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Dean Foods (NYSE:DF)

Q1 2011 Earnings Call

May 10, 2011 9:30 am ET

Executives

Shaun Mara - Chief Financial Officer and Executive Vice President

Barry Sievert - Vice President of Investor Relations

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

Analysts

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

Judy Hong - Goldman Sachs Group Inc.

Jonathan Feeney - Janney Montgomery Scott LLC

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

John Baumgartner

Eric Katzman - Deutsche Bank AG

Robert Dickerson - Consumer Edge Research, LLC

Alton Stump - Longbow Research LLC

Farha Aslam - Stephens Inc.

Akshay Jagdale - KeyBanc Capital Markets Inc.

Unknown Analyst -

David Palmer - UBS Investment Bank

Christine McCracken - Cleveland Research

Operator

Good morning, and welcome to the Dean Foods Co. First Quarter 2011 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 the property of Dean Foods. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of the company is strictly prohibited. At this time, I would like to turn the call over for opening remarks to the Vice President of Investor Relations, Mr. Barry Sievert. Please go ahead, sir.

Barry Sievert

Thank you, Doris, and good morning, everyone. Thanks for joining us for our first quarter 2011 earnings conference call. We issued an earnings release this morning which is available on our website at deanfoods.com. The release is also filed as an exhibit to a Form 8-K available on the SEC's website at sec.gov.

Also available during this call at the Dean Foods website is a slide presentation, which accompanies today's prepared remarks. A replay of today's call, along with the slide presentation, will be available on our website beginning this afternoon.

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

We also would like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements will include, among 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 Shaun Mara, our Chief Financial Officer. Gregg will start us off by providing a general review of the results, walking through the performance of the operating units and current business trends. Following Gregg, Shaun will offer additional comments on our financial results before turning the call back to Gregg for some additional commentary on the forward outlook and other call closing comments. We will then open the call for your questions.

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

Gregg Engles

Thank you, Barry, and thank you for the lapidary style of that forward-looking statement. As you know, we entered 2011 with significant headwinds in the Fresh Dairy business. Processor profits for fluid milk have been significantly reduced over the last 2 years. Retailer strategy to discount private label milk, the spillover effect on branded milk volumes and ensuing direct pressure for price concessions have impacted the entire processing industry. Weak sales volumes across fresh milk and related products have compounded our challenges.

To address these issues, it was imperative that we take prompt, focused actions to stem the decline and begin to rebuild our profitability. During the first quarter, we focused on 3 business fundamentals: accelerated cost reduction, price realization to pass through input cost inflation and volume performance. These activities will continue to be our focus throughout 2011.

While we have a long way to go at Fresh Dairy Direct-Morningstar, I am cautiously optimistic that the trajectory of our business is upward, and that we're on a path for continued progress as we move through the balance of the year.

In our other major business segment, WhiteWave-Alpro continued to perform well, with both strong top and bottom line growth against a tough overlap and an unfavorable holiday calendar.

For the first quarter, we delivered $0.14 of adjusted diluted earnings per share. Consolidated operating income was $107 million, with all platforms performing above our ingoing expectations. Net debt declined $95 million, aided by the sale of Mountain High yogurt in the quarter. Since the close the first quarter, we've further reduced our debt by $155 million through the sale of our private label Yogurt business and receipt of a tax refund. Overall, the business is off to a stronger start than we had anticipated, and we're somewhat encouraged as we look to the balance of the year.

Our team has responded decisively to deteriorating cost and volume environment of early 2011, quickly driving costs out of the business and working to offset inflation through effective input cost pass through. After a slow start in January and February, March showed market improvement. For the quarter, we significantly outperformed our expectations based on early quarter conditions. This outperformance versus expectations was driven in large part by strong overdelivery against our cost targets in FDD-Morningstar and in corporate.

We've significantly stepped up our short-term cost agenda, while remaining committed to our longer-term transformation strategies. This cost outperformance drove approximately $0.04 to $0.05 of upside versus our expectations, offset by approximately $0.02 of volume weakness in Fresh Dairy Direct-Morningstar.

Moreover, our businesses were more successful in passing through cost inflation in a volatile environment than we had expected, adding an additional $0.03 of earnings. A stronger-than-expected top and bottom line performance against tough comps at WhiteWave-Alpro drove the remainder of the upside to our expectations.

Let's now look at each business unit in greater detail, starting with Fresh Dairy Direct-Morningstar. The external environment for our Fresh Dairy Direct-Morningstar business remains challenging, but we did see improvement in Q1. On the whole, retail pricing for private label milk improved in the quarter, as retailers backed away from their deep discount strategy. This reduced the price gap between private label and our regional brands and led our brands to outperform private label during the quarter.

Retail private label pricing improved a bit in both January and February before taking a step back in March, as retailers were slow to reflect the $0.20 per gallon month-over-month increase in raw milk cost at retail. However, we believe the overall trend in retail pricing is up. In addition to improving retail pricing, wholesale pricing on private label milk appears to have stabilized, albeit at historically low levels.

While the news on the pricing front feels better, volume continues to be a concern. Industry-wide fresh milk volumes were down an estimated 1.2% in the first quarter, consistent with recent trends. Our fluid milk sales volumes underperformed the industry, declining 2.4% in the quarter as our channel mix and certain customers underperformed the broader category. Soft industry volumes appear to be driven by a number of factors including weak employment and wages among lower income consumers, declining birth rates and a weak cereal category, which drives roughly 30% of milk use.

Cereal category volumes in measure channels were down approximately 4.5% in the quarter. To address our volume weakness, we've selectively targeted and won new pieces of business. While some of this business came online toward the end of the first quarter, the majority of the volume will come into our system in Q2. We expect this new volume to help partially offset our recent volume trends.

