Dividend Payout & Dividend Yield only

Dividend Payout & Dividend Yield only

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Diamond Foods, Inc.

San Francisco, California

We have audited the accompanying consolidated balance sheets of Diamond Foods, Inc. and subsidiaries (the “Company”) as of July 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended July 31, 2011. We also have audited the Company’s internal control over financial reporting as of July 31, 2011, based on criteria established in  Internal Control — Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diamond Foods, Inc. and subsidiaries as of July 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2011, based on the criteria established in  Internal Control — Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Deloitte & Touche LLP

San Francisco, California

September 15, 2011

 

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DIAMOND FOODS, INC.

CONSOLIDATED BALANCE SHEETS

 

         
  July 31, 
  2011  2010 
  (In thousands, except share

and per share information)

 
ASSETS        
Current assets:        
Cash and cash equivalents $3,112  $5,642 
Trade receivables, net  98,218   65,553 
Inventories  145,575   143,405 
Deferred income taxes  13,249   10,497 
Prepaid income taxes  2,783   9,225 
Prepaid expenses and other current assets  13,102   5,767 
         
Total current assets  276,039   240,089 
Restricted cash  15,795    
Property, plant and equipment, net  127,407   117,816 
Deferred income taxes  3,870   13,625 
Goodwill  407,587   396,788 
Other intangible assets, net  450,855   449,018 
Other long-term assets  6,842   8,536 
         
Total assets $1,288,395  $1,225,872 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
Current liabilities:        
Current portion of long-term debt $41,700  $40,000 
Accounts payable and accrued liabilities  144,060   127,921 
         
Total current liabilities  185,760   167,921 
Long-term obligations  490,001   516,100 
Deferred income taxes  131,870   144,755 
Other liabilities  25,969   17,153 
Commitments and contingencies        
Stockholders’ equity:        
Preferred stock, $0.001 par value; Authorized: 5,000,000 shares; no shares issued or outstanding      
Common stock, $0.001 par value; Authorized: 100,000,000 shares; 22,319,016 and 22,121,534 shares issued and 22,049,636 and 21,891,928 shares outstanding at July 31, 2011 and 2010, respectively  22   22 
Treasury stock, at cost: 269,380 and 229,606 shares at July 31, 2011 and 2010  (6,867)  (5,050)
Additional paid-in capital  318,083   307,032 
Accumulated other comprehensive loss  18,500   (869)
Retained earnings  125,057   78,808 
         
Total stockholders’ equity  454,795   379,943 
         
Total liabilities and stockholders’ equity $1,288,395  $1,225,872 
         

See notes to consolidated financial statements.

 

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DIAMOND FOODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

             
  Year Ended July 31, 
  2011  2010  2009 
  (In thousands, except per share

information)

 
Net sales $965,922  $680,162  $570,940 
Cost of sales  714,775   519,161   435,344 
             
Gross profit  251,147   161,001   135,596 
Operating expenses:            
Selling, general and administrative  96,960   64,301   60,971 
Advertising  44,415   32,962   28,785 
Acquisition and integration related expenses  16,792   11,508    
             
Total operating expenses  158,167   108,771   89,756 
             
Income from operations  92,980   52,230   45,840 
Interest expense, net  23,840   10,180   6,255 
Other expense, net     1,849   898 
             
Income before income taxes  69,140   40,201   38,687 
Income taxes  18,929   13,990   14,944 
             
Net income $50,211  $26,211  $23,743 
             
Earnings per share:            
Basic $2.28  $1.40  $1.45 
Diluted $2.22  $1.36  $1.42 
    
Shares used to compute earnings per share:            
Basic  21,577   18,313   16,073 
Diluted  22,242   18,843   16,391 
    
Dividends declared per share $0.18  $0.18  $0.18 

See notes to consolidated financial statements.

 

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DIAMOND FOODS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

                               
  Common Stock

 

  Treasury

Stock

  Additional

Paid-In

Capital

  Retained

Earnings

  Accumulated

Other

Comprehensive

Income (Loss)

  Total

Stockholders’

Equity

   
  Shares  Amount     
  (In thousands, except share information)    
Balance, July 31, 2008  16,180,771  $16  $(3,203) $112,550  $35,276  $1,584  $146,223     
Shares issued under ESPP and upon stock option exercises  298,133   1       5,299           5,300     
Stock compensation expense  115,587           3,901           3,901     
Tax benefit from ESPP and stock option transactions              1,067           1,067     
Treasury stock repurchased  (42,472)      (1,053)              (1,053)    
Dividends paid                  (2,960)      (2,960)    
Comprehensive income:                                
Net income                  23,743       23,743     
Change in pension liabilities                      (2,743)  (2,743)    
Other comprehensive income                      (137)  (137)    
                                 
Total comprehensive income:                    20,863     
                                 
Balance, July 31, 2009  16,552,019   17   (4,256)  122,817   56,059   (1,296)  173,341     
Shares issued upon stock option exercises  44,574           818           818     
Stock compensation expense  148,164           3,231           3,231     
Tax benefit from stock

option transactions

              434           434     
Shares issued for equity offering  5,175,000   5       191,470           191,475     
Equity offering costs              (11,738)          (11,738)    
Treasury stock repurchased  (27,829)      (794)              (794)    
Dividends paid                  (3,462)      (3,462)    
Comprehensive income:                                
Net income                  26,211       26,211     
Change in pension liabilities                      (773)  (773)    
Foreign currency translation adjustment                      1,477   1,477     
Other comprehensive income                      (277)  (277)    
                                 
