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Diamond Foods, Inc. (NASDAQ:DMND)

F2Q08 Earnings Call

March 11, 2008 4:30 pm ET

Executives

Bob Philipps – Investor Relations

Michael J. Mendes – President, Chief Executive Officer & Director

Steven M. Neil – Chief Financial Officer, Executive Vice President & Director

Analysts

Diane Geissler – Merrill Lynch

Kenneth Zaslow – Bank of Montreal

Heather Jones - BB&T Capital Markets

Mark Churchill – Piper Jaffray & Co.

Sara Lester - Sidoti & Company

Operator

Good afternoon. My name is Christian and I’ll be your conference operator today. At this time I would like to welcome everyone to the Diamond Foods fiscal 2008 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After these speakers remarks there will be a question and answer session. (Operator Instructions) Thank you Mr. Bob Philipps, you may begin your conference.

Bob Philipps

Good afternoon everyone. Welcome to the Diamond Food investor conference call and webcast to review the financial results of our fiscal 2008 second quarter which ended January 31. Before we get started we need to cover several housekeeping items. First, a printed copy of our prepared remarks is current available on our website DiamondFoods.com under the section entitled investor relations followed by earnings release. Second, we’ve arranged for a tape replay of this call which may be accessed by telephone. This replay will take affect approximately two hours after the calls conclusion and will remain available until midnight eastern time on March 18th. The dial in number to access the replay from the US or Canada is 1-800-642-1687 and 706-645-9291 elsewhere. The conference ID required to access the call regardless of the number you have dialed is 35705785. In addition, this call is being webcast live with a replay also available on our website. Third, we want to remind you during the course of this call we will make forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 including projections of our results. Since actual results may differ materially from projections made today I encourage you to learn more about the risks and uncertainties that affect our business by reviewing our SEC filings under the heading risk factors. Note that our projects or forward-looking statements are based on factors that are subject to change and therefore these statements only as of the date they are given. We do not undertake to update projections or forward-looking statements.

Now, I’d like to turn the call over to Michael Mendes, President and Chief Executive Officer of Diamond Foods.

Michael J. Mendes

Good afternoon everyone and thank you for joining us. Since we reviewed our preliminary results at the CAGNY conference in February we’ll keep our prepared remarks brief today. Joining me on our call will be Steve Neil our new Chief Financial and Administrative Officer. Welcome Steve, it’s great to have you on board with the company.

At the beginning of the fiscal year we established some very aggressive financial targets, the heart of which was to demonstrate that this business was capable of delivering compelling profit growth. After posting strong profits in the second quarter we believe we are well on our way to achieving our full year EPS guidance of $0.80 to $0.90 per share. On a GAAP basis this would represent growth of more than 50%. Our earning growths is indicative of the progress we’ve made improving our margins despite higher input costs. As a result we expect to deliver positive earnings in both the third and the fourth quarter compared to prior years when the third quarter has typically generated a net loss.

Let me take a moment to highlight some of the areas that support our confidence in achieving our 2008 earnings target and positions us for continued growth in the future. Culinary sales increased 17% during the quarter and are now 12% ahead of the first half of the year demonstrating the pricing power of our brands. Importantly, we protected our retail distribution and believe that the full impact of this pricing should benefit us in the future. Growth in the quarter was strong across all channels led by expansion in the mass merchandiser channel. In traditional grocery we ran a successfully culinary tie in with Hershey’s Chocolate which drove incremental display activity. We also ran an integrated print and online program around the holidays which increased traffic to the recipe section of our new redesigned website DiamondFoods.com. In snack we modified our consumer support program to more effectively spread our investment throughout the year. Last year we ran and in and out promotion in the value channel which we elected not to repeat this year. In addition, we strengthened the quality of our distribution by more aggressively rationalizing less profitable SKUs.

Even though sales decline 8% in the quarter we preserved our market share from the prior year. According to syndicated data released last week, the brand grew 21% for the full year into February and market share is up 90 basis points. Even in the month of February when we were up against 38% growth comps from last year, the brand grew 7%. We continue to gain traction in our retail distribution as Emerald grew 300 basis points to 87% distribution. While we’ve had a broad retail presence we continue to have ample opportunity to increase distribution of distinct items which represent the core of our product offering. To enable our retail activation strategy we have a series of in store promotional partnerships scheduled in May through October with Coca Cola, Yellow Tail Wine and Heineken. It is important that we continue to identify partnerships that bring new consumers into the category as syndicated data indicates that 77% of Emeralds growth is incremental to the snack nut category.

