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Diamond Foods, Inc. (NASDAQ:DMND)

F4Q08 Earnings Call

September 25, 2008 4:30 pm ET

Executives

Robert Philipps – Vice President of Investor Relations

Michael J. Mendes – President & Chief Executive Officer

Gary K. Ford – Chief Operating Officer

Steven M. Neil – Chief Financial and Administrative Officer

Andrew Burke – Senior Vice President Marketing

Analysts

Heather Jones - BB&T Capital Markets

Mark Argento – Craig-Hallum Capital Group

Kenneth Zaslow - BMO Capital Markets

Diane Geissler - Merrill Lynch

Operator

Welcome everyone to the Diamond Foods fourth quarter and full year fiscal 2008 earnings conference. (Operator Instructions) I would now like to turn the call over to Mr. Phillips.

Robert Philipps

Welcome to the Diamond Foods investor conference call and webcast to review the financial results of our fiscal 2008 fourth quarter and full year, which ended July 31, 2008.

Before we get started, let’s cover a few housekeeping items. First, a printed copy of our prepared remarks is currently available on our website diamondfoods.com under the section titled Investor Relations followed by Earnings Releases.

Second, we've arranged for a telephone replay of this call to be available about two hours after the call’s conclusion and it will remain in effect until midnight Eastern Time on October 2, 2008. The dial-in number to access the replay is either 1-800-642-1687 or 706-645-9291 and the conference ID is 62420021. In addition, this call is being webcast live and a replay also available on the website.

Third, we want to remind you that 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 these projections, we 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 forward-looking statements are based on factors that are subject to change and therefore these statements speak only as of the date they are given. We do not undertake to update 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

Thanks, Bob. Good afternoon everyone, and thank you for joining us. With me on our call today will be Gary Ford, our Chief Operating Officer and Steve Neil, our Chief Financial and Administrative Officer. Andrew Burke, our Senior Vice President of Marketing, will also be joining us for questions as we conclude our opening remarks.

Fiscal 2008 was an outstanding year for Diamond Foods. We demonstrated the intrinsic profit generation potential of this business, particularly during a period in which we faced record high input costs while funding significant brand building investments to strengthen our snack portfolio.

In the third quarter, we raised full-year 2008 EPS guidance to $0.85 to $0.90 per share. We are pleased to report that we succeeded in beating this range by earning $0.91 per share, posting 72% growth over last year.

Two major factors behind this profit expansion are the effective execution of cost reduction initiatives and strong growth of our retail business. Let me turn the call over to Gary Ford to review our progress in these areas.

Gary K. Ford

Thanks Michael.

We have made some great progress in our operations area to lower costs and improve efficiencies. Some of the most impactful include restructuring several areas of our walnut receiving and processing operations, including consolidating in-shell processing in Stockton and eliminating some off-site storage locations. These actions saved us over $1.5 million. We also optimized the utilization of the Dried Fruit Association inspection services, saving us $540,000. We reduced the cost of our packaging operations by $350,000. Most of this came from the installation of a PET packaging line that was instrumental in our successful launch of Cocoa Roast Almonds and Sea Salt & Pepper Cashews into the club channel. And we reduced warehouse and shipping supplies, which saved us $250,000. In addition to these projects, there were several others which not only saved money, but were environmentally friendly:

We streamlined our distribution network in order to reduce miles driven and finished goods inventory. By consolidating seven retail forward warehouses into four, we saved over $1 million and offset fuel surcharge increases.

We installed a new HVA system in our Stockton plant that allows us to separately manage the temperature of each zone in our 120,000 square foot refrigerated storage area. We estimate the annual savings will be approximately $600,000.

We completed the installation of motion-sensing, high-efficiency lighting fixtures, and estimate energy savings of approximately $135,000.

Another major contributor to profit expansion was the continued growth of our branded North American Retail business, which was up 24% during the quarter and 11% for the year.

In snack, one of our key execution initiatives for fiscal 2008 was to increase distribution of the core ten Emerald items, and we did so by growing our shelf presence by 28%. This initiative will continue to be an important area of focus during fiscal 2009.

Innovation continues to be the cornerstone of our growth strategy. Our recently launched Cocoa Roast almonds and Sea Salt & Pepper cashews are among the top ten fastest growing snack nuts in U.S. grocery.

Breakfast-On-The-Go, which was launched in the mass merchandiser channel in June, has now gone through several re-order cycles and consumer take away has exceeded both our expectations, as well as our customer’s. We are now evaluating how we will expand the line.