Total comprehensive income:                    26,638     
                                 
Balance, July 31, 2010  21,891,928   22   (5,050)  307,032   78,808   (869)  379,943     
Shares issued upon stock option exercises  96,924           1,803           1,803     
Stock compensation expense  100,558           6,974           6,974     
Tax benefit from stock

option transactions

              2,274           2,274     
Treasury stock repurchased  (39,774)      (1,817)              (1,817)    
Dividends paid                  (3,962)      (3,962)    
Comprehensive income:                                
Net income                  50,211       50,211     
Change in pension liabilities                      (659)  (659)    
Foreign currency translation adjustment                      19,930   19,930     
Other comprehensive income                      98   98     
                                 
Total comprehensive income:                    69,580     
                                 
Balance, July 31, 2011  22,049,636  $22  $(6,867) $318,083  $125,057  $18,500  $454,795     
                                 

See notes to consolidated financial statements.

 

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DIAMOND FOODS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

             
  Year Ended July 31, 
  2011  2010  2009 
  (In thousands) 
CASH FLOWS FROM OPERATING ACTIVITIES            
Net income $50,211  $26,211  $23,743 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:            
Depreciation and amortization  29,465   17,154   11,362 
Deferred income taxes  (7,534)  7,072   (2,800)
Excess tax benefit from stock option transactions  (2,274)  (434)  (1,067)
Stock-based compensation  6,974   3,231   3,901 
Other, net  1,055   1,109   858 
Changes in assets and liabilities:            
Trade receivables  (32,665)  (2,873)  12,764 
Inventories  (2,170)  (45,852)  10,316 
Prepaid expenses and income taxes and other current assets  (893)  (6,437)  1,053 
Accounts payable and accrued liabilities  17,577   (5,462)  (6,562)
Other, net  5,921   4,693   (200)
             
Net cash provided by (used in) operating activities  65,667   (1,588)  53,368 
             
CASH FLOWS FROM INVESTING ACTIVITIES:            
Purchases of property, plant and equipment  (27,703)  (11,790)  (7,994)
Deposits of restricted cash  (21,200)      
Proceeds from restricted cash  5,405       
Acquisitions, net of cash acquired     (615,389)  (190,224)
Other, net  262   618   133 
             
Net cash used in investing activities  (43,236)  (626,561)  (198,085)
             
CASH FLOWS FROM FINANCING ACTIVITIES:            
Revolving line of credit borrowings under the Secured Credit Facility     176,000    
Repayment of revolving line of credit under the Secured Credit Facility  (4,800)  (9,900)   
Proceeds from issuance of long-term debt  21,350   400,000   125,000 
Debt issuance costs     (8,852)  (1,973)
Payment of long-term debt and notes payable  (40,884)  (125,119)  (30,141)
Gross proceeds from equity offering     191,475    
Equity offering costs     (11,738)   
Dividends paid  (3,962)  (3,462)  (2,960)
Excess tax benefit from stock option transactions  2,274   434   1,067 
Other, net  940   24   4,247 
             
Net cash (used in) provided by financing activities  (25,082)  608,862   95,240 
             
Effect of exchange rate changes on cash  121   127    
    
Net decrease in cash and cash equivalents  (2,530)  (19,160)  (49,477)
Cash and cash equivalents:            
Beginning of period  5,642   24,802   74,279 
             
End of period $3,112  $5,642  $24,802 
             
Supplemental disclosure of cash flow information:            
Cash paid during the period for:            
Interest $21,998  $9,088  $5,989 
Income taxes  8,751   11,113   19,438 
Non-cash investing activities:            
Accrued capital expenditures  2,323   1,076   497 

See notes to consolidated financial statements.

 

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DIAMOND FOODS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

July 31, 2011, 2010 and 2009

(In thousands, except share and per share information unless otherwise noted)

(1) Organization and Significant Accounting Policies

Business

Diamond Foods, Inc. (the “Company” or “Diamond”) is an innovative packaged food company focused on building, acquiring and energizing brands. Diamond specializes in processing, marketing and distributing snack products and culinary, in-shell and ingredient nuts. In 2004, Diamond complemented its strong heritage in the culinary nut market under the Diamond of California ®  brand by launching a full line of snack nuts under the Emerald ®  brand. In September 2008, Diamond acquired the Pop Secret ®  brand of microwave popcorn products, which provided the Company with increased scale in the snack market, significant supply chain economies of scale and cross promotional opportunities with its existing brands. In March 2010, Diamond acquired Kettle Foods, a leading premium potato chip company in the two largest potato chip markets in the world, the United States and United Kingdom, which added the complementary premium Kettle Brand ®  to Diamond’s existing portfolio of leading brands in the snack industry. In April 2011, Diamond entered into a definitive agreement with Proctor & Gamble (“P&G”) to merge the Pringles business into Diamond. Diamond sells its products to global, national, regional and independent grocery, drug and convenience store chains, as well as to mass merchandisers, club stores and other retail channels.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”). Certain prior period amounts have been reclassified to conform to the current period presentation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates.

On an ongoing basis, the Company evaluates its estimates, including those related to inventories, trade receivables, fair value of investments, useful lives of property, plant and equipment, intangible assets, goodwill and income taxes, among others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for management’s judgments about the carrying values of assets and liabilities.

