Diamond Foods' CEO Discusses F2Q 2014 Results - Earnings Call Transcript

| About: Diamond Foods, (DMND)

Diamond Foods, Inc. (NASDAQ:DMND)

F2Q 2014 Results Earnings Conference Call

March 11, 2014 4:30 PM ET

Executives

Katie Turner - ICR, Investor Relations

Brian Driscoll - President and CEO

Ray Silcock - Executive Vice President and CFO

Dave Colo - Chief Operating Officer

Analysts

Brett Hundley - BB&T Capital Markets

Ken Zaslow - Bank of Montreal

Bill Chappell - SunTrust Robinson Humphrey

Thilo Wrede - Jefferies

Akshay Jagdale - KeyBanc

Karru Martinson - Deutsche Bank

Operator

Please standby. Good day. And welcome to the Diamond Foods Second Quarter 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 of ICR. You may begin.

Katie Turner

Thank you. Good afternoon. And welcome to Diamond Food's second 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. 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 amounts, the 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 in 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 Driscoll

Thank you, Katie. Good afternoon, everyone, and thanks for joining us. With me this afternoon to review our second quarter and fiscal year-to-date results are Ray Silcock, our Chief Financial Officer; and Dave Colo, our Chief Operating Officer.

On an overall basis we are encouraged by our performance in both the second quarter and fiscal year-to-date. And while we still have some challenges ahead, we continue to make good progress against our core strategy and are growing increasingly confident that solid and sustainable foundation for future growth is being established.

We are particularly pleased with the success of our gross margin expansion efforts to-date, which have enabled us to continue investing behind our brand building strategies, innovation pipeline and organizational capability.

You can expect that our focus on gross margin expansion will continue. In fact, we are presently evaluating several new projects targeted to fiscal 2015 and beyond to meaningfully enhance our operating leverage, improve our productivity and reduce costs, all in service to adding fuel to our brand building efforts.

With that as backdrop, I’d like to turn our focus more specifically to our Q2 performance. As I mentioned, we are encouraged by our overall results. Net sales were $220.6 million, which was approximately flat on a year-over-year basis and our gross margin improved 250 basis points to 25.4%.

These results reflect strong sales growth and gross margin expansion from our Snacks segment, but were weighed down by the Nuts segment, which experienced lower sales, as well as gross margin compression due to tree nut cost increases that we were not able to recover with price increases in the quarter.

Adjusted EBITDA in quarter two increased 24.4% to $28.6 million, while at the same time, we increased advertising spending by about a $1 million compared to last year. EBITDA margin expanded 250 basis points, driven by accelerated growth in line with our strategic focus of the higher gross margins Snacks segment.

Let me now give you some insight on our segment performance for the quarter. Starting with Snacks, we achieved solid topline growth of 10.8%. This growth reflects continued market share improvement and distribution gains for Pop Secret, solid growth in Kettle’s core fried chip product line and in the U.K. increased household penetration and improved net price realization.

Our Snacks business also delivered strong gross margin growth of 340 basis points compared to the second quarter of last year. This improvement reflects gross margin expansion across each of our Snack brands as we get the benefit of manufacturing and supply chain and procurement cost savings initiatives and volume-related operating leverage.

Now digging a little deeper into the topline growth of our Snacks business, starting with Kettle U.S., we continued to be encourage by our consumption improvements as measured by Nielsen.

In the most recent 12-week period ended February 15th, Kettle retail sales grew 12% in the food channel and 8.2% in [xAOC] [ph] channels, compared to category growth of 6.1% and 4.2% respectively. Importantly, our core fried chip product line was up 17.6% and 13.5% in xAOC.

In addition, Kettle continued to grow at a strong clip and gained share in the natural channel. In the most recent 12-week spin-scanning period ending January 18th, Kettle grew 15%, gaining 60 basis points of market share.

