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Dean Food (NYSE:DF)

Q1 2010 Earnings Call

May 10, 2010 9:30 am ET

Executives

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

Barry Sievert - Vice President of Investor Relations

John Callahan - Chief Financial Officer and Executive Vice President

Joseph Scalzo - Chief Operating Officer, Chief Executive Officer of Whitewave Foods

Analysts

Lindsay Drucker Mann - Goldman Sachs

Jeffrey Omohundro - Wells Fargo Securities, LLC

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

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

Jonathan Feen - Janney Montgomery Scott LLC

Terry Bivens - JP Morgan Chase & Co

Eric Katzman - Deutsche Bank AG

Bryan Spillane - BofA Merrill Lynch

Michael Picken - CRC

Farha Aslam - Stephens Inc.

Operator

Good morning, and welcome to the Dean Foods Co. First Quarter 2010 Earnings Conference Call. [Operator Instructions] 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, Casey, and good morning, everyone. Thanks for joining us for our first quarter 2010 conference call. We issued an earnings press release this morning, which is available on our website at deanfoods.com. The release is also filed as an exhibit to a Form 8-K available on the SEC's website at sec.gov. Also available during this call at the Dean Foods website is a slide presentation, which accompanies today's prepared remarks. A replay of today's call will be available with the slide presentation on our website beginning this afternoon.

The consolidated earnings per share, operating income and operating margin information that will be provided today are from continuing operations and have been adjusted to exclude the expenses related to facility closings and reorganizations, expenses related to closed and expected-to-close acquisitions and other non-recurring items, in order to enable you to make a meaningful evaluation of our operating performance between periods. The earnings release contains a more detailed discussion of the reasons why these items are excluded from the consolidated results, along with the reconciliation between GAAP and adjusted earnings, and between net cash flow from continuing operations and free cash flow from continuing operations.

We would also 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.

Participating with me in the prepared section of today's call are Gregg Engles, our Chairman and CEO; and Jack Callahan, our Chief Financial Officer. Also joining the call today for the question-and-answer portion is Joe Scalzo, our Chief Operating Officer. Gregg will lead off the prepared remarks on today's call. Following Gregg, Jack will offer some additional commentary on the financial performance before turning the call back to Gregg for closing remarks and then opening the call to questions.

Before we begin, I would like to bring your attention to the change we made in our segment reporting to reflect the evolution of our long-term strategy. Our two operating segments are now Fresh Dairy Direct-Morningstar and WhiteWave-Alpro. The is a clear divergence between the strategies and objectives of these two business segments. Our branded businesses at WhiteWave-Alpro, which now have more scale and importance in the portfolio with last year's acquisition of Alpro, will succeed by driving growth through effective marketing and innovation. That is our focus and strategy.

Our traditional dairy businesses at Fresh Dairy Direct-Morningstar are the less branded and less differentiated. Their success will be driven by cost and service leadership, which is our strategic focus in these businesses. This segment shift allows us to focus and deepen our ongoing integration efforts in the supply chain and commercial aspects of the business. We believe these revised segments will increase the internal focus and better align our financial reporting with how we manage the business to the benefit of both management and investors. There is additional historical segment financial information reflecting the recast of this alignment in today's press release.

With that, I'll now turn the call over to Gregg for his opening remarks. Gregg?

Gregg Engles

Thank you, Barry, and thank all of you for joining us on today's call. As you know, we entered 2010 facing substantial margin pressure in our Milk business, as retailers compressed private label margins to attract value-conscious consumers. Despite a strong performance at WhiteWave-Alpro, these very low private label retails drained the profit pool of our regional brands and led the consolidated results that were below our expectations. Consolidated operating income of $123 million and diluted earnings per share of $0.23 were both down considerably from the very strong results of year ago.

Looking more closely at the drivers of this performance within the businesses, at Fresh Dairy Direct-Morningstar, the industry pressures we discussed with you last quarter in the CAGNY continue to impact results. For the quarter, gross profit at FDD-Morningstar declined 11% or $68 million to $573 million. Within this segment, the performance of our Fluid Milk business remains our biggest issue and drove about 2/3 of the gross profit decline at FDD-Morningstar. Of the gross margin decline in Milk, the bulk of the decline resulted from lower volumes in our regional brands, as consumers continue to trade down the private label. The remainder was the result of continued direct pressure on private label pricing.

The balance of the gross margin decline at FDD-Morningstar was the result of volume softness in several of our ancillary product categories, including juice, juice drinks, cultured products and ice cream, as well as channel softness in the food service arena. Our pricing of cultured and creamer products also lagged the rapid rise in Class II dairy commodities during the quarter, further impacting segment profitability.

Looking more closely at Milk, pressure on regional brands remains intense as retailers continue to offer private label gallons at margins well below historical norms. The reduction in private label margins has widened the price gap at retail between the regional brands and private label to the point we're trading down, and thus, private label share gains have accelerated. Not surprisingly, our most profitable brands with the largest price premiums have suffered the most.

While total volumes have been largely unaffected, this mix shift from brands into private label is eroding our gross margin. Our ability to directly impact this erosion in the short term is limited, as neither of our choices is attractive. We can reduce the price gap by lowering our branded pricing, thereby reducing our branded margins, where we can hold price and continue to lose branded share into private label.

We also continue to be impacted by direct pricing pressure from retailers. Retailers have invested heavily in the category to pursue their low-priced strategies. In many cases, private label milk is being priced by retailers at or below their cost. As a result, retailers seek to mitigate the impact on their P&Ls through price concession from processors. This price compression is further pressuring our results.

This hyper-competitive retail activity began in early 2009 as raw milk prices hit historic lows and unemployment peaked. I continue to believe that the retail industry will at some point return to more normal private label milk margins, as continued discounting no longer moves foot traffic and retailers seek to restore their profit pool. However, it is not clear when that will happen, leaving us cautious about segment results for the balance of the year.

