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Diamond Foods, Inc (NASDAQ:DMND)

Q3 2014 Earnings Conference Call

June 5, 2014 16:30 ET

Executives

Katie Turner - ICR, IR

Brian Driscoll - President & CEO

Ray Silcock - EVP & CFO

Dave Colo - COO

Analysts

Brett Hundley - BB&T Capital Markets

Ken Zaslow - Bank of Montreal

Andrew Lazar - Barclays

Akshay Jagdale - KeyBanc

Karen Eltrich - Mitsubishi

Operator

Good day and welcome to the Diamond Foods Third Quarter 2014 Earnings Conference Call. (Operator Instructions). At this time, I would like to turn the conference over to Katie Turner of ICR. You may begin.

Katie Turner

Thank you. Good afternoon. And welcome to Diamond Food's third 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 including refinancing related expenses, certain litigation-related amounts, the securities class action lawsuits settlement 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 a 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 this afternoon to review our third 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 third quarter and fiscal year-to-date performance and the strong progress we continue to make against our core strategies despite significant commodity cost pressure in the nut segment. We’re particularly pleased with the continued momentum of our snack segment which grew revenues by 9.6% in the quarter while expanding gross margin by a 130 basis points. The nut segment results were impacted by a $2.2 million increase in Walnut costs which reduced the segments gross margin. It is important to note that $1.5 million of this increase was for products sold in the first and second quarters of this year. As a result of the walnut commodity increase we have already announced a price increase that will take effect on August 1st.

I would now like to turn our focus more specifically to our Q3 performance. For the quarter we reported net sales of approximately $191 million, an increase of 3.2% over last year and our gross margin improved slightly to 23.6%. Adjusted EBITDA in the quarter increased 1.5% to $23.5 million while at the same time we increased advertising by approximately $600,000 or 7%.

As discussed these results reflect strong sales growth and gross margin expansion in our snack segment offset by a sales decline in out nut segment and the walnut cost increase. To amplify this point we recently communicated our final walnut price to our growers which was a $2.2 million fiscal year-to-date increase from our prior estimate. Global demand for walnuts continue to be quite strong through the spring months which led us to increase our final price.

Turning to our segment results beginning with snacks. As I mentioned earlier this segment continues to deliver solid results with strong net sales growth and gross margin expansion. Pop Secret continues to perform well. In the most recent 12 week period ended May 10th, Pop Secret retail sales grew 14.7% and xAOC channels substantially outpacing the overall category performance as measured by Nielsen.

As a result Pop Secret’s market share for the 12 week period climbed 5.1 share points to 28.4%. This growth stems from the effective combination of innovation, consumer marketing support and distribution gains. We believe this distribution base has more room to grow as we continue to demonstrate a leadership role in the broader category. Moving on to Kettle Brand in the U.S., we achieved double digit growth in four of the past five quad weeks while continuing to outpace both the category and premium segment as measured by Nielsen. In the most recent 12 week Nielsen period ending May 10th Kettle grew 13% in xAOC channels.

Further in the most recent 12 weeks spanning period and the April 20th, Kettle grew sales 8.2% increasing market share to 60.6%. Our Kettle U.S. volume growth was driven by the improved base velocity of our core fried chip items and improved merchandising execution.

We believe that our pivot from traditional media, the social media and public relations continues to play a central role to the growing momentum of this key blend. In addition to our media strategy we are looking to support growth with the expansion and development of new flavors, the launch of our real sliced line-up, continue traction on our small bag initiative and the rollout of Kettle ready to eat popcorn.

Overall we have made significant progress in the segment to-date and believe that we will continue to do so.

Now turning to our nut segment, on the top-line net sales declined 5% while gross margin declined to 4.4%. This gross margin level reflects the effects of the walnut cost increase I mentioned earlier and as a reminder the third quarter is a seasonally low volume quarter for the nut segment. For the Diamond of California brand in the quarter volume and net sales decreased over the same period last year. We feel the business is stabilizing however as we have been keeping pace with strong category growth in xAOC channels. In the most recent 12 week period ending May 10th, Diamond retail sales grew 5.1% which was slightly ahead of the category.

Looking ahead and based on our current contract renewal status, our preliminary belief is that we will increase our walnut pound receipts in fiscal year ’15 versus this year. While this could change depending on the size and quality of the crop we are encouraged by our progress to-date.

Our Emerald results were mixed in the quarter, the brands gross margin has improved and the on the go and convenience items which now represent approximately half of the brands, continue to grow nicely. We will remain focused on exploiting that momentum with improved marketing support, innovation and expanded distribution while continuing our repositioning work on the canister product-line where our progress to-date has not met our expectations.