Expanding the category as well as low interaction with store brands is critical to our retail partners. Combined with Emeralds’ demographic profile which skews towards younger snackers, this data validates our strategy to primarily target additional shelf place from regional brands. These regional brands represent a significant portion of the category however, they typically lack the national supply chain capability, they compete with retailers themselves by pricing at parody against the retailers own store brand and have limited product innovation and consumer support. Some examples of the innovation we are bringing to the category include the launch of Emeralds sea salt and pepper cashews and coco roast almonds. Both products have begun to make inroads at grocery and we will begin a test with coco roast at 250 club stores this month.

The feel of our brand continues to translate into progress in securing new distribution in other channels as well. This month for example we will begin shipping three more items to Home Depots nearly 1,700 locations which will give us a meaningful presence at checkout in this retailer that’s actually the second largest retailer in the United States. We are also pleased to announce that we are entering a new retail channel in the fourth quarter with the introduction of our new single serve items in over 4,000 Blockbuster video stores in the United States.

In shell in international sales are also on target with our projections for the year. The earlier walnut harvest shipped its sales to the first quarter resulting in a decline of sales in the second quarter compared to last year. We also continue to right size the ingredient business as we focus on value added products and customers who value quality and service. As a result, the profitability of this segment improved albeit on a smaller base. We launched two new natural energy television commercials in the second quarter during the Emerald Bowl whereas last year we launched our advertising campaign during the Super Bowl in the third quarter. This resulted in a $2.3 million increase in advertising spending during the quarter compared to last year and that’s worth noting because the incremental investment cost us about $0.09 in EPS. We expect this timing impact versus last year to normalize by the end of the third quarter.

In conclusion, we continue to manage our business with an emphasis on long term profitable growth and we remain on track to realize our aggressive earnings targets for the fiscal year. With that, I’d like to turn the call over to Steve Neil.

Steven M. Neil

Good afternoon everyone. It’s great to be on board. Since this is my first conference call with Diamond I will keep my remarks brief and focus on some of the financial highlights during the quarter rather than repeat the press release or the 10Q both of which have been filed today. Looking at sales, our mix of sales to the retail channel increased 700 basis points over the second quarter last year to 77%. This is driven by higher culinary sales and lower non-retail sales. This reflects the strengthening of our brands and is consistent with our strategy to shift sales to higher margin products.

Gross margin for the quarter was 16.8% well ahead of last year’s 14.2%. Gross profit per pound shipped increased 48% to $0.55 in the quarter reflecting aggressive pricing in order to offset an increase in cost of goods sold per pound of 21%. The COGS increase was driven by higher input costs and to a lesser extent the loss of volume leverage. SG&A expense excluding stock compensation was $8.9 million compared to $10.2 million last year. This improvement of about 12% reflects a concerted effort to tightly control costs, lower inspection fees tied to a smaller walnut crop and some timing items between periods. This all results in EPS for the quarter of $0.17 per share up 31% compared to last year’s EPS of $0.13. If you recall, last year’s EPS included net income from non-recurring items and excluding these items EPS grew 42% in the quarter. This puts us at $0.69 in year to date EPS which is 15% over last year’s non-GAAP number and we are well positioned to realize $0.80 to $0.90 in EPS for the year.

Our net cash position for the quarter was $39 million and that compared to a net debt position at the end of the first quarter. For the six month period we generated cash flow from operations of $30 million compared to a usage of cash of $9 million last year. During the second quarter we extended one of our credit agreements for another three years with favorable terms and so the balance sheet looks quite strong and has lots of dry powder. Additionally, we paid a $0.045 per share dividend on January 31st which is 50% higher than what we paid last year.

Looking at guidance, our full year guidance remains unchanged from what we stated at the CAGNY Conference in February. To summarize net sales of between $522 and $540 million, snack net sales of between $85 and $95 million and North American retail net sales growth of between 8 and 13%. Our gross margin guidance is for about 100 basis point improvement over last year’s 15% reflecting our confidence in maintaining pricing and focusing on cost cutting initiatives. Advertising expenditures are anticipated to be between $20 and $22 million. Earnings before interest, income taxes, equity compensation, depreciation and amortization or adjusted EBTIDA is expected to be in the range of $36 to $38.5 million and again, this falls down to an EPS of between $0.80 and $0.90 per share. For the three months ending April 30, 2008, our third fiscal quarter we expect net sales of between $93 and $103 million and EPS of between $0.04 and $0.08 per share. Note that the third fiscal quarter is seasonably the slowest quarter for Diamond.

