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

Diamond Foods (NASDAQ:DMND)

Q1 2014 Earnings Call

December 05, 2013 4:30 pm ET

Executives

Katie M. Turner - Managing Director

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

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

Analysts

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

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

Thilo Wrede - Jefferies LLC, Research Division

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

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

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

Operator

Good day, ladies and gentlemen, and welcome to the Diamond Foods First Quarter Fiscal 2014 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Katie Turner. Please go ahead, ma'am.

Katie M. Turner

Thank you. Good afternoon, and welcome to Diamond Food's first quarter fiscal 2014 earnings 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, please remember 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 statement.

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 certain litigation-related amount, proposed settlement of the securities class action lawsuits and Oaktree warrant liability 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 the 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. I'll begin with a review of our overall first quarter performance. I'll be followed by Ray Silcock, our CFO, who'll provide a review of our financial performance in more detail.

Our Q1 results illustrate the continued progress of our multi-year turnaround plan. We're pleased with our ability to once again improve gross margin, while strategically investing in innovation and brand equity building to support long-term, sustainable growth.

We believe that our progress has been and will continue to be dependent on a disciplined and intense focus on gross margin expansion, which fuels investment in brand building, innovation and organizational capability, driving momentum in our snacks portfolio with a premium emphasis, substantially improving the Emerald brand financial contribution and restoring it as a growth driver within our portfolio, stabilizing and growing walnut supply, while enlarging Diamond of California's existing brand credentials across other nut types and addressing our highly-levered capital structure. These 5 imperatives frame our approach to stabilize, position and grow the business over time.

Focusing in on Q1 more specifically. Gross margin improved 200 basis points to 24.7%, driven by a combination of net price realization, cost reductions and productivity improvements. We delivered this gross margin improvement despite approximately $2.1 million of transition costs associated with the Emerald brand relaunch and other non-recurring events. We also generated a 40 basis point improvement in EBITDA margin, while increasing our investment in innovation and brand equity building. Advertising spend was up approximately $1.6 million versus the first quarter of last year.

Let me now give you some color on our segment performance for the quarter. First, our Snack revenue increased a little over 1%. This result was principally driven by top line softness on Kettle U.S., which we do believe will reverse, pick up momentum in Q2 and beyond. Importantly, and by contrast, both Pop Secret and Kettle U.K. achieved solid revenue growth for the quarter.

Regarding Kettle U.S., we have begun to see our Nielsen consumption pattern improve. In the most recent 12-week period ended November 23, Kettle grew 9.1% in the food channel and 1.4% in xAOC channels. More importantly, our core flagship line was up 12.6% in food and 4.4% in xAOC.

Encouragingly, Kettle continued to grow at a strong cliff and gained share in the natural channel. In the most recent 12-week spin-scanning period ended October 26, Kettle grew 24%, gaining 410 basis points of market share to 62.4%.

When you consider the growth of the potato chip category in the natural channel, compared to mainstream channels, it appears that the trend is in our favor. Interestingly, although Kettle's market share in mainstream channels is substantially stronger in the Western U.S., its market share is much more evenly distributed across the country in the natural channel, which suggests that the brand's appeal stretches across the country.

While the recent Nielsen retail sales growth in mainstream channels is improving, we're still developing our strategy to accelerate Kettle's growth outside of the West. We do believe that our relative performance in the natural channel is evidenced of the opportunity we have to bridge this mainstream channel gap over time.

With regard to Kettle in the U.K., we are encouraged by the steady progress we're making. We continue to see the benefits of cost savings being invested in brand support and more effective advertising. In fact, household penetration and market share in the U.K. hit an all-time high in mid-November.

In addition, this month, we have just launched a new national ad campaign centered on the craftmanship of Kettle chips and reinforcing Kettle's authentic real food credentials.

Moving onto popcorn. Pop Secret also performed well in the first quarter. Additionally, in the most recent 12-week period ending November 23, the brand gained 320 basis points of market share across all outlets despite aggressive competitive activity.

We believe this speaks to the strength of the Pop Secret brand and the loyalty we're building with consumers.

Our consistent progress illustrates, again, the early benefits of investments in marketing, distribution gains and improved net price realization. A critical step for us and the principal stimulus for growth in our Snacks segment in fiscal year '15 and beyond is the continued development of our innovation pipeline and the gradual expansion of our distribution base.

Closer in, we plan to introduce 2 new Kettle varieties, sweet chili garlic and Sriracha, our formulated and repositioned tortilla chip line; and 2 new Pop Secret products we're expanding from TIAS! [ph] . We've also launched the Kettle single-serve initiative that, while early and on a small base, is demonstrating potential.

