Diamond Foods 10-Q 2009
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended October 31, 2009
For the transition period from to
Commission File Number: 000-51439
DIAMOND FOODS, INC.
(Exact name of registrant as specified in its charter)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ
Number of shares of common stock outstanding as of October 31, 2009: 16,626,540
TABLE OF CONTENTS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The statements contained in this Quarterly Report regarding our future financial and operating performance and results, business strategy, market prices, future commodity prices, plans and forecasts and other statements that are not historical facts are forward-looking statements. We use the words anticipate, believe, estimate, expect, intend, plan, seek, and other similar expressions to identify forward-looking statements; many of which discuss our future expectations, contain projections of our results of operations or financial condition or state other forward-looking information. We have based these forward-looking statements on our assumptions, expectations and projections about future events only as of the date of this Quarterly Report.
These forward-looking statements also involve many risks and uncertainties that could cause actual results to differ from our expectations in material ways. Please refer to the risks and uncertainties discussed in the section titled Risk Factors. You also should carefully consider other cautionary statements elsewhere in this Quarterly Report and in other documents we file from time to time with the Securities and Exchange Commission (SEC), including our most recent Annual Report on Form 10-K. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
See notes to condensed consolidated financial statements.
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share information)
See notes to condensed consolidated financial statements.
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to condensed consolidated financial statements.
DIAMOND FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the quarters ended October 31, 2009 and 2008
(In thousands, except share and per share information)
(1) Organization and Basis of Presentation
Diamond Foods, Inc. (the Company or Diamond) processes, markets and distributes culinary, in-shell and ingredient nuts and snack products, including Pop Secret popcorn products. The Company primarily obtains its walnuts from growers who are located in California, and through July 26, 2005, were members of Diamond Walnut Growers, Inc., a cooperative association. The Company obtains its other nuts from independent suppliers. Diamond sells products to approximately 1,250 customers, including over 140 international customers. In general, the Company sells directly to retailers, particularly large national grocery store and club stores, mass merchandisers and drug store chains, and indirectly through wholesale distributors who serve independent and small regional retail grocery store chains and convenience stores.
The accompanying unaudited condensed consolidated financial statements of Diamond have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements at and for the year ended July 31, 2009 and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Companys financial condition at October 31, 2009, and the results of the Companys operations and cash flows for the three months ended October 31, 2009 and 2008. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Companys 2009 Annual Report on Form 10-K. Operating results for the three months ended October 31, 2009 are not necessarily indicative of the results that may be expected for the year ending July 31, 2010. Management evaluated the Companys consolidated financial statements for the three months ended October 31, 2009 for subsequent events through December 3, 2009, the date the consolidated financial statements were issued.
Total comprehensive income was $15,159 and $10,504 for the three months ended October 31, 2009 and 2008, respectively.
Certain prior period amounts have been reclassified to conform to the current period presentation.
(2) Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued ASC 105-10 Generally Accepted Accounting Principles. This guidance establishes the FASB Accounting Standards Codification (the Codification or ASC) as the official single source of authoritative U.S. GAAP. All existing accounting standards are superseded. All other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes SEC guidance organized using the same topical structure in separate sections within the Codification. The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented. Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (ASU) which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification. Effective August 1, 2009, the Company adopted ASC 105-10 and the principal impact is limited to disclosures as all references to authoritative accounting literature will be referenced in accordance with the Codification.
In December 2008, the FASB issued ASC 715-20, Compensation Retirement Benefits. This guidance requires additional disclosures about plan assets for defined benefit pension and other postretirement benefit plans. ASC 715-20 will be effective for the Companys fiscal year ending after July 31, 2010. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
(3) Fair Value Measurements
The fair value of certain financial instruments, including cash and cash equivalents, trade receivables, accounts payable and accrued liabilities approximate the amounts recorded in the balance sheet because of the relatively short term nature of these financial instruments. The fair value of notes payable and long-term obligations at the end of each fiscal period approximates the amounts
recorded in the balance sheet based on information available to Diamond with respect to current interest rates and terms for similar financial instruments.