In fiscal 2009, we plan to launch additional new items. One of these is a line of four, 100- hundred-calorie pack items. This line will feature the following offerings: natural almonds; natural walnuts & almonds; cocoa roast almonds; and dry roast almonds. We continue to see growth in portion control across the snack category, and our items will enable consumers to enjoy a nutrient-dense, flavorful snack that only Emerald can deliver.

Culinary sales increased 39% during the quarter, and finished the year at $240.0 million, up 16%. We successfully executed three price increases for Diamond-branded products primarily due to higher input costs, and we still gained volume. Importantly, we are seeing the culinary nut category grow over the recent quarter which we attribute to consumers reducing their number of out-of-home meals, and preparing more meals at home. Diamond is well positioned to educate these consumers to the benefits of culinary nuts as a simple, wholesome, versatile ingredient that complements any meal.

Now I’ll turn it back to Michael.

Michael J. Mendes

Thanks Gary.

On September 15, we completed the acquisition of the Pop Secret snack business. Pop Secret is an exceptional addition to our snack portfolio. It enhances our distribution footprint in the snack aisle, is well suited for our supply chain, and expands the breadth of our offering to our target consumers.

Our focus over the next few months is on the rapid and effective integration of Pop Secret into our snack business. We are planning to host an analyst meeting in New York at the NASDAQ market site on January 27. By then we will have had more experience in managing the Pop Secret business, so we expect to provide a more thorough overview of this category and how we plan to integrate this line into our larger snack business.

In August, we announced the addition of Lloyd Johnson to our leadership team as Executive Vice President and Chief Sales Officer. Lloyd has extensive experience in the food and beverage industry, having served in leadership roles at Kraft, Nabisco, and E&J Gallo.

Gary Ford will expand his role in managing our operations and supply chain in light of the acquisition of Pop-Secret and will also assume a new role in grower services. Gary will also look to help us further expand our sales in the areas of vending, food service and our value-added ingredient business.

Looking ahead to fiscal 2009, we are well positioned for the future success of this company. We will continue to right-size our low margin business as we strive to achieve a more optimal mix. This will have a dampening effect on top line growth, but will help to improve margins and allow us to more effectively deploy capital.

While retail represented about 70% of sales in 2008, we expect this portion of our business to exceed 80% next year with the addition of Pop Secret.

With that, I would like to turn the call over to Steve Neil.

Steven M. Neil

Thanks Michael and good afternoon everyone.

Please note that both the press release and 10-K were filed today.

Let me start with a few comments about the quarter and fiscal year. Gross margin for the quarter was 16.5%, well ahead of last year’s 14.8%, reflecting our continuing product mix shift to higher margin sales and cost efficiency initiatives, as Gary mentioned.

Gross profit per pound shipped increased 36% to $0.61 in the quarter despite a 20% increase in costs of goods sold per pound. For the fiscal year gross margin was 16.6%, well ahead of last year’s 15.0%.

For the full fiscal year, SG&A expense was 8.2% of sales compared to 8.1% last year. Excluding stock compensation, SG&A expense was flat between years as we focused on operating margin leverage through the execution of cost reduction initiatives. Advertising expense for the year was $20.5 million, approximately equal to spending during fiscal 2007, and within our guidance expectations.

EPS for the quarter of $0.16 reflects earlier comments we’ve made about the business becoming less seasonal from a profit standpoint as we move the product mix towards retail, branded products. As noted on our press release today, EPS for the year was $0.91, an increase of 72% over last year.

Our net cash position on July 3, 2008, was $54.0 million, compared to $13.2 million at the end of fiscal year 2007.

Adjusted EBITDA, which includes the add-back of equity compensation, was $37.2 million, at the high end of our guidance range.

Additionally, cash flow from operations in 2008 was $47.1 million, a significant improvement from the $3.8 million in 2007. Importantly, this performance demonstrates the attractive cash generation capability of our business.

And finally, we paid a $0.045 per share dividend on July 30, which is 50% higher than the dividend we paid in Q4 last year.

Now I want to talk a bit about our new credit facility, the details of which were included in today’s filings. The new $250.0 million unsecured credit facility replaces three smaller lines totaling $150.0 million that we had with CoBank and Bank of the West, as well as two 7.35% senior notes totaling $20.0 million that we had with Prudential and Teachers.

