Thursday, February 9, 2012

Diamond foods - what the press releases says and does not say...

Diamond Foods is a short-battle-ground stock. Anyone who looks at Herb Greenberg's twitter feed can see that. Herb loves battlegrounds.

Today the company made a repetitive press release that has me reading between the lines. Here is the guts of the release:

[The company] today announced that the Audit Committee of its Board of Directors has substantially completed its investigation of the Company's accounting for certain crop payments to walnut growers. The Audit Committee has concluded that the Company's financial statements for the fiscal years 2010 and 2011 will need to be restated. Over the course of the last three months, the Audit Committee has carefully reviewed the accounting treatment of certain payments to walnut growers.  The Audit Committee has concluded that a "continuity" payment made to growers in August 2010 of approximately $20 million and a "momentum" payment made to growers in September 2011 of approximately $60 million were not accounted for in the correct periods, and  the Audit Committee identified material weaknesses in the Company's internal control over financial reporting. 
The Board of Directors is taking a number of corrective actions including the appointment of a new Chief Executive Officer and Chief Financial Officer.  Effective immediately, the Board has appointed Director Rick Wolford to serve as Acting President and Chief Executive Officer and Michael Murphy, of Alix Partners, LLP, to serve as Acting Chief Financial Officer. The Company is commencing searches for permanent replacements for the CEO and CFO positions.  The Board has also appointed Robert J. Zollars, who previously served as Lead Independent Director, to the position of Chairman of the Board. Michael J. Mendes and Steven M. Neil have been placed on administrative leave from the Company.
I have read the whole release - but there is no additional information.

I know relatively little about this company - indeed I did not bother looking because the short was crowded and the product (Kettle chips and walnuts) seemed OK. But this release had me puzzled.

The offence as described - moving $20 million of expense from one year to another in one year and $60 million in another year seems relatively minor. But the sacking of the CEO and CFO and the appointment of Alix Partners seemed less minor.

Still timing offences (and they admit timing offences) must be measured relative to earnings.

The last 10K (since amended and now withdrawn) shows nicely growing income in excess of $50 million.

$26 million in net income and about $50 million in the next year. If you were to add $20 million of expense to 2010 and $40 million (the net amount moved) to 2011 and tax-effect those amounts the profits drop from a net $26 million to $14 million for 2010 and $50 million to $22 million for 2011.

That is pretty nasty. But not terminal. Still there are 21 million shares outstanding and at the after-market price ($21 down 42 percent) that is still 20 times earnings.

It does not look like a salivating buy at 20 times. Not close.

And the loss of the CEO and CFO does matter. There is seldom only one cockroach.

The thing that gets me though is the appointment of the new CFO. Michael Murphy is from Alix Partners and his CV makes it very clear that he specializes in restructuring debt. Alix do a lot of bankruptcy work (though that is not the only thing they do).

The last balance sheet (also since withdrawn) is amusing.

It shows cash of just over $3 million, some short term debt and long term obligations of nearly half a billion dollars. And - given the restatement - we can guess this thing only earns just over $20 million a year - and even that presumes the absence of further cockroaches.

I shorted some in the after-market. Don't do that often - but am quite pleased with myself.



Daniel Y said...

Damn you John, I was just drafting a blog post, that states the SAME points you just made. ARGH. In the interest of avoiding redundancy, I will stop, and simply link your blog post to mine :)


Anonymous said...

I get the logic of reducing previous years' profitability given what the company disclosed. But assuming (for now) that the offense is just timing related - shouldn't profitability be higher by that same number in some period, perhaps the next twelve months? Shouldn't net income even out over some time period?

John Hempton said...

No - they shifted 20 million from 2011 into 2010 to make 2010 seem higher.

Now they shifted 60 million from 2012 to 2011 - 20 million to offset the above and 40 million for 2011.

The profitability was about 20 million really in all years. That is all. Now they will restate - and lo - it will be about 20 million in 2012.

Only problem - 20 million on over half a billion of debt - that looks bad to me. But then I am old-fashioned credit kind of guy.

If it were unlevered - then I would be more comfortable.

Anonymous said...

Thanks for the explanation. Seems almost hard to imagine that profitability would stay in the 20mm range per year when revenues are up substantially over those 3 years.

John Hempton said...

They bought stuff. They overpaid.

No increase in profitability after interest and tax - well some - but not enormous.

Massive increase in debt.

Daniel Y said...

Hope springeth eternal LOL.

Anonymous said...

Scanner data seems to show the retail brands (esp Kettle) kicking butt. Is there really not a few hundred million of value above the debt?
It seems to me based on restatement plus recent massive price increases at retail nut business that walnut profitability has been extremely poor; is this a business they want to stay in?
They need to remedy the technical default on covenants and worst case they issue a bit of equity. It doesn't seem to me that full restructuring is necessary. In the teens, I am intrigued on long side.

Anonymous said...

if that's your definition of 'worst case,' you haven't worked in finance for more than 6 months.

Art said...

John, I think you may be mistaken.

FY 2010 pre-tax income was overstated by $20 million.

FY 2011 pre-tax income was overstated by $40 million.

FY 2012 guidance was around $2.90 per share. If there's a $60 million "momentum payment" in fall 2012 that the old CFO would have booked in FY 2013 and will now be booked in FY 2012, then FY 2012 guidance would remain $2.90 (or ~$60 million).

If there is no $60 million "momentum payment" in fall 2012, then FY 2012 guidance would be around $4.80 (or $120 million).

DMND specifically stated that FY 2012 guidance included that $60 million no payment in fall 2012 means that guidance would be raised.

Of course, if the fall 2012 momentum payment is $100 million, then we're back to square one.

Anonymous said...

How is your short position on TSL doing?

Anonymous said...

Kettle's medium chip bag size just dropped from 9oz to 8.5oz in the last couple of months. Prices didnt noticably change. I wonder if they're trying to pull a fast one on buyers.

Michael R said...

Surely they can simply securitize the goodwill and intangible assets and thereby service the debt.

Anonymous said...

"If you were to add $20 million of expense to 2010 and $40 million (the net amount moved) to 2011."

John - is this correct? or do we need to add back 20m in 2010 and 60m in 2011? I have been reading through all of the press releases and it doesn't seem quite clear to me.

Appreciate the guidance.


Mobile Number said...

Kettle's medium chip bag size just dropped from 9oz to 8.5oz in the last couple of months. Prices didnt noticably change. I wonder if they're trying to pull a fast one on buyers.

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