Turning to the Nuts segment. We're pleased with the continued expansion of gross margin, which grew 140 basis points versus Q1 of last year, despite lower volume through our Stockton plant and the transitional Emerald costs I referred to earlier. Q1 top line in the Nuts segment was slightly better than we expected behind early seasonal demand on Diamond of California varieties and the impact of the Emerald relaunch.

As we previously reported, our overall top line in this segment will be somewhat muted on a full year basis as a result of fewer walnut pound receipts. That said, we are taking steps designed to enlarge Diamond of California's role across other high-volume nut varieties, while continuing our efforts to stabilize and grow our walnut supply base.

Turning to Emerald. We are encouraged by our progress with the brand repositioning. The new canister line that we launched in Q1 has achieved broad distribution at retail, and our 100-calorie product line is growing at a solid pace. Importantly, we are seeing improvements in Emerald's overall financial contribution to the company.

Moving to walnuts. While we will have less supply to sell than last year, we believe that we've stabilized our supply base. In this context, as I've said before, we continue to take the long view on this business and remain confident that we have the right strategy in place.

Overall, we are encouraged with the progress we're making across our strategic initiatives to achieve long-term sustainable growth. We remain focused on gross margin expansion as fuel for critical investment and brand-building innovation and organization capability. We're on track with our plan to deliver cost savings of $35 million to $40 million across fiscal 2013 and 2014, primarily from procurement and manufacturing productivity, and we'll continue to look for other cost reduction opportunities.

We remain fully committed to the execution of this behind our multi-year turnaround strategy. Looking ahead to the balance of fiscal 2014, consistent with what we said before, we continue to believe that we will generate year-over-year earnings improvement. I want to reinforce, however, that we do not expect to see top line growth momentum until later in fiscal '14 on our Snacks portfolio and then accelerating in fiscal '15 on a consolidated basis as our marketing campaign strategy unfolds, our new product pipeline manifests and we accelerate distribution expansion plans.

With that overview, I will turn it over to Ray to discuss our financial results in more detail and our effort toward addressing our capital structure. Ray?

Raymond P. Silcock

Thank you, Brian, and good afternoon, everyone. I will now take you through the key points in our Q1 financials. First quarter net sales were down 9.2% to $234.7 million, despite improved Snacks segment sales. Lower walnut sales impacted by lower supply and prior-year SKU reductions on the Emerald business both contributed to this decline. As a result, our reported gross profit was down $600,000 for the quarter, although our reported gross margin was up 200 basis points to 24.7% versus 22.7% in Q1 last year. The gross margin improvement was due to improved net price realization and ongoing cost improvements.

Moving onto operating expenses. In our first quarter reported SG&A of $56.6 million, there were several adjustments that were highlighted in the Q1 earnings press release. These included a charge of $23.5 million that resulted from our marking to market the value of the 4.45 million shares issuable to the plaintiffs as part of the cost of settling the securities class action litigation. We announced that preliminary settlement on August 21 of this year. Reported SG&A also included a $5 million charge to reflect our estimate of the potential cost to resolve the ongoing SEC investigation of the company.

Excluding both these charges, our adjusted SG&A for the first quarter was $28 million, an increase of $600,000 from our adjusted SG&A in Q1 last year.

Advertising expenses in the first quarter were up by $1.6 million to $10.7 million, primarily due to higher spending in the Nuts segment, increased support against the Diamond of California brand as we head into the holiday season and spend against our Emerald brand relaunch we started in August were the major elements of the increase.

Our operating expenses in the first quarter also included a charge of $17 million related to the Oaktree warrant liability. This charge, which resulted from a change in the fair value of the warrant principally due to the increase of our stock price in the quarter, is excluded from our non-GAAP financial measures.

In summary, reported operating expenses in the first quarter, $84.2 million. When adjusted for the items I just went through, there was a non-GAAP operating expense in Q1 of $38.6 million, an increase of $2.2 million as compared to Q1 last year. The principal variances from prior year being $600,000 in SG&A and $1.6 million in additional advertising.

Non-GAAP net income for the quarter was $5 million, down $200,000 from the same period last year; and non-GAAP fully diluted earnings per share were $0.18 as compared to $0.24 a share last year.

Adjusted EBITDA for Q1 was down $1.9 million to $29.1 million as compared to $31 million in the same quarter prior year, a reduction we had anticipated on our Q4 and full year 2013 earnings call in September.

