Diamond Foods Management Discusses Q4 2013 Results - Earnings Call Transcript

Sep.30.13 | About: Diamond Foods, (DMND)

Diamond Foods (NASDAQ:DMND)

Q4 2013 Earnings Call

September 30, 2013 4:30 pm ET

Executives

Katie M. Turner - Managing Director of Healthy Living, Packaged Food, Supermarket & Food Distribution Companies

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

Raymond P. Silcock - Chief Financial Officer and Executive Vice President

David J. Colo - Chief Operating Officer and Executive Vice President

Analysts

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

Brett M. Hundley - BB&T Capital Markets, Research Division

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

Thilo Wrede - Jefferies LLC, Research Division

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

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

Operator

Good day, and welcome to the Diamond Foods Fourth Quarter and Full Year Fiscal 2013 Earnings Conference Call. Today's call is being recorded and at this time, I'd like to turn the conference over to Katie Turner. Please go ahead.

Katie M. Turner

Thank you, Matt. Good afternoon, and welcome to the Diamond Foods fourth quarter and full year fiscal 2013 conference call and webcast. On today's call are Brian Driscoll, President and Chief Executive Officer; and Ray Silcock, Executive Vice President and Chief Financial Officer. Dave Colo, Diamond's Chief Operating Officer, will also be available for Q&A.

Before we begin, we'd like to remind you that during the course of this call, management may 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 in the company's press release issued today for a discussion of the risks associated with such forward-looking statements.

Finally, please note that on today's call, management will refer to certain non-GAAP financial measures, which exclude items such as expenses related to the proposed settlement of the securities class action suit, asset impairment, Oaktree warrant liability expenses, SG&A expenses primarily related to Audit Committee investigation, restatement and related expenses. The company believes these non-GAAP financial measures will provide useful information for investors. Please refer to today's press release for a reconciliation of non-GAAP performance measures to the GAAP financial results.

Management will also refer to adjusted EBITDA on today's call. For a calculation of this measure, please refer to the company's press release.

Now I'd like to turn the call over to Brian Driscoll, President and Chief Executive Officer.

Brian J. Driscoll

Thank you, Katie, and good afternoon, everyone. With the first full fiscal year of our multiyear turnaround plan now officially behind us, I'd like to review our overall performance and discuss progress made against our key initiatives. Ray Silcock will then follow with the review of our financial performance in more detail.

As we've discussed before, we face important and difficult challenges, which will take time and great execution to tackle. In this context, we've been focused on 5 key initiatives: improving gross margins through a combination of productivity improvements, cost reductions and net price realization; delivering sustainable organic growth over time through investments in brand-building, innovation and organization capability; fixing the Emerald business through a combination of SKU pruning and repositioning in order to substantially improve its earnings contribution; stabilizing and growing walnut time -- walnut supply over time and addressing our highly-levered capital structure.

Over the course of fiscal year '13, we have made strong foundational progress against these initiatives and began to track towards an operating model and discipline designed to produce consistently improved performance over time.

Regarding gross margins, we made great progress in fiscal '13. We communicated a strategy to deliver cost savings of $35 million to $40 million across fiscal '13 and '14, primarily from procurement and manufacturing productivity, and we are on track to deliver the full savings. Overall, we expanded gross margins by 770 basis points in the fourth quarter and 550 basis points for the fiscal year as compared to prior year.

Turning to the Nuts segment. Net sales during the quarter decreased in 25.2% to $82.7 million. This decrease in sale was primarily driven by a decrease in volume of 34%, partially offset by an increase in net price realization. Despite the sales decline, fourth quarter gross margin increased to 13% from 5.1% in the fourth quarter last year.

Regarding Emerald, much of the initial heavy lifting associated with its turnaround is behind us. A relaunch is now underway and while it's too soon to draw any conclusions, we are encouraged by early in-market signals. For instance, with initial shipments beginning in August, 95% of our customers currently have the new Emerald canister items on shelf. We also have new items in development that will launch in the second half of the fiscal year for both our canister and Breakfast on the go! product lines. Additional consumer-driven innovation and advertising is also planned that will begin delivering benefits in the second half of the year and into fiscal year '15.

