UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended October 31, 2011
OR
¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number: 000-51439
DIAMOND FOODS, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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20-2556965
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(State of Incorporation)
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(IRS Employer Identification No.)
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600 Montgomery Street, 13th Floor
San Francisco, California
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94111-2702
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(Address of Principal Executive Offices)
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(Zip Code)
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415-445-7444
(Telephone No.)
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
¨
No
x
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
¨
No
x
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):
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Large accelerated filer
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x
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Accelerated filer
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¨
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Non-accelerated filer
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¨
(Do not check if a smaller reporting company)
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Smaller reporting company
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¨
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Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule
12b-2). Yes
¨
No
x
Number of shares of common stock outstanding as of October 31, 2012: 22,085,507
TABLE OF CONTENTS
2
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements, including statements about our future financial
and operating performance and results, business strategy, market price, brand portfolio and performance, future commodity prices, supply of raw materials, and plans and forecasts, our SEC filings, our position in the walnut industry, enhancing
internal controls and remediating material weaknesses. We have based these forward-looking statements on our assumptions, expectations and projections about future events only as of the date of this presentation, and we make such forward-looking
statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Many of our forward-looking statements include discussions of trends and anticipated developments under the Risk
Factors and Managements Discussion and Analysis of Financial Condition and Results of Operations sections of the periodic reports that we file with the SEC. We use the words anticipate, believe,
estimate, expect, intend, plan, seek, may and other similar expressions to identify forward-looking statements that discuss our future expectations, contain projections of our
results of operations or financial condition or state other forward-looking information. You also should carefully consider other cautionary statements elsewhere in this amendment and in other documents we file from time to time with the
SEC. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this amendment. Actual results may differ materially from what we currently expect because of many risks and
uncertainties, including: uncertainty about the need to file additional reports in connection with our restatement; risks relating to our leverage and its effect on our ability to respond to changes in our business, markets and industry; increase in
the cost of our debt; ability to raise additional capital and possible dilutive impact of raising such capital; risks relating to litigation and regulatory proceedings; risks related to our current inability to timely file required periodic reports
under the Securities Exchange Act of 1934, as amended, and any resulting delisting of Diamonds common stock on the Nasdaq Global Select Market; uncertainties relating to relations with growers; availability and cost of walnuts and other raw
materials; increasing competition and possible loss of key customers; and general economic and capital markets conditions.
As
used in this Annual Report, the terms Diamond Foods, Diamond, Company, Registrant, we, us, and our mean Diamond Foods, Inc. and its subsidiaries unless the context
indicates otherwise.
3
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
(Unaudited)
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October 31,
2011
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July 31,
2011
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October 31,
2010
As
Restated
See Note 12
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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4,474
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$
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3,112
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$
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8,012
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Trade receivables, net
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141,760
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98,275
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122,660
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Inventories
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254,860
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153,534
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239,007
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Deferred income taxes
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14,010
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14,490
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12,218
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Prepaid income taxes
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29,392
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17,499
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10,477
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Prepaid expenses and other current assets
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18,665
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13,089
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9,992
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Total current assets
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463,161
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299,999
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402,366
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Restricted cash
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13,731
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15,795
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Property, plant and equipment, net
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146,417
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134,275
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118,243
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Deferred income taxes
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5,915
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5,376
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3,924
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Goodwill
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406,850
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409,735
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406,255
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Other intangible assets, net
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446,267
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450,855
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453,830
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Other long-term assets
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6,271
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6,872
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8,172
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Total assets
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$
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1,488,612
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$
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1,322,907
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$
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1,392,790
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LIABILITIES AND STOCKHOLDERS EQUITY
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Current liabilities:
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Current portion of long-term debt
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$
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41,700
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$
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41,700
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$
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40,000
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Accounts payable and accrued liabilities
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178,672
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129,153
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140,724
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Payable to growers
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151,700
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76,700
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143,598
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Total current liabilities
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372,072
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247,553
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324,322
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Long-term obligations
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535,078
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490,001
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515,000
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Deferred income taxes
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131,634
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132,470
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141,741
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Other liabilities
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24,507
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32,388
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19,599
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Stockholders equity:
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Preferred stock, $0.001 par value; Authorized: 5,000,000 shares; no shares issued or outstanding
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Common stock, $0.001 par value; Authorized: 100,000,000 shares; 22,369,311, 22,319,016 and 22,234,131 shares issued and
22,058,169, 22,049,636 and 21,974,522 shares outstanding at October 31, 2011, July 31, 2011, and October 31, 2010, respectively
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22
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22
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22
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Treasury stock, at cost: 311,142, 269,380 and 259,609 shares held at October 31, 2011, July 31, 2011, and
October 31, 2010, respectively
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(9,643
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)
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(6,867
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)
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(6,315
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)
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Additional paid-in capital
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321,843
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318,734
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311,066
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Accumulated other comprehensive income
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12,413
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17,728
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10,789
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Retained earnings
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100,686
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90,878
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76,566
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Total stockholders equity
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425,321
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420,495
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392,128
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Total liabilities and stockholders equity
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$
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1,488,612
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$
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1,322,907
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$
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1,392,790
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See notes to condensed consolidated financial statements.
4
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share information)
(Unaudited)
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Three Months Ended
October 31,
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2011
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2010
As Restated
See Note
12
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Net sales
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$
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287,393
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$
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252,061
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Cost of sales
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226,086
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195,953
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Gross profit
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61,307
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56,108
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Operating expenses:
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Selling, general and administrative
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29,455
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23,289
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Advertising
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12,716
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12,469
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Acquisition and integration related expenses
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17,214
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579
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Total operating expenses
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59,385
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36,337
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Income from operations
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1,922
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19,771
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Interest expense, net
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5,761
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6,117
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Income (loss) before income taxes
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(3,839
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)
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13,654
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Income taxes (benefit)
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(14,640
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)
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4,372
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Net income
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$
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10,801
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$
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9,282
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Earnings per share:
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Basic
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$
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0.49
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$
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0.42
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Diluted
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$
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0.47
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$
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0.42
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Shares used to compute earnings per share:
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Basic
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21,668
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21,489
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Diluted
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22,567
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21,933
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Dividends declared per share
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$
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0.045
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$
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0.045
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See notes to condensed consolidated financial statements.
5
DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Three Months Ended
October 31,
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2011
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2010
As Restated
See Note 12
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CASH FLOWS FROM OPERATING ACTIVITIES:
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Net income
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$
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10,801
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$
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9,282
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Adjustments to reconcile net income to net cash provided by (used in) operating activities:
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Depreciation and amortization
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7,180
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7,472
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Deferred income taxes
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(118
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)
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2,014
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Excess tax benefit from stock option transactions
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(1,163
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)
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(944
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)
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Stock-based compensation
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1,902
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1,772
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Other, net
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673
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84
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Changes in assets and liabilities:
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Trade receivables, net
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(43,485
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)
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(56,962
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)
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Inventories
|
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(101,326
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)
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(93,175
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)
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Prepaid expenses and other current assets and income taxes
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(17,468
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)
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(1,619
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)
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Other assets
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164
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(475
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)
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Accounts payable and accrued liabilities
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43,859
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53,086
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Payable to growers
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75,000
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87,094
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Other liabilities
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(7,714
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)
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319
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Net cash provided by (used in) operating activities
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(31,695
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)
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7,948
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CASH FLOWS FROM INVESTING ACTIVITIES:
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Purchases of property, plant and equipment
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(11,303
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)
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(4,732
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)
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Proceeds from sale of property, plant and equipment and other
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|
8
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Proceeds from restricted cash
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2,064
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Net cash used in investing activities
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(9,239
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)
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(4,724
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)
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CASH FLOWS FROM FINANCING ACTIVITIES:
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Borrowings of revolving line of credit under the Secured Credit Facility, net
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55,500
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|
|
|
8,900
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Payment of long-term debt and notes payable
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(10,423
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)
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(10,032
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)
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Dividends paid
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|
(993
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)
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|
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(989
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)
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Excess tax benefit from stock option transactions
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1,163
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|
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|
944
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Purchase of treasury stock
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(2,776
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)
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|
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(1,265
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)
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Other, net
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|
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(125
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)
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|
|
1,508
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|
|
|
|
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Net cash provided by (used in) financing activities
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42,346
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|
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(934
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)
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|
|
|
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Effect of exchange rate changes on cash
|
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(50
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)
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|
80
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Net increase in cash and cash equivalents
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|
1,362
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|
|
|
2,370
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Cash and cash equivalents:
|
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|
|
|
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Beginning of period
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3,112
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|
|
|
5,642
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|
|
|
|
|
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End of period
|
|
$
|
4,474
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|
|
$
|
8,012
|
|
|
|
|
|
|
|
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|
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Supplemental disclosure of cash flow information:
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Cash paid (refunded) during the period for:
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|
|
|
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Interest
|
|
$
|
5,559
|
|
|
$
|
5,622
|
|
Income taxes
|
|
|
3,738
|
|
|
|
(2,929
|
)
|
Non-cash investing activity:
|
|
|
|
|
|
|
|
|
Accrued capital expenditures
|
|
|
10,709
|
|
|
|
1,261
|
|
See notes to condensed consolidated financial statements.
6
DIAMOND FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended October 31, 2011 and 2010 (Restated)
(In thousands, except share and per share information unless otherwise noted)
(Unaudited)
(1) Organization and Basis of Presentation
Diamond Foods, Inc. (the Company or Diamond) is an innovative packaged
food company focused on building and energizing brands. Diamond specializes in processing, marketing and distributing snack products and culinary, in-shell and ingredient nuts. In 2004, Diamond complemented its 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 September 2008, Diamond acquired the Pop Secret
®
brand of microwave popcorn products, which provided the Company with increased scale in the snack market, significant supply chain economies of scale and cross
promotional opportunities with its existing brands. In March 2010, Diamond 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, which added the
complementary premium Kettle Brand
®
to Diamonds existing portfolio of leading brands in the snack
industry. Diamond sells its products to global, national, regional and independent grocery, drug, and convenience store chains, as well as to mass merchandisers, club stores, other retail channels and non-retail channels. Sales to the Companys
largest customer accounted for approximately 18.5% and 16.0% of total net sales for the three months ended October 31, 2011 and 2010, respectively.
The accompanying unaudited condensed consolidated financial statements of Diamond have been prepared in accordance with accounting principles generally accepted in the United States of America
(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 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 fiscal year ended July 31, 2011 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, 2011, the results of the Companys operations for the three months ended
October 31, 2011 and 2010, and cash flows for the three months ended October 31, 2011 and 2010. 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 Amendment No 2 to its Annual Report on Form 10-K for the fiscal year ended July 31, 2011. Operating results for the three months ended October 31, 2011 are not necessarily
indicative of the results that may be expected for the fiscal year ended July 31, 2012.
Total comprehensive income was
$5.5 million and $14.6 million for the three months ended October 31, 2011 and 2010, respectively.
During the three
months ended October 31, 2011, the Company concluded a tax ruling with the United Kingdom tax authorities. This resulted in a net tax benefit for the period of $5.6 million, attributable to the reversal of the Companys unrecognized tax
benefit related to this event.
Certain prior period amounts have been reclassified to conform to the current period
presentation. The line items within the consolidated statement of cash flows that include reclassifications are presented in Note 12 of the Notes to Condensed Consolidated Financial Statements.
We report our operating results on the basis of a fiscal year that starts August 1 and ends July 31. We refer to our fiscal
years ended July 31, 2010, 2011 and 2012, as, fiscal 2010, fiscal 2011 and fiscal 2012. For purposes of the Notes to Condensed Consolidated Financial Statements, quarterly and annual fiscal 2011 amounts have
been restated, unless otherwise specified.
(2) Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update
(ASU) No. 2010-29,
Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations
. This guidance was issued to clarify that pro forma disclosures should be presented
as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The disclosures should also be accompanied by a narrative description of the nature and amount
of material, nonrecurring pro forma adjustments. This new guidance is effective prospectively for business combinations consummated on or after the annual reporting period beginning on or after December 15, 2010. The Company early adopted this
amendment for fiscal 2011 and will apply this guidance to business combinations going forward.
7
In May 2011, the FASB issued ASU No. 2011-04,
Fair Value Measurement
(Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.
This guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for
disclosing information about fair value measurements. The guidance is effective for interim and annual periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Companys consolidated
financial statements.
In June 2011, the FASB issued ASU No. 2011-05,
Comprehensive Income (Topic 220):
Presentation of Comprehensive Income
. This guidance requires entities to present the total of comprehensive income, the components of net income and the components of other comprehensive income (OCI) in either a single
continuous statement of comprehensive income or in two separate consecutive statements. The guidance does not change the components of OCI or when an item of OCI must be reclassified to net income, or the earnings per share calculation. The guidance
is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance will only impact the presentation of the Companys consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08,
Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for
Impairment.
The new guidance provides the option to perform a qualitative assessment by applying a more likely than not scenario to determine whether the fair value of a reporting unit is less than its carrying amount, which may then allow
a company to skip the annual two-step quantitative goodwill impairment test depending on the determination. This guidance is effective for goodwill impairment tests performed in interim and annual periods for fiscal years beginning after
December 15, 2011. The Company does not believe that the adoption of this guidance will have a material impact 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.
The Company transacts business in foreign currencies and has international sales denominated in foreign currencies, subjecting the
Company to foreign currency risk. If appropriate, the Company enters into foreign currency derivative contracts, generally with monthly maturities of twelve months or less, to reduce the volatility of cash flows primarily related to forecasted
revenue denominated in certain foreign currencies. The Company does not use foreign currency derivative contracts for speculative or trading purposes. On the date a foreign currency hedging contract is entered into, the Company may designate the
contract as a hedge, for a forecasted transaction, of the variability of cash flows to be received (cash flow hedge). The Company formally documents all relationships between hedging instruments and hedged items, as well as its
risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to anticipated transactions. The Company also formally assesses, both at the
hedges inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. Effective changes in derivative contracts designated and
qualifying as cash flow hedges of forecasted revenue are reported in other comprehensive income. These gains and losses are reclassified into interest income or expense, as a component of revenue, in the same period as the hedged revenue is
recognized. The Company includes time value in the assessment of effectiveness of the foreign currency derivatives. The ineffective portion of the hedge is recorded in interest expense or income. There were no foreign currency contracts outstanding
as of October 31, 2011. No hedge ineffectiveness for foreign currency derivatives was recorded for the three months ended October 31, 2011.
In July 2010, the Company entered into three interest rate swap agreements in accordance with Company policy to mitigate the impact of London Interbank Offered Rate (LIBOR) based interest
expense fluctuations on Company profitability. These swap agreements, with a total hedged notional amount of $100 million, were entered into to hedge future interest payments associated with a portion of the Companys variable rate bank debt.
The Company has designated these swaps as hedges of future cash flows associated with its variable rate debt. All effective changes in the fair value of the designated swaps are recorded in other comprehensive income (loss) and are released to
interest income or expense as the underlying transaction occurs. Ineffective changes, if any, are recognized in interest income or expense immediately. For the three months ended October 31, 2011, the Company recognized other comprehensive
income of $0.1 million based on the change in fair value of the swap agreements; no hedge ineffectiveness for these swap agreements was recognized in interest income or expense over the same period.
8
The fair values of the Companys derivative instruments as of October 31,
2011, July 31, 2011 and October 31, 2010 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability Derivatives
|
|
Balance Sheet Location
|
|
Fair Value
|
|
|
|
|
|
10/31/11
|
|
|
7/31/11
|
|
|
10/31/10
|
|
Derivatives designated as hedging instruments under ASC 815:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate contracts
|
|
Accounts payable and accrued liabilities
|
|
$
|
(469
|
)
|
|
$
|
(581
|
)
|
|
$
|
(655
|
)
|
Interest rate contracts
|
|
Other liabilities
|
|
|
|
|
|
|
(4
|
)
|
|
|
(326
|
)
|
Foreign currency contracts
|
|
Accounts payable and accrued liabilities
|
|
|
|
|
|
|
|
|
|
|
(61
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total derivatives designated as hedging instruments under ASC 815
|
|
|
|
$
|
(469
|
)
|
|
$
|
(585
|
)
|
|
$
|
(1,042
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives not designated as hedging instruments under ASC 815:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency contracts
|
|
Accounts payable and accrued liabilities
|
|
|
|
|
|
|
(11
|
)
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total derivatives
|
|
|
|
$
|
(469
|
)
|
|
$
|
(596
|
)
|
|
$
|
(1,072
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The effect of the Companys derivative instruments on the Consolidated Statements of Operations for
the three months ended October 31, 2011 and 2010 is summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives in ASC
815 Cash Flow
Hedging Relationships
|
|
Amount of Loss
Recognized in OCI on
Derivative
(Effective
Portion)
|
|
|
Location of Loss
Reclassified from
Accumulated OCI into
Income
(Effective
Portion)
|
|
Amount of Loss
Reclassified
from
Accumulated OCI into
Income (Effective
Portion)
|
|
|
Location of Loss
Recognized in Income on
Derivative
(Ineffective
Portion)
|
|
Amount of Loss Recognized
in Income on Derivative
(Ineffective Portion)
|
|
|
|
10/31/11
|
|
|
10/31/10
|
|
|
|
|
10/31/11
|
|
|
10/31/10
|
|
|
|
|
10/31/11
|
|
|
10/31/10
|
|
Interest rate contracts
|
|
$
|
(79
|
)
|
|
$
|
(490
|
)
|
|
Interest expense
|
|
$
|
(191
|
)
|
|
$
|
(176
|
)
|
|
Interest expense
|
|
$
|
|
|
|
$
|
|
|
Foreign currency contracts
|
|
|
|
|
|
|
(49
|
)
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(79
|
)
|
|
$
|
(539
|
)
|
|
|
|
$
|
(191
|
)
|
|
$
|
(176
|
)
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Not Designated as Hedging Instruments under ASC 815
|
|
Location of Loss Recognized in
Income on Derivative
|
|
Amount of Loss
Recognized
in Income on Derivative
|
|
|
|
|
|
10/31/11
|
|
|
10/31/10
|
|
Foreign currency contracts
|
|
Interest expense
|
|
$
|
(10
|
)
|
|
$
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
(10
|
)
|
|
$
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The Companys derivative liabilities measured at fair value on a recurring basis were $0.5 million as of October 31, 2011 and
$0.6 million as of July 31, 2011. The Company has elected to use the income approach to value the derivative liabilities, 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). Mid-market pricing is used as a practical expedient for fair value measurements.
