Insight: Seeds of trouble sown at Diamond Foods years ago

Mon Mar 19, 2012 7:17am EDT
 
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By Nanette Byrnes, P.J. Huffstutter and Mihir Dalal

(Reuters) - The accounting scandal at snack maker Diamond Foods in recent months may have shocked shareholders and some California walnut farmers.

But a number of accounting and industry experts spotted red flags some time before. A close examination of business practices at Diamond Foods DMND.O, the nation's largest walnut processor and maker of Emerald nuts, points up a number of warning signs, including unusual timing of payments to growers, a leap in profit margins, and volatile inventories and cash flows.

The picture that emerges is of a company that for years seemed to push hard on every lever to meet increasingly ambitious earning targets and allowed top executives to pull in big bonuses, according to interviews with former Diamond employees and board members, rivals, suppliers and consultants, in addition to reviews of public and non-public Diamond records.

The company declined to make executives or board members available for this story, or to answer any specific questions, but made this statement through a spokesperson:

"Diamond and its advisers are making substantial progress strengthening the company's financial reporting and control capabilities and restating Diamond's consolidated financial statements for fiscal years 2010 and 2011."

Lawyers for Diamond's former top executives did not respond to multiple messages seeking their comments as well. Attempts to reach those executives at their homes were unsuccessful. Nick Feakins was among those who early on noticed something strange going on at Diamond.

He teaches forensic accounting at San Jose State University and does some work for Bevmark, a food and beverage consultant that was watching Diamond because it is a competitor to a Bevmark client, PepsiCo's Frito Lay. The head-turner for Feakins was the relentless climb in Diamond's profit margins. Boosted in part by acquisitions of two high-margin snack brands, net income rose to more than 5 percent of net sales in fiscal 2011 from 1.5 percent in fiscal 2006.

No competitors were improving like that, even with rising Asian demand. "That just doesn't make sense," Feakins said. A Reuters review of 11 companies listed as comparable organizations in Diamond's regulatory filings showed that only one, B&G Foods BGS.N, which made multiple acquisitions that added to earnings during the period, had a similar run.   Continued...

 
Walnut grower Matt Conant stands in his walnut grove in Rio Oso, California February 23, 2012. "There's a lot of uncertainty right now," says Conant, a walnut grower, former supplier to Diamond Foods and district director of the California Farm Bureau Federation. An accounting scandal over the payments made by the largest U.S. walnut processor Diamond Foods Inc to its growers has hurt their confidence in the company. Picture taken February 23, 2012. REUTERS/Robert Durell (UNITED STATES - Tags: AGRICULTURE BUSINESS)