I'd like to turn now to our business segments. In the Snacks segment, sales were up 1.2% to $112.6 million, with particular strength in our Pop Secret brand and in the Kettle U.K. business. Gross margins in Snack improved from 34.4% in Q1 last year to 35% in this year's first quarter, an improvement in gross profit of $1.1 million.

Nuts segment net sales were down 17.1% as compared to last year to $122.1 million. This was primarily due to a 20.3% decrease in volume, the consequence of last year's SKU rationalization of items in the Emerald line and of lower walnut supply and resulted in a decrease of $1.8 million in reported gross profits. Nuts segment gross margin, however, was up from 13.8% last year to 15.2% in Q1, driven by net price realization.

During the first quarter, we determined that the statutory tax rate we had used to value our U.K. subsidiaries' deferred taxes as of July 31, 2013, the end of our last fiscal year, was incorrect. This resulted in us overstating the net deferred tax balance on our fiscal year '13 balance sheet by $3.2 million. Using the correct tax rate would have reduced deferred taxes by $3.2 million and led us to a corresponding -- excuse me, and led to a corresponding increase in the reported tax benefit for the fourth quarter of last year. This item was not considered material and will be disclosed in the 10-Q for Q1 as a revision to our Q4 and full year 2013 results.

Turning now to the balance sheet. Our net debt as of October 31, 2013 amounted to $583 million, including the Oaktree notes outstanding. Our total revolving credit line capacity as of October 31 was $230 million, and we had $85.3 million in cash and availability. As of today, we have cash and availability amounting to $104.9 million.

As previously disclosed, our revolver capacity will drop by $50 million to $180 million on January 31, 2014. Based on current cash flow expectations, we do not anticipate that this will pose any problem for the company. We have also previously disclosed that our bank covenant relief ended in October 31, and that we now have to comply with all of our financial covenants.

Principle covenants include a consolidated senior leverage ratio of less than 4.7x and a fixed charge ratio of greater than 2x. As of the 31st of October, our senior leverage ratio, which does not include Oaktree indebtedness, was 3.8x and our fixed charge coverage ratio was 2.9x.

In closing, I'd like to briefly recap where we are with respect to achieving one of our key objectives for this year, addressing our highly levered capital structure.

We have already started down the refinancing road, including having discussions with banks and with our financial advisors. Currently, we anticipate moving forward with our refinancing to take out all or most of our current debt structure.

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

Brian J. Driscoll

Thanks, Ray. While we recognize we have much more work to do, we are encouraged about our progress and outlook for sustainable growth long term. Our team will further execute on our initiatives as we develop a platform of innovation that delivers distinct value to our consumers and retail partners, which we believe 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 our first question comes from Brett Hundley with BB&T Capital Markets.

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

My first question pertains back to Walnuts. And certainly, you guys mentioned in your prepared remarks that the margin improvement in Nuts is somewhat due to price realization. And recently, we've seen commentary that this year's walnut crop may come in smaller than expected. Prices have certainly remained high or moved higher. And I'm curious of your opinions on the ability of the industry to hold and/or add to pricing.

Brian J. Driscoll

Yes, let me take a shot at that. First of all, it's hard to say where the pricing will go, going forward. I will tell you that we have experienced some pressure, and we've already priced for the pressure that we've experienced. We do have some evidence that the crop will be lower this year versus last. As you know, the crop size was down. The weather was not good, although the yields were pretty favorable. The quality was very favorable. That said, we do see some pressure on the absolute crop size, but it's very difficult to say where that's going to land. Like I said, that has been a factor as well as international demand in some of the pricing pressure I referred to. We did price accordingly. But it's uncertain -- we're uncertain as to where it's going to go from here. A lot will depend on how international demand unfolds in the coming months. And to the extent that there is further pressure, then we will price accordingly going forward.

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

And you have confidence that you'll be able to do that?

Brian J. Driscoll

We believe that we'll be able to pass through whatever commodity pressure we experience. Of course, if we -- if the crop -- if the cost of the commodity goes up following the season, of course, we can't price what's already been sold. We'll have to price on a go-forward basis, but we have priced up till now where we believe the crop price will land at the end of the season.

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

Okay. That's helpful. I appreciate that. Brian, do you have any estimates, or how can you frame it for us? I guess, this is a 2-part question, and I have 1 other. But what is the feedback that you're hearing from growers as you've implemented new payment structures, et cetera? What is your feeling on summer 2014 bringing back a material base for you guys? But I guess, related to that, can you give us any sense of how your culinary segment can grow under current grower constraints?