As I said, these issues generally have minimal effect on overall sales volumes. And with the benefit of our acquisitions, we continue to post solid, fluid milk volume and share growth in the period. Fluid milk volumes increased 3% compared to the balance of the industry that we believe was down approximately 2%.

We continue to see positive impact on cost from our efforts in conversion and distribution. But given the gross margin pressures on the business, it's clear that we must accelerate our cost reduction efforts. Gross margin compression, combined with higher fuel and freight cost, drove a 41% decline in Fresh Dairy Direct-Morningstar operating margin against a tough year-ago comparison to $127 million.

Looking ahead, our inability to predict the end of the retailer price wars makes it difficult to forecast how the balance of the year will play out. However, if current price and mix pressures continue, the reduction in margins could impact segment operating profit by up to $100 million over the balance of the year. In the meantime, to begin to combat this margin pressure, we're actively looking for areas in our portfolio where we can increase prices. Perhaps more importantly, we're significantly accelerating our cost reduction efforts, as we strive to drive down the cost curve and position ourself to win in an industry increasingly focused on price and value.

With a sharpened focus on portfolio revenue management and the benefits of our ongoing cost initiative, we did see some improvement in Fresh Dairy Direct-Morningstar results as the first quarter progressed. However, at the end of the day, current industry pressures have created a significant pricing problem in our business. Price gaps are at levels that our brands cannot support and accelerated trade-down continues. Our industry remains highly competitive, and our ability to impact this problem directly to pricing on gallons of milk is limited.

The cost reduction strategy we have been pursuing is our single most important area of focus. We have discussed goals of $90 million in cost savings in 2010 and $300 million over three to five years. It is now clear that we have to be much more aggressive in both the timing and the magnitude of our efforts. Going forward, these efforts will include an increase in the scale of the initiatives we currently have underway, as well as an increase in the scope of these efforts across the business. We are developing plans to accelerate productivity across our entire cost structure, including production, distribution, sales, administration and corporate expenditures.

In that vein, we announced a new cost reduction and restructuring initiative this morning in the FDD-Morningstar business that will eliminate 350 to 400 positions on top of the approximately 100 positions we have already eliminated in 2010. We expect this additional action to result in annualized savings of approximately $25 million.

At WhiteWave-Alpro, the story is quite different. The strong performance that drove double-digit profit growth in 2009 continued into the first quarter of this year and accelerated, as volume-driven top line growth returned across all key brands. First quarter net sales increased 35% to $485 million. Approximately 26% of the sales growth is attributable to our Alpro acquisition, with about nine points of growth attributable to WhiteWave. Importantly, all of our key brands reported solid net sales growth in the quarter, and volume grew slightly ahead of sales.

Consumers appear to be cautiously returning to value-added brands, and we are benefiting from this trend. In addition to these secular trends, we are driving our brands with strong innovation in marketing, particularly in the dairy, milk alternative and creamer categories. Our Branded Creamer business continued to be a standout in the portfolio, with International Delight growing more than 25% and a Land O'Lakes creamers up high single digits. This growth is on the back of solid innovation and world-class marketing. International Delight creamers grew their share in the category by three full points in the quarter.

The organic milk category also return to growth in the first quarter. Horizon Organic outperformed the category and grew mid single digits in both volume and net sales in the quarter. Our Silk brand demonstrated strong growth in the quarter, with mid-single-digit net sales growth on the back of a very strong launch of our Silk PureAlmond line of almond beverages. Alpro continues to perform well with high single-digit volume and net sales growth across the business.

Our strong brand performance plus the Alpro acquisition drove 54% growth in segment operating income to $44 million. Operating income at WhiteWave, excluding Alpro, grew 34%. Our value-added branded business frankly is running on all cylinders. Looking ahead, we expect this top and bottom line growth to continue with the expectations for strong double-digit full year operating income growth in our WhiteWave-Alpro segment.

With that, I'll turn the call over to Jack for a more detailed review of the financial results. Jack?

John Callahan

Thanks, Gregg. Good morning, and thank you for joining us on this morning's call. I'll take a few minutes to walk through the consolidated financial performance in the quarter and discuss a few corporate items before turning the call back to Gregg for some closing remarks and opening the lines up for your questions.

Our first quarter performance eliminates the differences between the two segments with accelerated net sales and profit growth at WhiteWave-Alpro, offset by continued significant challenges at Fresh Dairy Direct-Morningstar. Corporate expense of $48 million remained above year-ago levels but was down a bit from the run rate of the previous three quarters. For the balance of the year, we do not expect any meaningful year-over-year growth in corporate expense, as our period of stepped-up investment is over, and we are working to reduce this expense over time as an element of our cost reduction program. In total, first quarter consolidated operating income was 40% below year-ago results at $123 million.

Within the consolidated results, total company gross profit declined $8 million. A $68 million decline in gross profit at Fresh Dairy Direct-Morningstar was largely offset by strong gross profit growth at WhiteWave-Alpro. Below the gross profit line, total company operating expenses increased $74 million over the year-ago period.

I'd like to provide some clarity into the drivers of these expenses in the quarter. Of the $74 million of operating expense growth, approximately 60% is directly related to the acquisition of Alpro Foremost and Heartland, which were completed in 2009. Other meaningful contributions to operating expense growth include higher fuel-related costs at Fresh Dairy Direct-Morningstar and increased marketing expense at WhiteWave-Alpro to support continued momentum behind our value-added branded portfolio.

Below the line, interest expense declined $10 million from the year-ago period as the result of lower average debt balances and lower interest rates. Our tax rate in the quarter was just under 35%, down from 39% a year ago, aided by our international tax rate and an increase in the U.S. domestic manufacturing deduction, as well as the one-time effect of finalizing certain tax audits in the quarter. We expect our full year tax rate to be 37% to 38%. Net income of $42 million drove first quarter diluted earnings per share of $0.23 well below year-ago results, as we lapped the best quarter in our history and a lower share count.