Moving to walnuts. While we will have somewhat less supply to sell than last year, we believe that we have now stabilized our supply base. This critical step should put us in a better position to add new growers going forward. Keep in mind, the number of walnut handlers in California has grown significantly in the past 3 to 4 years, offering growers many alternatives. The challenges that this new industry structure presents will take time to overcome. In this context, we continue to take the long view on this business, remain confident that we have the right strategy in place and believe that this segment can deliver strong cash contribution benefits to Diamond over time.

Focusing on our Snacks segment. Net sales were up 3.3% in the quarter and 3% for the full year. Gross margin expanded 380 basis points in the quarter and 460 basis points for the full year. While good progress has been made, we know we have more work to do and remain committed to accelerate both our productivity and our innovation pipelines.

Underlying our earnings improvements in the Snacks segment has been the continued momentum of Pop Secret. The brand experienced solid growth, gaining 240 basis points of market share in the most recent 12-week period and 190 basis points for the 52-week period. We attribute this progress to the combination of increased investment in marketing, distribution gains and improved net price realization. Going forward, we will build on our Pop Secret marketing campaign efforts and are ramping up our new product pipeline for fiscal '14, fiscal '15 and beyond.

Moving to Kettle. The brand continues to gain share in the natural channel, and we are seeing signs of stabilization in the grocery channel despite the continued negative trends in mass and drug due to the cycling of heavy promotional spending, which we will fully lap by the end of Q1. We are encouraged about the strategy we are taking with this brand. Good evidence of this is in the U.K. where we are seeing the benefits of cost savings and better management of promotional spending being vested [ph] in brand support and more effective advertising. This is translated into increased household penetration and solid growth.

Overall, while we are pleased with the progress we have made in fiscal year 2013, we are not yet satisfied with our performance. We recognize that to achieve sustained performance improvement, we must remain focused on the virtuous cycle of cost reduction and net price realization as fuel for critical investment in brand-building, innovation and organization capability. We are fully committed to the execution of this behind our multiyear turnaround strategy.

With respect to fiscal year '14, in Q1, we are anticipating sales and earnings to be lower than prior year, stemming from the continued top line cycling effects of the Emerald SKU rationalization, which should be fully lapped in November; the heavier Kettle promotional discounting in prior year; and as I mentioned earlier, lower walnut supply. On a full year fiscal '14 basis, however, we believe that our results will reflect good year-over-year earnings improvement.

While we are encouraged by our recent financial performance, we do not expect to see true top line growth momentum until later in fiscal '14 and accelerating in fiscal '15 and beyond, as our marketing campaign strategy unfolds, our new product pipeline manifests and we accelerate distribution expansion plans.

In conclusion and in addition, we are pleased to have preliminary court approval of the agreement on the securities class action suit. This marks an important milestone for us in our continuing efforts to move the company forward.

Before I turn the call over to Ray, I'd like to welcome him to the Diamond team. As many of you know, Ray joined us as CFO in June. He brings extensive food and beverage industry experience, as well as financial operations and capital structure experience. We have already started to leverage his expertise and look forward to his future contributions as we work to drive growth long term.

I will turn it over to Ray to discuss our financial results in more detail. Ray?

Raymond P. Silcock

Thank you, Brian, and good afternoon, everyone. It is a pleasure to be presenting on my first Diamond Foods earnings call, and I would like to start by briefly taking you through some of the key points in our financials for the fourth quarter and full year ended July 31, 2013.

In the fourth quarter, as we lapped higher promotional spending and other changes as compared to the same quarter last year, our net sales were down 10.8% to $199.8 million. Gross margin for the quarter was up 770 basis points to 26.6% versus 18.9% in the same quarter last year, an increase of $10.8 million in reported gross profits. Advertising expenses in the fourth quarter were also up sharply, almost doubling from $6.4 million in Q4 2012 to $12.2 million this past quarter.

Fourth quarter SG&A included a charge of $96.1 million to cover the cost of settling the securities class action litigation, which we first announced on August 21. Under the terms of the proposed settlement, we will give the plaintiffs 4.45 million Diamond Foods shares and $11 million in cash. Last Thursday, the settlement received preliminary approval from the court, and we expect a final approval hearing to take place in January 2014.