That’s enough numbers for now so I’ll turn the call back over to Michael.

Michael J. Mendes

With that we’d now like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll pause for just a moment to compile the Q&A roster. Our first question is from the line of Diane Geissler with Merrill Lynch.

Diane Geissler – Merrill Lynch

Did you give a top line expectation for snack in the third quarter? I may have missed it.

Michael J. Mendes

No, we did not.

Diane Geissler – Merrill Lynch

Okay. Any hints there about the flow of product in the third quarter versus fourth quarter on snack?

Michael J. Mendes

I think that proportionality generally would match up with last year outside of the timing of some new distribution. You know, we talked about this product shipping to Home Depot and to Blockbuster. We expect more of that to actually ship in Q4 but it’s going to be – these are 2.5 ounce items so they’re not the largest items. We’ve got these 250 clubs that are taking a pallet each of the coco roast, that will ship this quarter. So, I would say that using a proportionality of our Q3 versus Q4 last year would probably be a good starting point Diane and as we get later in the call if I can think to add more color to that I will.

Diane Geissler – Merrill Lynch

Then presumably the new distribution you have with Blockbuster, Home Depot and the coco roast club would all be no slotting?

Michael J. Mendes

Correct.

Diane Geissler – Merrill Lynch

On the culinary which had a better quarter than I had been estimating, can you give us some idea about the sustainability, obviously 17% growth, I think you had a pretty good 7% in the first quarter. I know you’re lapping some business in terms of getting the bake center back, etcetera, but could you give us an idea about kind of long term what your expectations are on the culinary side? Long term, maybe next couple of years.

Michael J. Mendes

One thing is that we did get the benefit of some pricing obviously given the stronger pricing commodity environment that’s underpinning walnuts right now is one of our sub-products. But at the same time almonds were a bit softer. I would say overall the tree nut commodity prices were stronger. I would say that that is a trend that will over time, I think the commodity prices will moderate a bit so maybe there might be some price deflation a few years out. I don’t know if I see that as an eminent trend though. The almond crop this year was the on crop in almonds, next year should be an off crop. However the bearing acreage is increasing dramatically. So I think there’s a big question mark with almonds. The prices today for almonds are in the probably mid $2.00 level compared to walnuts and pecans that are in the $4.00 to $5.00 level. So I don’t know if there’s a lot of price deflation in almonds. I think they’re an attractive value and they’re also going to be bolstered by the weak dollar as about maybe 70 to 80% of all almonds are export and a big part of that goes to Europe. So I think that naturally you would think there might be a little bit of price deflation as far as on the pricing volume I don’t think it’s going to be as dramatic as some people think. On the volume side we have some real nice opportunities to increase our volume in culinary. There’s a number of national retailers that have an opportunity to increase the number of skews and also as we grow our non-walnut business in club and mass merch in culinary we think that’s a growth opportunity. So I think that business has some nice growth opportunity for us maybe faster than center store baking but maybe not as fast as we saw this year given that we’re getting some incremental benefit of pricing. Now I would say sort of steady state 5% growth is I think sort of the intrinsic growth rate of that business and maybe a little better than that if we can get more distribution gains than I’m anticipating.

Diane Geissler – Merrill Lynch

And then I guess on the cost side, some of the comments you made about cost of goods increasing because of the raw commodity prices increasing, I know we had a record crop in almonds this year, we had a pretty good crop in pecans, walnuts not so much so. Is there an expectation that you’ll be – it sounds from your last comments that you don’t expect in the near term to be seeing much benefit from lower commodity costs, obviously it’s too early to talk about the 2008 crop, but given that this is an off year and factoring the increased acreage and kind of where stock levels are now, is there any expectation over the course of the next 12 months that you see some benefit on the cost side from lower tree nut prices? I don’t want to misconstrue your comments.