Turning to cash flow. Net cash from operations in the first quarter of 2010 was $71 million, subtracting net capital expenditures of $43 million from this yield of free cash flow of $28 million. For the full year, we anticipate capital spending of $250 million to $300 million, but we would point investors to the low end of this range as we prudently manage the pace of that spending to support ongoing debt paydowns.

Turning to the balance sheet. Total outstanding net debt at quarter end stood at $4.16 billion, down $27 million from last quarter. As expected, our leverage ratio of funded debt-to-EBITDA, as defined by our credit agreement, stepped up a bit this quarter due to the impact of losing the very strong first quarter of 2009 and our trailing 12-month EBITDA. As of the end of the quarter, our leverage ratio stood at 4.43x versus the current covenant of 5x and a year-end covenant step-down to 4.5x. To further support our debt paydown efforts, we continue to aggressively manage net operating working capital. On a year-over-year basis, net operating working capital was essentially flat despite a 23% increase in the Class I Mover, which allowed for a continued debt reduction in the quarter.

Given the continuing challenges in the business, we are not on pace against our previously stated goal of deleveraging the balance sheet to approximately 3.5x funded debt-to-EBITDA by mid-2011. In addition, over the medium term, we must ensure adequate operating flexibility against the final covenant step-down to 4.5x at the end of the year. Therefore, we continue to closely monitor the capital market and may choose to address our refinancing needs sooner than we previously anticipated. Both the bank and high-yield financing markets have significantly improved over the past year, affording us multiple debt financing options to consider.

With that, I conclude my comments, and thank you for your continued interest in Dean Foods, and will turn the call back over to Gregg for some closing comments before opening up the call to your questions. Gregg?

Gregg Engles

Thanks, Jack. Before we open up the call for questions, let me give you some perspective on our forward outlook. At WhiteWave-Alpro, we're on a solid path of volume sales and profit growth that we expect to continue through 2010. Our branded business is very strong with significant momentum. We expect to drive volume-led top line growth through effective marketing and innovation and to leverage this growth into another year of strong operating income growth.

At Fresh Dairy Direct-Morningstar, the road ahead appears rocky, with the retail price environment that appears unsustainable but is not yet abated. That makes it difficult to provide accurate guidance beyond the immediate quarter. The current pressures on FDD-Morningstar had a significant impact on Q1 results and could impact the balance of year operating covenants by up to $100 million if retailers continue to pursue a strategy of aggressive price promotion on private label milk. Additionally, dairy commodity prices are now expected to trend higher through the balance of the year, which could further pressure results.

Concerns about rising non-fat dry milk and butter prices have several economists predicting a rise in the Class I milk price of $3 to $4 per hundredweight over the balance of the year. The uncertainty in these forecast adds to our caution as we look out over the balance of the year.

For the time being, we're going to provide specific guidance only for the next quarter where our visibility is better. In this case, we expect adjusted diluted earnings per share in the second quarter to be $0.23 to $0.28, essentially in line with Q1 results. While we hope to see a more positive environment in the back half of the year, the uncertainty surrounding whether or when that will occur leads us to suspend our full year guidance for the present time.

I've now been in the dairy industry for nearly two decades. And while we faced our share of challenges over that time, today's challenges represent a unique moment in our industry. Processors were under pressure in ways that we have not experienced before. Periods of industry difficulty typically separate the strong from the weak. The longer these challenges persist, the more difficult it becomes for cost-disadvantaged competitors to survive. Pressures like we're expressing today should accelerate industry consolidation among the lowest and most sufficient and capable processors. We're a cost leader in the industry today and are committed to extending our lead going forward.

Our size and scale afford us opportunities to meaningfully extend our cost leadership position, and we are aggressively attacking those opportunities. The urgency, momentum and confidence we have in our ability to reduce cost have all increased. While it's too early to comment specifically on our plans to expand the scale and scope of our cost reduction efforts beyond what we've announced today, we expect meaningful progress in the quarters to come, as we work to combat these market pressures and build a sustainably differentiated position in our industry.

We believe that taking more aggressive action now will enable us to emerge from the current market challenges in a stronger position versus our competitors and will fuel our long-term success. The winner in the traditional dairy category will be the low-cost producer and Dean will be that company.

With that, I'd like to thank you for joining us today and ask the operator to open the call for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Alexia Howard with Sanford Bernstein.

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

The CAGNY conference in the middle of the quarter, I guess, the second quarter, we were expecting roughly flat EPS growth year-on-year. But clearly things have deterioration from that, from where we were a couple of months ago. I'm just wondering if you could give me a little bit more clarity on exactly what changed since then? It also seems that as we go into the next quarter, you've got less of a step-up in SG&A spending, Alpro is obviously coming through. WhiteWave is coming through better than it is, and it has been of late. And so it seems as though that the Fluid Milk business is actually getting worse rather than better. I was just trying to understand what has changed the worse since the middle of February.

Gregg Engles

Alexia, the fundamental issue is that the mix out from brand to private label frankly continues to accelerate. So you have industry leaders on the retail side who are pricing private labels as aggressively or more aggressively as they have throughout the back part of Q4 and into the beginning part of Q1. And while we had hoped to see those private retails begin to lift, we're in fact seeing the opposite. And so the mix out from brands to private labels is gaining steam. So the basic math on that is on average, if you look across our portfolio, we have about a $0.51 per gallon contribution margin difference between brand and private label. And that profit pool is eroding pretty rapidly.

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

And can you actually give us a number on what the percentage mix shift is from branded into private label right now? I mean it's obviously got to be a lot worse than the 3% that it was running at about a year ago.

