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Dean Foods Co. (DF)

Q2 2007 Earnings Call

August 7, 2007, 9:00 AM ET

Executives

Barry Sievert - Senior Director, IR

Gregg L. Engles - Chairman and CEO

Jack F. Callahan - EVP and CFO

Analysts

Terry Bivens - Bears Stearns & Company

Eric Katzman - Deutsche Bank

Christopher Growe - A.G. Edwards

Farha Aslam - Stephens Inc

Edgar Roesch - Banc of America Securities

Eric Serotta - Merrill Lynch

Pablo Zuanic - JP Morgan

Christine McCracken - Cleveland Research

Pi Aquino - Credit Suisse

Presentation

Operator

Good morning. Welcome to the Dean Foods Company Second Quarter earnings Conference Call. Please note that today’s call is being recorded and is also being broadcast live over the internet on Dean Foods' corporate website. This broadcast is the property of Dean Foods. Any redistribution, retransmission, or rebroadcast of this call with any form without the express written consent of the Company is strictly prohibited.

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

Barry Sievert - Senior Director, Investor Relations

Thank you Vicky and good morning everyone. Thanks for joining us for our second quarter 2007 conference call. We issued a press release this morning which is available on our website at DeanFoods.com. It’s also available on the SEC's website at SEC.gov. A replay of today's call will be available on our website beginning this afternoon.

The consolidated earnings, operating income, and operating margin information that will be provided today are from continuing operations and have been adjusted to exclude the impact of discontinued operations, financing cost related to the recapitalization of the balance sheet, the expense related to facility closing and reorganization and nonrecurring items in order to enable you to make meaningful evaluation of our operating performance during periods. The earnings release contains a more detailed discussion of the reasons why these items are excluded from the consolidated results along with a reconciliation between GAAP and adjusted earnings per share. We will explain these items in more detail later in the call.

We also would like to advice you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the 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, and various other aspects of our business. These statements involve risks and uncertainties that may cause actual results to differ materially from the statements made on today's conference call. Information concerning those risks is contained in the Company's periodic reports on Forms 10-K and 10-Q and in today's press release.

With these formalities out of the way, I will now turn the call over to Gregg Engles, our Chairman and CEO, who will review our second quarter performance and give an update on our strategic initiatives. Following Mr. Engles, Jack Callahan our Chief Financial Officer will summarize our consolidated financial results for the first quarter of 2007 and discuss our forward outlook. Following Mr. Callahan's remarks, we will open the call for your questions. Gregg?

Gregg L. Engles - Chairman and Chief Executive Officer

Thank you Barry and thank all of you for joining us on the call this morning. Before we begin the discussion of the second quarter’s results, I would like to first set the stage by reviewing the usually difficult operating environment, we're faced with this year.

Right now, it’s feel like a perfect storm, and it’s not over. Across the dairy complex, processes like Dean are being challenged by the most stubbornly inflationary dairy markets in history. Strong growth in foreign demand for U.S. nonfat dry milk powder, combined with the weak dollar and reduced production in another key global dairy markets has driven sustained increases in U.S. dairy prices throughout the year. Prices for nonfat dry milk have almost doubled since the beginning of the year, which in turn has led to rapid and sustained increases in fluid milk pricing. Through August of this year, the Class I mover has increased to 75% from its December level. In the second quarter, we saw sequential month-over-month price increases of 5%, 6%, and 12% respectively fro an average Class I prices of $16.25, almost 50% higher than the second quarter of 2006 average of $10.98 per hundred-weight.

We have a lot to talk about state with a fair amount of complexity. So I want to make sure that you understand four key points from today's conference call. Following the close of the quarter, prices are continue to decline with the August Class I mover set at $21.76, an all-time high. These steep and steadily increasing dairy commodity costs create difficultly for the Dairy Group as a reward to pass-through the price increases and offset the cost friction in the P&L related to the sharply increasing milk cost.

At the same time, we have a different set of challenges just facing our Horizon Organic Milk business. Over the last several years, the Organic Milk category has grown at rate of about 25% per year and processes have scrambled to find enough supply to meet the escalating demand. Pushing prices higher and creating strong economic incentives for conventional farmers to begin the transition to organic farming. This combined with the change in the organic farming transition regulations, resulted in the pulling forward of supply growth into the first half of 2007.

Total industry raw organic milk supply is expected to grow well over 40% this year, with a particular concentration of growth in the Northeast. This over is supply led to steep discounting and aggressive distribution expansion by processors and an effect to stimulate incremental demand and move their milk supply as Organic milk.

So, with this backdrop in mind, let’s turn to the results for the second quarter. We reported consolidated results of $0.30 per share for the quarter. On a divisional basis, WhiteWave results came in a bit better than we expected, of the Dairy Group was especially challenged by the commodity cost increases. For the Dairy Group, fresh milk volumes increased one half of 1% compared to an overall market that was flat to slightly down based on USDA and Federal market order data for the quarter. With the average retail price of a gallon of milk up materially through the first half of this year, I am encouraged by the strong level of inelasticity the category continues to show. We are seeing a bit of a mix shift, however, to work private label and out of our higher margin brands. We expect this to continue as prices remain high throughout the remainder of the year.

Cost of good sold in the Dairy Group was $350 million higher in the second quarter of 2007 than they were in the same period of 2006, entirely driven by the increase in dairy commodity cost. Overall, the Dairy Group has managed the sharp rise in dairy commodity cost fairly well passing through the majority of the cost increases to maintain a respectable level of profitability through this challenging period. Nonetheless, operating income for the Dairy Group second quarter was down 9% from the second quarter of last year to $165 million. In a few minutes, Jack will give you more detail on the challenges the Dairy Group is facing as prices steadily increase this year.

Turning to our WhiteWave Division, our national brands delivered a strong and balance quarter of top line growth across the portfolio. Overall, net sales increased 8%, while our four key brands grew 10% over the last year’s results. WhiteWave’s growth continues to be enhanced by the operational improvements we have made in the business, including the streamlining of our supply chain and the installation of SAP at WhiteWave, which is now largely complete, for building out our product innovation and marketing capabilities and an effort to continue to drive solid top-line growth behind our key brands. We began to ramp up investment behind the Horizon Organic brand in the quarter to protect and grow the brand in a base of increasingly intense competition. In spite of this industrial investment, which includes the lowering of retail prices in several geographies, WhiteWave operating income grew 8% in the quarter over last year to $32 million. Looking ahead, you should expect year-over-year profit to decrease at WhiteWave in the third quarter as the investment in Horizon Organic will be heavier than in the second quarter.