In the first quarter of fiscal year 2009, the Company entered into an interest rate swap agreement in accordance with Company policy to mitigate the impact of London Interbank Offered Rate (LIBOR) based interest rate fluctuations on Company profitability. The swap agreement, with a total hedged notional amount of $47.5 million, was entered into to hedge future cash flows associated with a portion of the Companys variable rate bank debt, which was used to finance the Pop Secret acquisition. On January 22, 2009, the company terminated this swap, which was set to mature on October 30, 2009. As a result of this swap termination, the Company amortized the loss of approximately $695 from other comprehensive income to interest expense through October 30, 2009, the original life of the swap. Accordingly, the Company recognized $240 in interest expense for the three months ended October 31, 2009.
In the second quarter of fiscal year 2009, the Company entered into a new interest rate swap agreement in accordance with Company policy to mitigate the impact of LIBOR based interest rate fluctuations on Company profitability. This new swap does not qualify for hedge accounting. As a result, any changes in the fair value of the swap will be included in the statement of operations in the period of change.
In September 2006, the FASB issued ASC 820, Fair Value Measurements and Disclosures. This guidance applies to all assets and liabilities that are being measured and reported on a fair value basis. ASC 820 requires new disclosures that establish a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. This guidance enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. In February 2008, the FASB issued ASC 820-10-15, which delayed the effective date of ASC 820 for all nonfinancial assets and liabilities, except those recognized or disclosed at fair value on a recurring basis, until fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. This includes fair value calculated in impairment assessments of goodwill, indefinite-lived intangible assets, and other long-lived assets.
Effective August 1, 2009, the Company adopted the provisions of ASC 820 regarding nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The adoption did not have a material impact.
ASC 820 requires that assets and liabilities carried at fair value be classified and disclosed based on the following criteria:
Level 1: Quoted market prices in active markets for identical assets or liabilities
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data
Level 3: Unobservable inputs that are not corroborated by market data
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents the Companys liabilities measured at fair value on a recurring basis as of October 31, 2009:
The Company has elected to use the income approach to value the derivative, using observable Level 2 market expectations at the measurement date and standard valuation techniques to convert future amounts to a single present amount assuming that participants are motivated, but not compelled to transact. Level 2 inputs for the valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates, and credit risk at commonly quoted intervals). Mid-market pricing is used as a practical expedient for fair value measurements. Under ASC 820, the fair value measurement of an asset or
liability must reflect the nonperformance risk of the entity and the counterparty. Therefore, the impact of the counterpartys creditworthiness when in an asset position and the Companys creditworthiness when in a liability position has also been factored into the fair value measurement of the derivative instruments and did not have a material impact on the fair value of the derivative instruments. Both the counterparty and the Company are expected to continue to perform under the contractual terms of the instruments.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company measures certain assets at fair value on a nonrecurring basis when there is an indication that the assets may be impaired. The fair value of these assets are determined based on valuation techniques using the best information available, which may include quoted market prices, market comparables and discounted cash flow projections.
An impairment charge is recorded when the cost of the asset exceeds its fair value. During the three months ended October 31, 2009, the Company did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
(4) Stock Plan Information
The Company uses a broad based equity incentive plan to help align employees and director incentives with stockholders interests, and accounts for stock-based compensation in accordance with ASC 718, Compensation Stock Compensation. Beginning with the adoption of this guidance in August 2005, the fair value of all stock options granted subsequent to July 20, 2005 is recognized as an expense in the Companys statement of operations, typically over the related vesting period of the options. The guidance requires use of fair value computed at the date of grant to measure share-based awards. The fair value of restricted stock awards is recognized as stock-based compensation expense over the vesting period. Stock options may be granted to officers, employees and directors. As required under this guidance, the Company continues to account for stock-based compensation for options granted prior to August 1, 2005 using the intrinsic value method. Since those options were granted at market price, no compensation expense is recognized.
In June 2008, the FASB issued ASC 260-10, Earnings Per Share. This guidance provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. Effective August 1, 2009, the Company adopted this guidance and the adoption did not have a material impact on the Companys results of operations, cash flows or financial position.
Stock Option Awards: The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model. Expected stock price volatilities are estimated based on the Companys implied historical volatility. The expected term of options granted and forfeiture rates are based on assumptions and historical data to the extent it is available. The risk-free rates are based on U.S. Treasury yields for notes with comparable terms as the option grants in effect at the time of the grant. For purposes of this valuation model, dividends are based on the historical rate. Assumptions used in the Black-Scholes model are presented below:
The following table summarizes stock option activity during the three months ended October 31, 2009:
The weighted average fair value per share of stock options granted during the three months ended October 31, 2009 and 2008 was $15.17 and $10.86, respectively. The fair value per share of options vested during the three months ended October 31, 2009 and 2008 was $7.77 and $6.53, respectively.