Gregg Engles

Yes, for the quarter versus year ago, it's about three share points. But I would point out that as I did in the script, of course, where we have the biggest price gaps is where we have the most significant erosion of our branded margins. And frankly, where the retail environment is, the hottest.

Operator

We'll take our next question from Terry Bivens of JPMorgan.

Terry Bivens - JP Morgan Chase & Co

Gregg, just to be clear, this $100 million gap you were talking about, that would apply Q2 through Q4, but not inclusive of Q1?

Gregg Engles

That's correct.

Terry Bivens - JP Morgan Chase & Co

I'm looking at kind of the FMMO [Federal Milk Marketing Order] butterfat price, it was kind of a proxy for butterfat. I guess I'm a little bit puzzled that, that seemed to bite you in the quarter as well since, by our numbers, it was down January, February, popped up a little bit in March. I mean, frankly, we thought it would be a problem in the second quarter, not the first. Am I looking at that properly?

Gregg Engles

Terry, it's really driven by how we price both products. We priced them based on a forecast, unlike the Class I Mover which have in advance, that we price in anticipation of the increase in the Mover. And our forecast was just below where the actuals came in for the period. So you should look at that as more of sequencing and timing issue. These things tend to revere. But it was driven by our forecast of the Class II prices as opposed to the inability to get rate in those categories.

John Callahan

And one more, Terry, remember the Morningstar business, which is very Class II-exposed, had sort of a tough finish to last year. And so while they meaningfully caught up as we went through first quarter, they kind of started out in a slow start, reflecting the end of the weakness we had at the close of last year.

Terry Bivens - JP Morgan Chase & Co

Well, I'll talk to you offline about that. I mean it looks like they were actually down in January, February. So I guess, you forecast them to be even lower.

Gregg Engles

Yes, our forecast was below the actuals for the quarter.

Terry Bivens - JP Morgan Chase & Co

And if you look at the Class I Mover, I mean, over the years, I've always kind of looked at it as the trajectory is being quite important. And it looks like the trajectory, January to March, should have been favorable to Dean. Was it indeed favorable, and why real problem here is this ongoing loss of market share to private label?

Gregg Engles

Yes, the real problem is the shift of share from brand to private label. Just to give you a little bit more of prospective on that, we have significant portions of the country where the gross margin, the retailer gross margin on private label is 0% to 5%. So those parts of the country has simply blown out to double or more the price spread between private label and gallons, and that is punishing gallon volume or branded volume in those marketplaces. So we have marketplaces in the Southeast, for example, where our branded half gallons are more expensive than private label gallons. And we're just seeing in those environments rapid mix shift out of brands into private labels. So that's really driving it. As we said in the script in the prepared remarks, our performance improved during the quarter. We had a very soft start to January. We improved through March. So we see the benefits of the declining trajectory in raw milk. It's just not enough to offset the mix out that we have inside our portfolio.

Terry Bivens - JP Morgan Chase & Co

Would you consider changing the strategy of kind of holding branded price and taking it on the chin in market share and maybe just capitulating for the time being on your branded pricing? Or have you already begun to do that?

Gregg Engles

We'd done some of that. But just to make the math clear, let's say a private label, a price of a gallon of milk -- wholesale gallon of milk is priced at $1.75 in today's marketplace. We've got retails at $1.75 to $1.79 in a lot of our markets. So if we were to take our branded prices down to $1.75, you'd be giving up on average that $0.50 a gallon across your brand portfolio, which would be pretty punishing to the P&L. And you still would be out of value because the retailer is taking no margin on their private label, right? So they're going to mark your brand. They're not going to take no margin on your brand. They're still going to price it up. Let's call it 35%. So we're way out of value today. But as long as the retailers are prepared to make no money or lose money at the gross margin level in this category, we're going to see a mix shift at of brands into private label.

Operator

We'll take our next question from Jonathan Feen with Janney Montgomery Scott.

Jonathan Feen - Janney Montgomery Scott LLC

I was surprised to see the 3.2% volume share gain. And I know I've probably asked the same question on 15 of the past 19 conference calls, but I'm a big believer that, in this period of time where you're really not out buying and shutting down capacity, your local competitors just get more and more desperate. The more share you take from them not just adds volatility to the business potentially going forward, and of course, I'm referring to the Fresh Dairy Direct side. So my two questions would be, do you hear any news or any signs that competitive capacity is coming out in any major way in any pockets where you compete on the Fresh Dairy Direct side nationally, first of all. And second of all, do you think your competitors are making money and that the current situation -- what is it that makes the current situation unsustainable in your words from the press release?

Gregg Engles

Well, no, we haven't seen any capacity come out yet. But keep in mind, we're now a quarter and a half into this effect really biting. So it's going to take sometime for this to play out. We are in that, frankly, hypercompetitive phase where our competitors are very seriously being delevered. So on an apples-to-apples basis, we did have an acquisition at the end of Q3, beginning of Q4 that you see in some of our volume numbers. But we still are growing, we believe, two to two and a half percentage points more than our competitors. So let me rephrase it. Our competitor, the rest of the industry is down in volume by 2% where we're flat on an x acquisition basis, rough number. And we see price realization in the category down four or five points, right? So very serious deleverage of our competitive set. And we see that in competitive bidding activity and pressure just on the basic transaction price in the category, right? That's the other effect that is biting us. We are in a period of more significant price competition, and that's a reflection of the stress on the rest of the industry.

Jonathan Feen - Janney Montgomery Scott LLC

Gregg, provided that your financial situation cooperates and you can remain cash flow positive, is it the plan to just push the pain on these guys and until they can't take it anymore and the hopes of realizing a stronger position in the future?

Gregg Engles

It's hard to say you have a plan because the marketplace, at some point in time, doesn't really give you a lot of choice. So we said in our last call, we said at CAGNY, we're going to hold share and we're going to hold share in this category. We're, in fact, growing share. We're going to aggressively defend volume in this category. And the way that we're aligning with growing customers and the way that we're pursuing our strategy is playing out as growing share. And I think that until capacity starts to shake out here, that will be the path that the market dictates to us.