It is a 5-year agreement with two components, a $125.0 million term loan that has back-end loaded amortization plus cash flow recapture of excess profits, and a $125.0 million revolver. Both have floating rates with credit spreads tied to our leverage ratio. The initial credit spreads start at LIBOR plus 250 basis points and then goes down to as low as LIBOR plus 100 basis points.

We were able to put together an eight-bank syndicate through a best efforts process, thereby saving underwriting fees, which can be significant. The process was led by Bank of America Securities, and the syndicate includes our legacy lenders, Bank of the West, CoBank, and Prudential, plus new lenders in addition to Bank of America which include Keybanc, Wells Fargo, Wachovia and Union Bank.

The offering was oversubscribed, so that afforded us the option to upsize it and take out the more expensive long-term senior notes. Since we did so, we’ll report during the first quarter of fiscal 2009 a one-time early debt termination charge of about $2.6 million which results from paying a make-whole provision on the retirement of the notes.

Now, let me shift gears and provide some more detail about our financial expectations for fiscal 2009. As we said during the initial Pop Secret announcement, we expect full-year non-GAAP EPS to range from $1.20 to $1.27 per share. GAAP EPS would be impacted by the early debt termination charge I just mentioned, which is about $0.10 per share.

We expect total sales to be between $585.0 million to $615.0 million, driven by North American retail sales growth of between 27% and 31%. Included in this growth is an assumption that Snack sales will be between $175.0 million to $185.0 million. Note that the snack number includes a partial year of Pop Secret sales, and as Michael mentioned, we will continue the right-sizing of low margin business during fiscal 2009.

Gross margins should continue to improve as a result of efficiency initiatives that we are driving in the manufacturing and supply chain areas, the right-sizing of our low margin business, and, of course, the addition of Pop Secret, which has higher gross margins than our core nut business. As a result, we expect gross margins to be in the range of 18% to 19%.

Let me also note that one of the advantages of having Pop Secret in the portfolio is that it is a much less commodity-dense product than some of our snack and culinary nuts. To give you a better sense of this, we expect corn to represent only about 2% of our total cost of goods sold.

Advertising expenses will range from $26.0 million to $29.0 million, reflecting the investments we plan to make in Pop Secret as well as continued heavy support of the Emerald and Diamond brands, and cross-promotional activities.

Interest expenses are likely to run between $9.0 million and $10.0 million, reflecting higher levels of debt incurred from financing Pop Secret.

The effective tax rate should be between 37% and 38%. This reflects a slightly lower estimated discrete item credit than what we realized in 2008 when our effective tax rate was 35.4%.

Cap-ex was $6.6 million in fiscal 2008, but will increase to between $10.0 million to $13.0 million in fiscal 2009 as we invest in some new Pop Secret ideas, information technology improvements, and equipment associated with manufacturing efficiency and capacity.

For the first quarter of fiscal 2009, we expect the top line to be between $190.0 million- $205.0 million, and EPS to be between $0.60 to $0.63, which compares to $0.52 in last year’s quarter.

In 2006 we provided performance targets for 2011. Now let me turn the call over to Michael for some comments on these targets.

Michael J. Mendes

Thanks, Steve. In the past, we have shared our long-term financial targets through 2011 which are comprised of the following objectives: annual North American retail sales growth to average 14% to 18% per year; snack sales to reach $200.0 million to $250.0 million by 2011; to increase our gross margin to 20% and operating margin to 10% by 2011; and to grow EPS an average of 40% to 50% per year over this period.

We are making great progress against these long-term objectives. And, with the guidance we’ve communicated for fiscal 2009, we are well on our way to accomplishing some of these targets prior to 2011. As a result, we plan to update our long-term targets at this time next year, after we have a deeper understanding of how the addition of Pop Secret will impact our total business.

At this time, we’d like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Heather Jones with BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

I had a couple of questions. One was I’m curious about your new walnut prices. Recently the estimate for the crop, it seems like it’s going to be up about 15% year-on-year and I’m just wondering if you think that’s going to bring down prices there?

Michael J. Mendes

We did note that the crop is going to be quite larger, based on the estimate. I think some of the things you need to factor, sort of into the context of that, is total supply. The carry-out inventory is at a record low going into this crop so that will have an impact on total supply.

Additionally, while the dollar has strengthened a bit in these last few weeks, it’s about 4% to 5% weaker than a year ago last year when we were contracting against the crop.

Finally, the pecan crop this year is below the off-cycle crop so it’s going to be a shorter crop and spot prices on pecans are reported to be quite high, considerably higher than even last year’s walnut prices at its peak.