Changes in the Companys nonvested stock options during the three months ended October 31, 2009 are summarized as follows:
As of October 31, 2009, there was approximately $1.4 million of total unrecognized compensation expense related to nonvested stock options, which is expected to be recognized over a weighted average period of 1.1 years.
Restricted Stock Awards: As of October 31, 2009, there were 351,195 shares of restricted stock outstanding. Restricted stock activity during the three months ended October 31, 2009 is summarized as follows:
The weighted average fair value per share of restricted stock granted during the three months ended October 31, 2009 and 2008 was $28.60 and $25.87, respectively. The fair value per share of restricted stock vested during the three months ended October 31, 2009 and 2008 was $20.88 and $17.45, respectively. The total intrinsic value of restricted stock vested in the three months ended October 31, 2009 and 2008 was $1,840 and $1,552, respectively.
As of October 31, 2009, there was $7.5 million of unrecognized compensation expense related to nonvested restricted stock awards, which is expected to be recognized over a weighted average period of 2.8 years.
(5) Earnings Per Share
The Company adopted certain amendments to ASC 260-10 on August 1, 2009, which impacted the determination and reporting of earnings per share by requiring the inclusion of restricted stock as participating securities, since they have the right to share in dividends, if declared, equally with common shareholders. Participating securities are allocated a proportional share of net income determined by dividing total weighted average participating securities by the sum of total weighted average common shares and participating securities (the two-class method). Including these shares in the Companys earnings per share calculation during periods of net income has the effect of diluting both basic and diluted earnings per share. As a result of adopting the amendments to ASC 260-10, prior period basic and diluted shares outstanding, as well as the related per share amounts presented below, have been adjusted retroactively. The retroactive application of the two-class method did not result in a change to previously reported basic and diluted earnings per share.
The computations for basic and diluted earnings per share are as follows:
Options to purchase 10,000 and 33,000 shares of common stock were not included in the computation of diluted earnings per share because their exercise prices were greater than the average market price of Diamonds common stock of $30.23 and $26.75 for the three months ended October 31, 2009 and 2008, respectively, and therefore their effect would be antidilutive.
(6) Acquisition of Pop Secret
On September 15, 2008, Diamond completed its acquisition of the Pop Secret popcorn business from General Mills, Inc. for a purchase price of approximately $190 million in cash. The results of the acquisition have been included in our consolidated statement of operations since that date. Pop Secret is the second largest brand in the microwave popcorn category in U.S. grocery stores, where it has approximately a 25% market share. Pop Secret, when combined with other Diamond and Emerald branded products, offers the Company significant supply chain economies of scale and cross promotional marketing opportunities.
The acquisition has been accounted for as a business combination in accordance with ASC 805, Business Combinations.
The total purchase price of $190 million, including $2 million in transaction related costs, has been allocated to the estimated fair values of assets acquired and liabilities assumed as follows:
The Company finalized its purchase price allocation during the fiscal quarter ended October 31, 2009. Changes in the Companys purchase price allocation during this fiscal quarter included an $895 reduction in assumed liabilities and an $833 reduction in goodwill.
Customer relationships of Pop Secret will be amortized on a straight-line basis over an average estimated life of 20 years. Brand intangibles relate to the Pop Secret brand name, which has an indefinite life, and therefore, is not amortizable.
(7) Balance Sheet Items
Inventories consisted of the following:
Accounts payable and accrued liabilities consisted of the following:
(8) Intangible Assets and Goodwill
The changes in the carrying amount of goodwill are as follows:
Other intangible assets consisted of the following:
Identifiable intangible asset amortization expense annually for each of the five succeeding years will amount to approximately $1,865 and will approximate $1,399 for the remainder of fiscal year 2010.
(9) Credit Facilities
On September 15, 2008, the Company replaced its $20 million Senior Notes due December 2013 (the Senior Notes), the Credit Agreement dated December 2, 2004, between the Company and Bank of the West, and the Master Loan Agreement dated February 23, 2004, between the Company and CoBank ACB, as amended (collectively, the Bank Debt), with a new five year unsecured $250 million Senior Credit Facility (the Credit Facility) with a syndicate of seven banks. The proceeds of the Credit Facility were used in part to fund the $190 million purchase of the Pop Secret business from General Mills and for ongoing operational needs, as well as to repay the Senior Notes. An early termination fee of $2.6 million was incurred in connection with the prepayment of the Senior Notes.