Operator

We'll take our next question from Bryan Spillane with Bank of America.

Bryan Spillane - BofA Merrill Lynch

Just a couple of clarification points. I guess, first, on the cost saving, are what you're doing for this morning and I guess, you're expecting to accelerate or have more announcements in coming months, is that on top of the $300 million, three- to five-year plan or is this still within the $300 million of three- to five-year plan?

Gregg Engles

No, it's on top of it. So we have to drive that $300 million up substantially.

Bryan Spillane - BofA Merrill Lynch

And so the point here is that you're now -- if this isn't going to change in the near term or may not change at all, you need to make some adjustments to what could be a permanent structural change in the industry?

Gregg Engles

Yes, I think you have to ask yourself the question, what the brand situation looks like when private label retail reverse to a more normal profit pool. I think it's entirely possible that some of that share doesn't come back to you. And as long as you have retailers believing that they need to demonstrate deep value to consumers. And not withstanding the rebound in fortunes in the stock market and the pickup in the economic outlook for people in the top half, people in the bottom half, I think, are still pretty stressed. So we think this situation persists for a while and we need to be positioned to return to the sort of profitability we historically experienced, even with this price environment.

Bryan Spillane - BofA Merrill Lynch

And then in terms of the initiatives you announced this morning, is there a cash cost component to that in terms of -- just what's the cash cost?

John Callahan

Bryan, there'll be some restructuring, maybe up to $6 million. But relative to the savings, this is an extraordinarily quick payback.

Bryan Spillane - BofA Merrill Lynch

And then in terms of capital spending, I know you've guided this morning to the low end of the range. But is there anything that or you're looking at anyways to maybe cut back on that even further or are there ways to trim that?

John Callahan

We prefer not to, Bryan. We have a number of pretty exciting network optimization projects that we would like to keep forward, that really have some wonderful benefits for us as we start to get into 2011 and 2012. So we are -- and there are some things, look, we just can't cut that are just part of our base operating. So we're are trying to kind of stay in that around 250 plus right now. But we're going to be very thoughtful about how we deploy that capital through the year.

Gregg Engles

Bryan, the bottom line is some of the costs we're going to get out, we're going to have to spend money and capital to get it out. So we're not going to be cutting that stuff. In fact, on some of these projects, we're going to be trying to go faster on them.

Bryan Spillane - BofA Merrill Lynch

In terms of the covenants and terms of renegotiating of debt, potentially renegotiating debt, I just want to make sure we're clear that what you're looking are all debt-related options in terms of refinancing, is that true?

John Callahan

That's consistent with the comments in the script, yes.

Operator

We'll take our next question from Chris Growe with Stifel, Nicolaus.

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

As you look at this branded versus private label shift, it would seem like this is an irreversible trend. I mean, I guess I'm trying to understand, if you stabilize it here, that's certainly a good thing. But is it possible these brands can be revived? And I guess to that point, I've heard and I've seen you've tested reducing price gaps in certain markets, I'm curious what the results were of those tests, if that's true?

Gregg Engles

Well, I think the first part of your question is an important question, and I would be making up a guess about what consumers will do if this trend reverses or when this trend reverses, because the retail industry has given up a ton of profit pool here. They will ultimately back away from this strategy as it stops moving share around, right? They're doing this to move share around and when that stops, then they'll go to restore the profit pool. So when that happens, some of the pressure will come off of our brands, and we will still have some brands in these marketplaces that have a premium over private label, right? This category is not going all private label. These brands have been around a long time and they have loyal consumers. On the other hand, I do think that where we had very high brand premiums, they will be permanently reduced. So I believe that our brand profit pool going forward will not return to its levels of 2008 and 2009, it will be some diminished level. And we'll know what that looks like after the retail profit pool gets restored, the private label retail profit pool. With respect to your last question, we had experienced and had talked about through 2009, 2008, as our brand premiums blew out against private labels, that we need to get our brands back in value and lower brand premiums in certain marketplaces, and we undertook to do that. And frankly, we were having good success with that in terms of holding and beginning to rebuild brand volume. But that was in a world in which retailers were taking 30 margins on private label and 30 to 35 margins on brand. In an environment where retailers are taking zero margins or 5% margins on private label, you just can't get your brands in value, as I discussed earlier to Alexia's question or Terry's question, without just tanking your P&L. The first half year has got to be retailers restoring some profit pool on private label milk. Until that happens, I think it's just going to be impossible to get a beat on where your brands are going.

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

We've been tracking for years now this retail price versus the input cost, as you showed a chart in your slides. But by our measure, that got worse sequentially in January, but it improved in February and March. And I understand it seems to be more about just private label versus branded milk, but in that -- I guess I'm getting at is as input costs go higher, should we assume that you're passing that along, especially on the private label milk? Is that getting passed along at all, or is that gap that we see at least narrow or getting better, is it really not getting better, is it the alternate channels that are working against that?

Gregg Engles

I think there are -- let me try and disaggregate the milk price phenomenon into three buckets. There's the monthly pass-through of commodities. That happens still with just perfect, almost perfect regularity. So milk goes up dime a gallon, our prices go up a dime a gallon. But we are experiencing mix shift, so that erodes our, if you will, our net margin over milk, not that our customers aren't taking the price increases, but we're mixing out of the consumer level from branded to private label. And then there is this competitive bidding phenomenon. So we're passing along $0.10 a gallon, but are retailers coming back to you and saying, well, yes, but I want you to take $0.01 out of the net margin that you make on a go-forward basis. So there's competitive bidding. There's pass-through, which has to work and does work in the industry and then there's mix shift. And that's the net of what's driving our gross margin decline in the FDD business. As to whether the spread is getting better, we said at CAGNY, in the middle of February, that we saw retailers trying to take the price up, and we do see that. We see retailers trying to take the price up and particularly, in conjunction with months where the Class I Mover goes up, we're seeing people trying to pass that along plus a little bit more in their private label retail. But we didn't see people coming back in and driving it back down. So it's not holding yet in terms of this margin over milk going forward. So we've refined -- you'll notice our chart, we refined a little bit. We're now looking at private label margin over milk because that's really what's driving the category, as opposed to the branded margin over milk. And that's, I think, for us, that's the key indicator today, what are the private label guys doing in terms of margin over milk.

