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Diamond Foods (NASDAQ:DMND)

Q2 2013 Earnings Call

March 11, 2013 4:30 pm ET

Executives

Linda B. Segre - Senior Vice President of Corporate Strategy and Human Resources

Brian J. Driscoll - Chief Executive Officer, President and Non-Independent Director

Michael Murphy - Interim Chief Financial Officer and Principal Accounting Officer

Analysts

Heather L. Jones - BB&T Capital Markets, Research Division

Thilo Wrede - Jefferies & Company, Inc., Research Division

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

Timothy S. Ramey - D.A. Davidson & Co., Research Division

Edward Aaron - RBC Capital Markets, LLC, Research Division

Kenneth B. Zaslow - BMO Capital Markets U.S.

Operator

Good day, and welcome to the Diamond Foods Q2 Fiscal Year 2013 Earnings Release Conference Call. Today's conference is being recorded. [Operator Instructions] Ms. Segre, you may begin your conference.

Linda B. Segre

Thank you, Angela. Good afternoon, and welcome to the Diamond Foods investor conference call and webcast to review our financial results for the second quarter of fiscal 2013. On today's call are President and CEO, Brian Driscoll; and interim CFO Mike Murphy of Alix Partners. In addition, Mark Hair, our Senior Vice President of Finance and Controller; and Andrew Burke, our Chief Marketing Officer, will be available for Q&A at the end of our prepared remarks.

Before we begin, please remember that during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks and uncertainties regarding the operations and future results of Diamond Foods. In addition to the company's periodic current and annual reports filed with the Securities and Exchange Commission, please refer to the text of our press release for a discussion of the risks associated with such forward-looking statements.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures, in which we exclude from our GAAP financial results certain items such as Audit Committee Investigation and restatement related expenses and consulting fees. We will also refer to adjusted EBITDA on today's call. For a calculation of this measure, please refer to our press release. We believe these non-GAAP measures will provide useful information for investors. Please refer to today's press release for reconciliation of the non-GAAP performance measures to the GAAP financial results. Now I'd like to turn the call over to Brian Driscoll, our President and Chief Executive Officer.

Brian J. Driscoll

Thank you, Linda, and good afternoon, everyone. Let me begin by saying that I am encouraged by the progress we are making with our turnaround efforts and the traction we're beginning to achieve against our key initiatives. This progress is evidenced in our second quarter financial performance. The improvements in gross profit, gross margin and EBITDA, achieved primarily as a result of improved net price realization and a focus on our cost-reduction initiatives, was coupled with targeted investment and brand-building activities. We believe that this profile, in time, can fuel consistent and profitable top line growth. Regarding our turnaround efforts, our areas of focus remain consistent with what we've shared before. We are focusing on sustainable, organic brand growth and innovation; fixing Emerald with emphasis on our more premium competitively insulated items; reducing our cost structure, while optimizing our operational effectiveness; and rebuilding walnut supply. So let me update you on our progress. Regarding our focus on sustainable organic brand growth and innovation, we're still in the early stages of our journey. The efforts of our innovation team are in development across our portfolio. As a result, our pipeline is not yet as robust as we plan it to be. It takes time to build out the capability necessary to produce the kind of insulating innovation and marketing programs required to win consistently in the marketplace. However, our shift away from discount-driven growth across the Snack portfolio and the elimination of low-margin SKUs in the Emerald line is progressing as evidenced by the 690 basis point expansion and our consolidated gross margin this quarter compared to last year. In the near term, our margin profile may fluctuate as this is an uneven and imperfect process, but we believe that we are directionally on track. We're seeking to achieve the right balance between net price realization, the development of our innovation pipeline, and investment in consumer support. For example, we've reduced promotional spending on Pop Secret, while investing concurrently in a new consumer support campaign effort. This campaign utilizes much more targeted media such as social, print and digital. In recent months, we've seen improvements in both market share and net price realization on Pop Secret, helping to fuel the 7% top line growth and gross margin expansion in the Snacks segment.

Regarding Kettle U.S., in the quarter we continued to reduce the amount of inefficient discounting as planned, while placing greater focus on targeted consumer acquisition, improved shelf presence at key customers and refining TIAS! and Bakes positioning. While new innovation platforms will be an important component of Kettle's growth strategy going forward, we will continue to add news to our base. For example, in early fiscal year '14, we will be launching 2 new flavors, sweet and salty, and maple bacon. Moving to our Kettle U.K. business, we have navigated the heavy promotional atmosphere in the U.K. market reasonably well. The brand has sharpened its consumer message and targeting approach, maintained a price premium to competitors, and market share has remained stable.