Michael J. Mendes

I think when you aggregate the tree nut universe there’s some trends that expose themselves that I think that might speak to your question even better than my projections. Let me just talk about some of the things we’re observing that we are assessing and drawing conclusions. The first thing is on pecans, the pecan crop this year was very large, it was 320 million pound crop, it was the on year for pecans. Last year it was in that 200 million pound range, this coming year it’s expected that the pecan crop will be – because it’s also bearing, in that 200 million pound range. However, the pecan crop carry out will be large, quite a bit larger than last year coming into the year. Walnuts are trading at a very high price right now, actually higher than pecans. Historically pecans are generally priced $1.00 a pound on a kernel basis higher than walnuts and when they are more at parody of walnuts that tends to see some shift of demand which results in adjustment of the that pecan price.

So I think that the shipments of pecans for the balance of the year will impact that price level and even though next year the pecan crop should be smaller next year, if shipments this year aren’t strong, I mean the pricing in pecans this year have maybe stayed $1.00 a pound higher than people would have expected because of the high walnut prices and a lot of demand in China. There was maybe 25 to 40 million of pecans that shipped from the US and Mexico to China drained the swamp a bit on supply this last year. All that being said there is still significant inventory going in so I would say there is a question mark on pecans, whether that can hold this pricing level going, even if the crop is shorter next year. Almonds with something like 60,000 net producing acres coming into production, that’s what some people are projecting and a very good bloom does have potential to put on quite a large crop this year even though last year was supposedly the on crop, so I think we’ve seen a little bit of weakening in almond crop pricing in the spot market in the last two to four weeks. I don’t know what that bodes for the future. I think there’s a question mark there.

And then on walnuts, walnuts are at the highest prices in history. Next year should be the on crop. I would think that maybe in the back half of next year there might be some moderating in walnut pricing but I wouldn’t bank on that and I wouldn’t bank on it happening early because the carrying inventory this year will be by far the lowest walnut carrying in history. When the walnut crop gets harvested in earnest in October and people start shelling the crop they have not shelled any significant volume until probably end of November and a lot of the fall demand has been satisfied or needs to be shipped by then. So I think if there’s any price moderating in walnuts, if there’s going to be price moderating, it would be more a second half of the year phenomenon. So that’s a little bit of the broad strokes on the commodities, Diane. I hope that’s a little bit helpful

Diane Geissler – Merrill Lynch

And just to clarify when you say next year, you’re referring to fiscal 2009 which would actually crop year 08?

Michael J. Mendes

Correct.

Diane Geissler – Merrill Lynch

And then the other just one final question on the equity comp, I think with this year you’ll be rolling off the three year vesting from the IPO, is that not this year that that ends in the end of fiscal 08? I’m just curious about the $0.25 to $0.27 in equity comp, how much of that will go away as we move into fiscal 09? Presumably you already have a plan in place that you kind of roll over. If you could just quantify that?

Michael J. Mendes

I think it’s probably $0.07 to $0.10 should be the fall off in terms of the delta. Obviously it was a small grant but I think the net effect will be $0.07 to $0.08 on a steady state basis I would imagine the equity comp charge will, be $0.07 to $0.08 or more lower next year than this year. We have also moved from a three year vesting cycle in our equity grants to a four year cycle which also will have an impact of reducing that expense.

Operator

Our next question is from the line of Ken Zaslow with BMO Capital Markets.

Kenneth Zaslow – Bank of Montreal

Can you just help us out a little bit, what snack products do you consider the low margin ones that you are rationalizing? Are they pride lines, are they sizes? What are they that you’re rationalizing?

Michael J. Mendes

I would say right now we’re spending a little more time on the Harmony side of the business. We had some items there that we had picked up that either the volume of the products going through the channel is not of scale or the quality is not consistent with our brand image or finally that maybe it doesn’t have the supply chain characteristics. Ken, we do have some confection items that are part of that mix that in some of those channels really don’t move cost effectively through our supply chain and we don’t think we’re really kind of on trend with our growth prospect or did we think that we were maybe the best player to distribute some of those products? A lot of it was a lot of small skews on that Harmony side were items that we thought might be good items but we really needed to try them out and try to develop them before we could really make that determination.

Ken

But within the Emerald side you’re not discontinuing any lines at this point or are you actualizing – I think there was a point in time I think there was like the cocoa gusted walnuts. Is there another level of what you’re doing on the Emerald side that’s coming out of the portfolio that we should think about?

