Case Analysis: Diamond Foods, Inc.Terry Knox Jose Ixchu LaKisha Woods Measurements I 632 Professor Lavelle Lemonier March 24, 2014 Increased credit availability 2. Momentum payment reporting times 3.Diamond Foods. implement deceitful accounting practices. Unfair pricing 3. Inc. Reported annual growth Purposely defrauding investors 1. Momentum payments 2. Diamond Foods engaged in unethical and questionable behavior as company leadership attempted to monopolize the market. Increase stock sales 3. Financial statements 2. Problem Statement With a goal of becoming a major competitor at any cost. Annual growth rate 2 . Key Issues The monopolization of the walnut market 1. Guaranteed future production Use of deceitful accounting practices 1. and defraud investors resulting in falsified annual growth rates and earnings from 2006-2011. The farmers clearly felt slighted by Diamond Foods. unfair pricing. yet farmers were on contracts as they received fluctuating payments. there were other factors that led to the farmer’s unhappiness and frustration with Diamond Foods. As the contracts ended. A momentum payment according to the investigating analyst was a new accounting term. There was also confusion about what a momentum payment was to the farmers. The farmers did not receive fair market value for their goods. However. Guaranteed future production of walnuts gave Diamond Foods exactly the edge they needed to compete in different snack industry markets. even before the momentum payment was an issue. For example. some farmers were upset because they believed they were underpaid by nearly $50 million for the years 2005 and 2006 harvest and they also believed that they had been underpaid for several years. 2013). The walnut industry catapulted the company into a new direction where it was able to capitalize on potential opportunities to increase market presence and grow sales and profits. 2013). The payment received by the farmers was said to be based on quality and other factors yet farmers received no price guarantee for their crops (Srinivasan & Gray. 2013). and guaranteed future production were just a few of the many underlining problems that existed with the relationship between the contracted walnut growers and Diamond Foods. As market shares increased. Analysis The confusion with momentum payment. by the 1990’s. consumer taste had changed and walnuts were not as popular as they previously were in the past (Srinivasan & Gray.Diamond Foods. Inc. But. the last momentum payment made to the farmers was 35 cents per pound versus the $1. Unfair pricing among Diamond Foods was also concern. The company had a no price guarantee but was willing to buy all walnuts from the farmers leading to a monopoly. Diamond Food 3 .50 per pound they previously received (Srinivasan & Gray. diamonds gave the farmers what they wanted them to have leaving the farmers in a nonnegotiating position. Because the farmers accepted the contract. With a growing loss in the market share of their core product. It is important that the farmers put themselves in a position to negotiate. there was just a small amount of farmers that was dissatisfied with the contract resulting in the company disregarded their opinions. it was through unfair practices the walnut farmers. Inc. Materiality does exist because the company failed to report correctly in its financial statements (Schmidt). as a result this drove investors to purchase stock. Moreover. A small amount of the farmers believed they were being underpaid for a long time and had done nothing about it. Diamond Foods was able to venture into other markets which led them into the snack industry. The walnut industry began to decline and Diamonds Food paid the farmers even less overtime which had the potential to lead to poor relationships. no matter how many walnuts were produced. There were some corrupt business practices present. was able to obtain better shelf locations and presence to the consumer which in turn has the ability to drive sales and profits even more. and a declining market for their 4 . Lack of communication and trust began to prevail as the relationship deteriorated between the two organizations. The loyalty bonus was given to the farmers in order to shift cost and boost profits. Diamond Foods utilized multiple less-than-ethical methods to ensure that their stock prices were of a high enough level that they could secure a substantial loan.Diamond Foods. Diamond Foods influenced the stock market by making the financial statements look stronger than they were. The amount credited to them would allow for the acquisition of Pringles from Proctor & Gamble (P&G). walnuts. To that end. Diamond would send payments to the farmers for their walnuts throughout the harvesting process each fiscal year. The true problem with the momentum payments was the manner in which they were reported in the financial statements. the payments for the 2010 harvest started in November 2010 and ended in August 2011. previously purchased Kettle Foods and Pop Secret companies. Diamond Foods sent momentum payments to their walnut farmers. however. it is not ethical nor legal to pay in a later fiscal year for goods of a past fiscal year. The practice was not uncommon for Diamond. In this case. Instead of being paid for the walnuts collected for the FY12 harvest. Typically. though they used different names for the payments each year. CEO Michael Mendes likely had given approval for creative accounting tactics to guarantee Diamond’s success. This act of mispricing effectively improved their earnings outlook and provided the push needed to impress investors and creditors. In 2011. Diamond Foods stated that the momentum payment was for the harvest that would begin in FY11. however. 2001). a boost from the iconic brand was seen as the path to a dominating role in the snack food industry.Diamond Foods. 