In the Nuts segment, we significantly improved net price realization, delivering strong improvements for Emerald. In addition, our focus on cost reduction helped keep unit cost under control on both Emerald and Diamond of California despite a significant drop in volume. In the quarter, we achieved a $2.3 million increase in gross profit and 540 basis point expansion in gross margin on a revenue decline of nearly 30%. Regarding Emerald specifically, we are encouraged by the pace of improvement in the brand's financial contribution but are still in the early phases of its overall transformation. Continued financial improvements should occur when the right consumer price value relationship and innovation are achieved simultaneously. We are monitoring progress closely and continue to reinforce with retailers the important consumer role Emerald plays within the category. The Diamond of California brand gave back some dollar market share this past holiday season, driven by lower volume as we elected not to participate in the same level of discounting as our competition. This decrease was expected as we expanded our price premium in the category. Now moving forward, we are increasing our consumer support for the brand as we seek to recapture high-quality market share.

Turning to walnut supply, as we've emphasized before, this continues to be one of our chief priorities. We've put tremendous effort and senior management time against this initiative. We've increased our grower services team, utilized insights from our grower advisory board, institutionalized our pricing process, and held numerous growers meetings in the Central Valley, where we've engaged with hundreds of growers. We continue to reinforce and also hear from growers about the importance in value of the Diamond of California brand and have increased the investment in this brand over prior years. As we've mentioned previously, we prioritize our walnut supply to our retail branded business first, and we do have ample supply of walnuts to serve our Diamond of California brand, as well as certain other select volume. However, to fully exploit the growth potential of our overall walnut business, we need to expand our supply base. Our efforts with growers to rebuild our walnut supply will be ongoing. We're encouraged by our progress on contract renewals to date, and we remain optimistic as the contract renewal season continues through the summer. I want to take the opportunity once again to thank our growers who have remained loyal and committed to Diamond, those who have decided to rejoin us, and those who have elected to join us for the first time. I would also like to recognize the efforts of our employees, who have contributed to improving financial results by keeping a keen focus on managing costs. The $20 million to $40 million in cost savings that we've discussed have been identified throughout our manufacturing operations and in non-walnut procurement. This quarter's financial results reflect only a small portion of these annualized savings. We expect to realize the full annualized improvement over the next 18 to 24 months.

Let me now take a few moments to give you my views of the puts and takes in our financial performance for the remainder of this fiscal year. First of all, we plan to stay the course with initiatives designed to fuel our brands. With that said, we do expect consolidated sales in the back half of the fiscal year to be down more compared to prior year than we saw in the first half of this fiscal year, primarily due to the full effect of the Emerald SKU reduction, the reduced amount of walnuts available to sell, and the continuing emphasis on net price realization. Our consolidated gross margin has been fairly stable for the past 2 quarters, and we currently believe represents a reasonable estimate for the remainder of the year. With that said, our margin level may fluctuate if we decide to make opportunistic changes to our brand development tactics and/or face increased walnut or other commodity cost. You should also expect us to invest in advertising across our brands as we see opportunities like we did this quarter with Diamond of California and Pop Secret, and as we continue to balance promotional spending with more consumer pull activities. With that said, I will turn it over to Mike to discuss our second quarter financial performance in more detail. Mike?