Outside of fluid milk, the other dairy categories we participate in are also weak. This, combined with the sale of our Mountain High Yogurt business, led to a 3.8% decline in total volume for FDD-Morningstar, which deleverages our manufacturing and distribution assets and creates a continuing challenge for our business. Soft volumes across FDD-Morningstar are our biggest concern for the balance of the year.

Commodity prices also post a challenge in Q1. The Class I Mover averaged $16.44 per hundredweight, down 3% sequentially from the fourth quarter. Within the quarter, however, the Class I price rose sharply in March, bringing with it all of the challenges rapid dairy inflation creates for our profit algorithm.

The Class II Butterfat price averaged $2.21 per pound for the quarter as a whole, up 2% sequentially and 49% year-over-year. Butterfat prices surged higher in January from December's relatively low levels, significantly challenging Q1 profitability on a portfolio of butterfat-rich Class II products.

Other commodity prices across the business have also risen substantially. Diesel fuel averaged $3.62 a gallon in Q1, up 15% sequentially and 27% year-over-year. HDPE resin prices were 6% higher sequentially and 4% higher year-over-year.

Despite these challenges, our Fresh Dairy Direct and Morningstar leadership teams manage the business to bottom line results well above plan and a level of gross profit effectively flat to year ago. Accelerated cost savings and effective pricing to cover input inflation helped deliver gross profits that declined only 1% or $3 million in the year ago period to $569 million. This is a significant improvement from our recent gross margin performance despite difficult volume, price and inflation trends.

The difficult conditions we have endured in 2010, and that continued to confront us in early 2011, have led us to revisit our cost agenda in an effort to make more progress, faster. These actions are critical to driving earnings performance this year. During the first quarter, we continued to drive costs across our business at an accelerated rate. In the quarter, we closed a dairy processing facility in the Southeast, helping to offset the deleveraging effect of soft volumes. We expect additional closures over the balance of the year. We eliminated 600 positions across all areas of the business, including manufacturing, distribution and G&A. Our distribution teams eliminated 28 additional routes in the first quarter, with more to come, and we continue to drive up manufacturing costs through plant simplification and continuous improvement projects.

During the quarter, we also scrubbed SG&A across the company in an effort to focus the business on delivering results in this challenging environment and to drive further SG&A reductions. The results of this effort are being rolled out in Q2, and we expect to at least double our original target of $30 million to $60 million in run rate savings by year end 2011. We have solid momentum behind our cost reduction initiatives, and we will continue to push this agenda over the balance of the year to help deliver our financial performance targets.

So, all in all, strong progress against cost reduction initiatives and solid pass through of rising costs was offset by broad-based volume weakness to result in segment operating profit of $111 million for Q1. These results were 12% below year ago levels but just 3% below the seasonally stronger Q4. We are, therefore, guardedly optimistic that FDD-Morningstar is stabilizing and poised to begin to grow earnings in the back half of 2011.

Turning to the WhiteWave-Alpro side of the business, first quarter results reflect continued strong momentum across this segment, with solid sales growth across all key product lines. The first quarter was the fifth consecutive quarter of positive growth across all of our brands. In total, first quarter net sales grew 7% over the prior year to $507 million.

All of our WhiteWave-Alpro brands posted solid results for the quarter. Sales in our WhiteWave Creamers business, which includes International Delight and Land O'Lakes, increased mid-single digits in the quarter. As expected, growth in the Creamers business slowed a bit in Q1, reflecting a shift in the timing of Easter to the second quarter and a price increase to offset inflation. Horizon Organic Milk growth was especially strong this quarter, with net sales up just over 20%. Core product strength, innovation in products and packaging and solid marketing growth continued market share expansion for the brand.

Silk net sales grew in the mid-single digits during the quarter, driven by the continued strong performance of Silk PureAlmond and the rollout of Silk Coconut. We are the market leader across a greatly expanded plant-based beverages category. This redefinition of the addressable market has given us a much larger playing field to grow and innovate under the Silk brand. Alpro net sales increased in the mid-single digits on a constant currency basis, as well as after currency translation.

For the segment, strong top line volume performance, tight cost control and effective pricing to cover inflation was offset somewhat by higher distribution costs, driven by fuel costs and resupply related to production capacity constraints. Despite a difficult calendar with the shift of Easter to Q2, segment operating income grew 8% of WhiteWave-Alpro to $48 million.

With that review of the business units, I'll now turn the call over to Shaun to discuss corporate items. Shaun?

Shaun Mara

Thanks, Gregg. Good morning, everyone. I'll take a few minutes now to walk through the consolidated financial performance for the quarter from a P&L, cash flow and net debt perspective. Starting with the P&L, we see consolidated gross profit of $750 million, driven by essentially flat Fresh Dairy Direct-Morningstar growth profit and 3% growth in WhiteWave-Alpro. This results in a slight increase from the year ago quarter on an absolute dollar basis, however on a per gallon basis, this represents a 4% increase from a year ago despite increased commodity costs that Gregg spoke of earlier.

Moving down the P&L, total distribution expense increased $14 million or 4% over the year ago period, driven principally by higher fuel costs at Fresh Dairy Direct-Morningstar and increased resupply and shipping costs at WhiteWave-Alpro due to continued tight capacity.

Selling and marketing costs in the quarter were 1% lower on a year-over-year basis due primarily to lower overall advertising expense. Conversely, G&A costs were 4% higher with the increase entirely attributable to increases in our incentive compensation that we discussed on our last earnings call.

SG&A costs are an important area of focus for us this year, particularly at FDD-Morningstar and at the corporate level. Last quarter, we set a goal to exit the year with a base SG&A run rate that was $30 million below 2010 levels. We now expect to at least double that target. In the first quarter, total SG&A costs increased 2% to $288 million. However, SG&A and FDD-Morningstar and corporate, excluding advertising and incentive compensation expense, was $20 million below fourth quarter levels and roughly on par with the first quarter of 2010. In addition, we took meaningful actions to reduce these costs early in Q2, including the elimination of approximately 140 positions across SG&A. We expect these actions to help drive our savings run rate going forward.

