Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Bob Philipps - Investor Relations

Michael J. Mendes - President, Chief Executive Officer, Director

Steven M. Neil - Executive Vice President, Chief Financial and Administrative Officer, Director

Analysts

Tim Ramey - D.A. Davidson

Heather Jones - BB&T Capital Markets

Mark Argento - Craig-Hallum Capital

Ken Zaslow - BMO Capital Markets

Alton Stump - Longbow Research

Akshay Jagdali - Keybanc

Sarah Lester - Sidoti & Company

Diamond Foods (DMND) F4Q9 Earnings Call September 30, 2009 5:00 PM ET

Operator

Good afternoon. My name is Jamie and I will be your conference operator today. At this time, I would like to welcome everyone to the Diamond Foods fourth quarter and full year fiscal 2009 earnings conference call. Today’s call is being recorded. (Operator Instructions) Mr. Philipps, you may begin your conference.

Bob Philipps

Thank you, Jamie, and good afternoon everyone. Welcome to the Diamond Foods investor conference call and webcast to review the financial results of our fiscal 2009 fourth quarter and full-year which ended July 31. Before we get started, let’s cover a few housekeeping items.

First, a printed copy of our prepared remarks will be available on our website diamondfoods.com under the section titled Investor Relations, followed by Earnings Releases, within 1 hour after the call’s conclusion.

Second, we've arranged for a taped replay of this call to be available via telephone beginning about two hours after the call's conclusion until 7:00 p.m. Eastern Time on October 5, 2009. The toll-free dial-in number to access the replay is 1-888-203-1112; otherwise, use 719-457-0820. In either case, the conference ID is 206-4149. In addition, this call is being webcast live, and a replay will be available on the website.

Third, we want to remind you that during the course of today’s call we will make forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, including projections of our results. Since actual results may differ materially from these projections, we encourage you to learn more about the risks and uncertainties that affect our business by reviewing our SEC filings under the heading Risk Factors.

Note that our forward-looking statements are based on factors that are subject to change, and therefore these statements speak only as of the date they are given. We do not undertake to update forward-looking statements.

Now I'd like to turn the call over to Michael Mendes, our President and Chief Executive Officer.

Michael J. Mendes

Thanks, Bob. Good afternoon everyone and we welcome your participation in our call today. Before we begin, I would like to introduce Steve Neil, our Chief Financial and Administrative Officer, who will join me as we review our prepared remarks. Andrew Burke, our Senior Vice President of Marketing, will join us for the Q&A session.

In the face of a very challenging economic environment, Diamond reported record sales and earnings, while continuing to make significant investments in our future. As we begin the call today, let me share some of the highlights for the year:

We completed the purchase of Pop Secret from General Mills and quickly integrated the brand into our supply chain, giving us a much larger footprint in the snack aisle.

We continued to improve the distribution and shelf position of both Diamond culinary nuts and our snack products in traditional grocery. In the second half of the year we gained significant new distribution in the mass merchandise and club channels for Emerald and Pop Secret.

Full-year sales exceeded $570 million. Retail sales, where we have focused much of our effort over the last few years, grew 26% and now make up over 80% of our business. In fact, it is worth noting that during fiscal 2009, while we added $95 million in retail sales growth, we also elected to eliminate $55 million in lower-margin non-retail sales. We will continue to monitor and right-size our non-retail business as we deem appropriate in the future.

Full-year EPS grew from $0.91 last year to a record $1.47 per share this year, an increase of 62%. Our earnings growth reflects a higher proportion of retail sales in our mix, incremental margins as we increase the scale of our snack portfolio, and production efficiencies coupled with normalizing input costs.

We also made significant progress in improving the strength of our balance sheet. In order to finance the Pop Secret acquisition, we assumed roughly $200 million in debt last fall. The capability of our business to generate strong cash flow coupled with tight working capital management, enabled us to pay down over $100 million of this debt within nine months.

Finally, we accomplished all of this while substantially increasing the investment in our brands. We doubled our spending on research and development, and increased advertising by 40% as we integrated Pop Secret and supported our expanded snack portfolio with a national television campaign. Late in the year, we began construction of an integrated roasting and packaging line at our Fishers, Indiana plant. This project will help enhance the quality and cost efficiency of our products and enable Emerald’s expansion into new segments within the snack nut category.

Now I’ll have Steve cover some of the highlights from the quarter.

Steven M. Neil

Thanks, Michael and good afternoon everyone. Please note that our earnings press release and 10-K were both filed today.

The fourth quarter, which concluded in July, was another very good quarter for Diamond Foods. Retail sales grew 17% as we more than doubled our snack sales; operating margins improved 450 basis points to 7.5%; we supported our brands with a 125% increase in advertising, and a significant increase in promotional activity; and we earned $0.25 per share, 56% more than we earned during the same period last year.

The strong retail sales growth we achieved in the fourth quarter came despite a 27% decline in Diamond culinary nut sales as we elected to pass on more favorable input costs to our retail partners and consumers, and we rationalized some non-strategic SKUs.

Our snack brands had an exceptional quarter. Sales were nearly $55 million, reflecting how we have continued to successfully execute across a wide range of objectives, including: converting existing shelf space of Emerald SKUs from lower velocity items, to core, higher velocity items; continuing to roll out innovative new products; and supporting our brands with effective advertising and promotions that excite our retail partners and attract new consumers to the category.

For the year, snack sales grew over 100%, reflecting the acquisition of Pop Secret and strong growth from Emerald new product introductions, distribution gains and more effective merchandising. Culinary sales grew 1% for the year, retaining market share, but unfavorably impacted by price deflation and our decision to rationalize non-strategic SKUs in the value channel.

Gross margin expansion in the fourth quarter and for the year was a result of a more profitable mix of retail sales, including Pop Secret in this year’s results, continuing strength of our retail nut business, more normalized input costs and manufacturing efficiencies.

At retail, declining input costs are largely being offset by higher promotional spending to spur greater unit velocity and deliver better consumer value.