That said we have a pipeline of ideas yet to be launched that we believe can uniquely position us in the category as we continue executing our turnaround strategy for Emerald.

In summary we believe that the strategy we’re successfully executing on snacks applies to and will work on nuts as well.

Moving on from segment results I wanted to pick-up on a point I made on our Q2 quarterly conference call regarding cost reduction and productivity improvement projects underway. As I’ve mentioned before we’re continuously looking for ways to drive our cost and complexity in our business and create feel to invest in our brands. In this context we had launched a companywide process improvement initiative that will be supported by the implementation of a new enterprise-wide system. This project is designed to support the integration of a back-office processes and establish a seamless end-to-end supply chain capability. Once fully implemented the new system should have a broad positive impact on our business as we are currently projecting $15 million to $25 million of cost savings the benefits of which will begin to accrue in late fiscal year ’15 and accelerate it at the fiscal year ’16 and ’17.

In closing we remain confident that a strong foundation for consistent growth in fiscal year ’15 and beyond is being established at Diamond Foods.

With that let me turn the discussion over to Ray Silcock.

Ray Silcock

Thank you Brian. Good afternoon everyone. I will now walk you through the key points in the Q3 and year-to-date summarized statement of operations that was attached to this afternoon’s earnings press release. Net sales for the quarter were up 3.2% from last year’s Q3 to a $190.9 million driven by a 9.6% increase in our snack segments the result of continued Pop Secret distribution gains as well as further strong volume growth in our Kettle U.S. business.

The snacks segment improvement was somewhat offset by a 5% decline in the nut segment where better net price realization versus Q3 last year was insufficient to counter volume declines this quarter. Gross profit for the third quarter was $45.1 million and gross margin was 23.6% 18 basis points better than for the same quarter last year. Excluding the 1.5 million portion of Q3’s 2.2 million walnut cost increase that was catch up for the first half. Q3 gross margin would have been 24.8%, 133 basis points better than last year. We continue to reap the benefit of our cost savings initiatives which we expect to top $40 million cumulatively by fiscal ’13 and fiscal ’14 as well as other cost savings throughout our supply chain.

Moving on to look at operating expenses and loss on debt extinguishment. It is worth first recalling that at the beginning of Q3 we refinanced our entire debt structure, we issued $230 million worth of 7% senior notes during 2019 and entered into a new $415 million covenant light 4.5 year bank term loan with variable interest rate at LIBOR plus 325 basis points. We also entered into an agreement for a $125 million asset backed revolving credit facility, an ABL, that would essentially undrawn as at the closing of the refinancing. The transaction constant termination fees incurred in the course of the refinancing significantly impacted our operating expenses in Q3. As I review the specifics I would like you to follow along on the summarized statement of operations with what is a rather complicated explanation of our Q3 operating expenses.

I would like to start by discussing total operating expenses for Q3, they amounted to $56.3 million and included a $15 million expense related to the refinancing the inducement fee paid to Oaktree to persuade them to exercise their warrants. Operating expenses for the quarter also included $2 million for the change in the fair market value of the Oaktree warrants between February 1 and February 19, the date on which they were exercised and $6 million for the change in the fair market value between February 1 and February 20 of the Diamond shares granted to settle the securities litigation. February the 20th was the last day on which the judge’s order approving the litigation settlement could be appealed.

Finally Q3 operating expenses included $1.9 million of various legal cost stemming from the Audit Committee Investigation and the related restatement in litigation. Excluding all of these items Q3 adjusted operating expense was $31.4 million. For Q3 last year total operating expense amounted to $45.2 million this included $1.9 million for the change in the fair value of the Oaktree warrants during that quarter and $12.8 million of various legal accounting and other expenses related to the Audit Committee Investigation.

Excluding these items last year’s adjusted operating expenses were $13.5 million. In summary the increase of approximately 900,000 in adjusted operating expenses for Q3 versus prior year was largely a result of increased advertising spending. Moving now down the P&L for the line entitled loss on debt extinguishment. This line item includes the refinancing expense that was charged to the third quarter over and above the $50 million warrant exercise inducement fee included in operating expense, $70.3 million of this is related to Oaktree and I will explain that amount in more detail in a moment. $10.6 million is to write-off a portion of the unamortized transaction cost from the prior debt and $2.1 million is to write-off part of the transaction cost relating to the new debt.