Below the operating income line, interest expense increased $7 million or 12% from the year ago period. The increase is the result of higher average interest rates related to the amendment and extension of our senior credit facility and the note issuance completed in 2010. The impact of these items was partially offset by lower than average debt balances. For the full year, we expect interest expense to be between $255 million and $260 million. Net income of $25 million resulted in first quarter adjusted diluted earnings per share of $0.14.

Turning now to the cash flow and the balance sheet, net cash from continuing operations for the quarter was $37 million, with $40 million of capital expenditures, this resulted in effectively zero-free cash flow for the quarter. Operating cash flows were lower than average in the quarter, due to reduced net income and higher inventory and receivable valuations driven primarily by the increase in commodity costs at the end of the quarter. Despite this, we expect operating free cash flow generation to pick up considerably over the balance of the year and expect full year free cash flow to be in excess of $200 million.

We did, however, continue to reduce our outstanding total debt in Q1. Asset sales drove net debt reductions of $95 million in the quarter, total outstanding net debt at quarter end to $3.88 billion, and our quarter end leverage ratio of funded debt to EBITDA, as defined by our credit agreement, was essentially flat with last quarter at 5.14x.

Debt reduction in the early part of the second quarter has already been strong due to the closing of the sales of our Private Label Yogurt business and the receive of a tax refund, which together provided an additional $155 million of debt reduction. With the additional proceeds, we have fully repaid our 2012 tranche A term loan, therefore, our next 12 months of required debt paydown has been cut in half, now totaling only $53 million.

As a reminder, our maximum total leverage covenant is now 5.75x our net funded debt to EBITDA as calculated per our credit agreement. This compares to our reported quarter and total leverage ratio of 5.14x. However, our leverage ratio would have been approximately 5x at quarter end if you pro-forma for the proceeds of the $155 million from our asset sale and tax refund received in April.

Our covenant remained at 5.75x until March of 2012, but then it stepped down to 5x times. It remains at that level until the end of March 2013 before stepping down to 5.25x. We expected our first quarter leverage ratio of 5.14x will represent our peak leverage going forward, and we anticipate ending the year below 4.75x levered.

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

Gregg Engles

Thank you, Shaun. As you can see, the WhiteWave-Alpro business continues to perform extremely well, with solid top and bottom line momentum. We expect the strong performance from WhiteWave-Alpro to continue throughout the balance of the year, with operating income growth in the low to mid teens for the full year.

In our Dairy business challenges remain, particularly related to soft volume performance of the business. As we have previously discussed, overall pricing was reset to lower level throughout last year, and the overlaps remain challenging until we get to the back half of 2011. Moreover, the expense related to the restoration of incentive compensation to target levels will remain a headwind throughout this year.

In this environment, we're focused on 3 fundamental things to improve the business. First, we've stepped up our agenda to reduce costs and improve profitability. Second, because input cost volatility is here to stay, we're focused on pricing to offset inflation. We're working hard to maintain and, where necessary, improve our pricing tools. Third, to offset volume softness at FDD-Morningstar, we're pursuing new business. Beginning in the second quarter, we should begin to see new business volume mitigate some of the fluid milk volume weakness we previously experienced. I'm encouraged by the progress we've made so far this year across these 3 fronts. We hope to drive improving results through the balance of the year and enter 2012 with renewed momentum.

Looking ahead at the balance of the year, many challenges remain, but our ability to overcome them continues to improve. All told, we expect second quarter adjusted diluted earnings per share of between $0.15 and $0.20. Based on our performance in the first quarter, as well as our expectations for the second, we've raised our full year guidance to between $0.67 and $0.75 per adjusted diluted share.

In summary, at Fresh Dairy Direct-Morningstar, we're focused on the fundamentals. Costs are coming out, and we expect results to improve as we move through the year. The pricing environment continues to stabilize, and our team has done a solid job, thus far, in pricing to recover the inflationary pressures on the business. Soft volumes remain but will be augmented by new business beginning in the second quarter. At WhiteWave-Alpro, the strong momentum we entered the year with continues, and we expect a solid year of low to mid teens earnings growth.

All in all, we're cautiously optimistic the business has stabilized and is beginning to turn around, and our current view is that it will continue to improve and return to year-over-year growth by the back half of 2011.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Farha Aslam with Stephens Inc.

Farha Aslam - Stephens Inc.

Quick question on your cost going through the year. Would you say that your formulas are working well in terms of passing along the current diesel and resin costs? And how are you thinking about margins going forward?

Gregg Engles

Well, I think as evidenced by the Q1 outperformance, we're doing a good job of passing along commodity inflation, generally. As it relates to our formulas, we discussed this over the last several quarters, but our formulas are best at passing along the milk commodity inflation. They're a little less well-developed across the totality of our business at recovering other input cost inflation, such as those around the fuel complex and packaging. They're getting better, but we still have work to do there, which leaves us working more manually, if you will, from period to period to pass those costs along. But so far, it's going pretty well. Like the marketplace is highly aware of the fact that these costs are going up. So while it's a little bit less automatic than milk price inflation, so far, we're recovering it out on the marketplace. In terms of margins, we were much more off of a profit per gallon, $0.01 profit per gallon as opposed to a percentage margin, just because the commodity and its volatility makes it difficult to make meaningful comparisons from period to period as input costs change around a percentage margin. We were in FDD-Morningstar, I think, a little bit north of 4% in terms of margin for this quarter. Given the fact that milk prices have gone up so much, it wouldn't surprise me to see that margin percentage come down. But I think our increased guidance is evidence of the fact that we expect the $0.01 profit per gallon here to drift up at a slight incremental rate over the balance of the year as we continue to drive cost out of the business.

Farha Aslam - Stephens Inc.