Our Q4 operating expenses included a $36 million noncash impairment charge to Kettle U.S. other intangible assets, reflecting the fact that sales growth and margin expansion expectations incorporated into the original projections made following the acquisition of Kettle in 2010 were higher than the company now expects is reasonable to achieve. We would note, however, that despite the impairment, Kettle remains a key jewel in our portfolio of brands, and we still expect substantial Kettle sales growth and margin expansion over the next few years.

Operating expense for the quarter also included a charge of $20.6 million, resulting from a change in the fair value of the Oaktree warrant, which came about as a consequence of the increase in our stock price in Q4 and other factors. Excluding these charges, non-GAAP net income for Q4 was $2.3 million, and non-GAAP fully diluted earnings were $0.09 per share as compared to $0.05 a share last year. Adjusted EBITDA for Q4 was $24.6 million, up 12.5% from the same quarter prior year.

Going onto the full year, in fiscal 2013, net sales were down 12% as we rationalized SKUs, lowered promotional spending and focused on improving the company's profitability. Our gross margin for the full year, however, increased to 23.8%, up from 18.3% in fiscal 2012, an improvement of 550 basis points and a $25.8 million increase in our gross profits.

As I've covered in more detail when discussing the fourth quarter, SG&A for the full year 2013 was adversely impacted by the $96.1 million securities class action litigation settlement. In operating expense during the year, the company incurred $35.4 million in charges arising from the Audit Committee investigation, the earnings restatement and related legal and other expenses; an $11 million charge resulting from the change in the fair value of the Oaktree warrant; and the total of $37.6 million in noncash impairment charges, which were partially offset by a $13.5 million tax benefit.

Excluding these charges, which amounted to $180.4 million, non-GAAP net income for fiscal 2012 was $9.7 million, and non-GAAP fully diluted earnings were $0.40 per share. Adjusted EBITDA for the year amounted to $101.7 million, an increase of 28.2% over last year's $79.4 million. Net interest expense for fiscal 2013 was $57.9 million, up by $23.9 million from the $34 million of interest that we incurred in the prior year, the increase principally resulting from the Oaktree debt. Capital expenditures for the year were $9.6 million.

Turning now to segment performance. Both our 2 segments, Nuts and Snacks, benefited from increased net price realization, as well as from significant cost savings improvements during the year. This combination of improvements resulted in the 550 basis point increase in our total gross margin as we already noted.

For the Nuts segment, despite improved price realization, our net sales were down 23.4% to $426.1 million as a consequence of lower volumes, the result of SKU rationalization, reduced promotional spending and a curtailed walnut supply. Nuts segment gross margin, however, was up from 9.3% last year to 12.5% in 2013, an increase of $1.8 million in reported gross profit for the segment.

In our Snacks segment, sales were up 3% to $438 million as we gained market share with our Pop Secret brand and despite sharply reduced promotional spending on Kettle potato chips, where we sought to return the brand to superior profitability and cash flow. Margins in the Snacks segment were up from 30.1% in 2012 to 34.7% in this fiscal year, an improvement of $24 million in our reported Snacks segment gross profit.

Turning now to the balance sheet. Net debt as of July 31, 2013, amounted to $585.1 million, including the Oaktree notes. Our total revolving credit line capacity as at July 31 was $230 million, with $74.5 million of cash and availability as at July 31, 2013. As of last Friday, we had $102.4 million of cash and availability.

As we've disclosed previously, our revolver capacity will drop to $180 million on January 31, 2014. But based on current cash flow expectations, we do not anticipate this will pose problems for the company. And as we have also previously disclosed, our negotiated bank covenant relief ends on October 31 of this year, so we will have to start complying with our financial covenants, a consolidated senior leverage ratio of less than 4.7x and a fixed charge ratio of greater than 2x.

As of July 31, our senior leverage ratio, which does not include Oaktree indebtedness, was 4x, and our fixed charge coverage ratio was 2.7x. We expect to be in compliance with all bank covenants as of the October deadline.