Looking ahead to the second half of the fiscal year, we are planning to launch and to test Kettle brand ready-to-eat popcorns in four varieties, White Cheddar, Sea Salt, Maple Bacon and Salt & Fresh Ground Pepper, bringing Kettle’s natural flavor credentials to this rapidly growing category segment.

We are also planning to launch Kettle branded real sliced potato chips into test. These will come in five varieties, Sea Salt, Sea Salt & Vinegar, Hickory Honey Barbeque, Cheddar & Roasted Tomato and Olive Oil. We believe that both of these launches have promising new platform potential.

Turning to Kettle in the U.K., we remained encouraged by the steady progress we're making in the marketplace. As we improved net price realization and achieved 6% retail sales growth in the 12-week period ended February 1st, as compared to just under 1% growth in the category.

We attribute this topline momentum and household penetration improvement in part to our new artisanal craft ad campaign investments. Regarding new products in the U.K., in Q2 we launched a new hint of lime of Kettle brand chips hint of lime and hint of Rosemary and in the second half we are launching into test Kettle Baked Potato and Baked Sweet Potato varieties.

Moving on to popcorn, Pop Secret also performed very well in the second quarter. In the most recent 12-week period ending February 15th, the brands retail sales grew 17.7%, resulting in a 500 basis point gain in market share across all outlets.

This growth is a result of solid base business, the early success of our new sweet and crunchy offering and distribution gains. Importantly, our growing distribution base has become an impetus to achieving steady shelf base -- space improvements with key retailers.

I’ll now transition to the Nut segment. First, our gross margin results were substantially pressured in the quarter by tree nut cost headwinds that were, we were unable to fully recover through pricing.

This dynamic while transitory will continue to weigh to some extent on our debt cap Nuts segment margins, particularly on walnuts due to the effects of walnuts sales seasonality and retail lead time requirements for price increases.

On the top line, both volume and net sales declined in the quarter primarily due to declines from Diamond of California and to a lesser extent from Emerald. As we’ve previously stated, our sales for the segment would be impacted by lower walnut supply and the steps we took to transition the Emerald brand with a focus on its profitable quarter.

Regarding the Diamond of California brand specifically coupled with our efforts to increase walnut supply with a brand investment effort around the holidays, we believe this campaign was effective. In the most recent Nielsen scans, we are seeing some growth returning to the brand, which outpaced the category in the grocery channel growing 16.2% in 12-week period ending February 15 and gaining 10 basis points share.

Looking more closely at the Emerald brand, its financial contribution has been improving significantly. And we are experiencing strong growth with our 100 calorie pack product line, which now represents over 20% of Emerald’s total revenue and growing. In the quarter, we also launched Emerald Yogurt Bites, Strawberry Vanilla and Mixed Berry into test and believe we’re going to establish a strong new growth platforms for the brand going forward.

Regarding canisters, we remain optimistic about the potential of our reposition product line but it is still too early to tell that we have the right strategy in place to deliver the type of profitable growth we’re seeking. Net, we are continually evaluating in making the appropriate adjustments to our strategy but remain confident in Emerald’s prospects.

Overall we are encouraged with the progress we are making. The foundation of our business is continuing to improve. And despite anticipated headwinds associated with tree nut commodity costs in the back half of fiscal 2014 that will adversely impact results in the Nut segment, we nevertheless continue to expect to realize an increase in adjusted EBITDA on a year-over-year basis.

Also as many of you are likely aware, we recently completed the refinancing of our debt capital structure which will materially reduce our interest expense going forward to provide us with additional financial flexibility. We are very pleased with this new financing arrangement and believe that it will improve our profile with all of our stakeholders.

Ray will provide additional insight about this during his remarks. With that, let me turn the discussion over to Ray Silcock.

Ray Silcock

Thank you Brian and good afternoon everyone. I would now like to take you through the key points in the Q2 financial summary appended to today’s press release. Second quarter consolidated net sales were approximately flat at $220.6 million. Strong Snack segment sales in the quarter, offset lower sales in the Nuts segment, which were adversely impacted by lower walnut supply, as well as by last year’s Emerald SKU rationalization.