And one follow-up, just could you give us a little more color about the new business that you're bringing on in the fiscal second [ph] quarter in terms of the size of that new business that's coming on?

Gregg Engles

It's business, really, across our systems, so it's customers in all channels. But there's some larger pieces to the business, of course, the larger pieces in this business are in large format. So we've picked up a couple of nice large-format accounts or expended business with existing accounts. The net total of the new business coming on is in excess of 50 million gallons a year. So it's a nice piece of business.

Operator

And we'll go next to Alton Stump with Longbow Research.

Alton Stump - Longbow Research LLC

Just with the pricing mechanism, obviously, there's been a lot of talk about as you see the price gap close, whether or not consumers will actually shift back to regional brands of milk, and, if so, at what pace -- what are you seeing so far now that we actually are seeing the price gap close? Is that driving consumers back to the regional branded milk?

Gregg Engles

Yes, it is driving consumers back to the regionally branded milk. So we saw revenue growth in our brands this quarter ahead of growth of private label. So there is intra-category elasticity between brands and private label. So as the price gaps have closed, we've seen the brands accelerate and private label somewhat decelerate. I think the long-term trend still is towards increased private label penetration in this category. But we saw the brands take quite a beating over the last 5 quarters, and I think for a few quarters, you're going to see them rebound in terms of share relative to private label. I would point out that it, frankly, is in everybody's interest to sell more brands. So we make more money on our brands, but our retail partners make more money on our brands as well, on a profit per gallon basis. So I think the industry is reverting to a more traditional view of what the profit pool ought to be in the category. Everyone has suffered over the last 5 quarters by virtue of these retail price wars and the blow back effect on the processing segment. And I think, as we've indicated over the last few quarters, it feels like it's abating and this is the first time you've actually seen that show up in our results.

Alton Stump - Longbow Research LLC

If I could just ask one quick housekeeping item, with the $19.49 million benefit listed in your other operating income as part of your operating cost, is that just adjusting for the divestiture that is in the SG&A lines? I just want to make sure that, that's not a one-time...

Shaun Mara

Are you referring to the adjusted to GAAP?

Alton Stump - Longbow Research LLC

Yes.

Shaun Mara

There's 2 pieces of that. One is the sale of Mountain High, and I think it's partially offset by the closure of -- it's a closure of a facility up in Wisconsin. So that's the 2 pieces that are in there.

Gregg Engles

That's sort of net to 0.

Operator

And we'll go next to a David Palmer with UBS.

David Palmer - UBS Investment Bank

I wanted to get a sense of the sequence of events and how you think about your guidance. From the first quarter, and I think -- correct me if I'm wrong about this, but I think you mentioned that January and February were really the source of upsides for the quarter for the environment, at least in terms of price and cost relationship, a little bit better in those 2 months than March, which was characterized as a bit of a setback. I guess what I'm trying to figure out is, you gave guidance for that quarter of $0.05 on February 16. Could you maybe just walk us through how that played out and how you got the upside? Because, obviously, TheStreet was in somewhere in the midteens on earnings before that guidance, and then you somehow beat, but the beat seemed to happen from the first 2/3 of the quarter.

Gregg Engles

No, the beat happened primarily in March. If you go back and look at the transcript, David, maybe the line was fuzzy when we were going through the call, but the beat was primarily driven by March. We had a soft January and February, quite a soft January and February.

David Palmer - UBS Investment Bank

Okay. But there was no -- March was a better, even though the pricing was a setback. Was that what you said about March?

Gregg Engles

At retail, we had a $0.20 per gallon increase in the cost of milk for March -- from February to March, not all of which was reflected in private label pricing at retail in the quarter was the comment. It has nothing to do with our pricing. It's what the retailer did on shelf with private label pricing in the month of March.

David Palmer - UBS Investment Bank

And what sort of -- and that retail pricing in March, does that imply -- does that foreshadow any sort of implications for your margins in April, May? Or what are the implications of that action in March in that retail?

Gregg Engles

Well, you probably didn't have the charts and the slides up, but if you were to look at the private label margin over milk chart, you will see that it rises for most of the first quarter but then steps back in March. Just the commentary was really just -- and that's to illustrate that there is a lag in reflecting changing milk prices on shelf at retail. But, as we said in our prepared remarks, we believe that the retail price trend on private label milk is up, notwithstanding, the step back in March due to the lag in passing through the $0.20 per gallon rise in the cost.

Operator

And we'll go next to Ahmit Sharma [ph] with BMO Capital Markets.

Unknown Analyst -

Just wanted to focus on the promotional activity that you are seeing at the retailer level. You indicated in the presentation slides that the external environment is getting better. Just wanted to get a little bit more color around that if you may, please.

Gregg Engles

Well, I think this is a continuation of a dialogue that we've had with you over the last few quarters, really, since the beginning of this heavy level of retail price discounting. It was always our view that, that was unsustainable. It was our view that it was unsustainable because we didn't believe that deep discounting of milk at retail would drive incremental volume, nor did we believe that over time, as the entire market came down, it would drive permanent changes in share among retailers. I think that those conclusions have been borne out by the facts over the last 5 quarters, and so you're seeing the recognition of that reality by retailers being reflected in their price strategy on shelf, right? So an enormous amount of industry profit pool was destroyed by retailers that, frankly, were significantly below cost. And as those heavy promotional activities have failed to generate share gains, traffic and incremental profitability for the retailers driving them, they've walked back to more traditional pricing at shelf. And, of course, that's what you would expect economically rational people to do.

Unknown Analyst -

Great. And as that environment improves, do you expect some of those benefits? Or as discounting declines in the retail, do you see some of that coming back to you as well? Or are retailers likely to keep all the benefit from lower promotional spending?