In closing, I'd like to briefly return to the proposed settlement of the securities class action litigation now preliminarily approved by the court. I would like to point out that while the 4.45 million shares we expect to give the plaintiffs will increase the total number of shares outstanding in future EPS calculations, the company does believe that this settlement is a first step to our being able to move toward a better capital structure and thus achieve 1 of our 5 key initiatives. While obstacles do remain, we're moving forward with our banks and with our financial advisers to evaluate all potential refinancing options.

I would now like to turn the call back to our CEO, Brian Driscoll. Brian?

Brian J. Driscoll

Thanks, Ray. Our path towards an operating model that will create sustainable growth long term must be built on a platform of innovation that delivers distinct value to our consumers and retail partners. We will remain sharply focused on this direction going forward. In turn, we believe our plan will enable us to maximize shareholder value long term.

That concludes our prepared remarks. Ray, Dave and I are now available for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And at this time, we will take the first question, which will be from Bill Chappell with SunTrust.

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

Can you maybe just give us a little more color on what's going on at walnuts, and I'm just trying to make sure I understand. When you say you're going to have a lower supply this year versus last year, so I think last year was less than 120 million pounds, it'll be even below that number. And then how does that kind of match up with, kind of, the comments we've had over the past couple of quarters of kind of optimistic and how maybe the final contracts came in?

Brian J. Driscoll

Yes, I think the comment we said was we were encouraged by what we were seeing. And frankly, we do remain encouraged by the momentum that was starting to build, especially during the last 2 contract renewal cycles. We will have somewhat less than that number, as I've discussed. We are not disclosing what the absolute number is, but we do have a more than ample supply to satisfy the demands of our retail branded business.

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

But I guess I'm just trying to understand, did things come in worse than expected towards the end? Or did -- I mean, did the market get more aggressive in terms of other buyers out there?

Brian J. Driscoll

I think we came in pretty much where we were expecting. And I think the way we feel right now, we feel like -- I think the important thing is that we've stabilized our grower base at this point, and we look forward to building off of that base as we go forward over the next couple of years.

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

And just to make sure I understand, the next building phase will kind of come next spring to summer?

Brian J. Driscoll

Yes, we hope that, foundationally, we've stabilized the grower base, I guess, that we want to continue to retain existing growers. But the real -- the bigger opportunity going forward for us -- or another opportunity for us going forward is to secure more new growers.

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

Okay. And then just one last one, I mean, what does the crop look like? And I mean, is it -- are prices spiking where it's going to change kind of the payable cycle for the next few quarters?

Brian J. Driscoll

So the crop is roughly similar to the size last year. I want to say it's 495,000 tons. We're in the midst of harvest now so it's hard to predict just yet what the yield is going to be and what the actual end result will be. So more or less along the same size as last year from crop size perspective. We are seeing and anticipating some headwinds in the cost of walnuts. We have announced pricing action in the marketplace accordingly, and I don't think it'll have -- shouldn't have any effect on our payable cycle.

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

Okay. And then last one for me, just understanding the first quarter comparison. Is that largely just higher A&P or higher SG&A for the Emerald launch? Or are there other major drivers of the year-over-year decline?

Brian J. Driscoll

It was the 3 things I articulated, but Emerald is a big piece of it. So what we're suffering from in Q1 is the pre-SKU rationalization volume that we had on Emerald. What we benefit from Q2 and beyond is that behind us, and then the relaunch volume and momentum going forward on that brand. So Emerald is a big piece of it. And then of course, as I mentioned, we're -- we'll be -- the promotional spending that we've been cycling on Kettle will be behind us as well.

Operator

At this time, we'll take another question. This will be from Brett Hundley with BB&T Capital Markets.

Brett M. Hundley - BB&T Capital Markets, Research Division

I had a question on gross margin performance. And I was wondering if you can speak to more detail as far as some of the initiatives you've been driving there and maybe parsing out some of -- that increasing gross margin, what is pricing versus SKU rationalization versus operating efficiency, et cetera? If you can just put more color to that, please.

David J. Colo

Yes, I think it's a combination of all. I think we've been focused on improving net price realization through more effective promotional spend. On the cost of goods sold area, we've been primarily focused in our procurement initiatives and taking costs out of our procurement area specific to packaging, raw materials, et cetera. And then we've been very focused on productivity improvements inside of our manufacturing base. And those are the key areas that we've primarily been focused on to improve gross margin.