Gross profit for the quarter increased by $5.4 million to $55.9 million, up from $50.6 million last year while Q2 gross margin was up 250 basis points to 25.4% versus 22.9% in Q2 fiscal ‘13. The improvement in gross margin came from better net price realization, as well as from our ongoing cost improvement program despite the tree nut costs increases we saw in the quarter.

As we move on down the P&L, I’d like to direct your attention to the non-GAAP financial information included in today's press release in addition to the GAAP financial summary, we’ve just been reviewing.

Starting with SG&A, we reported SG&A expense of $33.8 million in Q2 adjusted as you can see from the non-GAAP financial information for an $8.7 million charge to mark-to-market the shares issuable in connection with the settlement of the securities class action lawsuit and $1 million charge for legal expenses and other fees.

Excluding these one-time charges, adjusted SG&A for the second quarter was $24.2 million, a decrease of $1.4 million from the same quarter last year. Q2 operating expense also included a charge of $7 million arising from the change in fair market value of the Oaktree warrant. We exclude this from our non-GAAP financials.

We reported advertising expense in the second quarter of $13.1 million after $800,000 from the same period last year due to higher online spending in the nuts segment during the holiday season as well as increased advertising on the Kettle Brand in the U.K.

In summary then, our second quarter operating expenses reported as $53.9 million, became a non-GAAP adjusted $37.3 million, a decline of $600,000 as compared to the prior year. The Q2 SG&A reduction of $1.4 million was partially offset by $800,000 in additional advertising in the quarter.

Our net loss for the quarter was $15.1 million, a loss of $0.68 per share on a fully diluted basis. While non-GAAP net income for the quarter was $2.6 million, up $1.4 million from the same period last year.

Non-GAAP fully diluted earnings in Q2 were $0.09 per share based on our 29.9 million share count as compared to earnings on a non-GAAP basis of $0.05 per share last year. Adjusted EBITDA improved by $5.6 million to $28.6 million as compared to $22.9 million for the same quarter last year.

Turning now to year-to-date results, net sales for the first six months of fiscal 2014 were down 5% to $455.2 million as compared to $479.3 million in the first half of last year. Our gross margin, however, increased to 25% for the first half of the year, an improvement versus last year of 220 basis points.

We reported a net loss for the first six months this fiscal year of $57.2 million, a loss of $2.60 per share on a fully diluted basis. First half non-GAAP net income was $7.6 million, excluding unusual items and first half non-GAAP fully diluted earnings per share were $0.26. First half Adjusted EBITDA was $57.7 million versus $54 million for the first half of last year.

I’d now like to turn to segment reporting. As we’ve already noted on this call, the Snack segment performed very well in the second quarter. Sales were up 10.8% to $116.8 million, reflecting strong growth across all our Snack brands but especially in Pop Secret our microwave popcorn brand where we took number one share in U.S. food during the quarter as we continued to gain distribution.

We also saw nice growth both in Kettle U.S. where we significantly outpaced the category and in Kettle U.K., where we sharply beat the category while simultaneously increasing our net price realization. We also continue to expand Kettle out of the U.K. into Continental Europe, building on our already strong base in the Netherlands. We are now looking to Germany and France for added growth.

Overall, our Snack segment gross margins improved from 33% in Q2 last year to 36.4% this year, an improvement in our Snack segment gross profit of $7.7 million. This margin improvement was driven by better plant utilization, principally a function of increased sales, as well as by our ongoing focus on cost improvements.

In the nuts segment, however, we saw a 10.1% decline in net sales to $103.8 million, a 12.2% volume decrease. This came as a result of lower walnut supply, combined with last year's Emerald SKU rationalization.

Gross profit in the quarter dropped $2.3 million due primarily to an increase in tree nut costs in the quarter and our gross margin decreased by 70 basis points to 12.9%. Due to the seasonality of our nut business and to repay the lead time requirements, we are not expecting to recover these costs increases until the beginning of the new fiscal year.