The manufacturing efficiencies in the fourth quarter were due primarily to higher recovery from our shelling operations. Normally the crop is not completely shelled until after the fiscal year, essentially following the normal demand cycle. However, we were successful in marketing our remaining uncommitted inventory which allowed us to shell the crop out early and reduce our secondary processing.

SG&A expense as a percentage of sales for the year was 10.7% compared to 8.2% last year. The increase reflects the impact from the Pop Secret acquisition and costs associated with supporting our growing retail business. We anticipate the percentage will decline in fiscal 2010 since we will not incur Pop Secret transition costs, and in 2009 we adjusted our trademark intangibles which caused current year expense to be higher than what we anticipate going forward.

Fourth quarter advertising expense was $7.7 million, up $4.3 million from last year. This primarily reflects activity in support of our snack product lines. For the year we invested $8.3 million more than last year, which is consistent with the high end of the guidance we communicated earlier in the fiscal year. As a result, operating margin grew 450 basis points to 7.5% during the quarter, and finished the year at 8.0%, up 350 basis points.

Interest expense continued to track in the same range as during the third quarter, so that we finished with $6.3 million for the year, at the low end of our initial guidance. This reflected lower borrowing rates and our ability to use free cash flow to pay down debt. Our year-end leverage ratio was less than 1.8 times, so we will continue to benefit from a low 150 basis point credit spread over LIBOR during the first quarter of fiscal 2010.

Our effective tax rate was 38.6% for the year, which reflected some discrete tax expense items recorded in the quarter. We anticipate the effective tax rate in fiscal 2010 to be similar to the 2009 rate.

As a result of our favorable sales mix and cost efficiencies, EPS was $0.25 in the quarter, compared to $0.16 in the fourth quarter last year, and as Michael noted, full-year EPS was $1.47, up 62% over last year.

On July 24 we paid a four and one-half cent per share dividend, for a total payment of $0.18 per share for the year.

Briefly looking at cash flow, we generated $45.4 million in free cash flow in 2009, reflecting $53.4 million in cash flow from operations and $8 million in capital expenditures. In 2010 we anticipate CapEx will be $8-10 million.

Given our strong finish in 2009 and the scale benefits we expect as snacks grow to $220-230 million, we are increasing fiscal year 2010 EPS guidance to a range of $1.70 to $1.80 per share, from the previous range of $1.55 to $1.70. This represents growth of between 16 and 22 % above fiscal 2009’s $1.47.

Finally, I want to address two other topics. Today we filed a $250 million universal shelf registration statement on Form S-3 with the SEC. While we have no specific plans or needs to offer securities under the shelf registration at this point, the filing gives us the ability to move quickly to access capital if necessary. By filing now with our recurring annual filings, we condense certain accounting and legal services and save the company some money.

Second, I wanted to comment on our performance against the long-term financial targets that we first established in fiscal 2006. Back then, we said that we expected to achieve the following by fiscal 2011: top line growth of 8% to 10% per year; snack sales growth of 40% per year; gross margin of 20% and operating margin of 10%; and EPS growth of more than 15% per year. Through fiscal 2009, we have significantly outpaced our snack and EPS growth targets, we are already realizing greater than 20% gross margins, and our compounded annual top line growth rate is only slightly below our target. So roughly midway through this initial long-term period we are certainly meeting our target expectations.

We thought it appropriate to update these targets now given our performance against them and since we’ve had about a year of experience in the microwave popcorn category from which to better understand the opportunities we have with Pop Secret.

I am going to turn the call over to Michael to cover our new long term targets.

Michael J. Mendes

Thank you, Steve. As we look to establish the credibility and confidence that is only achieved by consistently delivering strong, stable financial performance, Diamond has done so while continuing to make substantial investments in our future. Our strategy is to: drive profitable, sustainable growth as we leverage our premium brand portfolio; focus on categories where we can achieve scale at the retail shelf and deliver exceptional value to retailers and consumers, alike; and introduce innovative new products and packaging, while stimulating consumer interest with effective marketing that will provide the foundation for dynamic organic growth.

As we look to the future, we believe we can deliver significant growth, which when effectively leveraging our resources, can help produce exceptional earnings and cash flow. Over the next five years, we believe this business is capable of generating $1 billion in total sales, snack sales of over $500 million and earnings of $3.50 per share. In order to meet these targets, we will seek to drive strong organic growth while exploring acquisition opportunities that can enable or accelerate our ability to deliver and sustain long-term shareholder value.

At this time, we will conclude our formal comments and open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tim Ramey with D.A. Davidson.

Tim Ramey - D.A. Davidson

I was trying to figure out if there was any real seasonality to the Pop Secret business. Is there any kind of spike in the 4Q or is pretty ratable throughout the year?

Steven M. Neil

Pop Secret, when you compare it to our nut business, is much more ratable over the year. If there is seasonality, you’ll see it sometimes in September with the new TV season coming on and you may see it around the Super Bowl time but really when you look at it compared to our other businesses, it’s pretty ratable over the year.

Tim Ramey - D.A. Davidson

If I think about it being sort of a $90 million run-rate, $22.5 million quarterly rate that means your snack business was kind of $32 million in the fourth quarter and if I annualize that, we’re kind of in the $128 million, $130 million range, which seems like that’s sort of smack in the middle of what you are guiding us to. So are you guiding us to essentially flat sales for fiscal ’10 or is that just conservative or what are we expecting there? You know, flat with a run-rate of the fourth quarter.

Michael J. Mendes

Well, I think Tim, as far as the fourth quarter, there’s a lot of noise in that fourth quarter in that what you are seeing in some of that is some pipeline fill of new distribution gains, for example, with our 100-calorie pack in the mass merch channel and also with our peanut business as we are getting some new distribution there, so part of that surge in Q4 does show some channel pipeline fill. So I think when you clear that out of Q4, there is growth in next year even on a run-rate basis but part of what you see in Q4 is some pipeline from that new distribution. And also we had a new piece of club business in Pop Secret in a regional club customer which also we had pipeline from Q4.