Brett M. Hundley - BB&T Capital Markets, Research Division

Okay. And then back to walnuts just quickly. Have you -- do you have a comment on where international demand lies? Is it a situation where international demand remains robust and that's keeping pricing higher? Can you talk to that dynamic a little bit?

Brian J. Driscoll

Yes, we do believe that the lion's share of pressure on the commodity is international demand. That's what's driving the prices up, primarily China. But it's still very early in the cycle. Early indications are, however, that there is some headwinds here. But there's still a lot more data that come in as we get through the crop season. So more to come, but that's the driver primarily.

Brett M. Hundley - BB&T Capital Markets, Research Division

And Ray, I just had a quick question. Did currency help your top line on Snacks sales at all?

Raymond P. Silcock

No, no, no. It has no significant impact.

Brett M. Hundley - BB&T Capital Markets, Research Division

Okay. And then Brian, just for my last question, just kind of broader -- there's been some talk of inventory build at the customer level, and I was wondering if that has changed your outlook at all. If you have a comment on that, I appreciate it.

Brian J. Driscoll

I'm sorry, say it again, the comment on inventory build?

Brett M. Hundley - BB&T Capital Markets, Research Division

Yes, inventory build, the customer level. I was wondering maybe what you're seeing, if it's changed your outlook as far as growth trajectory, anything like that, I'd appreciate it.

Brian J. Driscoll

Yes, we like to have our shipments match demands. And I -- that -- what you've been reading, of course, I've been reading the same things, but we don't see it having any material impact on our top line for the quarter.

Operator

At this time, we'll move to Kenneth Zaslow with Bank of Montreal.

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

So just a couple of questions. One is, when I think about next year, do I think about the 1Q marks the low point of your earnings and then it builds throughout the year into 2015? Can you give us a little bit of the cadence?

Brian J. Driscoll

Yes, I think that's the right way to look at it. I think the trajectory for the year begins to change in Q2. And then I think the algorithm in terms of a top line-driven growth becomes much more of the case beginning in fiscal '15.

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

Okay. Then you mentioned on the call that the first step -- this is a first step in the capital structure -- or restructure in the capital structure. Can you talk about how you think of the next steps going forward and how we can kind of at least monitor that things are progressing the way you would think would they? And just if you have a plan in terms of what the timing and how we should look at it.

Raymond P. Silcock

Yes, we are -- it's early days. We are moving forward with developing our plans. We believe that right now, the market -- the debt markets are particularly accepting of higher leverage and that we would have an opportunity to refinance our debt on favorable terms. But we don't really have any specific plan to discuss with you at this point in time.

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

And then you would have -- to be fair, you would have to pay Oaktree the fees upfront, right? Is that so? Or is that not the debt you were talking about in terms of refinancing?

Raymond P. Silcock

We're looking at the whole thing, and I don't think we've reached any kind of conclusion as to what the right path would be. But yes, where we to repay the Oaktree debt, there is a may call [ph] payment that is associated with that.

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

Okay. And then my last thing is just more in the business, can you talk specifically about the relaunch of Emerald? Like, when you say it's going well, what does that mean? And is it more anecdotal? Is it -- how do you think about that?

Brian J. Driscoll

I think we passed anecdotal. I think some of the feedback I had given after our last call was more anecdotal. But now we know we've got 95% of our customer base with distribution on the new Emerald, if you will. And the early signs in terms of velocity for point of distribution are looking promising. So we're encouraged by it. We have some real market evidence of it, but it's still early. I mean, we just -- we literally just launched it in August. But I think there's some tangible evidence that it's for us to be encouraged by.

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

How many SKUs will you have now versus where you started?

David J. Colo

On the Emerald canister, we'll have 18.

Operator

At this time, we'll hear from Thilo Wrede with Jefferies.

Thilo Wrede - Jefferies LLC, Research Division

Can I just start off with some housekeeping questions? What's the tax rate that you're expecting for fiscal '14?