Gregg Engles

Well, the primary place where it's going to come back to us, again, is in the relative value proposition of our brands. So we never deeply discounted our brands. We could never have afforded to invest as much in the category as the retailers did because, of course, we don't get the benefit of whatever perceived increase in traffic they might have had across the balance of their store. So we became significantly out of value in our brands during this period of deep promotion, and the principal benefit is a return to more traditional brand price gaps with the restoration of a more logical private label pricing on shelf. With respect to the procurement cost of retailers, as a result of the heavy pressures helped fund deep discounts -- while I don't think the retailers will give that back quickly, I do think that at some level, pricing at the wholesale trade became in the heat of the battle, quite low as well. I think, over time, the industry is evidencing the fact that just like private label retails at very low levels are unsustainable, private label wholesales are unsustainable, too. But that will be a much more slow restoration of the profit pool because there's going to be a negotiation between buyers and sellers as opposed to a unilateral decision on the part of retailers to take their price up at the shelf.

Operator

[Operator Instructions] We'll go next to Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

Just in terms of your feeds and volume trends, so if you look at your results in the quarter, the 2.4% I think was the total number. Can you tell us how brands did versus the private label did within that mix?

Gregg Engles

I don't have that number right of the top of my head, but Barry can get it for you after the call.

Judy Hong - Goldman Sachs Group Inc.

Okay. But I think you said branded did better than private label.

Gregg Engles

Yes. Branded definitely did better than private label.

Barry Sievert

Both were down. Branded was slightly better than private level.

Gregg Engles

Barry says both were down, but brand is less than private level.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then just from an industry term perspective, you called out some of the headwinds that has been pressuring the industry volume, but if feels like some of those have been around for some time now, whether it's employment trends, the weak cereal category, which actually is starting to get a little bit better, the birth rate declines. I'm just wondering if there's anything that has gotten incrementally worse that's causing the volume softness in recent quarters? And then as you think about, from a consumer perspective, as they feel now that the higher gas prices and inflation in other areas, how do you think about volume sort of going forward regardless of some of these businesses that you've won in Q2?

Gregg Engles

We call volume out in our prepared remarks as the biggest risk going forward. And that is absolutely the case in our view. It is the big risk going forward. So as it relates to the category, we had a slide in the slides that accompany the script that show category volumes over, I think, the last 5 quarters, they're pretty consistently down across that period of time in this sort of 1% to 2% range. And that feels right now like it's a trend that's going to continue certainly into Q2, and we'll see how it trends beyond that. At some point in time, you get the soft comps and volume should start to turn up here, but I think that's probably not going to happen over the balance of this year. So I think the most telling indicator for us that economic weakness and employment is the key issue driving soft volumes is the fact that we continue to see, as in contrast to the historical norms, we continue to see volume pick up heavily at the beginning of each month and then steadily erode through the month, being particularly soft in the last week to 10 days of the month. That just tells us that people are running out of money. Now this is an all-family, all-population product, so the people at the bottom are still suffering very high rates of unemployment and weak income growth. And I just think that's playing out in continued pressure on all purchases that those folks make, and most of those purchases, as you get lower and lower in the income strata, are what you would describe in your Coverage Universe as staples. So we're just seeing them soft, and we're looking forward to an improving economy and employment picture, but it's got to really create jobs and income down in the bottom 25% to 30%, I think, before soft volumes are really going to start to improve here. So I think that's the key driver. Us taking business within the category is just a share play, right? So we're not driving category volumes there, we're just trying to pickup share and maintain volume within our system in order not to suffer asset deleverage. And the key to that is being competitively able to do so, which means driving costs out of the business, which is what we're doing every day. So gas prices, anything that takes money out of the average consumer's pocket that is a necessity forces them to make choices. So you see consumers driving less, right? They're cutting back on their miles driven in order to offset the price of gasoline, and you see them buying less stuff in order to offset the higher prices of gasoline. So inflation in stable purchases and items is going to be negative for this category. So we're worried about volumes, and it has a meaningful impact on our P&L. So we're doing a lot of good things here, but volume is an issue we have to really keep our eye on.

Judy Hong - Goldman Sachs Group Inc.

So when you think about, for the balance of the year, what's embedded in your guidance? Because I think in fourth quarter, at the end of fourth quarter, you called out some of the considerations in the back half that would drive a stronger recovery. And I think that is still the case, but I'm just wondering how much of the risk in terms of volume are sort of embedded in that second half recovery outlook.

Gregg Engles

Our outlook for the balance of the year basically calls for holding our volume flat with where we were in the first half, right? So if a category continues to decline, that means we're going to have to start gaining this year, the whole volume is flat.

Judy Hong - Goldman Sachs Group Inc.

So the volume is flat including the new business, you're saying?

Gregg Engles

Yes, including the new business.

Judy Hong - Goldman Sachs Group Inc.

Okay. So from down 2.5% in Q1 gets better with the new business, but, basically, that implies that industry is down kind of 1% to 2% percent and then you win some new businesses that helps you in Q2 and beyond?

Gregg Engles

Yes. And there, I'm really speaking about milk volumes. We think our other volumes are going to continue to be very soft. So total volume, we expect to be down over the balance of the year, probably, in the 1% to 2% range.

Operator

And we'll go next to Alexia Howard with Sanford Bernstein.

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

Can I ask about the Horizon Milk business? I think it was the third quarter of last year there were some comments about it getting, I guess improving to about break even from being quite negative over the last few years. Given the surge in volumes this time, are we now seeing Horizon move into being much more profitable? And what would the ultimate margin be on that business, do you think?

Gregg Engles

Yes, Horizon has returned to profitability. So I think we've come to this extended period that was driven by significant excess supply beginning in '07 that led to discounting, and then compounded by a soft economy for '08 and '09. We've emerged from that and are, again, profitable in our Horizon Organic business. Right now its profitability, don't look a whole lot different than conventional milk. So it's a significant drag on the overall profit margins of WhiteWave-Alpro, but it's on an improving trend, and we're pleased by that.