Certain Risks and Concentrations

The Company’s revenues are principally derived from the sale of snack, culinary, domestic in-shell, international and ingredient/food service nuts. Significant changes in customer buying behavior could adversely affect the Company’s operating results. Sales to the Company’s largest customer accounted for approximately 15%, 17% and 21% of net sales in 2011, 2010 and 2009, respectively. Sales to the second largest customer accounted for approximately 11%, 12% and 13% of net sales in 2011, 2010 and 2009, respectively.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

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Cash and Cash Equivalents

Cash and cash equivalents include investment of surplus cash in securities (primarily money market funds) with maturities at date of purchase of three months or less.

Inventories

All inventories are accounted for at the lower of cost (first-in, first-out) or market.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of assets ranging from 30 to 39 years for buildings and ranging from 3 to 15 years for equipment.

Slotting and Other Contractual Arrangements

In certain situations, the Company pays slotting fees to retail customers to acquire access to shelf space. These payments are recognized as a reduction of sales. In addition, the Company makes payments pursuant to contracts that stipulate the term of the agreement, the quantity and type of products to be sold and other requirements. Payments pursuant to these agreements are capitalized and included in other current and long-term assets, and are amortized on a straight-line basis over the term of the contract. The Company expenses payments if no written arrangement exists.

Impairment of Long-Lived and Intangible Assets and Goodwill

Management reviews long-lived assets and certain identifiable intangible assets with finite lives for impairment in accordance with ASC 360, “ Property, Plant, and Equipment .” Goodwill and intangible assets not subject to amortization are reviewed annually for impairment in accordance with ASC 350, “ Intangibles — Goodwill and Other, ” or more often if there are indications of possible impairment.

The analysis to determine whether or not an asset is impaired requires significant judgments that are dependent on internal forecasts, including estimated future cash flows, estimates of long-term growth rates for our business, the expected life over which cash flows will be realized, and assumed royalty and discount rates. Changes in these estimates and assumptions could materially affect the determination of fair value and any impairment charge. While the fair value of these assets exceeds their carrying value based on management’s current estimates and assumptions, materially different estimates and assumptions in the future in response to changing economic conditions, changes in the business or for other reasons could result in the recognition of impairment losses.

For assets to be held and used, including acquired intangible assets subject to amortization, the Company initiates a review whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Significant management judgment is required in this process.

The Company tests its brand intangible assets not subject to amortization for impairment annually, or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. In testing brand intangibles for impairment, Diamond compares the fair value with the carrying value. The determination of fair value is based on a discounted cash flow analysis, using inputs such as forecasted future revenues attributable to the brand, assumed royalty rates, and a risk-adjusted discount rate that approximates our estimated cost of capital. If the carrying value exceeds the estimated fair value, the brand intangible asset is considered impaired, and an impairment loss will be recognized in an amount equal to the excess of the carrying value over the fair value of the brand intangible asset.

 

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The Company performs its annual goodwill impairment test required by ASC 350 as of June 30th of each year. In testing goodwill for impairment, Diamond initially compares the fair value of the Company’s single reporting unit with the net book value of the Company because it represents the carrying value of the reporting unit. Diamond has one operating and reportable segment. If fair value of the reporting unit is less than the carrying value of the reporting unit, we perform an additional step to determine the implied fair value of goodwill. The implied fair value of goodwill is determined by first allocating the fair value of the reporting unit to all assets and liabilities and then computing the excess of the reporting units’ fair value over the amounts assigned to the assets and liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, the excess represents the amount of goodwill impairment. Accordingly, the Company would recognize an impairment loss in the amount of such excess. The Company considers the estimated fair value of the reporting unit in relation to the Company’s market capitalization.

Revenue Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred to the buyer, price is fixed, delivery occurs and collection is reasonably assured. Revenues are recorded net of rebates, introductory or slotting payments, coupons, promotion and marketing allowances. The amount the Company accrues for promotion is based on an estimate of the level of performance of the trade promotion, which is dependent upon factors such as historical trends with similar promotions, expectations regarding customer and consumer participation, and sales and payment trends with similar previously offered programs. Customers have the right to return certain products. Product returns are estimated based upon historical results and are reflected as a reduction in sales.

Promotion and Advertising Costs

Promotional allowances, customer rebates, coupons and marketing allowances are recorded at the time the related revenue is recognized and are reflected as reductions of sales. Annual volume rebates, promotion, and marketing allowances are recorded based upon the terms of the arrangements. Coupon incentives are recorded at the time of distribution in amounts based on estimated redemption rates. The Company expenses advertising costs as incurred. Payments to reimburse customers for cooperative advertising programs are recorded in accordance with ASC 605-50, “ Revenue Recognition — Customer Payments and Incentives .”

Shipping and Handling Costs

Amounts billed to customers for shipping and handling costs are included in net sales. Shipping and handling costs are charged to cost of sales as incurred.

Acquisition and Integration Related Expenses

Acquisition and integration related expenses are costs incurred to effect a business combination and subsequently to integrate the acquired business into the Company. These expenses are shown as a separate line within operating expenses and are expensed as incurred. These expenses may include transaction related legal and consulting fees, as well as business and systems integration costs.

Income Taxes

Diamond accounts for income taxes in accordance with ASC 740, “Income Taxes.” which requires that deferred tax assets and liabilities be recognized for the tax effect of temporary differences between the financial statement and tax basis of recorded assets and liabilities at current tax rates. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The recoverability of deferred tax assets is based on both the historical and anticipated earnings levels and is reviewed periodically to determine if any additional valuation allowance is necessary when it is more likely than not that amounts will not be recovered.