Michael Murphy

Thanks, Brian. During the second quarter, the company changed from 1 reporting segment to 2 segments. Snacks, which includes Pop Secret and Kettle, and the Nuts segment, which includes Emerald and all products sold in the Diamond of California brand. As Brian mentioned, our profitability performance this quarter reflects the progress we are making against our key initiatives. The company has increased both gross profit and adjusted EBITDA in dollar terms and as a percentage of net sales, while investing $12.3 million in advertising support for the brand this quarter. This performance was driven primarily by the increase of net price realization with commensurate focus on cost controls. So with that as a backdrop, I'll go through our financials in a bit more detail. Consolidated net sales during the quarter decreased by 15.8% to $220.8 million compared to the same quarter of the prior year. The Snack segment, net sales increased 7.2% to $105.4 million on a 2% volume increase. Pop Secret continues to perform well and Kettle revenues were up slightly in the quarter as we saw some improvement in net price realization due to our planned reduction in promotional spending. In the Nuts segment, net sales decreased 29.6% to $150.4 million compared to the prior year. This decline was driven by several factors: walnut supply, as well as the planned reduction in SKUs and promotional spend on Emerald. Consolidated gross profit was $50.6 million this quarter, or 22.9% of net sales that's compared to $41.9 million or 16% of net sales in the prior year. The Snacks segment gross profit was $34.8 million or 33% of net sales for the quarter compared to $28.4 million or 28.9% of net sales in the prior year. A strong increase in net price realization for both Kettle and Pop Secret encountered some commodity cost headwinds in both brands to deliver this 410% basis point expansion in gross margin. The Nuts segment gross profit was $15.7 million or 13.6% of net sales compared to $13.5 million or 8.2% in the prior year. 540-basis-point expansion in gross margin reflects an improvement in net price realization for the Emerald brand and cost management to better align capacity with reduced walnut volume.

On a GAAP basis, SG&A decreased to $32.3 million in the quarter from $34.3 million last year. On an adjusted basis, SG&A expense was up about 9% over last year with adjusted SG&A at $25.6 million this quarter or 11.6% of net sales as compared to $23.6 million last year or 9% of net sales. These adjusted figures exclude certain expenses, which are outlined in our press release. The company has been focused on reducing controllable SG&A spending to counter increases in some expenses such as audit and insurance, as well as investment and innovation in our category business team. Advertising expense was $12.3 million or 5.6% of net sales during the second quarter compared to $11.6 million or 4.4% in the prior year. The increase in advertising expense reflects investment and programs related to the 100-year anniversary of the Diamond of California brand and a new digital and social campaigns for Pop Secret, as well as a shift in timing of advertising spending from earlier in the fiscal year.

As we noted on our last call, the Oaktree warrant is accounted for as a derivative liability and, therefore, is remeasured at fair value every reporting period. In the second quarter, the company recognized an $18.6 million noncash gain on the warrant primarily due to decline in the company's stock price between the end of the first quarter and second quarter of this year. Net interest expense was $14.2 million in the second quarter of fiscal 2013, compared to $6.5 million in the same period last year. This interest expense includes certain noncash items such as interest paid in kind on the Oaktree notes and amortization of capitalized fees.

On a GAAP basis, the effective tax rate was 2.5% for the second quarter. GAAP net income was $10.1 million compared to a loss of $20.2 million last year. GAAP diluted earnings per share was $0.43 compared to a loss of $0.93 in the prior year. On a non-GAAP basis, Diamond earned $1.1 million of net income or $0.05 per diluted share in the quarter. This compares to $0.2 million or $0.01 per share in the second quarter of the prior fiscal year. A non-GAAP fully diluted EPS calculation includes 1.4 million and 1.8 million shares related to the Oaktree warrants based on the treasury stock method for the second quarter and year-to-date periods respectively. Based on the trends we've discussed, adjusted EBITDA expanded to $22.9 million in the second quarter, up from $16.6 million last year. Capital expenditures were $1.6 million for the second quarter of fiscal 2013, reflecting our current maintenance level of spending. As of January 31, 2013, net debt outstanding was $553.8 million on a GAAP basis with the Oaktree debt at its carrying value as described in Footnote 3 of the 10Q. Cash and availability on Diamond's bank revolving line of credit on March 8, 2013, was approximately $80 million. As we have discussed, we're looking at a range of options to address our interest costs and the structure of our balance sheet. In evaluating options, we're balancing what is available to us today versus what may be available in the future as to such items as rate, terms and flexibility. We'd like to open the call for questions at this time.

Linda B. Segre

Angela, can you open the call for questions, please?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Heather Jones with BB&T.

Heather L. Jones - BB&T Capital Markets, Research Division

First of all, thank you for the increased disclosure in the press release. Secondly, just listening to your commentary regarding the cadence of sales, gross margin, is it fair to assume that on an EPS basis, that the losses will be fairly significant in the back half of 2013 for a non-GAAP basis?

Michael Murphy

I don't think I follow you on that, kind of, that assumption there.

Heather L. Jones - BB&T Capital Markets, Research Division

Did you say that the year-on-year declines in revenue were going to be more pronounced than they were in the first half, or were you just talking about on an absolute basis?