Tim Ramey - D.A. Davidson

Great. Thanks so much.

Operator

Your next question comes from Heather Jones with BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

Good evening. Great quarter. A couple of questions. You mentioned price deflation in culinary and I guess just trying to get a sense of -- I guess my core question is how much was strategic volume up there for the quarter? You mentioned walking away from rationalizing some of your SKUs there and then you mentioned price deflation, so trying to get a feel for the business you want to keep strategic, how much of those volumes were up?

Michael J. Mendes

On our strategic business, the non-strategic business that we were talking about in culinary was non-walnut related. We had some almond and pine nut business that we were doing as part of our larger service to some of our club customers that really was quite nominal in its contribution to us and really not leveraging our brand platform, so we moved away from some of that, so that’s what we were referring to in terms of moving away from non-strategic business on the culinary side.

Heather Jones - BB&T Capital Markets

So could you give us an idea of what volumes did give some price deflation, like what kind of growth are you seeing there? It seems like it’s sort of mass [higher] on the price deflation.

Michael J. Mendes

Yeah, I think that when you -- you know, absent the price deflation, you are still looking at culinary as a single digit grower, or may low-single-digit grower during that fourth quarter when you clear the market with some distribution gains that we had. If you -- we did get a major new national retail customer when we got the national culinary contract which basically artificially increases our pound volume growth and if you clear the market of that, you see low-single-digit volume growth on that culinary business.

Heather Jones - BB&T Capital Markets

Okay, and do you expect -- I mean, are we going to be comping price deflation for all of ‘010 or just -- if you could give some guidance as to that.

Michael J. Mendes

You know, we will still see -- in the first quarter, we will be lapping higher prices on a per pound basis than the same period last year. That’s reflected in our guidance and -- but we will be lapping that on the top line basis. We don’t think that’s going to be a margin issue but it will have a -- that won't be a penny profit issue but it will be a top line impact in Q1.

Heather Jones - BB&T Capital Markets

Okay, just in Q1?

Michael J. Mendes

Well, primarily Q1.

Heather Jones - BB&T Capital Markets

And then going to the margins, gross margins -- two questions, gross margins were phenomenal and much better than we were looking for and I think you had done -- I don’t have your model in front of me but I think you had done like 23%, 24% in Q3, and the sequential improvement, is that largely due to these efficiencies you noted and as far as N-Shell or did you see further cost relief or --

Michael J. Mendes

You know, a little bit about Q4 -- one thing that was a benefit for us was the remaining inventory on walnuts, for example, that we had left to sell, we happened to have a market opportunity that allowed us to sell that product in more of its natural form to that customer that we had identified, which avoided us having to double chop the material which would have had a recovery and yield hit for us. So kind of the happenstance that we had -- we were able to market that remaining inventory more in its natural format versus having to double chop it as has been our history, gave us some upside that -- you know, I don’t know if that’s something we’ll be able to achieve on the out period but it’s always something we are going to try to do. But that in part contributed to that surge. The other elements were some cost efficiencies we did talk about. I don’t know if you have anymore color to that, Steve.

Steven M. Neil

I think as you start to see your snack business ramp up, we do give some incremental margin there so it was -- the big one unusual item was the shelling operations and the others are just continuing efficiencies in the business.

Heather Jones - BB&T Capital Markets

Okay, and then on the SG&A line, that moved up considerably and just wondering -- I understand part of it is a function of greater retail sales but I didn’t know if there was some, for lack of a better word, unusual items in that.

Steven M. Neil

The only unusual item in there is we did adjust our harmony intangibles in the quarter, so that had a little bit over a $1 million impact on the quarter, so that would be unusual. The balance was frankly spending to support the retail growth that we had in the quarter and really overall for the year as we are coming into the season here as well. So other than that, a little over $1 million amount, I would say it’s a pretty normalized amount. We do expect, as we indicated, the SG&A as a percent of sales to go down next year because you don’t have that item and we don’t have the transition costs for Pop Secret.

Heather Jones - BB&T Capital Markets

Okay, and then on your guidance, you took out the bottom end and raised the top end nicely. Just wondering if you could speak to -- clearly you have some comfort with that but do you feel like your projections for ‘010 are fairly conservative or do you feel like -- do you think you could speak to your view on your guidance?

Steven M. Neil

You know, Heather, if you recollect in our comments, we mentioned -- I think we have it in our press release -- that we kept quite a wide range in our advertising projection from $29 million to $34 million in sales. Also, this coming year, we’ve got quite a host of new products that we are going to be bringing into the market. We have one new item in the Pop Secret side of the ledger right now that’s pending. We’ve got at least four items on the Emerald front that are currently pending launch this coming year, plus more things in the pipeline, so we will be spending slotting dollars to launch those items. We will have accelerated promotional spending as we look to get products -- get our consumers to have trial with those items and you know, that can be quite a significant up-front expense, so all that’s baked into our number. So we do feel very good about that 16% to 22% EPS growth next year and doing that while investing and really putting ourselves in a position for that long-term earnings growth track that we talked about in terms of our long-term vision.

Heather Jones - BB&T Capital Markets

Okay. Thank you and congratulations again.

Operator

Your next question comes from the line of Mark Argento with Craig-Hallum Capital.

Mark Argento - Craig-Hallum Capital

In terms of the $500 million [inaudible] -- long-term goal on the snack side, could you walk us through your thoughts in terms of organic growth relative to potential acquisition growth?

Steven M. Neil

You know, Mark, I think that we have talked in previous calls about our concept of the build or buy decision. You know, this is a company that over its 97-year history, due to the lack of resources, have had to generate virtually all of its growth through organic growth, which to be candid with you, I think is a very good disposition to come to the game with. I think that building is a lot of times a lot more difficult than acquiring and that is definitely at the heart of our effort. That’s definitely in our DNA, it’s what we are all about. And with that being said, Pop Secret has turned out to be a very nice acquisition for us and not only as a freestanding entity, it helped make us better as a company. It enabled us to do a better job in servicing the larger snack category and has built efficiency that the entire business has enjoyed. You know, there are some channels that we would like to more effectively be able to service in the future. There’s some consumers that we would like to augment our product line to more effectively appeal to those consumers. On occasion, an acquisition could be a much more cost-efficient and rapid path to achieve those objectives.