 

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There are inherent uncertainties related to the interpretations of tax regulations in the jurisdictions in which the Company operates. Diamond may take tax positions that management believes are supportable, but are potentially subject to successful challenge by the applicable taxing authority. Tax positions are evaluated and liabilities are established in accordance with the guidance on uncertainty in income taxes. Diamond reviews these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjusts them accordingly.

Fair Value of Financial Instruments

The fair value of certain financial instruments, including cash and cash equivalents, trade receivables, accounts payable and accrued liabilities approximate the amounts recorded in the balance sheet because of the relatively short term nature of these financial instruments. The fair value of notes payable and long-term obligations at the end of each fiscal period approximates the amounts recorded in the balance sheet based on information available to Diamond with respect to current interest rates and terms for similar financial instruments.

Stock-Based Compensation

The Company accounts for stock-based compensation arrangements, including stock option grants and restricted stock awards, in accordance with ASC 718, “ Compensation — Stock Compensation .” Under this guidance, compensation cost is recognized based on the fair value of equity awards on the date of grant. The compensation cost is then amortized on a straight-line basis over the vesting period. The Black-Scholes option pricing model is used to determine the fair value of stock options at the date of grant. This model requires the Company to make assumptions such as expected term, dividends, volatility, and forfeiture rates that determine the stock options fair value. These key assumptions are based on historical information and judgment regarding market factors and trends. If actual results are not consistent with the Company’s assumptions and judgments used in estimating these factors, the Company may be required to increase or decrease compensation expense, which could be material to its results of operations.

Recent Accounting Pronouncements

In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-29, “ Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations .” This guidance was issued to clarify that pro forma disclosures should be presented as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The disclosures should also be accompanied by a narrative description of the nature and amount of material, nonrecurring pro forma adjustments. This new guidance is effective prospectively for business combinations consummated on or after the annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ” This guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The guidance is effective for interim and annual periods beginning after December 15, 2011. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” This guidance requires entities to present the total of comprehensive income, the components of net income and the components of other comprehensive income (OCI) in either a single continuous statement of comprehensive income or in two separate consecutive statements. The guidance does not change the components of OCI or when an item of OCI must be reclassified to net income, or the earnings per share calculation. The guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

 

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(2) Fair Value of Financial Instruments

The Company transacts business in foreign currencies and has international sales denominated in foreign currencies, subjecting the Company to foreign currency risk. The Company may enter into foreign currency forward contracts, generally with monthly maturities over twelve months or less, to reduce the volatility of cash flows primarily related to forecasted revenue denominated in certain foreign currencies. The Company does not use foreign currency contracts for speculative or trading purposes. On the date a foreign currency forward contract is entered into, the Company designates the contract as a hedge, for a forecasted transaction, of the variability of cash flows to be received (“cash flow hedge”). The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to anticipated transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. Effective changes in derivative contracts designated and qualifying as cash flow hedges of forecasted revenue are reported in other comprehensive income. These gains and losses are reclassified into interest income or expense, as a component of revenue, in the same period as the hedged revenue is recognized. The Company includes time value in the assessment of effectiveness of the foreign currency derivatives. The ineffective portion of the hedge is recorded in interest expense or income. No hedge ineffectiveness for foreign currency derivatives was recorded for the year ended July 31, 2011 . The maximum length of time over which the Company is hedging its exposure to the variability in future cash flows associated with forecasted foreign currency transactions is less than twelve months. Within the next twelve months, amounts expected to be reclassified from other comprehensive income to revenue for foreign currency derivatives are nil.

In the three months ended July 31, 2010, the Company entered into three interest rate swap agreements in accordance with Company policy to mitigate the impact of LIBOR based interest expense fluctuations on Company profitability. These swap agreements, with a total hedged notional amount of $100 million were entered into to hedge future cash interest payments associated with a portion of the Company’s variable rate bank debt. The Company has designated these swaps as cash flow hedges of future cash flows associated with its variable rate debt. All effective changes in the fair value of the designated swaps are recorded in other comprehensive income (loss) and are released to interest income or expense on a monthly basis as the hedged debt payments are accrued. Ineffective changes, if any, are recognized in interest income or expense immediately. For the year ended July 31, 2011, the Company recognized other comprehensive income of $84 based on the change in fair value of the swap agreements; no hedge ineffectiveness for these swap agreements was recognized in interest income or expense over the same period. Other comprehensive loss of $581 is expected to be reclassified to interest expense within the next twelve months.

The fair values of the Company’s derivative instruments as of July 31 were as follows:

 

           
Liability Derivatives Balance Sheet Location Fair Value 
    2011  2010 
Derivatives designated as hedging instruments under ASC 815:          
Interest rate contracts Other current liabilities $(581) $(668)
Interest rate contracts Other non-current liabilities  (4)   
Foreign currency contracts Accounts payable and accrued liabilities     (12)
           
Total derivatives designated as hedging instruments under ASC 815   $(585 $(680
           
Derivatives not designated as hedging instruments under ASC 815:          
Foreign currency contracts Accounts payable and accrued liabilities $(11) $ 
           
Total derivatives not designated as hedging instrument under ASC 815   $(11 $—    
           
Total derivatives   $(596 $(680
           

 

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The effects of the Company’s derivative instruments on the Consolidated Statements of Operations for the years ended July 31 were as follows:

 