Operator

We'll take our next question from Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank AG

I guess, first, just maybe from a broader industry perspective, I guess what worries me about this situation is that retailers are flexing their muscles in a way we haven't seen, Gregg, as you noted. I mean, what do you think this says about the brands and the value and consumer willingness to look at them versus the retailers' desire to drive their own private label, even if it means for the moment, taking profit out of their own business?

Gregg Engles

Well, let me try and get at some of the suppositions in your question. The most important one being that what retailers are trying to do is build their private labels as opposed to build store traffic. We are in deep and continual conversation with our retailers around this issue and this strategy. And I'm confident in saying that what a given retailer is trying to do with their private label here is not build their retailer brand. What they're trying to do is they're trying to move a shopper from chain X to their chain by being more deeply discounted on milk, and they're doing that through their private label. I think, look, these retailers are all very, very good at math. And they understand that they make more money on a gallon of branded milk because of both the higher price point and the higher margin that they take than they do on a gallon of private label. And that there is a role for brand in this category and that, that role is not going to go away as we come out of this deep period of discounting. But the math that we don't benefit from in the private label price compression math is that the shopper that comes in to buy a gallon of milk at $1.77 buys a bunch of other stuff on which they have much higher margins. So right now, the calculus is that if I can move shoppers to my store and put traffic, it pays out this milk price compression. Again, I'd make the point I made earlier, that math works only so long as you are advantaged as a retailer in this private label category versus other retailers, and I'm moving traffic around between my competitors and myself. We've got to a point where most of the industry's down here at these cheap price levels. And as retailers stop seeing store count, foot traffic change as a result of the things they're doing to promote, they will seek to restore what's a very big margin get back in this category. So this is not about building private label brands, this is about driving foot traffic and share at the retail level

Eric Katzman - Deutsche Bank AG

This is more of a legal question, but to the extent that you could answer it, did the captive retailers, are they allowed to sell at a loss legally? I mean, isn't that again, I'm not a lawyer, but isn't that you cannot sell a product at a loss to gain share? I mean is there an issue here? I mean it's got to be one of the most politically-sensitive categories out there, I mean you know that, from just the antitrust issues?

Gregg Engles

There are a few marketplaces in which there are state regulations that to purport set minimum prices. But as a general rule, and I'm above my pay grade here in answering a legal question, but as a general rule, I think that actions that you might take that would destroy your profit pool are not illegal. I think people can -- other than these state regulations, I don't think there is at a competitive regulations that would limit your ability to reduce your margins. Now what you can't do, you can't target a competitor in a limited geography with price reductions that you subsidize from keeping prices higher elsewhere, the Robinson-Patman program [ph](1:11:46), but just generally low prices are not illegal.

Eric Katzman - Deutsche Bank AG

The $100 million, is that versus your plan or versus a year ago?

Gregg Engles

Versus a year ago.

Eric Katzman - Deutsche Bank AG

And then the working capital, to the extent that milk cost go up, Jack, is that a potential problem as far as how your covenant and leverage ratios are calculated, because historically, that's a drain on your cash flow, albeit, temporary?

John Callahan

Well, I mean, it will be a use of cash. So it would slow our ability to pay down that debt, so it would be putting some headwinds in. But that's why we're working pretty diligently to improve our working capital effectiveness, it's something we're looking at some quite closely.

Gregg Engles

And have been for quite a while. So we're making progress against what our net working capital position is, that's offsetting some of the rise in raw milk prices. That we, in a rising milk price of environment in Q1, we held our networking capital flat. So obviously, the more milk goes up, the more challenging that becomes. And so it is a potential headwind in terms of the numerator, right? Your net debt position would be higher in a rising working capital environment than a falling working capital environment.

Eric Katzman - Deutsche Bank AG

Having followed the company for a long time, Gregg, Morningstar, I guess you've changed where it's reporting now. And its seems like that's change back and forth over the years from what was dairy to what was branded, now it was back to dairy. Can you just kind of -- like, has that business been hurt in some way by the same factors and therefore, you feel it's better to be back in, I guess, the lower margin, more competitive food-milk side of its side of things?

Joseph Scalzo

Yes, it's actually, this is Joe Scalzo, it's driven by two factors. First, our scale in our Branded business enabled us to focus our branded portfolio together in a segment. And then second, as we go after this accelerated cost opportunity, putting these two businesses together as we started considering integration and synergy opportunities just affords us the ability to do that quicker and more seamlessly.

Gregg Engles

Eric, the product line and the customer base that Morningstar has is very similar to FDD. So we're selling retailers their private labels and cultured products and ESL products, just like FDD is selling them their private labels and our branded products in liquid milk, short shelf life products. We originally moved Morningstar into WhiteWave because of its products are warehouse-distributed. And we saw some benefits of leveraging our warehouse capabilities and systems and knowledges between WhiteWave and Morningstar. But as we have moved into this period, it's clear that we need to leverage our scale with customers more, on the Morningstar side, and product portfolio more on the Morningstar FDD side. And WhiteWave with Alpro has acquired more scale to focus exclusively on being branded. So our opportunity to take cost out is enhanced by further integration of the Morningstar and FDD business, particularly on the front end, the selling end and the customer side of things. So that's really one of the drivers behind the move.