Brian J. Driscoll

If I understand your question correctly, first of all, I think the reaction from our growers to the steps we've taken to address the concerns they've had has been quite good. That has not necessarily manifested into substantially more pounds, but understand that growers may be under contract with other handlers and/or are taking a wait-and-see attitude in terms of how -- whether or not Diamond will be consistent in terms of our approach towards the grower community. I do believe we've demonstrated a consistency for a period of time now. I do believe that our relationships have improved. I do believe that the quality of our progress as a company as compared to what we told them we'd do has been consistent. So we're doing what we said we'd do. And I think that's -- those things will build on themselves over time and ultimately produce a positive outcome for us. It's very difficult, though, for me to predict, considering the nature of relationships with growers, whether or not they're actually going to shift and come towards us. But I certainly believe we're taking all of the appropriate steps to do that. With respect to branded, I do believe that there's ample supply for our branded business. As I've mentioned before, I think the Diamond brand name has more range outside of walnuts. We have a nice business in almonds, a nice business in pecans, and I think there's other nut types we can and should be participating in both in the U.S. and around the world. That said, on walnut and culinary in particular, I do believe that we'll be able to continue getting ample supply to grow that business.

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

And lastly, Ray, any commentary you can offer -- I appreciate your comment on the outlook for refinancing. Has the market become any more conducive to you're being able to take out the Oaktree debt, or has it been, kind of, a stable view from your standpoint in recent months?

Raymond P. Silcock

No, I think it's been a pretty stable view. I don't think we've seen any changes,, and I think that it is -- we believe that the current market would permit us to take out pretty much all of the Oaktree debt, as well as refinance our existing bank debt.

Operator

And our next question comes from Bill Chappell with SunTrust.

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

First, going back to the Nuts segment. I know you're not giving...

[Technical Difficulty]

Brian J. Driscoll

We can't hear Bill. I don't know if it's us or Bill.

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

I was just -- on looking at the Nuts segment, trying to understand, now that we've lapped the, kind of, the Emerald restage, do you think that business can actually grow or be flat to having some growth for the remainder of the year?

Brian J. Driscoll

The Emerald business?

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

The Nuts segment in general. So I'm just trying to understand how much of it was...

Brian J. Driscoll

Well, I think we can see growth on Emerald, but not on the Diamond of California business because of the pressures on crop receipts. So that will have a full year effect. But we do believe, for the balance of the fiscal year, we will see growth on Emerald.

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

But the combined Nuts segment will still be down for the remainder...

Brian J. Driscoll

Yes, not inconsistent with I said in the last call, I think we're going to be slightly down year-over-year.

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

Slightly down? Okay, perfect.

Brian J. Driscoll

Yes.

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

And then, just trying to understand what's driving the recent, kind of, resurgence in Kettle because I think you had talked to more new products early next year, and it does seem to have kind of turned inter-quarter. So what's driving that?

Brian J. Driscoll

Well, the -- as I mentioned in my comments, the Kettle U.S. business was down year-over-year in the quarter. Kettle U.K. and Pop Secret were much stronger. However -- and again, there's timing factors here, et cetera, that will always make these dialogues complex. But we are beginning to see signs, as evidenced in Nielsen data and clearly in SPINS data, that the brand is starting to gain and pick up some momentum. So we feel good about that. In terms of the shipments on Kettle for the quarter, we participated in some events that didn't produce the return we'd hoped for. We learn from it. We made adjustments. We're moving on. Our Snacks margins continued to improve. We anticipate they will continue to from here. Our focus on net price realization and cost reduction will continue. And we think, going forward, the effects of distribution expansion, as well as innovation, will have much more of an impact than they've had up till now. We really have had little to no impact from innovation or marketing campaign efforts on the Kettle business up till now and through now.

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

Okay. And then, just last one for me. Just -- as I'm looking at the advertising budget for this year, I mean, I can't remember if you said overall it should be up or to what extent or if there's a timing or it should be maybe more around the back half when you have more new products launched. Any color you can give will be great.

Brian J. Driscoll

Yes. Right now -- and again, I -- as I've said before, in a turnaround, and as we're assessing the efficacy of some of our campaign efforts and so on, we're keeping an open mind in terms of what levels we're going to invest. Right now, I would say, year-over-year, advertising is going to be flattish. But to the extent that we have a tiger by the tail, we've got a new item that we believe is showing real promise that we want to accelerate, then I reserve the right to invest more heavily. So right now, it's flattish. But depending on the momentum amount around some of the innovation going forward, it could increase.

Operator

And our next question comes from Thilo Wrede.