Turning now to the balance sheet, our reported net debt as of January 31 was $551.8 million. When the fair market value of the Oaktree indebtedness and a $32.3 million Oaktree prepayment penalty are included, our total debt amounted to $630.8 million. We had overcapacity as of January 31, was $180 million and we had $74.4 million in cash in availability.

As previously announced, shortly after the end of the second quarter, we refinanced our entire debt structure. We issued $230 million worth of 7% Senior Notes due in 2019 and entered into a new $415 million, covenant-lite 4.5-year bank term loan, with a variable interest rate at LIBOR plus 325 basis points.

We used the proceeds from these offerings, together with net proceeds from the exercise by Oaktree of its warrants, to pay off outstanding indebtedness under our existing credit facilities, redeem Oaktree’s senior unsecured notes in their prepayment penalty, as well as the bank’s legal expenses related to the refinancing.

At the same time, we also closed on a $125 million asset-backed revolving credit facility, which will use for our seasonal working capital needs. The ABL, which was a 4.5-year term, was essentially undrawn at closing. We are very pleased with our new financing arrangements. They will save us approximately $20 million a year in interest expense, improve our earnings per share by more than $0.60 annually and enable us to generate as much as profits and free cash flow a year.

We believe that having a more market debt structure will also improve our profile to grow with another stakeholders and will serve to strengthen the entirety of our multinational business. Addressing the debt structure was one of our key objectives in fiscal 2014. And with this refinancing behind us, we are now even better positioned to focus single-mindedly on our key operating initiatives.

Before I turn the call back to our CEO, Brian Driscoll, I'd like to comment briefly on our share count. This quarter we are including in our non-GAAP share count a 29.9 million, all of the 4.45 million shares recently issued to settle the securities class action lawsuit, as well as approximately 2.7 million shares related to the Oaktree warrant as determined using the treasury method of accounting.

In Q3, the number of shares outstanding will rise to approximately 31.6 million. This increase principally reflects the full amount of 4.4 million shares that we issued to Oaktree as a consequence of them exercising their warrants.

And now back to Brian.

Brian Driscoll

Thanks, Ray. We are pleased with our achievements to-date in fiscal 2014, particularly the strong performance of the Snacks segment as well as our improved capital structure. Looking ahead, we will continue to face headwinds from our Nuts segment, but we remain confident that we are taking the right steps to position our business for the long term.

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

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Brett Hundley with BB&T Capital Markets.

Brett Hundley - BB&T Capital Markets

Hi. Thank you. Good afternoon, gentlemen. Can you hear me all right?

Brian Driscoll

Yes. Hi, Brett.

Ray Silcock

Hi, Brett.

Brett Hundley - BB&T Capital Markets

My first question is your current composition today is somewhat complementary in my eyes. You have Kettle that is a bit more growth here. You’re innovating there. You’re expanding in the Continental Europe, doing better on the East Coast. It seems Pop Secret put up nice numbers. But historically, I’ve looked at it is a more stable brand and a stable category. Emerald seems like it’s improving, and it’s still early there. Could you guys operate as just a nut company going forward, or would you prefer to have the Snack brands underneath the Diamond root?

Brian Driscoll

Let me see, if I understand the question, could we operate as just a nut company?

Brett Hundley - BB&T Capital Markets

Yes. Would you? In other words, how do you view your Snack brand, they seem very attracted, needed by the company for growth. Would you ever jettison them to pay down debt or do you view them as needed for the overall company?

Brian Driscoll

No. First of all, we love our portfolio. We think that there's plenty of room for continued organic expansion within this existing portfolio. We also like the growth profile. As you think about the qualities of this portfolio, we have a place in protein, we have a place in gluten-free, we have a place in all natural and non-GMO. I mean, we really have a very attractive and complementary portfolio as it is. So we had no plans to jettison. And frankly, as Ray explained in his remarks, we are generating good cash flow and ought to be able to organically reduce our overall debt profile.