Eric Katzman - Deutsche Bank AG

And if I remember correctly, a year ago or so, at your analyst day, it seems like a lifetime ago, that Morningstar was not part of your $300 million calculation, right? You were still kind of trying to figure that one out?

Gregg Engles

That's correct. Morningstar was not a significant part of the calculation. So there wasn't a clear number associated with the Morningstar business.

Operator

We'll take our next question from Christine McCracken with Cleveland Research.

Michael Picken - CRC

This is Michael Picken calling in for Christine. You gave us the share of your loss in terms of your branded to private label. But I was wondering about in terms actual shelf space, are you seeing any difference in the stores between the amount of private label milk that's out there versus your branded products, and if you've seen any changes there towards the shelf space?

Gregg Engles

Not yet. We're holding them on to the space that we have. Again, I think I would come back to the basic notion that over time, that retailers see a role for brand here in maximizing their profitability out of the category. So taking the brand out of distribution or a limiting at distribution would belie a change in that long-term view.

Michael Picken - CRC

And when you say not yet, I mean, are you anticipating then that there might be a slight change but not a major one? Is that how I should read into that or are you [indiscernible](1:17:25)?

Gregg Engles

No, we are not anticipating a change. This is what we expect, not yet. It's just my level of confidence around expectations but maybe not quite as high as it.

Michael Picken - CRC

And then lastly, it looks like you're Horizon business did pretty well this last quarter. And I'm just trying to understand kind of the price spread between organic and conventional milk and maybe why was Horizon able to do so well in an environment that was so challenging for your branded conventional milk? Is that just strictly sort of going back to the higher-income people doing better or some channel improvement in natural? But if you can talk about kind of why Horizon was able to withstand some of the challenges that you're branded is doing, that would be great?

Joseph Scalzo

There are number of factors around horizon. Probably the single biggest one is we're seeing the category start to regain some momentum, and we're seeing in the category starting to grow. Second, Horizon is tapping a number of core growth segments, among them is single serve and DHA business. And then third, while not highly correlated, the price gap between organic and conventional milk is one of the things that we see does have some impact on volume. And so that gap, as the quarter progressed from fourth quarter to first quarter and even within the quarter, closed a bit. And all three of those factors help the growth of our Horizon business.

Operator

We'll take our next question from Lindsay Drucker Mann with Goldman Sachs.

Lindsay Drucker Mann - Goldman Sachs

I guess, I was just trying to understand a bit better, clearly, you're gaining significant volume share of the food-milk market at even a far more rapid pace than we're used to seeing you. So can you explain a bit why the aggressive volume share target in light of the damage you're doing to your margin? I mean, why not let some of this less profitable volume go so you can preserve your bottom line?

Gregg Engles

Well, it's not the bidding and taking of private label share that's destroying our profit pool, it's the mix shift from brand to private label. And that's frankly, an element of this that we don't have a lot of control over. If you actually go back to price concessions on private label quarter-over-quarter and the diminishment of our operating profit pool as a result of that, it's frankly a smaller number than you would expect. It's less than $10 million of the profit degradation. So the bidding phenomenon is out there, it's an element of the decline in our profit pool in milk, but it is by far, the smallest factor.

Joseph Scalzo

The other thing to consider is we're not net gaining new distribution. So we're not competing for new distribution and then gaining it in growing volume. That volume growth that you see, beyond the factor that Gregg mentioned, is also just channel shifting and customer shifting. Our mix of channel mix and customer mix is driving volume into our system and away from our competitors.

Lindsay Drucker Mann - Goldman Sachs

So the issue here is not so much the bidding or the contract renegotiations. It's really the mix shift to private label, right? That's what you're saying.

Gregg Engles

That's by far the predominant reduction in our profit pool. There is bidding going on and it is eroding our profit pool. But it is not the predominant driver of our gross margin decline. It's this mix shift.

Lindsay Drucker Mann - Goldman Sachs

So I guess one might anticipate that when you're seeing this big trade down to private label, that perhaps you'd be able to have some pricing power on the private label side, it would help you out to offset that the mix shift and we're starting to see other suppliers look to press on that, to help to center margins. So I mean, I guess I'm wondering why, given your dominant share position, your DSD capability, your relationship with the retailers, why you're not able to get pricing power this time around?

Joseph Scalzo

Again, our issue today in the marketplace is not price concessions on private label from us, it's margin compression by the retailer on private label to send a value message to its shoppers. So they, the retailers are making margin concessions in their business in order to drive shoppers into their store. So frankly, our price is relatively unchanged, and as Gregg mentioned, has been moving with the commodities.

Gregg Engles

And just one more factor that again, back to Joe's earlier point, that a large part of what's driving our volume growth is our alignment with growing retailers. That phenomenon, the channel and customer shifting is everyday delevering, taking volume out of our competitors. And so the incoming price offer from delevered competitors with excess capacity is you just hear more and more of that, right? So that's putting a bit of a lid on our ability to go to take price when the buyer's getting regular calls with people at least, suggesting that they're willing to lower it.

Lindsay Drucker Mann - Goldman Sachs

So the volume share declines that you're talking about in the grocery store and Wal-Mart data that we see, I mean, it just doesn't jive with what you're talking about in terms of seeing acceleration. In fact, the numbers that we're looking at seemed to have gotten better and certainly, versus last year. So where are some of the areas that maybe aren't measured that we're not able to look at where stuff is getting worse?

Gregg Engles

I don't know what your data you're referring to, so it's hard for me to respond.

Lindsay Drucker Mann - Goldman Sachs

Okay. I'm looking at the Nielsen data, so I may imagine you guys might check that out too.

Gregg Engles

We work off of IRI data. Yes, I don't -- without you giving me specific data to respond to, it's going to hard for me to get it right. So we're happy to take it off-line, though, if you want to dig in to data more on what's happening with volumes or price.