So I would say that I think that we are in a little different marketplace today than we were say three or four years ago. I think that if assets were to come available and they were to reflect more of the current day multiples or maybe the multiples that we anticipate we might see next year, that could be an interesting choice for us and if that’s the case, we want to be well-prepared to pursue those. That being said, we have quite a robust organic growth strategy and we are working very hard to execute against that.

Mark Argento - Craig-Hallum Capital

And then dovetailing into that, in terms of this Emerald brand that you guys have built has become -- has clearly become a fairly powerful brand in the snack nut area and growing fairly nicely. Any thoughts on taking that brand somewhere else in the grocery -- you know, other snacks or other places in the grocery store?

Steven M. Neil

You know, we have made a foray into the breakfast cereal aisle with our breakfast on the go product, which you will find in the mass merch channel. That product is doing very well there. We think that that’s a very interesting opportunity to pursue different day part to build upon the equities we’ve built in the brand and to leverage capabilities that we currently have into a channel where maybe there’s a lot more room on the shelf. And one thing that’s appealing about that breakfast cereal category is there’s a lot more real estate over there than there is in the snack nut aisle and so -- so I think that that’s been an interesting foray for us. We’ve been in the produce aisle historically with our in-shell nut products. We’ve -- making a slow build with our Emerald harmony produce snack offering. You know, we’ve evolved that offering a good bit since we’ve acquired that business, that Harmony business, to make it more of a nut-centric offering, probably building off of the strengths of our capabilities. We dropped that under the Emerald endorser brand and I think there’s an opportunity to sell to consumers through that high velocity part of retail.

You know, I think the future is open for us. I do think though that it’s very important that we finish the job in the -- with Emerald as a snack offering. We feel that we are still very much under-distributed with our product in traditional grocery as well as other channels. I mean, in traditional grocery, we only have three of all of our offerings -- we only have three items that are in distribution in more than 60% of the U.S. grocery. And the rest of our items have less than 60% distribution. So you can imagine if we just get to that 80% distribution line with our top 10 items, there’s a lot of velocity and there’s a lot of presence that we can gain and build on our franchise that way.

Not to mention opportunities in club, mass merch, drug, which are wholesale distribution customers that work well through our supply chain, and then finally looking at that convenience store segment that we are very lightly developed in and we think there’s a big opportunity there.

So I think that you bring up a good point. I think that if we continue to make Emerald a strong brand, the ability to deploy those equities in other parts of retail is a big opportunity for us. I think the most immediate opportunity is to really go from good to great as a snack-nut brand and that’s our focus right now.

Mark Argento - Craig-Hallum Capital

Great. Thank you very much.

Operator

Your next question comes from the line of Ken Zaslow with BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

Just making sure -- I looked through some of my numbers; if I look at the internal sales growth of your snack nut business in the year, I get about 18%; for the quarter, I get about 24%. If I think about going forward, that looks like based on your guidance is about 10%. Is that the right kind of magnitude, the way I’m looking at it?

Steven M. Neil

You know, I think it -- we’d have to pull out some of the pipe fill-in stuff. I think our growth rate going forward certainly in fiscal 2010 should be similar overall for Emerald. I mean, I think it’s again timing of launches, et cetera, so I don’t think it’s going to be meaningfully different. We did though, and one of the things that is going against that growth rate is we did take out some non-strategic SKUs. For example, we had some SKUs carrying over from the Harmony acquisition, Gummi Bears and the like and we just didn’t think that manufactured outside and not really a core product, so that’s going against -- not huge dollars but that’s going against the growth rate as you look into 2010.

Ken Zaslow - BMO Capital Markets

When do you -- how much do you think that will take off? Are we talking about two to three percentage points? And when does it anniversary?

Steven M. Neil

You know, interestingly enough in the Diamond Foods organization, we continually challenge to rationalize SKUs and make sure that we have the higher velocity items there, so it happens ratably throughout the year. That’s the good news. You know, it’s a couple of percentage points, but we don’t really quantify that, Ken. Again, the core Emerald growth rate should be similar -- roughly similar in 2010 than what we see in -- I think the year-on-year numbers of our snack business I think are more indicative and sort of clears the noise between the quarters in terms of our snack business from last year -- from this year to next year.

I think the one thing to keep in mind is we do have quite a surge of new products and we are going to separate these items. You know, just give you an example -- in the large -- in one of the two large mass merch customers, if we want to do one demo, one national demo, the cost is $450,000. And that’s at [inaudible] expense and that’s also because promo, it’s a reduction of net sales. We have found trial to be so important for our products and we think that some of our slow successes or failures of items that we think could have succeeded were based on our inability to get consumer trial. So one thing that is going to be a big focus for us is we will spend hard early to make sure that we give our products an opportunity to succeed and that is built into our guidance for our snack number again, which does net out of our top line sales there.

So again, we’ve got some very -- we think some very interesting items that are core to our retailer. They are appealing to a consumer base and a need that is existing, that is substantial and -- but I think it has a unique offering from our perspective. I think it gives a lot of opportunity. We need to get people to get trial of those products so we will make sure we adequately promote against that.

And then there’s also the issue of traditional grocery [we will be paying slotting] this coming year, which will also be contra revenue.

Michael J. Mendes

I am going to pile on just a bit here, Ken. One of our focus here is to manage our brands as one portfolio. We are just launching -- and you know this -- the feed the fingers promotion where we are actually going to be cross-promoting with all three of our brands, so it’s less of a focus on what’s Emerald, what’s Pop Secret, what’s Diamond doing but more as that portfolio of brands, so we are getting away I think from singularly focusing on that one brand and looking at the overall portfolio so it may seem a little bit murky but I think what is really driving that full offering for our retail partners and the consumers.