Operator

And we'll go next to Christine McCracken with Cleveland Research.

Christine McCracken - Cleveland Research

Just on your fuel and resins exposure. In the past, you've had some longer-term contracts that kind of protected you, at least, over the short run, and I thought from rising prices, is that something that you continue to have some protection on? Or maybe you can talk about how that pricing mechanism works.

Gregg Engles

We're exposed to these markets broadly overtime because while you can hedge period-to-period, you can't hedge over the long-term. We have -- we came into the year with some hedges out through the first half on the fuel complex. We have -- those have largely run out or largely will run out. We have baked into our guidance a fuel price sort of in the $3.50 to $4 range. If it's materially above that, then we'll suffer some margin compression and we'll have to go get it out of the marketplace. So we're coming in to a fuel price range here where we're having a price in the marketplace. In our natural gas, we're pretty well covered and we don't see a lot of volatility there. Sugar and other input costs, depending upon which part of the business we're in and how pricing works in that business, we're either covered or naked depending upon, again, what the business model is in those businesses. So we've clearly experienced some input cost inflation in the sweetener complex. But we expected it to be higher through the year. And we've been pricing for it. In our WhiteWave businesses, we are on crop-based inputs were more hedged than not, given the nature of pricing in those commodities. And in butter and cream and those sorts of things, again as I said, the business model is a period-to-period pass-through model. So we pretty much move with the market.

Christine McCracken - Cleveland Research

Okay. And you talked about the changes to your contracts, I guess, with the retailers. I'm just wondering, you're trying to get a little bit more market based it seems. Is there anything, specifically, that you've changed in terms of how quickly you can realize kind of those cost increases? And maybe just a little color around that.

Gregg Engles

Well, in the Fluid Milk business, we're trying to move the business model more towards a transparent model where our customers understand the impact that input costs have on their costs and their pass through in a transparent way, right? So the more we can move the business model towards a pass through of inputs, whether they're milk or fuel or resin, the better everybody is going to understand the feel about the dynamics in the marketplace, and the more predictable our earnings are going to be. So we're definitely trying to move the business model in that direction. But we have tens of thousands of customers, and it is a lot of work doing that. So we're making some progress. And I think you see that in somewhat improved predictability of our performance, but we've got a long way to go.

Operator

And we'll go next to Robert Dickerson with Consumer Edge Research.

Robert Dickerson - Consumer Edge Research, LLC

It's a simple question for you I'm sure people ask you on every call, but I just wanted to hear what your current outlook is for the Class I Mover just for the rest of the year. If that has changed from what you said in the past few months? Or if you're still in line.

Gregg Engles

We're pretty much in the same place we were last quarter. We've experienced the run up that we predicted at the end of Q1. So the prices have moved up to the $19, $20 range, and we basically see them staying for the balance of the year. Maybe a slight drift down towards the end of the year, but we basically see them stand in this range.

Robert Dickerson - Consumer Edge Research, LLC

Okay, fair enough. And then all the commentary that you have around pricing at retail, it does sound -- I mean what you're potentially saying is that for the most part, retailers have reached the bottom with respect to wholesale pricing. Now if -- but is it safe to assume that, I mean, that outlook, that commentary, is also based upon the assumption that the Class I Mover remains at $19 to $20? Or, I mean, could we see in theory if the Class I were to go down to $17 that it, I mean it could, potentially in that scenario, be a little bit more difficult to get the pricing that you're getting, which in turn would hopefully help your volumes? Is that fair?

Gregg Engles

Well, again, the way that we measure the retail marketplace is look at the spread over the cost of milk, right? So if the price goes up or down on balance, the retailer is going to pass that along. The question is going to be, do they pass it along 100% or something less than 100%? So if the price of milk goes up to $24, you can be pretty sure that the price of milk in the shelf is going to go up. The question is, is it going to go up to roughly $0.40 that, that would imply? Or is it going to go up some lesser amount as retailers try and hit a particular price point in a rising price environment? If the price of milk comes down, again, $3 or roughly $0.30 a gallon, you'll see it come down at shelf. I wouldn't expect, in this environment, to see it go down more than the cost of milk. And, in fact, I would expect to see that the margin over milk, perhaps, expand a little bit in that environment. So the price is going to get pass through, by and large. If the price of milk comes down and we get better price points at retail, I think we will see some improvement in the volume. But over time, the trend is towards retailers trying to reestablish their gross margins at retail.

Robert Dickerson - Consumer Edge Research, LLC

Right. So I mean, essentially though, if the price of milk were to come down some, I mean it's not necessarily negative for you because you think that...

Gregg Engles

No, it's positive for us. No question about it. It's positive for us.

Robert Dickerson - Consumer Edge Research, LLC

Yes, I mean, and especially what's happened over the past year, right? I mean the retailers, on average, have experienced what it means to see lower pricings. So if they can increase the pricing and you make a little bit more money on wholesale, you don't think that it should revert back to being worse. It should really, hopefully, get better even if the price of milk comes down.

Gregg Engles

I would think so. I mean, if the price of milk goes down to $9 again, you'll see really hot retail prices, and it could get a little crazy. But I don't see any circumstance other than when if that happens.

Robert Dickerson - Consumer Edge Research, LLC

Okay, fair enough.

Operator

And we go next to Chris Growe with Stifel, Nicolaus.

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

I just wanted to ask you 2 questions. The first one would be, as we're watching kind of branded milk get better versus private label milk, is the price gather, which the consumer goes back to branded milk, any lower than it used to be? So are you seeing kind of those same sort of consumer trends that you give it a little more flexibility or kind of where branded milk may be later in the year?

Gregg Engles

I don't think we can call it with that level of precision, yet. What is clear is smaller price gaps lead to better performance on the part of brands. To disaggregate the price gap issue versus the overall level of price because the Class I Mover has moved up meaningfully is just really go out and do. So I wish I could answer your question, but I'm not sure that I can.