Michael J. Mendes

We really like our Glaze line, we do think that our core items are original glazed walnuts and pecan pie are sort of the top two, want to have those as part of core set anyplace we go. The other items we think we need to map them against the demographic in a region. So if we do think that, for example, apple cinnamon walnut and almond product might not be better suited for a region we might be better to come in with something like a cocoa roast almond, we might switch those items out, but by and large on the Emerald items we’re not really doing a pure elimination of items. It’s more of a trade out for maybe what we think might be a better performing item. More of the pure rationalization is more that produce, snack side of things.

Kenneth Zaslow – Bank of Montreal

And you think that you could, in terms of going after both spectrums of the snack nut category, both the high end and the low end, can you just discuss what you’d think about that strategy because that strategy has historically not been – I guess has not always been successfully implemented and maybe the phraseology of what you did on the press release may be overstating it, but can you just talk about how you’re going after both sides of the market?

Michael J. Mendes

Are you talking about the value channel versus the more high-low traditional retail?

Kenneth Zaslow – Bank of Montreal

You said in the press release that on both sides of the spectrum you’re getting a share of both the mixed nuts and then the peanuts.

Michael J. Mendes

I apologize.

Kenneth Zaslow – Bank of Montreal

Is that really part of your strategy, to go after that the peanut category? I always thought that was not part of your strategy. I just was surprised by that.

Michael J. Mendes

I think in every product there’s different stratus of consumers and I would think within that peanut category there is a subset of that group that matches up with our demographic and I think that the item that we have offered has not been really optimal for that set. So again I don’t think that peanuts is going to be a massive part of our portfolio. I think it will be a bigger part of our portfolio in the future though and I think it adds to our offering as a full line solution vis-à-vis the national brand. I think we need to have an answer on that front. So I would say we’re building a better mousetrap with our PETI that we’re developing, but I concur with you. We are not going to dumb down the brand or we’re not going to diminish our quality. Because generally I think the big compromise is that people are diminishing quality in order to hit price points. We won’t do that, Ken, I agree with you 100%, but I still think we can do better in that category by having a little better offering that’s maybe more in caring with the set. And as I said on our last webcast for us to sell an 11 ounce peanut in a rigid package and against a competitive base that’s selling a 16 ounce peanut in a rigid package we have a cost per ounce on packaging that is more prohibitive than I think it needs to be. So we’re just trying to re-frame our offering and maybe build out our footprint there. So I think that when you look at our growth opportunities, last year our snack business came in at $80 million of sales, we’re looking to grow to North of $200 million. There is going to be a few large channels that are going to contribute to that and there’s going to be a lot of small channels that are going to contribute to that. And I think doing a few more million dollars in peanuts by bringing better value and better packaging is just part of those many small paths that’s going to get us there.

Kenneth Zaslow – Bank of Montreal

And my last question is, you’re talking about the commodity environment being high and it sounds like it’s going to be high for a little bit, can you meet your long term growth objectives in this current environment?

Michael J. Mendes

Absolutely, Ken. I think that if there’s one thing that gets me excited about how we’d be able to handle the difficult periods has been the pricing power of our brands and the ability for us to drive costs out of the system. We’re a company that’s been in existence for 97 years but I think as we’ve really had quite an incentive to drive greater profitability here as we’ve converted to a four profit however we trade the company and to drive those values for the bottom line by not destroying value for either our vendors or our consumers and it’s been exciting for me as we look at the efficiency. We had this infusion of capital in the operation, when you go in our production facility and you see our in line roasting packaging operation where in the past we had bins and forklifts and people moving parts around because we didn’t have the capital to improve our unit cost, we’re doing some very exciting things that are going to improve our cost efficiency. We’re doing some things in our facility right now, two projects on the capital front side, one is a refrigeration replacement project in our Stockton facility, one is a lighting retrofit which is actually a very nice green initiative, but is also very cost efficient. Projects that have a 20 to 40% IRR that is going to really drive bottom line improvement and improve our service to our customers in the long run. So I do feel that while the commodity environment is not giving us anything, Ken, I would say there’s not a lot of upside we’re receiving there I think we’re dealing with it effectively and I feel very confident in us achieving our plan.

Operator

Our next question is from the line of Heather Jones with BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

I have a few questions and I hopped on the call a little late so I apologize if you’ve already said this, but what is your volumes due for the quarter?