So I think in context, it’s a little too early to say obviously with a larger walnut crop and also larger almond crop, I do think we are definitely are in a position where we can see some stabilization of pricing which would be viewed as a positive for us and that’s dialed into our forecast.

Heather Jones - BB&T Capital Markets

How much did the culinary category grow during the quarter? The category, not your sales. I think last year, or fiscal 2008, you benefited from being added to the bake aisle at Walmart and so I’m just trying to get a feel for what kind of growth are you projecting into fiscal 2009 for culinary.

Andrew Burke

The culinary category over the last quarter, and this is based on syndicated data, in terms of dollars was up about 6%. And that comes off a 52-week number of about 4%. The thing we like to see about that, which was mentioned in the call, was the culinary category seems to be really increasing over the last quarter and what we think is the driver of this is the fact that consumers are cutting down the amount of meals that eat out of home and they are preparing meals at home, which is perfect for our brand and our business and supports a lot of the activities that we are currently doing.

Heather Jones - BB&T Capital Markets

So what drove your culinary growth? Again, I understand the bake aisles and I guess it would have been your Q1 last year, but this quarter what kind of increased distribution do you have? Because did I understand culinary sales were up 39%?

Gary K. Ford

Distribution was pretty well flat. We are in the 90% range for ACV. We just saw higher consumer take away in really all channels: club; mass merchandiser; and traditional grocery. And I think Andrew is right, we are seeing consumers preparing more meals at home; that’s a positive impact.

And we also, because of the tight supply, we did have good levels of inventory positioned, particularly at the club level where we probably got a little pick up in possibly what might be small bakeries and in the food service channel through the club business.

Michael J. Mendes

Also, as we mentioned earlier in the call, we take three pricing actions throughout the year which obviously we saw more benefit of that in the back end of the fiscal year than we would have earlier and mapping against those numbers we saw some nice price strength in our total numbers.

Heather Jones - BB&T Capital Markets

I think I may not have asked my question clearly. When you said the category was up 6%, was that on volume or sales?

Andrew Burke

That was on dollars. Dollar sales.

Heather Jones - BB&T Capital Markets

And your dollar sales were up 39%?

Steven M. Neil

That’s correct.

Heather Jones - BB&T Capital Markets

Did price increases greatly exceed the category?

Andrew Burke

Those are shipping dollars.

Michael J. Mendes

And that’s idea, that’s the food, the syndicated segment. Our shipments are all channels. So keep in mind, for example, in our numbers are club shipments. Some of the benefit we enjoyed in the last quarter is that as inventories were low a lot of the small bakery distributors that the club customers sometimes sell to were looking to the club channel as a source where maybe that might have come through some other channels in the past.

Heather Jones - BB&T Capital Markets

On your 2011 snack guidance, because it looks like if you back out Pop Secret for the roughly 10.5 months it will be in there, that you are guiding to about $90.0 million to $100.0 million in snack sales, so call it 10% growth, roughly, at the top end. And I’m just wondering where you get your confidence to take that core snack business from $100.0 million to $200.0 million to $250.0 million by 2011?

Steven M. Neil

Gary mentioned in the prepared remarks that one of our focuses is significantly on our distribution. We increased distribution in grocer by 28% last year. Our core of ten items of snack nuts will continue to focus there significantly during 2009. So we are certainly not decelerating at all our expectations on snack nuts.

But I think in a broader sense what we’re looking at for the snack market is with Pop Secret in there, we are taking a look at our priorities and what is the strongest profitable growth to the market that we can bring with our overall product mix. And frankly, what we can do to stimulate profitable growth at our customer.

So it’s not as much a focus on one product, one channel, it’s focused on our current product portfolio. So don’t read into any of the messages that we’re decelerating or accelerating any of our products. We are a different company now with Pop Secret, which avails ourselves to a lot of different priorities and we are going to chase those, certainly from a more material, significant impact one.

So we will realign our priorities. But, again, we’re pretty comfortable with growth in all channels and all products.

Heather Jones - BB&T Capital Markets

You’re maintaining the $200.0 million to $250.0 million on core, ex Pop Secret snacks. So combined looking at somewhere between $300.0 million to $350.0 million snack sales by 2011?

Michael J. Mendes

That’s not correct. What we have said is we were planning to grow our snack business to $200.0 million to $250.0 million and we have always clearly stated that we would, when asked about acquisitions, we would always make a decision between what was best for the company to build or to buy. We had an opportunity to acquire a business that is squarely in the snack aisle in which we participate and now we’re going to be reframing where we focus attention and the resources put behind those opportunities in context of the brands that we currently have.