In conclusion, this was a challenging and volatile quarter, one of the toughest I have seen in my many years in the industry. I am pleased we were able to deliver consolidated second quarter results that were about as expected. As we look forward to the second half of the year, we believe the third quarter, in particular is likely to be even more challenging than the second quarter, but we anticipate some stabilization of the operating environment in the fourth quarter and as we head into next year.

With that I would like to turn the call over to Jack Callahan, who will walk you through more detail on our second quarter results and summarize our forward outlook. Jack?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Thank you Gregg and good morning everyone.

As Gregg mentioned, consolidated adjusted results came in at $0.30 per share compared to $0.55 in the second quarter of 2006. Approximately $0.18 of the reduction in earnings is related to our increase interest expense connected to the special cash dividend we issued to shareholders in early April, which effectively increased interest expense by over $40 million in the quarter.

Let me focus first on the Dairy Group. While Dairy Group operating income for the quarter was below last year’s, its important to keep these results in perspective. Dairy Group operating income declined by 9% or $16 million on a year-over-year basis, even though cost of good sold were $350 million higher than they were in the second quarter of 2006, due to the sharply higher dairy commodity costs. The pass-through mechanism is working fairly well. Second quarter Dairy Group sales were up 16% from last year offsetting dairy commodity costs that were 48% higher in the quarter than they were last year.

As prices have moved up rapidly, the Dairy Group has faced two distinct challenges to the P&L. The first challenge is to achieve enough price realization to compensate for the month-after-month increase in dairy commodities. As you are aware, the Dairy Group generally is able to pass on higher prices to customers to a system of regular monthly price adjustments. This largely insulates the industry from swings in the underlying commodities and as largely protected our profitability in spite of the $450 million of additional cost of goods sold through the first half of this year, most of which hit the P&L in the second quarter.

However, the pass-through is not perfect when prices move up steadily over a period of several months. For example, some retailers have variance schedules for when prices changes are effective. Price changes for one large customer occur on the first Monday of the month. So, in May, and as for example, the first Monday sale on the 7th with raw milk prices rising 6% sequentially in May, our results at that customer suffered for those days until we are able institute the price adjustment.

We also have a significant portion of our business that is price list business, which adjust prices less frequently than our more formula driven business. This tends to work itself out over time as prices move up and down, but it puts pressure on results when commodity prices are increasing steadily month-after-month, especially at this highly unusual rate.

The second challenge for the Dairy Group P&L is to manage the impact of costs that rise along with the price of the underlying commodity. One leading example of this type of cost is shrink or waste in the plants, which generally accounts for about 1% to 1.5% of all the milk that enters our plants. Other frication points that become increasingly painful as cost move up include some commissions tied to the sales and that debt reserves. Overall, we estimate that cost related items accounts for at least half of the underperformance of the Dairy Group in the quarter, while with the remainder begin related to price realization.

Turing to WhiteWave Foods. Total net sales for the quarter increased 8% to $326 million as our four key brands grew a strong 10% with all brand showing good year-on-year growth. Operating income at WhiteWave for the quarter was $32 million, an increase of 8% over the prior year. Operating margins are close to 10% were roughly on par with last year’s margin.

The quarter overall was a bit better than expected at WhiteWave due to the strong performance of the portfolio and the investment in Horizon Organic that’s a bit took… a bit longer to ramp up than we originally thought. Let me explain more. Our Silk brand had another strong quarter, increasing sales in the high single digits. In the Flavored Creamer segment, International Delight continue to post strong results, driving double digit growth behind new products and packaging.

In the Dairy Creamer segment Land O'Lakes posted a strong quarter, driven by continued strength in the core Half and Half products increasing total sales for the brand in the low double digits. In short, the challenge to WhiteWave is Horizon Organic. Sales of Horizon Organic Milk were up in the low double digits as the low promotion… in the low double digits as the promotional pricing began to take effect during the quarter. These price reductions are part of our strategy to defend the brand from competitive price cuts through this volatile period of oversupply. In addition to lowering prices, we are introducing new innovations including a DHA Omega-3 enhanced product, and we are increasing our advertising support to build brand equity.

Our efforts are beginning to bear fruit as we are seeing encouraging market share trends in our most competitive markets and are pleased with the results of our efforts so far. We saw sequential improvement throughout the quarter, and are continuing to see improving month-over-month trends in sales and volumes with July being our strongest month of the year so far. However, volume growth is now running ahead of sales growth, and we expect that we remain that way at least through the third quarter. But overall, we are focus on sustaining Horizon Organic’s leadership position during this period of oversupply.

Corporate expenses in the second quarter totaled $39.5 million a 9% increase over prior year results. This increase was largely due to investments in support of our strategic initiatives. We continue to expect that this line could move around a bit quarter-to-quarter as we plan to continue our work on these strategic initiatives, building for the future despite this challenging time.

On a consolidated Dean Food’s basis, the profit growth at WhiteWave was more than offset by the lower year-over-year results in the Dairy Group, resulting in consolidating operating income of a $157 million, a 10% decrease from the second quarter of 2006.

Interest expense totaled $88.9 million in the second quarter compared to $48.8 million of interest expense in the second quarter of 2006 under our old capital structure. Our higher interest expense is largely related to the new $4.8 billion credit facility we put in place with the successful recapitalization of our balance sheet at the beginning of the second quarter. We now anticipate full year interest expense will be about $325 million for 2007.

I would like to remind you that following the execution of the recapitalization, we entered into approximately $3 billion in fixed rate interest hedges to take advantage of the inverted forward yield curve to lock-in very attractive rates. Also we expense $18 million related to the dividend as non-reoccurring items in the second quarter.

Due to the significant increase in interest expense and the decline in operating profits, net income for the quarter was $41.6 million, down from $76.6 million in the second quarter of last year. Cash flow from the continuing operations for the first six months of the year was $170 million, down from last year, due in part to increased working capital requirements and higher year-over-year interest expense. With the steep increase in Dairy commodity costs, our related working capital need have also risen substantially. Once commodity is crest and began to decrease, our working capital needs will also decrease accelerating debt repayment.