Turning first to the debt extinguishment cost related to Oaktree. There was a difference between the economic value of their loan and the accounting value on our balance sheet at $46.9 million. This difference came about as a consequence of how we treated on the U.S. GAAP at $225 million originally borrowed from Oaktree, a transaction in which they were also granted a 4.4 million share warrant. The warrant was assigned a value of $36.5 million combined with Oaktree’s originally issued discount of $6.7 million and subtracted from the loan. Total day one discount of $43.2 million was amortized over the life of the loan. However, each time we recorded pick interest additional discount was created leading to the total difference of $46.9 million as of the refinancing date. We also paid Oaktree a 12% call premium $32.3 million for a grand total payment of 79.2 million.

We were only able to expense $70.3 million of the $79.2 million paid to Oaktree in the third quarter. Since they purchased some of our new debt following the refinance and we could only expense in proportion to the amount of debt that was extinguished. $8.9 million the amount paid to Oaktree has there been put on our balance sheet as a contra liability and what we amortized over the next 4.5 year term of the loan. For the same reason that not all of our Oaktree debt was extinguished, we also had to leave on our balance sheet $1.1 million of unamortized transaction costs from the original Oaktree notes. Several other lenders who were holders of our prior term debt also purchased our new debt, as a result we were unable to expense a further $1.5 million of extinguishment cost related to those lenders which we will also amortize over the life of the term loan.

In addition there were transaction costs to setup a new bank term loan high yield note and a ABL revolving credit facility amounting to $14.4 million that we also put in our balance sheet. In total we have $25.8 million on our balance sheet to be amortized over the next 4.5 years or 5 years in the case of note related expenses. In Q3, we amortized $1.4 million of this and added it back to our non-GAAP net income and non-GAAP EPS. Turning briefly to the balance sheet net debt at the end of the second quarter was 551.8 million. When it's fully economic value is included net debt at the end of the second quarter amounted to 630.8 million, cash and availability at the end of Q2 was 74.4 million. In contrast our net debt at the end of Q3 was 635.4 million and cash and availability amounted to a 127.2 million.

On the interest expense line we had $10.6 million of expense in Q3, a saving of $4 million from Q3 last year reflecting the savings that resulted from our refinancing. Had we completed the refinancing at the beginning of the third quarter our interest expense for the quarter would have been $8.5 million, $6 million less than in the third quarter last year.

Tax for the quarter of $823,000 reflects the fact that we have tax expense inspite of our continuing net operating loss position. Tax expense varies from quarter-to-quarter and we actually had a small benefit on this line last year and the amount in this year’s Q3 is more typical.

In summary moving now to the press release attachment entitled non-GAAP financial information. We reported a GAAP loss before tax in Q3 of $104.8 million as compared to a loss of $16.4 million last year. On an adjusted basis we reported a before-tax profits of $4.6 million to Q3 this year as compared to a loss of $327,000 last year.

Non-GAAP net income for Q3 was $3.5 million or $0.11 per share as compared to $2 million or $0.08 a share last year. This excludes amortization of deferred financing cost and discounts and you should note that we have adjusted last year’s non-GAAP information to reflect the fact that we are now excluding amortization of debt related transaction cost in both years. EBITDA for Q3 was $23.5 million up 1.5% from last year and nine months EBITDA was $81.2 million, 5.3% ahead of the first nine months of fiscal year ’13. For the remainder of this fiscal year our outlook has not changed since last quarter’s conference call. Despite the walnut cost increase this quarter we still expect to realize that increase in full year adjusted EBITDA as compared to prior year.

With that I will turn the call back to the operator so that Brian, Dave and I can take some questions. Operator?

Question-and-Answer Session

Operator

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

Brett Hundley - BB&T Capital Markets

I just wanted to start on the $2.2 million walnut cost increase, is there a potential to see any of that come back in fiscal Q4 in other words is that a true-up for the whole year or that just captures the first three quarters to-date?

Ray Silcock

It just captures the first three quarters to-date in answer to that part of that question but it won't change and what I mean by that is we have a final price to our walnut growers and there will be an additional -- its going to depend on sales but $600,000 to $800,000 of additional expense related to the most recent increase in the cost of walnuts in Q4 and that number is fixed in terms of the price we pay the growers and the variation in the cost to Q4 will depend on the sales of walnuts in the quarter.

Brett Hundley - BB&T Capital Markets

So staying on that topic can you talk a little bit about the final prices on walnuts and really I’m interested in where you believe or how competitive you believe you’re in the market both for this year and next year? Can you just talk a little bit about what you’re seeing on the inflation side in regards to walnut prices to growers?

