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DMND > SEC Filings for DMND > Form 10-Q on 9-Jun-2014All Recent SEC Filings

Show all filings for DIAMOND FOODS INC

Form 10-Q for DIAMOND FOODS INC


9-Jun-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are an innovative packaged food company focused on building and energizing brands. We specialize in processing, marketing and distributing snack products and culinary, in-shell and ingredient nuts. In 2004, we complemented our strong heritage in the culinary nut market under the Diamond of California® brand by launching a line of snack nuts under the Emerald® brand. In 2008, we acquired the Pop Secret® brand of microwave popcorn products, which provided us with increased scale in the snack market. In 2010, we acquired Kettle Foods, a leading premium potato chip company in the two largest potato chip markets in the world, the United States and the United Kingdom, adding the complementary premium Kettle Brand® to our existing portfolio.

Our business is seasonal. In sourcing walnuts, we contract directly with growers for their walnut crop. We typically receive walnuts during the period from September to November, and we pay for the crop throughout the year in accordance with our walnut purchase agreements with the growers. We typically receive in-shell pecans during the period from October to March, and shelled pecans throughout the fiscal year, and pay for them over those periods upon receipt. As a result of this seasonality, our personnel, working capital requirements and walnut inventories peak during the last four months of each calendar year. We experience seasonality in capacity utilization at our Stockton, California facility associated with the annual walnut harvest and seasonal in-shell and culinary product demand. Generally, we receive and pay for approximately 50% of the corn for popcorn in November and approximately 50% in April. We contract for potatoes and oil annually and at times throughout the year and receive and pay for supply throughout the year.

During the preparation of the Quarterly Report on Form 10-Q for first quarter fiscal 2014, we determined that the statutory income tax rate used to value United Kingdom deferred taxes as of July 31, 2013 was not correct. This was due to a change in the statutory tax rate enacted in the fourth quarter of fiscal 2013, and resulted in a $3.2 million overstatement of the net deferred income tax liability balance at July 31, 2013 and a $3.3 million understatement of the income tax benefit for fiscal year 2013. We assessed the materiality of the error in accordance with SEC Staff Accounting Bulletin No. 99, Materiality and concluded that this error was not material to the fiscal year 2013 consolidated financial statements. In accordance with SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, due to the immaterial nature of this error, on both prior and projected current year results we elected to revise the July 31, 2013 Consolidated Balance Sheet included financial statements in this filing and we will revise the 2013 consolidated financial statements when our Annual Report on Form 10-K for fiscal 2014 is filed.

Results of Operations

The Company's chief operating decision maker ("CODM") changed during the fourth quarter of fiscal 2012 and in the second quarter of fiscal 2013 there was a change in the information used by the CODM to make decisions about the allocation of resources and the assessment of performance. As a result, during the second quarter of fiscal 2013, we changed our operating and reportable segments. We previously had one operating segment and one reportable segment; we now aggregate our operating segments into two reportable segments, which are Snacks and Nuts. The Snacks reportable segment predominately includes products sold under the


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Kettle Brand®, Kettle Chips®, and Pop Secret® trade names. The Nuts reportable segment predominantly includes products sold under the Emerald® and Diamond of California® trade names. The Company evaluates the performance of its segments based on net sales and gross margin for each segment. Gross profit is calculated as net sales less all cost of sales.

Our net sales and gross profit by segment for the periods identified below were as follows (in thousands):

                                   Three Months Ended                            Nine Months Ended
                                        April 30,            % Change from          April 30,            % Change from
                                   2014          2013        2013 to 2014      2014          2013        2013 to 2014
Net sales
Snacks                           $ 114,255     $ 104,201          10%        $ 343,601     $ 320,865           7%
Nuts                                76,637        80,704          -5%          302,536       343,346         -12%

Total                            $ 190,892     $ 184,905           3%        $ 646,137     $ 664,211          -3%

Gross profit
Snacks                           $  41,699     $  36,684          14%        $ 123,660     $ 109,812          13%
Nuts                                 3,397         6,666         -49%           35,297        42,653         -17%

Total                            $  45,096     $  43,350           4%        $ 158,957     $ 152,465           4%

For the three and nine months ended April 30, 2014, aside from favorable impact of foreign exchange on net sales, Snacks segment net sales increased to $114.3 million and $343.6 million from $104.2 million and $320.9 million, respectively, primarily due to increases in volume of 11.4% and 8.1% and product mix, partially offset by increased promotional activities.

