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Earlier this year when Diamond Foods, Inc. (NASDAQ:DMND) routed long-time chairman and chief executive officer Michael Mendes and incumbent chief financial officer Steven Neil, I made a note to revisit the stock to see if new management could find success in righting allegedly false finance reports. Imagine my surprise when I checked news on Diamond Foods first thing this week to find that not only had the new leadership failed to bring financial reports up to speed, the stock listing on Nasdaq is in jeopardy.

A Very Quick Review of How Diamond Foods Went Stale

In early November 2011, shortly after filing Diamond Food's annual report for the fiscal year ending July 2011, the Mendes-Neil team announced the company's audit committee had received a letter from a third party bringing into question payments made to the walnut growers which are Diamond's primary suppliers. By mid-December 2011, the Securities and Exchange Commission had joined the fray, sending Diamond Foods a nasty-gram in the form of a notice of criminal investigation. The discrepancy soured a deal to buy the Pringles chips brand from Proctor & Gamble. Mendes and Neil were unceremoniously tossed out by early February 2012.

In late March 2012, interim management for Diamond negotiated a forbearance agreement with Diamond's creditors and the board suspended the dividend. It looked very dark for the company, which had been viewed by many as among the most promising healthy snack and food companies in the U.S. The company's namesake Diamond brand is a strong challenger to Planter's in the whole and chopped nuts aisle and Emerald Nuts is one of the fastest growing nut snack brand in the U.S. Indeed, Emerald Nuts commercials were ranked by Advertising Age among the top SuperBowl ads.

There was a glimmer of hope in late May 2012, when a new management team led by Brian Driscoll, a serial alumnus of world renowned food brands, including Kraft, Nabisco and Nestle. A loan of $225 million from OakTree Capital Management just a few weeks later seemed to inject momentum into Diamond's recovery. Serving as a proxy for an insider buy, the investment seemed to bode well for Diamond getting its books in order.

Unfortunately, two months later investors are still waiting for accurate financial statements. The last filing made by Diamond Foods was the company's annual report for fiscal year 2011. The share price languishes with each passing day.

Is it Safe to Buy DMND?

We all know the dangers of eating potato salad left too long on the picnic table. The same admonition might be well applied to DMND. Without the benefit of the details fed to OakTree Capital, we can only guess at how its analysts justified a new loan. Just for fun let's use the most recently available numbers.

At the end of July 2011, Diamond Foods reported $1.3 billion in total assets and $883.6 million in total liabilities. Included in assets were $858.4 million in intangibles and goodwill. Excluding these and other assets that are probably not readily saleable, tangible assets on Diamond's balance sheet totaled $390.1 million, not even close to obligations on the balance sheet nearly a year ago.

Of course, some of Diamond's intangible assets may actually have marketable value. The Kettle's brand of healthy chips and snacks was put on the books at $235.0 million. What is more, intangibles composed of customer lists are valued at $163.8 million. A strong case can be made that in a pinch both are saleable. What is more Diamond's property, plant and equipment is shown as net of $250.0 million in depreciation. For lack of real detail on Diamond's equipment, we could write PP&E assets up by half of total depreciation. Making these adjustments to our tangible assets, Diamond's tangible, saleable assets total $913.9 million.

Against total liabilities of $833.6 million this implies net tangible assets of $80.3 million. In my view, that is less than impressive asset coverage for a $235.0 million loan.

Before you condemn OakTree Capital for making a dismal mistake, note that Diamond's most important brand is not represented on its balance sheet. Emerald Nuts is Diamond's own creation and likely holds marketable value not shown on the company's balance sheet. The most popular means to calculate brand value is through discounting cash flows. Most likely OakTree got a good enough peek behind the curtain to estimate values they believe justify their loan.

We note one of the provisions of the note agreement is a "profitability exchange," in which OakTree Capital agrees to exchange a portion of the notes for preferred stock if Diamond is successful in sourcing at least 125 million pounds of walnuts and generating $54.4 million in gross profit related to "in-the-shell" sales in the first six months of fiscal year 2013. Achievement of the benchmark would also trigger the cancellation of warrants issued to OakTree.

The linkage of OakTree's investment return to Diamond's performance may reveal something about Diamond's representations and OakTree's expectations for Diamond's future walnut business. As seductive as the implied confidence might be, Diamond Foods shares seem to have gone too stale for a long stake by anyone who does not have the benefit of accurate financial reports.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Source: Diamond Foods Goes Stale