Year-to-date capital expenditures totaled $103 million. We are tracking towards approximately $250 million in capital spending for the year, although, we are looking at the balance of the year spending very closely, given the significant step-up in our working capital needs. Net debt outstanding at end of the second quarter was $5.3 billion. Our leverage ratio at the end of the second quarter was 5.6 times fund to debt to EBITDA.

In closing, I do want to expand on the forward outlook that Gregg provided earlier. But please keep in mind we are in a period of tremendous volatility, making it very difficult to forecast the external factors that can influence our business. Looking ahead for the third quarter for the Dairy Group, record high raw milk prices will pressure results. The Class I mover increased over $3 per 100 weight for July. The August price stepped up another $0.85, taking the U.S. dairy markets to unprecedented levels. Even if you assume the Class I remain flat with August prices in September. The third quarter average price will be nearly doubled year ago levels.

As we discussed earlier, the pass-through mechanisms are working reasonably well. But we are cautious about how consumers will react to these material high… materially higher prices at retail. Although, we believe dairy commodity prices maybe near their peak, given the level of input inflation we have already seen, we expect Dairy Group third quarter operating income to be below year ago levels similar to the second quarter.

At WhiteWave, the increased investment behind the Horizon Brand is now fully ramped up and will negatively impact WhiteWave’s profit growth. We expect the full quarter impact of these efforts to overshadow the strong performance across the balance of the portfolio, likely to result in WhiteWave operating income below year ago results in the third quarter.

Net-net, we expect the third quarter to be more difficult and volatile than the second. We believe earnings could range anywhere between $0.24 to $0.28 per share for the third quarter. While frankly, it’s hard for us to look beyond the third quarter given its environment we do anticipate commodity prices to moderate somewhat by the fourth quarter providing some relief as we head into the holiday season.

Assuming decreases in the Class I mover in the fourth quarter and some moderation in the investment required for Horizon Organic, we believe we maybe able to hit the low-end of our current 2007 guidance for adjusted earnings per share of $1.52 to $1.58. But I want to reiterate that this is an unusually challenging and volatile environment.

With that, I would like you for thank you for joining us on this mornings call and ask the operator to open up the call for questions. Operator?

Question and Answer

Operator

Thank you. The question-and-answer session will be conducted electronically today. [Operator Instructions].

We’ll take our first question from Terry Bivens with Bear Sterns.

Terry Bivens - Bears Stearns & Company

Good morning, everyone.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning, Terry.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Good morning, Terry.

Terry Bivens - Bears Stearns & Company

Two quick things, number one, Jack, I was a little bit surprised by your remarks in terms of the cost line I guess and commodity dairy about shrink the commissions to bad debt. Did I understand you just say that was roughly half the damage?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

That’s correct Terry. And I will be honest, it’s a part… it’s a part of the P&L that we are spend a lot of time understanding and really diving into. We have never seen prices at this high level for such a sustained period of time. So, the negative cost pressure here is unusually high versus what we have seen before.

Terry Bivens - Bears Stearns & Company

And is the… I mean is there one big item among those three…three--?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

I [inaudible] to shrink. It’s just done rough range year-on-year, the cost of shrink to us in the second quarter alone was somewhere between $6 million and $7 million.

Gregg L. Engles - Chairman and Chief Executive Officer

Yes, Terry, just to elaborate on that. This industry has traded with a commodity in a reasonably narrow range with the exception of 2004 where we had two or three month extrusion from the mean. And that consistency over time, I think has caused the industry to embed certain practices in the way it prices frankly. So, we are good at passing along month-to-month changes in the price and we haven’t looked so hard at other aspects of the P&L that are tied to the cost of the raw commodity, because they have been temporary and been relatively moderate. With prices now going up and staying up at levels really unprecedented in the history of the industry, some of the weaknesses of our pricing model are becoming apparent. So, while we price extremely well for changes in the commodity, the fact is we have to price ahead of the commodity to overcome the fact that the 1% to 2% of the milk that we take in during any given month, ends up as product loss with the price of raw milk doubling the cost of that shrink is doubling in our P&L, and we are not pricing for it. So, we have got some work to do to overcome some of those items as we move into this higher price regime. It’s going to last now for several months in the Dairy Group.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

And also Terry, it’s highlighting for us a number of key items like shrink in some other areas where we need perhaps stronger policies. But over time, I think we can not completely mitigate, but at least partially offset some of these cost issues over time.

Terry Bivens - Bears Stearns & Company

Okay. And just one other quick thing. One of your competitors here on the East Coast with Organic milk is… of the opinion that the surplus probably ends sooner rather than later i.e. this fall. Is that consistent with how you are looking at the supply demand in Organic?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

I think we have been consistent, Terry, in saying it and into sometime between the end of this year and the middle of next year. It’s… None of us have a great visibility on the supply constraints. Right now, there is still meaningful excess supply in the marketplace. So, I think it’s too early to call it over by the end of this year. You certainly wouldn’t recognize that by… in terms of the level of pricing in the marketplace. People are still being very aggressive in the marketplace with their milk. We are seeing a demand response as we lower prices, but that’s going to move back the other way as we move to raise prices backup. So, I think we are going to be in and out of oversupply for a while.

Terry Bivens - Bears Stearns & Company

Okay. Thanks for that. I will pass it on.

Operator

Our next question will come from Deutsche Bank’s Eric Katzman.

Eric Katzman - Deutsche Bank

Hi, good morning everybody.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning, Eric.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Good morning, Eric.

Eric Katzman - Deutsche Bank

Few questions, I guess first, Jack, did you mention an $18 million like banker’s fees that’s included in some line, was that in the interest expense? And then you also talked about an open sale?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Yes, the two steps, there as… in part of our unadjusted earnings, there is an $18 million that is related to the write-off of previous financing and one-time fees as it relates to recapitalization of the balance sheet. It’s in this $18 million and we adjusted that and now included in our adjusted EPS calculation. And, yes, we did sell our tofu business in the quarter. And from an operating point, it was not material going forward, but there was I think about a little over $1 million hit… one-time hit to goodwill. That is also included in those adjusted earnings.

Eric Katzman - Deutsche Bank

Okay. Thank you for that. And then I guess to Gregg, in terms of the volatility of the underlying inputs, what can the industry do or what can you do to change how the product is priced? I mean, can you negotiate with some of the Foodservice companies that you do business with to go to more of a pass-through mechanism rather than just being relying upon no contract?