Under Accounting Standards Codification (ASC) 820,
Fair Value Measurements and Disclosures,
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.
(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
. The fair value of all stock options granted is recognized as an expense in the
Companys statements 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.
9
Stock Option Awards:
The fair value of each stock option grant was estimated
on the date of grant using the Black-Scholes option valuation model. Expected stock price volatilities were estimated based on the Companys implied historical volatility. The expected term of options granted is based on the simplified method
due to the lack of historical Company information. Forfeiture rates were based on assumptions and historical data to the extent it is available. The risk-free rates were based on U.S. Treasury yields 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:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended October 31,
|
|
|
|
2011
|
|
|
2010
|
|
Average expected life, in years
|
|
|
6
|
|
|
|
6
|
|
Expected volatility
|
|
|
41.87
|
%
|
|
|
42.35
|
%
|
Risk-free interest rate
|
|
|
1.27
|
%
|
|
|
1.73
|
%
|
Dividend rate
|
|
|
0.24
|
%
|
|
|
0.43
|
%
|
The following table summarizes stock option activity during the three months ended October 31, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
(in
thousands)
|
|
|
Weighted
average exercise
price per share
|
|
|
Weighted average
remaining
contractual life
(in years)
|
|
|
Aggregate
intrinsic
value
(in thousands)
|
|
Outstanding at July 31, 2011
|
|
|
1,771
|
|
|
$
|
27.34
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
271
|
|
|
|
86.59
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1
|
)
|
|
|
27.94
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at October 31, 2011
|
|
|
2,041
|
|
|
|
35.21
|
|
|
|
6.6
|
|
|
$
|
68,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at October 31, 2011
|
|
|
1,332
|
|
|
|
21.40
|
|
|
|
5.2
|
|
|
|
59,090
|
|
The weighted average fair value per share of stock options granted during the three months ended
October 31, 2011 and 2010 was $35.39 and $16.66, respectively. The fair value per share of stock options vested during the three months ended October 31, 2011 and 2010 was $16.06 and $15.51, respectively.
Changes in the Companys nonvested stock options during the three months ended October 31, 2011 are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
Number
of
Shares
(in thousands)
|
|
|
Weighted
average grant
date fair value
per share
|
|
Nonvested at July 31, 2011
|
|
|
536
|
|
|
$
|
18.09
|
|
Granted
|
|
|
271
|
|
|
|
35.39
|
|
Vested
|
|
|
(98
|
)
|
|
|
16.06
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested at October 31, 2011
|
|
|
709
|
|
|
|
24.99
|
|
|
|
|
|
|
|
|
|
|
As of October 31, 2011, there was approximately $16.2 million of total unrecognized compensation
expense related to nonvested stock options, which is expected to be recognized over a weighted average period of 3.1 years.
10
Restricted Stock Awards:
Restricted stock and restricted stock unit activity
during the three months ended October 31, 2011 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock
|
|
|
Restricted Stock Units
|
|
|
|
Number of
Shares
(in thousands)
|
|
|
Weighted average
grant date fair
value per share
|
|
|
Number
of
Shares
(in thousands)
|
|
|
Weighted average
grant date fair
value per share
|
|
Outstanding at July 31, 2011
|
|
|
393
|
|
|
$
|
32.96
|
|
|
|
|
|
|
$
|
|
|
Granted
|
|
|
49
|
|
|
|
89.02
|
|
|
|
16
|
|
|
|
74.62
|
|
Vested
|
|
|
(106
|
)
|
|
|
25.87
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at October 31, 2011
|
|
|
336
|
|
|
|
43.35
|
|
|
|
16
|
|
|
|
74.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average fair value per share of restricted stock granted during the three months ended
October 31, 2011 and 2010 was $89.02 and $40.56, respectively. The weighted average fair value per share of restricted stock vested during the three months ended October 31, 2011 and 2010 was $25.87 and $20.92, respectively. The total
intrinsic value of restricted stock vested in the three months ended October 31, 2011 and 2010 was $7.1 million and $3.1 million, respectively.
As of October 31, 2011 there was $12.1 million of unrecognized compensation expense related to nonvested restricted stock, which is expected to be recognized over a weighted average period of 2.6
years. As of October 31, 2011 there was $1.2 million of unrecognized compensation expense related to nonvested restricted stock units, which is expected to be recognized over a weighted average period of 5.0 years.
(5) Earnings Per Share
ASC 260-10,
Earnings Per Share
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.
11
The computations for basic and diluted earnings per share are as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended
October 31,
|
|
|
|
2011
|
|
|
2010
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
10,801
|
|
|
$
|
9,282
|
|
Less: income allocated to participating securities
|
|
|
(177
|
)
|
|
|
(173
|
)
|
|
|
|
|
|
|
|
|
|
Income attributable to common shareholders - basic
|
|
|
10,624
|
|
|
|
9,109
|
|
Add: undistributed income attributable to participating securities
|
|
|
162
|
|
|
|
155
|
|
Less: undistributed income reallocated to participating securities
|
|
|
(156
|
)
|
|
|
(152
|
)
|
|
|
|
|
|
|
|
|
|
Income attributable to common shareholders - diluted
|
|
$
|
10,630
|
|
|
$
|
9,112
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding - basic
|
|
|
21,668
|
|
|
|
21,489
|
|
Dilutive shares - stock options
|
|
|
899
|
|
|
|
444
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding - diluted
|
|
|
22,567
|
|
|
|
21,933
|
|
|
|
|
|
|
|
|
|
|
Income per share attributable to common shareholders (1):
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.49
|
|
|
$
|
0.42
|
|
Diluted
|
|
$
|
0.47
|
|
|
$
|
0.42
|
|
(1)
|
Computations may reflect rounding adjustments.
|
Options to purchase 196,553 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 $74.69 for the three months ended October 31, 2011 and therefore their effect would be antidilutive. Options to purchase 80,010 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 $42.24 for the three months ended October 31, 2010 and therefore their effect would be antidilutive.
(6) Balance Sheet Items
Inventories consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 31,
2011
|
|
|
July 31,
2011
|
|
|
October 31,
2010
|
|
Raw materials and supplies
|
|
$
|
160,504
|
|
|
$
|
64,060
|
|
|
$
|
159,224
|
|
Work in process
|
|
|
26,985
|
|
|
|
25,031
|
|
|
|
17,586
|
|
Finished goods
|
|
|
67,371
|
|
|
|
64,443
|
|
|
|
62,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
254,860
|
|
|
$
|
153,534
|
|
|
$
|
239,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 31,
2011
|
|
|
July 31,
2011
|
|
|
October 31,
2010
|
|
Accounts payable
|
|
$
|
126,932
|
|
|
$
|
74,471
|
|
|
$
|
93,081
|
|
Accrued promotion
|
|
|
32,344
|
|
|
|
27,358
|
|
|
|
24,061
|
|
Accrued salaries and benefits
|
|
|
9,484
|
|
|
|
16,616
|
|
|
|
12,203
|
|
Accrued taxes
|
|
|
3,053
|
|
|
|
4,099
|
|
|
|
3,173
|
(1)
|
Other
|
|
|
6,859
|
|
|
|
6,609
|
|
|
|
8,206
|
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
178,672
|
|
|
$
|
129,153
|
|
|
$
|
140,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Accrued taxes were previously included within Other and have been reclassified to a separate line.
|
(2)
|
The current and long term portion of capital leases are reflected in Accounts payable and accrued liabilities and Other liabilities, respectively, on the Consolidated
Balance Sheets.
|
12
(7) Intangible Assets and Goodwill
The changes in the carrying amount of goodwill are as follows:
|
|
|
|
|
Balance as of July 31, 2010
|
|
$
|
403,264
|
|
Translation adjustments
|
|
|
2,991
|
|
|
|
|
|
|
Balance as of October 31, 2010
|
|
$
|
406,255
|
|
|
|
|
|
|
|
|
Balance as of July 31, 2011
|
|
$
|
409,735
|
|
Translation adjustments
|
|
|
(2,885
|
)
|
|
|
|
|
|
Balance as of October 31, 2011
|
|
$
|
406,850
|
|
|
|
|
|
|
As of October 31, 2011, Diamond performed step 1 of the goodwill impairment analysis by comparing
the estimated fair value of our single reporting unit in relation to our market capitalization including an estimate for a control premium. Goodwill was determined not to be impaired.
Other intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 31,
2011
|
|
|
July 31,
2011
|
|
|
October 31,
2010
|
|
Brand intangibles (not subject to amortization)
|
|
$
|
300,185
|
|
|
$
|
301,148
|
|
|
$
|
299,986
|
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer contracts and related relationships
|
|
|
162,128
|
|
|
|
163,786
|
|
|
|
161,592
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets, gross
|
|
|
462,313
|
|
|
|
464,934
|
|
|
|
461,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less accumulated amortization on intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer contracts and related relationships
|
|
|
(16,046
|
)
|
|
|
(14,079
|
)
|
|
|
(7,748
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets, net
|
|
$
|
446,267
|
|
|
$
|
450,855
|
|
|
$
|
453,830
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable intangible asset amortization expense for each of the five succeeding years will amount to
approximately $8.1 million and will approximate $6.1 million for the remainder of fiscal 2012.
(8) Credit Facilities and Long-Term Obligations
In February 2010, Diamond entered into an agreement with a syndicate of lenders to replace its prior credit facility
with a five-year $600 million secured credit facility (the Secured Credit Facility). As of October 31, 2011, the Secured Credit Facility consisted of a $285 million revolving credit facility, of which $217 million was outstanding,
and a $400 million term loan facility, of which $340 million was outstanding. Since the inception of the Secured Credit Facility, the syndicate of lenders has approved two requests to increase the revolving credit facility of the Secured Credit
Facility: in March 2011, the revolving credit facility was increased from $200 million to $235 million to fund increased working capital requirements, and in August 2011, the revolving credit facility was increased from $235 million to $285 million
to accommodate spending related to the proposed Pringles merger and to increase general liquidity. In both cases, the terms of the revolving credit facility were not changed. On the term loan, scheduled principal payments were $40 million for fiscal
2012 and each of the succeeding two years (due quarterly), and $10 million for each of the first two quarters in fiscal 2015, with the remaining principal balance and any outstanding loans under the revolving credit facility to be repaid on the
fifth anniversary of initial funding. As of October 31, 2011, borrowings under the Secured Credit Facility initially bear interest, at Diamonds option, at either a fluctuating rate per annum (the Base Rate) plus a margin of
2.50%, or the LIBOR rate, plus a margin for LIBOR loans ranging from 2.25% to 3.50%, based on the consolidated leverage ratio, which is defined as the ratio of total debt to earnings before interest, taxes, depreciation and amortization
(EBITDA). For the three months ended October 31, 2011, the blended interest rate was 3.9% for the Companys consolidated borrowings. Substantially all of the Companys tangible and intangible assets are considered
collateral security under the Secured Credit Facility.
13
In December 2010, Kettle Foods obtained, and Diamond guaranteed, a 10-year fixed rate loan
with respect to the Beloit, Wisconsin plant expansion (the Guaranteed Loan) in the principal amount of $21.2 million, of which $20.0 million was outstanding as of October 31, 2011. Principal and interest payments are due monthly
throughout the term of the loan. The Guaranteed Loan is being used to purchase equipment for the Beloit, Wisconsin plant expansion. Borrowed funds were placed in an interest-bearing escrow account. Withdrawals from the escrow account were restricted
to reimburse, dollar-for-dollar, approved expenditures directly related to equipment purchases. As the cash is being used to purchase non-current assets, such restricted cash is classified as non-current on the balance sheet. The Guaranteed Loan
also provides for customary affirmative and negative covenants, which are similar to the covenants under the Secured Credit Facility. Initially, there was a limit to the debt to EBITDA ratio to no more than 4.35 to 1.00, and the fixed charge
coverage ratio to no less than 1.05 to 1.00. As a result of the errors identified causing the restatement of the consolidated financial statements, Diamond was in default with certain financial and reporting covenants, which non-compliance was
waived as of July 31, 2012. In addition, the financial covenants within the Guaranteed Loan were reset to match those in the Third Amendment, as defined below.
The Secured Credit Facility provides for customary affirmative and negative covenants and cross default provisions that may be triggered if Diamond fails to comply with obligations under their other
credit facilities or indebtedness. The Secured Credit Facility initially included a covenant that restricts the amount of indebtedness (including capital leases and purchase money obligations for fixed or capital assets) to no more than $25 million.
On April 30, 2011, Diamond entered into a seven-year equipment lease for its Salem, Oregon plant (the Kettle US Lease) that has been treated as a capital lease for accounting purposes. This accounting treatment caused the Company to
be in default of the covenants in the Secured Credit Facility and the Securities Purchase Agreement dated as of May 22, 2012, by and between the Company and OCM PF/FF Adamantine Holdings, Ltd (the Oaktree SPA) limiting other
indebtedness. These defaults were waived, with respect to the Kettle US Lease on August 23, 2012. Additionally, the Secured Credit Facility and the Oaktree SPA were each amended to allow the Company to incur up to $31 million of capital leases
and purchase money obligations for fixed or capital assets, which amount will be reduced from and after December 31, 2013 (a) to $25 million under the Secured Credit Facility and (b) to $27.5 million under the Oaktree SPA.
As of October 31, 2011, the Companys Secured Credit Facility debt to EBITDA ratio was limited to no more than 4.25 to 1.00,
and the fixed charge coverage ratio to no less than 1.10 to 1.00. As a result of the errors identified causing the restatement of our consolidated financial statements, Diamond was non-compliant with certain financial and reporting covenants, which
non-compliance was waived as a result of the Waiver and Third Amendment to the Secured Credit Facility (the Third Amendment). Please refer to Note 11 of the Notes to Condensed Consolidated Financial Statements for information regarding
the Forbearance agreement and the Third Amendment.
Please refer to Note 11 of the Notes to Condensed Consolidated Financial
Statements for information regarding developments related to the Companys recapitalization.
(9) 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. The amounts shown for pension benefits are combined amounts for all plans. Diamond uses a July 31 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 after January 15, 1999 is not entitled to retiree medical benefits.
Components of net periodic benefit cost (income) were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
Other Benefits
|
|
|
|
Three Months Ended
October 31,
|
|
|
Three Months Ended
October 31,
|
|
|
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
Service cost
|
|
$
|
24
|
|
|
$
|
20
|
|
|
$
|
16
|
|
|
$
|
16
|
|
Interest cost
|
|
|
332
|
|
|
|
316
|
|
|
|
26
|
|
|
|
27
|
|
Expected return on plan assets
|
|
|
(284
|
)
|
|
|
(258
|
)
|
|
|
|
|
|
|
|
|
Amortization of prior service cost
|
|
|
4
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
Amortization of net loss / (gain)
|
|
|
198
|
|
|
|
165
|
|
|
|
(193
|
)
|
|
|
(199
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost / (income)
|
|
$
|
274
|
|
|
$
|
247
|
|
|
$
|
(151
|
)
|
|
$
|
(156
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recognized defined contribution plan expenses of $0.5 million and $0.3 million for the three
months ended October 31, 2011 and 2010, respectively. The Company expects to contribute approximately $1.8 million to the defined contribution plan during fiscal 2012.
14
(10) Contingencies
In November 2011, December 2011 and June 2012, various putative shareholder class action and derivative complaints
were filed in federal and state court against Diamond and certain current and former Diamond directors and officers.