                              
Derivatives in ASC 815 Cash

Flow Hedging Relationships

 Amount of Loss

Recognized in

OCI on

Derivative

(Effective

Portion)

  Location of Loss

Reclassified from

Accumulated OCI

into Income

(Effective

Portion)

 Amount of

Loss

Reclassified

from

Accumulated

OCI into

Income

(Effective

Portion)

  Location of Loss

Recognized in

Income on

Derivative

(Ineffective

Portion)

 Amount of

Loss

Recognized in

Income on

Derivative

(Ineffective

Portion)

 
  2011  2010    2011  2010    2011  2010  
Interest rate contracts $(643) $(479) Interest expense $(728) $(52) Interest expense $  $  
Foreign currency contracts  (182)  (12) Net sales  (194)    Net sales       
                              
Total $(825 $(491   $(922 $(52   $—     $—     
                              

 

           
Derivatives Not Designated as Hedging Instruments under ASC 815 Location of Loss Recognized in

Income on Derivative

 Amount of Loss Recognized in

Income on Derivative

 
        2011          2010     
Foreign currency contracts Interest expense $(145) $ 
           
Total   $(145 $—    
           

ASC 820 requires that assets and liabilities carried at fair value be measured using the following three levels of inputs:

Level 1: Quoted market prices in active markets for identical assets or liabilities

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data

Level 3: Unobservable inputs that are not corroborated by market data

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Company’s cash equivalents measured at fair value on a recurring basis was $586 as of July 31, 2010. These investments were classified as Level 1 based on quoted prices in active markets for identical assets, to value the cash equivalents. There were no cash equivalents as of July 31, 2011.

The Company’s derivative liabilities measured at fair value on a recurring basis were $596 and $680 as of July 31, 2011 and 2010. The Company has elected to use the income approach to value the derivative liabilities, using observable Level 2 market expectations at the measurement date and standard valuation techniques to convert future amounts to a single present amount assuming that participants are motivated, but not compelled to transact. Level 2 inputs for the valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates). Mid-market pricing is used as a practical expedient for fair value measurements. Under Accounting Standards Codification (“ASC”) 820, “ Fair Value Measurements and Disclosures, ” the fair value measurement of an asset or liability must reflect the nonperformance risk of the entity and the counterparty. Therefore, the impact of the counterparty’s creditworthiness when in an asset position and the Company’s creditworthiness when in a liability position has also been factored into the fair value measurement of the derivative instruments.

(3) Equity Offering and Stock-Based Compensation

In March 2010, the Company issued and sold 5,175,000 shares of its common stock for $37.00 per share. After deducting the underwriting discount and other related expenses, the Company received total net proceeds from the sale of its common stock of approximately $179.7 million. The proceeds from the equity offering were used to fund a portion of the purchase price for the Kettle Foods acquisition.

 

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The Company uses a broad based equity incentive plan to help align employee and director incentives with stockholders’ interests. The 2005 Equity Incentive Plan (the “Plan”) was approved in March 2005 and provides for the awarding of options, restricted stock, stock bonuses, restricted stock units, and stock appreciation rights. The Compensation Committee of the Board of Directors administers the Plan. A total of 2,500,000 shares of common stock were initially reserved for issuance under the Plan, and the number of shares available for issuance under the Plan is increased by an amount equal to 2% of the Company’s total outstanding shares as of July 31 each year.

In 2005, the Company began granting shares of restricted stock and stock options under the Plan. The shares of restricted stock vest over three, four or five-year periods. The stock options expire in ten years and vest over three, four or five years. As of July 31, 2011, options to purchase 1,771,253 shares of common stock were outstanding, of which 1,235,297 were exercisable. At July 31, 2011, the Company had 685,187 shares available for future grant under the Plan.

ASC 718, “Compensation — Stock Compensation,” requires the recognition of compensation expense in an amount equal to the fair value of share-based awards. Beginning with the Company’s adoption of ASC 718 in August 2005, the fair value of all stock options granted subsequent to August 1, 2005 is recognized as an expense in the Company’s statement of operations, typically over the related vesting period of the options. The guidance requires use of fair value computed at the date of grant to measure share-based awards. The fair value of restricted stock awards is recognized as stock-based compensation expense over the vesting period, generally three, four or five years from date of grant or award. The Company recorded total stock-based compensation expense of $6,974, $3,231, and $3,901 for the years ended July 31, 2011, 2010, and 2009, respectively.

Stock Option Awards: The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option valuation model. Expected stock price volatilities were estimated based on the Company’s implied historical volatility. The expected term of options granted and forfeiture rates were based on assumptions and historical data to the extent it is available. The risk-free rates were based on U.S. Treasury yields in effect at the time of the grant. For purposes of this valuation model, dividends are based on the historical rate. Assumptions used in the Black-Scholes model are presented below (for the year ended July 31):

 

             
  2011  2010  2009 
Average expected life, in years  6   6   6 
Expected volatility  35.25%  46.00%  38.50%
Risk-free interest rate  2.10%  3.04%  3.23%
Dividend rate  0.34%  0.50%  0.70%

 

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The following table summarizes option activity during the years ended July 31, 2011, 2010 and 2009:

 

                 
  Number of

Shares

  Weighted

Average Exercise

Price Per Share

  Average

Remaining

Contractual Life

  Aggregate

Intrinsic Value

 
  (In thousands)     (In years)  (In thousands) 
Outstanding at July 31, 2008  1,510   17.74   7.5  $9,979 
Granted  128   26.06         
Exercised  (294)  17.78         
Cancelled  (12)  17.24         
                 