Gregg L. Engles - Chairman and Chief Executive Officer

Well, again, I would come back and reiterate that the pass-through mechanism works incredibly well here. So, you we had a $350 million step-up in input cost during the period, almost all of which got passed along.

Eric Katzman - Deutsche Bank

So… to the extent that you would change the way that works you are really just speaking?

Gregg L. Engles - Chairman and Chief Executive Officer

I think there is probably more benefit for us to be had to bring now more attention to these non-pass-through related items that Jack mentioned in our P&L. So, that the next time this happens, we mitigate the negative effect of shrink commissions those sorts of things. Now some of it’s just unavoidable. Our bad debt reserves go up as our sales go up and our sales go up, because the price of the underlying commodity is going up. So, if you have got a customer that defaults on its payment, now it’s defaulting on payment based on $20 milk instead of $10 milk, and that’s just more expensive. So, a higher commodity environment is just more difficult, but we can do better in terms of how much price we have to pass along and we can do better in terms of managing the expense lines in our P&L. But the reality that is becoming clear in this very, very significant move up is that in order to completely maintain our profitability, right now, we have to price ahead of the cost inflation.

Eric Katzman - Deutsche Bank

Is there any change to the longer term I guess was $5 billion compressible cost figure?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

No.

Eric Katzman - Deutsche Bank

No.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

That change is still there, no question.

Gregg L. Engles - Chairman and Chief Executive Officer

And we are working on it.

Eric Katzman - Deutsche Bank

Okay. And then last question is on the Horizon Organic business is that… I am sorry, on the raw material cost issue, what gives you confidence that we may see somewhat moderation in the milk pricing, because I thought it was kind of a function of the nonfat dry milk pressure?

Gregg L. Engles - Chairman and Chief Executive Officer

Well, it is. But there is elasticity and this is a global market. So, these prices have gotten very high around the world. And these foods are substitutable at some level particularly in the developing world. So, we are… we believe and the other prognosticators that we tally seem to be believe that we are going to peak some time in the fourth quarter. It’s unclear whether that’s going to be October, or whether that’s going to be December. And these prices are going to start to come down, because we are already seeing the evidence of it not moving materially higher after September. So, at least that’s our view today and it seems to be the consensus view in the industry. I will tell you the industry and its analysts’ and economists clearly missed the global nature of this phenomenon and this move up. So, at the beginning of the year, none of us, nobody was calling the strength of this move anywhere in the global food industry. So, our recent track record of calling milk prices has not been great and I don’t want to try and give you overly robust sense of confidence that we are going to call it right this time. But our belief is and the consensus belief is, it’s going to peak sometime here in the fourth quarter and move down modestly as we move into 2008 at least the first half of 2008.

Eric Katzman - Deutsche Bank

Okay. I will pass it on. Thank you.

Operator

Chris Growe with A.G. Edwards has our next question.

Christopher Growe - A.G. Edwards

Good morning.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning, Chris.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Hi, Chris.

Christopher Growe - A.G. Edwards

Hi. I just want to ask about your guidance. When we talked back in June, you have been talking about $24 or $25 milk and looks less than likely today obviously. So, I am just curious how you put that together with the guidance from at the low end of the range that should have been a help by ticket to your numbers, but how should we look at that?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

I think that we are going back to what we talked about it a bit earlier today. The issue I think that we understand I think a bit better and as bigger issue we realize is this whole cost friction in the Dairy Group P&L. As we… again, as Gregg mentioned earlier, we have never been in such a sustained period of high pricing that we’ve seen for the commodity inputs. And I would tell you that the… that cost challenge is significantly greater. And so, that… despite the fact that maybe we’re not looking at that top end of the range as it relates to the Class I mover, this cost challenge is relatively bigger than we initially thought as we work through it. And we certainly saw that with the significant step-up in pricing in May and June, and we are seeing that now in July. The benefit of this is that it’s not… unlike most costs, it’s not lasting in nature. So, once we start to get some relief in the commodity input pricing, we should start to see some moderation in debt impact in the P&L as we move forward.

Christopher Growe - A.G. Edwards

Would that be, I guess, a major factor or meaningful factor for your… I guess your assumption within your guidance that Q4 should be up year-over-year kind of on a pro forma basis. Is that a major driver of that? And then I guess also there is an expectation for lower milk prices as well in the fourth quarter.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Yes, the fourth quarter is always seasonally always our strongest quarter. There is a belief baked into our fourth quarter guidance that the organic milk situations stabilized. You heard Terry’s question around Organic milk pricing, and I believe that we start to see the light at the end of the tunnel at least as it relates to Organic milk oversupply on the WhiteWave side. Then on the Dairy side, we… as prices begin to stop rising and hopefully turndown, we’re making efforts to catch up to price realization here to cover the increase costs that result from these higher prices above and beyond just the pure milk cost price rise. So, we’re moving aggressively to restore our P&L. It just takes time and you got to… we’re going to have to get to the point where milk prices stop rising before we’re ultimately going to be able to do that. So, that’s what’s baked into the belief around the fourth quarter, but just in the way I describe it you can tell that there is not a huge amount of certainty around it.

Christopher Growe - A.G. Edwards

I understand that, yes. And just one last question, a bit of follow-up on Horizon. You have supply growth in the order of 20% to 25% this year, I think you said. Obviously, your sales and your volumes have not been keeping up with that. So, what’s happening in that gap there? Is that sort of inventory build which I think Horizon used to do in the old days? Is that something that’s occurring today? Or what are you doing with the excess milk?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

It’s pretty much right on our plan. Our milk supply growth was always back half loaded, really driven by this July 1 conversion date for these additional farmers who got pull forward into the supply chain. So, that milk wasn’t in the first half results. You don’t see it more in the second half results where we’ve got volume growth well in access of 20%, so far through the third quarters. So, it’s common.

Christopher Growe - A.G. Edwards

Okay.

Gregg L. Engles - Chairman and Chief Executive Officer

And Chris, if you just look at the more recent IRI acceleration in grocery, I think you will see volume growth starting ahead at the high teens, I think even hit 20 in the last period. So, we are seeing that acceleration of volume as the supply comes on.

Christopher Growe - A.G. Edwards

Okay. Great. Thank you.

Operator

Farha Aslam with Stephens Incorporated has our next question.