In re
Diamond Foods, Inc., Securities Litigation
Beginning on November 7, 2011, the first of a number of putative
securities class action suits was filed in the United States District Court for the Northern District of California against Diamond and certain of its former executive officers (defendants). These suits allege that defendants made
materially false and misleading statements, or failed to disclose material facts, regarding Diamonds financial results, operations and prospects, including its accounting for payments to walnut growers and the anticipated closing of
Diamonds proposed acquisition of the Pringles business from The Procter & Gamble Company (P&G). The various suits assert claims covering the period from December 9, 2010 through November 4, 2011 and seek
compensatory damages, interest thereon, costs and expenses incurred in such actions, as well as equitable or other relief. On January 24, 2012, these class actions were consolidated by the court as
In re Diamond Foods Inc., Securities
Litigation
. On March 20, 2012, the court appointed a lead plaintiff, and on June 13, 2012, the court appointed legal counsel for the plaintiff. On July 30, 2012, an amended complaint was filed in the consolidated action naming
Diamond, certain of its former executive officers and our outside auditor as defendants. On September 28, 2012, Diamond moved to dismiss the action.
In re Diamond Foods Inc., Shareholder Derivative Litigation
Beginning on
November 14, 2011, three putative shareholder derivative lawsuits were filed in the Superior Court for the State of California, San Francisco County, purportedly on behalf of Diamond Foods and naming certain executive officers and the members
of the Companys board of directors as individual defendants. On January 17, 2012, the court consolidated these actions as
In re Diamond Foods, Inc., Shareholder Derivative Litigation
and appointed co-lead counsel. On
February 16, 2012, plaintiffs filed their consolidated complaint, naming certain current and former executive officers and members of the Companys board, and the Companys outside auditor, as individual defendants. The consolidated
complaint arises from the same or similar alleged facts as alleged in the federal securities action and the federal derivative litigation (discussed in the next paragraph below), and purported to set forth claims for breach of fiduciary duty, unjust
enrichment, abuse of control and gross mismanagement, and against the auditor for professional negligence and breach of contract. The suit seeks the recovery of unspecified damages allegedly sustained by Diamond, which is named as a nominal
defendant, corporate reforms, disgorgement, restitution, the recovery of plaintiffs attorneys fees and other relief. On August 20, 2012, Diamond filed a demurrer seeking to dismiss the action. On October 23, 2012, the court
sustained the Companys demurrer with leave to amend the complaint excluding the gross mismanagement claim, which the court sustained with prejudice.
In re Diamond Foods, Inc., Derivative Litigation
On November 28, 2011
and December 19, 2011, two putative shareholder derivative lawsuits were filed in the United States District Court for the Northern District of California, purportedly on behalf of Diamond Foods and naming certain current and former executive
officers and members of the Companys board of directors as individual defendants. On February 16, 2012, the court consolidated these actions as
In re Diamond Foods, Inc., Derivative Litigation
. Plaintiffs filed their consolidated
complaint on March 1, 2012, again naming certain current and former executive officers and members of the Companys board of directors as individual defendants, and also adding the Companys outside auditor as a defendant. The suit
was based on essentially the same allegations as those in the federal securities action and the state derivative litigation, and purported to set forth claims under Section 14 (a) of the Securities Exchange Act of 1934 alleging that
defendants made materially false or misleading statements or omissions in proxy statements issued on or about November 26, 2010 and on or about September 26, 2011, and for breach of fiduciary duty, unjust enrichment, contribution and
indemnification, gross mismanagement, and, against the Companys auditor, for professional negligence, accounting malpractice and aiding and abetting the breach of fiduciary duties of the other individual defendants. The suit sought to recover
unspecified damages allegedly sustained by Diamond, which was named as a nominal defendant, corporate reforms, restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees and other relief. On April 16,
2012, Diamond moved to dismiss the action. On May 29, 2012, the court granted Diamonds motion and dismissed the action with prejudice, based on lack of subject matter jurisdiction related to deficiencies in plaintiffs
Section 14(a) claims. The court entered judgment in favor of Diamond the same day. On June 4, 2012, one of the plaintiffs in the consolidated matter filed a Notice of Appeal with the United States Court of Appeals for the Ninth Circuit,
seeking to appeal the May 29, 2012 order granting Diamonds motion to dismiss. On October 12, 2012, the appellant filed its opening brief.
15
Astor BK Realty Trust v. Diamond Foods, Inc.
On February 22, 2012
,
an action was filed in Delaware Chancery Court by a shareholder seeking to enforce a demand to inspect
certain of Diamonds records pursuant to Section 220 of the Delaware General Corporation Law, as a possible prelude to the shareholder bringing a derivative action. This action has been stayed by the agreement of the parties.
Delaware Derivative Litigation
On June 27, 2012, two putative shareholder derivative lawsuits,
Board of Trustees of City of Hialeah Employees Retirement System v. Mendes, et al.
and
Lucia v. Mendes et al.
, were
filed in the Delaware Chancery Court purportedly on behalf of Diamond and naming certain current and former executive officers and members of the Companys board of directors as individual defendants. On August 7, 2012 the court
consolidated these actions as
In re Diamond Foods, Inc., Derivative Litigation
and appointed co-lead counsel. Plaintiffs filed their consolidated complaint on September 19, 2012, again naming certain current and former executive officers
and members of our board of directors as individual defendants. The suit is based on essentially the same allegations as those in the federal securities action and the federal and California derivative litigation and purports to set forth claims for
breach of fiduciary duty, unjust enrichment, contribution and indemnification, gross mismanagement and breach of the duty of loyalty. The suit seeks recovery of unspecified damages allegedly sustained by Diamond, which is named as a nominal
defendant, corporate reforms, disgorgement, restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees and other relief.
Governmental Proceedings
On December 14, 2011, Diamond received a
formal order of investigation from the staff of the United States Securities and Exchange Commission (SEC). Diamond also has had contact with the U.S. Attorneys office for the Northern District of California (DOJ). We
have cooperated with the government and expect to continue to do so.
Other
The Company is involved in other various legal actions in the ordinary course of our business. Such matters are subject to many
uncertainties that make their outcomes, and any potential liability we may incur, unpredictable.
We do not believe it is
feasible to predict or determine the outcome or resolution of the above litigation proceedings, or to estimate the amounts of, or potential range of, loss with respect to those proceedings. In addition, the timing of the final resolution of these
proceedings is uncertain. The range of possible resolutions of these proceedings could include judgments against the Company or settlements that could require substantial payments by the Company, which could have a material impact on Diamonds
financial position, results of operations and cash flows.
(11) Subsequent Events
The Secured Credit Facility initially included a covenant that restricts the amount of indebtedness (including capital
leases and purchase money obligations for fixed or capital assets) to no more than $25 million. On January 30, 2012, Diamond entered into a five-year equipment lease for its Norfolk, UK plant (the Kettle UK Lease) that has been
treated as a capital lease for accounting purposes. The accounting treatment for the Kettle US Lease and the Kettle UK Lease caused the Company to be in default of the Secured Credit Facility covenant limiting other indebtedness. These defaults
were waived, with respect to the Kettle UK Lease on July 27, 2012, and with respect to the Kettle US Lease, on August 23, 2012. Additionally, the Secured Credit Facility and the Oaktree SPA were each amended to allow the Company to incur
up to $31 million of capital leases and purchase money obligations for fixed or capital assets, which amount will be reduced from and after December 31, 2013 (a) to $25 million under the Secured Credit Facility and (b) to $27.5
million under the Oaktree SPA.
On February 8, 2012, the Audit Committee of Diamonds Board of Directors
substantially completed its investigation of the Companys accounting for certain crop payments to walnut growers. The Audit Committee concluded that Diamonds consolidated financial statements for fiscal 2010 and fiscal 2011 would need to
be restated and identified material weaknesses in the Companys internal control over financial reporting.
On
February 15, 2012, Diamond and The Procter & Gamble Company (P&G) mutually agreed to terminate the Companys proposed merger of the Pringles business. No break-up fee or other fees were paid in connection
with the termination, which included a mutual release.
16
On March 21, 2012, Diamond reached an agreement with its lenders to forbear from
seeking any remedies under the Secured Credit Facility with respect to specified existing and anticipated non-compliance with the credit agreement and to amend its credit agreement (the Second Amendment). Under the amended credit
agreement, Diamond had continued access to its existing revolving credit facility through a forbearance period (initially through June 18, 2012) subject to Diamonds compliance with the terms and conditions of the amended credit agreement.
During the forbearance period, the interest rate on borrowings increased. The amended credit agreement required Diamond to suspend dividend payments to stockholders. In addition, Diamond paid a forbearance fee of 0.25% to its lenders. The
forbearance period concluded on May 29, 2012, when Diamond closed agreements to recapitalize its balance sheet with an investment by Oaktree Capital Management, L.P. (Oaktree).
On May 22, 2012, the Company entered into the Third Amendment, which provided for a lower level of total bank debt, initially $475
million, along with substantial covenant relief until October 31, 2013, at which time the covenants will apply at revised levels set forth in the Third Amendment (initially 4.70 to 1.00 for the senior leverage ratio, declining over four
quarters to 3.25 to 1.00 in the quarter ending July 31, 2014 and thereafter, and 2.00 to 1.00 for the fixed charge coverage ratio for each fiscal quarter). Prior to the Third Amendment, as of July 31, 2011, the debt to EBITDA ratio was
limited to no more than 4.25 to 1.00 and the fixed charge coverage ratio to no less than 1.10 to 1.00. As a result of the errors identified causing the restatement of our consolidated financial statements, Diamond was non-compliant with these
financial ratio covenants, which non-compliance was waived as a result of the Third Amendment. The Third Amendment included a new covenant requiring that Diamond have at least $20 million of cash, cash equivalents and revolving credit availability
beginning February 1, 2013. In addition, the Third Amendment required a $100 million pre-payment of the term loan facility, while reducing the remaining scheduled principal payments on the term loan facility from $10 million to $0.9 million.
The Third Amendment also amended the definition of Applicable Rate under the Secured Credit Agreement (which sets the margin over LIBOR and the Base Rate at which loans under the Secured Credit Agreement bear interest). Initially,
Eurodollar rate loans will bear interest at 5.50% plus the LIBOR for the applicable loan period, and Base rate loans will bear interest at 4.50% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the Prime Rate, or
(iii) Eurodollar Rate plus 1.00%. The LIBOR rate is subject to a LIBOR floor, initially 1.25% (the LIBOR Floor). The margins over LIBOR, the LIBOR floor, and the Base Rate will decline if and when Diamond achieves specified
reductions in its ratio of senior debt to EBITDA. The Third Amendment also eliminated the requirement that proceeds of future equity issuances be applied to repay outstanding loans, and waived certain covenants that the Company was non-compliant
with in connection with the restatement of our consolidated financial statements.
On May 29, 2012, Diamond closed
agreements to recapitalize Diamonds balance sheet with an investment by Oaktree. The Oaktree investment initially consists of $225 million of newly-issued senior notes and warrants to purchase approximately 4.4 million shares of Diamond
common stock. The senior notes will mature in 2020 and will bear interest at 12% per year that may be paid-in-kind at Diamonds option for the first two years. Oaktrees warrants will be exercisable at $10 per share, and would
constitute a fully diluted ownership level of approximately 16.4% of the Company.
The Oaktree agreements provide that if
Diamond secures a specified minimum supply of walnuts from the 2012 crop and achieves profitability targets for its nut businesses for the six-month period ending January 31, 2013, all of the warrants will be cancelled and Oaktree may exchange
$75 million of the senior notes for convertible preferred stock of Diamond (the Special Redemption). The convertible preferred stock would have an initial conversion price of $20.75, which represents a 3.5% discount to the closing price
of Diamond common stock on April 25, 2012, the date that the Company entered into its commitment with Oaktree. The convertible preferred stock would pay a 10% dividend that would be paid in-kind for the first two years. Diamond does not
currently anticipate that the Special Redemption will occur.
On October 25, 2012, Diamond announced a plan to
consolidate its manufacturing operations and will close its leased facility in Fishers, Indiana. Certain manufacturing equipment at Fishers will be relocated to Diamonds facility in Stockton, California. Additionally, the Company will
record an impairment charge of approximately $4 million associated with Fishers equipment that will not be utilized.
(12) Restatement of Consolidated Financial Statements
Walnut Correction
Subsequent to the issuance of the fiscal 2011 consolidated financial statements, the Audit Committee initiated an independent investigation into walnut grower payments made subsequent to fiscal years end
2011 and 2010, of approximately $61.5 million (the Momentum Payments) and $20.8 million (the Continuity Payments), respectively. The Company previously accounted for those walnut grower payments as expenses in the fiscal
years when the payments were made (fiscal 2012 and fiscal 2011, respectively), reflecting the payments as pre-payments for the walnut crop to be delivered in the respective fiscal years. As a result of an evaluation of the substance of information
obtained in this investigation we determined that the Momentum Payments and Continuity Payments related to the prior year walnut crops and such payments were not accounted for in the correct periods. The Company and Audit Committee concluded that
the original accounting for the walnut grower payments in fiscal 2011 and fiscal 2010 was not sufficiently supported and was not based on consideration of all relevant information available at the time. Accordingly, the three months ended October
31, 2010 was affected for the remaining July 31, 2010 walnut inventories that were sold during the period.
17
Fiscal 2011 Quarterly Walnut Estimate Correction
The Companys original walnut cost estimate used for the period ended October 31, 2010, was not sufficiently supported and was not
based on consideration of all relevant information available at the time. We have determined that the contemporaneously available relevant information supports a correction of the original walnut cost estimate in this period. The effect of
correcting this error for the period ended October 31, 2010 is summarized below. The corrections summarized below include consideration of the income tax effect of the restatement adjustments.
For the three months ended October 31, 2010, the corrected walnut costs increased cost of sales by $7.0 million, increased
inventories by $33.6 million, and increased payable to growers by $58.8 million.
Accounts Payable and Accrued Expenses Correction
Subsequent to the issuance of the consolidated financial statements for the fiscal year ended July 31, 2011, an
invoice for services related to the then-pending Pringles merger was identified as not properly accrued for as of July 31, 2011. In response to this information, the Company performed an extensive review of vendor invoices and
supporting documentation to determine whether other unrecorded liabilities existed for the interim and annual periods within the fiscal year ended July 31, 2011. The review identified certain expenses that were not properly reflected in
accounts payable and accrued liabilities as of July 31, 2011 and for the interim period ended October 31, 2010. The effect of correcting this error for the period ended October 31, 2010 is summarized below.
Other Corrections
In addition to the restatements described above, the Company has made other corrections, some of which were previously identified, but
were not corrected because management had determined they were not material, individually or in the aggregate, to our consolidated financial statements. These corrections related to stock-based compensation, foreign currency translation, timing of
prepaid and expense recognition, and deferred income tax. The effect of correcting this error for the period ended October 31, 2010 is summarized below. The corrections summarized below include consideration of the income tax effect of the
restatement adjustments.