Brian J. Driscoll

No. On the back half of the year on a year-over-year basis, we'll see the declines being greater than declines we've experienced in the first half of the year.

Heather L. Jones - BB&T Capital Markets, Research Division

And you're talking about a gross margin fairly similar to the first half?

Brian J. Driscoll

Yes.

Heather L. Jones - BB&T Capital Markets, Research Division

So that -- I mean unless I'm doing my math wrong, if I assume that interest expense is similar to the first half. And if I assume SG&A, adjusted SG&A is similar to the first half, it gets me to losses, unless there's a big offset in taxes. So am I thinking about this correctly or is there something that will offset that?

Michael Murphy

I think the other way to look at it is also you'd want to normalize the gain on the Oaktree warrant valuation as well.

Heather L. Jones - BB&T Capital Markets, Research Division

Right. That just being neutral each quarter?

Michael Murphy

Correct.

Heather L. Jones - BB&T Capital Markets, Research Division

Yes, yes. And I was wondering if I did my math correct. Did you reduce debt, net debt about $50 million sequentially?

Michael Murphy

We did, yes.

Heather L. Jones - BB&T Capital Markets, Research Division

And then finally on the walnut side, the February data came out on Friday, and we had been seeing weakness in total shipments, but then January sort of rebounded and February was strong. Do you believe this is -- and it's, honestly, each month is coming from different areas as far as the export market. I mean, what is -- where is your anticipation in coming months for the strength of export demand?

Brian J. Driscoll

Well, we were a little bit surprised by the surge in February. Primarily, it was Hong Kong and Vietnam, and of course, Hong Kong being an indicator of demand in China. So we're still sorting through all the data and trying to determine the -- what's behind it. We just recently received it as well. But we don't necessarily believe that, that portends any continuation of that in the coming months. There's any number of factors that could be underlying this, and we just are sorting that out now.

Heather L. Jones - BB&T Capital Markets, Research Division

Okay, so just wait and see?

Brian J. Driscoll

Yes.

Operator

And we will take our next question from Thilo Wrede with Jefferies.

Thilo Wrede - Jefferies & Company, Inc., Research Division

I'm impressed by your ability to increase the gross margin in the Snacks and then in the Nuts business so much year-over-year despite the drop in revenues. Does that say that the volumes that you take out were really unprofitable? Maybe you can put a little bit more details behind those numbers.

Brian J. Driscoll

Yes, I think there's a couple of factors there. I think on the Emerald side, you can say that a substantial amount of the improvement was taking out unprofitable SKUs. So the 65% or so of the SKUs we took out, was a big contributor, I think. Net price realization, of course, is a contributor. But on the walnut supply, I think we did a particularly good job of aligning our capacity with the actual demand. So last crop season, the one before the '11 crop year, we had a more difficult time flexing our capacity to match the lower volume. We did a much better job this past fall and winter doing that, and that had a significant effect on our costs.

Thilo Wrede - Jefferies & Company, Inc., Research Division

And can you elaborate a little bit why Emerald is considered Nut brand or Snack brand? I'm just trying to understand how should we think about it? Is it going to be a snack product going forward? How do you think about it?

Michael Murphy

Yes, there's probably more disclosure in the Q in terms of the reason for why the company, for GAAP purposes, had Emerald in with Nuts as a segment. There's lots of other factors to it. One about where the margin profiles are for the underlying brands. There's another factor to it just in terms of what facility, where both products are processed as well. And then you look at kind of the composition of the underlying commodities in both of those brands, that's another factor we weigh in as well.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Okay. Can we hope for a segment EBIT data at some point?

Michael Murphy

Starting with the gross profit? We'll evolve and we'll get more details, we'll keep you...

Brian J. Driscoll

Haven't decided, haven't decided.

Operator

We will take our next question from Bill Chappell with SunTrust.

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

Maybe just a follow-up on that question. So on the combination of Emerald in the Walnut business, I mean is it going to be one sales force, management team? How will that be integrated or -- and how -- are there some cost savings that are coming from that?

Brian J. Driscoll

So we're aggregating, operating segments into reportable segments. And so in terms of how we're managing the business from a personnel perspective, at the GM level, Emerald and Diamond of California are being overseen separately. However, in terms of our sales force and other like functions, it is consolidated. But we are producing Emerald in the same location as Diamond. And then there's a set of other criteria that we follow to determine how these segments are formed, and we follow that criteria in making this decision.