Farha Aslam - Stephens Inc

Hi, good morning.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Hi, Farha.

Farha Aslam - Stephens Inc

Just going back to Horizon Organic, could you share with us a little more detail about the level of price discounting you are having to do in the second quarter and what do anticipate in the third quarter?

Gregg L. Engles - Chairman and Chief Executive Officer

Well, we… first of all, Farha, it took a little while for us to ramp up in terms of getting some of the promotional price points executed in the marketplace. So, that’s why we really were not fully ramped up until June. And the kind of key promotional price point that we’re focusing on is… and in most accounts is somewhere around $2 for $6 is sort of the key price now. It won’t be executed out that way, but we’re starting to see that more aggressive level as we work throughout… you should expect that throughout the third quarter.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

We’re sort of dealing down from $3.69 to $3.99 price point down to $3.00 price point per half gallon. So, that’s the cost. That’s the debt of the discounting.

Farha Aslam - Stephens Inc

And you do about 90 million gallons, prior than Organic?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Yes, I think that’s about right. 85 million to 90 million gallons.

Farha Aslam - Stephens Inc

And that was last year, and then you’re going to increase that by about 20% to 25% in ’07?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

That's more of an '07 number.

Farha Aslam - Stephens Inc

That's a 2007 number. And then kind of when you look at the longer term health of Horizon Organic going into next year beyond this. Do you think that the consumer is going to be kind of getting used to $3.00 Organic milk price is maybe $3.25, or do you think you can go all the way backup to the $3.99, $3.69 price point level, given that now you have private label Organic milk here to stay?

Gregg L. Engles - Chairman and Chief Executive Officer

There's… let me give you two or three parts to that answer. First of all, private label has exactly the same cost structure in this industry as the brands do. So, they don't have a… they don't having a cost of goods advantage. They don't have a processing cost advantage. And they are historically, because of the undersupply situation hasn't been a lot of marketing money spends. So, they don't really have a significant marketing budget advantage. So, what you see is very tight spreads here between private label and brand pricing. In fact, you see really no spread today, because of the private label are having a deal down to $3 a half gallon too. So, there is not a big differential there. And this is a P&L challenge category today. So, I think as we see supply and demand come back into balance, you are going to see everybody including the private label's try and move back to a more normalized level of profitability for the category.

That having been said, I will just go back to my response to Terry's question. You might find yourself in supply demand balance in $3.00 retail and you might find yourself back in oversupply at $3.99 retail, because there is elasticity in this category. And so, I think we are, as an industry, going to be trying to find the market clearing price. And I can't tell you yet what that's going to be, but a different way of saying, the consumer gets used to $3 a half gallon for Organic milk is really saying there is price elasticity in this category. And they are absolutely… yes, we can tell you our volumes are up when we move from $3.99 to $3, the volumes in the category have really accelerated. So, they will decelerate when you go back to $4.

Farha Aslam - Stephens Inc

Okay. That's helpful. And my final question. I will pass it on. And Jack, what do you anticipate your debt repayment to be for fiscal 2007?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

It will just be very modest.

Farha Aslam - Stephens Inc

Okay. Great.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

However, as we go into next year with… once we hope it gets relief in the commodity prices, and then we will have a reduction in working capital come in and out the other side. That combined with, hopefully, growth in operating profits, we expect that it will significantly accelerate as we go through '08.

Gregg L. Engles - Chairman and Chief Executive Officer

Yes, I mean really the way to think about it, by and large is that debt repayment this year is becoming investment in working capital.

Farha Aslam - Stephens Inc

That makes sense. Thank you very much.

Operator

Moving on, we will here from Edgar Roesch with Banc of America Securities.

Edgar Roesch - Banc of America Securities

Good morning.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning.

Edgar Roesch - Banc of America Securities

Just wanted to say thanks for all the color you have been adding. I know it’s a torturous time right now.

Gregg L. Engles - Chairman and Chief Executive Officer

Well, trust me we are giving you as much as we can.

Edgar Roesch - Banc of America Securities

Well, it’s very much appreciated. A couple of questions. First, I am kind of looking at the dairy herd and it looks like it’s actually down a little bit year-over-year. And I am just wondering, Gregg, you mentioned earlier that you think demand for dry milk will responding cut back a little bit. But are the producers getting good incentives here to increase supply going into next year, or even currently?

Gregg L. Engles - Chairman and Chief Executive Officer

Boy! If they not getting good incentives now, they are never going to get them.

Edgar Roesch - Banc of America Securities

Even with the fee costs up and everything?

Gregg L. Engles - Chairman and Chief Executive Officer

Yes. Our view of the breakeven for the… I guess, the market clearing price for milk at these levels of corn and feed inputs are somewhere between $15 and $16 hundred-weight. And farmers are making… ought to be making four to five times as much as they normally make in terms of net margin with these milk prices right now. So, if farmers are not growing supply now, then you probably will never see them grow supply. Now some… it takes time to put a cattle on the ground. And it takes time to expand capacity in milking barns and those sorts of things. So, it’s not an instantaneous response, but I think we are seeing pretty good milk growth and I think we will continue to see that accelerator as we move forward into the year.

Edgar Roesch - Banc of America Securities

Great. Thank you. And one other question. If I remember correctly, back in ’04 there was an expectation that after the spike in prices, there would be some gradual declines and I would have allow been the experience the inverse of what you have experiencing today and the pass-through where the more slightly more positive side of things?

Gregg L. Engles - Chairman and Chief Executive Officer

Absolutely.

Edgar Roesch - Banc of America Securities

And I think though that no further the spike was so high, and it became such an issue for consumers and retailers that the declines had to be passed on more quickly, now referencing kind of your comments early about the consumer and their response, can we see that same scenario where you have to pass along the clients much more quickly?

Gregg L. Engles - Chairman and Chief Executive Officer

Well, I think it’s going to be a… we are going to find out how much elasticity there is in conventional milk right now. I will tell you so far through July, or through June, we have been really… frankly a little surprised by the lack of elasticity so far. Now July was a step up, a retail or probably close to $0.50 a gallon. So, that will be really be the tell tale but we have not seen volumes decelerate dramatically yet. So, we will see whether we get that impact in the third quarter, but one another more important factors in terms of how you do on the way down is the speed of the drive. So in 2004, we went up like a rocket and then we came straight back down in terms of price declines because there was really a speculative move up and a motional move up as apposed to a real supply demand driven move up. And so, everybody was really just raw from the price move up and keenly aware of the price move down. So, the market dynamic was very different, I think then what we are going to have this time, I think prices are going to get up to these high levels and then instead of crashing back down and then probably going to drift back down. Frankly, we think that’s going to be a better scenario for us.