For the three and nine months ended April 30, 2014, Nuts segment net sales decreased to $76.6 million and $302.5 million from $80.7 million and $343.3 million, primarily driven by decreases in volume of 8.1% and 15.1%, respectively. The decline in volume was primarily driven by lower walnut supply. The decreases in volume were partially offset by product mix in our Emerald brand, and increases in pricing in our Diamond of California brand.

Sales to our largest customer, Wal-Mart Stores, Inc. (which includes sales to both Sam's Club and Wal-Mart), represented approximately 18.5% and 16.2% of total net sales for the three and nine months ended April 30, 2014, respectively, and 13.2% and 17.0% of total net sales for the three and nine months ended April 30, 2013, respectively. Our second largest customer accounted for less than 10% of total net sales for the three and nine months ended April 30, 2014 and 12.3% and less than 10% for the three and nine months ended April 30, 2013. No other customer accounted for 10% or more of our total net sales for those periods.

Gross profit. Snacks segment gross profit as a percentage of net sales was 36.5% and 36.0% for the three and nine months ended April 30, 2014 and 35.2% and 34.2% for the three and nine months ended April 30, 2013, respectively. The increase is largely driven by increases in volume, product mix and a reduction in certain commodity costs for the three and nine months ended April 30, 2014.

Nuts segment gross profit as a percentage of net sales was 4.4% and 11.7% for the three and nine months ended April 30, 2014, respectively, and 8.3% and 12.4% for the three and nine months ended April 30, 2013, respectively. For the three months and nine months ended April 30, 2014, the decrease in gross profit as a percentage of net sales was driven by decrease in volume and increases in commodity costs for the Diamond of California and Emerald brands. As discussed in Item 1A. Risk factors, our commodity costs are subject to fluctuations in availability and price that could adversely impact our business and financial results.

Selling, general and administrative. Selling, general and administrative expenses consist principally of salaries and benefits for sales and administrative personnel, brokerage, professional services, travel, non-manufacturing depreciation and facility costs. Selling, general and administrative expenses were $30.7 million and $121.1 million and 16.1% and 18.7% as a percentage of net sales for the three and nine months ended April 30, 2014, respectively, and was $35.3 million and $105.8 million and 19.1% and 15.9% as a percentage of net sales for the three and nine months ended April 30, 2013, respectively. For the three months ended April 30, 2014, selling, general and administrative expenses decreased primarily due to lower audit and consulting fees in the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013 and cost saving initiatives. For the nine months ended April 30, 2014, selling, general and administrative expenses increased primarily due to the $38.1 million loss recorded as a result of the change in the fair value of the stock settlement of the Securities Settlement. Additionally, in the first quarter of fiscal 2014, we recorded an estimated $5.0 million liability associated with the SEC investigation. On January 9, 2014, the SEC authorized the $5.0 million settlement between the Company and the SEC which was paid to the SEC in the second quarter of fiscal 2014. These increases for the nine


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months ended April 30, 2014 were partially offset by the $1.6 million gain relating to the shareholder derivative settlement in the first quarter of fiscal 2014, incurring no costs related to the Audit Committee investigation and related legal expenses as compared to prior year, and lower audit and consulting fees.

Advertising. Advertising costs were $8.6 million and $32.4 million for the three and nine months ended April 30, 2014, respectively, and $8.0 million and $29.4 million for the three and nine months ended April 30, 2013, respectively. Advertising expenses as a percentage of net sales were 4.5% and 5.0% for the three and nine months ended April 30, 2014, respectively, and 4.3% and 4.4% for the three and nine months ended April 30, 2013, respectively. For the three months ended April 30, 2014, increases in advertising was due to increases in online media spending focused on support of Emerald brands. For the nine months ended April 30, 2014, increases in advertising expenses was primarily due to an increase in online media spending in support of Diamond of California and Emerald brands.

(Gain) loss on warrant liability. Loss on warrant liability was $2.0 million and $25.9 million, and 1.1% and 4.0% of net sales for the three and nine months ended April 30, 2014, respectively. (Gain) loss on warrant liability was $1.9 million and ($9.2) million, and 1.0% and (1.4%) of net sales for the three and nine months ended April 30, 2013, respectively. The (gain) loss on warrant liability for the three months ended April 30, 2014 was due to the change in the fair value of the warrant liability. As a result of the financing, the warrant was exercised and we no longer have a liability associated with the warrant as of April 30, 2014.

Warrant exercise fee. Warrant exercise fee was $15.0 million and $15.0 million, and 7.9% and 2.3% of net sales for the three and nine months ended April 30, 2014, respectively. Warrant exercise fee was nil for the three and nine months ended April 30, 2013. The $15.0 million warrant exercise fee represents the contractual modification inducement fee paid to Oaktree Capital Management, L.P. ("Oaktree"). See further discussion in the Liquidity and Capital Resources section under Description of Refinancing.