Brett Hundley - BB&T Capital Markets

Okay. Thank you, Brian. And I wanted to revisit a comment you made earlier on as far as evaluating projects for 2013 to kind of enhance ongoing margin? Can you dig a little bit deeper to that and talk about some of the things that you are looking at?

Brian Driscoll

Yeah. We are not prepared to get into detail just yet, Brett. We are evaluating some significant projects. I will be prepared to talk more specifically about that on our next conference call after Q3. But again, we think that we have to continue to reinvigorate that productivity pipeline in an effort to enable us to continue investing and improving our investment profile against our brands and our innovation profile going forward. So we -- I am not prepared yet to give you an order of magnitude on that other than to say we believe it will be a meaningful set of initiatives.

Brett Hundley - BB&T Capital Markets

And Brian is that more topline base or is that efficiency type investment spending?

Brian Driscoll

No. I think our focus on productivity, what I am referring to is more productivity and cost reduction, I wasn’t referring in those remarks to net price realization and margin improvement associated with that. Although, that will always be an area of focus, specifically on these remarks I am referring to productivity and cost improvement.

Brett Hundley - BB&T Capital Markets

Okay. And to be clear, is your original $30 million to $40 million that you guys talked about, is that in the P&L now?

Brian Driscoll

It’s flowing through the P&L as we have described for this fiscal year, yes.

Brett Hundley - BB&T Capital Markets

Okay. And your topline is better than I had expected, basically a neutral comp close to a positive comp came quarter sooner than I expected which is great to see? Can you give us any window into how your Snacks performance has been quarter-to-date in Q3, has those trends continued into Q3?

Brian Driscoll

We are not going to, we can’t give, we are not planning to give guidance along those lines other than to say that we did anticipate that our Snacks topline momentum would begin to manifest as we approach the back half. I would say that we probably did a touch better in Q2 than we thought we would and we are hopeful that the innovation I described a few minutes ago will help fund the pump as we enter fiscal ’15.

Brett Hundley - BB&T Capital Markets

And gentlemen, my last question, a qualitatively, can you discuss a little bit about where Emerald margins are today versus where you would like to see them? Thank you.

Ray Silcock

I think they are getting better than they have been historically. We are seeing nice improvement on the brand. We still feel like there is upside in improving the margin and I think those are some of the initiatives that, Brain, spoke to earlier as we bring new innovation to that brand. We continue to optimize our cost structure overall and the brand should benefit through improved gross margins.

Brett Hundley - BB&T Capital Markets

Okay. Thank you.

Brian Driscoll

Thank you, Brian.

Operator

(Operator Instructions) We will move next to Ken Zaslow with Bank of Montreal.

Ken Zaslow - Bank of Montreal

Hey. Good afternoon, everyone.

Brian Driscoll

Hi, Ken.

Ken Zaslow - Bank of Montreal

How do you evaluate potential offers from the outsiders to like buy assets or is that not part of the value creation goal that you are looking to do over the next couple of years?

Brian Driscoll

Yeah. I would say that's not part of the value creation goal we are looking at and then we would not, that would not be -- and so it’s not something we have got any real thought on, Ken.

Ken Zaslow - Bank of Montreal

Okay. Great. And then second question is, I think Brian, you mentioned, project to increase your gross margin. Can you talk - I didn’t - it sounds like you alluded to, but you didn’t go into details if I missed it? Can you talk about that and actually, I will sneak in one more, what is the progress for debt pay down over the next couple of years?

Brian Driscoll

I didn’t catch the second part of the question, what was the progress on what?

Ray Silcock

Debt pay down.

Brian Driscoll

Okay.

Ken Zaslow - Bank of Montreal

Debt pay down, - now that you refinanced, you have EBITDA positive, how do you expect to pay down, but the real, the first question really is, related to the projects to increase the gross margin outlook. You alluded to it, but I just didn’t know if there were more details that you can provide us.