Raymond P. Silcock

We don't really talk about it in terms of tax rate very much. I think we're expecting that taxes in 2014 would be about the same as they are for 2013, except that we're not looking to -- or not expecting to have that $13.5 million tax benefits that's related to the asset impairment charge. So if you look at 2013 or in 2012, was about the same, too. We'd expect our tax situation to be about the same. But as I said, the one-time $13.5 million tax benefits that we just referred to, we wouldn't have that next year.

Thilo Wrede - Jefferies LLC, Research Division

Okay. And then of the total long-term debt that you have, the $585 million, how much of that is the Oaktree debt at this point? You're paying that in kind for a few quarters now, right?

Raymond P. Silcock

We have. I think the total amount of the Oaktree, I think, is $250 million -- I think about $260 million, I think, about $260 million. I can get you the exact number. I'll shoot you an email afterwards with the exact number on it. But I think $260 million will be a good working number.

Thilo Wrede - Jefferies LLC, Research Division

Okay. And then at what point should we expect the 4.45 million shares on the shareholder settlement to be dilutive?

Raymond P. Silcock

Q1.

Thilo Wrede - Jefferies LLC, Research Division

Q1, okay. And then maybe a slightly more substantial question, Brian, you called out that Kettle in the U.K. is doing well. Is there anything that you can learn from Kettle in the U.K. that you're bringing to the U.S.? And kind of what do you expect there?

Brian J. Driscoll

Yes, I would say that Kettle U.K. had a bit of a head start, if you will, in that they didn't have the same type of approach to expansion and discounting as was executed in the U.S. at that time. So they started off with a little bit of a head start, if you will. However, the same emphasis we place here in terms of cost reduction and net price realization we've done there to improve their margins. And then as I talk about the virtuous cycle, we're taking a good piece of that, reinvesting it back in equity inspired activity, new products, et cetera. And so we're seeing that cycle produce benefit there earlier than here, but it gives us good evidence that it can work here. Now we're also seeing that in the natural channels here where we also didn't have the same kind of approach as we did in mainstream channels. So we also have evidence here that the strategy resonates with consumers and affects the brand well.

Thilo Wrede - Jefferies LLC, Research Division

Okay. And maybe one last question on Kettle, if I may. I think at the beginning of the year, you talked about flavors like maple and bacon for Kettle, or sweet and salty. I don't think I've seen them launched yet. And I was over in the U.K. 2 weeks ago, and I saw Kettle flavors in mozzarella and pesto, which actually tasted really good. Why not bring more of the innovation from the U.K. over to the U.S., and why haven't these U.S. flavors launched yet?

Brian J. Driscoll

Well, first of all, on maple, bacon and sweet and salty, we've done somewhat of a soft launch. We're in about 25% of the ACV. Where we have it -- the sales at the point of distribution are pretty good. But we wanted to take a test-and-learn approach to it. We didn't want to get over our skis. We wanted to really make sure that the nature of the innovation we were investing in here would resonate with consumers. As far as your second point is, I think it's a great point, and I think you're going to be seeing us do a lot more of that.

Thilo Wrede - Jefferies LLC, Research Division

Is a soft -- sorry, I apologize. I actually have one more. Is a soft launch like that what you just talked about, is that a new approach for you?

Brian J. Driscoll

Is that a new approach for the company?

Thilo Wrede - Jefferies LLC, Research Division

Well, yes. So the soft launch on flavors where you're announcing new flavors, but then you don't just don't put them out in the market, but you test them in the market first. Is that a new approach how you launch innovation, or is it just a unique thing with these flavors? Or have you always done that like this?

Brian J. Driscoll

No, I think it depends. It depends on the nature of the innovation. It depends on what you're going to do. I think there's innovations that would respond better more surgically and prescriptively. You may want to do it in certain markets, not others; certain channels and not others. And then there's innovation that's truly breakthrough, that's truly insulating, that you'd want to go bigger, faster on. And so this type of innovation would be more of the more slower, surgical type. As I mentioned on the last call, I never viewed maple, bacon and sweet and salty as the kind of insulating breakthrough innovation that we hope to have. We view it as just the necessary investment in the brand to create to continue to inspire excitement around it and new news. But it's certainly not anything we have considered as a breakout innovation. So again, it really depends on the nature of it.