Brian Driscoll

It's been a very strong year on walnut inflation this year versus prior crop year. We have seen north of 20% in walnut cost inflation on this new crop year that we’re currently selling and as far as being competitive on what we’re paying to the growers we definitely feel like we’re in a very competitive position as we have been in the last couple of years and with the increase in inflation of the cost which is then driven primarily by a continued increase in global walnut demand. We feel like we have kept pace with competitive pricing this year.

Brett Hundley - BB&T Capital Markets

And is that primarily what plays into Brian your comment about, I forgot the words you used but some level of confidence that your receipts will be up in 2015?

Brian Driscoll

Yes, our preliminary view based on our contract renewal status is that we will have more pounds in fiscal ’15 than we had in fiscal ’14 and I think it's probably a fair statement to say that us continually being competitive as well as some of the other things I think we do from the service perspective et cetera has played a role in us strengthening our position.

Brett Hundley - BB&T Capital Markets

And can you just give us any sense of magnitude? Are you happy with the additional receipts you could see in fiscal ’15? Is there more work to be done there? Where are we timing wise on all that? That would be helpful.

Brian Driscoll

Let’s say to this period of time in the process because keep in mind we continue to see pounds right through harvest and that’s I think that’s fairly standard in the industry for this period of time I feel certainly better than I did at this period of time last year. And so I would say that I feel good about our progress to-date and I think again it's early, I mean you really don’t know until you know but it does appear and so the crop is shaping up relatively well. So I feel as if we will be improved from what we were a year ago from five year [ph].

Brett Hundley - BB&T Capital Markets

Okay and then the pricing on the nut side as of August 1, can you give us a sense of cost coverage there. Do you feel relatively confident that you’re going to be able to recover a majority of cost increase that you’re seeing?

Brian Driscoll

We do, we have already announced the price increase that takes effective on August 1. As a percentage increase it certainly captures the increase that we’re experiencing in the commodity. We didn’t price sooner because of contract status with customers as well as customer lead time requirements but we feel confident that we will be able to get reflection.

Brett Hundley - BB&T Capital Markets

Okay and then just my last question is on the Emerald business, Brian can you just talk a little bit about, what do you think it is on the canister side that the repositioning hasn’t gain the traction that you would like? Do you think it's something surrounding internal decision making? Is it external just what have you seen there? And thank you so much.

Brian Driscoll

I think that first of all one of the things I think is important to recognize is that the starting points with our nut business was a little bit different than the starting point on our snacks businesses. While we had work to do across our portfolio we have applied a very similar strategy across all brands and we believe that the effect that we have had on the snack business we will be have the same effect if you will on the nut business. It's just is taking more time because it was a different starting point. We address an element of the issues on Emerald, we have not addressed the entirety of it on the canister line. Obviously for competitive reasons I can’t share exactly what that is, other than to say that that we believe we have a range of options that is the next step to this transition that we believe will resonate in the marketplace. That said we’re exceeding our expectation on the on the go and convenience elements of Emerald which is growing very nicely and so I think that’s a demonstration if you will of the efficacy that this brand has.

The brand name with the right proposition resonates with consumers and we now have a portion of the business representing 50% of the business that’s growing very nicely. So the next stage is to take the canister business to the next level and I believe we will do it.

Operator

And we go next to Ken Zaslow with Bank of Montreal.

Ken Zaslow - Bank of Montreal

Just two questions, I will start with these two. I guess I'm somewhat surprised by the sequential, the gross margin expansion that you had decelerated from last couple of quarters and even excluding the impact of the nut business. It seems like I would have thought that the margin expansion would have continued at some sort of that pace that you’ve been getting. Is there some of that change, is there something I’m missing?

Brian Driscoll

No I don’t think so. One of the things that I believe we mentioned throughout is that on a year-over-year basis we continue to see expansion frankly as we think about our snack business, I think it's as you look at the level of net sales we’re getting and at the same time seeing continued gross margin expansion. We are pleased with it and we continue to believe that we will get margin expansion on both of the businesses going forward. So now we’re not surprised that at the levels we’re at.

Ken Zaslow - Bank of Montreal

On the sales growth line, I’m assuming that IRI data somewhat matched your actual takeaway volume growth within your segment right? I think that’s a fair point, there is no mismatch between IRI data take away and actual volumes is that fair? The IRI’s -- the volumes -- the retail takeaway?

Brian Driscoll

Right.

Ken Zaslow - Bank of Montreal

And then actually well you reported actually in the quarter, right?

Ray Silcock

We reported total company sales.