Additionally, the Company has corrected certain disclosures, the most significant of which are
discussed below:
|
|
|
Expected volatility assumptions used in the Black-Scholes model for the three months ended October 31, 2010 was previously reported as 37.00% and
was restated to 42.35%. This change impacted several disclosures in Note 4 of the Notes to Condensed Consolidated Financial Statements. The weighted average fair value per share of options granted during the three months ended October 31,
2010 was previously reported as $14.89 and restated to $16.66. The fair value per share of stock options vested during the three months ended October 31, 2010 was previously reported as $8.86 and was restated to $15.51. Finally, the change in
expected volatility impacted the calculation of diluted shares for the three months ended October 31, 2010 resulting in a decrease from 21,947 previously reported to 21,933 as restated.
|
|
|
|
In Note 9 of the Notes to Condensed Consolidated Financial Statements, defined contribution plan expenses for the three months ended
October 31, 2010 were previously reported as $0.2 million and were restated to $0.3 million.
|
18
The effects of the restatement on the condensed consolidated balance sheet as of
October 31, 2010 are summarized in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 31, 2010
|
|
|
|
(In thousands, except share and
per share information)
|
|
|
|
Previously
Reported
|
|
|
Walnut
Corrections
|
|
|
Accounts
Payable and
Accrued
Expenses
Correction
|
|
|
Other
Correction
|
|
|
Restated
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
8,012
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
8,012
|
|
Trade receivables, net
|
|
|
122,660
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
122,660
|
|
Inventories
|
|
|
205,518
|
|
|
|
33,572
|
|
|
|
|
|
|
|
(83
|
)
|
|
|
239,007
|
|
Deferred income taxes
|
|
|
10,497
|
|
|
|
|
|
|
|
|
|
|
|
1,721
|
|
|
|
12,218
|
|
Prepaid income taxes
|
|
|
3,055
|
|
|
|
8,443
|
|
|
|
24
|
|
|
|
(1,045
|
)
|
|
|
10,477
|
|
Prepaid expenses and other current assets
|
|
|
10,168
|
|
|
|
|
|
|
|
|
|
|
|
(176
|
)
|
|
|
9,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
359,910
|
|
|
|
42,015
|
|
|
|
24
|
|
|
|
417
|
|
|
|
402,366
|
|
Property, plant and equipment, net
|
|
|
118,243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
118,243
|
|
Deferred income taxes
|
|
|
13,120
|
|
|
|
|
|
|
|
|
|
|
|
(9,196
|
)
|
|
|
3,924
|
|
Goodwill
|
|
|
396,788
|
|
|
|
|
|
|
|
|
|
|
|
9,467
|
|
|
|
406,255
|
|
Other intangible assets, net
|
|
|
447,052
|
|
|
|
|
|
|
|
|
|
|
|
6,778
|
|
|
|
453,830
|
|
Other long-term assets
|
|
|
7,978
|
|
|
|
|
|
|
|
|
|
|
|
194
|
|
|
|
8,172
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,343,091
|
|
|
$
|
42,015
|
|
|
$
|
24
|
|
|
$
|
7,660
|
|
|
$
|
1,392,790
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current portion of long-term debt
|
|
$
|
40,000
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
40,000
|
|
Accounts payable and accrued liabilities
|
|
|
143,180
|
|
|
|
|
|
|
|
130
|
|
|
|
(2,586
|
)
|
|
|
140,724
|
|
Payable to growers
|
|
|
84,804
|
|
|
|
58,794
|
|
|
|
|
|
|
|
|
|
|
|
143,598
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
267,984
|
|
|
|
58,794
|
|
|
|
130
|
|
|
|
(2,586
|
)
|
|
|
324,322
|
|
Long-term obligations
|
|
|
515,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
515,000
|
|
Deferred income taxes
|
|
|
146,265
|
|
|
|
|
|
|
|
|
|
|
|
(4,524
|
)
|
|
|
141,741
|
|
Other liabilities
|
|
|
18,154
|
|
|
|
|
|
|
|
|
|
|
|
1,445
|
|
|
|
19,599
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value; Authorized: 5,000,000 shares; no shares issued or outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value; Authorized: 100,000,000 shares; 22,234,131 shares issued and 21,974,522 shares outstanding at
October 31, 2010
|
|
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22
|
|
Treasury stock, at cost: 259,609 shares at October 31, 2010
|
|
|
(6,315
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,315
|
)
|
Additional paid-in capital
|
|
|
310,470
|
|
|
|
|
|
|
|
|
|
|
|
596
|
|
|
|
311,066
|
|
Accumulated other comprehensive income (loss)
|
|
|
(522
|
)
|
|
|
|
|
|
|
|
|
|
|
11,311
|
|
|
|
10,789
|
|
Retained earnings
|
|
|
92,033
|
|
|
|
(16,779
|
)
|
|
|
(106
|
)
|
|
|
1,418
|
|
|
|
76,566
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
395,688
|
|
|
|
(16,779
|
)
|
|
|
(106
|
)
|
|
|
13,325
|
|
|
|
392,128
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
1,343,091
|
|
|
$
|
42,015
|
|
|
$
|
24
|
|
|
$
|
7,660
|
|
|
$
|
1,392,790
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
The effects of the restatement on the condensed consolidated statement of operations for the
quarter ended October 31, 2010 are summarized in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended October 31, 2010
|
|
|
|
(In thousands, except per share information)
|
|
|
|
Previously
Reported
|
|
|
Walnut
Corrections
|
|
|
Accounts
Payable and
Accrued
Expenses
Correction
|
|
|
Other
Correction
|
|
|
Restated
|
|
Net sales
|
|
$
|
252,566
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(505
|
)
|
|
$
|
252,061
|
|
Cost of sales
|
|
|
188,970
|
|
|
|
6,952
|
|
|
|
|
|
|
|
31
|
|
|
|
195,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
63,596
|
|
|
|
(6,952
|
)
|
|
|
|
|
|
|
(536
|
)
|
|
|
56,108
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
23,103
|
|
|
|
|
|
|
|
|
|
|
|
186
|
|
|
|
23,289
|
|
Advertising
|
|
|
12,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,469
|
|
Acquisition and integration related expenses
|
|
|
499
|
|
|
|
|
|
|
|
|
|
|
|
80
|
|
|
|
579
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
36,071
|
|
|
|
|
|
|
|
|
|
|
|
266
|
|
|
|
36,337
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
27,525
|
|
|
|
(6,952
|
)
|
|
|
|
|
|
|
(802
|
)
|
|
|
19,771
|
|
Interest expense, net
|
|
|
6,117
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,117
|
|
Income before income taxes
|
|
|
21,408
|
|
|
|
(6,952
|
)
|
|
|
|
|
|
|
(802
|
)
|
|
|
13,654
|
|
Income taxes
|
|
|
7,194
|
|
|
|
(2,530
|
)
|
|
|
|
|
|
|
(292
|
)
|
|
|
4,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
14,214
|
|
|
$
|
(4,422
|
)
|
|
$
|
|
|
|
$
|
(510
|
)
|
|
$
|
9,282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.65
|
|
|
$
|
(0.21
|
)
|
|
$
|
|
|
|
$
|
(0.02
|
)
|
|
$
|
0.42
|
|
Diluted
|
|
$
|
0.64
|
|
|
$
|
(0.20
|
)
|
|
$
|
|
|
|
$
|
(0.02
|
)
|
|
$
|
0.42
|
|
Shares used to compute earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
21,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21,489
|
|
Diluted
|
|
|
21,947
|
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
|
|
21,933
|
|
Dividends declared per share
|
|
$
|
0.045
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
0.045
|
|
20
The effects of the restatement on the condensed consolidated statement of cash flows for the
quarter ended October 31, 2010 are summarized in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended October 31, 2010
|
|
|
|
(In thousands)
|
|
|
|
Previously
Reported
|
|
|
Walnut
Corrections
|
|
|
Accounts
Payable and
Accrued
Expenses
Correction
|
|
|
Other
Correction
|
|
|
Reclassifications
|
|
|
Restated
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
14,214
|
|
|
$
|
(4,422
|
)
|
|
$
|
|
|
|
$
|
(510
|
)
|
|
$
|
|
|
|
$
|
9,282
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
7,472
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,472
|
|
Deferred income taxes
|
|
|
2,347
|
|
|
|
|
|
|
|
|
|
|
|
(333
|
)
|
|
|
|
|
|
|
2,014
|
|
Excess tax benefit from stock option transactions
|
|
|
(1,304
|
)
|
|
|
|
|
|
|
|
|
|
|
360
|
|
|
|
|
|
|
|
(944
|
)
|
Stock-based compensation
|
|
|
1,580
|
|
|
|
|
|
|
|
|
|
|
|
192
|
|
|
|
|
|
|
|
1,772
|
|
Other, net
|
|
|
84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
84
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade receivables, net
|
|
|
(57,107
|
)
|
|
|
|
|
|
|
|
|
|
|
145
|
|
|
|
|
|
|
|
(56,962
|
)
|
Inventories
|
|
|
(62,113
|
)
|
|
|
(31,093
|
)
|
|
|
|
|
|
|
31
|
|
|
|
|
|
|
|
(93,175
|
)
|
Prepaid expenses and other current assets and income taxes
|
|
|
1,769
|
|
|
|
(2,530
|
)
|
|
|
|
|
|
|
(858
|
)
|
|
|
|
|
|
|
(1,619
|
)
|
Other assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(475
|
)
|
|
|
(475
|
)
|
Accounts payable and accrued liabilities
|
|
|
51,753
|
|
|
|
|
|
|
|
|
|
|
|
1,333
|
|
|
|
|
|
|
|
53,086
|
|
Payable to growers
|
|
|
49,049
|
|
|
|
38,045
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87,094
|
|
Other liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
319
|
|
|
|
319
|
|
Other, net
|
|
|
(156
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
7,588
|
|
|
|
|
|
|
|
|
|
|
|
360
|
|
|
|
|
|
|
|
7,948
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment
|
|
|
(4,732
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,732
|
)
|
Proceeds from sale of property, plant and equipment
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(4,724
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,724
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving line of credit borrowings under the Secured Credit Facility, net
|
|
|
8,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,900
|
|
Payment of long-term debt and notes payable
|
|
|
(10,032
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,032
|
)
|
Dividends paid
|
|
|
(989
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(989
|
)
|
Excess tax benefit from stock option transactions
|
|
|
1,304
|
|
|
|
|
|
|
|
|
|
|
|
(360
|
)
|
|
|
|
|
|
|
944
|
|
Purchase of treasury stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,265
|
)
|
|
|
(1,265
|
)
|
Other, net
|
|
|
243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,265
|
|
|
|
1,508
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(574
|
)
|
|
|
|
|
|
|
|
|
|
|
(360
|
)
|
|
|
|
|
|
|
(934
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash
|
|
|
80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
80
|
|
Net increase in cash and cash equivalents
|
|
|
2,370
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,370
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
5,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
$
|
8,012
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
8,012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid (refunded) during the period for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
5,622
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
5,622
|
|
Income taxes
|
|
|
(2,929
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,929
|
)
|
Non-cash investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued capital expenditures
|
|
|
1,261
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,261
|
|
21
Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
Overview
Diamond Foods, Inc. (Diamond, the Company, or we) is 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 heritage in the culinary nut market under the Diamond of California
®
brand by launching a line of snack nuts under the Emerald
®
brand. In September 2008, we acquired the Pop Secret
®
brand of microwave popcorn products, which provided us with increased scale in the snack market, supply chain economies of scale and cross promotional opportunities
with our existing brands. In March 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, which added the complementary premium Kettle
Brand
®
to our existing portfolio of brands in the snack industry. In general, we sell directly to retailers,
particularly large national grocery store and drug store chains, and indirectly through wholesale distributors to independent and small regional retail grocery store chains and convenience stores. We sell our products to global, national, regional
and independent grocery, drug and convenience store chains, as well as to mass merchandisers, club stores, other retail channels and non-retail channels.
As discussed in Note 12 of the Notes to Condensed Consolidated Financial Statements, we have restated our previously issued condensed consolidated financial statements as of and for the three months ended
October 31, 2010, accordingly the following has been revised for the effects of the restatement.
Results of Operations
Net sales were $287.4 million and $252.1 million for the three months ended October 31, 2011 and 2010, respectively.
The increase in net sales was primarily due to increased snack and culinary sales. Higher pricing, net of promotional spending, was reflected across all channels as we increased pricing to offset higher input costs. The impact of foreign exchange on
our net sales for the three months ended October 31, 2011 and 2010 was not significant.
Net sales by channel (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
October 31,
|
|
|
|
|
|
|
2011
|
|
|
2010
|
|
|
% Change from
2010 to 2011
|
|
Snack
|
|
$
|
157,122
|
|
|
$
|
137,056
|
|
|
|
14.6
|
%
|
Culinary and Retail In-shell
|
|
|
98,112
|
|
|
|
90,190
|
|
|
|
8.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Retail
|
|
|
255,234
|
|
|
|
227,246
|
|
|
|
12.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International Non-Retail
|
|
|
21,444
|
|
|
|
21,015
|
|
|
|
2.0
|
%
|
North American Ingredient/Food Service and Other
|
|
|
10,715
|
|
|
|
3,800
|
|
|
|
182.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-Retail
|
|
|
32,159
|
|
|
|
24,815
|
|
|
|
29.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sales
|
|
$
|
287,393
|
|
|
$
|
252,061
|
|
|
|
14.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended October 31, 2011, the increase in retail sales resulted from higher sales
of snack products, which increased by 14.6% and culinary and domestic in-shell sales, which increased by 8.8%. The growth in snack products was driven by increased volume across all brands and to a lesser extent by favorable pricing, partially
offset by increased promotional spending. The increase in culinary and retail in-shell sales was driven by both volume and price increases in culinary, offset by lower retail in-shell sales due to delays of customer orders into November.
International non-retail sales were relatively flat, as volume declines were offset by price increases. North American ingredient/food service and other sales increased for the three months ended October 31, 2011, as a result of additional
walnut inventory on hand as of July 31, 2011 as compared to the prior year, allowing for higher sales volume ahead of the 2011 crop. Additionally, North American ingredient/food service and other sales for the three months ended
October 31, 2010 were impacted by the timing of the later tree nut harvest in the prior year.
22
Sales to our largest customer, Wal-Mart Stores, Inc. (which includes sales to both
Sams Club and Wal-Mart) represented approximately 18.5% and 16.0% of total net sales for the three months ended October 31, 2011 and 2010, respectively. No other customer accounted for 10% or more of our total net sales for those periods.
Gross profit.
Gross profit as a percentage of net sales was 21.3% and 22.3% for the three months ended
October 31, 2011 and 2010, respectively. Gross profit as a percentage of net sales in the current quarter reflects higher commodity costs, particularly for walnuts, partially offset by pricing increases taken in response to those rising costs.
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 $29.5 million and $23.3 million, and 10.2% and 9.2% as a
percentage of net sales, for the three months ended October 31, 2011 and 2010, respectively. The increase in expense was primarily due to increased variable selling expenses related to higher sales and $1.8 million in legal settlement accruals
related to walnut labeling claims.
Advertising.
Advertising expenses were $12.7 million and $12.5 million, and 4.4%
and 4.9% as a percentage of net sales, for the three months ended October 31, 2011 and 2010, respectively.
Acquisition and integration related expenses.
Acquisition and integration related expenses include items such as transaction
related legal and consulting fees, as well as business and systems integration costs. Acquisition and integration related expenses associated with the proposed Pringles merger were $17.2 million for the three months ended October 31, 2011.
Acquisition and integration related expenses associated with Kettle Foods were $0.6 million for the three months ended October 31, 2010.
Interest expense, net.
Net interest expense was $5.8 million and $6.1 million, and 2.0% and 2.4% as a percentage of net sales, for the three months ended October 31, 2011 and 2010,
respectively.
Income taxes.
The effective tax rate for the three months ended October 31, 2011 and 2010 was
approximately 381.3% and 32.0%, respectively. The higher effective tax rate for the three months ended October 31, 2011 was related to three amounts comprising the tax benefit of $14.6 million. A discrete tax benefit of $5.5 million resulting,
primarily, from the conclusion of a tax ruling with the United Kingdom tax authorities and, consequently, the reversal of our unrecognized tax benefit related to this event. Second, during the quarter, we incurred acquisition and integration related
expenses resulting in a tax benefit of $6.1 million. Third, the forecasted annual tax rate applied to profit before tax and acquisition and integration related expenses, resulting in a tax benefit of $3.0 million.
Proposed Pringles Merger Subsequently Terminated
On April 5, 2011, Diamond entered into a definitive agreement with The Procter & Gamble Company (P&G) to merge P&Gs Pringles business into the Company; on
February 15, 2012, Diamond and P&G mutually agreed to terminate this proposed merger. No break-up fee or other fees were paid in connection with the termination, which included a mutual release.
Liquidity and Capital Resources
Our liquidity is dependent upon funds generated from operations and external sources of financing.
Cash used in operating activities was $31.7 million during the three months ended October 31, 2011 compared to $7.9 million provided by operating activities for the three months ended
October 31, 2010. The increase in cash used in operating activities was primarily due to spending related to the proposed Pringles merger and increased Fall payments associated with the 2011 walnut harvest. Cash used in investing activities was
$9.2 million during the three months ended October 31, 2011 compared to $4.7 million for the three months ended October 31, 2010. The higher cash used in investing activities for the three months ended October 31, 2011 was due mainly
to the Beloit, Wisconsin plant expansion. Cash provided by financing activities during the three months ended October 31, 2011 was $42.3 million compared to $0.9 million used in financing activities for the three months ended October 31,
2010. The cash provided by financing activities was primarily attributable to increased borrowings under the revolving credit facility.
23
In February 2010, we entered into an agreement with a syndicate of lenders to replace our
prior credit facility with a five-year $600 million secured credit facility (the Secured Credit Facility). As of October 31, 2011, our Secured Credit Facility consists of a $285 million revolving credit facility, of which $217
million was outstanding, and a $400 million term loan facility, of which $340 million was outstanding. Since the inception of the Secured Credit Facility, the syndicate of lenders has approved two requests to increase the revolving credit facility
of the Secured Credit Facility: in March 2011, the revolving credit facility was increased from $200 million to $235 million to fund increased working capital requirements, and then in August 2011, the revolving credit facility was increased from
$235 million to $285 million to accommodate spending related to the proposed Pringles merger and to increase general liquidity. In both cases, the terms of the revolving credit facility were not changed. On the term loan, scheduled principal
payments were $40 million for fiscal 2012 and each of the succeeding two years (due quarterly), and $10 million for each of the first two quarters in fiscal 2015, with the remaining principal balance and any outstanding loans under the revolving
credit facility to be repaid on the fifth anniversary of initial funding. As of October 31, 2011, borrowings under the Secured Credit Facility initially bear interest, at our option, at either a fluctuating rate per annum (the Base
Rate) plus a margin of 2.50%, or the London Interbank Offered Rate (LIBOR), plus a margin for LIBOR loans ranging from 2.25% to 3.50%, based on the consolidated leverage ratio, which is defined as the ratio of total debt to
earnings before interest, taxes, depreciation and amortization (EBITDA). Substantially all of our tangible and intangible assets are considered collateral security under the Secured Credit Facility.
