Financial Statement Analysis
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Case: Diamond Foods, Inc.: A Comprehensive Case in Financial by Analysis and Valuation
Question: Critically analyze the case study - diamond foods.
Answer: Introduction: Diamond Foods is one of the largest walnut processors in the United Statesspecializing in the marketing, processing, and distribution of the nuts and snack products. The following report presents the real financial reporting issues around the company that showed the falsified earning of the company management, by using the tactics of delaying the recognition of part of the company cost into the later accounting periods among other facts. According to various studies, the company materially underreported the cost of sales and overstated some of its earnings in the financial years running to 2011(Gujarathi, 2019). The following report thus provides a financial analysis of the company by looking at different financial issues facing the company reports.
Background: Diamond foods were found in 912 beneath the brand Diamond from the state of California. In 1930, the company grew up to the international level, and by 2004 the company was publicly traded. As at the moment, the products from Diamond foods are internationally distributed, and the company is reported to have about 1700 full-time employees(Gujarathi, 2019). Thecompany has a reputation of being to build up to its brands, coming up with new opportunities, and connecting producers with consumers. This is important as it adds the value of the customer to the product. The main focus of the product is on the five essential product lines that include snack nuts, potato chips, popcorn, culinary nuts, and shell nuts. In 1997, the company hired Michael Mendes to become its chief executive officer and the president. During this time, he also became a member of the board by 2005.
Before becoming the president of the company and CEO, Mendes was the vice president of Diamond Foods international sales and marketing department. Before diamond foods, Mendez also worked for different corporations in the competitive snack food business, plus the Dole Food company and the hornet foods business. While working that the diamond foods, he was also known for having a competitive nature and the implementation philosophy that ‘Bigger isbetter.' The impact of this viewpoint had on the operations of the company corporate culture was big(Anon, 2013). Unfortunately, even though the company like it would continue to grow rapidly, the financial reports indicate that there was some questionable practice of while the company losses were misrepresented while it tried to recover its chances inobtaining the Pringles brand from Procter and Gamble. According to the financial report of 2011, there were a number of accounting issues related to the company, that it showed it was only struggling. Later on, Diamond foods reported a Net loss of $86,336,000 in earnings or loss per share to up to $3.98. By 2002, there was a lot of volatility of the company stock experience which went down to 42 percent from the company development to about $21.50 in regards to the prices of November to the time to the significant drop, the company began to realize a rise in the stock price which raised to a value of $33.22 by early 2015(Gujarathi, 2019).
Corporate issues in financial management: According to Gujarathi, (2019), the snack food business is generally very competitive. It is estimated that the global snack market stands at around $374 billion. In this regard, the diamond food company also competes with national and global companies. The competition can be said to occur, especially when it comes to the retail shelf space with a remarkable form of competition, the company has continued to face a lot of pressure inquest to be successful. The previous CEO Michael Mendes was very ambitious in his plans to make the corporationextra competitive leading to more millions of dollars acquired in the form of loans for the pop secret popcorn; these loans amounted to up to $1 billion for the purchase of the Pringles(Gujarathi, 2019).
By the company acquiring the Pringles brand from Procter and Gamble, this means that diamond foods would grow enough to be the second largest distributor of snack food in the whole of the US after PepsiCo. The existing force to increase shares in the snack food market and become one of the largest distributors of snack food, with an increased competition that would have motivated unethical behavior in the company. It is evident that the company has been highly competitive and ambitious in its business culture, which might have driven the company to financial fraud(Gujarathi, 2019). From interviews by the media and other agencies with former employees and the member of the board, it was discovered that the company was pushing very hard in meeting an increasingly ambitious target for earnings. At this, the executives were allowed to gain huge bonuses to ensure that these goals were met.