Ken Zaslow - Bank of Montreal

Yes but on the Pop Secret side as well as at Kettle, I’m assuming, it's parallel right?

Brian Driscoll

Well we’re using Nielsen, yes.

Ken Zaslow - Bank of Montreal

Again I thought that given the new product innovation and the robust number of new products coming out. I would not have thought that the year-over-year sales growth would have decelerated. Well at least what we were looking for is that this -- last quarter we were under the inflection point and we would actually see a greater growth level in the back half of the year given that you are all set up new product innovation and I guess I’m confused why is that -- that did not happen?

Brian Driscoll

Well first of all the ready to eat popcorn launch is in Q4 not Q3 as is real slice, so those launches are in the quarter we’re in that may have something to do with your comment but we feel quite good about our top line moment on snacks.

Ken Zaslow - Bank of Montreal

But it's decelerated sequentially -- again I just want to -- like to me you guys strike me as a growth company that should be accelerating your growth algorithm on both sales and gross margin expansion yet this quarter showed again I’m not going to say it's a setback it did show a little bit less robust on both those measures than I would have thought, I’m sure exactly, again I don’t get why the sales growth did not accelerate. I mean the Pop Secret seems to be again the distribution game seem to be there, earnings seems to be in-place, so is there any product lines that may not have hit the right target or is that something that slowed that we should think about? Is there a competitive activity that we should think about? Just help me out.

Brian Driscoll

Well one of the factors again in terms of your own expectation that might be a consideration is the fact that the category growth in the microwave popcorn, the business has come down quite substantially. I want to say it was roughly down 10% for the last quarter [ph]. But frankly we feel quite good about our top line on snacks and again that top line was not supported by as much robust innovation as we believe we have in front of us. So one of the things we’re considering doing as we go forward at the other side of Q4 is providing little bit more insight on our business and perhaps we’re considering whether or not we give a little bit more guidance around these things.

Operator

And we go next to Andrew Lazar with Barclays.

Andrew Lazar – Barclays

If we start with gross margins in the snack space, obviously if we look versus a couple of years ago you’re up a good 600 - 700 basis points, in some cases tremendous improvement there. Trying to get a sense of sort of what inning you think you’re in with respect to gross margins in snacks? Are you -- you seem confident obviously, we will see further expansion but is there a way to benchmark where you think that should be over time or are we closer to that level or is there still a lot of room to go and if so what next sort of metric or the next sort of actions that get you there? Or do we need to see to sort of get you there?

Brian Driscoll

Yes I mean it's hard to say what inning we’re in other than to say that I believe we have meaningfully more room for margin expansion. One of the things I talked about in the past is the underdevelopment of our small bag business on Kettle which as you may know in snack business is really strong margins. We’re very pleased with our momentum on that and we have really only just begun. So we think that the build out of that can have a nice improvement. We also, the real slice launch is a nice margin improvement profile for us. Frankly as is the ready to eat popcorn launch.

So we think that to the extent that these initiatives developed the way we think they can, we think it can build a mode around this margin stuff and allow us to continue to improve there. So we think this innovation which -- this is a pretty straightforward stuff we believe can continue to help accelerate the margin expansion plus the continued emphasis on the cost reduction effort. I think too that what needs to be considered is the overhead leverage that we’re trying to achieve in the plant. As we have mentioned before that our Kettle plants are roughly I want to say 30% to 40% underutilized so for the extent that we continue to drive the top line volume on this business we got to see that impact our margin as well. So we think we have a nice pool of options here that will help us to continue to accelerate, I’m not prepared yet to get more specific. We may in fact in the near future but we do feel that we have got the right plans in place to do it.

Andrew Lazar – Barclays

Pop Secret also has continued to be incredibly strong and I just marvel at the sort of the Nielsen data we see kind of month in and month out around how much share is being given up or donated by a certain brand or brands. I guess I’m just trying to get a sense of, I mean are there certain brands that are just going to zero at this stage, like are there certain companies that are just doing absolutely nothing or is it just that your execution and as you talked about distribution gains, is that much better? Just where you see and for lack of better word just such horrendous market share trends from a fairly well-known brand in a space?

