous time for Dean Foods. Our performance across all of our businesses through the first 3 quarters of this year has been strong. This performance has put us in position to create significant shareholder value, through the IPO and potential spin-off of the WhiteWave Foods Company and the possible sale of Morningstar. The end result is an independently valued WhiteWave with strong growth prospects and a Dean Foods with significantly increased financial flexibility to continue pursuing its strategic imperatives.

Thank you again for joining us today during this important time for our companies and for all of those who follow this company closely, for listening to my earnings remarks for over 60 consecutive quarters. I will now conclude our prepared remarks, and ask the operator to open the line for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Amit Sharma with BMO Capital Markets.

Amit Sharma - BMO Capital Markets U.S.

Gregg, just want to talk about -- certainly a strong quarter and a really strong guidance, too. And as you indicated, milk prices are rising. So I just wanted to get your view on what gives you the confidence that in this environment you're still be able to perform better than what the market is expecting at this time?

Gregg L. Engles

Well, let me take a sort of a high-level shot at it, and then I'll see if Gregg Tanner wants to amplify my comments. But we've noted now for several quarters that we have been taking steadily and significantly, cost out of our structural fixed cost base, both in the FDD business and in the corporate overhead structures that lie above the 3 operating businesses. And that's resulted, frankly, in just a structurally lower cost base against which we're operating. And that cost takeout continues period-over-period. So it's mitigating some of the margin pressure that we face in a rising margin environment. In terms of this particular cycle, while no one's crystal ball is clear, I think we believe that with the rising milk price environment that we've experienced up through the third quarter and into the fourth quarter, we're well more than half of the way through the path from the trough to the peak of this commodity cycle. And you see the performance that we've delivered here, it's been solid performance. Much of it comes down to the work that Gregg Tanner and his organization have done with respect to streamlining the focus of their group, and I'll turn it over to Gregg to make a couple comments about that.

Gregg A. Tanner

Yes, thanks. I would tell you that the other thing beyond just the fixed cost base coming out is the fact that we've got some really good pricing discipline in the field. Our sales organization has done an outstanding job of being focused on this starting back when the commodity started to rise. And I believe they've done a great job of staying on top of it, especially on the fluid milk or the Class I side. We still have opportunities on the Class II side or cultured. But I'm very pleased with how they've made it this far through the cycle. And as Gregg said, we expect that to start to mitigate itself in the first quarter of next year and then fall into its normal seasonal trends that we've seen in the past. The other thing is, is there's been no real deep retail discounting this cycle, and that makes a big difference from our perspective as well. And we don't anticipate that, that will happen again. We don't think in 2009 and '10 that it worked very effectively for the retailer then, and so we don't believe they're going to do it again.

Operator

We'll go next to Judy Hong with Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

I guess on the FDD business, just maybe get your perspective on the volume outlook. Clearly, I think the pricing discipline has been a positive, and you've done a great job taking out cost. But I guess, the industry volume continues to be under a bit more pressure. So what is your expectation in terms of volume outlook for balance of this year and into 2013? And can you take out more cost more quickly, if the volume pressure continues? And is there more market share opportunity that you can go after?

Gregg A. Tanner

Yes, Judy, I'll take that, try to take it [indiscernible]. If I look at the volume in the third quarter and you put it on an adjusted basis, it gets back closer to the historical declines. Our expectation is that we'll continue to see 1 point to 1.5 point decline in the category, and our expectation is that we'll continue to outperform the category. I do believe that we have considerable opportunity to continue to bring our fixed cost base down, which then allows us even additional flexibility to adjust and variablize our cost structure further than what we have to-date. So I think if the volume continues to decline, which we believe the category will continue to decline, I also believe there's new business that we can continue to go after that's still available to us.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. And then if I can just ask about the Morningstar, and as you think about the strategic options and evaluating potential sale of that business, I guess how much is it driven by the need to really improve the FDD's financial flexibility, particularly as the cost environment is more challenging in the near term and even with the paydown of debt from the IPO proceeds that you're left with, 3.5x kind of leverage. Do you think that, that is a reasonable leverage for FDD plus Morningstar to kind of maintain going forward?