In December 2010, Kettle Foods obtained, and we guaranteed, a 10-year fixed rate loan with respect to our Beloit, Wisconsin plant
expansion (the Guaranteed Loan) in the principal amount of $21.2 million, of which $20.0 million was outstanding as of October 31, 2011. Principal and interest payments are due monthly throughout the term of the loan. The Guaranteed
Loan is being used to purchase equipment for our Beloit, Wisconsin plant expansion. Borrowed funds were placed in an interest-bearing escrow account. Withdrawals from the escrow account were restricted to reimburse, dollar-for-dollar, approved
expenditures directly related to equipment purchases. As the cash is being used to purchase non-current assets, such restricted cash is classified as non-current on the balance sheet. The Guaranteed Loan also provides for customary affirmative and
negative covenants, which are similar to the covenants under the Secured Credit Facility. Initially, there was a limit to our debt to EBITDA ratio to no more than 4.35 to 1.00, and our fixed charge coverage ratio to no less than 1.05 to 1.00. As a
result of the errors identified causing the restatement of our consolidated financial statements, we were in default with certain financial and reporting covenants, which non-compliance was waived as of July 31, 2012. In addition, the financial
covenants within the Guaranteed Loan were reset to match those in the Third Amendment, as defined below.
On March 21,
2012, we reached an agreement with our lenders to forbear from seeking any remedies under the Secured Credit Facility with respect to specified existing and anticipated non-compliance with the credit agreement and to amend our credit agreement (the
Second Amendment). Under the amended credit agreement, we had continued access to our existing revolving credit facility through a forbearance period (initially through June 18, 2012) subject to our compliance with the terms and
conditions of the amended credit agreement. During the forbearance period, the interest rate on borrowings increased. The amended credit agreement required us to suspend dividend payments to stockholders. In addition, we paid a forbearance
fee of 0.25% to our lenders. The forbearance period concluded on May 29, 2012, when we closed agreements to recapitalize our balance sheet with an investment by Oaktree Capital Management, L.P. (Oaktree).
On May 22, 2012, we entered into a Waiver and Third Amendment to our Secured Credit Facility (Third Amendment), which
provided for a lower level of total bank debt, initially $475 million, along with substantial covenant relief until October 31, 2013, at which time the covenants will apply at revised levels set forth in the Third Amendment (initially 4.70 to
1.00 for the senior leverage ratio, declining over four quarters to 3.25 to 1.00 in the quarter ending July 31, 2014 and thereafter, and 2.00 to 1.00 for the fixed charge coverage ratio for each fiscal quarter). Prior to the Third Amendment, as
of July 31, 2011, our debt to EBITDA ratio was limited to no more than 4.25 to 1.00 and our fixed charge coverage ratio to no less than 1.10 to 1.00. As a result of the errors identified causing the restatement of our consolidated financial
statements, we were non-compliant with these financial ratio covenants, which non-compliance was waived as a result of the Third Amendment. The Third Amendment included a new covenant requiring that we have at least $20 million of cash, cash
equivalents and revolving credit availability beginning February 1, 2013. In addition, the Third Amendment required a $100 million pre-payment of the term loan facility, while reducing the remaining scheduled principal payments on the term loan
facility from $10 million to $0.9 million. The Third Amendment also amended the definition of Applicable Rate under the Secured Credit Agreement (which sets the margin over LIBOR and the Base Rate at which loans under the Secured Credit
Agreement bear interest). Initially, Eurodollar rate loans will bear interest at 5.50% plus the LIBOR for the applicable loan period, and Base Rate loans will bear interest at 4.50% plus the highest of (i) the Federal Funds Rate plus 0.50%,
(ii) the Prime Rate, or (iii) Eurodollar Rate plus 1.00%. The LIBOR rate is subject to a LIBOR floor, initially 1.25% (the LIBOR Floor). The margins over LIBOR, the LIBOR floor, and the Base Rate will decline if and when we
achieve specified reductions in our ratio of senior debt to EBITDA. The Third Amendment also eliminated the requirement that proceeds of future equity issuances be applied to repay outstanding loans, and waived certain covenants that we were
non-compliant with in connection with our restatement of our consolidated financial statements.
24
The Secured Credit Facility, and the Securities Purchase Agreement, dated as of May 22,
2012, by and between Diamond and OCM PF/FF Adamantine Holdings, Ltd. (the Oaktree SPA), provide for customary affirmative and negative covenants and cross default provisions that may be triggered if we fail to comply with our obligations
under our other credit facilities or indebtedness. The Secured Credit Facility and the Oaktree SPA include a covenant that restricts the amount of indebtedness (including capital leases and purchase money obligations for fixed or capital assets), to
no more than $25 million. As of October 31, 2011, Diamond exceeded the covenant limit, due to the seven-year equipment lease with respect to our Salem, Oregon plant (the Kettle US Lease). These defaults were waived, with
respect to the Kettle US Lease on August 23, 2012. Additionally, the Secured Credit Facility and the Oaktree SPA were each amended to allow Diamond to incur up to $31 million of capital leases and purchase money obligations for fixed or capital
assets, which amount will be reduced from and after December 31, 2013 (a) to $25 million under the Secured Credit Facility and (b) to $27.5 million under the Oaktree SPA.
On May 29, 2012, Diamond closed agreements to recapitalize Diamonds balance sheet with an investment by Oaktree. The Oaktree
investment initially consists of $225 million of newly-issued senior notes and warrants to purchase approximately 4.4 million shares of Diamond common stock. The senior notes will mature in 2020 and will bear interest at 12% per year that
may be paid-in-kind at our option for the first two years. Oaktrees warrants will be exercisable at $10 per share, and would constitute a fully diluted ownership level of approximately 16.4% of Diamond.
The Oaktree agreements provide that if we secure a specified minimum supply of walnuts from the 2012 crop and achieve profitability
targets for our nut businesses for the six-month period ending January 31, 2013, all of the warrants will be cancelled and Oaktree may exchange $75 million of the senior notes for convertible preferred stock of Diamond (the Special
Redemption). The convertible preferred stock would have an initial conversion price of $20.75, which represents a 3.5% discount to the closing price of Diamond common stock on April 25, 2012, the date that we entered into our commitment
with Oaktree. The convertible preferred stock would pay a 10% dividend that would be paid in-kind for the first two years. Diamond does not currently anticipate that the Special Redemption will occur.
Working capital and stockholders equity were $91.1 million and $425.3 million at October 31, 2011, compared to $52.4 million
and $420.5 million at July 31, 2011, and $78.0 million and $392.1 million at October 31, 2010. The increase in working capital was due to an increase in receivables attributable to increased sales and an increase in inventory due to the
walnut harvest season, which were offset by an increase in accounts payable and accrued liabilities, partially attributable to acquisition expenses.
Our business is seasonal. 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. 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 pecans during the period from October to March, and we pay for our pecan receipts over such period. As a result of this seasonality, our personnel and working capital requirements and walnut inventories peak during the last quarter
of the calendar year. We experience seasonality in capacity utilization at our Stockton, California and Fishers, Indiana facilities 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 receive and pay for supply throughout the year. Generally, demand for potato chips is highest in the
months of June, July and August in the United States, and November and December in the United Kingdom. Accordingly, the working capital requirement of our popcorn and potato chip product lines is less seasonal than that of the tree nut product
lines.
We believe our cash and cash equivalents, cash expected to be provided from our operations, borrowings available under
our Secured Credit Facility, the Oaktree investment, and restricted cash provided by the Guaranteed Loan, will be sufficient to fund our contractual commitments, repay obligations as required and fund our operational requirements for at least the
next twelve months.
25
Contractual Obligations and Commitments
Contractual obligations and commitments at October 31, 2011 were as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
Total
|
|
|
Remainder
FY 2012
|
|
|
FY 2013 -
FY 2014
|
|
|
FY 2015 -
FY 2016
|
|
|
Thereafter
|
|
Revolving line of credit
|
|
$
|
216.8
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
216.8
|
|
|
$
|
|
|
Long-term obligations
|
|
|
360.0
|
|
|
|
31.3
|
|
|
|
83.7
|
|
|
|
234.1
|
|
|
|
10.9
|
|
Interest on long-term obligations (a)
|
|
|
38.4
|
|
|
|
9.3
|
|
|
|
20.8
|
|
|
|
7.0
|
|
|
|
1.3
|
|
Capital leases
|
|
|
6.1
|
|
|
|
0.7
|
|
|
|
1.9
|
|
|
|
1.9
|
|
|
|
1.6
|
|
Operating leases
|
|
|
28.1
|
|
|
|
4.6
|
|
|
|
9.7
|
|
|
|
6.6
|
|
|
|
7.2
|
|
Purchase commitments (b)
|
|
|
75.1
|
|
|
|
68.6
|
|
|
|
6.5
|
|
|
|
|
|
|
|
|
|
Pension liability (c)
|
|
|
27.0
|
|
|
|
0.4
|
|
|
|
5.2
|
|
|
|
1.5
|
|
|
|
19.9
|
|
Long-term deferred tax liabilities (d)
|
|
|
131.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
131.6
|
|
Other long-term liabilities (e)
|
|
|
3.4
|
|
|
|
0.6
|
|
|
|
0.9
|
|
|
|
0.4
|
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
886.5
|
|
|
$
|
115.5
|
|
|
$
|
128.7
|
|
|
$
|
468.3
|
|
|
$
|
174.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
Amounts represent the expected cash interest payments on our long-term debt. Interest on our variable rate debt was forecasted using a LIBOR forward curve analysis as
of October 31, 2011.
|
(b)
|
Commitments to purchase inventory and equipment. Excludes purchase commitments under Walnut Purchase Agreements due to uncertainty of pricing and quantity of future
deliveries, but includes payments to walnut growers for walnuts delivered prior to October 31, 2011, but paid after that date.
|
(c)
|
Represents obligations and commitments for the remaining nine months of fiscal 2012.
|
(d)
|
Primarily relates to intangible assets of Kettle Foods.
|
(e)
|
Excludes $0.6 million in deferred rent liabilities. Additionally, the liability for uncertain tax positions ($3.5 million at October 31, 2011, excluding associated
interest and penalties) has been excluded from the contractual obligations table because a reasonably reliable estimate of the timing of future tax settlements cannot be determined.
|
Effects of Inflation
There has been no material change in our exposure to inflation from that discussed in Amendment No. 2 to our Annual Report on Form
10-K for the fiscal year ended July 31, 2011.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States
of America. The preparation of these consolidated 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 rebates, introductory or slotting payments, coupons, promotion and marketing allowances. The amount we accrue for promotion is based on an estimate of the level of performance of the trade promotion, which is dependent upon factors such as
historical trends with similar promotions, expectations regarding customer and consumer participation and sales and payment trends with similar previously offered programs. Customers have the right to return certain products. Product returns are
estimated based upon historical results and are reflected as a reduction in sales.
Inventories.
All inventories are
accounted for on a lower of cost (first-in, first-out or weighted average) or market basis. We have entered into walnut purchase agreements with growers, under which they deliver their walnut crop to us during the Fall harvest season, and pursuant
to our walnut purchase agreement, we determine the price for this inventory after delivery and by the end of the fiscal year. This purchase price is determined by us based on our discretion provided in the agreements, taking into account market
conditions, crop size, quality and nut varieties, among other relevant factors. Since the ultimate purchase price to be paid will be determined subsequent to receiving the walnut crop, we estimate the final purchase price for our interim financial
statements. Those interim estimates may subsequently change due to changes in the factors described above and the effect of the change could be significant. Any such changes in estimates are accounted for in the period of change by adjusting
inventory or cost of goods sold if inventory is sold through.
26
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,
increased competition or loss of market share, product innovation or obsolescence, product claims that result in a significant loss of sales or profitability over the product life 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.
For brand intangible assets not subject to amortization, we test 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 as of June 30th of each year. As of October 31, 2011, we also performed an interim goodwill impairment test. Goodwill was
determined not to be impaired. In testing goodwill for impairment, we initially compare the estimated fair value of our single reporting unit in relation to our market capitalization including an estimate for a control premium. We have one operating
and reportable segment. If the estimated 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.
We cannot guarantee that a material impairment charge will not be recorded in the future. To the extent our market capitalization results
in a fair value of our common stock that is below our net book value, or if other indicators of potential impairment are present, then we will be required to take further steps to determine if an impairment of goodwill has occurred and to calculate
an impairment loss.
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 Taxe
s. 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.
27
There are inherent uncertainties related to the interpretations of tax regulations in the
jurisdictions in which we operate. We may take tax positions that management believes are supportable, but are potentially subject to successful challenge by the applicable taxing authority. We evaluate our tax positions and establish liabilities in
accordance with the guidance on uncertainty in income taxes. We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly.
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 Notes to 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 Amendment No. 2 to our Annual
Report on Form 10-K for the fiscal year ended July 31, 2011.
Item 4. Controls and Procedures
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 Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Our Chief Executive Officer and Interim Chief
Financial Officer, based upon their evaluation as of October 31, 2011, the end of the fiscal quarter covered in this report, concluded that due to material weaknesses in our control environment, walnut grower accounting and accounts payable and
accrued expenses accounting as described below, our disclosure controls and procedures were not effective.
A material
weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the companys annual or interim financial statements will not
be prevented or detected on a timely basis. The material weaknesses in our internal control over financial reporting are identified as follows:
|
|
|
Control Environment
The control environment, which includes the Companys Code of Conduct and Ethics Policy, is the responsibility
of senior management, sets the tone of the organization, influences the control consciousness of its employees, and is the foundation for the other components of internal control over financial reporting. Senior managements operating style did
not result in the open flow of information and communication and set a tone that contributed to an ineffective control environment in which dissemination of information was limited and alternative ideas were not routinely encouraged. This control
environment material weakness contributed significantly to the material weaknesses related to walnut grower accounting described below.
|
|
|
|
Walnut Grower Accounting
Senior management did not document the accounting policies or sufficiently design the processes for walnut
grower payments and determination of walnut cost estimates. Further, management did not effectively or consistently communicate the nature and intent of certain walnut grower payments throughout the organization which contributed to conflicting
communications with growers and incomplete and ineffective communication and flow of information throughout the company and to those charged with governance. The controls in place at the time were not designed to ensure that the annual walnut costs
and the quarterly walnut cost estimates and changes in such estimates were sufficiently supported and based on consideration of all relevant information. The controls in place at that time were also not designed to provide for appropriate
segregation of duties. These factors caused our controls related to accounting for walnut grower payments and quarterly walnut cost estimates to be ineffective for ensuring that walnut costs were recorded correctly within the appropriate period.
|
28
|
|
|
Accounts Payable and Accrued Expenses
Our controls over invoice processing were improperly designed and were not effective in ensuring
that costs were recorded within the appropriate account and period. Controls were not in place to address the volume and nature of payment processing.
|
As a result of the restatement of our consolidated financial statements and the related reassessment of our internal control over financial reporting, we have developed certain remediation steps to
address the material weaknesses discussed above, to reinforce a control environment that facilitates internal and external communications, and to improve our internal control over financial reporting. If not remediated, these control deficiencies
could result in further material misstatements to our financial statements. The Company and the Board take the control and integrity of the Companys financial statements seriously and believe that the remediation steps described below,
including with respect to personnel changes, and the planned additional remedial actions are essential to maintaining a strong internal control environment. The following steps are among the measures that either have already been implemented or will
be implemented as soon as practicable:
Control Environment
|
|
|
Replacement of former CEO;
|
|
|
|
Replacement of former CFO;
|
|
|
|
Hiring of a new Controller;
|
|
|
|
Enhanced monthly financial and operational reporting packages with detailed financial analysis and identification of significant and non-routine
transactions which are circulated for review by management; and
|
|
|
|
Development and implementation of training, led by the CEO and reinforced by finance executives with appropriate accounting expertise, for executives,
finance personnel and grower accounting to enhance awareness and understanding of standards and principles for accounting and financial reporting as well as the importance of financial reporting integrity and the Companys Code of Conduct and
Ethics Policy.
|
Walnut Grower Accounting
|
|
|
Revised the walnut cost estimation policy to incorporate a wide variety of inputs each quarter with review and sign-off by cross-functional management;
|
|
|
|
Enhanced documentation, oversight and monitoring of accounting policies and procedures relating to walnut grower payments and walnut grower accounting;
|
|
|
|
Reassessment of responsibilities and realignment of reporting relationships within the walnut operations and grower accounting function;
|
|
|
|
Revised grower contracts and enhanced review and oversight of grower communications;
|
|
|
|
Creation of a Grower Advisory Board including members from a cross section of Diamonds grower base to provide a forum for input from growers and
communication between Diamond senior management and growers;
|
|
|
|
Implementation of quarterly representations by grower services regarding compliance with grower contracting procedures; and
|
|
|
|
Update and revision of Sarbanes-Oxley internal control narratives related to grower accounting.
|
29
Accounts Payable and Accrued Expenses
|
|
|
Enhanced month-end accounting close processes with increased visibility in finance and accounting organization;
|
|
|
|
Enhanced period-end controls and procedures to improve recording of all outstanding accounts payable and accrued expenses;
|
|
|
|
Requiring all existing and new vendors to remit invoices directly to the Companys central accounts payable department;
|
|
|
|
Communication throughout the organization to ensure that information related to all vendors engaged, services incurred, and invoices received in the
current or prior month are captured; and
|
|
|
|
Update and revision of Sarbanes-Oxley internal control narratives related to accounts payable and accrued expenses.
|
The Audit Committee has directed management to develop a detailed plan and timetable for the implementation of the foregoing remedial
measures (to the extent not already completed) and will monitor their implementation. In addition, under the direction of the Audit Committee, management will continue to review and make necessary changes to the overall design of our internal
control environment, as well as policies and procedures to improve the overall effectiveness of internal control over financial reporting.