Edgar Roesch - Banc of America Securities

Great. Thanks for your help.

Gregg L. Engles - Chairman and Chief Executive Officer

You bet.

Operator

Our next question will come from Eric Serotta with Merrill Lynch.

Eric Serotta - Merrill Lynch

Good morning.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Good morning.

Eric Serotta - Merrill Lynch

Couple of quick questions here. First of all up on Chris’s question regarding the fourth quarter and I realize there is still not a lot of visibility here, but if you take the bottom end of your third quarter guidance and the bottom end of your fourth quarter guidance, it implies that pretty massive pick up in terms of EPS and operating income in the fourth quarter in order to get there. I really decided some relief in Class I price at the forecast for having Class I on average down about 10%, 12% sequentially third quarter to fourth quarter. And you talked about the Horizon situation moderating but are there any other major factors that are missing that would drive such a large increase from the third quarter to fourth quarter?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Eric, looks we are supposedly at the September milk and there is announcement for the September price of milk. I think one of the things we have to look very closely and one of the things that could help us move towards the… that gives the more conscious about the range for the third quarter with that we start to see some moderation in the September numbers because we have seen big step up in July and August and that directly relates back to the way we kind of characterize the fourth quarter that to make the range, we would need to have a more favorable commodity environment and we may start to get the first inkling to that as soon as September. So, there is a linkage is not like suddenly, we are going to finish the third quarter than the prices are going to start moving down in consistent with how we think about on a fiscal quarter-to-quarter basis. So, look at the next pricing announcement very closely.

Eric Serotta - Merrill Lynch

Could you make the full year range with a fourth quarter average down about 10%, 12% from the third quarter on the past one?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

As we go back to as Greg was talking about earlier, it’s not just the average for the quarter, its when does it happen, how big is the move and its how does that vary from month-to-month. So, that what makes it very hard for us to forecast right now.

Gregg L. Engles - Chairman and Chief Executive Officer

If it all happens in December, you are not going to see a fabulous fourth quarter.

Eric Serotta - Merrill Lynch

Okay.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

So, we need to have it throughout the quarter. And the other thing that I pointed to Eric is that the fourth quarter really is the big quarter for much of WhiteWave’s portfolio of business. And there is a tremendous margin advantage in that part of the portfolio. So, if you go back and look at WhiteWave margins historically, you will see 300 or 400 basis points step-up in margin on a higher… significantly higher level of sales. And that’s just the seasonality of the Creamer business kicking in as you move into the end of the fourth quarter. So, that drives a lot of tailwind in the fourth quarter also.

Gregg L. Engles - Chairman and Chief Executive Officer

Eric, and one other thing that I point to you, maybe I also want to consider the year-on-your overlaps, particularly in the Dairy Group. In the third quarter, the Dairy Group had an extraordinarily tough overlap. They grew 10% in ‘06 in the third quarter. Part of that was driven by a settlement with the supplier, whereas in the fourth quarter the overlap that we have going forward into the fourth quarter is… the fourth quarter of ’06 is only 4% growth. So, on a run rate basis, the milk is a little bit, it’s not quite as great as it’s going to be in the third quarter.

Eric Serotta - Merrill Lynch

Okay. And on WhiteWave, could you give us an idea as to your sort of best estimate at this point as to what you guys are looking at for overall Organic milk supply increase in 2008 and the timing of it? And then your supply increase or the supply increase that’s accessible to Dean between your Company-owned farms and your family farmer network?

Gregg L. Engles - Chairman and Chief Executive Officer

We are just starting right now, kicking off our 2008 planning process. So, we don’t want to jump to too far ahead. I mean, just generally in terms of supply growth, we are going to look to be able to like we were in ‘07 to grow with the market supply. And as yet… but in terms of pricing of milk, we are working through that. And remember a lot of our contracts are longer than one year in nature, so, it’s not a reset every year.

Eric Serotta - Merrill Lynch

Okay. And just finally along those lines’06, you were up against very different challenges in WhiteWave would be shortfall in supply in Organic milk. ‘07 we have moved to a glut. There were some people out there who were calling for a shortfall in ’07 and in 2008. What’s the risk that we don’t get to an equilibrium or a balance where you guys in the industry could generate a reasonably healthy margin? It just seems that this industry seems… which is in infancy still seems to swing in one direction or the other.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Well, that is the big risk in our P&L over the long-term, right. We are going to have… we got conventional milk changes right now, we will manage through that because the supply and demand are both so large in the conventional milk segment. You are right. This is a nascence [ph] category as 2.5% or 3% of the total category. There are clear indications that it could get to be as much as 10% of the category, perhaps even more.

So, it is still an important and exciting and a challenging category to be in. The reality of it is supply response relatively slowly because you have to create organic animals in order to create additional supply. Demand is going to be influenced by a number of things that are on a different phase. And it is pretty tough right now to find balance.

So, just to be clear, we are committed to this category. We think it’s strategic to us as a Company. We have the leading brand here. And we have got a play in Organic milk for the long run. But you are right, we run the risk of swinging from one form of disequilibrium to the other for a while, and over time, we hope that those… the amplitude of those swings gets smaller as this category gets bigger.

Eric Serotta - Merrill Lynch

Great. Well, thanks a lot and good luck.

Gregg L. Engles - Chairman and Chief Executive Officer

You bet. Thank you.

Operator

Moving on, we will hear from Pablo Zuanic with JP Morgan.

Pablo Zuanic - JP Morgan

Good morning everyone.

Gregg L. Engles - Chairman and Chief Executive Officer

Good morning Pablo.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Good morning.