Thilo Wrede - Jefferies LLC, Research Division

Brian, when I look at Nielsen data, it looks like, in the last 3 months, you've really stepped up the promotional supports on shelf for Kettle. Do I read that data right? And if so, how does that go together with your desire to position Kettle more clearly as a premium brand? And obviously, in the past, you have cut the promotions to get that positioning.

Brian J. Driscoll

Yes. Well, clearly, our positioning on Kettle is premium. And that premium remains despite that discounting you're referring to. But as I've said from before, we're in a turnaround. We're going to hit some speed bumps along the way. It's fairly common in a situation like this. We participated in some events on the brand that didn't produce the return we hope for. We learned from it. We made adjustments. We're moving on. I don't think that condition is going to exist going forward to that extent. The important thing, that said, to consider is that our Snack margins do continue to improve, and we anticipate that they will continue to. And our focus on net price realization has been effective across the entirety of the portfolio, and we continue to be dedicated to maintaining that focus. And then, going forward, the real benefit, especially from a margin perspective, comes from successful innovation and distribution gains, especially from a mix perspective. So we understand and we recognize that, in the quarter, we participated in some activity that didn't produce the returns we had hoped for. But as I said, we learn from it. We made adjustments. We moved on and we feel confident that the way we've described the positioning of this brand going forward will -- is our commitment.

Thilo Wrede - Jefferies LLC, Research Division

So that's really a one-time step up in promotions that you'll dive [ph] back? It's not a correction to overly aggressive cutting a year ago, if I understand you right?

Brian J. Driscoll

No. I think there's -- that could be part of it. I mean -- so in fiscal '13, we were cycling very high levels. We've course-corrected. And we -- in that process, you learn to what extent that you may have pulled back too far. So I think, on balance, I don't anticipate that we'll see the degree to which you observe the discounting in this quarter. But that's not to suggest that we'll not -- we may not be surgical and very prescriptive about spending depending on the opportunity. But all of that said, all of that said, our goal is to continue to grow margins. That's what we believe is going to happen. And our focus will continue to be on net price realization, and we believe that the mix effect of the innovation going forward will be positive and the distribution gains and the nature of that distribution gains we're going after will also have a positive mix effect.

Thilo Wrede - Jefferies LLC, Research Division

Brian, you just mentioned the positive price realization. You used to break out volume and price both for Snacks and for Nuts. In the last 2 quarters, you haven't done that. Why not provide us with that kind of detail?

Brian J. Driscoll

I think you raised a good point, and let us take a look at that. I don't know why we didn't provide it.

Thilo Wrede - Jefferies LLC, Research Division

Okay. And then, the last question I have for you. On the Emerald relaunch, I was in some stores in the Midwest recently, and I couldn't see any Emerald on shelves there. Has the SKU rationalization of Emerald led to you losing shelf space entirely? So not just that they cut SKUs, but the stores take you off the shelf entirely? And if that's the case, does that just create a big obstacle for a successful relaunch?

Brian J. Driscoll

Actually, we've been quite pleased with our distribution results and the signs we're seeing on velocity levels. We think the brand and the relaunch are beginning to gain traction. I can't speak to the particular stores where you are in, and I'm sure you don't want to mention the retailer. But we do have a roughly 97% acceptance level. Perhaps it was selling so well that it was out of stock. I don't know if -- I don't know.

Thilo Wrede - Jefferies LLC, Research Division

There were wide gaps on the nut shelf, exactly.

Brian J. Driscoll

Okay. So if you didn't check the stickers, then I -- it's hard to say. But disappointing that you saw what you saw, clearly. We don't want to be out of stock, that's for sure. But the acceptance levels have been 97%. And like I said, I think we're gaining some good traction on it, and the financial contribution has improved quite a bit.

Operator

And our next question comes from Tim Ramey with Davidson.

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

The $5 million estimate on the SEC settlement, how was that derived? And is that in consultation with the other side of the equation, or is that enlightened by any discussion, or is it just an estimate?

Raymond P. Silcock

The fact of the matter is that we are -- at this point, we're really not going to discuss this beyond what we've disclosed in the press release and what I've talked about in my prepared remarks. We're really just not in a position to be able to discuss it further, so I'm very sorry.

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

Okay. And then, just thinking about the overall picture in Snacks, is the momentum improvement that you're talking about driven by the steps of the last few quarters, i.e. rationalization to more core SKUs, or is it driven by steps that you expect to take in the next few quarters? Do you understand what I'm saying? Was the -- okay.