I think that it is interesting when you look at the intrinsic gross margin of the Pop Secret business and you look at the new products in the pipeline that we have an opportunity to fund the expansion to, in context of the snack business we had ex-Pop Secret, we are going to have to evaluate the best place to focus and the time which we will resources against the relative new products.

So again, the intrinsic ability for Emerald to be north of a $200.0 million business, stand alone, definitely stands there, as it has in the past. Now, though, that brand will be competing with this new brand for resources through the time we grow that business. So we will be making the best economic decisions and fueling the total snack growth in concert.

Steven M. Neil

And let me just pile in one more second. One of the reasons why, in our prepared remarks, and I think it was Michael commented that we will come back to you this time next year with long-term guidance, once we’ve got Pop Secret under our belt and see what the future is, that we really learn that business. Rather than just add up numbers and throw out a number for, I’ll call it modeling sake internally, we want to really understand the business and the multiples that we can put up cross promotions, etc.

So we didn’t want to get too far out there and just add numbers together and put a stake in the ground without us really understanding the business and knowing how to drive it. So we thought that integrity and really that good focus so we do have a meaningful mid- to long-term target was most appropriate, so that’s why we didn’t really give you that number at this time.

Heather Jones - BB&T Capital Markets

I had just always been under the impression that your 2011 margin and sales targets were organic and that acquisitions would be gravy to that.

Operator

Your next question comes from Mark Argento with Craig-Hallum Capital Group.

Mark Argento – Craig-Hallum Capital Group

Maybe I will go after the culinary question a little differently. Could you just talk about on a unit basis, per pound, how many more pounds of product did you ship this year in the quarter than last year, so we can get a little better idea where the growth came from in terms of how much should we ascribe to price increases versus unit volume? If you have that data, that would be helpful.

And then your expectations in terms of Pop Secret, like the last individual was talking about organic growth rates relative to adding back Pop Secret, do you expect in year one you will be able to grow Pop Secret from that $85.0 million-ish run rate on an annualized basis? What are your expectations built into your guidance for the year?

Steven M. Neil

We really don’t want to get into putting too much data out onto the call in volume and pricing. I just will say that the growth in the fourth quarter was a combination of volume and price. So we did grow volume in the quarter. We also had the benefit in the last quarter, compared to the prior year, of the price increases we had. So it was not simply price but there was unit growth as well.

I’ll let Michael handle the Pop Secret question.

Michael J. Mendes

On the Pop Secret business, we have owned this business all of ten days, and that’s counting the weekends. So I think that humility would serve us well as we approach our vision for the future. I will tell you, we will know a lot more about this business and its growth potential as we move out in January. Hopefully we will have a chance to sit together when we have that analyst meeting at that time.

I would say that our focus at this time is to sustain our distribution. You know, General Mills has a tremendous sales force, a direct sales force, that managed their business. We are taking over that business through our broker network and we recognize that the distribution is quite strong on the brand, there are a lot of good items that have very nice location on the shelf. We really need to stabilize that base distribution. We need to do a great job of getting movement with the product to show our retail partners that we are additive to the category.

And I think first stabilize and put ourselves in a position for growth going to next fiscal year would be at the heart of our objectives. And if as a result of that, we get some growth, that is going to be some upside.

So I think when you again, in the context of this, you know, with the Pop Secret business at grocery on a per-average-customer is actually larger than our existing Emerald business. So we have a lot to take on there. We want to try to do a good job of stabilizing that business and optimizing the promotional effectiveness.

Mark Argento – Craig-Hallum Capital Group

Are you guys content with 10% growth? I assume that you are going to come into the Street with relatively conservative guides of 10%-ish type growth in the core snack business, ex-Pop Secret. And what are your thoughts, in that 10% kind of, let’s assume you’re holding Pop Secret flattish, we’ll call it, on a year-over-year basis, what kind of assumptions does 10% leave us with in terms of additional distribution? Do you have any assumptions built into your expectations that you’re going to pick up material distribution for the year?

Michael J. Mendes

First of all, those break outs are your numbers, those are not ours. We have not broken out those components. And keep it mind it’s not a full year of Pop Secret sales that we have here. We have 45 days of the fiscal year have gone by before we picked that business up.

But the upward trajectory on Emerald is primarily, at this point, we believe going to be driven by some nice work we have already began in expanding our distribution in the club and mass merch side of the business.