The Credit Facility consists of a $125 million revolving credit line and a $125 million term loan. At October 31, 2009, there were no borrowings outstanding on the revolving credit line. Principal payments on the term loan outstanding are $15 million, $20 million, $25 million and $55 million annually, in each of the four succeeding years (due quarterly, commencing October 31, 2009). The Company paid down $10 million of this term loan in fiscal year 2009. In addition, the Company is required to pay down the term loan at a faster rate in the event cash flows and leverage exceed certain specified levels. The interest rate for the entire Credit Facility is tied to LIBOR, plus a credit spread linked to our leverage ratio. As of October 31, 2009 the interest rate was 2.70%.
The Credit Facility subjects the Company to financial and other covenants (including a debt-to-EBITDA ratio and limitations on dividends) and certain customary events of default. As of October 31, 2009, the Company was in compliance with all applicable financial covenants. The Credit Facility also requires an annual compliance certificate from the Companys independent certified public accountants that they are not aware of any defaults under the financial covenants. Since disclosure that the Company was in compliance with applicable financial covenants has been included in the Companys fiscal 2009 annual report on Form 10-K, the Company did not request the compliance certificate and the syndicate banks have waived the certificate requirement for 2009.
(10) Retirement Plans
Diamond provides retiree medical benefits and sponsors two defined benefit pension plans. One plan is a qualified plan covering all bargaining unit employees and the other is a nonqualified plan for certain salaried employees. A third plan covering all salaried employees was terminated in 2007. The amounts shown for pension benefits are combined amounts for all plans. Diamond uses an August 1 measurement date for its plans. Plan assets are held in trust and primarily include mutual funds and money market accounts. Any employee who joined the Company following January 15, 1999 is not entitled to retiree medical benefits.
Components of net periodic benefit cost for the three months ended October 31 were as follows:
The Company recognized defined contribution plan expenses of $161 and $120 for the three months ended October 31, 2009 and 2008, respectively.
In March 2008, a former grower and an organization named Walnut Producers of California filed suit against Diamond in San Joaquin County Superior Court claiming, among other things, breach of contract relating to alleged underpayment for walnut deliveries for the 2005 and 2006 crop years. The plaintiffs purport to represent a class of walnut growers who entered into contracts with Diamond. Diamond intends to defend itself vigorously against these allegations. In May 2008, Diamond argued a motion in front of the judge in the case requesting, among other things, that all class action allegations be struck from the plaintiffs complaint. In August 2008, the court granted Diamonds motion. The plaintiffs have appealed the courts ruling striking the class allegations from the complaint.
The Company has various other legal actions in the ordinary course of business. All such matters, and the matter described above, are subject to many uncertainties that make their ultimate outcomes unpredictable. However, in the opinion of management, resolution of all legal matters is not expected to have a material adverse effect on the Companys financial condition, operating results or cash flows.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
We are a branded food company specializing in processing, marketing and distributing culinary, in-shell and ingredient nuts and snack products. Our company was founded in 1912 and has a strong heritage in the walnut market under the Diamond of California brand. On July 26, 2005 we converted from an agricultural cooperative association to a Delaware corporation and completed the initial public offering of our common stock. As a public company, our focus is on building stockholder value. We intend to expand our existing business, and to continue to introduce higher-value branded products in our culinary and snack product lines, including snack products marketed under our Emerald and Pop Secret brand names. The acquisition of Pop Secret is anticipated to provide supply chain economies of scale and cross promotional opportunities with our other brands. Our products are sold in over 60,000 retail locations in the United States and in over 100 countries. We sell products to approximately 1,250 customers, including over 140 international customers. In general, we sell directly to retailers, particularly large national grocery store and drug store chains, and indirectly through wholesale distributors who serve independent and small regional retail grocery store chains and convenience stores. We also sell our products to mass merchandisers, club stores, convenience stores and through other retail channels.