Pablo Zuanic - JP Morgan

Just trying to get a better sense here that picked up in earnings later in the year. In the case of Organic milk cost, aren’t you concerned that once the pendulum swings the other way that given the high rise in organic feed cost, there is 50% more dairy farms out there. Aren’t you concerned that we are going to se an increase in the cost organic meal that you are paying, while your retail prices may not adjust just as much? And as a follow-on to that, it sounds to in terms of your… what you are guiding or implying for the fourth quarter, that you are implying that when conventional dairy costs start to come down; your prices to retailers may not come down as fast. You may be able pocket a bit of a gap there. Just get me understand that better please, those two points.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

The one… the once more short-term it feels more short-term, I went more long-term, while I take the short-term one first. I think you are right, and if indeed in the fourth quarter we have a period when we start to see some relief in commodity prices, where minimum we will have caught up in terms of our pricing realization. And more likely on our way down, we will have better pricing realization in the fourth quarter and certainly that we saw on the second and the third which we go a long way to restoring profitability to the Dairy Group. So, that’s the right way to think about it.

On the… your question on Horizon, that’s not an issue that would impact the fourth quarter again because our cost of organic milk is not as volatile as that. Again they are based on contracts that can range anywhere between one and in three years and it’s a real question for us to think about as we move into FY ‘08 and beyond in terms of what is the real underlined cost of organic milk supply. What but I would say that over the last year that there has been in… to think about where all the growth came in the category, ahead of the historical growth it was a lot of our competitors that were out there trying to anxiously find supply and perhaps that won't be quite as anxious as we go into the next two years.

Pablo Zuanic - JP Morgan

That’s the off one. Just a question on the second quarter, can you quantify the EBIT drop caused by Horizon in the second quarter?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Let’s put it this way, we have said historically that we think that WhiteWave has the capability on a sustained basis to deduce sort of double digit mid profit growth. I would say that WhiteWave sort of exercised in kind of delivered on that long-term algorithm in the second quarter.

Pablo Zuanic - JP Morgan

Yes, that’s helpful. And just one last one. Concentrating on conventional milk; you talked about somewhere head wins, EBIT was down $16 million, you said half a way at six to seven shrink and the other balance not being able to pass on higher cost entirely. On my marks and from the data in the third quarter, even through July you were getting very good pass-through. So, I am just wondering just give us more color in terms of what else went wrong in the quarter like for example, were there an issue with other products outside of Fluid Milk? Can you quantify the trade onto private label, if I am not wrong two-thirds of your meals are private label? Just help me understand that because the way I look at it, the third quarter in terms of pastor, its looking quite good. So, I am just trying to assess what the other the sources are driving the numbers down besides the shrink?

Gregg L. Engles - Chairman and Chief Executive Officer

Let’s… first of all let’s step back and put it in perspective. We sell 300 million gallons a quarter. No, I am sorry 300 million gallons a month of product. So, 800 million to 900 million gallons a quarter. We are telling you we missed last year by $16 million half if which was price realization, so $8 million. That is a tiny fraction of the increase of cost during the period. So, the pass-through works remarkably well right, remarkably well. Now, if it’s working remarkably well in the third quarter with a step up in price is much larger in the third quarter than the second quarter, right. The move in July is larger than the entire move in the second quarter. So, we can do incredibly well in pass-through which I believe we will. And still suffer the same kind or slightly larger profit erosion in the quarter. And that’s what we are telling you we expect to experience.

Now, we talk about this as though its all milk, the reality of it is about two-thirds of our sale in the Dairy Group or Milk the rest are Ice Cream and Class II products like, Cottage Cheese and Sour Cream and those sorts of things. And we got the same issues in all the classes of milk. Whether it’s Class I or Class II products or Ice Cream, we got the same issues in all of those products. With respect to the pass-through and frankly, the mechanism doesn’t work quite as well in those other categories as it does in milk. So, there is… we would be on this call for five hours that we are trying to talk all the parts and pieces of the P&L. But yes, we are having the same sorts of issues across our portfolio. But I think it’s a good proxy for talking about them as though they were milk. It’s a same basic underline dynamics.

Pablo Zuanic - JP Morgan

True. But can you talk about what was positive in the quarter, for example, you must have some cost savings that kick in, diesel prices, if I am not wrong were down also year-on-year. Can you just quantify some of the gross positives in the quarter, because there were some, right?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Sure. Our plan here was to grow Dairy Group operating income in sort of mid single digits. So, we had a plans and programs in place that we are driving against in order to get to those kinds of numbers and those are in place. So, in fact, I guess your point is that we are suffering more decline to get to a negative position than just the raw $16 million and that’s an accurate point. But there are things that are going the other way that are… that would otherwise be driving profit growth in the business that are being more than offset by price realization in these costs.

Gregg L. Engles - Chairman and Chief Executive Officer

And in fact, Pablo, this year, we are just putting the… putting even greater focus as we move forward in terms of actions that we can take to really fundamentally lower our cost structure. So, if anything in terms of get the idea as we talked about with you in the past, we are seeing each move forward aggressively on them more than ever as we work through this.

Pablo Zuanic - JP Morgan

Okay. And last one. I am trying to facing in terms of normalized earnings, we do with other companies. But in terms of conventional dairy, can you give us any color on guidance in terms of how should we think about EBIT per pound because I find that profit margins right now distorted. They are offered a much higher base. What in terms of guidance, in terms of what maybe a more normal level in terms of EBIT per pound for the dairy unit. What would you think that would be?

Gregg L. Engles - Chairman and Chief Executive Officer

Yes. We have always encouraged people not to look at operating margins here because the price of the commodity moves around every month. So, I think that we… of course, we got again our portfolio of businesses, but the right way to look about… look at this business I think on balance is sort of operating profit per gallon is the what we think about it.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

But keep in mind we sell so many gallons $0.05 change goes through a lot. So, this year, we are seeing sort of high teens profit per gallon, and last year, we nearly touch 20 a couple month. So, that gives you sort of… and it doesn’t take a lot of movement here. It doesn’t take a lot of movement here to really make a difference in the overall profit growth of the business.

Pablo Zuanic - JP Morgan

And just last one. Just in terms of seasonality, the fourth quarter in terms of volume for dairy compared to the third quarter, is it 5% step-up to 10%, just roughly? People drink more milk in the winters.

Gregg L. Engles - Chairman and Chief Executive Officer

School come back in, you sort of losing the ice cream businesses. It’s both volume and mix, Pablo, in terms of what happens in Q4. I think to give you anything meaningful you probably have to circle back with us.

Pablo Zuanic - JP Morgan

Yes.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

And then go back to Gregg’s point this is the mix that probably a bit… the profit mix is probably bit more important than the absolute volume growth.

Pablo Zuanic - JP Morgan

Good. Thanks.