5 . This would be the catalyst for the implementation of the company’s creative accounting scandal. Inc. These payments were to pre-purchase the entire walnut harvest of the farmers and lock them into multiyear contract for their walnuts. What Diamond Foods was doing was committing accounting fraud. In their income statement. Diamond Foods would have the payment count toward the 2011 statements instead of 2010. “Some transactions require firms to make commitments to provided future resources that are casually related to economic events that occur” (Healy & Choudhary. As stated earlier. As for the CAGR. “The momentum payment might have been a way to make the company to look more profitable. In this particular dissemination of payments to the farmers. however. Inc. Had the two companies been in the growth phase of the market cycle. report it in that manner. 2013). Again. the companies were actually in a mature or even a declining stage. Diamond Foods continued their practice of inaccurate financial reporting by inflating their compound annual growth rate (CAGR). However. this form of inaccurate financial status reporting was intended bolster investor confidence in the company and drive up the price of their stock through fraud. and less risky. Diamond was looking to obtain the credit worthiness to buy Pringles from P&G. As it was. revenue increase by a margin of 15%. Diamond was able to proceed further into the deal with P&G for the acquisition of Pringle. they did not. the 15% stated was actually closer to 3. had they continued submitting payments to the farmers as they had normally done in the previous years. than it really was” (Srinivasan & Gray. So. they provided payments to their walnut growers at the time that they were expecting payment for the previous harvest. the percentage fabricated by Diamond would look a little more convincing. their earnings for the 2011 income statement would have stated that the earning were less than half of what was reported. 6 . Documentation would go on to show that both Kettle Foods and Pop Secret were suffering from major losses in revenue during their time with Diamond Foods. 2013). They reported that between FY06 and FY11. however. They go on to state that the rapid grown was due to the assimilation of Kettle Foods and Pop Secret. Another problem plaguing the accounting practices of Diamond Foods was the time in which they were distributed the momentum payments. making them one step closer to securing the number two position within the snack food industry.Diamond Foods.5% (Srinivasan & Gray. Inc. As a result. Diamond Foods deliberately misrepresented their financial statements in order to represent a stronger economic position in violation of accrual accounting practices. Competition was really focused on market share. and Pringles. the momentum payments were said to be an advance on the next year’s crop. The goal of “bigger is better” became the driving force in the very competitive market. Reporting these payments in the wrong period basically impacted how financial statements were perceived by investors. The main accusation was incorrectly reporting its payment to suppliers which skewed its fiscal financial results. the company was able to enter into negotiated loans.Diamond Foods. Kettle Foods. The payments were reported in September which was after the fiscal year ended in July. For example. and better than actual annual growth rate by defrauding investors. higher stock prices. 2012) There were many reasons why these types of irregularities were 7 . creating an environment where unethical behavior and lack of oversight ultimately resulted in increased availability to credit. 2012). The competition and pressure to be successful led the company to make several bold and expensive acquisitions (Diamond Foods Accounting Scandal Seeds Sown Years Ago. CEO Michael Mendes’ goal of making the company more competitive resulted in entering into billions of dollars in debt to acquire Pop Secret. and the company insisted they had nothing to do with previous year’s production. 2012). both regional and national. increasing their available credit from lending institutions. The end result of these questionable practices was to hide losses and improved its chance of acquiring product lines like Pringles from Proctor & Gamble and other products (Diamond Foods Accounting Scandal Seeds Sown Years Ago. shareholders and the industry in general. specifically the retail shelf space at the local supermarket. Diamond Food competed in several markets. (Diamond Foods Accounting Scandal Seeds Sown Years Ago. what price the company was actually paying for the crops and the lack of open communications that contributed to the fraud environment. 2013). allowed. resulted in improved earnings per share (EPS) from $1. 2012).75 to 3. The additional pressures resulted in unethical and criminal misreporting in order to increase stock prices and investors. The employees and many of the managers were reacting to the ambitious earning targets set by their CEO. The company offered $181 million in stocks at an elevated price resulting in increased income from the sale of the stock offering (Srinivasan & Gray. their primary business needed to generate income through any business cycle. If the information leaked. Michael Mendes.14 to $2. As stated. however shareholders would be left 8 .1 through October 2012 (Srinivasan & Gray. Company projections identified a $100 million merger cost. Additionally. Additionally. the momentum payments. The debt obligations carried very restrictive covenants requiring low debt on their balance sheets from 4. or even encourage by leadership. These actions were put in place to misrepresent their financial status which would have the intended outcome of incentivizing P&G shareholders when paid in Diamond’s stock. Inc. the company was required to satisfy fixed interest financing expenses a minimum of 1 to 1. 