We are committed to maintaining a strong internal control environment, and believe that these remediation actions will represent significant improvements in our controls when they are fully implemented.
Additional remediation measures may be required, which may require additional implementation time. We will continue to assess the effectiveness of our remediation efforts in connection with our evaluations of internal control over financial
reporting.
As of October 31, 2011, 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.
30
PART II OTHER INFORMATION
Item 1. Legal Proceedings
In November 2011, December 2011 and June 2012, various putative shareholder class action and derivative complaints were filed in federal and state court against Diamond and certain current and former
Diamond directors and officers.
In re Diamond Foods, Inc., Securities Litigation
Beginning on November 7, 2011, the first of a number of putative securities class action suits was filed in the United States
District Court for the Northern District of California against Diamond and certain of its former executive officers (defendants). These suits allege that defendants made materially false and misleading statements, or failed to disclose
material facts, regarding Diamonds financial results, operations and prospects, including its accounting for payments to walnut growers and the anticipated closing of Diamonds proposed merger of the Pringles business from P&G. The
various suits assert claims covering the period from December 9, 2010 through November 4, 2011 and seek compensatory damages, interest thereon, costs and expenses incurred in such actions, as well as equitable or other relief. On
January 24, 2012, these class actions were consolidated by the court as
In re Diamond Foods Inc., Securities Litigation
. On March 20, 2012, the court appointed a lead plaintiff, and on June 13, 2012, the court appointed lead
counsel for the plaintiff. On July 30, 2012, an amended complaint was filed in the consolidated action naming Diamond, certain of its former executive officers and our outside auditor as defendants. On September 28, 2012, Diamond moved to
dismiss the action.
In re Diamond Foods Inc., Shareholder Derivative Litigation
Beginning on November 14, 2011, three putative shareholder derivative lawsuits were filed in the Superior Court for the State of
California, San Francisco County, purportedly on behalf of Diamond Foods and naming certain executive officers and the members of our board of directors as individual defendants. On January 17, 2012, the court consolidated these actions as
In re Diamond Foods, Inc., Shareholder Derivative Litigation
and appointed co-lead counsel. On February 16, 2012, plaintiffs filed their consolidated complaint, naming certain current and former executive officers and members of our
board, and our outside auditor, as individual defendants. The consolidated complaint arises from the same or similar alleged facts as alleged in the federal securities action and the federal derivative litigation (discussed in the next paragraph
below), and purported to set forth claims for breach of fiduciary duty, unjust enrichment, abuse of control and gross mismanagement, and against the auditor for professional negligence and breach of contract. The suit seeks the recovery of
unspecified damages allegedly sustained by Diamond, which is named as a nominal defendant, corporate reforms, disgorgement, restitution, the recovery of plaintiffs attorneys fees and other relief. On August 20, 2012, Diamond filed a
demurrer seeking to dismiss the action. On October 23, 2012, the court sustained Diamonds demurrer with leave to amend the complaint excluding the gross mismanagement claim, which the court sustained with prejudice.
In re Diamond Foods, Inc., Derivative Litigation
On November 28, 2011 and December 19, 2011, two putative shareholder derivative lawsuits were filed in the United States District Court for the Northern District of California, purportedly on
behalf of Diamond Foods and naming certain current and former executive officers and members of our board of directors as individual defendants. On February 16, 2012, the court consolidated these actions as
In re Diamond Foods, Inc.,
Derivative Litigation
. Plaintiffs filed their consolidated complaint on March 1, 2012, again naming certain current and former executive officers and members of our board of directors as individual defendants, and also adding our outside
auditor as a defendant. The suit was based on essentially the same allegations as those in the federal securities action and the state derivative litigation, and purported to set forth claims under Section 14 (a) of the Securities Exchange
Act of 1934 alleging that defendants made materially false or misleading statements or omissions in proxy statements issued on or about November 26, 2010 and on or about September 26, 2011, and for breach of fiduciary duty, unjust
enrichment, contribution and indemnification, gross mismanagement and, against our auditor, for professional negligence, accounting malpractice and aiding and abetting the breach of fiduciary duties of the other individual defendants. The suit
sought to recover unspecified damages allegedly sustained by Diamond, which was named as a nominal defendant, corporate reforms, restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees and other relief. On
April 16, 2012, Diamond moved to dismiss the action. On May 29, 2012, the court granted Diamonds motion and dismissed the action with prejudice, based on lack of subject matter jurisdiction related to deficiencies in plaintiffs
Section 14(a) claims. The court entered judgment in favor of Diamond the same day. On June 4, 2012, one of the plaintiffs in the consolidated matter filed a Notice of Appeal with the United States Court of Appeals for the Ninth Circuit,
seeking to appeal the May 29, 2012 order granting Diamonds motion to dismiss. On October 12, 2012, the appellant filed its opening brief.
Astor BK Realty Trust v. Diamond Foods, Inc.
On February 22, 2012
,
an action was filed in Delaware Chancery Court by a shareholder seeking to enforce a demand to inspect certain of Diamonds records pursuant to Section 220 of the Delaware General Corporation Law, as a possible prelude to the
shareholder bringing a derivative action. This action has been stayed by the agreement of the parties.
Delaware
Derivative Litigation
On June 27, 2012, two putative shareholder derivative lawsuits,
Board of Trustees of City of Hialeah Employees Retirement System v. Mendes, et al.
and
Lucia v. Mendes et al.
, were filed in the Delaware Chancery Court purportedly on behalf of Diamond and naming certain current and former
executive officers and members of our board of directors as individual defendants. On August 7, 2012 the court consolidated these actions as
In re Diamond Foods, Inc., Derivative Litigation
and appointed co-lead counsel. Plaintiffs filed
their consolidated complaint on September 19, 2012, again naming certain current and former executive officers and members of our board of directors as individual defendants. The suit is based on essentially the same allegations as those in the
federal securities action and the federal and California derivative litigation and purports to set forth claims for breach of fiduciary duty, unjust enrichment, contribution and indemnification, gross mismanagement and breach of the duty of loyalty.
The suit seeks recovery of unspecified damages allegedly sustained by Diamond, which is named as a nominal defendant, corporate reforms, disgorgement, restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees
and other relief.
Governmental Proceedings
On December 14, 2011, Diamond received a formal order of investigation from the staff of the United States Securities and Exchange Commission (SEC). We have also had contact with the U.S.
Attorneys office for the Northern District of California (DOJ). We have cooperated with the government and expect to continue to do so.
Other
Diamond is involved in various legal actions in the ordinary course
of our business. We do not believe it is feasible to predict or determine the outcome or resolution of the above litigation proceedings, or to estimate the amounts of, or potential range of, loss with respect to those proceedings. In addition, the
timing of the final resolution of these proceedings is uncertain. The range of possible resolutions of these proceedings could include judgments against us or settlements that could require substantial payments by us, which could have a material
impact on Diamonds financial position, results of operations and cash flows.
31
Item 1A. Risk Factors
An investment in our common stock involves various material risks. You should carefully consider all of the information contained or
incorporated by reference in this Quarterly Report on Form 10-Q and in our other filings with the SEC, including Amendment No. 2 to our Annual Report on Form 10-K for the year ended July 31, 2011, before deciding to invest in our common
stock. The occurrence of any of the following risks could materially and adversely affect our business, financial condition, prospects, results of operations and cash flows. In that event, the trading price of our common stock could decline and you
could lose all or part of your investment. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, prospects, financial condition, results of
operations and cash flows.
Risks Related to Our Business
Diamond, and some of our current and former officers and directors, have been named as parties to various lawsuits arising out of or related to Diamonds restatement of the consolidated
financial statements, primarily resulting from our accounting for payments to walnut growers related to fiscal 2010 and fiscal 2011, and those lawsuits could adversely affect Diamond, require significant management time and attention, result in
significant legal expenses or damages, and cause our business, financial condition, results of operations and cash flows to suffer.
In November 2011, December 2011 and June 2012, various putative shareholder class action and derivative complaints were filed in federal and state court against Diamond and certain current and former
Diamond directors and officers.
Beginning on November 7, 2011, the first of a number of putative securities class action
suits was filed in the United States District Court for the Northern District of California against Diamond and certain of its former executive officers (defendants). These suits allege that defendants made materially false and
misleading statements, or failed to disclose material facts, regarding Diamonds financial results, operations and prospects, including its accounting for payments to walnut growers and the anticipated closing of Diamonds proposed merger
of the Pringles business from The Procter & Gamble Company (P&G). The various suits assert claims covering the period from December 9, 2010 through November 4, 2011 and seek compensatory damages, interest thereon,
costs and expenses incurred in such actions, as well as equitable or other relief. On January 24, 2012, these class actions were consolidated by the court as
In re Diamond Foods Inc., Securities Litigation
. On March 20, 2012, the
court appointed a lead plaintiff, and on June 13, 2012, the court appointed lead counsel for the plaintiff. On July 30, 2012, an amended complaint was filed in the consolidated action naming Diamond, certain of its former executive
officers and our outside auditor as defendants.
Beginning on November 14, 2011, three putative shareholder derivative
lawsuits were filed in the Superior Court for the State of California, San Francisco County, purportedly on behalf of Diamond Foods and naming certain executive officers and the members of our board of directors as individual defendants. On
January 17, 2012, the court consolidated these actions as
In re Diamond Foods, Inc., Shareholder Derivative Litigation
and appointed co-lead counsel. On February 16, 2012, plaintiffs filed their consolidated complaint, naming
certain current and former executive officers and members of our board, and our outside auditor, as individual defendants. The consolidated complaint arises from the same or similar alleged facts as alleged in the federal securities action and the
federal derivative litigation (discussed in the next paragraph below), and purported to set forth claims for breach of fiduciary duty, unjust enrichment, abuse of control and gross mismanagement, and against the auditor for professional negligence
and breach of contract. The suit seeks the recovery of unspecified damages allegedly sustained by Diamond, which is named as a nominal defendant, corporate reforms, disgorgement, restitution, the recovery of plaintiffs attorneys fees and
other relief.
32
On November 28, 2011 and December 19, 2011, two putative shareholder derivative
lawsuits were filed in the United States District Court for the Northern District of California, purportedly on behalf of Diamond Foods and naming certain current and former executive officers and members of our board of directors as individual
defendants. On February 16, 2012, the court consolidated these actions as
In re Diamond Foods, Inc., Derivative Litigation
. Plaintiffs filed their consolidated complaint on March 1, 2012, again naming certain current and former
executive officers and members of our board of directors as individual defendants, and also adding our outside auditor as a defendant. The suit was based on essentially the same allegations as those in the federal securities action and the state
derivative litigation, and purported to set forth claims under Section 14 (a) of the Securities Exchange Act of 1934 alleging that defendants made materially false or misleading statements or omissions in proxy statements issued on or
about November 26, 2010 and on or about September 26, 2011, and for breach of fiduciary duty, unjust enrichment, contribution and indemnification, gross mismanagement and, against our auditor, for professional negligence, accounting
malpractice and aiding and abetting the breach of fiduciary duties of the other individual defendants. The suit sought to recover unspecified damages allegedly sustained by Diamond, which was named as a nominal defendant, corporate reforms,
restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees and other relief. On April 16, 2012, Diamond moved to dismiss the action. On May 29, 2012, the court granted Diamonds motion and
dismissed the action with prejudice, based on lack of subject matter jurisdiction related to deficiencies in plaintiffs Section 14(a) claims. The court entered judgment in favor of Diamond the same day. On June 4, 2012, one of the
plaintiffs in the consolidated matter filed a Notice of Appeal with the United States Court of Appeals for the Ninth Circuit, seeking to appeal the May 29, 2012 order granting Diamonds motion to dismiss.
On February 22, 2012
,
an action was filed in Delaware Chancery Court by a shareholder seeking to enforce a demand to inspect
certain of Diamonds records pursuant to Section 220 of the Delaware General Corporation Law, as a possible prelude to the shareholder bringing a derivative action. This action has been stayed by the agreement of the parties.
On June 27, 2012, two putative shareholder derivative lawsuits,
Board of Trustees of City of Hialeah Employees
Retirement System v. Mendes, et al.
and
Lucia v. Mendes et al.
, were filed in the Delaware Chancery Court purportedly on behalf of Diamond and naming certain current and former executive officers and members of our board of directors as
individual defendants. On August 7, 2012 the court consolidated these actions as
In re Diamond Foods, Inc., Derivative Litigation
and appointed co-lead counsel. Plaintiffs filed their consolidated complaint on September 19, 2012,
again naming certain current and former executive officers and members of our board of directors as individual defendants. The suit is based on essentially the same allegations as those in the federal securities action and the federal and California
derivative litigation and purports to set forth claims for breach of fiduciary duty, unjust enrichment, contribution and indemnification, gross mismanagement and breach of the duty of loyalty. The suit seeks recovery of unspecified damages allegedly
sustained by Diamond, which is named as a nominal defendant, corporate reforms, disgorgement, restitution, equitable and/or injunctive relief, to recover plaintiffs attorneys fees and other relief.
We cannot predict the outcome of these lawsuits. The matters which led to our Audit Committees investigation and the restatement of
our consolidated financial statements have exposed us to greater risks associated with litigation, regulatory proceedings and government enforcement actions. We and our current and former officers and directors may, in the future, be subject to
additional litigation relating to such matters. Subject to certain limitations, we are obligated to indemnify our current and former officers and directors in connection with such lawsuits and any related litigation or settlements amounts.
Regardless of the outcome, these lawsuits, and any other litigation that may be brought against us or our current or former officers and directors, could be time-consuming, result in significant expense and divert the attention and resources of our
management and other key employees. An unfavorable outcome in any of these matters could exceed coverage provided under potentially applicable insurance policies, which is limited. Any such unfavorable outcome could have a material effect on our
business, financial condition, results of operations and cash flows. Further, we could be required to pay damages or additional penalties or have other remedies imposed against us, or our current or former directors or officers, which could harm our
reputation, business, financial condition, results of operations or cash flows.
Government investigations may require
significant management time and attention, result in significant legal expenses or damages and cause our business, financial condition, results of operations and cash flows to suffer. Diamond could face additional governmental investigations with
respect to these matters, could incur substantial costs to defend any such investigations and be required to pay damages, fines and penalties, or incur additional expenses or be subject to injunctions as a result of the outcome of such
investigations. The unfavorable resolution of one or more matters could adversely impact Diamond.
On
December 14, 2011, Diamond received a formal order of investigation from the staff of the United States Securities and Exchange Commission (SEC). In addition, Diamond has had contact with the U.S. Attorneys office for the
Northern District of California (DOJ). We have cooperated with the government and expect to continue to do so. The amount of time needed to resolve these investigations is uncertain, and we cannot predict the outcome of these
investigations or whether we will face additional government investigations, inquiries or other actions related to our accounting for payments to walnut growers or otherwise. Subject to certain limitations, we are obligated to indemnify our current
and former directors, officers and employees in connection with the ongoing governmental investigation and any future government inquiries, investigations or actions. These matters could require us to expend significant management time and incur
significant legal and other expenses and could result in civil and criminal actions seeking, among other things, injunctions against us and the payment of significant fines and penalties by us, which could have a material effect on our financial
condition, business, results of operations and cash flow.
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If the SEC or DOJ were to commence legal action, we could be required to pay significant
penalties and could become subject to injunctions, a cease and desist order and other equitable remedies. The filing of our restated consolidated financial statements will not resolve the SEC investigation. We can provide no assurances as to the
outcome of any governmental investigation.
We have not been in compliance with the Nasdaq Stock Markets
requirements for continued listing and as a result our common stock may be delisted from trading on Nasdaq, which would have a material effect on us and our stockholders.
We have been delinquent in the filing of our periodic reports with the SEC, and have delayed convening our annual meeting of
stockholders, as a result of which we are not in compliance with the rules of the Nasdaq Stock Market and are subject to having our stock delisted from trading on Nasdaq. Nasdaq has approved our common stock for continued listing contingent upon our
ability to convene our 2012 annual meeting of stockholders no later than January 14, 2013. There can be no assurance that we will be able to comply with this condition, in which case our common stock may again be subject to delisting by Nasdaq.
If our common stock is delisted, there can no assurance whether or when it would again be listed for trading on Nasdaq or any other exchange. If our common stock is delisted, the market price of our shares will likely decline and become more
volatile, and our stockholders may find that their ability to trade in our stock will be adversely affected. Furthermore, institutions whose charters do not allow them to hold securities in unlisted companies might sell our shares, which could have
a further adverse effect on the price of our stock.
As a result of the delayed filing of our periodic reports with the
SEC, we are not currently eligible to use a registration statement on Form S-3 to register the offer and sale of securities, which may adversely affect our ability to raise future capital or complete acquisitions.