Loss on debt extinguishment. Loss on debt extinguishment and other related charges was $83.0 million for the three and nine months ended April 30, 2014 and 43.5% and 12.9% of net sales. Loss on debt extinguishment was nil for the three and nine months ended April 30, 2013. We recorded certain expenses in accordance with Accounting Standards Codification ("ASC") Section 470-50-40-2 - Debt - Modifications and Extinguishments including the differential between the repayment amount and carrying value of the senior notes ("Oaktree Senior Notes") held by Oaktree, a call premium associated with senior notes held by Oaktree, write-offs of unamortized debt issuance and transaction costs related to our five-year $600 million secured credit facility (the "Secured Credit Facility") and Oaktree Senior Notes and write-offs of unamortized debt issuance costs associated the new refinancing. For additional description of our debt, see Note 10 to the Notes to the Condensed Consolidated Financial Statements.

Interest expense, net. Interest expense, net was $10.6 million and $41.5 million, and 5.5% and 6.4% of net sales, for the three and nine months ended April 30, 2014, respectively, and was $14.5 million and $42.7 million, and 7.9% and 6.4% of net sales, for the three and nine months ended April 30, 2013, respectively. Interest expense, net decreased for the three and nine months ended April 30, 2014 primarily due to our refinanced capital debt structure which yields lower interest rates than our previously held debt obligations which included the election of the payment-in-kind interest on the Oaktree Senior Notes.

Income taxes. Our effective tax rates for the three and nine months ended April 30, 2014, was approximately (0.8%) and (1.8%), respectively. Our effective tax rates for the three and nine months ended April 30, 2013, was approximately 5.1% and (0.3%), respectively. The difference between the effective tax rate and the statutory rate of 35%, in these periods, was primarily due to the valuation allowance which was provided to reduce United States and state deferred tax assets to amounts considered recoverable and the change in domestic deferred taxes resulting from the Company's long lived intangibles' amortization.

The tax provision for the three and nine months ended April 30, 2014, was calculated on a jurisdiction basis. We estimated the United Kingdom income tax provision using the effective income tax rate expected to be applicable for the full year. We estimated the United States (U.S.) income tax provision using the discrete method provided in ASC 740, as a reliable estimate of the U.S. annual effective tax rate could not be made, primarily due to the unpredictable trends existing within the Company's net income (loss) positions due to the loss on debt extinguishment and the above mentioned selling, general and administrative expenses and their impact on results from operations.

Liquidity and Capital Resources

Our liquidity is dependent upon funds generated from operations and external sources of financing.

Cash used in operating activities was $101.9 million during the nine months ended April 30, 2014, compared to $43.9 million cash provided by operating activities for the nine months ended April 30, 2013. The change from cash provided by operating activities to cash used in operating activities was primarily due to decreases in accounts payable, changes in inventories, and repayment of the Oaktree Senior Notes. Cash used in investing activities was $14.4 million during the nine months ended April 30, 2014, compared to cash provided by investing activities of $0.9 million cash provided by investing activities for the nine months ended April 30, 2013. The change in cash used for investing activities primarily related to machinery and equipment additions associated with our standard business operations in the U.S. and U.K. and capitalizable costs associated with our financial system implementation of $5.3 million. In addition, cash provided by financing activities was $117.5 million during the nine months ended April 30, 2014, compared to $40.8 million cash used in financing activities during the nine months ended April 30, 2013. The increase in cash used by financing activities primarily is due to proceeds received from refinanced debt, and proceeds from the Oaktree warrant exercise.


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Description of Refinancing

On February 19, 2014, we refinanced our debt capital structure. We entered into the Term Loan Facility in an aggregate principal amount of $415 million, a 4.5 year senior secured asset-based revolving credit facility (the "ABL Facility") in an aggregate principal amount of $125 million and issued $230 million in 7.000% Senior Notes due March 2019 (the "Notes"). Pursuant to an agreement dated February 9, 2014 (the "Warrant Exercise Agreement"), OCM PF/FF Adamantine Holdings, Ltd. (a subsidiary of Oaktree) exercised its warrant to purchase 4,420,859 shares of our common stock at the $10 exercise price per share for $44.2 million, less a warrant cash exercise and contractual modification inducement fee of $15 million (the "Warrant Exercise Transaction"). The Warrant Exercise Transaction closed on February 19, 2014, concurrent with the refinancing transactions and we derecognized the warrant liability of approximately $84.1 million on that date.