Gregg L. Engles

Judy, this is Gregg Engles. The potential sale of Morningstar gives us a lot of optionality. So the disaggregation of the business starting with the WhiteWave IPO and ultimately spin, and then considering the Morningstar transaction, I think really is an effort to deliver to our shareholders the implicit value that we feel exists in the portfolio of where our businesses have very, very different trading multiples. So we believe that Morningstar is a business that has inherently higher growth rates and higher returns on capital than the FDD business, that it should trade at a significantly higher multiple. We just happen to believe that in this circumstance, the best way to realize that multiple benefit for our shareholders is through a sale as opposed to a public market transaction. Frankly, if it turns out that those values don't materialize in this process, which I do not expect, but if that happens, we're happy to own that business as part of Dean Foods. There are certain complements between the businesses, although they have very different sales and go-to-market strategies than the FDD business, which is DSD, the Morningstar's businesses warehouse. But in other ways, they're complementary businesses between the 2 companies. So really, it is an effort of the board and the senior management of the company to say, "How do we put the value inherent in Dean Foods' businesses into the hands of our shareholders over a reasonably short period of time?" And that's the exercise that we're going through. At 3.5x leverage following the IPO, I think that is a corporation. We're quite comfortable with that on a combined FDD-Morningstar basis coming out of what will be this rising commodity cycle. We feel like we have good momentum in both of those businesses, and we like where we're positioned. FDD stand-alone, obviously, a sale of Morningstar, if it happens, will again, meaningfully delever FDD and leave it with, I think, a very robust balance sheet to pursue its strategic imperatives as a stand-alone business. So that's how we're thinking about it.

Operator

We'll go next to Christine McCracken with Cleveland Research.

Christine McCracken - Cleveland Research Company

Yes. Just on Morningstar, I was wondering, you've had a couple of really strong quarters here, and we haven't maybe had as much information about the improvements that you're seeing over there and what's driving a lot of that year-over-year growth in operating income. Just curious is that a cost? Are you reducing costs? Is it efficiency gain? Can you be more specific in terms of where you're seeing the improvements?

Gregg A. Tanner

Yes. Christine, this is Gregg Tanner. On the -- probably the 2 biggest things is the innovation that the Morningstar team has put in the marketplace and their really close partnerships with some of their major customers. And so they've been able to innovate and put new products out in the marketplace that have -- has really driven their volumes. And that volume has really translated into the cost leverage. They've done an outstanding cost of -- or outstanding job of managing their cost structure as they leverage their volume up. And so I think the combination of the 2 of those has really helped their results.

Christine McCracken - Cleveland Research Company

Okay. And then just a follow-up, you mentioned the impact from the hurricane, just curious if you could quantify where you saw the losses or if it's too early to estimate on that?

Gregg A. Tanner

Yes. I think it's too early to estimate because there are still a number of stores and schools who have not reopened, and we're not sure when they will reopen. So I think it's too early to estimate. What I can tell you is from a property perspective of our 13 facilities across the East Coast, we had minimal impact. We did lose power at one facility for an extended period, but I think our planning and preparation for the storm and having the advance notification really allowed the teams in the field to do a great job of working through that. And we had backup generators available, and we've had no physical or structural damage to any of our facilities. So I think it's just another example of why having a major network during times like this really pays off. So we were shipping a lot of product between different plants to make sure that our customers' needs were met.

Operator

We'll go next to Eric Katzman of Deutsche Bank.

Eric R. Katzman - Deutsche Bank AG, Research Division

One question, 10 parts. Here we go. Okay, let's start with your -- I guess, Gregg Tanner, your commentary around the milk cost kind of peaking in the fourth quarter and then I guess starting to come down in the first quarter. Why do you think that's true?

Gregg A. Tanner

Well, I would tell you that I think it's mainly because of the supply side. I think we will continue to -- the supply side -- production side, September was the first month in 2 years where the production was not above a year ago -- or above previous year. And so what we are seeing is, is that on the volume declines that the production side is going in the same direction. So our belief is that with exports being down and -- that's going to help drive. So as the butter costs come down, our Class II prices will fall off mainly because of the holiday season. And that will then start to bring Class I down shortly thereafter. So we just -- we're convinced that as we look at the holiday season, I think the Class II is being held up by that. And with the cheese exports declining, our belief is that, that's going to drive Class I down in the first quarter next year.

Gregg L. Engles

Okay. I think, Eric, to put a little -- to put a bow on it, while you do have some pressure on the supply side, we're just now starting to have negative year-over-year comps. And the U.S. price level is so significantly above the world price levels that you're starting to see a significant falloff in exports. So demand is falling faster than supply here. And frankly, the grain complex has stabilized and drifted down. And farmers are not in a significantly negative position today given these prices. So we don't expect the volume of supply to continue to fall off. And we've got robust stocks of all of the commodities that influence the price out there in the marketplace. So we have a survey of 5 dairy economists, I think. The vast majority of them are aligned to this view, that we're peaking in terms of price today. And absent some unforeseen circumstance, you'll see the price start to drift down in its normal sort of seasonal cycle when we get the early -- late winter and early spring flush of dairy production next year.

Gregg A. Tanner

Eric, let me just add a little more color to that. If you look at the gap that Gregg spoke to, as far as the international price versus the domestic price on cheese, you've got an international price of $1.80 a pound. You've got $2.10, domestically. You look at butter at $1.44 internationally, and about $1.90 or $1.88 in domestic market. So those 2 just can't sustain themselves at that level.

