Significant headwinds facing Diamond Foods

by Keith Nunes
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SAN FRANCISCO — Diamond Foods, Inc. faces significant headwinds as it enters the second half of fiscal year 2013, and company executives warned the investment community to expect sales to be down compared to the same period of the previous year as well as the first-half of the fiscal year.

“We plan to stay the course with initiatives designed to fuel our brands,” said Brian Driscoll, president and chief executive officer, in a conference call with securities analysts to discuss Diamond’s second-quarter earnings on March 11. “With that said, we do expect consolidated sales in the back half of the fiscal year to be down more compared to the prior year than we saw in the first half of this fiscal year, primarily due to the full effect of the Emerald s.k.u. (stock-keeping-unit) reduction, the reduced amount of walnuts available to sell, and the continuing emphasis on net price realization.

“Our consolidated gross margin has been fairly stable for the past two quarters and we currently believe represents a reasonable estimate for the remainder of the year. With that said, our margin level may fluctuate if we decide to make opportunistic changes to our brand development tactics and/or face increased walnut or other commodity costs.”

Sales during the second quarter ended Jan. 31 totaled $220,844,000, down 16% from the same period a year ago. Diamond Foods recorded net income of $10,141,000, equal to 46c per share on the common stock. The company incurred a loss of $20,184,000 during the same period of the previous year.

Mr. Driscoll said the transformation of Diamond’s Emerald nuts line is progressing as evidenced by the 690 basis point expansion of gross margin during the second quarter of fiscal 2013 compared with the same period in fiscal 2012. He added that the Emerald brand will make a full transition through Diamond’s shift away from discounting and s.k.u. reduction by the end of fiscal 2013, and anticipates Emerald brand sales increasing during the first quarter of fiscal 2014, which starts in August.

Another challenge the company faces is developing innovation in the Emerald portfolio and throughout the entire company.

“Our pipeline is not yet as robust as we plan it to be,” Mr. Driscoll said. “It takes time to build out the capability necessary to produce the kind of insulating innovation and marketing programs required to win consistently in the marketplace.”

The final, and perhaps most challenging, headwind facing the company is the supply of walnuts available. Calling acquiring supply a “chief priority” of the company, Mr. Driscoll said Diamond Foods invested a significant amount of time working with California walnut growers in an effort to attract more supply.

“As we’ve mentioned previously, we prioritize our walnut supply to our retail branded business first and we do have ample supply of walnuts to serve our Diamond of California brand as well as certain other select volume,” he said. “However, to fully exploit the growth potential of our overall walnut business, we need to expand our supply base. Our efforts with growers to rebuild our walnut supply will be ongoing. We are encouraged by our progress on contract renewals to date, and we remain optimistic as the contract renewal season continues through the summer.”

But Mr. Driscoll added that the company will not know their walnut supply position until mid-summer.
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