As a result of the delayed filing of our periodic reports with the SEC, we will not be eligible to register the offer and sale of our
securities using a registration statement on Form S-3 until we have timely filed all periodic reports required under the Securities Exchange Act of 1934 for one year and there can be no assurance that we will be able to timely file such reports
in the future. Should we wish to register the offer and sale of our securities to the public, our transaction costs would increase and the amount of time required to complete the transaction could increase, making it more difficult to execute any
such transaction successfully and potentially harming our financial condition.
If we do not adequately manage our
financial reporting and internal control systems and processes, our ability to manage and grow our business may be harmed.
Our ability to implement our business plan and comply with regulations requires an effective planning and management process. We expect that we will need to improve existing operational and financial
systems, procedures and controls, and implement new ones, to manage our future business effectively. Any implementation delays, or disruption in the transition to new or enhanced systems, procedures or controls, could harm our ability to forecast
sales, manage our supply chain, and record and report financial and management information on a timely and accurate basis.
We have determined that material weaknesses exist in our system of internal control over financial reporting, which could have a
material impact on our business.
We are required to maintain internal control over financial reporting to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles. In connection with the Audit
Committees investigation of the accounting for certain payments to walnut growers, and the restatement of our consolidated financial statements, we determined that we had material weaknesses in our control environment, as follows:
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Control Environment
The control environment, which includes the Companys Code of Conduct and Ethics Policy, is the responsibility
of senior management, sets the tone of the organization, influences the control consciousness of its employees, and is the foundation for the other components of internal control over financial reporting. Senior managements operating style did
not result in the open flow of information and communication and set a tone that contributed to an ineffective control environment in which dissemination of information was limited and alternative ideas were not routinely encouraged. This control
environment material weakness contributed significantly to the material weaknesses related to walnut grower accounting described below.
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Walnut Grower Accounting
Senior management did not document the accounting policies or sufficiently design the processes for walnut
grower payments and determination of walnut cost estimates. Further, management did not effectively or consistently communicate the nature and intent of certain walnut grower payments throughout the organization which contributed to conflicting
communications with growers and incomplete and ineffective communication and flow of information throughout the company and to those charged with governance. The controls in place at the time were not designed to ensure that the annual walnut costs
and the quarterly walnut cost estimates and changes in such estimates were sufficiently supported and based on consideration of all relevant information. The controls in place at that time were also not designed to provide for appropriate
segregation of duties. These factors caused our controls related to accounting for walnut grower payments and quarterly walnut cost estimates to be ineffective for ensuring that walnut costs were recorded correctly within the appropriate period.
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Accounts Payable and Accrued Expenses
Our controls over invoice processing were improperly designed and were not effective in ensuring
that costs were recorded within the appropriate account and period. Controls were not in place to address the volume and nature of payment processing.
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Due to these material weaknesses, we have concluded that as of the end of the period covered by this report, our internal control over financial reporting, and our disclosure controls and procedures, were
not effective. Until these control deficiencies are fully remediated, it may be more difficult for us to manage our business, our results of operations could be harmed, our ability to report results accurately and on time could be impaired,
investors may lose faith in the reliability of our statements, and the price of our securities may be materially impacted.
We
do not expect that our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems
objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts
of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures may
occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal
control over financial reporting will be identified in the future.
Any failure to maintain or implement required new or
improved controls, or any difficulties we encounter in their implementation, could result in additional significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in additional
material misstatements in our consolidated financial statements. Any such failure could adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our
internal control over financial reporting. The existence of a material weakness could result in errors in our consolidated financial statements that could require a restatement of our consolidated financial statements, cause us to fail to timely
meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
We may be required to conduct product recalls and concerns with the safety and quality of food products could cause consumers to avoid our products and reduce our sales, net income and liquidity.
The sale of food products for human consumption involves risk of injury to consumers. We face risks associated with
product recalls and liability claims if our products become adulterated, mislabeled or misbranded, or cause injury, illness or death. Our products may be subject to product tampering and to contamination and spoilage risks, such as mold, bacteria,
insects and other pests, shell fragments, cross-contamination and off-flavor contamination. If any of our products were to be tampered with, or otherwise tainted and we were unable to detect it prior to shipment, our products could be subject to a
recall. Recalls might also be required due to usage of raw materials provided by third-party ingredient suppliers. Such suppliers are required to supply material free of contamination, but may, on occasion, identify issues after selling
material to Diamond manufacturing locations. Our ability to sell products could be reduced if governmental agencies conclude that our products have been tampered with, or that certain pesticides, herbicides or other chemicals used by growers have
left harmful residues on portions of the crop or that the crop has been contaminated by aflatoxin or other agents. A significant product recall could cause our products to be unavailable for a period of time and reduce our sales. Adverse publicity
could result in a loss of consumer confidence in our products, damage to our reputation and also reduce our sales for an extended period. Product recalls and product liability claims could increase our expenses and have an adverse effect on demand
for our products and, consequently, reduce our sales, net income and liquidity.
Government regulations could increase
our costs of production and our business could be adversely affected.
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As a food company, we are subject to extensive government regulation, including regulation
of the manufacturing, importation, processing, product quality, packaging, storage, distribution and labeling of our products. Furthermore, there may be changes in the legal and regulatory environment, and governmental entities or agencies in
jurisdictions where we operate may impose new manufacturing, importation, processing, packaging, storage, distribution, labeling or other restrictions, which could increase our costs and affect our profitability. For example, various regulatory
authorities and others have paid increasing attention to the effect on humans due to the consumption of acrylamidea naturally-occurring chemical compound that is formed in the process of cooking many foods, including potato chips, and a
potential carcinogenand have imposed additional regulatory requirements. In the State of California, we are required to warn about the presence of acrylamide and other potential carcinogens in our products. If consumer concerns about
acrylamide increase, demand for affected products could decline and our revenues and business could be harmed. Our manufacturing operations are subject to various national, regional or state and local laws and regulations that require us to obtain
licenses relating to customs, health and safety, building and land use and environmental protection. We are also subject to environmental regulations governing the discharge into the air, and the generation, handling, storage, transportation,
treatment and disposal of waste materials. New or amended statutes and regulations, increased production at our existing facilities and our expansion into new operations and jurisdictions may require us to obtain new licenses and permits, and could
require us to change our methods of operations, which could be costly. Failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls or seizures, as well as possible criminal
sanctions, all of which could have an adverse effect on our business.
A disruption at any of our production facilities
would significantly decrease production, which could increase our cost of sales and reduce our net sales and income from operations.
We process and package our products in several domestic and international facilities and also have co-manufacturing agreements and co-pack arrangements with third parties. A temporary or extended
interruption in operations at any of our facilities, whether due to technical or labor difficulties, destruction or damage from fire, flood or earthquake, infrastructure failures such as power or water shortages, raw material shortage or any other
reason, whether or not covered by insurance, could interrupt our manufacturing operations, disrupt communications with our customers and suppliers and cause us to lose sales and write off inventory. Any prolonged disruption in the operations of our
facilities would have a significant negative impact on our ability to manufacture and package our products on our own and may cause us to seek additional third-party arrangements, thereby increasing production costs. These third parties may not be
as efficient as we are and may not have the capabilities to process and package some of our products, which could adversely affect sales or operating income. Further, current and potential customers might not purchase our products if they perceive
our lack of alternate manufacturing facilities to be a risk to their continuing source of products.
Changes in the food
industry, including changing dietary trends and consumer preferences and adverse publicity about the Company and the health effects of consuming some products, could reduce demand for our products.
Consumer tastes can change rapidly as a result of many factors, including shifting consumer preferences, dietary trends and purchasing
patterns. To address consumer preferences, we invest significant resources in research and development of new products. Dietary trends, such as the consumption of food in low carbohydrate content, have in the past, and may in the future, harm our
sales. If we fail to anticipate, identify or react to consumer trends, or if new products we develop do not achieve acceptance by retailers or consumers, demand for our products could decline, which would in turn cause our revenue and profitability
to be lower.
In addition, some of our products contain sodium, preservatives and other ingredients, the health effects of
which are the subject of increasing public scrutiny, including the suggestion that excessive consumption of these ingredients can lead to a variety of adverse health effects. In the United States and other countries, there is increasing consumer
awareness of health risks, including obesity, associated with consumption of these ingredients, as well as increased consumer litigation based on alleged adverse health impacts of consumption of various food products. A continuing global focus on
health and wellness, including weight management, and increasing media attention to the role of food marketing, could adversely affect our sales or lead to stricter regulations and greater scrutiny of food marketing practices. Moreover, adverse
publicity about regulatory or legal action against us could damage our reputation and brand image, undermine consumer confidence or customer relations, and reduce demand for our products, even if the regulatory or legal action is unfounded or not
material to our operations.
Increased costs associated with product processing and transportation, such as water,
electricity, natural gas and fuel costs, could increase our expenses and reduce our profitability.
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We require a substantial amount of energy and water to process our products. Transportation
costs, including fuel and labor, also represent a significant portion of the cost of our products, because we use third party truck and rail companies to collect our raw materials and deliver our products to our distributors and customers. These
costs fluctuate significantly over time due to factors that may be beyond our control, including increased fuel prices, adverse weather conditions or natural disasters, employee strikes and increased export and import restrictions. We may not be
able to pass on increased costs of production or transportation to our customers. In addition, from time to time, transportation service providers have a backlog of shipping requests, which could impact our ability to ship products in a timely
fashion. Increases in the cost of water, electricity, natural gas, fuel or labor and failure to ship products on time, could increase our costs of production and adversely affect our profitability.
Raw materials that are key ingredients to our products are subject to fluctuations in availability and price that could adversely
impact our business and financial results.
The availability, size, quality and cost of raw materials for the
production and packaging of our products, including nuts, potatoes, corn and corn products, cooking and vegetable oils, corrugate, resins and other commodities, are subject to price volatility and fluctuations in availability caused by changes in
global supply and demand, weather conditions, governmental agricultural and energy programs, exchange rates for foreign currencies and consumer demand. In particular, the availability and cost of walnuts and other nuts are subject to crop size,
quality, yield fluctuations, changes in governmental regulation, and the rate of supply contract renewals, as well as other factors.
We source walnuts primarily from growers with whom we have entered into walnut purchase agreements of various durations. To the extent contracted growers deliver less supply than we expected or we are
unable to renew enough walnut purchase agreements or enter into such agreements with new growers in any particular year, we may not have sufficient walnut supply under contract to satisfy our business requirements, which could have an adverse effect
on our sales and our results of operations. To obtain sufficient walnut supply, which represents a significant portion of our cost of goods sold, we may be required to purchase walnuts from third parties at substantially higher prices, which would
reduce our profitability.
We make estimates of the price we will pay for walnuts to growers under contract starting in the
first quarter of our fiscal year and, pursuant to our current accounting policies, finalize the price to be paid to growers by the end of the fiscal year. To the extent that we underestimate the price to be paid for walnuts and enter into contracts
with our customers for products including walnuts at prices based on walnut cost estimates that are below the price we ultimately pay to growers, our business and results of operations could be harmed. Each year some of our walnut supply agreements
are up for renewal, and significant competition among walnut handlers makes renewal with us uncertain. Disruption in our walnut supply and inability to secure walnuts cost effectively may adversely impact our business and our financial results.
Our potato chip products are dependent on suppliers providing us with an adequate supply of quality potatoes on a timely
basis. The failure of our suppliers to meet the specifications, quality standards or delivery schedules could have an adverse effect on our potato chip operations. In particular, a sudden scarcity, substantial price increase, quality issues or
unavailability of ingredients could adversely affect our operating results. There can be no assurance that alternative ingredients would be available when needed on commercially attractive terms, if at all. In addition, high commodity prices could
lead to unexpected costs and price increases of our products which might dampen growth of consumer demand for our products. If we are unable to increase productivity to offset these increased costs or increase our prices, this could substantially
harm our business and results of operations.
If the parties we depend upon for raw material supplies do not perform
adequately, our ability to manufacture our products may be impaired, which could harm our business and results of operations.
We rely on third-party suppliers for the raw materials we use to manufacture our products, and our ability to manufacture our products depends on receiving adequate supplies on a timely basis, which may
be difficult or uneconomical to procure. If we do not maintain good relationships with suppliers that are important to us or are unable to identify a replacement supplier or develop our own sourcing capabilities, our ability to manufacture our
products may be harmed, which would result in interruptions in our business. In addition, even if we are able to find replacement suppliers when needed, we may not be able to enter into agreements with them on favorable terms and conditions, which
could increase our costs of production. The occurrence of any of these risks could adversely affect our business and results of operations.
If we are unable to compete effectively in the markets in which we operate, our sales and profitability would be negatively affected.
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In general, competition in our markets is highly competitive and based on product quality,
price, brand recognition and brand loyalty. As a result, there are ongoing competitive product and pricing pressures in the markets in which we operate, as well as challenges in establishing and maintaining profit margins. Our products compete
against food and snack products sold by many regional and national companies, some of which are substantially larger and have greater resources than we have. The greater scale and resources that may be available to our competitors could provide them
with the ability to lower prices or increase their promotional or marketing spending to compete more effectively. To address these challenges, we must be able to successfully respond to competitive factors, including pricing, promotional incentives
and trade terms. We may need to reduce our prices or increase promotional incentives in response to competition or to grow or maintain our market share. Competition and customer pressures may restrict our ability to increase prices in response to
commodity or other cost increases. We may also need to increase spending on marketing, advertising and new product innovation to maintain or increase our market share. If we are unable to compete effectively, we could be unable to increase the
breadth of the distribution of our products or lose customers or distribution of products, which could have an adverse impact on our sales and profitability. In addition, if we are required to maintain high levels of promotional incentives or trade
terms with respect to particular product lines, our margins and profitability would be adversely effected.
The loss of
any major customer could decrease sales and adversely impact our net income.
We depend on a few significant customers
for a large proportion of our net sales. This concentration has become more pronounced with the trend toward consolidation in the retail grocery store industry. Sales to our largest customer, Wal-Mart Stores, Inc. (which includes sales to both
Sams Club and Wal-Mart), represented approximately 18% and 15% of our total net sales in fiscal 2012 and 2011, respectively. Sales to our second largest customer, Costco Wholesale Corporation, represented approximately 11% of our total net
sales in both fiscal 2012 and 2011. The success of our business is dependent on our ability to successfully manage relationships with these customers, or any other significant customer. Further, there is a continuing trend towards retail trade
consolidation, which can create significant cost and margin pressure on our business. The loss of any major customers, or any other significant customer, or a material decrease in their purchases from us, could result in decreased sales and
adversely impact our net income.
The consolidation of retail customers could adversely affect us.
Retail customers, such as supermarkets, warehouse clubs and food distributors, continue to consolidate, resulting in fewer customers on
which we can rely for business. Consolidation also produces large, more sophisticated retail customers that can resist price increases and demand lower pricing, increased promotional programs or specifically tailored products. In addition, larger
retailers have the scale to develop supply chains that permit them to operate with reduced inventories or to develop and market their own retailer brands. Further retail consolidation and increasing retail power could materially and adversely affect
our product sales, financial condition and results of operations.
Retail consolidation also increases the risk that adverse
changes in our customers business operations or financial performance will have a corresponding material effect on us. For example, if our customers cannot access sufficient funds or financing, then they may delay, decrease or cancel purchases
of our products, or delay or fail to pay us for previous purchases.
We must leverage our value proposition to compete
against retailer brands and other economy brands.
Our branded products face competition from private label products
that are generally sold at lower price points. The impact of price gaps between our products and private label products may result in share erosion and harm our business. A number of our competitors have broader product lines, substantially greater
financial and other resources and/or lower fixed costs than we have. Our competitors may succeed in developing new or enhanced products that are more attractive to customers or consumers than ours. These competitors may also prove to be more
successful in marketing and selling their products than we are; and may be better able to increase prices to reflect cost pressures. We may not compete successfully with these other companies or maintain or grow the distribution of our products. We
cannot predict the pricing or promotional activities of our competitors or whether they will have a negative effect on us. Many of our competitors engage in aggressive pricing and promotional activities. There are competitive pressures and other
factors which could cause our products to lose market share or decline in sales or result in significant price or margin erosion, which would have a material effect on our business, financial condition and results of operations.
Our proprietary brands and packaging designs are essential to the value of our business, and the inability to protect, and costs
associated with protecting, our intellectual property could harm the value of our brands and adversely affect our business and results of operations.
Our success depends significantly on our know-how and other intellectual property. We rely on a combination of trademarks, service marks, trade secrets, patents, copyrights and similar rights to protect
our intellectual property. Our success also depends in large part on our continued ability to use existing trademarks and service marks in order to maintain and increase brand awareness and further develop our brand.
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Our efforts to protect our intellectual property may not be adequate, third parties may
misappropriate or infringe on our intellectual property or develop more efficient and advanced technologies, our patents expire over time and third parties may use such previously patented technology to compete against us, and our third-party
manufacturers and partners may disclose our trade secrets. From time to time, we engage in litigation to protect our intellectual property, which could result in substantial costs as well as diversion of management attention. The occurrence of any
of these risks could adversely affect our business and results of operations.
We depend on our key personnel and if we
lose the services of any of these individuals, or fail to attract and retain additional key personnel, we may not be able to implement our business strategy or operate our business effectively.