We mentioned in some of the previous calls some test we’ve done with our Coca Roast almond in a 38-ounce PDT pack in the club set. We are very pleased with the performance on that item. We think that it is going to grow in distribution. Very well received, got a lot of positive reviews from consumer trade publications.

We’ve got about five items in small tests to our various club customers which we feel very confident that some of those of tests are going to get us some permanent distribution in a large in-order in the clubs. So we’re quite pleased with the trajectories on that front.

On the mass merch side we have two Breakfast-On-The-Go items which we secured distribution on this year, two of those items in over 3,000 mass merch retail outlets. We are happy with the velocity of those items and again, we had a partial year on that and if we can hold our distribution and that becomes an everyday item, that’s intrinsically going to give us some growth.

So I think we have the building block today for growth that gets us on the right trajectory. And I also am just pleased about the expansion of our distribution of our core items. You know, that is some spade work that is not sexy but is really, I think, at the heart of driving greater velocity of our brand.

I mean, one thing, in Gary’s comment he mentioned that we increased our core item distribution by about 28% and that’s very important for us. That means that we’re getting more of the mainstay items that are franchises of the retailers, the kind of items the retailers are going to sell every day, that the retailer intrinsically has demand for, no matter who the brand is. That first the gain distribution on that sector of products versus new, unique products, there’s just a lot of velocity there naturally and we can partake in that and we think we can really excel because we think our products have superior quality and packaging on top of that.

Finally, you look at something like Trail Mix. Our trends on Trail Mix are very good. Our sales velocity for the 52-week is up 22% and on the 4-week period our sales are up 40%+. That’s a great base item, I think it’s a unique item. We have a proprietary blend of products and as we gain distribution I think that’s terra firma that we’re going to be able to hold on well into the future.

So I think that we see some very nice growth, but we see them in franchised products. Items that we are pleased to be lapping in the future. And I think that’s the key as a growing, young, publicly-traded company, is are we building terra firma growth? Are we building a foundation that we can stand in the future? And I really feel that the growth that we’re building in 2009 is going to set up 2010. And I think we assume you heard in our last call is we’re very keen on using 2009 to really establish our footprint in 2010 and we see that being a particular break out year on the snack side, which we’ve been focusing on most.

Mark Argento – Craig-Hallum Capital Group

On pricing, historically when you take price increases at retail do they typically stick or do you ever see price erosion at retail? Meaning how sustainable should those increases be?

Michael J. Mendes

Generally we have very strong pricing power with our brands. I think that when there is some erosion from either off-brands or own-label that may result in some increased promotional activity, over the long term if there is a significant value differential, there can be erosion but generally if there is a bit of a need to provide more value, we can do that through promotional events.

Operator

Your next question comes from Ken Zaslow with BMO Capital Markets.

Kenneth Zaslow - BMO Capital Markets

Have you guys decided if you’re going to split up the snack nuts from the Pop Secret business in the sales line? I know that was a question I asked last time, I didn’t know if you gave more thought to it.

Michael J. Mendes

We have given more thought to it and I kind of touched on, I think with Heather, we are going to focus on the whole snack category. We’ve got more SKUs obviously now with Pop Secret and our focus is just going to be driving the top priority products, channels, customers, etc. and not really focus on snack nuts and popcorn.

So the other thing that you get to that gets to be difficult, and this is the defensive side, is how do you allocate cross promotions and distribution charges, etc., and I don’t want to spend time focusing on those allocations. I would rather focus on the category and, frankly, our buyers are focusing on our snack products, not just snack nuts or popcorn. So we’re going to show just snack as one item and drive growth through that one item.

Kenneth Zaslow - BMO Capital Markets

The other thing is just to clarify on Heather’s point and clarify your point on this, the $200.0 million to $250.0 million snack nut sales was always inclusive of acquisitions? I might have misunderstood that, is that true?

Michael J. Mendes

That’s been our snack goal and it was build-to-buy has been how we’ve evaluated that. I think the thing to keep in mind is that obviously in the absence of the Pop Secret acquisition we would have a lot of band width to focus on our core snack items and our new products. Now in context of this larger business, we have got a much larger portfolio to manage, a whole new set of new products to evaluate in terms of which items are going to get slotting and incremental promotion, and so that’s going to, we conceive, our view, again, I think that intrinsically the base of the Emerald brand is very strong.

I think the thing that gets me excited is when you put these two brands together and you look at our critical mass in that snack set and our ability to promote with that snack buyer that we’re going to see a lot of benefits for both brands by marketing the two together.