We used the net proceeds of the Term Loan Facility, the Notes and the Warrant Exercise Transaction to (1) prepay approximately $348 million of indebtedness outstanding under, and terminate, the Secured Credit Facility, (2) prepay approximately $276 million of indebtedness outstanding under, and terminate, the Oaktree Senior Notes, (3) pay approximately $32.3 million of prepayment premiums to the holders of the Oaktree Senior Notes, and (4) pay fees related to the preparation, negotiation, execution and delivery of the definitive documentation for the Term Loan Facility, the Notes and the ABL Facility. In accordance with ASC 835-30-45-3 Imputation of Interest - Other Presentation Matters, we recorded $14.3 million of new debt issuance costs associated with the February 2014 debt refinancing as deferred financing charges. Certain debt issuance costs incurred were expensed to Loss on debt extinguishment based on the portion of the refinancing that was considered a debt modification that arose from certain lenders continued participation in our refinanced debt structure. Debt issuance costs largely included arrangement fees paid to underwriters, legal fees, accounting fees, consulting fees, and printing fees. We recorded the current portion of these costs in Prepaid expenses and other current assets and the non-current portion was recorded in Other long-term assets in our Condensed Consolidated Balance Sheets. These amounts will be amortized over the life of the respective new debt agreements.

In accordance with ASC 470-50-40-2 - Debt - Modifications and Extinguishments, we recorded a Loss on debt extinguishment in the Condensed Consolidated Statement of Operations for the three and nine months ended April 30, 2014. Loss on debt extinguishment for the three and nine months ended April 30, 2014 was $83.0 million. Of the $83.0 million, we recorded approximately $70.3 million associated with the Oaktree Senior Notes which included the $28.7 million prepayment premium we paid to the holders of the Oaktree Senior Notes and approximately $41.6 million related to the excess payout of the Oaktree Senior Notes to account for the difference in the carrying value and actual payout which was based on the Oaktree Senior Notes fair value as of the date of refinancing. Of the $32.3 million call premium, $3.6 million related to the portion of the refinancing that was considered a debt modification and was recorded as a contra-debt liability on our Condensed Consolidated Balance Sheets, the remaining call premium of $28.7 million was recorded as a Loss on debt extinguishment. Additionally, we incurred non-cash charges of $10.6 million resulting from the write-off of unamortized Oaktree and Secured Credit Facility transaction costs and fees. We also expensed $2.1 million in new third party debt issuance costs associated with certain lenders continued participation in the debt arrangements both prior to and subsequent to the refinancing transaction.

Debt After Refinancing

In December 2010, Kettle Foods obtained, and we guaranteed, a 10-year fixed rate loan (the "Guaranteed Loan") in the principal amount of $21.2 million, of which $8.9 million was outstanding as of April 30, 2014. Principal and interest payments were due monthly throughout the term of the loan. The Guaranteed Loan was being used to purchase equipment for our Beloit, Wisconsin plant expansion. Borrowed funds were placed in an interest-bearing escrow account and made available as expenditures were approved for reimbursement. As the cash was used to purchase non-current assets, such restricted cash was classified as non-current on the balance sheet. In December 2012, the remaining balance within the escrow account was released back to the lender and was used to pay down the outstanding loan balance. Also, as part of the paydown, we paid a 4% prepayment penalty, which was recorded in Interest expense, net.


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The Guaranteed Loan provides for customary affirmative and negative covenants, which are similar to the covenants under the Secured Credit Facility, as defined below. The financial covenants within the Guaranteed Loan were reset to match those in the Waiver and Third Amendment to its Secured Credit Facility, as described in more detail below.

Additionally, on February 9, 2014, we entered into, and on February 19, 2014, we closed, a warrant exercise agreement with Oaktree (the "Warrant Exercise Agreement"), pursuant to which Oaktree agreed to exercise in full its warrant to purchase an aggregate of 4,420,859 shares of our common stock, by paying in cash the exercise price of approximately $44.2 million less a cash exercise and contractual modification inducement fee of $15.0 million. The warrant was issued to Oaktree in connection with the Securities Purchase Agreement, dated May 22, 2012 ("Securities Purchase Agreement"), under which we issued the Oaktree Senior Notes. The $15.0 million inducement fee is included within Warrant exercise fee on the Condensed Consolidated Statement of Operations.