Ken Zaslow - BMO Capital Markets

I guess what I was trying to get at, and just thinking about it, is your sales growth call it 4% or 5%, your EPS growth is 19% but yet on a per annum basis, I guess with all the new products and what is happening on the IRI data, it seems like the growth in your EPS is more coming from the bottom -- from cost management and commodity prices going down then from the growth in the snack business. I guess that’s what I was just trying to get at and --

Steven M. Neil

No, I don’t think that is the case at all, Ken. And if -- let me -- again, we’re growing -- we’re looking at our snack is growing 16% to 22% and in that, in that is some rationalization of non-strategic snack items that were part of that Harmony acquisition, you know, and clearing that would drive that number even further north.

What we are seeing is when you talk about our non-retail business, we talked about our retail business is going to be north of 80% of our total sales, so that means that that non-retail business is somewhere around $100 million in sales. You know, a 10% -- and in that business, Ken, the -- there’s a lot of -- the price, the commodity cost, and the wholesale selling price tend to move quite closely in tandem, so we did see some significant price deflation that we are going to be seeing going into next year and in that case, you know, just a 10% reduction in input costs that went through to the wholesale price is a reduction in $10 million of sales, or 2% of our total top line. So I think that some of the magnitude and aggregate business and I think is where it gives you that less than stellar appearance on the top line growth but when you get behind that and you carve out that commodity price deflation, I think we are seeing some very good growth on our baseline core business.

Ken Zaslow - BMO Capital Markets

Okay, the 19% growth from 2009 to 2014, I am assuming that’s -- you know, from -- call it 140, whatever you did, to 350 -- how much of that is internal versus acquisitive in terms of what you think is the growth?

Steven M. Neil

You know, I would say that we -- I would definitely say that there will be some acquisition that would be a part of that but at this point in time, a lot of that depends on the opportunities that present itself. You know, we’ve -- we’re not going to put ourselves in a position, Ken, that we say something today that sort of forces our hands to make an acquisition that is not prudent, so I have to tell you, when you look at the $3 billion snack nut category and our relatively small business in that snack nut category. Do we think we could drive tremendous growth in snack nuts absent the acquisition? We do. We absolutely do.

Ken Zaslow - BMO Capital Markets

-- get to that number without acquisitions, I guess. I would think that you could but you are kind of --

Steven M. Neil

Well, I would say we could but that might -- we might not get the most cost-effectively and most rapidly if we rule out acquisitions.

Ken Zaslow - BMO Capital Markets

My last question is, you know, when you do make acquisitions, what is your desire to use stock versus debt? I mean, going historically, you’ve used debt. Obviously with the offering it brings up the potential of the stock side of it rather than just debt. How do you decide between the two and what is your appetite to use your stock as cash?

Steven M. Neil

Well, as a fellow shareholder with many people on the call, I prefer to avoid dilution unless it’s at a great return. You know, that being said, I think it’s very prudent that at the time we are filing our 10-K that we very cost-effectively file the shelf that we just did. You know, our bent is at the current cost of debt, we like using debt, I gotta tell you. We think that we are very fortunate that our banking partners are very positive in their experience with us. It’s amazing how much the banks like you when you pay them back and we’ve executed against our strategy and I think we are very fortunate to have lending institutions that are very supportive and trying to help enable our growth objectives.

You know, that being said, we all want to be prepared in the event that there is some opportunity that is significant and could have a great return for our shareholders that might require in part some equity consideration. So our strong preference is to use debt, especially at the current cost of debt right now, absolutely. And I tell you, we would be very, very cautious in any consideration of using equity as an asset because we think our equity is very valuable and so -- but I do think that it’s very, very prudent for us to file that shelf and to have that available amongst a robust capabilities of things we could do to help scale up this business in the future.

Ken Zaslow - BMO Capital Markets

Do you have target debt-to-cap ratios? How do you think about that?

Steven M. Neil

I wouldn’t say we have target debt-to-cap ratios, Ken. I think leverage is good because obviously that drives significant growth and earnings but I think those ratios, if you look in the past year, everybody is rewriting as to what is the ideal leverage ratio so no, I don’t think we really have a target. I think we have the desire to generate cash flow to service all of our financing, so I think it’s more tied to that and it would have to be specific to the situation, so I wouldn’t constrain myself there but again, if you look at leverage, et cetera, I mean, the markets have changed dramatically from there and I think being a good steward of the business either to our borrowers or to our shareholders is what we are all about.

Ken Zaslow - BMO Capital Markets

Great. Thank you very much.

Operator

Your next question comes from Alton Stump with Longbow Research.

Alton Stump - Longbow Research

Thank you. Good afternoon. I guess just a quick question on the walnut cost environment and in particular heading into the next year, it looks like the initial projections are actually pretty good for the upcoming harvest. Do you have any thoughts on what you think walnut costs may do over the course of the fiscal year 2010?

Michael J. Mendes

Thanks, Alton. On the walnut situation, we are just getting the harvest started. Last year’s crop, they expect the crop to be around 380,000 tons. The final crop in January was reported at over 430,000 tons. As a result, carry-out inventory coming out of last year was larger than the prior year. This current crop, the estimate was 415,000 tons, which this is supposed to be the off year. A little bit larger than I think some people were thinking.

Right now, given what we have seen in the early harvest, I would think that that 415 might be in the higher end but we are very, very early in the harvest. If the crop comes in a little shorter than the 415, I think pricing will hold relatively firm to where it is today. One thing about last year is that walnut prices, they weakened about the middle of the season and there was a lot of shipment, big, big shipments into markets that normally don’t import a lot of walnuts, markets like Turkey and China and with some additional products into China coming through Hong Kong, which really reduced the total inventory much lower than people expect by the end of the year.