From the financial report filings of 2009, 2010 and 2011, it can be seen that the CEO Michael Mendes was given about $2.6 million in bonuses for exceeding earnings per share for the company regarding their goals(Reuters, 2012). Also, reports indicate that by 2010, Mr. Mendez, who boldly assured 15 to 20 percent EPS growth in the following five years. The increasing incentivized competitive culture was also worsened by the point that the culture of diamond foods did not allow for clear communication. For example, the supplier of nuts to the company was informed of what happened to be confusingevidence regarding different expenditures for their crops(Reuters, 2012). For example, there was a lack of communication, which continued to increase opportunities for unethical behavior.
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Poor financial ethics: There was a lot of suspicions that arose regarding Diamond Foods in 2011 when it came to accounting practices. According to an offWall Street consulting group, financial analyst, diamond foods were guilty of wrongly reporting payments to their suppliers. The accusation also indicated that Diamond Foods was issuing "Impetus Payments" in the 2011 fiscal year, and this had already ended in July. Even though this might not be viewed as a significant financial issue, poor reporting of payment meaningfully impacted the ways in which the financial statements of diamond foods were perceived(SEC, 2014). If this is done intentionally, it means that the conduct was illegal.
When the anomalies were first discovered, Diamond foods were not read to own up, and they continued to argue that the payments were made in advance for the 2012 crop and also had nothing to do with the 2011 crops. However, some growers continued to contradict this defense. Some of the growers were even told that they had to remit payments even when they had not provided crops for 2011(SEC, 2014). It is reported that they were informed the checks were previous year payment. According to investigations, it was found that the payment made by Diamond foods, was used to inflate the 2011 financial results by shifting costs regarding the upcoming financial year. In this regard, it also caused owners of the company to question if the company was going to represent its financial performance more accurately. There was also an internal investigation that discovered the company, in particular, is CEO had mentioned payments to organizations like the Walnut growers, which in the end skewed the financial results of diamond foods(Gujarathi, 2019). To add on this, the continued payment to the company growers in 2010 of August that closely came to $20 million were also accounted for in the wrong period.
This shows that the company moved around $60 million in unclear ways in payments to walnut growers concerning the fourth quarter of the 2011 fiscal year and the first quarter of the 2012 fiscal year. At this, the momentum of diamond foods payment thus showed an improvement to the full year of 2011 in terms of earnings per share from $1.14 to $2.61. With these results regarding greater earning, it was, therefore, possible for the top management to gain in millions in terms of compensation. Also, it had been speculated that the fraud is intended to encourage the sale of the Pringles Brand of potato chips from Procter and Gamble(Gujarathi, 2019). In this regard, the company saw an increase in earnings per share that would also incentivize shareholders from Procter and Gamble. In this regard, the company earnings per share were also increased and paid to diamond stock.
Several factors can be said to have encouraged the unethical behavior at Diamond Foods. For example, it cannot be said Diamond foods was very competitive only, but also it was the culture of the company. This means that the bigger the competition, the better as per their slogan which was supported by CEO Michael Mendes, that placed the different pressure on the company's attempted acquisition of Pringles, that would have highly expanded the growth of diamond foods. Due to this fact, the company continues to fall into massive debts that in the end, the company was required to take out loans to ensure that these acquisitions were realized(Gujarathi, 2019). Due to these loans, the there company made debt agreements that called for different performance standards being met. There was also a debt to earning covenant in one of the company's debt agreements, which also called for the company to realize higher earnings. The covenant for debt earnings saw an increase in compensation for stakeholders in meeting increased performance standards. This also saw increased pressure for them to acquire Pringles, which played a significant role in inaccurate financial reporting.
Also, the other thing that the company was required to watch is the fact that Diamond foods chief financial officer was given a position on the company's board. In this manner, there was a conflict of interest regarding the company corporate governance structure. According to Gujarathi, (2019), a board member that can directly receive compensation from the company is likely to mislead the company board to realize less oversight concerning operation and decision making which would also not going to be in the best long term interest of the firm.