Outstanding at July 31, 2009  1,332   18.54   6.9  $12,871 
Granted  191   40.79         
Exercised  (45)  18.35         
Cancelled  (26)  38.64         
                 
Outstanding at July 31, 2010  1,452   21.11   6.4  $34,027 
Granted  442   46.59         
Exercised  (97)  18.61         
Cancelled  (26)  38.61         
                 
Outstanding at July 31, 2011  1,771   27.34   6.3  $78,551 
                 
Exercisable at July 31, 2009  1,107   17.76   6.6  $11,562 
Exercisable at July 31, 2010  1,218   18.32   5.9  $31,939 
Exercisable at July 31, 2011  1,235   19.98   5.1  $63,756 

The weighted average fair value of options granted during 2011, 2010 and 2009 was $16.37, $18.18 and $10.67, respectively. The total intrinsic value of options exercised during 2011, 2010 and 2009 was $3,035, $829 and $2,816, respectively. The total fair value of options vested during 2011, 2010 and 2009 was $2,004, $1,378 and $1,402, respectively.

Changes in the Company’s nonvested options during 2011 are summarized as follows:

 

         
  Number of

Shares

  Weighted

Average Grant

Date Fair Value

 
  (In thousands)    
Nonvested at July 31, 2010  234  $15.28 
Granted  442   16.37 
Vested  (130)  15.36 
Cancelled  (10)  18.18 
         
Nonvested at July 31, 2011  536   16.08 
         

As of July 31, 2011, there was $7.2 million of total unrecognized compensation cost related to nonvested stock options, which is expected to be recognized over a weighted average period of 2.2 years.

 

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Restricted Stock Awards: Restricted stock activity during 2011, 2010 and 2009 is summarized as follows:

 

         
  Number of

Shares

  Weighted

Average Grant

Date Fair Value

Per Share

 
  (In thousands)    
Outstanding at July 31, 2008  332  $17.74 
Granted  194   25.80 
Vested  (111)  18.02 
Cancelled  (79)  19.94 
         
Outstanding at July 31, 2009  336   21.79 
Granted  193   34.29 
Vested  (76)  20.92 
Cancelled  (45)  31.60 
         
Outstanding at July 31, 2010  408   26.78 
Granted  115   47.04 
Vested  (115)  24.51 
Cancelled  (15)  38.44 
         
Outstanding at July 31, 2011  393   32.96 
         

The total intrinsic value of restricted stock vested in 2011, 2010 and 2009 was $5,482, $2,192 and $2,771, respectively.

As of July 31, 2011, there was $9.9 million of unrecognized compensation cost related to nonvested restricted stock awards, which is expected to be recognized over a weighted average period of 2.2 years.

(4) Earnings Per Share

ASC 260-10, “Earnings Per Share” impacted the determination and reporting of earnings per share by requiring the inclusion of restricted stock as participating securities, since they have the right to share in dividends, if declared, equally with common shareholders. Participating securities are allocated a proportional share of net income determined by dividing total weighted average participating securities by the sum of total weighted average common shares and participating securities (“the two-class method”). Including these shares in the Company’s earnings per share calculation during periods of net income has the effect of diluting both basic and diluted earnings per share.

The computations for basic and diluted earnings per share are as follows:

 

             
  Year Ended July 31, 
  2011  2010  2009 
Numerator:            
Net income $50,211  $26,211  $23,743 
Less: income allocated to participating securities  (912)  (520)  (486)
             
Income attributable to common shareholders — basic  49,299   25,691   23,257 
Add: undistributed income attributable to participating securities  843   505   469 
Less: undistributed income reallocated to participating securities  (818)  (490)  (460)
             
Income attributable to common shareholders — diluted $49,324  $25,706  $23,266 
             
Denominator:            
Weighted average shares outstanding — basic  21,577   18,313   16,073 
Dilutive shares — stock options  665   530   318 
             
Weighted average shares outstanding — diluted  22,242   18,843   16,391 
             
Income per share attributable to common shareholders (1):            
Basic $2.28  $1.40  $1.45 
Diluted $2.22  $1.36  $1.42 

 

(1)Computations may reflect rounding adjustments.

 

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Options to purchase 1,771,253, 1,451,963 and 1,331,737 shares of common stock were outstanding at July 31, 2011, 2010 and 2009, respectively. Options to purchase 87,500, 156,000 and 48,000 shares of common stock were not included in the computation of diluted earnings per share for 2011, 2010 and 2009 because their exercise prices were greater than the average market price of Diamond’s common stock of $54.62, $36.43 and $25.87, and therefore their effect would be antidilutive.

(5) Acquisition and Pending Transaction

Pending Pringles Merger

On April 5, 2011, Diamond entered into a definitive agreement with P&G to merge P&G’s Pringles business into the Company. The value of the proposed transaction at April 5, 2011 was approximately $2.35 billion, consisting of $1.5 billion in Diamond common stock and the assumption of $850 million of Pringles debt. The parties have also agreed to a collar mechanism that would adjust the amount of debt assumed by Diamond based upon Diamond’s stock price during a trading period prior to the commencement of the Exchange Offer. The amount of debt to be assumed by Diamond could increase by up to $200 million or decrease by up to $150 million based on this adjustment mechanism. The purchase price will be represented by approximately 29.1 million shares of Diamond common stock.