Brian Driscoll

Yes. We are not prepared to provide details, but I would suggest that when we started with this turnaround of Diamond, we honed in on manufacturing and supply chain cost improvements, sourcing optimization which is essentially procurement and net price realization. We feel as if that those initiatives were very effective and they’re flowing through the P&L in real time. And we are ongoing looking at additional projects to continue to improve our profile and our margin profile as well as our investment profile.

And so, we are evaluating a set of additional initiatives that we believe will produce a meaningful improvement in '15 and beyond, but we’ll be more prepared to talk specifically about that after doing our Q3 call. So I just wanted to surface it at this stage, but we’re not prepared to talk more specifically about it until later in this fiscal.

Ray Silcock

And with respect to cash flow and I think with second part of your question, Ken, basically we are fairly public on the fact that we expect to generate at least enough cash flow to reduce our debt by some profit turn of EBITDA leverage a year. But I think the key thing for us is that we’re looking at reinvesting in our current businesses, whether it's capital expenditures to satisfy the increase demand in the U.K. business that we've talked about, and that our number one priority would be making sure that we use the cash to invest in our current businesses. But the number two priority is to reduce that and to delever the business a little. We said that we'd like to see our leverage closer to 5 than the current 6.5 time leverage that we have.

Ken Zaslow - Bank of Montreal

All right. Thank you very much.

Brian Driscoll

Thank you.

Operator

The next question comes from Bill Chappell with SunTrust.

Bill Chappell - SunTrust Robinson Humphrey

Good afternoon. Thanks for question.

Brian Driscoll

Hey, Bill.

Bill Chappell - SunTrust Robinson Humphrey

I guess just digging into the tree nut issue, I mean, can you maybe give a little more clarity on what's going on in terms of is this drought or is this just overall demand, is spiking prices in the nut? I didn’t fully understand within that of, are you not able to pass off the full price increase you’re seeing or is it just happening so quick it does take longer to actually get it through?

Brian Driscoll

Yeah. I think on what's going on with the category in general, I think on the global basis we continue to see strong demand for walnuts. And this year, we had a slightly smaller crop than last year, coupled with solid demand for the year is what's driving the walnut commodity cost up for the year.

Relative to the pricing, I think, as you all know, we did take pricing earlier in the year and costs have continued their increase. And just given the timing of the seasonality of the business, it’s the incremental costs that we’re seeing on this business that we’re not going to be able to fully recover for the balance of the year. But we anticipate being able to recover that as we move into fiscal '15.

Bill Chappell - SunTrust Robinson Humphrey

And just to follow up on that, just to make sure I understand, I mean you’re still seeing the benefits from Emerald and what you’ve done there, but it sounds like the cost inflation in walnuts is more than offsetting that and probably don't see a year-over-year improvement in gross margin again until we get this '15, is that the way to look at it?

Brian Driscoll

I think that’s a right way to look at it, yes.

Bill Chappell - SunTrust Robinson Humphrey

Okay, great. I will turn it over to somebody else.

Operator

We’ll take the next question from Thilo Wrede with Jefferies.

Thilo Wrede - Jefferies

Good afternoon, everybody. Can I ask just a -- can I ask just a simple housekeeping question. Do I get it right that your outstanding depth right now at $680 million?

Brian Driscoll

Our outstanding debt right now is that sounds about right, I’m just looking for the number on the balance sheet, hang on a second, it’s not right in my head. Why don’t you go ahead and we’ll confirm that…

Thilo Wrede - Jefferies

Okay.

Brian Driscoll

…let’s talk about.

Thilo Wrede - Jefferies

Yeah. Thank you so much.

Brian Driscoll

…I have got to calculate that one, just if you want the exact number. I have got to -- get the -- just help you out.

Thilo Wrede - Jefferies

Got it. Okay. And we can follow-up offline, but I’m going to ask Brian a question to give you a chance and look for your time. Brian, you talked about creating fuel for additional brand building. Will this brand building take this form of more advertising, more investment and price, how are you thinking about that?