Brian J. Driscoll

I do. I think it's a little bit of both. I think Pop Secret's -- Pop Secret's case, we felt early that the brand had more pricing power, so we took steps to price-realize there, and the brand responded well. We benefited from real gains in distribution, which helped provide fuel to invest back in the combination of those 2 things. And we think that the campaign efforts, the new distribution and the pricing has really given this brand a nice, sustained pattern of growth, and we think there's more upside ahead. I think -- so I think it's kind of steady as she goes there. I think we'll continue to see benefits. And then, in that case, it will be building -- it will be innovation beyond that, that takes us to the next level. I would say, on Kettle U.K., it's been -- certainly, it's been price realization and better marketing campaign efforts. And I think same kind of outlook there in terms of innovation being the key driver. With Kettle U.S., we believe that we've got significant opportunity on the distribution side in single-serve and, of course, development in the East. And as I've mentioned before, the fact that our market share in natural channels is so evenly distributed across the country, it does suggest that the brand's credentials and efficacies in markets where we're not well developed otherwise can be better developed. And so, we're working through strategies there that we think could capitalize on that. We have not yet finalized our marketing campaign efforts there, so opportunity to make progress there. And innovation pipeline that's starting to shape up nicely there, I think, is going to be a real catalyst going forward.

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

Okay. That's helpful. And just 1 or 2 others, if I could. On the balance sheet, you made similar constructive comments after the fourth quarter on the fourth quarter call, and I would have guessed that we would have been closer to it based on your commentary there. You made constructive comments about the acceptance of a refinance today. Should we assume that this is relatively closed-end business, or you're just still waiting on other events that need to occur?

Raymond P. Silcock

No, I think you can definitely assume it's relatively closed-end. We, as I have said on the -- in my prepared remarks, we've had discussions with multiple banks, as well as with our financial advisors. And we anticipate that we would be able to secure financing to cover, as I've said, the Oaktree notes, as well as our existing bank indebtedness.

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

Okay. And then, just one more on -- remind me, it's been a long time since I've asked this question, but trans fats in Pop Secret seems to be you have a solution there, or maybe you already do. Can you update us on that?

Brian J. Driscoll

Yes, I think we have 15 of our 37 Pop Secret SKUs already have 0 grams of trans fat per serving. So it's something we've been working for quite a while. And we're aware of the current FDA situation, and we'll work in compliance with that. And our plans are to try to reformulate the product and work in conjunction with the FDA ruling, whatever it ends up being, and we think that we'll be able to do that in a very economical manner for the brand.

Operator

And our next question comes from Ken Zaslow with Bank of Montreal.

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

Just talk a little bit about the outlook. You put a very succinct statement in the outlook section that you expect year-over-year improvement in fiscal 2014 adjusted EBITDA. What exactly does that mean? Can you give us a little bit more color on that? Is it -- just kind of giving us some framework to work with? It's a pretty broad statement.

Raymond P. Silcock

We really don't give guidance. I think that, in the last quarter, we did talk fairly directly about the impacts on reduced sales and earnings that we were anticipating for the first quarter. And some of those came to pass, as you saw from the results today, which were broadly as we had anticipated at the time. With respect to the year, I think we have been clear that we see the potential for earnings, EBITDA, adjusted EBITDA according to the normal conventions to improve for fiscal year '14 over fiscal year '13. And I don't think that -- and in terms of the fact that we don't provide guidance, per se, that we will be willing to go further than to say we expect to see a substantial improvement.

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

Okay. I guess, well, just following on this, when I think about 2015 and beyond, I'm assuming there's a point in time that you expect to be a relatively large inflection point or a step-up in profitability. Like, as you get the Kettle utilization higher, I'm assuming you're not looking for 5%, 10% growth. There has to be material step-up in your EBITDA, right, at this point in time that you have to get a certain level of EBITDA year-over-year change? How do you see that? And is that something that we would see in fiscal '15? Will we see the progression in 2014? Can you help us out with that because it seems like that's really the case to be thinking about Diamond Foods?

Brian J. Driscoll

Yes, I think you'll see steady progress. We believe you'll see steady progress in adjusted EBITDA performance over time. In terms of a step-up or an order of magnitude step-up, I would view this more as steady. And I think the reason for that is because a lot of what we're doing to assure that we have a sustainable pattern of growth and create momentum that's enduring is investing in brands. And so, by definition, if we're going to be reliant on innovation as a core and principal stimulus to our growth, it's going to require investment spending. And so, again, that's part and parcel as to why we're working so hard to assure that we continue to grow our margins. So I think I would -- the best I can do, again, without giving guidance, is to say that we anticipate steady improvement over the course of '14, accelerating in '15, which is benefiting from getting help from under all the overlaps and the benefit of some of the innovation and activities I talked about. And then, I think that builds on itself over time. I don't think, though, I'd want to characterize our outlook as demonstrating step-function improvements, as I define it, but steady, steady improvement over time.