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

I'm just curious, if there's any indication the consumer or if there's going -- is the consumer in better shape less than employment, is that better? That's all I'm trying to get out there. My other question then would be on the channel mix. You've started out a couple of quarters, maybe a few quarters now, in terms of your new product or new account wins, is that helping you get into some of these channels that are growing and taking share, be it dollar stores, or that kind of thing?

Gregg Engles

Well we're definitely penetrating some of the growing channels more than we have in the past. So we've got a good dollar channel business, we have a good drug and C-store channel business. We have a food service business that remains pretty soft. That is an issue with respect to volumes. And I think as you see gas prices going up, you're starting to see reflected in the reports out of certain parts of the out-of-home dining industry, some softness. So that's a channel issue that we have been fighting to some degree.

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

And then I just want to be clear on the cost savings and my final question, so I read that you indicated that -- or I guess from an SG&A standpoint, I just want to be clear on the comment, I think it was Shaun, made about $20 million relatively where you were a year ago in SG&A, is that right in the quarter?

Gregg Engles

$20 million versus Q4 if you take out the advertising and the incentive accruals.

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

Okay. And then in terms of your...

Gregg Engles

The point of that, Chris, is that the underlying rate of spend on SG&A is going down.

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

Right. Okay. And that's in-line with the $60 million you have for the year, then?

Gregg Engles

Correct, $60 million is run rate for the year exiting Q4.

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

Okay, that's great.

Operator

And we'll go next to the Eric Katzman with Deutsche Bank.

Eric Katzman - Deutsche Bank AG

Gregg, it's getting close to $15 a share. Does that mean the beard comes off?

Gregg Engles

I still have it on, Eric. If it keeps working maybe we'll push the price target higher.

Eric Katzman - Deutsche Bank AG

I hope that doesn't go against my questions. There's a couple of things, and it's all seriousness, there's a couple of things that don't make sense to me. Like on the one hand, you're calling out cold cereal as a factor in the consumption of milk. And yet a week ago, we heard from Kellogg, number one player in cereal, who probably has pretty good visibility into that business, and they said the category is actually looking pretty good. So that doesn't jive. And then second, we were talking about the volume in the category being down because the consumer is so weak in part. And then at the same time, we're saying that branded is doing better even though the dollar difference obviously still exists. It may be narrower, but it's still a greater price outlay. So there's a couple of things here that just seemed to me kind of go against one another. Can you kind of help me with those?

Gregg Engles

Sure, as to the cereal comment and Kellogg's comment, I would just say our comments on the cereal category is where the comment about Q1 volume softness and it's historical fact based comment. IRI Cereal was down 4.5% in volume, right? And that was Q1 look at the business. So I didn't listen to the Kellogg call, maybe I need to start doing that going forward, but they may see the category improving, and I certainly hope that it does. And I hope that their outlook for the category is positive in terms of volume as opposed to price and margin. But Q1, it was a soft category. So I don't know if that is an accurate explanation, but it's my explanation, at this point in time, to your question. In terms of the brand private label price spread, we've seen this dichotomy for an extended number of quarters now. So our $8 milk at Horizon Organic was up in volume close to 20% in Q1, right? But Tiffany's is doing great, and the high-end department stores are doing well. So people at the top, who are not in that bottom half or bottom third of the income demographic, are feeling quite good about their circumstances, right? Unemployment rates are very low, incomes are rock-solid, their portfolios are up 100% off the bottom and they're back to buying the brands and the products that they buy to make their lives richer and better. And that extends in a certain part of the demographic to our regional milk brands as well, right? But if you look at where the totality of our volume is sold it's to everybody in the population. And all you have to do is flip back within the last 2 or 3 weeks and read Mike Duke's commentary about the Wal-Mart customer and the rate at which they're struggling with difficult employment conditions and inflation, and you'll see that folks who are in that income demographic are still trimming their sails. So that's the best explanation I can give you for the divergence between our branded portfolio's performance, whether it's WhiteWave or whether it's our regional brands, and the overall category's performance.

Eric Katzman - Deutsche Bank AG

Just a quick follow-up, on the fact that Easter is shifting and you've highlighted that, how much does that kind of help the second quarter?

Gregg Engles

I think it helps it somewhat in certain parts of our WhiteWave portfolio, it definitely helps. So we've got the creamer and half-and-half part of our WhiteWave business respond well to holidays and to Easter. And I don't think you'll see a huge change in traditional milk consumption based upon where Easter falls. Although, we do get a bit of an Easter bump but if on the basic milk business, it's not a tremendous bump.

Operator

And we'll go next to Jonathan Feeney with Janney Montgomery Scott.

Jonathan Feeney - Janney Montgomery Scott LLC

Gregg, I wanted to dig into -- it was interesting commentary that you're seeking to hold volumes flat and protect sharing, potentially down market. You've done some encouraging things it seems. I'm just going off the website and a couple of announcements you've made in terms of divesting plants, closing down plants, clearly that's there in the reduced SG&A, and do you reach a point where you can afford to lose your lower profit customers when you take out these costs and take out this capacity? That's what I'm wondering and I have a follow-up to that.

Gregg Engles

John, look, this is a fixed cost oriented business in the FDD-Morningstar network. There's a lot of excess capacity in the industry. Taking capacity out of our system against fixed volumes has a lot of positive benefits. So you're going to see us continue to drive capacity out of our network. But the real benefits are going to come against leveraging our existing or even more volume against that reduced set of fixed cost, and that's what you're starting to see play out, I think, in our profit algorithm. And I hope you'll continue to see it play out more over the balance of the year. So we need to get the margin right on the business that we have in our system. We're working hard on that. And then we need to get the costs right and as low as possible, and then we need to drive as much volume across that at appropriate margins as we can. And so that's sort of the simultaneous equation that we're trying to solve here. We're not looking to push any volume out of our system, but we are looking to earn an economical return on the volume that we serve. So part of that is price, part of it is cost, and we're driving against all those levers. I guess that's the best explanation I can give you.