Our business is seasonal. For example, in 2009 and 2008, we recognized 61% and 60% of our net sales for the full fiscal year in the first six months of the year. Demand for nut products, particularly in-shell nuts and to a lesser extent, culinary nuts, is highest during the months of October, November and December. We receive our principal raw material, walnuts, during the period from September to November and process it throughout the year. As a result of this seasonality, our personnel and working capital requirements and walnut inventories peak during the last quarter of the calendar year. This seasonality also impacts capacity utilization at our facilities, which routinely operate at capacity for the last four months of the calendar year. Generally, we receive and pay for approximately 50% of the corn for popcorn in December, and the remaining 50% in May. Accordingly, the working capital requirement of popcorn is less seasonal than that of the tree nut product lines.
Results of Operations
Net sales were $180.6 million and $195.5 million for the three months ended October 31, 2009 and 2008, respectively. The decrease in net sales was primarily due to lower volume related to a later walnut harvest in 2009, price deflation associated with lower input costs and continued rationalization of non-strategic SKUs. This was partially offset by strong snack sales.
Net sales by channel (in thousands):
The decrease in North American Retail and International sales was mainly due to lower volume related to a later walnut harvest, price deflation associated with lower input costs and continued rationalization of non-strategic SKUs. This was partially offset by a 64% increase in snack sales.
Sales of walnuts, other nuts and popcorn products as a percentage of net sales were:
Sales to Wal-Mart Stores, Inc. represented approximately 16.1% and 21.7% of total net sales for the three months ended October 31, 2009 and 2008, respectively. Sales to Costco Wholesale Corporation were less than 10.0% of total net sales for the three months ended October 31, 2009. Sales to Costco Wholesale Corporation represented approximately 12.0% of total net sales for the three months ended October 31, 2008.
Gross Profit. Gross profit as a percentage of net sales for the three months ended October 31, 2009 and 2008 was 25.2% and 21.0%, respectively. Gross profit for the three months ended October 31, 2009 increased mainly due to favorable product mix, transitioning product sales to retail from international and ingredient, favorable impact of Pop Secret sales, favorable input costs and the result of cost efficiency initiatives.
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 $13.5 million and $15.8 million, and 7.5% and 8.1% as a percentage of net sales for the three months ended October 31, 2009 and 2008, respectively. The decrease was mainly due to transition service and other duplicative expenses associated with the Pop Secret acquisition incurred in 2008.
Advertising. Advertising expense was $6.3 million and $5.9 million, and 3.5% and 3.0% as a percentage of net sales for the three months ended October 31, 2009 and 2008, respectively. The increase was mainly due to the launch of our Feed Your Fingers campaign, which features in-store and online marketing.
Interest. Interest expense was $1.2 million and $1.4 million, and 0.7% as a percentage of net sales for the three months ended October 31, 2009 and 2008.
Other expense. There was no other expense during the three months ended October 31, 2009. Other expense was $0.9 million and 0.5% as a percentage of net sales for the three months ended October 31, 2008. The other expense in 2008 was due to a $2.6 million payment on the early termination of debt, partially offset by a gain on the sale of emission reduction credits of $1.7 million.
Income Taxes. The effective tax rate for the three months ended October 31, 2009 and 2008 was approximately 38.9% and 37.5%, respectively. Income tax expense for fiscal year 2010 is expected to be approximately 38% - 39% of pre-tax income before the impact of any discrete tax items.
Liquidity and Capital Resources
Our liquidity is dependent upon funds generated from operations and external sources of financing.
During the three months ended October 31, 2009, cash used in operating activities was $11.5 million compared to $59.2 million for the three months ended October 31, 2008. The decrease was primarily due to improved profitability and better working capital management. Cash used in investing activities was $2.0 million during the three months ended October 31, 2009 compared to $193.8 million for the three months ended October 31, 2008. This change was mainly due to the acquisition of the Pop Secret popcorn business in 2008. Cash used in financing activities during the three months ended October 31, 2009 was $4.7 million compared to $183.5 million of cash provided by financing activities for the three months ended October 31, 2008. This change was mainly due to borrowings in 2008 to fund the Pop Secret acquisition.
On September 15, 2008, we replaced our $20 million Senior Notes due December 2013 (the Senior Notes), the Credit Agreement dated December 2, 2004, between us and Bank of the West, and the Master Loan Agreement dated February 23, 2004, between us and CoBank ACB, as amended (collectively, the Bank Debt) with a new five year unsecured $250 million Senior Credit Facility (the Credit Facility) with a syndicate of seven banks. The proceeds of the Credit Facility were used in part to fund the $190 million purchase of the Pop Secret business from General Mills and ongoing operational needs, as well as to repay the Senior Notes. An early termination fee of $2.6 million was incurred in connection with the prepayment of the Senior Notes.