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

Because I was just trying to understand. I mean I would think that you have the same buyer at Walmart or other customers for Kettle and Emerald and Pop Secret, while you have a completely different one for the Diamond business, is that not right or -- I mean I would think you would line them up more on kind of the customers' end buyer.

Brian J. Driscoll

I think it does vary. I think customers treat categories differently. And certainly, the way they choose to procure may vary as well. I also think that as an example, you might find Emerald more present in the same aisle as Pop Secret than you would in terms of Kettle or Diamond. It all varies depending on the individual strategies of a retailer. But in terms of how we chose to provide the segments, it was driven by a set of criteria that we followed closely in making that decision. I think Mike described that in summary, but it's in greater detail in the Q.

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

Okay. Switching to the walnut business, I guess I'm a little surprised by your -- I guess, the timing of your optimism of signing growers and what have you just because I didn't think many growers really had to commit to you one way or the other for another few months at the earliest. So can you maybe quantify what you're seeing or what percentage or maybe give us a timeline of when you will have better visibility on how many growers signed up with you for the year?

Brian J. Driscoll

Yes. First of all, I am encouraged by the early renewal traction, but it is early. As I also mentioned, we've -- in the past couple of months, we've been in front of hundreds of growers. And so the combination of the early traction we're getting and feedback we're getting from other growers gives us that encouragement. However, to be clear, that is far from an assurance that our crop receipt levels are going to be robust versus year ago. We just simply don't know yet. But the early signs of traction are good.

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

So when do you think -- when should we have greater visibility? Midsummer?

Brian J. Driscoll

Well, the grower renewal season, if you will, goes through the summer. So I would say probably, we'll have a better sense for where we are by midsummer.

William B. Chappell - SunTrust Robinson Humphrey, Inc., Research Division

Okay. and then switching a little bit to -- back to Emerald, is the SKU rationalization done, and so what we're seeing now is just you kind of cycle through that over the next couple of quarters or are there more to do? And then with that in mind, you should have a pretty good sense on what the retailers are doing in terms of your shelf space now that you're not spending quite as much behind it or promoting quite as much. Are you comfortable? Are you pleased? Are you discouraged with the kind of shelf space gains, losses you have going into the planogram resets?

Brian J. Driscoll

Well, first of all, on SKUs, the heavy lifting is done. I mean I'll never say that it's totally done, but the heavy lifting, the most significant effort is behind us in terms of SKU rationalization. In terms of shelf space, while we don't have a definitive measure of shelf space available, I could tell you that the distribution on the brand itself has held up better than we thought it would overall, and we're gearing up for a relaunch of the brand timing to come. But we believe that we've established the appropriate baseline, the shelf level foundation, and now we need to bridge ourselves to the relaunch. And again, we are encouraged by what we've been seeing of late.

Operator

And we will take our next question from Tim Ramey with D.A. Davidson.

Timothy S. Ramey - D.A. Davidson & Co., Research Division

I guess I too was a little surprised on the grouping of the segments just from the perspective of kind of maximizing value for shareholders. Wouldn't it make sense to put kind of the potentially high-margin businesses together and the things that people tend to place a higher valuation on such as snacks together, and then culinary and the In-Shell business separately? How did you think about that?

Michael Murphy

Tim, it's Mike Murphy. So first off, it's how the chief decision-maker for the company runs the business. We do have 5 operating segments, but in terms of the reportable segment, it's how they're grouped. One of those factors, you're correct, is about margins. And so the snack, the ones -- the 2 operating segments that we combined in with Snacks, they have a different margin profile than the ones that we have in the Nut segment. They fit more together with that. That's a factor we have to weigh for those purposes as well. That's a factor we're determining for the requirements to identify your segment also. Another factor though is the way they're produced. There's a lot of shared cost and a lot of shared processes there. That weighs in under there. But you're right on the margins, but the margin profile -- we felt the Emerald goes better with the Nuts based on its commodity, and it hits margin profile combined with Diamond.

Timothy S. Ramey - D.A. Davidson & Co., Research Division

If I could just follow up. The reduction in net debt, should we think about that as seasonal or should we think about that as working capital or ...