Jonathan Feeney - Janney Montgomery Scott LLC

Just one question that will stretch the definition of a follow-up because it has [indiscernible] my first question. It doesn't meet the definition at all. The free cash flow guidance, when you look at the trajectory of milk prices, I know that tends to drive inventories up. It did it in the quarter, and that hurt your free cash flow realization. You're guiding to $100 million it looks like ahead of what guided net income is over the remainder of this year. Is that dependent on the declining milk cost forecast and then will positive free cash flow be possible in Q2 with this trajectory in fluid dairy?

Shaun Mara

You mentioned it already but, obviously, the big part of that is the income coming up so affect about probably half of that. We do see some slight improvement in working capital for the rest of the year, and another thing to keep in mind there, is we talked about the tax refund that came through in April, so that's a big number to step up in the second quarter as well.

Operator

And we'll go next to John Baumgartner with Telsey Advisory Group.

John Baumgartner

I guess, first off, thinking about the excess cream sales in the quarter, how meaningful of a benefit was that this time around in Q1, given where multiples were in the butterfat price?

Gregg Engles

The excess cream sales are, I would say, slightly ahead of historical norms right now. Not unusually so, but we have a high butter price, and we have the skim price in control. So right now, we're pretty much in the middle of the fairway in terms of excess cream sales. So they're certainly not hurting us.

John Baumgartner

And then, Gregg, just to follow up. Thinking about the organic milk category. It looks like just the overall category growth rate. I guess you're kind of back to levels of the middle of the decade, given the higher base now, has there been a change in how retailers are managing the category as far as advertising or heavily in circulars? Is it being used as more of a traffic driver for a higher end consumer? What do you attribute this new 20% plus growth in category to right now?

Gregg Engles

I attribute it to the fact that the fundamental organic proposition is a really powerful one, and we still have among the appropriate income demographic very low rates of household penetration. So there's lots opportunity for this category to grow. The proposition for families with children is a compelling proposition. And you now have a category that is more orderly. So you've had a great winnowing of me-too brands in the category. The category, really, now is driven by Horizon Organic and private label, Horizon having more than a 40% share in this category. We're advertising the benefits of the proposition more heavily than we have historically, and we're innovating in the category. And so, we think we're on a long-term, secular trend of sort of 10-plus percent volume growth in this category. And that will be a fantastic algorithm for us if it plays out over time because you can manage supply against those kinds of growth rates. If the growth rates stay close to 20%, the category will go through throws of imbalance of supply and demand again. So we see the category sort of coming back down into that low teens area, and that's a good thing.

Operator

And our final question comes from Akshay Jagdale with KeyBanc Capital Markets.

Akshay Jagdale - KeyBanc Capital Markets Inc.

So I just wanted to follow-up on one of the comments you made about structurally lower margins in private label milk. I think most analysts have modeled this business on a percentage basis. Can you help us understand what you think the new normal for FDD margins is? And perhaps, how far away you are from getting to that new normal, given all the good work you're doing on the cost cutting side?

Gregg Engles

Yes, I don't want to get in the business of predicting this with too much precision. But if you go back into the 2005 to 2008 period, you would've found operating income per gallon in the sort of $0.16 to $0.20 range, depending upon what was happening with the commodity and this volatility and what was happening competitively. As we came through the back half of 2000 -- when we came into 2009, with this rapid drop of all the commodity inputs we had, you saw operating income per gallon in Q1 move up into the mid 20s, right? Clearly, an unsustainable level. And it drifted back down into sort of that high teens by the end of 2009. What happened in 2010 though, with all of the issues that we've discussed endlessly on these calls, is you saw that operating income per gallon moved down into the low teens. What you're seeing now is it starts to tick back up a little bit. So I would expect that over the balance of this year, we would move back into the territory of the mid-teens sort of operating income margins here. Beyond that, it's going to be driven north, I believe, by cost reductions. I do think that, ultimately, we can end back up in the traditional range of profitability that we had prior to the 2009 period, though. I do believe we can get there over time.

Akshay Jagdale - KeyBanc Capital Markets Inc.

One last one, in terms of the comments you've made, overall, about the category, the one thing that I'm a bit confused about is with volumes declining for the overall industry, why would we expect gross margins at the wholesale level to improve? So if I'm a processor of milk, and I see my volumes coming down in desperation, I'm going try it to win as much business as I can. It points to a more competitive environment than anything else. So can you help me understand that aspect? I mean, I understand that you are cutting costs in your company ahead of, probably, others. But it just doesn't jive with volumes coming down relative to gross margins at the wholesale level improving for the industry.

Gregg Engles

Yes, you're hitting on a key challenge here, and that's why we say volumes remain our biggest concern for the balance of the year and, frankly, going forward. So the category for the last 5 quarters, volumes come down 1% to 1.5%, if you look at the category as a whole. So we clearly are taking capacity out of our system ahead of the volume decline. You're seeing capacity come out of the rest of the system as well. So slowly, you're seeing plant closures across the plant network. So I would say that on balance in that environment, with plants coming out, you're probably maintaining capacity utilization about where you were. But, clearly, soft volumes, if they persist over time, will be downward pressure on pricing and margin. I think the counterbalance to that is, as we come through 2009, I think we sort of tested the bottom of what margins can get to. And we've seen the industry on the processing side. Basically, it appears to me to conclude that they can't sustain prices at those levels. So you'd rather surrender volume than surrender more price. And I think we're sort of forming that kind of bottom in the industry. Thank you all for joining us on the call. We appreciate it, and we look forward to the next time we have to speak to you.

Operator

And ladies and gentlemen, that does conclude today's presentation. We thank you for your participation.

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