The transaction, which is expected to be completed by the end of calendar 2011, is subject to approval by Diamond’s stockholders and satisfaction of customary closing conditions and regulatory approvals. The merger will be accounted for as a purchase business combination and for accounting purposes, Diamond will be treated as the acquiring entity.

Kettle Foods

In March 2010, Diamond completed its acquisition of Kettle Foods for a purchase price of approximately $616 million in cash. The acquisition was accounted for under the purchase method of accounting in accordance with ASC 805, “ Business Combinations .”

The total purchase price has been allocated to the estimated fair values of assets acquired and liabilities assumed as follows:

 

     
Accounts receivable $29,188 
Inventory  12,526 
Deferred tax asset  2,119 
Prepaid expenses and other assets  3,617 
Property, plant and equipment  66,289 
Brand intangibles  235,000 
Customer relationships  120,000 
Goodwill  321,545 
Assumed liabilities  (39,211)
Deferred tax liabilities  (134,851)
     
Purchase price $616,222 
     

Goodwill associated with the Kettle Foods acquisition is not amortized and is not deductible for tax purposes.

Customer relationships of Kettle Foods will be amortized on a straight-line basis over an estimated life of 20 years. Brand intangibles relate to the “Kettle Foods” brand name, which has an indefinite life, and therefore is not amortizable.

 

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Pro Forma — Financial Information

The following reflects the unaudited pro forma combined results of operations of the Company and Kettle Foods as if the acquisition had taken place at the beginning of the fiscal years presented:

 

         
  Year Ended July 31, 
  2010  2009 
Net sales $854,579  $828,863 
Net income $36,474  $28,643 
Diluted earnings per share $1.63  $1.31 

The Company incurred a loss on extinguishment of debt of $1.8 million when Diamond replaced an existing credit facility with a new secured credit facility to fund the Kettle Foods acquisition. Additionally, the Company incurred acquisition and integration costs of $11.5 million during the year ended July 31, 2010. These amounts are included in the above pro forma results of operations for the twelve month periods for fiscal years 2010 and 2009.

The net sales and associated earnings Kettle Foods has contributed to Diamond’s results of operations are not determinable as certain operational and go-to-market activities of Kettle Foods have been integrated into Diamond.

(6) Intangible Assets and Goodwill

The changes in the carrying amount of goodwill were as follows:

 

     
Balance as of July 31, 2009: $76,076 
Pop Secret purchase price allocation changes  (833)
Acquisition of Kettle Foods  321,545 
     
Balance as of July 31, 2010:  396,788 
Translation adjustments  10,799 
     
Balance as of July 31, 2011: $407,587 
     

Other intangible assets consisted of the following at July 31:

 

         
  2011  2010 
Brand intangibles (not subject to amortization) $301,148  $297,500 
Intangible assets subject to amortization:        
Customer contracts and related relationships  163,786   157,300 
         
Total other intangible assets, gross  464,934   454,800 
         
Less accumulated amortization on intangible assets:        
Customer contracts and related relationships  (14,079)  (5,782)
         
Total other intangible assets, net $450,855  $449,018 
         

During the quarter ended July 31, 2009, the Company recorded a $1.2 million non-cash impairment charge to write off the unamortized balance of the Harmony/Homa trademark and trade names, since we no longer utilize them as primary trade dress and concluded that they have no future value. This amount was included in selling, general and administrative expenses on the Consolidated Statements of Operations.

Identifiable intangible asset amortization expense in each of the five succeeding years will amount to approximately $8,189.

 

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For the years ended July 31, 2011, 2010 and 2009, the amortization period for identifiable intangible assets was approximately 20 years with amortization expense of approximately $7,865 , $3,865 and $1,761 recognized, respectively.

The Company also performed its 2011 annual impairment test of goodwill and non-amortizing intangible assets required by ASC 350 as of June 30, 2011. There were no goodwill impairments during 2011, 2010 and 2009.

(7) Notes Payable and Long-Term Obligations

In February 2010, Diamond entered into an agreement to replace an existing credit facility with a new five-year $600 million secured credit facility (the “Secured Credit Facility”) with a syndicate of lenders. The Company used the borrowings under the Secured Credit Facility to fund a portion of the Kettle Foods acquisition and to fund ongoing operations.

Diamond’s Secured Credit Facility consists of a $235 million revolving credit facility, of which $161 million was outstanding as of July 31, 2011, and a $400 million term loan facility, of which $350 million was outstanding as of July 31, 2011. Scheduled principal payments on the term loan are $40 million for fiscal year 2011 and each of the succeeding three years (due quarterly), and $10 million for each of the first two quarters in fiscal year 2015, with the remaining principal balance and any outstanding loans under the revolving credit facility to be repaid on the fifth anniversary of initial funding. In March 2011, the syndicate of lenders approved Diamond’s request for an increase in its revolving credit facility by $35 million from $200 million, under the same terms. In August 2011, the syndicate of lenders approved Diamond’s request for an increase in its revolving credit facility by $50 million from $235 million to $285 million, under the same terms. Borrowings under the Secured Credit Facility will bear interest, at Diamond’s option, at either the agent’s base rate or the LIBOR rate, plus a margin for LIBOR loans ranging from 2.25% to 3.50%, based on the consolidated leverage ratio which is defined as the ratio of total debt to EBITDA. For the year ended July 31, 2011, the blended interest rate was 3.92% for the Company’s consolidated borrowings. Substantially all of the Company’s tangible and intangible assets are considered collateral security under the Secured Credit Facility.