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

Great. And my last question is can you talk about your product pipeline? You alluded throughout the call that you believe that certain brands should go beyond the core brand. And I'm trying to figure out, can you talk about the pipeline of new products, say, in the next 6 months, as well as in the next 18 months? And how much will be more disruptive type of innovation versus just simply line extensions?

Brian J. Driscoll

Well, first of all, I'm not -- I don't think it would be advisable for me to give you what our pipeline is. I don't want to give my competition keys to the kingdom. But I will tell you that we believe that the company can benefit from just good, straightforward, pragmatic innovation in growing categories. We do believe that the brands have range to extend outside of the categories they're in, but closely outside, if you will. I don't know that I'd characterize the pipeline of consisting of disruptive, as I would define disruptive, but certainly accretive; and I think, hopefully, also in its entirety, margin-accretive as well.

Operator

[Operator Instructions] We'll take our next question from Akshay Jagdale with KeyBanc Capital Markets.

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

Okay. So just on Tim's question on the SEC stuff. I mean, can you -- it's pretty, obviously, important. But I'm curious as to why you can't say anything about it when it's very material as far as this quarter and just in general. So can you just comment on why you're unable to say anything about something that's very material?

Brian J. Driscoll

The best I can say is that, that's the charge after discussions that have been ongoing. And other than that, we can't discuss it.

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

Okay. And I was able to look through your proxy statement a couple of days ago, and this is really -- again, going on, I think, Ken's question on growth. So your -- it was clear through the proxy that your compensation -- management's compensation is tied to gross profit and EBITDA growth, if I may. But there was no indication whether those metrics have changed or will change. There was a lot of flexibility in that regard. So the first question is really, for this year, your annual incentive, is it still based on gross profit and EBITDA growth?

Brian J. Driscoll

Yes, it is.

Raymond P. Silcock

Yes, it is.

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

Okay. So how would you characterize 2013 as far as EBITDA growth? Again, I'm trying to get to what Ken was asking, which is -- you've said EBITDA is going to improve this year. How would you characterize the 28% growth you saw in adjusted EBITDA in 2013? Is that steady growth?

Brian J. Driscoll

I see exactly where you're taking this. I would say that's very aggressive growth.

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

Okay, okay. That's helpful. And do you envision, at some point, where the targets -- I mean, I know that, Brian, for you specifically, there's a significant component of your compensation that's tied to equity, right? I know that. But at some point, will you consider changing the targets to have some sales and EPS growth targets tied to it? Because, I mean, obviously, at some point, we'd like to see this turn around, get into full effect and thus become a growth company like it used to be. So is that something you considered? And if you did, I mean, are we 2 years out before we see that, or am I just thinking about it incorrectly?

Brian J. Driscoll

So I think, well, first of all, let me begin by saying that this is certainly a matter for our Compensation Committee. But just generally speaking, I believe that a company needs to evolve its compensation structure depending on what the opportunity is for the company to improve. Our compensation is heavily dependent on gross profit dollars and EBITDA. And I think, considering the position and condition of the company at the time and turnaround, those are the appropriate measures. As we continue to evolve as an organization and we move into the next part of our journey, the prospect of evolving it to include elements like revenue and perhaps other factors like EPS, is certainly may be something for the compensation to consider. In the end, we're looking to create a compensation structure that incents the organization to provide or to deliver great total shareholder return. I mean, that, in the end, is what our goal is. And my expectation is that we will be evolving our compensation structure, such that the organization is incented to do just that.

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

Okay, and that's helpful. And then, on Kettle U.S., just -- if you just take a step back, can you give us your view of the category and its prospects? So the way, I think, we're used to talking about the Kettle chip category was that it was a subset of just the overall chip category, around 20% of that category in total, and it was growing double digits because of the taste profile and perceived, I think, as being healthier even. So can you just give us an overall picture of how you think of the Kettle chip category and, within that framework, where Kettle U.S. fits and sort of what the opportunity is?

Brian J. Driscoll

Yes. I mean, I like to think about the brand as more of, call it, a mainstream luxury. It's a brand that, as I indicated in my prepared remarks, performs extremely well in natural channels. It is -- it performs extremely well in the Western U.S. across all channels. I'm hesitant to view it as -- and/or to limit it by describing it only as a brand that is -- participates against premium. That's why I think of it more as a mainstream premium, if you will, or mainstream luxury because I do think that the brand has potential to participate in ways that it hasn't before: small format, single-serve. I think that it could participate better in the East with a more comprehensive approach, as well -- well, maybe, probably not as well, but certainly better than it is today, consistent with the fact that it's performing well in natural channels out there. So I do believe that we're staying true to what the brand stands for. I think the innovation and the approach we're taking to it is consistent with that. And I think that answers your question.