Eric R. Katzman - Deutsche Bank AG, Research Division

Got you. Okay, that's helpful. I guess just stepping back for a second, and I guess either Gregg can answer this one. But what is -- how should we think about Dean, and let's combine it with Morningstar for the moment, but how do we think about like the long-term dynamics for the business? Category has been in decline forever but you're taking share, you're taking cost out. So what is that -- how do we think about the income statement for Dean and your goals for the business over time?

Gregg A. Tanner

Well, I'll give you my thoughts, and I'm sure Gregg will have an opinion on this as well. I would tell you that I think the opportunity in the near term, Eric, is that we still have tremendous cost opportunities across, I think, both businesses, more so on the FDD side than we do on the Morningstar side. So I think there's tremendous value to be created and continuing to focus on the fundamentals as we have in 2012. Beyond that, then you start to get into the longer-term plans. And we really haven't flushed out the longer-term plans yet at this point. We're doing that as we speak, and we will be out in the first quarter of next year, starting to share that with everyone as to what that vision for Dean Foods in the future looks like once we get through the IPO and we get through the Morningstar potential sale. So I would tell you that I think there's significant opportunity to continue to drive cost, to continue to outperform the category. We've had good success with a couple of our new products. We think we can continue down that path to try to mitigate some of the volume and category decline.

Eric R. Katzman - Deutsche Bank AG, Research Division

Okay. And then Gregg, Gregg Engles, last question. So let's say that you sell Morningstar, you delever the Dean core business and at a certain point, WhiteWave is spun out. So what is the -- from, I guess, the board's perspective, what is the right return to -- of cash to shareholders on a business that's inherently going to have pretty low, I guess, growth prospects on the top line? So how should we think about that?

Gregg L. Engles

Well, again, I think that they will come into sharper focus over time once we ultimately know what Dean RemainCo's balance sheet looks like following all of these transactions. But I think what you'll have left is, much as Gregg described, a business that is clearly the predominant player in a very, very large marketplace that albeit slightly declining, still is a mid-$20 billion category, where it has significant advantages in terms of size and scope and network, 5x as large as its next largest competitor, increasing its share through the leveraging of its efficiencies into the marketplace as the category slowly declines. That, I think, we believe over time generates a stable and slightly growing P&L and generates an awful lot of cash. So I mean, that's I think how we see the business of the FDD core business going forward on a stand-alone basis. I think the first thing that we'll do with that cash is to the extent the board decides that it wants to further deleverage the business from where Dean RemainCo ultimately settles out following all of these actions, it'll use the proceeds for debt paydown for some period of time. And then I think it will -- I believe the board in its exercise of its oversight will find a way to return that cash to shareholders on a go-forward basis. And I think that decision will, to some degree, depend upon what happens here legislatively over the next several quarters as we figure out what the net after-tax benefits of putting that cash in shareholders' hands is going to be across the various alternatives that we have. But Dean will be a quite unlevered, significantly cash-flow-generating business going forward.

Operator

We'll go next to Farha Aslam with Stevens Inc.

Farha Aslam - Stephens Inc., Research Division

As you consider the sale of Morningstar, could you just share with us kind of the timing of when that decision would be made and what the cost basis is of that base Morningstar business?

Gregg L. Engles

No. We're in the middle of a process. These things sort of aren't on -- they're not on rails like a train, where you can say we're going to be in Hoboken in -- at 10:17. But the process is well along. It is a robust process, and we'll be back to you when we have an answer.

Farha Aslam - Stephens Inc., Research Division

Okay. And so maybe I can ask a follow-up on that base Dean business. Kind of going back to Eric's question, do you -- have you laid out if the business is a combined business or a separate business what your cash flow ROIC targets are and if you'll pay a dividend out of that new business?

Gregg A. Tanner

We're in the process right now, Farha, of going through our process for 2013 and how we're developing our plans. We haven't done that work at this point in time. We'll come back to you in the first quarter with a better answer on that.

Operator

We'll go next to Alexia Howard with Bernstein.

Gretchen Guo

This is Gretchen calling in for Alexia. So at the beginning of the year, you had noted some concerns over the shortage of organic milk constraining growth of Horizon, but that has held up pretty well. So what is the outlook from here on out and how secure is your supply over the coming quarters in 2014, let's say?

Gregg L. Engles

Gretchen, I think we feel very good about where we are from a supply perspective for organic milk. So organic really was ahead of conventional in this cycle, so we gave pay-price increases to our farmers in the back half of 2011 and in the front half of 2012 that I think put them in a better financial position. We passed those price increases along into the marketplace, which slowed the volume down a little bit, which has brought supply and demand back into better balance. We think over the long term, this -- the base organic milk category is sort of a mid- to high-teens growth category. And as we lap those price increases, I think we'll start to revert to that type of growth rate in organic. And we're well positioned to some supply it in the marketplace.