Brian Driscoll

Yes as I’ve said on past calls I have actually been quite impressed with their innovation. I frankly I’m not quite sure why it's not resonating in the marketplace as much as I thought it would but I have actually being quite impressed with some of the changes they have made. I think there are some very big differences between the brands. I think we compete with different consumers, I think frankly our starting point was right for development and we have been able to capitalize on that. We’re big believers that momentum builds on momentum itself and so we want to focus on the elements of our businesses that are showing the most traction and really drive those and so what’s happening on Pop Secret is the momentum is driving increased interest from retailers which is driving more distribution which is driving greater shelf space and when you get better distribution and better shelf space that's the gift that keeps on giving and so it just builds on itself overtime. So it's really not a promotional strategy, its social media, its PR, its distribution and shelf space, it's real blocking and tackling and frankly we also recognize that the category has been in decline and that’s why we felt the need to launch into ready to eat popcorn but we’re going to continue to innovate in microwave. We’re going to continue to plow money into microwave but we’re also moving into ready to eat because we think that that category has real legs, that segment.

Andrew Lazar – Barclays

And then lastly it would be, it sounds like you’re probably going to get more granular around your thought process for fiscal ’15 maybe on the next quarter conference call. But I guess as we think forward is there a way to at least layout maybe what are some of the sort of the key puts and takes that we should be at least considering in the way we think about our modeling for next year even if it's certain just buckets or items directional? Things that may not have a good sense for that we have to start at least thinking about in terms of forming expectations.

Brian Driscoll

Well my hope is we have been clear about what the big priorities are, so from our vantage point I mean clearly one of the items that the top of the list is our ability to get additional crop receipt, the culinary category is growing very, very nicely and we would like to exploit our market leadership role in that by getting more crops. So I think that is clearly an area that is an area of focus, to what extent can we demonstrate the ability to turn around the Emerald canister business as we have the snack business. We certainly have our eye on that, I’m the first to say that we’re very pleased with what we’re doing with 50% of the portfolio. I’m not so pleased with what we have done so far in the rest but I think we have demonstrated by what we have done on our snack business is that we can do no Emerald and I believe we will. So that’s something to keep an eye on.

On snacks, well our new products resonate. I mean one of the things we have talked about in terms of the virtual cycle is improved productivity, cost reduced, net price realized, grow margins and spend back. It's what you spend back on that matters most, because that adds high traction. So will ready to eat popcorn resonate? Will real slice resonate? Will our new flavors resonate in the marketplace and so on? So these are the things we keep a careful eye on that I imagine if you did as well would be a good place to start. We probably be in a position to offer greater clarity around the pace and phasing of the cost savings initiatives. I feel real good about our ability to drive productivity and improve margins and I think you will continue to see us do so. So these are the things that we’re tracking. Did that answer your question?

Operator

And we will go next to Bill Chappell from SunTrust.

Unidentified Analyst

This is Stephanie in for Bill. Kind of going back to the nut business and the higher turn up [ph] cost, do you feel that the hit was at more on the walnut side or did it actually hit the Emerald and snack business as well and then kind of going from there do you feel like you kind of plateaued on the cost improvements for Emerald business or do you expect more possibility kind of going forward?

Brian Driscoll

We have seen some almond pressure as I’m sure you’ve heard from others in the industry. We have priced for it and we continue to keep a careful eye on it. The $2.2 million though that we referred to was all walnuts, 1.5 million of that was catch up from Q1 and Q2. And we did provide our final price on walnuts to our growers for the season.

Unidentified Analyst

And then just kind of switching over to snacks to the new product roll-out, whether they are kind of being rolled out right now. So should we expect to see those in the stores kind of any day or a little bit more color on that if you don’t mind?

Brian Driscoll

Yes both Kettle ready to eat and Pop Secret ready to eat have begun to ship. They will be in stores over the course of the next couple of weeks, real slice will also be in stores as part of a soft launch actually it's in some stores now but the bigger roll out of that is later I think it's in the second and -- end of in Q1. So I think that’s pattern [ph].

Dave Colo

And on ready to eat popcorn we’re doing kind of some initial shifts in Q4 and full distribution in Q1 of next year.

Operator

And now we go to actually Akshay Jagdale with KeyBanc.

Akshay Jagdale - KeyBanc

Just focus first on a couple questions on nut segment. You mentioned you expect receipts to be up next year. How much of that is just current suppliers producing more as a result of higher yields and acreage versus new customers or new --

Brian Driscoll

It's a little hard to answer other than to say that yes there is some of greater yield from existing acreage but we also have some new pounds as well. If we’re going to get acceleration of new pounds which we hope to get, that process would begin roughly around now through harvest. So the good news is as we look at it, we believe we have stabilized the base and grown it a bit without the full benefit yet of new pounds if you will that we’re really beginning to emphasize essentially beginning now right through harvest. We think we have put ourselves in a very good position because we have now being consistently competitive from a payment perspective. I believe that many of the issues that were troubling to growers as we understand it for the first time are all behind us.