So, yes, that’s correct. And back to Steve’s point about how we look at the business, I think it’s interesting when you ask yourself how would the buyer look at our items and how would we be evaluating the product line. You know, Pop Secret, one of their more successful product lines is their 100-calorie product line. We now are introducing a new set of 100-calorie Emerald snack products. We are going to be presenting that whole 100-calorie portion control portfolio as a set. We will not be designating by raw material type. So just give you a little more color on how we’re looking at the business.

Kenneth Zaslow - BMO Capital Markets

In terms of sales growth, if you look at the annual versus the quarter, in the snack nuts, it did [decelerate] 11% and most recently 3%. That deceleration was expected or can you just give a little color on why that happened?

Steven M. Neil

Our guidance for the year on snack nuts was $85.0 million to $95.0 million. We came in at $89.0 million, so slightly below that midpoint. And a lot of that has to do with the timing of new distribution and slotting, the timing of promotions, we had a couple of joint promotional activities with some of our partners and so it’s very, very difficult to kind of land on a dime there as to what that number is. So we were very much within our expectations of snack for the quarter and certainly are not disappointed at all as to where we landed.

Kenneth Zaslow - BMO Capital Markets

How accretive is Pop Secret. I know you have it only 10 days, I’m assuming you have some financial outlooks on this. Just give us some idea of how accretive this is to 2009.

Michael J. Mendes

Our thoughts haven’t changed from when we announced back in August. It is going to be accretive, including financing costs. It should be mid-single-digit accretive is where our thinking is today. That hasn’t changed. We’re really excited about it. We definitely think there are ways to drive growth, etc. but even after 10 days, and we all did work the weekend because other parts of our business is going right now as well. It’s still too soon to tell as to how much more there could be there but we are very comfortable that it will be accretive and we look to grow it.

Kenneth Zaslow - BMO Capital Markets

When you say mid-single digit, is it $0.09 or is it $0.04 to $0.07?

Michael J. Mendes

$0.04 to $0.07.

Kenneth Zaslow - BMO Capital Markets

Is it a percentage of growth or a percentage of cents?

Michael J. Mendes

BPV.

Kenneth Zaslow - BMO Capital Markets

So it’s like $0.04 to $0.05 is what you think it is?

Michael J. Mendes

Correct.

Kenneth Zaslow - BMO Capital Markets

Is it the advertising that is going to take it down? Because if I look at the margin structure I can almost get to $0.15 to $0.20.

Michael J. Mendes

I think there’s a couple of things you have to figure in and what we have factored in. Yes, advertising, as you saw our forecast for the year of $26.0 million to $29.0 million is significantly up and so we’re certainly going to support Pop Secret as well as continue to heavily support Emerald and Diamond. You do have financing costs involved in there. And frankly, we didn’t want to get too out in front of ourselves as to our ability to grow the business until we’ve actually owned it and experienced it. As the nature is of acquisitions now-a-days, you don’t get that much in due diligence until you actually own the beast.

And we now firmly own the beast and we’re running it but it’s still a little bit early days and I don’t think it benefits us too much to get too far out there on expectations of cost efficiencies. If we look long term the gentleman sitting next to me here, Mr. Ford, is going to drive as much efficiencies out of popcorn as he has the nuts and so we are very, very comfortable with that. It’s just that we would rather take a conservative-growth view in that first year and gain experience.

Steven M. Neil

And also in order to really ensure we do a strong job in integration, we negotiated to pay for transitional services for an extended period with General Mills. We think that’s very prudent in terms of assuring a smooth integration of this business, but we have hired a lot of the people who are going to be running that business so that’s going to duplicate our costs for a five to six month period and we hope that we will see some more efficiency when we’re lapping these numbers next year when we don’t have that transitional services agreement.

Operator

Your next question comes from Diane Geissler with Merrill Lynch.

Diane Geissler - Merrill Lynch

I missed the first part of the call, but did you talk about your expectations on your costs for next year, in terms of nuts, almonds, walnuts, peanuts?

Gary K. Ford

We are going to have a record walnut crop if the estimate comes to fruition, about 375,000 tons. That’s up 15%. But we’re early. The crop is running a little late. We are going to have good supply. We are not ready to speculate on pricing but we know it appears at this point in time that we are going to have adequate supply and great quality.