Gretchen Guo

Great. And then if you could, WhiteWave is still trading below its IPO price. So how are you thinking about that? Is that surprising to you and what do you think investors are missing here? Or what sort of concerns are being expressed by the market?

Gregg L. Engles

I really am not spending a whole lot of time thinking about it. We had a roadshow where we sat down in front of close to 100 highly sophisticated investors in this transaction. They produced a really robust order book. We priced this thing in an efficient, traditional way. There's a lot going on in the market since we priced this stock. There's absolutely nothing that's changed with respect to the business that we didn't articulate in the roadshow. And I think that WhiteWave will find its legs. And at the end of the day, the value of that company will be based upon the sort of growth in sales and earnings that we produce as a management team going forward. And as you heard from our prepared remarks today, we're incredibly bullish on the outlook of the WhiteWave-Alpro segment.

Operator

We'll go next to Akshay Jagdale with KeyBanc.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

I wanted to ask about Morningstar, just to follow up on some of the comments made earlier. I think it was outstanding performance this quarter. In light of what happened with the commodity, the Class II was up sequentially and on a year-over-year basis. Can you help us understand a little bit better why gross margins were up about 400 basis points?

Shaun P. Mara

I think if you go back to the discussion we had on cost and efficiency, and how we're driving that in our plant, I think that's a big part of it. I think we have a good mix of product, which is in there. And I think we have a nice job doing the pricing protocols to make sure we're passing through those costs overall. I'd also caution a little bit to use probably not so much a percentage of sales. We look at it as more on a per gallon basis because of the impact of cost -- the underlying commodity cost below that. So I think we've done all the things that we wanted to do to improve the efficiencies of those plants that are helping drive our margins overall.

Gregg L. Engles

Yes. I think, Akshay, really that last point is an important point here. If you look at profitability per unit at the gross margin line, it's increasing for the reasons that Shaun articulated in the first part of his answer. But a big driver here in these dairy-based businesses is that margins expand when raw material costs fall, and raw materials costs period-over-period were falling in that segment. So I think that's how you got to think about it.

Shaun P. Mara

If you look at our gross profit per gallon for Morningstar versus Q2, it's relatively flat. So it's [indiscernible] trend.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

And just one question on fluid milk or FDD generally longer term, and this is for Gregg Engles. I agree with most of the comments you made about deleveraging and a really good cash flow profile. But I just wanted to get your perspective on stability in that business. It's been anything but stable, and I understand part of that's just related to the commodity environment. But can't we just assume today that commodities are going to be much more volatile? I mean, that seems to be the case with every commodity that we follow, and milk is no exception. And so help me understand why you still think longer term this is a stable earnings business.

Gregg L. Engles

Well, I'm not going to suppose for a second that we've repealed the commodity cycle or its impact on our business. But if you look at this business over the -- a time period that spans more than quarters, and now what you see is, you suffer some in terms of margin when the prices of the commodity are going up and you benefit when the commodity is going down. And if you look at stability in a time frame that spans more than next quarter, I think this business has always been a very steady cash flow generative business, and we don't really expect that to change. The really exceptional period in the performance of this business was the sort of 2010, early 2011 period, characterized by very, very deep discounting in the retail environment and lots of dislocation in the industry during that period. I really don't expect at this point in time to see that repeat itself. So the business is a profit-making, cash flow-generating business over time. It's much less leveraged now than it was in the past. That will improve further with the sale of the Morningstar business when it happens. And so I think the board and -- will look at it, and I think investors should look at it as, in terms of not what's going to happen in Q2 or a particular year, but what's happened over the past 4 quarters and what they ought to expect to happen over the next 4 quarters.

Shaun P. Mara

I think the other piece that you can't underestimate here is the cost takeout. I think we're better able to handle these commoditive volatilities as we work through this commodity cycle is because we have taken the costs out. I think as Gregg alluded to in his prepared remarks, on an annualized basis from 2010, we're about $250 million to $300 million in reduction in our cost basis and including interest expense and plant costs. So that helps us weather those storms a lot better now than what we did a few years ago.

Gregg A. Tanner

I think that I would just add to that, that I think the deleveraging of the business gives us flexibility to drive that further.

Operator

Thank you. I'd now like to turn the call back over to Gregg Engles for any additional or closing remarks.

Gregg L. Engles

Thank you, operator. I would just like to thank you all for joining us on the call this morning, for your interest in Dean Foods over the years and your interest in Dean Foods and The WhiteWave Foods Company going forward. And we appreciate your hard work and understanding the business and your excellent questions, and both Gregg Tanner and I look forward to interacting with you and the investment community broadly in the years to come. So thank you very much.

Gregg A. Tanner

Thank you, all.

Operator

That does conclude today's conference. Thank you for your participation.

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