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

Okay. And just the subcategory that it competes in, I mean, it seems like the Kettle chip category is not -- obviously not growing anywhere close to what it was a couple of years ago. Is it your contention that it will grow in line with the overall salty snack category, or...

Brian J. Driscoll

Well, I mean, the overall potato chip category in mainstream has not exactly been robust. So I think whenever a category that has historically grown exceedingly well doesn't, there's a number of factors to that. One could be potentially a lack of innovation, another could be impact from other segments, other salty categories. I think, in our case, I can't speak for our competition, I think, in our case, the lack of growth has been driven by the lack of innovation. And I think that it's in our hands in terms of -- especially as a leader in premium chips, the growth within that segment is in our hands to influence. So I think, to the extent that we produce a campaign strategy and innovation that delivers in the market the way we think it can, that we can have an effect on that segment of the category.

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

Okay. And just a couple on Emerald, if I can. What -- you mentioned a lot about expectations on the cost side. Shipments, especially for October, were really robust. The demand seems to be very strong, again, internationally, and we have a smaller crop. So that implies cost to the growers are going to be up then. It looks like you are saying that that's the case. Can you give us some order of magnitude as to what you're thinking or what's in your plan for the full year, like what are you expecting? Because I know that things can change as the year goes along. As it goes along, you adjust. But what is the starting point? Are we thinking 10% increase in your walnut cost? Is it 5%? Is it 20%?

Brian J. Driscoll

Well, first of all, I think you opened by referring to Emerald. I just want to make sure. Are you talking about Diamond of California...

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

Yes, yes, yes. I do have an Emerald [ph] question after that for you.

Brian J. Driscoll

Yes. And again, to clarify, I didn't say that the top line was robust. I said it was slightly better than we expected, and that was driven by some early seasonal shipments or behind some early seasonal activity. So we were, of course, pleased with that. But in terms of the outlook, in terms of supply, we don't give guidance on the actual level of crop we get, other than to say that we have ample supply to support the branded business, our ingredient non-retail business and some international business. But as I said before, not enough supply to exploit what we think could be even further potential on the international landscape or in other opportunities we may have if we had more walnuts. I think it's a segment of overall nut commodities that truly you can grow just by virtue of getting more crop receipt. So again, I can't give you an outlook on it other than what I already have. I think, and as I said, the sales for our Nuts business will be slightly down year-over-year. That's the best word [ph] we could do right now.

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

Yes. Sorry, I think I just asked the question incorrectly and completely confused you. But I was talking more about the cost it's relating to. So I'm talking about overall Nuts segment. I'm talking about the cost that you're incurring by payments to the growers and in relation to the gross margins that you're reporting. Yes. So I'm just saying that crop is down year-over-year. Shipments, according to the industry data, are up. And so, you're going to have to pay more, it looks like, to the farmers. So -- and you alluded to that. I'm just trying to get a sense of what's...

Brian J. Driscoll

Oh, I see, I see. Actually, you asked that question right. I just answered the wrong question. The volume incentive and incentive structure that we put in place for crop '13 is already embedded in our COGS for Q1. So the margin profile you're seeing on the business right now for Q1 already includes that cost. It also -- I also want to point out that, to the extent that we're anticipating and experiencing further pressure on the commodity, we've already taken price to cover that. It's just hard to determine whether or not that we're going to feel additional pressure beyond what we've already seen.

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

Okay. And just the margin, I mean, it was impressive, 15.2%, despite the 17% decline in sales. Where -- I mean, I was very pleasantly surprised by that. Where -- you said it's going to sort of build, it seems like, from here. Where are we in terms of margin improvement in the Nuts segment in your sort of multi-year effort? Are we in the second inning, fifth inning, because it looks like the Snacks business margins have stabilized and improving? But on the Nuts side, are we still in early stages of a full recovery?

Brian J. Driscoll

I would say that we are still in the early stages of a full recovery from a margin perspective, yes.

Operator

And there are no further questions at this time. I'd like to turn the conference back over to management for any additional or closing remarks.

Brian J. Driscoll

Okay. Thank you, all, 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 second quarter fiscal 2014 financial results. Operator, please conclude the call.

Operator

And that does conclude today's conference. We thank you for your participation. 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 Management Discusses Q1 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts