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Diamond Foods: When Accounting Goes Wrong

Accounting corrections at Diamond Foods lead to a total revamp of senior management.
Kathy HoffelderNovember 16, 2012

Not many companies can bounce back in a short time from an accounting scandal that results in the ousting of its chief executive officer and CFO, a Securities and Exchange Commission investigation, and tarnished relationships with its key product suppliers. But Diamond Foods is attempting to do just that.

Plagued by improper accounting for payments made to walnut growers, the San Francisco, California-based snack maker this week restated its financial results from 2010 and 2011, and filed its results for the first three quarters of 2012, which had also been delayed by the preparation of the restatements. The results showed a reduction in income before taxes of $39.5 million in fiscal 2011 and $17.0 million in fiscal 2010 from what was previously reported.

Diamond acknowledged that it accounted for certain payments to walnut growers in the wrong fiscal periods. The company’s acting CFO, Michael Murphy, who was brought in as interim CFO from business advisory AlixPartners, noted on Diamond’s earnings call this week that the case boiled down to not having “appropriate matching of the costs with the revenues and not [having] appropriate recognition of all the indicators of what cost should be for that period.”

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The SEC opened an investigation into the accounting for the payments last December, after the company’s audit committee had initiated an internal probe last fall. It was the internal probe that resulted in this week’s restatements.

At the heart of the investigation was the question of whether Diamond senior management adjusted the accounting for the grower payments on purpose to increase profits for a given period. But the internal probe concluded there was not enough evidence to state that claim. Still, former CEO Michael J. Mendes and former CFO Steven M. Neil were placed on administrative leave in February. The firm hired current president and CEO Brian J. Driscoll in May.

The restatement also required a review of quarterly walnut cost estimates during 2010 and 2011, since questions were raised about whether or not Diamond paid its walnut suppliers appropriately. Walnut growers typically deliver their walnuts at the end of the crop year, but companies buying those products pay for them throughout the year. Diamond used what the company called momentum payments, which were made in advance of crops, as well as continuity payments, which typically involve a lump-sum payment and follow-up payments.

Pressed by analysts, Diamond officials on the call did not admit to mispricing in the company’s arrangements with the growers. But the executives emphasized that several changes have been implemented to help smooth relations with them. The company has begun using new contracts with the growers that feature shorter terms, such as fewer than 3 years in duration, compared with the 3-to-10-year terms previously used; more accelerated payment schedules; and earlier final price communication for growers.

Both Murphy and Driscoll reiterated that building up relations between Diamond and walnut growers is an ongoing part of their daily operations. The executives noted that it’s crucial to have a level of certainty and confidence in a supply partner. As a result of the investigation, the company added William L. Tos, a walnut grower and former member of the board of Diamond Walnut Growers, the cooperative that was the predecessor to Diamond Foods.

The snack maker also made a number of other employee and board changes to help thwart any such accounting mishap from occurring again. It added five new members to its board, including one former CFO: Alison Davis, former CFO of Barclays Global Investors and a consultant with A.T. Kearney and McKinsey.

The company also hired Nigel Rees, vice president and controller of McKesson Corp.; R. Dean Hollis, former president and chief operating officer of ConAgra Consumer Foods and International Division; and Matt Wilson, managing director at Oaktree, the investment-management firm that recapitalized Diamond with $225 million in May. In addition, the firm hired Mark Hair, who previously worked at Deloitte, as senior vice president of finance and controller.

Diamond has also taken other measures to improve its financial and operation reporting throughout the company, according to Murphy.