Lindsay Drucker Mann - Goldman Sachs

And then just lastly, the $100 million balance of year, can you just kind of walk through the drivers behind that estimate, whether its private label volume share gains at this space or price concessions at this pace?

John Callahan

It is basically a continuation of the trend that we've seen here in the first quarter, with the major issue here is milk within the FDD business and predominant driver is the lost volume on Branded. That by far is the number one issue, but there is, as Gregg mentioned, a little bit of margin compression on our Private Label business. Those are the primary drivers going forward.

Lindsay Drucker Mann - Goldman Sachs

So we should flow that -- I think it was a 300 basis points number that you said before, we should flow through and that's the basis of it?

Gregg Engles

The shift from brand to private label?

Lindsay Drucker Mann - Goldman Sachs

Yes.

Gregg Engles

That's an appropriate way of thinking about it plus a little price concession.

Operator

We'll take our next Farha Aslam with Stephens Inc.

Farha Aslam - Stephens Inc.

First one for Jack, where are your current interest rates? And when you're looking at refinancing, kind of where are you seeing the market pricing where you could get money today?

John Callahan

Well, remember, the big part of our current bank deal, we had a hedge position in for about...

Farha Aslam - Stephens Inc.

That just rolled off, right?

John Callahan

Part of it did. About $800 million rolled off. But on a go forward, we still have about $2 billion of roughly $3.5 billion that's hedged. And hedged at an interest rate of around, when you average it all in, of around 4.8%.

Farha Aslam - Stephens Inc.

Your current total average interest rates are 4.8% or just on the hedged portion?

John Callahan

On the hedge, it's 4.8%. On the balance, it's not hedge, the average right now is like 1.3%. So on a go-forward basis, the place where we would have some increase on interest expense would really be on the unhedged portion of our debt.

Farha Aslam - Stephens Inc.

So you're not refinancing all of it even with the covenant issues, you don't have to for potential covenant issues?

John Callahan

Well, we're looking at a variety of options as we have been for sometime. Our point today is just that we were going to have to move forward with some refinancing options in 2011. There's just some possibility we may do that a bit sooner in 2010.

Farha Aslam - Stephens Inc.

This is two quarters in the row where the butterfat issue has been an issue, could you share with us kind of were there different issues in each quarter and is there going forward, a better read on butterfat, or is this going to be an issue that continues?

Gregg Engles

Because the business is forecasted with respect to the commodity, we're going to have some volatility, if you will, around the accuracy of our forecast, because these markets, the underlying markets are somewhat volatile. But it really does tend to swing both ways. So in the first part of last year, we benefited enormously from having a butterfat forecast that was higher than what butterfat turned out to be. So it tends to neutralize over time. It is a predictability issue not a fundamental earnings issue.

Farha Aslam - Stephens Inc.

And do you think that, that's going to -- that butterfat has been pretty volatile lately and Europe has a big dash. Is it that you're thinking Europe is going to come in and sell and they haven't, or is it just international demand that's been so strong? Can you give us some color around that?

Gregg Engles

Butter is one of the last places that milk or milk components goes, because of its relatively lower position on the value scale. So as the cheese market and the powder market move around in terms of value, that drives how much milk is available to the churn. And those factors, they're complicated, right? If they're really globally traded commodities, we were driven by production around the world and by demand around the world. So the view had been, we had relatively ample stocks of butter coming into this year. And unexpectedly, low amount of milk has gone to the churn as milk has moved into the Cheese segment, which is a high consumer of fat. So you're getting tighter butter stocks, that's what's really driving the butter market.

Farha Aslam - Stephens Inc.

Gregg, you mentioned that brands have a place on the shelf and a place for retailers. Could you share with us kind of what the brand differentiation is right now in dairy? Kind of are you looking to invest and differentiate your brands more, can you do that and...

Joseph Scalzo

Yes, I think, again, the factor here is the premium pricing relative to private and private label. So in every category that you cover, there's an optimal price gap between branded and private label. And when those brands get outside that price gap, they can no longer grow regardless of what their marketing investment is. So that's the situation that we have today with a number of our very premium brands. The price gap to private label is outside of the range, that frankly, even effective marketing can offset. So until we see some alleviation of the retailers investment in private label, it's very difficult to make an investment in a brand. It's going to change the momentum of the Branded business.

Operator

We'll take our last question today from Jeff Omohundro with Wells Fargo.

Jeffrey Omohundro - Wells Fargo Securities, LLC

I just had a question on WhiteWave and the Branded business. In particular, maybe you can expand on the marketing efforts of how those brands and specifically, the broadcast media, how you see the evolution of your marketing spending continuing over the balance of the year?

Joseph Scalzo

We stepped up investment in the first quarter, principally in our Creamer and Soy businesses, with the launch of our Almond business and Silk, and just strong momentum on our ID business. So we envision to continue making investments in the business as we go forward at a level certainly, not as accelerated as we had in the first quarter. But we're going to invest continue that growth momentum in the business as we go forward. As Gregg mentioned in his prepared comments, this is a business that the volume growth in this business is driving bottom line growth overall in the brand. We've got good cost containment, both in manufacturing and in overhead cost. And so the top line growth driven by volume is doing a terrific job in driving operating margins on the business, and we're going to continue that momentum.

Operator

This does conclude the question-and-answer session. I'll turn the conference back over to our speakers for any additional or closing remarks.

Gregg Engles

Well, thank you all for joining us on the call today. We're in a difficult period in our Milk business, but we are redoubling our efforts to reduce our cost and position ourselves to be successful here for the long run. Thank you for your attendance on the call, and we look forward to talking to you again soon. Thank you.

Operator

Thank you. Ladies and gentlemen, this does concludes today's presentation. We appreciate your participation, and you may now disconnect.

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