Michael J. Mendes

We didn’t talk about volumes. Are you talking about dollar volumes for a certain segment?

Heather Jones - BB&T Capital Markets

No, like volume versus sales, because you mentioned pricing I was wondering how much of your pricing was up, I’m just trying to figure out what volumes did for the quarter as opposed to –

Michael J. Mendes

I would say a lot of our growth was based on pricing, most was pricing, particularly on the culinary side.

Heather Jones - BB&T Capital Markets

I was wondering, you spoke about almond export trends being strong particularly with the wheat dollars, I was wondering if you’ve seen an acceleration in those export trends over the last couple of months?

Michael J. Mendes

It’s interesting, the receipts though are still higher than the shipment growth so the almond industry is tracking towards an increase in carat inventory at the end of this year versus last year and I think that that’s just something to monitor as you go through the periods. The almond board reports those numbers, I think that the thing that bodes well for the almond industry though is that a lot of these products are being shipped to Europe and the dollar value just continues to make almonds a very attractive purchase for them and I think that’s going to take some of the sting out of that increased inventory position out of the almond industry by potentially having stronger demand in Europe. But I would say the gap between receipts of the crop and exports is I would say that the receipts might be 10% stronger at this moment in time. But there’s still a lot of time on the clock to see how that finalizes towards the end of the year. I would say the thing is inspecting spot prices a bit now as they did have a very good bloom period in the almond crop and pricing sometimes does reflect a little bit of that and so I think the good news is there should be a very good almond crop given the natural bearing nature of the commodity.

Heather Jones - BB&T Capital Markets

Second quarter snack sales I believe were down 8%, do you know roughly what proportion of that was due to the rationalization of these Harmony skews as opposed to Emerald sales declines?

Michael J. Mendes

I think most of it is we were lapping an in and out promotion in the value channel last year that we elected not to conduct this year. That would probably be the biggest contributor and I think that the rationalizing of skews is having a modest impact on the second quarter and we’ll see a little bit more of that in the third and fourth quarter.

Heather Jones - BB&T Capital Markets

What’s your level of confidence with your new 08 snack sales guidance?

Michael J. Mendes

We’re very confident. We still need to do things, we need to do new things in distribution that we haven’t done. That’s the thing about a growth business is obviously you’re needing to project forward on things you haven’t secured but we feel very good about the progress we’re making on those new distribution objectives and we feel good about hitting that number and, more importantly, we feel very good about some of the lead indicators of the business like our IRR data and how the product is moving off the shelf.

Heather Jones - BB&T Capital Markets

So this new $85 to $95 million I heard you mention Blockbuster, Home Depot, pallets to the club stores, etcetera, hitting the $85 to $95 million, does it assume that you first of all secure all of those pieces of business but also win new business?

Michael J. Mendes

Yes.

Heather Jones - BB&T Capital Markets

And then finally I was just wondering, someone alluded to this question earlier, but just wondering if you could explore in greater detail I think you reaffirmed your 2011 goal of reaching $200 to $250 million in snack sales which is roughly 2.5 times what your guiding to this year and just wondering if you could give us some sense of how you’re going to progress against that? Are we going to see a big jump in fiscal 09 and then another big jump in 2010 and how you foresee, what channels do you think you’re going to penetrate the most to get to this? If you could talk to that more?