The Credit Facility consists of a $125 million revolving credit line and a $125 million term loan. Principal payments on the term loan outstanding are $15 million, $20 million, $25 million and $55 million, annually over the succeeding four years (due quarterly, commencing October 31, 2009). We paid down $10 million on this term loan in fiscal year 2009. In addition, there is a provision that requires us to pay down the term loan at a faster rate in the event cash flows exceed certain specified levels. The interest rate for the entire Credit Facility is tied to LIBOR, plus a credit spread linked to our leverage ratio.
The Credit Facility subjects us to financial and other covenants (including a debt-to-EBITDA ratio and limitations on dividends) and certain customary events of default. As of October 31, 2009, we were in compliance with all applicable financial covenants. The Credit Facility also requires an annual compliance certificate from our independent certified public accountants that they are not aware of any defaults under the financial covenants. Since disclosure that we were in compliance with applicable financial covenants has been included in our fiscal 2009 annual report on Form 10-K, we did not request the compliance certificate and the syndicate banks have waived the certificate requirement for 2009.
Working capital and stockholders equity were $63.5 million and $188.1 million at October 31, 2009 compared to $51.4 million and $173.3 million at July 31, 2009 and $34.6 million and $157.6 million at October 31, 2008. The increase in working capital was mainly due to the reduction of notes payable.
We believe our cash and cash equivalents and cash expected to be provided from our operations, in addition to borrowings available under our Credit Facility, will be sufficient to fund our contractual commitments, repay obligations as required, and fund our operational requirements for at least the next twelve months.
Contractual Obligations and Commitments
Contractual obligations and commitments at October 31, 2009 are as follows (in millions):
Effects of Inflation
There has been no material change in our exposure to inflation from that discussed in our 2009 Annual Report on Form 10-K.
Critical Accounting Policies
Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Our critical accounting policies are set forth below.
Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred to the buyer (based upon terms of shipment), price is fixed, delivery occurs and collection is reasonably assured. Revenues are recorded net of estimated rebates, introductory or slotting payments, coupons, promotion and marketing allowances. Customers have the right to return certain products. Product returns are estimated based upon historical results and are reflected as a reduction in net sales.
Inventories. All inventories are accounted for on a lower of cost (first-in, first-out) or market basis.
We have entered into long-term Walnut Purchase Agreements with growers, under which they deliver their entire walnut crop to us during the Fall harvest season and we determine the purchase price for this inventory by March 31, or later, of the following year. This purchase price will be a price determined by us in good faith, taking into account market conditions, crop size, quality, and nut varieties, among other relevant factors. Since the ultimate price to be paid will be determined each March, or later, subsequent to receiving the walnut crop, we must make an estimate of this price for interim financial statements. Those estimates may subsequently change and the effect of the change could be significant.
Valuation of Long-lived and Intangible Assets and Goodwill. We periodically review long-lived assets and certain identifiable intangible assets for impairment in accordance with ASC 360, Property, Plant, and Equipment. Goodwill and intangible assets not subject to amortization are reviewed annually for impairment in accordance with ASC 350, Intangibles Goodwill and Other, or more often if there are indications of possible impairment.
The analysis to determine whether or not an asset is impaired requires significant judgments that are dependent on internal forecasts, including estimated future cash flows, estimates of long-term growth rates for our business, the expected life over which cash flows will be realized, and assumed royalty and discount rates. Changes in these estimates and assumptions could materially affect the determination of fair value and any impairment charge. While the fair value of these assets exceeds their carrying value based on our current estimates and assumptions, materially different estimates and assumptions in the future in response to changing economic conditions, changes in our business or for other reasons could result in the recognition of impairment losses.
For assets to be held and used, including acquired intangible assets subject to amortization, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Significant management judgment is required in this process.
We test our brand intangible assets not subject to amortization for impairment annually, or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. In testing brand intangibles for impairment, we compare the fair value with the carrying value. The determination of fair value is based on a discounted cash flow analysis, using inputs such as forecasted future revenues attributable to the brand, assumed royalty rates, and a risk-adjusted discount rate that approximates our estimated cost of capital. If the carrying value exceeds the estimated fair value, the brand intangible asset is considered impaired, and an impairment loss will be recognized in an amount equal to the excess of the carrying value over the fair value of the brand intangible asset.