So the things that were troubling growers about the Diamond Company we believe that those things we can now official say are all behind us. We've all been paying competitively and we hope that that will persuade new growers to give us a chance here.

Akshay Jagdale - KeyBanc

Okay and then just continuing on that, what’s your sense of what the supply is going to look like early stages, I’m sure -- but what is the supply outlook for next year look like as we sit here today?

Brian Driscoll

Very early but interestingly it looks pretty good. So the draught effects of course didn’t affect the walnut crop it appears. So we are projecting an increase at this stage but it's really too early to give a number other than to say that our first look looks pretty good.

Akshay Jagdale – KeyBanc

And the look being good is I mean obviously it's alternative bearing crops, so the yields next year is the on crop if I’m not wrong. So you’ve that element. Is that generally driving your view or are we also?

Brian Driscoll

We think we might see a yield per acre improvement in the 5% to 10% range at this stage.

Akshay Jagdale – KeyBanc

And what about acres because the USDA always lags by two years on acres and trees per acre as well. I mean obviously even as going back three years, nurseries were out of seeds for walnut trees and it takes five years --

Brian Driscoll

Bearing acres are up.

Akshay Jagdale – KeyBanc

Could be productive, so what’s your sense of acres being up as well as trees per acre?

Brian Driscoll

So bearing acres are projected to be up, and trees per acre are projected to be up and yield per acre is projected to be up in the 5% to 10% range.

Akshay Jagdale – KeyBanc

And so demand has been exploding for so many years now, can you just talk a little bit more broadly as to export demand I believe especially related to China that’s been driving most of the increase year-over-year for seems like the past 3 or 4 years. Is next year finally going to be a year where perhaps supply might actually be growing faster than demand, or we still expect the Chinese to just keep backing up the truck and buying as many walnuts as possible.

Brian Driscoll

I would say the commodity actually has been very resilient. The China demand actually on a year-over-year basis softens quite a bit and it was picked up in the Middle-East and Europe. So that’s why comments about in the spring demand continued to improve while China came off Middle-East and Europe picked up. So I would not bet against the crop in my view in terms of the demand. I think it's a resilient commodity, I think demand will continue to grow and I’m hesitant around thinking that the supply will exceed demand. That said that’s why we think it's so important to continue to investing in our brands because we must maintain pricing power. We have to be able to price to cover, we believe we still have that capability and that’s why it's so important in this business to continue to invest back.

Akshay Jagdale – KeyBanc

Okay and so if I’m thinking about it correctly. So based on what you’ve told me and obviously you guys are a lot smarter on this topic than I am. I’m thinking supply is going to be up double-digits pretty strong maybe a record crop, expect demand to continue to be strong. So at this stage perhaps payment should be up again next year maybe not at the rate at which we saw this year but just a volume increasing should meaningfully impact gross margins in the nut right? All else equal and then it will depend on how well you’re able to price to see how much of magnitude of the --

Brian Driscoll

Yes I think it's real premature to think that. I mean it's just so much left to unfold here in terms of supply and demand. What we’re estimating is what we have said in terms of the increase of supply, the demand equation is really difficult to calculate at this stage. So I would be real hesitant to give you a feel for that.

Akshay Jagdale – KeyBanc

Okay and just one on Emerald, can you talk a little bit more broadly again and on the category obviously you’ve mentioned that the canister didn’t go as well I guess as you had hoped but the starting point was a tough one to put it lightly I guess. But can you just talk a little bit more broadly about the opportunity in snack nuts and how you see it in general, because obviously your competitor has -- your largest competitor has benefited from some of the corrective actions that you’ve taken and I’ve actually seen them be pretty active on innovation and even marketing. I mean they have been very visible. So just can you just give us a broadly your current view on the nut category and how you know what type of opportunity exists in that space for market share for you guys?

Brian Driscoll

Sure. So first of all we think this nut category is a very good category. It's growing quite nicely, we think it's going to continue to grow nicely. We think that the category addresses consumer needs in a very powerful way in terms of being nutrient dense, protein dense and so on. We have benefited on that on our on the go and convenience element of the portfolio which would -- like I said it's greater than half of our business and growing quite nicely. But we think on the canister line while we have addressed some of the price value issues we have not yet launched the innovation we think that will allow us to navigate between the competitors you just referred to. We have certain competitors that are particularly strong in particular elements of these commodities, we think there is a scene to navigate that will do [ph] quite well for us and so we’re working on that very thoughtfully and more to come.