Michael Murphy

We're definitely seasonal if you think about the early part of the year, we'd sell into the heavy holiday season. That's -- again the walnut part of the business converts the cash pretty quickly in that part there, so that's where you saw a lot of paydown on the line there.

Operator

[Operator Instructions] And we'll take our next question from Ed Aaron with RBC Capital Markets.

Edward Aaron - RBC Capital Markets, LLC, Research Division

So the $20 million to $40 million of cost opportunity that you've talked about in your current revenue basis, roughly 200 to 400 basis points of margin, all else being equal, if you think about kind of where gross margins are right now on kind of a baseline basis, is 200 to 400 basis points of margin improvement kind of a reasonable view of the medium-term gross margin opportunity for the company? I'm just trying to get a sense of whether maybe these cost improvements kind of understate the margin opportunity. Or on the flip side, maybe you're looking to reinvest a portion of these savings as they flow through.

Brian J. Driscoll

Yes. I would not consider the savings profile on a linear basis, as you associate it with margin. We're looking to reinvest a good percentage. I'm not prepared to be precise on that at this stage all those savings back into the brands, but importantly, back into high-traction activities. I think that's the virtuous cycle we want, right? So you get improvements in your cost profile. You continue to build that profile. You invest in strong margin, high-traction activities. And then that just kind of -- that cycle kind of builds on itself over time. That's the model we're trying to produce here as opposed to just taking the savings to margin.

Edward Aaron - RBC Capital Markets, LLC, Research Division

Okay, that's helpful. And then my next question is with the move to segment reporting, which I also appreciate. I guess the trade up with that is that it didn't look like we're going be able to see the breakout of culinary versus non-retail on the walnut side. Is there a -- how do you plan to kind of communicate the differences between those 2 businesses as you move forward, since that's kind of information that we used to have but perhaps won't anymore?

Michael Murphy

Yes, I think that's something we could consider on there. I mean if you think about one message for the company is obviously a lot more of the focus in terms of walnut supply been on the retail business. We're kind of commenting on where most of the decline has been on non-retail channel. But that's something we consider in terms of kind of the revenue component of that on a go-forward basis.

Brian J. Driscoll

Yes, I agree.

Edward Aaron - RBC Capital Markets, LLC, Research Division

Okay. And then just one last one for me. I think the adjusted SG&A was up, I believe, 9% year-over-year. You talked about the more aggressive cost control effort. And I guess I would tend to associate that with maybe a smaller increase in SG&A or perhaps even for a company your situation, a decrease on a year-over-year basis. I was just hoping you could give a little more color on that.

Michael Murphy

Yes, I mean there are still some items we're trying to get ourselves back to kind of a normalized run rate on in terms of SG&A, still working through kind of some of those outstanding costs that we haven't been able to bring down. There are some increased costs from audit insurance. The company did invest in innovation, which -- as well as these category business teams. So the other items that we're working on, we just haven't been able to kind of bring down those down yet, but they're teed up for us to address.

Brian J. Driscoll

So we're trying to eliminate redundant tasks and those activities that don't produce an outcome consistent with our key priorities. At the same time, we're investing back, as Mike said, in our category business teams. So we're building and strengthening our financial organization, our marketing organization and building an innovation team. So on balance, we feel like the dollars we are spending will be targeted more to producing the kind of outcome we're describing over time. But on an absolute basis, we do think there's more opportunity on SG&A. Some of those things are, in many respects, out of our hands in the short term, but we do believe that there's more opportunity there.

Operator

And we will now go to Ken Zaslow with Bank of Montréal.

Kenneth B. Zaslow - BMO Capital Markets U.S.

How did Kettle sell?

Michael Murphy

Say again?

Kenneth B. Zaslow - BMO Capital Markets U.S.

How did kettle do during the quarter?

Brian J. Driscoll

Well, on a -- we're not reporting the gross profit by brand. But we mentioned that the overall segment was up on a top line basis 7%, and that Kettle was up slightly. So we think Kettle performed reasonably well, especially considering the freshness of the strategy. As you may know, our most recent Nielsen data on Kettle was less than robust, but not unexpected. The impact of the net price realization in the steps we took there, especially in our expansion markets, are going to have an effect in the short term. And yet we were still able to grow top line marginally. So we think it performed reasonably well.

Kenneth B. Zaslow - BMO Capital Markets U.S.