Operator

[Operator Instructions] Moving forward, we will hear from Akshay Jagdale with KeyBanc Capital Markets.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

My first one is for Ray. Just I know this is the first time you're talking to investors and analysts. Can you just talk about what brought you to Diamond, and maybe if you can just give us some insights into your compensation plan and what it's tied to, so that we get an idea of what is there in it for you in terms of the growth algorithm. Because I know you're not giving a lot right now in terms of what this company could look like 3 years from now but perhaps we could get some insights into why you came here and what the opportunity in your mind is for shareholder value creation.

Raymond P. Silcock

Well, a very comprehensive question, but I think that with respect to what I -- the reasons why I came to Kettle had to do with what I see as being the opportunity for the company. Great brands like Kettle and Pop Secret, I think, are always -- represents opportunity for the future. And I think that the growth and margin expansion opportunities we've talked about on the call reflect the fact that we see a bright future for the company, and I would like to help drive that and be a part of it. With respect to compensation, I'm not sure if you're talking about my compensation or how the company compensates its people generally. And we use a mixture of options and shares in terms of longer-term contribution and contribution tied to the value of the company as a whole. And with respect to bonus, which is a significant part of my compensation, my cash compensation, and a significant part of several of the other senior executives' cash compensation, that's tied to financial performance in the short term over the course of the year, generally speaking. So I don't -- but then that's -- that bonus goes down into the managerial ranks of the company.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

That's helpful. Can you just -- maybe this one is for Brian, but can you talk a little bit about growth for next year? I know you're being pretty vague on what type of growth. I think you implied that you will see -- we will see improvement in earnings. But can you just help us out a little bit on the top line, what type of growth, if any, we should see? And then maybe talk a little bit about profitability and perhaps what are the drivers of earnings growth.

Brian J. Driscoll

So you're talking about for fiscal '15, Akshay?

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Well, first for '14, and then if you want to comment on '15, too.

Brian J. Driscoll

Sure. I think it's -- we're pretty balanced for the year in terms of once we get the Q1 behind us. We see Snacks improving as we continue to cycle some of the effects of the discounting on -- with that behind us on Kettle. We'll begin to launch some of our innovation in the back half. So we start to see improvement towards the back half on the top line on Kettle. We see the Pop Secret top line momentum continuing. And we see the Nuts' overall top line experiencing some pressure for the year. As we morph into '15, the pipeline should be far more developed, far more fully developed, our campaign strategy far more fully developed. And we really believe that that's when we're going to begin to see the trajectory shift to more of a top line-driven model and again, supported by the work we've been doing on cost reduction and net price realization. By the way, we don't anticipate that our focus on productivity improvement, cost reduction, net price realization to end. We view that as an ongoing area to fuel investment in the brands. But that's kind of how we see it. I know you're looking for more there, but we're not giving guidance. That's [indiscernible] .

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Yes, no, I appreciate it. It's just that you're talking in terms of the individual brands, but you don't report individual brands. So can you just -- I mean, Snacks was up 3% in sales this year. Relative to that, are we going to see a similar year in '14? I'm just trying to help -- get some help on modeling. I'm not trying to get any guidance.

Brian J. Driscoll

I think that's a fair assumption.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

And Nuts order of magnitude? I mean, we're not going to see another 25% decline, right? It's going to be more muted than that.

Brian J. Driscoll

It will be more muted than that.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

Okay. And then just longer term, I mean, the way I view the issue, if I may, with the walnut business is you've seen tremendous growth in demand internationally. Your model -- sales model is driven retail U.S. And of course, you had some management issues in terms of how you're paying the growers, but I think you're taking care of that. But going forward, I mean, is -- for margins to normalize in your walnut business, does it simply need to be such that the supply continues to grow because obviously, number of acres, number of trees, is growing. And I think the future, like 5 years out, we're going to see a lot more supply than we see today based on just how many seeds are being bought, et cetera. So is it just a matter of at some point the demand is going to stabilize to come down internationally, and that's going to get a bunch of the growers to come back to who they were getting their supply from or who they were providing the supply to before? Or do you still just expect demand to continue to grow like it has and for the business to be successful in that environment?