Operator

And we go now to Karen Eltrich with Mitsubishi.

Karen Eltrich - Mitsubishi

It sounds like you’ve made a lot of progress with regards to distribution particularly on a same store sales basis. But are there any distribution channels that you think they are under penetrated in? How much more opportunity is there in this area?

Brian Driscoll

For snacks in general or?

Karen Eltrich - Mitsubishi

For those product lines.

Brian Driscoll

Yes I think we’re under developed on kernels in Pop Secret. As I mentioned on Kettle we’re under developed on small bag, so the up and down the street if you will convenience channels we were under developed on. Also club and drug were developed on Pop Secret and we think that our momentum -- and dollar channel. So I think the momentum we have been able to demonstrate hopefully will give us the ability to gain increased distribution in those channels for greater distribution. I think the other key too as you measure distribution is the look at total distribution points. So what’s happening we’re getting additional distribution where we already have the product present, so what that allows us to do is build on our shelf space which is as you know in CPG to the extent that you could improve your presence in the store on the shelf on the basis of improving your market share, it builds on itself and so we’re quite pleased with our progress along those lines.

Karen Eltrich - Mitsubishi

And can you maybe elaborate on how you’re using social media to reach your customers and maybe how kind of that data base has evolved and what kind of rate of growth you’re seeing for that customer data base?

Brian Driscoll

Yes so we have effectively in the last quarter and half, two quarters really ramped up our social media camps across all of our brands that primarily initially focused on our snacks brand and basically it's key part of our marketing mix where we utilize the social media formats as well as the enhanced PR strategy where we call it our always on campaign and we’re seeing a significant improvement in the number of engagement levels we have in the different formats and we feel that that’s really driving and helping create greater awareness for our brand. So we see that as a key element to our marketing mix across all of our brand as we continue to move forward.

Karen Eltrich - Mitsubishi

And final question for the ready to eat popcorn line. How many SKUs are in that -- I mean how big of a market do you think that could be for you?

Brian Driscoll

It's appropriate nine SKUs at this time, we will expand that as we take the ready to eat products in the different channels where different SKUs and sizes will be required but you know if you look at the category dynamics on ready to eat popcorn it's been growing double-digits for the last 3-4 years. It's a category now that’s north of around $600 million in annual sales. So we think there is a lot of staying power in that category. We anticipate the category to continue to grow and we’re hopeful that we’re going to have a decent part of the share of the categories we establish our footing with our two new brands.

Operator

And we will now go to Andrew Lazar from Barclays for a follow-up.

Andrew Lazar – Barclays

Just two quick follow-ups, first I don’t think I heard you talk about Kettle in the UK, if you did and I missed it I apologize and then with ready to eat popcorn, when Orville did it I don’t think it worked out very well, it clearly could have been solely on them in their execution but were there certain pitfalls there that you have studied such that you can avoid whatever they might have been when you roll yours out. Thanks a lot.

Brian Driscoll

Sure. Well first with Kettle UK frankly we didn’t add them to the -- we don’t report the individual segments. With all we had to talk about we didn't add Kettle UK but we’re quite pleased with our Kettle UK performance, we continue to be and it's a well performing business for us. With respect to, what’s your question?

Andrew Lazar – Barclays

On ready to eat popcorn, the recent launch hasn't done very well and that could have been just all on them but only want to get a sense if you understand the pitfalls there.

Brian Driscoll

Yes, first of all the ready to eat popcorn category is growing quite rapidly and the ones that are growing fastest are the ones that have clean label, all natural, they are outpacing the entirety of it, they are driving the growth. We believe that the Kettle brand for instance resonates quite well in that space. I mean we have over a 60 share of the potato chip business in the natural channel and that we believe that the popcorn growth is sourced in part from all-natural chips, and so we believe the Kettle brand resonates real well with that consumer and has the credentials to really do well. I don’t think that some of the others that were in this space historically deliver the kind of credentials that Kettle is delivering in the category. As far as Pop Secret goes we have really addressed it in the same way, I think we have got a unique approach, having learned some lessons from others that I prefer not to -- rather not to discuss further in terms of our approach but I think we will allow it to do quite well.

Operator

And we have no further questions. I would like to turn the call back to Brian Driscoll.

Brian Driscoll

Thank you for joining us this afternoon. I’m pleased with how our team continues to move our business in the right direction, to position our company for future growth. Thank you very much.

Operator

And this does conclude our conference. Thank you for your participation.

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Source: Diamond Foods' (DMND) CEO Brian Driscoll on FQ3 2014 Results - Earnings Call
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