Michael J. Mendes

Let me try to talk about the broader category we’re competing in and talk about our methodology and hopefully it’ll give you some more confidence as we’re feeling. First of all when you look at the measure channels, nutritional food, the food segment, the measure channels represents about $1 billion in sales. So one share point gain in that channel would generate approximately $10 million in sales for us, I think that’s one thought, so you’ve got to ask yourself, if we’re sitting here with five, six share right now if we could get up to a 10 share that can be another $50 million in sales from that channel. Secondly when you look at the non-measure channels club, mass merch, drug and then all of these other snack venues that we’ve talked about, c store, nontraditional channels, that’s probably another $2+ billion sales opportunity in those channels. So we see our four constructs that are going to be driving us from the business today to $200+ billion. The first is increasing our distribution of the items in channels we currently service and that’s things like, for example, on core products. We have 87% distribution in US food but the highest single item has distribution in the 60 percentile range and when you get to our sixth item it has distribution in the 40% range. So if you can just see if we take our top eight items and got them fully distributed that’s one very good, we think a very good way to not only grow our business but also improve our profitability because we can get more promotional effectiveness. So one component is improving the distribution in the channels that we currently scan. A second thing is driving velocity, basically moving more product off the shelf and moving product more efficiently in our promotional windows. If you look at the Northeast markets where we are periodically driving market shares North of 10% during promotional windows we are getting much more effective and efficient in merchandising our products. We’ve gone from having off shelf displays at the shipper to having mod displays to pallet displays and the pallet displays are – these mod shippers have 40 display cases on about a half pallet, it’s placed on the shelf of the retailer, the actual display unit is our shipping case so it’s a real winner for us because you’ve got scale of a lot of product on the floor, your incremental cost is virtually nil because the shipping unit is the display unit with our shrink wrap displayable case and that is a great way, that off shelf display activity is a tremendous way for us to drive velocity. In our Cagney presentation with the deck which you’ll find on our site, we actually show our lift tables that illustrate that the snacks that will get something like a 400% lift when they do a feature, a promotion, a display whereas Emerald is getting a lift of 800%. So that increasing velocity would be element number two. Element number three is new products. New products is I think important in terms of who we are as a brand and what we bring to the retail partner in terms of excitement to the category. I think that we’ve had some very good ideas on the new product front. I think we execute very rapidly with new products and I think that we have a big opportunity to bring some real incremental volume to our set through new products and we’ve got some nice things in the pipeline. And the fourth thing, and probably the most ample volume opportunity would be new channels like mass merch and club which are more traditional snack channels and then other channels I mentioned like Blockbuster and Home Depot. We’re quite underdeveloped in the mass merch and club channels relative to where we are with our culinary business and when you look at our culinary business we have tripled the size of our club and mass merch business over the last six years so we have a track record of servicing that channel effectively and rapidly growing there. So if we can perform at a fraction of the success level we have historically in culinary in those channels I think we have a lot of paths to help us get to o our $200+ million in sales.

Heather Jones - BB&T Capital Markets

So going back to your balance sheet cash position, so acquisitions don’t play into this at all?

Michael J. Mendes

I think it’s a builder by-question. I would definitely not rule out acquisitions. We feel very fortunate to have someone like Steve Neil join our organization which I think is a massive infusion of skill set to help us explore some of those concepts. One of my challenges to Steve is to explore these opportunities, not only to just help us grow and hit the scale objectives we have, but also to see if we can look at opportunities that make this a better company. And I think that those opportunities tend to be limited but if you look at the market today versus 18 months ago I think it’s a much better time for a strategic acquirer like Diamond to explore an opportunity to maybe be able to look at something at a value that makes good economic sense for us versus 18 months ago when we thought things were just overpriced in the market.

Operator

Our next question is from the line of Mark Churchill with Piper Jaffray.

Mark Churchill – Piper Jaffray & Co.

I think on the last call Gary had mentioned that you guys were about 25% completed on the PET packaging line that was going to eliminate some co-packers, can you give us an update where that stands and what kind of a margin lift or how much that’s helping you with your gross margin expansion right now?

Michael J. Mendes

I answered the first half of the question and I’ll speak to the second part. We are very happy to report that line is up and running, we’re very, very pleased with the line and I would say that it’s going to quite effectively achieve our needs in terms of a high quality product having a continuous roast right to the pack line and so all of the elements that we feel that intrinsically makes it a very cost effective unit is established, we just started running it and so we’re not at the point to really talk about that kind of benefits. But just the fact that our co-packer obviously had some profits in that process and we had to take snack products, put it in bins, ship it to a co-packer, ship it back, we’re definitely seeing some benefits on that and a bit of that is baked into our numbers for the current fiscal.

Mark Churchill – Piper Jaffray & Co.

Can you talk a little bit about the timing of your advertising because certainly it shifted in the first half of this year?