Brian J. Driscoll

I guess to start, nothing's forever, but it's hard to see a slowdown in the momentum that we've been seeing internationally. However, no matter how fast it grows, we're not participating at the level that we could be if we had more supply. So even if it did become more muted going forward, there'll still be substantial opportunity for us because we're presently not participating in the way we can. So that'd be the first thing. The second thing is that there are expectations for a substantial increase in varying acres on walnuts in the coming next 3 years or so. And we think the credibility that we're establishing in terms of our overall performance is resonating with our growers. And as that supply base continues to improve, we continue to do what we've been doing in terms of our relationships and our performance, I do think we'll be -- we'll reap the benefits of that. I think this business could serve as a strong cash contribution benefit for the company, and that cash contribution could be used as fuel to grow in higher-margin businesses. So I think that this has legs.

Akshay S. Jagdale - KeyBanc Capital Markets Inc., Research Division

And just one last one. You said 1Q profitability will be down year-over-year. Did you mean adjusted EBITDA or adjusted EPS or both?

Brian J. Driscoll

We were referring to adjusted EBITDA, top line adjusted EBITDA.

Operator

At this time, we'll take a question from Tim Ramey with Davidson.

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

Just relative to the impairment charge at Kettle. Obviously, different set of folks made the original projections. Does it make any sense to kind of discuss what the -- what created the impairment in terms of the difference in trajectory for the business versus original expectations?

Raymond P. Silcock

It's an interesting question, but I don't think that we disclose at that level of detail by brand. So I think what we've said about the fact that the original expectations being just a little too aggressive, although we still have strong expectations for Kettle, it's still, as I had mentioned in my prepared remarks, a jewel in our brand portfolio. It's just -- we're just being a little less aggressive in our -- in those expectations that the people who were responsible for the original purchase equation were.

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

Is it fair to say that it would relate to the kind of the development of the distribution through snack aisle rather than specialty or the sort of the reversal that you've had relative to that, I assume, has a significant part of that.

Brian J. Driscoll

I think that the growth algorithm used at the time was distribution expansion and heavy promotion. And so as you know, that's one of the things we identified early as a growth model that we didn't believe was sustainable for the brand and was dilutive to margins. So I think that has something to do with it, certainly.

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

Great. And then just to reask the tax rate question. So obviously, the tax rate has been completely unforecastable from an outside perspective, and it's had an outside impact on the results. What are the things in fiscal '14 that would cause the tax rate to vary from a normal tax rate? Or do you still foresee meaningful one-time kind of issues that would impact the tax rate?

Raymond P. Silcock

I mean, the tax rate's impacted principally by the fact that we have $185 million of NOLs sitting on our balance sheet. So we don't expect to pay all that much in taxes. We didn't pay very much in 2012 or in 2013. And as I answered in a prior question, we expect that 2014 would look pretty much the same and the only sort of outlier for 2013, the year that just finished, was that $9 million -- was that one-time $9.5 million charge that related to the -- I'm sorry, it's $13 million -- $13.5 million, I beg your pardon, I misremembering, the $13.5 million one-time credit that was related to the asset impairment charge. So apart from that, we have had fairly stable taxes, albeit that the rate was bounced up and down. The amount of tax we've paid has been in that $1 million or $2 million range per year for the last 2 years, and we expect that to continue in the coming year.

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

Great. That's helpful. And then just to maybe ask a question that's been asked before a different way, but it sounds like you're looking for sales growth in the third quarter and fourth quarter but overall, sales should be down for the year. Is that a fair interpretation of your comment?

Brian J. Driscoll

Yes, I think we may start to see the growth trajectory turn sooner than that. But yes, Q2.

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

Q2, okay. So the only down quarter in sales would be Q1, but it's enough to make the sales down for the full year?

Brian J. Driscoll

On the Nuts segment, yes.

Operator

And this will conclude the question-and-answer session. At this time, I'd like to turn the call back over to management for any additional or closing remarks.

Brian J. Driscoll

Thank you for your participation today. We appreciate the support of our growers, strategic partners, customers and shareholders. We look forward to speaking with you again when we report our first fiscal quarter -- fiscal 2014 financial results. Thank you.

Operator

And again, ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.

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