So the aggregate of all that noise is that I do think that with the very weak dollar, we are going to see strong exports in walnuts this year and prices probably will stay firmer throughout the year than they did last year.

The thing that’s difficult to tell is based on the alternate varying crops, next year is supposed to be the on-year for the walnut crop and if it is going to be the on-year and if the inventory is appearing to be similar to the same size inventory as the start of this year, that could be a period where there might be some weakness as people anticipate a larger crop coming.

So those are some of the considerations around the crop. It’s very early. Quality is again important. I think last year we had a tremendous quality crop. This coming year, it appears that we are seeing a little more shrivel in the crop. I think that the odds are that this crop will probably be more average in quality compared to last year, which will mean the net yield will be a little bit lower. So even if the crop is fairly large, I think the net shellable yield is going to be lower, which will probably add a little firmness to pricing.

So I would say it’s all coming in about what we expected and that’s pretty much baked into our guidance.

Alton Stump - Longbow Research

Thank you. That’s all I had.

Operator

Your next question comes from the line of [Akshay Jagdali] with Keybanc.

Akshay Jagdali - Keybanc

I just wanted to make one comment -- again, there are not many companies that are giving long-term guidance anymore and for you guys to come out here and give 20%-plus guidance for EPS I think is commendable. And to that point, I just wanted to confirm -- I know many people have asked this question but the numbers I am coming up with on the long-term guidance are 12% top line growth overall, 21% growth on average for snacks and then operating margins of around 9% to 10% to get to the 350. Is that roughly in line?

Steven M. Neil

Roughly in line. You’re in the ballpark.

Akshay Jagdali - Keybanc

Okay. And then Michael, when you look at the 350 five years out, what in your mind are the top three risks to getting to that number?

Michael J. Mendes

You know, it’s -- maybe I’m going to frame that into a language that I would more use around the office every day. Probably the things that I would be looking to build that’s going to enable us to achieve that, I think the key is sustain brand value is very important. I think that we need to support our brands and make sure that these are brands that consumers value and what I mean is that we need to be sure that we are meaningfully differentiating ourselves and sustaining value in the packaging and the raw materials and the innovation. I think we are going to need to be supporting our brands the way we communicate with our customers, so that our retail partners see us as a value-add to them, stimulate the consumption, bring consumers to the shelf. And then finally, we need to have the scale operationally to effectively service those customers and our trade partners. I think if we can do those things, we will be able to sustain and build a brand premium that will make incremental sales profitable. I think that’s very, very important.

I think a second assumption in this is that we need to continue to attract high quality talent in our management team. You know, it’s -- we’re not a massive company. I take a lot of pride that pound for pound, we think we are -- we compete well with our other CPG competitors. I think that good talent doesn’t just fall into your doorstep. We need to aggressively evaluate the skills and the talents of our team. We need to all work to get better as individuals -- that includes me. And we need to, as we look to bring new talent to the organization, ask ourselves are we averaging up? I think that that is going to be very important. We are going to have to continue to get -- I mean, we are a better company today on average than we were three years ago. We need to be able to say the same thing three, four, five years from now.

I think finally, we need to have discipline in terms of our focus. I think that there’s a lot of companies that take a very disparate approach to their product line and kind of use the excuse that well, my consumer uses this product. Well, I always say that that’s a nice thing to say when you are trying to rationalize a disparate group of projects but I think that you are not going to see us selling fresh pomegranates tomorrow. I mean, we are going to be staying very disciplined within our supply chain and I think when you look at right now, we are very much a center store food company. Generally our products have a year plus shelf life. They generally are products that don’t require refrigeration and they go through a warehouse distribution system.

For us to move outside of that, we are going to have to do that in a way that we gain scale. So you will not see us randomly move into a product line or a brand portfolio with a fourth, fifth, sixth place brand, small franchise that we can't get scale in how we move the products from manufacturing to that end consumer. So if we can maintain that discipline, I think the risk again is losing our discipline and focus so that we leverage to scale our infrastructure and if we can remember some of those things, I think it’s going to really enable us to achieve strong results in our out periods.

Akshay Jagdali - Keybanc

Thank you and then just focusing on Emerald, I think you said 220 to 230. That’s still your plan for Emerald as of right now. I know that --

Michael J. Mendes

That was our -- that’s for our snack business next year.

Akshay Jagdali - Keybanc

Next year, okay. Well, you’ve said Emerald is going to be about a $200 million brand. That was your vision for it, so if that is the end game, I think you don’t put out those numbers today but I think most people would agree that you are around $100 million today. So we see you as being halfway through there on the top line target but to me it seems like on the investment side, you may be even ahead of that. And it’s hard for us to see what you are doing on the promo side, given how people report these days. Can you just give us a sense of that aspect? I mean, what’s your competitive advantage in snack nuts relative to your competition? I mean, you’ve obviously been succeeding with your growth but it’s hard for us to really quantify how much you have invested in the brand and we are seeing the quality of your investments but what makes you comfortable that this brand is going to double in the next three to five years? I mean, it has to be your pipeline regarding your investment.

So can you just give us a little bit more color into sort of your pipeline investment wise and how much promo dollars you may have already spent, et cetera?

Michael J. Mendes

Let me try to speak towards your question, because there is also some information I want to be cautious about because this is a public call, for competitive reasons. When you look at our Emerald business, I think one of the things as a member of management and as someone who’s been with it since the inception of the brand that we get excited about is the velocity of the turn of the items that we have in distribution and the opportunity that we have just to build out the distribution more in just traditional grocery. I mean, when you look at our top-selling item in almonds, it’s only distributed in 71% of the U.S. grocery and it’s the number one selling single almond item scanned in U.S. grocery. But when you go to the cashew segment, the number two selling whole cashew in U.S. grocery is our Emerald whole cashew and we are number two with distribution in only a third of U.S. grocery stores. So this product is really moving off the shelf where we have it in distribution.

