Diamond Foods' Earnings Restatement Imperils Pringles Deal, Ends CEO Dreams

Thursday, 09 Feb 2012 02:37 PM

 

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Diamond Foods Inc.’s decision to restate earnings after an accounting probe puts in peril a deal to acquire the Pringles brand — and ends the empire-building dreams of its ousted chief executive officer, Michael J. Mendes.

Diamond, which sells Emerald snack nuts and Pop Secret popcorn, said yesterday it was replacing Mendes and the chief financial officer as well as restating earnings for the past two years after the board found payments to walnut growers had been booked in the wrong periods.

Procter & Gamble Co., which last year agreed to sell Pringles to Diamond for about $1.5 billion, had previously said the sale depended on a favorable resolution of the probe.

P&G finds the results of the probe “very disappointing,” Paul Fox, a spokesman, said yesterday in an interview. Pringles has attracted “considerable interest” from other potential buyers and the company will keep all its options open, he said.

As part of the Pringles deal, Diamond gave assurances to P&G that its financial statements were accurate. Under the terms of the agreement, P&G may be able to terminate the deal if it demonstrates that problems with the financial statements represent a “material adverse effect” in Diamond’s business.

The documents also state that a change in employment status of the acquirer’s senior management that may negatively affect its future prospects constitutes a material adverse change.

Pringles Deal

“You have to assume the Pringles deal doesn’t happen,” said Timothy Ramey, senior vice president of equity research at D.A. Davidson & Co. in Lake Oswego, Oregon. “I doubt they can get their house in order.”

Diamond fell 35 percent at 10:30 a.m. to $23.93. The results of the investigation were announced after the close of trading yesterday.

The three-month investigation, later taken up by the U.S. Securities and Exchange Commission, concluded that about $20 million in “continuity” payments made to walnut growers in August 2010 and about $60 million in “momentum” payments in September 2011 weren’t accounted for in the correct periods, Diamond said. The board also identified material weaknesses in the company’s financial reporting controls.

Director Rick Wolford will serve as CEO, and Alix Partners LP’s Michael Murphy will be CFO while the company searches for permanent replacements, San Francisco-based Diamond said yesterday in a statement. The board put Mendes and former CFO Steven M. Neil on administrative leave.

Career Ender

Mendes’s ouster ends a career at Diamond that began 21 years ago, when the son of immigrants joined the company’s sales and marketing office.

Back then, Diamond was a cooperative, a collection of growers who band together to process and market their products. Mendes was named its head in 1997. Ambitious and hard-working, he threw himself into the job, sometimes walking into factories at 3 a.m. to schmooze with workers loading walnuts, according to a former Diamond Foods executive who has since retired.

At the time, walnuts were mainly used by housewives for baking brownies and other sweets. Mendes saw an opportunity to boost sales by marketing walnuts to younger consumers as a snack, while also expanding into other nuts like almonds and cashews. He created a new nut brand, Emerald, backed by TV ads - -including Super Bowl spots -- and sold in sleek green canisters that fit into car cup holders.

Glazed Walnuts

A year or so into the CEO job, Mendes pledged to boost sales to $500 million from about $200 million in five years. With new products such as tasty glazed walnuts and snack mixes, which encouraged retailers including Safeway Inc. and restaurants such as McDonald’s Corp. to buy more of Diamond’s nuts, Mendes blew past the target.

Mendes took Diamond public in 2005, giving the company the capital to acquire Pop Secret for $190 million in 2008 and Kettle for $615 million in 2010. With the ink on the Kettle deal not yet dry, Mendes pursued Pringles, telling analysts who said he’d bitten off more than he could chew that “you don’t get to pick your time with good transactions.”

In the near term, Diamond will probably incur some heavy costs, Thilo Wrede, a Jefferies & Co. analyst, said in a research report. Diamond may have to pay P&G a $60 million breakup fee if the deal falls through, wrote Wrede, who is based in New York.

Debt Covenants

Diamond’s change in earnings may also be a violation of its debt covenants, Wrede wrote. The company’s effective interest rate of 4.5 percent could rise. For every percentage point of interest, costs would rise by 16.5 cents a share, or $3.6 million, according to Wrede’s report.

Even without Pringles, Diamond is a solid company that has products in growing businesses such as chips, popcorn and snack nuts, Ramey said. The earnings restatement will push costs back to prior periods and should clear the air for investors once the restatements have been made, Ramey said in an interview.

Other suitors may even be interested in buying pieces of Diamond, Ramey said. Assuming the company remains intact, investors may be concerned that new management won’t expand the business as quickly, he said.

“Mendes was an inspirational CEO -- he drove growth,” Ramey said. “It’s sad that two respected executives did this.”

© Copyright 2014 Bloomberg News. All rights reserved.

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