2013). In an extremely competitive market. Additionally.Diamond Foods. These actions also led to an artificially inflated stock price. creditors would have concerns with the internal controls and could choose to call in all the loans and force Diamond Foods into bankruptcy (Michael Mendes' Dream for Diamond Foods Shattered. there are many driving forces which create an incentive to twist financial reports. the company entered into various debt obligations requiring increased performance in order to generate enough income and ensure they were able to keep a low interest coverage ratio. there was confusion about the meaning of the payments.25 to 1 by the end of April 2014. The main culprit.61 as the company’s operating costs were transfer to a different reporting period. 47 high.Diamond Foods. On September of 2011. Industry experts considered Diamond Foods leadership an example of creative marketing and product development/enhancement (Srinivasan & Gray. 2012). and rationalization allowed illegal activities to influence the processes of an up and coming snack food giant. however. were the leadership’s character flaws. with 43% of the new company. “Many in the industry saw the warning signs like unusual timing of payments. jump in profit margins and volatile inventories and cash flows” (Darragh. The last factor. employees did not have clear guidance and internal controls were not implemented. especially when accompanied by the power of a position. Reports noted Diamond Foods’ snack food focused acquisitions would result in higher revenues as the company could use the Pringles brand as a jump off to introduce other snacks. Inc. The drive for success in a competitive market clouded their decision making processes. As a result. The biggest. the company stock rose to new $92. When does loyalty lead to corruption? There were different reasons for the problems. The momentum payments seemed to do more than increase EPS. Top leadership and managers did not set ethical examples giving more reasons to violate guidelines (Diamond Foods Accounting Scandal Seeds Sown Years Ago. meet debt to earnings ratios and help qualify for debt covenants. investors poured money into the company and top managers enjoyed millions in additional compensation (Darragh. leading to an environment where opportunity. Because of the drive to succeed at any cost. rationalization focused on 9 . 2012). Money was a very persuasive motivator. motivation. showing improved EPS would allow a twofold strategy. 2013). These factors also had a beneficial effect resulting in large executive bonuses. assisting in the Pringles acquisition. 2012). As noted. 2013). Michael Mendes’ enthusiasm even led many industry analysts to recommend their stock and contributed to their growth (Srinivasan & Gray. it also elevated the CEO’s public persona to somewhat of a financial celebrity. Also. As a result of the payments. or loyalty. the momentum. Diamond Foods should resort back to the previous method of paying installments for the current fiscal years walnut harvest to prevent any additional mispricing on financial statements. payments. the company’s reporting procedures also allowed leadership ability to deny the illegal actions because of the complexity and no one person really understood the illegal actions. Along with training. Recommendation The company should implement several corrective measures including. internal auditors should be mindful of and more diligent in their efforts to ensure the integrity of reported financial statements. While denying these payments. leadership denied the wrong doing (Davidoff. These actions should be put in place immediately and documented with annual employee training modules. a single term should be decided upon for their payments. in concern with the payments. Rather than constantly rename the payments provided to the walnut farmers. 10 . stock price plunged to the lowest point since 2006 (Diamond Foods Shares Plunge Following Restatement. 2011). 2012). These were reported in the wrong reporting period and when confronted. improving the internal controls environment to include ethics training. proper accounting for Walnut growers ensuring the company meet all legally required guidelines. Inc.Diamond Foods. robust accrual accounting practices and defined procedures with different level of approvals. com/materialityconcept. M.d..com/diamond-foods-accounting-scandal-stems-from-years-of-badpractices/ Davidoff. 2014. Expense Recognition. 2014. S. from Businessweek: http://www.com/business/article/Michael-Mendes-dreamfor-Diamond-Foods-shattered-3302085. Accounting Weighs on Pringles Deal. (2001). 2014. (2012. Retrieved March 24. February 12).businessweek. from SFGate: http://www.php Darragh. (2012. & Gray. Schmidt. Materiality Concept in Accounting Explained.business-case-analysis. Inc.sfgate. Diamond Foods.com/2011/11/29/accounting-at-diamond-foods-weighs-onpringles-deal/?_php=true&_type=blogs&_r=0 Healy. Inc.com/ap/2012-11-15/diamondfoods-shares-plunge-following-restatement Michael Mendes' Dream for Diamond Foods Shattered.).Diamond Foods. S. March 19). References Diamond Foods Accounting Scandal Seeds Sown Years Ago. (n. from CompliancEX: http://compliancex. P. 11 . M.html Diamond Foods Shares Plunge Following Restatement. from Huffington Post: http://www. (2012.nytimes. Retrieved March 24. Diamond Foods Accounting Scandal Stems From Years of Bad Practices. 2014.. November 15). 2014. March 20). R. from The New York Times: http://dealbook. Boston: Harvard Business School.html Srinivasan. P. Retrieved March 24. (2012. & Choudhary. M.huffingtonpost. November 29). Retrieved March 24. (2013). Retrieved Marxh 24. At Diamond Foods. from Building the Business Case: http://www. (2011. 2014. T.com/2012/03/19/diamondfoods-accounting-scandal_n_1361234. Retrieved March 24. Boston: Harvard Business School.