Michael J. Mendes

The thing about being a small company which is very committed to quality support of its brands is we are constantly evaluating the best way to move the brand forward and when we launched the brand, I think we discussed this a bit at one of our earlier calls, the initial thrust was brand recognition. We were trying to get people to register Emerald and we wanted to get them to get a visual reinforcement of our trade dress and that it was a snack nut and we’re trying to appeal to a younger demographic. We’re trying to bring these younger snackers into the set. We thought that made us quite valuable as a new player in the snack category. As we’ve now established an 87% distribution, at least one item scanning in 87% of the US food stores, we felt that we were now at the next stage of our evolution trying to build a reason for being for the brand and we really are trying to own this concept that people generally snack, our research has shown that people snack on nuts between meals, not really during meals and the most popular time is that period between lunch and dinner. Given the great health attributes of snack nuts versus other snack choices we’ve tried to position Emerald as this natural energy snack which is a better choice to make at that time, at 3:00 when you’re looking to make a snack choice and we’re a better choice. We do feel that to try to entertain while we inform is very effective, particularly when people enjoy food, a big construct about our company is we sell food that people enjoy. This is not a nutritional company first, it’s a great tasting food company first, it’s nutritional second and we’re very excited we’ve got products that taste great and bring a lot of nutritional benefit. So we felt that our media buy and our media creation could be quite instrumental in helping us drive that next generation of the vision of the brand. So when we looked at the Super Bowl as a great launch tool which we’re very pleased in terms of helping us get that resonating with a lot of people to recognize the brand, we felt somewhat limited given the episodic nature of that event to really have a more subtle message as we were trying to deliver. So we elected to shift our media plan and to still do Super Bowl commercials in terms of our promotions, in terms of our retail program and we had a nice Super Bowl retail support program but to spread our media dollar more evenly throughout the year and that was the result of the campaign this year. So I think you’ll see more of that in the future, Mark, where will try to provide more air support for the brand in effect and basically have more consumer pull media dollars spent in more weeks throughout the year.

Mark Churchill – Piper Jaffray & Co.

And can you give any guidance how it’s going to be spent through the rest of the year? Third quarter weighted or fourth quarter weighted?

Michael J. Mendes

I’m not really prepared to give that outside of what we’ve already done. I think kind of as a rule of thumb, Mark, I generally take last year’s guidant control for the specific change that we have revised but I don’t – the one part of our spending that is advertising is demos and so we will be doing some demos in the third our the fourth quarter. The actual timing of that depends on when our product shifts in, so there’s a little noise around timing on that and I apologize I can’t give you more color on that.

Steven M. Neil

We did say that it should normalize, what you saw is a heavier spend here in the second quarter. Last year there was a heavier spend in the third quarter, so it should normalize around the third quarter and then the fourth quarter again would be comparable percentage wise to the balance of the year, $20 to $22 million for the full year.

Operator

Our final question comes from the line of Sara Lester with Sidoti & Company.

Sara Lester - Sidoti & Company

I wanted to just go back to packaging, I think you’ve talked about introducing some different packaging sizes or styles, is that going to be some additional equipment that you’re going to use or is that going to be outsourced for now?

Michael J. Mendes

On the packaging front we were looking at leveraging our PET concept, this clear single wall barrier packaging for peanuts versus our multi-layered green packaging which is sort of that 11 ounce peanut size. What we’re really trying to accomplish is to get a larger frame package but the idea was to leverage our PET equipment so our plan is to do that in house and really to use that strictly for peanuts. If it works well on peanuts we may use that for some of our value partners for a few other nuts. But it’s intended for peanuts, it’s intended to be a PET pack. One thing about a PET package is it’s a pre-made package but it has one layer in the package versus our traditional canister which is a multi-layered film which is less permeable and has a better shelf life. Our thought process on this peanut item is it still gives us very good shelf life but given the turns of that product this might be a better costs efficient package and a larger size package.

Operator

There are no further questions at this time. Are there any closing remarks?

Michael J. Mendes

Before we conclude our call today we want to remind you of a few upcoming events. We are presenting at the at the Sidoti Conference in New York in March and the Piper Jaffray Conference in New York in June. For more information about these and other investor events please check our investor calendar on the Diamond website. Also, if you’re looking for some exercise that is a bit more ambitious than ranking the leaves this weekend we invite you this Sunday to join us for the Emerald Across the Bay 12K which is recognized as one of the best bridge runs in the America. So, if you’ve never had a change to run or walk across the Golden Gate Bridge, we invite you to join us for this event and then enjoy some of our healthy Diamond and Emerald products when you cross the finish line. Thanks for joining our call today.

Operator

Ladies and gentlemen this concludes the Diamond Foods fiscal 2008 second quarter earnings conference call. You may now disconnect

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Source: Diamond Foods, Inc. F2Q08 (Quarter End 1/31/2007) Earnings Call Transcript
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