Our future success largely depends on the contributions of our senior management team. We believe that these individuals expertise
and knowledge about our industry and their respective fields and their relationships with other individuals in our industry are critical factors to our continued growth and success. We do not carry key person insurance. The loss of the services of
any member of our senior management team and the failure to hire and retain qualified management and other key personnel could have an adverse effect on our business and prospects. Our success also depends upon our ability to attract and retain
additional qualified sales, marketing and other personnel.
Economic downturns may adversely affect our business,
financial condition and results of operations.
Unfavorable economic conditions may negatively affect our business and
financial results. For example, instability in the global credit markets, including the recent European economic and financial turmoil, may lead to slower growth or recession in European or United States markets where we sell our products. These
economic conditions could negatively impact consumer demand for our products, the mix of our products sales, our ability to collect accounts receivable on a timely basis, the ability of suppliers to provide the materials required in our
operations, and our ability to obtain financing or to otherwise access the capital markets. Additionally, unfavorable economic conditions could have an impact on our lenders or customers, causing them to fail to meet their obligations to us. The
occurrence of any of these risks could adversely affect our business, financial condition and results of operations.
The acquisition or divestiture of other product lines or businesses could pose risks to our business and the market price of our
common stock.
We may review acquisition prospects that we believe could complement our existing business. There is no
assurance that we will be successful in identifying, negotiating or consummating any future acquisitions. Any such future acquisitions could result in accounting charges, potentially dilutive issuances of stock and increased debt and contingent
liabilities, any of which could have a material effect on our business and the market price of our common stock. Acquisitions entail many financial, managerial and operational risks, including difficulties integrating the acquired operations,
effective and immediate implementation of internal control over financial reporting, diversion of management attention during the negotiation and integration phases, uncertainty entering markets in which we have limited prior experience and
potential loss of key employees of acquired organizations. We may be unable to integrate product lines or businesses that we acquire, which could have a material effect on our business and on the market price of our common stock. We may evaluate the
various components of our portfolio of businesses and may, as a result, explore divesting such products or businesses. Divestitures have inherent risks, including possible delays in closing transactions (including potential difficulties in obtaining
regulatory approvals), the risk of lower-than-expected sales proceeds for the divested businesses, unexpected costs associated with the separation of the business to be sold from our integrated information technology systems and other operating
systems and potential post-closing claims for indemnification. In addition, adverse economic or market conditions may result in fewer potential bidders and unsuccessful divestiture efforts. Transaction costs may be high, and expected cost savings,
which are offset by revenue losses from divested businesses, may be difficult to achieve, and we may experience varying success in reducing costs or transferring liabilities previously associated with the divested businesses.
Our business and operations could be negatively impacted if we fail to maintain satisfactory labor relations.
The success of our business depends substantially upon our ability to maintain satisfactory relations with our employees. Our production
workforce in one of our facilities is covered by a collective bargaining agreement. Strikes or work stoppages and interruptions could occur if we are unable to renew this agreement on satisfactory terms. If a work stoppage or slow down were to
occur, it could adversely affect our business and disrupt our operations. The terms and conditions of existing or renegotiated agreements also could increase our costs or otherwise affect our ability to fully implement future operational changes to
our business.
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Our business, financial condition and results of operations could be adversely
affected by the political and economic conditions of the countries in which we conduct business and other factors related to our international operations.
We conduct a substantial amount of business with vendors and customers located outside the United States. During 2011 and 2012, sales outside the United States, primarily in the United Kingdom, Canada,
South Korea, Japan, Germany, Netherlands, Turkey, China and Spain accounted for approximately 30% and 23% of our net sales, respectively. Many factors relating to our international operations and to particular countries in which we operate could
have a material negative impact on our business, financial condition and results of operations. These factors include:
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negative economic developments in economies around the world and the instability of governments, including the threat of war, terrorist attacks,
epidemic or civil unrest;
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pandemics, such as the flu, which may adversely affect our workforce as well as our local suppliers and customers;
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earthquakes, tsunamis, floods or other major disasters that may limit the supply of nuts or other products that we purchase abroad;
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tariffs, quotas, trade barriers, other trade protection measures and import or export licensing requirements imposed by governments;
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foreign currency exchange and transfer restrictions;
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increased costs, disruptions in shipping or reduced availability of freight transportation;
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differing labor standards;
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differing levels of protection of intellectual property;
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difficulties and costs associated with complying with U.S. laws and regulations applicable to entities with overseas operations;
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the threat that our operations or property could be subject to nationalization and expropriation;
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varying regulatory, tax, judicial and administrative practices in the jurisdictions where we operate;
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difficulties associated with operating under a wide variety of complex foreign laws, treaties and regulations; and
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potentially burdensome taxation.
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Any of these factors could have an adverse effect on our business, financial condition and results of operations.
A material impairment in the carrying value of acquired goodwill or other intangible assets could negatively affect our consolidated operating results and net worth.
A significant portion of our assets are goodwill and other intangible assets, the majority of which are not amortized but are reviewed at
least annually for impairment. If the carrying value of these assets exceeds the current fair value, the asset is considered impaired and is reduced to fair value resulting in a non-cash charge to earnings. Events and conditions that could result in
impairment include a sustained drop in the market price of our common stock, increased competition or loss of market share, product innovation or obsolescence, or product claims that result in a significant loss of sales or profitability over the
product life. For example, our stock price dropped from $71.48 on August 1, 2011 to $16.27 on July 31, 2012. To the extent our market capitalization results in a fair value of our common stock that is below our net book value, or if other
indicators of potential impairment are present, then we will be required to take further steps to determine if an impairment of goodwill has occurred and to calculate an impairment loss. At July 31, 2011, the carrying value of goodwill and
other intangible assets totaled approximately $860.6 million, compared to total assets of approximately $1,322.9 million and total shareholders equity of approximately $420.5 million. At April 30, 2012, the carrying value of goodwill and other
intangible assets totaled approximately $851.4 million, compared to total assets of approximately $1,375.0 million and total shareholders equity of approximately $366.5 million.
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Risks Related to Indebtedness
We are highly leveraged and have substantial debt service requirements that could adversely affect our ability to fulfill our debt
obligations, place us at a competitive disadvantage in our industry and limit our ability to react to changes in the economy or our industry.
We have incurred a substantial amount of indebtedness and our high debt service requirements could adversely affect our ability to operate our business, and might limit our ability to take advantage of
potential business opportunities. Our ability to make scheduled payments or to refinance our indebtedness depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to financial,
business and other factors beyond our control. Our business may not generate cash flow in an amount sufficient to enable us to pay the principal of, or interest on, our indebtedness, or to fund our other liquidity needs, including working capital,
capital expenditures, product development efforts and other general corporate requirements.
This high degree of leverage
could have other important consequences for us, including:
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increasing our vulnerability to adverse economic, industry or competitive developments;
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exposing us to the risk of increased interest rates because our Secured Credit Facility, as defined below, is at variable rates of interest;
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making it more difficult to satisfy obligations with respect to our indebtedness, including restrictive covenants and borrowing conditions,
which could result in an event of default under the agreements governing the indebtedness;
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restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;
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limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements,
acquisitions and general corporate or other purposes; and
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placing us at a competitive disadvantage compared to competitors who are less highly leveraged and who therefore, may be able to take advantage
of opportunities that our leverage prevents us from pursuing.
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Our debt agreements contain
representations, warranties, affirmative and negative covenants and financial ratios, and any failure to satisfy these requirements could adversely affect our business.
A breach of any of the representations, warranties or affirmative and negative covenants contained in our credit facilities and
outstanding senior notes, or other financing arrangements, including our inability to comply with the financial ratios required under any of those arrangements, could trigger events of default. As a result of the errors identified causing the
restatement of our consolidated financial statements, we were in default under our five-year $600 million secured credit facility (Secured Credit Facility) and other financing arrangements for failing to comply with certain
representations and warranties and not complying with certain covenants, including delivering certain financial statements in a timely manner and maintaining specified financial ratios. These defaults were waived by the required lenders of the
Secured Credit Facility on May 22, 2012 and July 31, 2012. Additional events of default associated with the accounting classification of certain capital leases were waived on July 27, 2012 and August 23, 2012 by the required
lenders of the Secured Credit Facility. If any further events of default occur and we are not able either to cure it or to obtain a waiver from the requisite lenders or noteholders, our lenders or noteholders may declare outstanding
obligations, with accrued interest and fees, to be immediately due and payable. Such acceleration of our outstanding financial obligations could result in additional lenders or noteholders declaring other outstanding obligations to be immediately
due and payable. In addition, upon any event of default, the administrative agent under our Secured Credit Facility may, and at the request of the requisite lenders shall, terminate the lenders commitments under the revolving credit facility
and cease making further loans and could institute foreclosure proceedings against our pledged assets.
Our debt
agreements contain restrictions that may limit our flexibility in operating our business.
Our Secured Credit
Facility, our outstanding senior notes and our other financing arrangements contain various covenants that may limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:
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incur indebtedness, including capital leases;
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41
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make investments or other capital expenditures;
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acquire other companies and businesses;
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borrow additional funds under new revolving credit facilities;
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consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
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make restricted payments, which could limit our ability to pay dividends on our common stock; and
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enter into transactions with our affiliates.
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Additionally, under our Secured Credit Facility we are required to have at least $20 million of cash, cash equivalents and revolving credit available beginning February 1, 2013.
A breach of any of these covenants could result in an event of default, which could harm our liquidity and financial condition.
We are highly leveraged and have substantial debt service obligations, which could affect our ability to raise
additional capital or fund our operations.
If our cash flows and capital resources are insufficient to fund our debt
service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, or restructure or refinance our indebtedness. We may not be able to take any of these actions, or they may not be sufficient for us
to meet our scheduled debt service obligations. If our operating results are not adequate and we are not able to secure adequate capital resources, we could face liquidity problems and be required to dispose of assets or operations to meet our debt
service and other obligations. Since our existing debt agreements restrict our ability to dispose of assets, we may not be able to consummate those dispositions, which could impair our ability to meet our debt service obligations.
One of our existing financing arrangements provides that if we secure a specified minimum supply of walnuts from the 2012 crop and
achieve profitability targets for our nut businesses for the six-month period ending January 31, 2013, then warrants to purchase 4.4 million shares of our common stock at $10 per share that were issued to the lender will be cancelled and
the lender may exchange $75 million of our senior notes for shares of our convertible preferred stock at an initial conversion price of $20.75. We believe it is unlikely that we will be able to meet those walnut crop and profitability targets, and
as a result the entire $225 million principal amount of this indebtedness and the warrants would remain outstanding, which could dilute existing stockholders and impair our ability to meet our debt service obligations.
Risks Related to Our Common Stock
The market price of our common stock is volatile and may result in investors selling shares of our common stock at a loss.
The trading price of our common stock is volatile and subject to fluctuations in price in response to various factors, many of which are
beyond our control, including:
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our operating performance and the performance of other similar companies;
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changes in our revenues, earnings, prospects or recommendations of securities analysts who follow our stock or our industry;
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publication of research reports about us or our industry by any securities analysts who follow our stock or our industry;
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speculation in the press or investment community;
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42
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general market conditions, including economic factors unrelated to our performance.
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In the past, securities class action litigation has often been instituted against companies following periods of volatility in their
stock price. This type of litigation against us could result in substantial costs and divert our managements attention and resources.
The private equity firm Oaktree Capital Management may have interests that diverge from our interests and the interests of our other security holders.
Oaktree Capital Management L.P. (Oaktree) is one of our creditors and beneficially owns a significant equity position in
Diamond through its warrant holdings and may have interests that diverge from our interests and the interests of our security holders. In addition, so long as Oaktree maintains ownership of specified thresholds of its warrant and senior note
holdings, it will have the right to nominate up to two members of our board of directors and will be entitled to certain information rights and a right to participate in future offerings of our equity securities. Oaktree is in the business of
investing in companies and is not restricted from investing in our current or future competitors. Future events may give rise to a divergence of interests between Oaktree and us or our other security holders.
A substantial number of shares of our common stock may be issued upon exercise of a warrant issued to Oaktree, which could cause a
decline in the market price of our common stock.
Oaktree is the holder of a warrant exercisable for an aggregate of
approximately 4.4 million shares of our common stock, representing approximately 16.4% of our common stock on a fully-diluted basis (after giving effect to the issuance of the shares underlying such warrant). The presence of these additional
issuable shares of our common stock may have an adverse effect on the market price of our shares.
Our ability to raise
capital in the future may be limited, and our failure to raise capital when needed could prevent us from executing our growth strategy.
The timing and amount of our working capital and capital expenditure requirements may vary significantly as a result of many factors, including:
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market acceptance of our products;
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the need to make large capital expenditures to support and expand production capacity;
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the existence of opportunities for expansion; and
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access to and availability of sufficient management, technical, marketing and financial personnel.
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If our capital resources are not sufficient to satisfy our liquidity needs, we may seek to sell additional equity or debt securities or
obtain other debt financing. The sale of additional equity or convertible debt securities would result in additional dilution to our stockholders. Additional debt would result in increased expenses and could result in covenants that would restrict
our operations. With the exception of the Secured Credit Facility, we have not made arrangements to obtain additional financing. We may not be able to obtain additional financing, if required, in amounts or on terms acceptable to us, or at all.
Anti-takeover provisions could make it more difficult for a third party to acquire us.
We have adopted a stockholder rights plan and will issue one preferred stock purchase right with each share of our common stock that we
issue. Each right will entitle the holder to purchase one one-hundredth of a share of our Series A Junior Participating Preferred Stock. Under certain circumstances, if a person or group acquires 15% or more of our outstanding common stock, holders
of the rights (other than the person or group triggering their exercise) will be able to purchase, in exchange for the $60.00 exercise price, shares of our common stock or of any company into which we are merged having a value of $120.00. The rights
expire in March 2015 unless extended by our board of directors. Because the rights may substantially dilute the stock ownership of a person or group attempting to acquire us without the approval of our board of directors, our rights plan could make
it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our board of directors regarding such acquisition. In connection with the sale and issuance of notes and
warrants to Oaktree, we amended the stockholder rights plan to exclude such securities from triggering such rights plan.
43
In addition, our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock (of which 500,000 shares have been designated as Series A Junior Participating Preferred Stock) and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any
further vote or action by the stockholders. The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future.
Further, some provisions of our charter documents, including provisions establishing a classified board of directors, eliminating the
ability of stockholders to take action by written consent and limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or our
management, which could have an adverse effect on the market price of our stock. Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit an interested
stockholder from engaging in a business combination with us for a period of three years after the date of the transaction in which the person became an interested stockholder, even if such combination is favored by a majority of
stockholders, unless the business combination is approved in a prescribed manner. All of the foregoing could have the effect of delaying or preventing a change in control or management.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following are details of repurchases of common stock during the three months ended October 31, 2011:
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Period
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Total number
of shares
repurchased (1)
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Average price
paid per
share
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Total number of
shares repurchased as
part of publicly
announced
plans
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Approximate Dollar
value of shares that
may yet be purchased
under the
plans
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Repurchases from August 1 - August 31, 2011
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39,140
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$
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65.72
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$
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Repurchases from September 1 - September 30, 2011
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2,622
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$
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77.62
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$
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Repurchases from October 1 - October 31, 2011
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$
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$
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Total
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41,762
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$
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66.47
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$
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(1)
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All of the shares in the table above were originally granted to employees as restricted stock pursuant to our 2005 Equity Incentive Plan (EIP). Pursuant to
the EIP, all of the shares reflected above were relinquished by employees in exchange for Diamonds agreement to pay federal and state withholding obligations resulting from the vesting of the restricted stock. The repurchases reflected above
were not made pursuant to a publicly announced plan.
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Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
None.
44
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.
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Filed
with
this
10-Q
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Incorporated by reference
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Number
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Exhibit Title
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Form
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File No.
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Date Filed
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10.01
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Credit Agreement, dated October 5, 2011, by and among Diamond Foods, Inc., Wimbledon Acquisition LLC, Bank of America, N.A., the Lenders party thereto
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10-K/A
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000-51439
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November 28, 2011
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31.01
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Rule 13a-14(a) and 15d-14(a) Certification of Chief Executive Officer
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X
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31.02
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Rule 13a-14(a) and 15d-14(a) Certification of Chief Financial Officer
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X
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32.01
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Section 1350 Certifications
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X
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101.INS*
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XBRL Instance Document.
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X
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101.SCH*
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XBRL Taxonomy Extension Schema Document.
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X
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101.CAL*
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XBRL Taxonomy Extension Calculation Linkbase Document.
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X
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101.DEF*
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XBRL Taxonomy Extension Definition Linkbase Document.
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X
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101.LAB*
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XBRL Taxonomy Extension Labels Linkbase Document.
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X
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101.PRE*
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XBRL Taxonomy Extension Presentation Linkbase Document.
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X
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*
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XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or Prospectus for purposes of
sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
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45
SIGNATURES
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.
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DIAMOND FOODS, INC.
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Date: November 14, 2012
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By:
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/s/ Michael Murphy
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Michael Murphy
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Interim Chief Financial Officer
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46
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