As our team is able to effect greater distribution in the U.S. grocery landscape, we are very excited about the future of that business. Our deluxe mixed nut similar type thing -- number three, selling deluxe mixed item. It’s only in about 60% of distribution, really moving well, differentiating itself in terms of its offering but really driving velocity. And so I think the thing that we are gratified in is that retailers -- one of the biggest discussions from retailers is they are trying to be more effective with their shelf space. They are looking to put the number one, number two brand and maybe their own brand and then they want to try to reduce these other brands that basically are regional, that they cannibalize the owned store brand because they only sell on price, that they really don’t have any unique packaging or flavor profile and they are not really spending anything to invest in bringing consumers to the store for making the product top of mind for consumers.

So I think that when you look at the velocity of movement of our items, that that is a very encouraging element of the DNA of the brand.

Secondly, I think that we have clearly established ourselves as the innovate in the snack nut set. I think our retail partners recognize that we are going to bring that innovation, that we are going spend against the brand, that we are going to draw, try to bring consumers to the segment, and that also we are going to try to appeal to a broader demographic. You know, with Emerald being much more positioned to appeal to a younger snack demographic, which is more consistent with a $30 billion snack universe than the national brand, we are also very [inaudible] to the set in that we are bringing younger consumers into the snack nut category and helping them move into that set earlier than they naturally would in their life.

So again, I think that the aggregate dollars spent is data that could tell you something or it could just tell you we wasted a lot of money. So I think that that’s information -- I appreciate you asking for it -- but we prefer not to disclose much of that publicly but I would say that what we have spent I think has been very effective and I will tell you this, we’re a student to the game and we are constantly learning on what we think was effective and what wasn’t and trying to do better every year.

And so we’ve got -- we’ve guided this coming year we are going to spend $29 million to $34 million in consumer support against our brand, and that reflects that if we see the opportunity to scale up our consumer support program in a very meaningful way to build brand equity and to stimulate consumption, we’re going to make that investment.

Akshay Jagdali - Keybanc

All right, that’s helpful. One last one on M&A, just generally can you talk a little bit about the environment? I understand your shell filling. I mean, you are framing it as though it is just cost effective and timing wise the right time, and there may not be something imminent but if you can just talk to the environment, your preferences and maybe -- you know, I know Ken asked about some specific financial targets but do you have any -- can you share any hurdle rates with us? That would be very helpful.

Steven M. Neil

We are not giving the impression that we don’t have a need or whatever -- I’m teasing you a little bit there but you know, we’re seeing the M&A environment to start to get more active. I mean, I think if you see the IPO activity that is happening in the market today, if you follow the follow-on registration statements, the high yield market, et cetera, you are starting to see the financial markets recover a bit. I think that’s naturally going to bring some assets out, their pent-up demand, et cetera on financing.

So we think that the deal flow, so to speak, should pick up here in the next six months to a year, so you want to be in a position that if there is something that makes you better, then you are in a position to take advantage of that.

As far as hurdle rates, I could give you a list of 100 interesting brands or whatever would make us a better company but each one of them are unique, so I don’t think, at least from our perspective, we don’t put that hurdle rate there. If it is going to improve shareholder value, if it is going to make us better, if it is going to help our other brands further distribute and we’ve discussed with you situations where Pop Secret has made Emerald a better brand, just dealing and having more influence with the buyers at retail, so I don’t think we have any specific metrics that we are going to put out there. I think we want to stay open to what may happen.

With that said, we’ve got 850 employees here and 845 of them work on three brands and making them the best three brands they possibly can and maybe there’s five of us who think every now and then about M&A so we are really focusing on what we control and as the opportunity comes up, we will react accordingly.

Michael J. Mendes

-- could also imagine we want to be careful about what we say because we would like to acquire things at the most attractive value we can and so disclosing kind of what we would be some kind of a marker of what we’d be satisfied with could actually be harmful to us down the road, so we are going to be careful about that. But I would -- in speaking to your question on the filters generally, I sort of see concentric circles around where we are good and where we could get better and obviously we are trying to go to that snack business. We enjoyed some unanticipated benefits of scale when we acquired Pop Secret related to our snack business in general that were very interesting for us which probably puts that maybe the highest on our list as the opportunity we’d like to expand upon.

I think that the ability for an acquisition to maybe provide us access to a channel that we currently don’t have access to because of our own distribution capability, for example, that could be particularly interesting. I think that when you look at the baking needs aisle, obviously we’ve got a very strong program with our Diamond business in the baking needs aisle. We’re important to our retail partners. We think we will be very effectively and cost-efficiently distribute other products in that set and that we could have a very accretive acquisition if the right target was available there, so that would be something we’d consider.

I think broadly center store is something that we could consider in terms of more readily consumable snacks. But probably those that more likely fit within our current supply chain capabilities would be more top of list.

So I would say that’s a bit how we are approaching it and we are going to be very prudent on how we approach that discussion. I would say that today we don’t see a lot of opportunities that we think fit within those filters but it’s something we’re going to be constantly evaluating.

Akshay Jagdali - Keybanc

Okay. Thank you very much and congratulations again.

Operator

Your next question comes from the line of Sarah Lester with Sidoti & Company.

Sarah Lester - Sidoti & Company

I wanted to just get some clarity on the main reasons for raising your guidance. I guess what has changed since you originally introduced your guidance three, four months ago?

Steven M. Neil

I’ll take that initially, Sarah. We put the guidance out at the end of our second quarter, if you’ll recall, and we did that at a time when the market was very soft. We came through a -- we would call it a below-average holiday season, et cetera and we wanted to certainly express our feeling that we had growth in our product lines, et cetera.

What we’ve experienced here in the second half of the year with the success of new product launches with Emerald, with the success of taking over the full operations of Pop Secret -- remember at the time we had just in the middle of February taken over the -- what I would call the back office but the supply chain for Pop Secret. I think we are gaining confidence in our ability to develop the brand for Pop Secret and drive demand there. So I would say that those are two primary areas that we are focusing on and again I think as we get into the year and take a look at how we have grown our business to more retail focused as opposed to non-retail business, has given us more confidence as well. So I think those are our three components certainly on the top line that’s driving a lot of the change in estimate.