Operator

Christine McCracken with Cleveland Research.

Christine McCracken - Cleveland Research

Good morning. I just wanted to follow-up a bit more on your expectations for the price gap between organic and traditional or conventional milk. I am wondering if you could give us any sense where that stands today and what you expect it to do going into the fourth quarter.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

It really depends by parts of the country right now. In fact, there are some parts of the country right now where there is a deep discounting of organic milk where the price of organic milk may indeed be lower than the price of branded conventional milk. It sort of a unique confluence of two different issues out there at the same time with commodity prices rising as to all time highs and this glut of organic milk. So, it… we really look at more on region-by-region basis, because it does vary quite significantly.

Christine McCracken - Cleveland Research

Are there any cases where it’s actually below the conventional milk at this point or is it--?

Gregg L. Engles - Chairman and Chief Executive Officer

Yes, that’s what Jack just said. There are places where Horizon Organic today selling below some of our regional brands.

Christine McCracken - Cleveland Research

Okay.

Gregg L. Engles - Chairman and Chief Executive Officer

That’s not selling below private label, but it’s getting a lot closer.

Christine McCracken - Cleveland Research

All right. And then when you look at sales by channel, are you seeing a greater resistance I guess in Foodservice, I know that those are much smaller piece of your business, but obviously, the pass-through mechanism probably won't work as well in that channel. I am wondering is it your experience that as a slower pass-through and is that a bigger challenge for you in dairy?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

We are not seeing anything that fundamental in terms of channel shifts right now. What… the things that is probably that we would point to is more than mix shift within channel that and so we mentioned, while total aggregate to sort of volume growth is hanging in there despite these higher prices. We are seeing on the margin a little bit of mix shift towards private label within our mix versus the branded products.

Christine McCracken - Cleveland Research

Are there any cases either retailer could service where you are passing it along to them, but you don’t get the sense that they are passing it through the shelf? And then, with that you would expect if they aren’t passing it thorough you would see an even bigger demand response into the back half of the year.

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Our sense is that retailers are very anxious to pass the prices along and are doing quite well this year.

Christine McCracken - Cleveland Research

All right. I leave it there. Thanks.

Operator

Our last question today will come from Pi Aquino from Credit Suisse.

Pi Aquino - Credit Suisse

Good morning.

Gregg L. Engles - Chairman and Chief Executive Officer

Hi, Pi.

Pi Aquino - Credit Suisse

Just a quick question on Horizon Organic. Share I think at the end of last year was 45 share, can you update us on how your share performance is doing?

Gregg L. Engles - Chairman and Chief Executive Officer

Jack is digging it out. I think the quick response is our shares our around 40 at this point in time… 42. Time to correct, it’s 42.

Pi Aquino - Credit Suisse

Great. And then in terms of just maybe nit picking a little bit more in terms of the cost savings that you are realizing at the Dairy Group, can you quantify, I mean you guys have completed the finance consolidation. You are working to purchasing initiatives and so forth. How much realization did you get from that in the quarter?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Yes, let me get you where we are. I wish we were down with the finance consolidation. We were right… I would call maybe dead middle. We are making some great progress as right now we have… have or in the process of moving or accounting out of the plant facilities at about two-thirds of our location. So, we are well into it, but we are also sort of at the time of peak investment because of as we are bringing in new staff and we have double staff for a period of time. So, we are very much still into it and the finance reorganization will be a net investment for the business throughout the year. On the area of purchasing, we are making some good progress. We did build into the plan and are seeing real cost reductions in some of… some key components. And I believe this sort of guidance that we gave earlier in the year, as you sort of netted the savings through purchasing versus the net investment in finance that we thought it would deliver profit to the business. So, approximately between $5 million and $10 million over the course of the year, and that was our view going in and pretty consistent what we are seeing right now in the P&L.

Pi Aquino - Credit Suisse

All right. And then lastly, in terms of the Class I price, coming down in the fourth quarter and then moving into next year, but still it’s pretty high level versus historical. How do you think the Class? And you also talked about that price drifting down being a little bit better than kind of what we saw in 2004 spiking down. What is the Class I price have to get to… to get back to say operating income levels of last year at $685 million?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Well, I don’t think you can correlate just perfectly with the Class I price, Pi. We have got these ongoing cost reduction initiatives that should be driving our operating income north. And you are going to have a swing back towards profitability that will abet as prices come down and stabilize at whatever levels they are going to stabilize at. So, I think it’s hard to call a price at which we are back to level. At least it’s hard for me to call one. What I would tell you… I think that given on farm economics in the United States, it’s a big world out there. So, I think there are obviously now more external factors than we might have assumed there were a couple of years ago. But giving on farms economics in the United States, we think with this price of inputs that the price at milk ought to stabilize somewhere between $15 and $16 and that surprise that we can be very successful at and grow our profitability at in accordance with the long range plan that we are articulating at the beginning of this year. That’s probably the best way that I could say it.

Pi Aquino - Credit Suisse

Got you. And then just lastly, are you still targeting 3.75ish debt to EBITDA range by the end of FY ’09?

Jack F. Callahan - Executive Vice President and Chief Financial Officer

Well, I think that given the profitability that we have lost this year, we are probably six to 12 months behind that time horizon.

Gregg L. Engles - Chairman and Chief Executive Officer

Yes, we have lost the year effectively. I would think in terms of what's happened with the commodity prices. Now again, if we… for some reason during the next three years, we come back to $14 milk that would go a long way in terms of point cash out the business to help us accelerate the debt pay down. And that is sort of hard to predict right now.

Pi Aquino - Credit Suisse

Got you. Thank you.

Gregg L. Engles - Chairman and Chief Executive Officer

Thank you. Thank you, Pi. And thank you all for joining us on the call this morning. Although, our near-term results are not what we had hope they would be coming into this year. The stress put on our business by this volatile commodity environment increases our result to fundamentally transform our business over the next several years. With the steep rise in dairy commodity cost, our attention has been focused on additional areas for potential improvement. These initiatives give us a great opportunity to build sustainable cost advantages in our business and assure that we are even better prepare the next time commodity prices rise. And we look forward to discussing our progress in those areas with you in the coming quarters. Thank you again for joining us on this call and we will be speaking with you on a regular basis.

Operator

And that does conclude today's teleconference. We thank you all for joining. Have a wonderful day.

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