We perform our annual goodwill impairment test required by ASC 350 in the fourth quarter of each year. In testing goodwill for impairment, we initially compare the fair value of the Companys single reporting unit with the net book value of the Company since it represents the carrying value of the reporting unit. We have one operating and reportable segment. If the fair value of the reporting unit is less than the carrying value of the reporting unit, we perform an additional step to determine the implied fair value of goodwill. The implied fair value of goodwill is determined by first allocating the fair value of the reporting unit to all assets and liabilities and then computing the excess of the reporting units fair value over the amounts assigned to the assets and liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, the excess represents the amount of goodwill impairment. Accordingly, we would recognize an impairment loss in the amount of such excess. Our impairment assessment employs present value techniques and involves the use of significant estimates and assumptions, including a projection of future revenues, gross margins, operating costs and cash flows, as well as general economic and market conditions and the impact of planned business and operational strategies. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Actual results may differ from these estimates. We also consider the estimated fair value of our reporting unit in relation to the Companys market capitalization.
We can not guarantee that a material impairment charge will not be recorded in the future.
Employee Benefits. We incur various employment-related benefit costs with respect to qualified and nonqualified pension and deferred compensation plans. Assumptions are made related to discount rates used to value certain liabilities, assumed rates of return on assets in the plans, compensation increases, employee turnover and mortality rates. Different assumptions could result in the recognition of differing amounts of expense over different periods of time.
Income Taxes. We account for income taxes in accordance with ASC 740, Income Taxes. This guidance requires that deferred tax assets and liabilities be recognized for the tax effect of temporary differences between the financial statement and tax basis of recorded assets and liabilities at current tax rates. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The recoverability of deferred tax assets is based on both our historical and anticipated earnings levels and is reviewed periodically to determine if any additional valuation allowance is necessary when it is more likely than not that amounts will not be recovered.
Accounting for Stock-Based Compensation. We account for stock-based compensation arrangements, including stock option grants and restricted stock awards, in accordance with the provisions of ASC 718, Compensation Stock Compensation. Under this guidance, compensation cost is recognized based on the fair value of equity awards on the date of grant. The compensation cost is then amortized on a straight-line basis over the vesting period. We use the Black-Scholes option pricing model to determine the fair value of stock options at the date of grant. This model requires us to make assumptions such as expected term, volatility, and forfeiture rates that determine the stock options fair value. These key assumptions are based on historical information and judgment regarding market
factors and trends. If actual results are not consistent with our assumptions and judgments used in estimating these factors, we may be required to increase or decrease compensation expense, which could be material to our results of operations.
Recent Accounting Pronouncements
See Note 2 of the condensed consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in our exposure to market risk from that discussed in our 2009 Annual Report on Form 10-K.
Item 4. Controls and Procedures
We have established and currently maintain disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that any material information relating to the Company is recorded, processed, summarized and reported to our principal officers to allow timely decisions regarding required disclosures.
In conjunction with the close of each fiscal quarter, we conduct a review and evaluation, under the supervision and with the participation of our management, including the President and Chief Executive Officer and the Chief Financial and Administrative Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Our President and Chief Executive Officer and Chief Financial and Administrative Officer, based upon their evaluation as of October 31, 2009, the end of the fiscal quarter covered in this report, concluded that our disclosure controls and procedures were effective.
As of October 31, 2009, there has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
In March 2008, a former grower and an organization named Walnut Producers of California filed suit against us in San Joaquin County Superior Court claiming, among other things, breach of contract relating to alleged underpayment for walnut deliveries for the 2005 and 2006 crop years. The plaintiffs purport to represent a class of walnut growers who entered into contracts with us. We intend to defend ourselves vigorously against these allegations. In May 2008, we argued a motion in front of the judge in the case requesting, among other things, that all class action allegations be struck from the plaintiffs complaint. In August 2008, the court granted our motion. The plaintiffs have appealed the courts ruling striking the class allegations from the complaint.
We are the subject of various legal actions in the ordinary course of our business. All such matters, and the matter described above, are subject to many uncertainties that make their outcomes unpredictable. We believe that resolution of these matters will not have a material adverse effect on our financial condition, operating results or cash flows.
Item 1A. Risk Factors
There were no material changes to the Risk Factors disclosed in the Companys Annual Report on Form 10-K for the year ended July 31, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
The following exhibits are filed as part of this report or are incorporated by reference to exhibits previously filed with the SEC.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.