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 Diamond’s 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 Diamond’s financial results, operations and prospects, including its accounting for payments to walnut growers and the anticipated closing of Diamond’s 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 plaintiff’s attorney’s fees and
other relief.
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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 plaintiff’s attorney’s fees and other relief. On April 16, 2012, Diamond moved to dismiss the action. On May 29, 2012, the court granted Diamond’s 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 Diamond’s 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 Diamond’s 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’ attorney’s fees and other relief.
We cannot predict the outcome of these lawsuits. The matters which led to our Audit Committee’s 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. Attorney’s 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 Market’s
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
Committee’s 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 Company’s 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 management’s 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 system’s
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 acrylamide—a naturally-occurring chemical compound that is formed in the process of cooking many foods, including potato chips, and a
potential carcinogen—and 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
Sam’s 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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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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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 management’s 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.
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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.