The Warrant Exercise Agreement provided that so long as Oaktree and/or its affiliates hold at least 10% of our outstanding common stock, Oaktree will have the right to nominate one member of our Board of Directors. In addition, until the later of (a) twelve months after Oaktree no longer has the right to nominate a member of our Board of Directors or (b) twelve months after any director nominated by Oaktree under the Warrant Exercise Agreement or the Securities Purchase Agreement no longer serves as a director, Oaktree and its affiliates agree not to: acquire or beneficially own more than 30% of the outstanding common stock of Diamond; commence or support any tender offer for our common stock; make or participate in any solicitation of proxies to vote or seek to influence any person with respect to voting its Diamond common stock; publicly announce a proposal or offer concerning any extraordinary transaction with us; form, join or participate in a group for the purpose of acquiring, holding, voting or disposing of any our securities; take any actions that could reasonably be expected to require us to make a public announcement regarding the possibility of such an acquisition, tender offer or proxy solicitation; enter into any agreements with a third party regarding any such prohibited actions; or request us to amend or waive such provisions. Upon the closing of the transactions contemplated by the Warrant Exercise Agreement, the Securities Purchase Agreement, and our obligations thereunder, terminated. The common stock issued upon exercise of the warrant will be issued in a private placement pursuant to exemptions from the registration requirements of the Securities Act of 1933 and are covered by a Registration Rights Agreement entered into on May 29, 2012 in connection with the Securities Purchase Agreement.

The Term Loan Facility will mature in 4.5 years and will amortize in equal quarterly installments in an aggregate annual amount equal to 1.0% of the original principal amount of the Term Loan Facility with the balance payable on the maturity date of the Term Loan Facility. The Term Loan Facility will permit us to increase the term loans, or add a separate tranche of term loans, by an amount not to exceed $100 million plus the maximum amount of additional term loans that we could incur without our senior secured leverage ratio exceeding 4.50 to 1.00 on a pro forma basis after giving effect to such increase or addition. Amounts outstanding are expected to bear interest at a rate per annum equal to: (i) the Eurodollar Rate (as defined in the Term Loan Facility and subject to a "floor" of 1.00%) plus the applicable margin or (ii) the Base Rate (as defined in the Term Loan Facility), which is the greatest of (a) Credit Suisse's prime rate, (b) the federal funds effective rate plus 0.50% and (c) the Eurodollar Rate for an interest period of one month plus 1.00%, plus, in each case, the applicable margin to be agreed with the lenders party thereto.

Loans under the ABL facility would be available up to a maximum amount outstanding at any one time equal to the lesser of (a) $125 million and (b) the amount of the Borrowing Base, in each case, less customary reserves. Under the ABL Facility, we have a $20 million sublimit for the issuance of letters of credit, and a Swing Line Facility of up to $12.5 million for same day borrowings. Borrowing Base is defined as (a) 85% of the amount of our eligible accounts receivable; plus (b) the lesser of (i) 70% of the book value of eligible inventory in the US and (ii) 85% times the net orderly liquidation value of our eligible inventory in the US; less (c) in each case, customary reserves.

Under the ABL Facility, we may elect that the loans bear interest at a rate per annum equal to: (i) the Base Rate plus the applicable margin; or (ii) the LIBOR Rate plus the applicable margin. "Base Rate" means the greatest of (a) the Federal Funds Rate plus 0.5%, (b) the LIBOR Rate (which rate shall be calculated based upon an interest period of 1 month and shall be determined on a daily basis), plus 1.00%, and (c) the rate of interest announced, from time to time, by Wells Fargo at its principal office in San Francisco as its "prime rate." The LIBOR Rate shall be available for interest periods of one week or, one, two, three or six months and, if all lenders agree, twelve months.

The Term Loan Facility and ABL Facility provide for customary affirmative and negative covenants. The Term Loan Facility has customary cross default provisions and the ABL Facility contains cross-acceleration provisions, in each case that may be triggered if we fail to comply with obligations under our other credit facilities or indebtedness. The Term Loan Facility has a first priority perfected lien on substantially all property, plant and equipment, capital stock, intangibles and second priority lien on the ABL Priority Collateral, subject to customary exceptions. The ABL Facility requires us to maintain a minimum fixed charge coverage ratio of 1.1:1 if at any time excess availability is less than 10% of maximum availability; and requires us to apply substantially all cash collections to reduce outstanding borrowings under the ABL Facility if excess availability falls below 12.5% of maximum availability for a period of 5 business days. The ABL Facility is secured by a first-priority lien on accounts receivable, inventory, cash and deposit accounts and a second-priority lien on all real estate, equipment and equity interests of the Company under, and guarantors of, the ABL Facility.


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The Notes, which will mature on March 15, 2019, were offered only to
(i) qualified institutional buyers in reliance on Rule 144A of the Securities Act of 1933, as amended ("Securities Act"), and (ii) to certain non-U.S. persons in offshore transactions in reliance on Regulation S of the Securities Act. The initial issuance and sale of the Notes were not registered under the Securities Act, and the Notes may not be offered or sold in the United States absent . . .

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