Brian Driscoll

I think it’s all of the above. It depends on the brand, it depends on the opportunity. Of course, the items that I talked about in test will require investments behind them. But it would be both. It would be new products and it would be investment in our core. What I don't want to do, which is why I emphasized the strength of our core fried line on Kettle is I don't want to lose sight of the growth we could get just in our base businesses.

I want to be able to innovate incrementally and so we keep a very careful eye. On the base businesses, we think have strong upside potential and then how we surround that and build a mod around that, if you will with innovation. And so the -- it's always important to continue to try to achieve or get more fuel to support that.

Thilo Wrede - Jefferies

Right. Are the prices for Kettle and Emerald now where you want them to be or where…?

Brian Driscoll

On Kettle in particular, I do think we have the right investment profile on that. I think the return we’re getting for the promotional investment we're making today it’s probably about right going forward. We are getting the right execution and feel comfortable in that that space. With Emerald, I would say that we're close to right. We are still sorting out some possibilities on the canister side but I do think overall, we're probably in the right realm on Emerald as well.

Thilo Wrede - Jefferies

Okay. Thanks a lot.

Brian Driscoll

Have you got it?

Thilo Wrede - Jefferies

That’s it.

Brian Driscoll

I will answer your question if you want to because the number we posted on our Q, I think was the $551.8 million as reported net debt. But if you looked at our total debt including fair market value of Oaktree and the prepayment penalty at the end of the quarter, it was $630.8 million. And if we looked at it now post the refinancing, it's about $655 million.

Thilo Wrede - Jefferies

Okay. Thank you. That’s helpful.

Operator

We will go to the next question. It comes from Akshay Jagdale with KeyBanc.

Akshay Jagdale - KeyBanc

Hi. Can you hear me?

Brian Driscoll

Sure, can. Hi, Akshay.

Akshay Jagdale - KeyBanc

Hi. How you doing? So, first question is on the innovation you talked about on sale with the popcorn. Can you just talk about how you think that innovation will fit into the category? Obviously, there is few brands that have done pretty well. So you are getting to the party a little bit late.

So, I'm wondering what the point of differentiation would be there and if you are just wanting to play into the growth of the category or is that sort of a market share play, can you just help me understand how that innovation might end up being a platform and what you think of that subset of ready to eat Kettle popcorn?

Brian Driscoll

Sure. Well, first of all, the ready-to-eat popcorn category is growing quite significantly. I want to say it’s up almost 25% year-to-date, 30% last 12 weeks, somewhat on those lines. And we think that the category will continue to grow at a rapid pace. The segment of the ready-to-eat category that's growing the fastest are the all natural products and I think we will be bringing into the category in our opinion, the most credentialed all-natural snack.

Kettle has, as you know, a 60 share in natural channels on our potato chip line and we believe those credentials will be meaningful to consumers. We think it will bring new buyers to the category and, therefore, we think it will be meaningful to retailers. So, we think we have a very important role to play that could actually add a lot of value to the category.

Akshay Jagdale - KeyBanc

And where are those incremental consumers coming from? Like, what were they eating before or it’s just incremental eating occasion?

Brian Driscoll

That’s a great question because the source of growth that -- from our standpoint that it has been from the potato chip category. So ready-to-eat popcorn has been sourcing a lot of growth from potato chips.

Akshay Jagdale - KeyBanc

Okay. And then just turning to what you call a multi-year turnaround in Nuts. I'm assuming -- what I’d really like to know but I'm guessing you won't go there but what I'd really like to know is what sort of a normalized gross margin structure that you think you can achieve over a longer period of time for that particular Nut segment.

And if you can’t answer that specifically then at least tell us what are the -- what is sort of the -- what's the roadmap towards getting there. Can you get to a much better margin without doubling your walnut volumes and then maybe talk a little bit about that strategy on Emerald. It seems from your commentary that things didn’t go perfectly as planned with the canister items. Well I’m curious to know or get more details on that strategy?