Sarah Lester - Sidoti & Company

Okay. And then for your advertising plan for fiscal ’10, I guess how should we expect advertising expense to be weighted? Are there certain quarters where it could be heavier with the Pop Secret ads coming up maybe in the first half, a little bit heavier there?

Steven M. Neil

Certainly it’s going to be what we affectionately call, and this is a finance term, it’s going to be lumpy. Again, I am teasing you a little bit there but our accounting method is we expense the costs as they are incurred. In other words, you can’t put them on the balance sheet and amortize them in, so that naturally causes them to be lumpy.

As we come here in the late fall with our Pop Secret media, et cetera, that will be certainly one area where we will spend but I think we are also going to remain opportunistic and that’s why you see a wide spread in our guidance.

Michael J. Mendes

You know, Sarah, we are in the midst of creating a consumer support campaign for Pop Secret. We are carefully evaluating the best timetable to deploy that media and that’s going to have a real effect on our steady state media spend on a go-forward basis, so this is going to be a year where we are going to see some shift in how we are spending our advertising because we are bringing this brand in for a full year and I think this will be more of a base year for the future, so we’ll try to give you more color on that next quarter.

Sarah Lester - Sidoti & Company

Okay. And then just -- I think this question has been asked but I am still a little bit confused about your long-term targets. Do these targets include or exclude acquisitions?

Michael J. Mendes

They include acquisitions.

Sarah Lester - Sidoti & Company

Okay. And then finally, what’s the maximum debt level that you would be comfortable with?

Steven M. Neil

I will nebulously answer that -- that which we are comfortable we can pay back, and I am pulling your leg a little bit here but I really think it’s on the -- our ability to generate cash than corresponds to the debt level that we are willing to take on. So we are fortunate to be in a position in our markets that we can drive our business and so if you notice that we not only generate earnings, we generate cash flow and we actually have some sales growth so that’s a really good question. I think we are comfortable more perhaps than the debt markets would lend to people today just because the finance markets have changed. So we really don’t have a particular item. I think it’s just very, very important for us to evaluate the ability of targets and the existing business to generate cash flow that in turn tells you how much debt you can take on.

Sarah Lester - Sidoti & Company

Okay. That’s all. Thank you.

Operator

Your next question comes from Tim Ramey with D.A. Davidson.

Tim Ramey - D.A. Davidson

Thanks for the follow-up. Are you actually shipping the new peanut package to any customers yet? Can you tell us anything about your ability to sell that product?

Michael J. Mendes

The product is in the Northeast and we’ve been very pleased with the velocity in the limited number of accounts that it is currently in but I would say that it’s a good start but not enough time to call it a trend, so the performance period that counts is still in front of us but we’ve gotten a start in the Northeast and we are making progress.

Tim Ramey - D.A. Davidson

And Michael, on the culinary sales decline, you indicated that you gave some of the input costs back. Was that an actual list price declines? Was that in additional promotion and trade spending? What form does that take and should we be modeling that number down certainly probably through the first half for fiscal ’10?

Michael J. Mendes

Yeah, that would be right, Tim and we -- most of that would be in promotional spending and high redemption levels on our FSIs in out periods. Also, some wholesale price reduction in some of the value channels, so outside of the value channels, most of that would be seen through increased promotional spending.

Tim Ramey - D.A. Davidson

Terrific. Thanks again.

Operator

We will also take a follow-up from Ken Zaslow with BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

Just following that question, it took me a minute to read through the 10-K, the $10 million in this quarter, $10 million last quarter, is that the run-rate that we are going to -- we should use for the next -- each of the next two quarters for the reduction in inventories from the commodity costs?

Steven M. Neil

Wow -- $10 million reduction -- no, I don’t think there would be any tie -- oh, I understand what you did. It was on the --

Ken Zaslow - BMO Capital Markets

Page 45.

Steven M. Neil

We had a change in estimate. No, absolutely not. Remember we don’t finalize our costs until the end of the year and as a result in the interim quarters, we have to use estimates so that’s all trued up at the end of the fiscal year, so it’s difficult for us on a quarterly basis to manage that so again, it’s a fiscal year to fiscal year, so don’t plan anything at all. We are into a new season for all commodities.

Ken Zaslow - BMO Capital Markets

Okay, so in this year, you are not assuming anything in terms of lower commodity costs of that magnitude? This is now, you know --

Steven M. Neil

Again, that’s all within year, Ken. The overall commodity market obviously depends on supply and demand, carrying inventories, et cetera, so it’s an -- you know, annual crops, it’s an annual thing. So no inference from one fiscal year to the other. We use estimates throughout the year though.

Michael J. Mendes

Ken, I’ll just speak to that broader subject, the three major tree nuts that we acquire -- walnuts, pecans, and almonds -- I think we will see a lot less volatility in this next 12-month period than we saw in the prior three years. Probably if the current industry estimates would probably be that might see a bit stronger pricing costs in walnuts and almonds within certain varieties -- pecans in the back half of the year should come off, given the projected record crop. So I think all in, it should be about a push.

Ken Zaslow - BMO Capital Markets

And you are still able to grow? That’s the major question.

Michael J. Mendes

Absolutely. Absolutely.

Ken Zaslow - BMO Capital Markets

Not because of the commodity costs being $20 million something lower -- you can grow off this without any sort of commodity tailwind behind you?

Michael J. Mendes

Absolutely. That’s what is reflected in our guidance. Thanks.

Operator

And that does conclude today’s question-and-answer session. At this time, I would like to turn the call back over to Mr. Philipps.

Bob Philipps

Thank you, Jamie. Thank you, everybody for joining us. We will conclude the call and thanks for your attention today.

Operator

That does conclude today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Diamond Foods F4Q09 (Qtr End 8/31/09) Earnings Call Transcript
This Transcript
All Transcripts