In this regard, it was inevitable that the company should be investigated for criminal fraud, thus the audit report. According to the investigations, it was evident that stakeholders would become uneasy, thus prevented the ability of the company to acquire Pringles. At the end of these investigations, it was difficult for diamond foods to meet deadlines to present financial results. Also, complaints were coming from nut growers on the fact that diamond foods were paying the 10 cents a pound less than what they would be earning if they transacted with independent buyers, this, in the end, led to a lot of in satisfaction from suppliers of diamond foods(Gujarathi, 2019). The issue attracted a lot of attention from regulators and investors.
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Financial Fraud ethical aspects: According to Gujarathi, (2019), the things to what in financial fraud are motivation, rationalization, and opportunity. By use of this model, it is obvious ways in which the accounting fraud at diamond foods was able to take place. For example, it is reported that employees of the company were given a chance to conduct fraud because the internal controls were not being implemented. Also, the company top management also was not able to set an ethical tone on the top. This gave employees moreopportunities to practice financial fraud due to the fact that internalcontrols werenot in any way implemented. Also, the company top management also did not set an ethical attitude at the top; in the end, provided more employees a chance for unethical behavior. In this regard, investigations also revealed that the top management was hugely responsible for depicting various unethical behavior.
Looking at the reports, it is evident that Diamond foods had a lot of chances to improve its performance at any cost. By improving the company's EPS, this would also ensure that that the company won the deal on Pringles brand and allowed Diamond Foods to meet the debt to earning ration as required by its debt covenant. Also, it is possible that diamond foods might have rationalized their actions by denying that it was illegal to make momentum payments(Anon, 2013). After the irregularities in payment were discovered, the management of the company also denied the fact that these payments were for the crops of the previous year. Also instead, the company continued to state that the fees were accounted for last year.
According to the financial statements, the company's six-year low stock price of $12.50, which saw the company face a lot of financial difficulties. These results were as a result of the company's restatement of financial results that were removed from the previous year at $56.5 million in profits because of the fraud in accounting(Anon, 2013). Besides, the same issue was also exacerbated by the 2011 SEC investigation towards the company. According to reports, shorting of stock was linked to the billionaire investor, leading to the loss of uncertainty and trust from the investor in the company.
Also, apart from the company's plummet regarding the stock price, the company also lost its deal in purchasing the Pringles from Procter and Gamble. Also, the subsequent audit also found that there was an existing weakness in the internal systems of the firm regarding financial reporting, in this regard, the weakness also breached a loan agreement with the company creditors. Also, regarding the said agreements, it is possible that diamond foods went to bankruptcy due to creditors not being ableto require foods to repay all of the company's outstanding loans. According to Reuters, (2012), the CFO Steven Neil and CEO Michael Mendes were removed from Diamond foods on November 19, 2012. According to the employment agreement provided to Mendes, he was not allowed to get his insurance benefits because his resignation was considered as being a violation of his duty as the company CEO. It was also required that diamond foods enter to separation and clawback agreement with Mended, which called on him to repay his fiscal 2010 and 2011 bonus to a total of $2,743,400(Gujarathi, 2019).
Also, Mendes was required to pay back all of the significant stock shares which he received from the fiscal year 2010, which amounted to 6,665 shares for the common stock at Diamond Foods. Also, it was important that other amounts be recovered from his retirement restoration plan, though he was still able to receive $2,696,600 payment(Gujarathi, 2019). The fabricated financial reports also had to be restated for two years involved in the fabricated payments.
Conclusion: In summary, the financial statement issues at Diamond foods resulted in a loss of its reputation and financial loses. Regarding its financial blunders, the company underwent a risk of legal action, government enforcement, regulatory proceedings, and claims from the insurance firms. In the end, the company paid $5 million to the commission of securities exchange so that they would have settled the fraud allegations. Also, the SEC had charged the former CFO Steven Neil in his participation on falsifying the cost of walnut, in addition, the former CEO Michael Mendes for the role he played to mislead the making of financial statements. In this regard, Mendes Forfeited $4 million in Benefits and Bonuses also had to pay a penalty of $125,000. The SEC also required Steven Neil to pay a settlement of $125,000 as civil penalty though he had initially contested. In the end, the company settled with investors a total of $100 million.
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