And when do you expect to see sales growth in Emerald? Is it 2 years out? Is it 1 year out? When do you rightsize this business where you've reached the base to [indiscernible] ? How long does it take?

Brian J. Driscoll

I think we'll probably cycle through the full effect of the discounting shift and the SKU reduction by the end of our fiscal year. So we're thinking the first quarter of fiscal '14, which starts in August for us, is probably going to be the right baseline.

Kenneth B. Zaslow - BMO Capital Markets U.S.

In your commentary, you've talked about gross margins, but you said, and I don't know exactly the words, I jotted it down quickly, is, our gross margins should be relatively stable except for we have to be aware of tactical investments and commodity prices. I think those are the 2 words. Can you talk about what tactical investments you're actually talking about? [indiscernible]

Brian J. Driscoll

I guess what I'm trying to do is I don't want us to be tied to a very precise number at this stage of our turnaround because, to the extent that we believe that for the improvement of this company going forward and for the long-term, there are high-traction activities on the brand side we could be investing in that are working. I want to invest in them. So to the extent that some of these efforts build traction and, again, consistent with this virtuous cycle I referred to earlier, to the extent that we are beginning to experience some good traction, I'm going to want to invest back in those. On the commodity side, there's any number of things that could happen. But as you may know, the final pricing on walnuts is not in yet either. And so to the extent that it has an unexpected or unplanned shift, that could have some impact.

Kenneth B. Zaslow - BMO Capital Markets U.S.

That commodity side though would only be an unplanned or is it -- does it include like if you're discounting to get people to sign long-term contracts? Anything like that, that would be greater in that yield. I'm talking about the commodities or they're just getting unexpected changes in the Deltas of what we could see on the commodity expense side?

Brian J. Driscoll

Primarily delta.

Kenneth B. Zaslow - BMO Capital Markets U.S.

And then my last question is, what progress have you guys made with your capital structure? Like where are we in that, and how long will we have to wait to see you guys make a definitive -- because I'm assuming whatever can happen is going to happen sometime and, just kind of figure out what the timing is and how we should reassess it at the time. Because it seems like that should be a relatively big event or no?

Michael Murphy

I don't have an answer for you on the definitive timing. But the more that the company shows progress and improving its margins, the more it kind of removse the uncertainty of building up walnut supply and builds from there a lot more easier in terms of option in terms of the market there. So that's something we're addressing kind of week by week as to what's the alternatives available for us now versus in the future.

Kenneth B. Zaslow - BMO Capital Markets U.S.

Are there anything that we should be thinking about that would make your decision -- like are there indicators out there that we should see that would make your decision easier or hard to actually make a definitive answer on this?

Brian J. Driscoll

I'm not sure I follow you there. I mean...

Kenneth B. Zaslow - BMO Capital Markets U.S.

Like if walnut prices were to fall, and you got more comfortable with it, if you were able to secure a certain amounts of walnuts? If we saw IRI data getting better, if there is profitability in these businesses quicker than you think, if your gross margins -- what are the signals that you guys are looking at...

Brian J. Driscoll

I guess in terms of reported results, we're talking about the same information there, right? Kind of what we're booking, how we're showing results to the plan by brand.

Kenneth B. Zaslow - BMO Capital Markets U.S.

But there aren't any key metrics? Like if sales were to reach a certain level or -- are there any metrics that you guys are looking at?

Brian J. Driscoll

I think the foundation for every option we have is continuing to improve the overall economic profile of this company. So as we mentioned, we're evaluating and examining a number of options. We can't give you time parameters on it, but one thing that remains true is that, again, the foundation for every option is the continued improvement of the overall economic profile of this company, and we're encouraged by what we're seeing thus far.

Operator

[Operator Instructions] And it appears there are no further questions at this time. Mr. Driscoll, I would like to turn the conference back to you for any additional or closing remarks.

Brian J. Driscoll

Thanks, everyone, for joining us. I wanted to close by saying that this quarter's performance reflects progress against the initiatives we've been working on over the past nine months. Although we are still in the early stages of our transformation process, we believe that our areas of focus can get us to a profitable, sustainable growth platform for the future. Thank you again for joining us today. At this time, we will conclude the call.

Operator

Ladies and gentlemen, this concludes today's conference. We thank you for your participation.

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Source: Diamond Foods Management Discusses Q2 2013 Results - Earnings Call Transcript

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