As you are aware, there is going to be a record almond crop as well, about 5 billion pounds, and almonds is about 30 days ahead of walnuts in terms of harvesting that crop. It looks very good. At this point in time it looks like that number is going to be there so we’re expecting stability with adequate supply there.

And in pecans, while this is the off year for an alternate bearing crop, because a lot of that production has shifted to Mexico, maybe as much as 1/3 of the crop this year, we are expecting a decent off year, we are expecting adequate supply there as well.

And then in peanuts, that crop appears right now, based on the USD estimate to be up about 20% versus prior year.

So when you look at the four big ones, we are expecting adequate supply but at this point in time we are not prepared to say what that’s exactly going to do in pricing. But supply looks to be very adequate.

Michael J. Mendes

I think what I would characterize generally is that one thing about the walnut industry is that they have the lowest carrion in history. That’s coupled by the fact that although the dollar is a little stronger over the last few weeks versus a year ago, the dollar is 4% weaker. And with the pecan crop being short, that could provide an environment that walnut prices might stay stronger than they would otherwise.

I guess one thing we do feel comfortable with is, since we went public three years ago, we’ve seen constant accelerating input prices in these general commodities. And I think we are in an environment where we should see that stabilizing and that’s what we’ve built into our model.

Diane Geissler - Merrill Lynch

The other question I have is your categories strike me as ones that are what one could consider a discretionary item and carry a rather high price point, particularly on the tree nut side. Can you talk about are you seeing trading out of your category because of economic reasons? Obviously gas has come down but the period you are measuring here really measured that period and since then we’ve only had bad news. Could you talk a little bit about the discretionariness of your category.

Michael J. Mendes

Andrew did speak to that broadly but let me just give a little more color on what Andrew shared. What we have noted is that out-of-home meals seem to be declining and people are looking to at-home-prepared meals as a better value opportunity. We’ve actually seen the 52-week, 12- and 4-week trends skewing positively, in terms of culinary nuts in our business in particular. And we think that is a bit of a reflection of people recognizing the better value of at-home meals. And so we think that actually plays nicely for our culinary product line.

I do think that we may see a little bit of context in terms of maybe which pack sizes people may pick. I think that there may be some shifting to smaller pack sizes. I think while that may have a little bit of erosion on the otherwise trajectory of the sales dollars, the margins are better for us in those items. So I feel that we have ways in which we think we can optimize, particularly in culinary for that area.

On the in-shell nut side, I think that that produce segment, because the pricing is done annually, there’s not a lot of consumer memory on the price point. But we think overall the price points will be more attractive than they were a year ago. So I think that should offset maybe some inflationary issues.

And then on the snack products, you know we’re on a bit distribution drive, trying to get more points of distribution for our product. And the fact that we’ve grown quite significantly in the value channels in the mass merchant club, while still we’ve got a long ways to go, we’ve made some nice growth in those areas, I think that’s a good place for us to have some additional distribution going into this kind of environment.

Diane Geissler - Merrill Lynch

When I hear you say we’re on a big distribution drive that makes me think promotional dollars. What’s built into the snack revenue, not the snack nut but the snack revenue, projection for fiscal 2009 in terms of promotional.

Michael J. Mendes

You have accurately assessed sort of our disposition. We are quite focused on, you know, we have a portfolio of 100-calorie snack products that we are bringing to market. We also, for competitive reasons don’t want to share more but we have a few base items that we think we have restructured and repositioned that are going to be very interesting for our snack buyers. This will be in a grocery push.

And then also we have some items on the Pop Secret front that we’re looking to build out that we think is a nice opportunity.

So we have reflected a surge in slotting spending that would reflect building distribution of these items. And I think that’s exciting for us. We feel these are quite mainstream products and so we are going to be working very hard to build our distribution this coming year.

Operator

There are no further questions at this time.

Michael J. Mendes

Before we do conclude our call today, we wanted to remind you of a few upcoming events.

We are presenting at the Wachovia Consumer Growth Conference in New York on October 15th, and the Merrill Lynch Small Cap Consumer Conference in Boston on December 9th and 10th.

We are also a sponsor of the New York Marathon, which will take place on November 2nd, and is part of our Emerald Final 5 Healthy Lifestyle promotion. The program features marquee running events throughout the country, and provides an excellent venue for sampling, nutritional education, and to amplify our natural energy brand positioning.

For more information about our upcoming investor events, please check our investor calendar on the Diamond website.

Thank you for joining our call.

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Source: Diamond Foods, Inc. F4Q08 (Qtr End 07/31/08) Earnings Call Transcript
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