Brian Driscoll

So -- well first of all, you guessed correctly. We're not willing to get more specific but I will say we do think that this margin improvement potentially we have demonstrated that before, the tree nut costs issue with respect to walnuts. We do think it’s transitory and we’ll get back to more normalized improvement as we begin the fiscal ‘15.

But we -- we do believe that that the Emerald brand is a strong brand. We do believe that we continue to grow and improve its margin profile. We are seeing a significant improvement in that regard. Canister, we’re still learning. I wouldn’t say that that we aren’t experiencing more improvements in other parts of the portfolio. We are but not those are nice margin elements of our portfolio like 100-calorie pack and it’s growing quite well.

So we’re learning a lot about the range of Emerald and where and how we want to compete. We think the margin profile there can continue to improve and the same with Diamond. The Diamond brand name, we think has great range and we think innovation and exploring our growth trajectory, and other Nut types could really help us improve that profile as well. But like I said, we were not -- we're not willing to give more detail on that.

Akshay Jagdale - KeyBanc

But can you be successful at a multi-year turnaround without significantly increasing your walnut volumes in terms of procurement?

Brian Driscoll

Yeah, I think -- I think we can, in fact, again setting aside this year-end issue on tree nut commodity costs, we were beginning to demonstrate just that. Our crop receipt levels were down as you know and considerably compared to historical levels. And we demonstrated that we are able to improve that margin profile and we think we can continue to do that.

Akshay Jagdale - KeyBanc

And just one for Ray, can you tell us what's the normalized free cash flow generation that we should expect from this company? I mean you mentioned half return lower leverage. I mean that seems quite conservative especially relative to where consensus, EBITDA numbers are over the next couple of years. But there's a lot of moving parts, obviously which will likely start to go away in the next couple of quarters. How should we be thinking about modeling free cash flow for this business? Is it just 100% of net income? Is there a ton of room on working capital that you can enhance the free cash flow here? Can you help with that?

Brian Driscoll

I mean, I think that the numbers we’ve talked about are half ton of EBITDA reduction. That is what our free cash flow expectations are not taken into account what we think we’re going to be sort of spending in cash interest and modest amount of cash taxes, CapEx and so forth.

I don’t think we expect -- we anticipate particular changes in working capital. Looking forward, I don’t know what you see as a consequence of the growth of the business.

Akshay Jagdale - KeyBanc

Okay. I will leave at that. Thank you.

Brian Driscoll

Thank you.

Operator

(Operator Instructions) We will go next to Karru Martinson with Deutsche Bank.

Karru Martinson - Deutsche Bank

Good afternoon. When we look at the Nuts segment and the higher nut cost we had this year, I mean with the drought in California, how do you feel that that will play out on cost going forward?

Brian Driscoll

Actually, we are not at this stage anticipating that the drought effect will result in and of itself an increase in or an effect on the crop, and therefore in turn an effect on the price. Much of the walnut crop are irrigated and the feedback we are getting from growers is at this stage is that the drought is going to have a minimal effect on the harvest this coming fall.

Karru Martinson - Deutsche Bank

Okay. And when we look at the demand profile going forward, I mean is there any expectation that that will abate from the current high levels and then or is it just that we are going to get or hopefully we will get greater supply with the fall harvest?

Brian Driscoll

Yes. It’s hard to say right now. I think USDA publish is there estimate of next year’s crop size within the next -- in September. But as we’ve indicated before, there has been a lot more acres in the state devoted to new crop. And to the extent that that materializes in any way in the near term, it can have an effect -- downward effect on pricing, but again at this stage it’s an unknown.

In terms of demand, the demand of walnuts globally has been fairly resilient. Year-over-year it’s flattish to the most recent report, but that’s off of a very high level. So the commodity globally is demonstrating real resiliency, but the marketing year for walnuts are not done yet, and so more to come.

Karru Martinson - Deutsche Bank

Thank you very much, guys. I appreciate it.

Brian Driscoll

Sure.

Operator

We have no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Brian Driscoll

Well, thank you very much and we are good. Thank you

Operator

That does conclude today’s presentation. Thank you for your participation.

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