The Secured Credit Facility also provides for customary affirmative and negative covenants, including a debt to EBITDA ratio and minimum fixed charge coverage ratio. As of July 31, 2011, the Company was in compliance with all applicable financial covenants under the Secured Credit Facility.

On December 20, 2010, Kettle Foods obtained, and Diamond guaranteed, a 10-year fixed rate loan (the “Guaranteed Loan”) in the principal amount of $21 million, of which $20 million was outstanding as of July 31, 2011. The principal and interest payments are due monthly throughout the term of the loan. The Guaranteed Loan will be used to purchase equipment for the Beloit, Wisconsin plant expansion. Borrowed funds have been placed in an interest-bearing escrow account and will be made available as expenditures are approved for reimbursement. As the cash will be used to purchase non-current assets, such restricted cash has been classified as non-current on the balance sheet. The Guaranteed Loan also provides for customary affirmative and negative covenants, which are similar to the covenants under the Secured Credit Facility.

(8) Balance Sheet Items

Inventories consisted of the following at July 31:

 

         
  2011  2010 
Raw materials and supplies $63,775  $64,660 
Work in process  20,798   23,768 
Finished goods  61,002   54,977 
         
Total $145,575  $143,405 
         

 

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Accounts payable and accrued liabilities consisted of the following at July 31:

 

         
  2011  2010 
Accounts payable $66,245  $42,784 
Payable to growers  15,186   35,755 
Accrued salaries and benefits  17,050   17,587 
Accrued promotion  29,360   22,787 
Accrued taxes  8,703   1,482 
Other  7,516   7,526 
         
Total $144,060  $127,921 
         

(9) Property, Plant and Equipment

Property, plant and equipment consisted of the following at July 31:

 

         
  2011  2010 
Land and improvements $10,822  $10,012 
Buildings and improvements  41,303   38,231 
Machinery, equipment and software  168,974   164,926 
Construction in progress  26,546   7,214 
         
Total  247,645   220,383 
Less accumulated depreciation  (120,238)  (102,567)
         
Property, plant and equipment, net $127,407  $117,816 
         

(10) Income Taxes

Income tax expense consisted of the following for the year ended July 31:

 

             
  2011  2010  2009 
Current            
Federal $18,477  $5,895  $14,831 
State  2,459   (665)  2,913 
Foreign  5,527   1,688    
             
Total current  26,463   6,918   17,744 
             
Deferred            
Federal  (3,018)  7,324   (2,830)
State  (237)  1,216   30 
Foreign  (4,279)  (1,468)   
             
Total deferred  (7,534)  7,072   (2,800)
             
Total tax provision $18,929  $13,990  $14,944 
             

The components of earnings from continuing operations before income taxes, by tax jurisdiction, are as follows for the fiscal years ended July 31:

 

             
  2011  2010  2009 
United States $81,924  $42,235  $38,687 
Foreign  (12,784)  (2,034)   
             
Total $69,140  $40,201  $38,687 
             

 

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A reconciliation of the statutory federal income tax rate of 35% to Diamond’s effective income tax rate is as follows for the year ended July 31:

 

             
  2011  2010  2009 
Federal tax computed at the statutory rate $24,199  $14,071  $13,540 
Stock-based compensation  162   (16)  3 
Domestic production activities deduction  (1,685)  (371)  (894)
State taxes, net of federal impact  1,476   361   1,908 
Acquisition costs     2,282    
Foreign income tax rate differential  1,276   7    
Changes in tax rates  (2,697)  (1,271)   
Net benefit of certain interest  (4,404)  (1,547)   
Other items, net  602   474   387 
             
Income tax expense $18,929  $13,990  $14,944 
             

Applicable U.S. income taxes have not been provided on approximately $19,803 of undistributed earnings of certain foreign subsidiaries at July 31, 2011, because these earnings are considered indefinitely reinvested. The net federal income tax liability that would arise if these earnings were not indefinitely reinvested is approximately $6,931. Applicable U.S. income taxes are provided on these earnings in the periods in which they are no longer considered indefinitely reinvested.

With respect to the Company’s stock option plans, realized tax benefits in excess of tax benefits recognized in net earnings are recorded as increases to additional paid-in capital. Excess tax benefits of approximately $2,274, $434, and $1,067, were realized and recorded to additional paid-in capital for the fiscal years 2011, 2010 and 2009, respectively.

The tax effect of temporary differences and net operating losses which give rise to deferred tax assets and liabilities consist of the following as of July 31:

 

         
  2011  2010 
Deferred tax assets:        
Current:        
Inventories $2,136  $940 
Receivables  253   378 
Accruals  6,465   4,974 
Compensation  3,896   3,661 
State tax  499   258 
Other     380 
         
Total current  13,249   10,591 
         
Non-current:        
State tax credits  5,674   5,524 
Retirement benefits  3,938   4,341 
Employee stock compensation benefits  3,345   2,025 
Acquisition costs  4,848    
Other  3,578   2,706 
         
Total non-current  21,383   14,596 
         

 

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  2011  2010 
Deferred tax liabilities:        
Current     14 
Non-current:        
Property, plant and equipment  13,555   11,846 
Intangibles  129,301   127,884 
Other  6,527   6,076 
         
Total non-current  149,383   145,806 
         
Total deferred taxes, net $(114,751) $(120,633)
         
Composed of:        
Net current deferred taxes $13,249  $10,577 
Net non-current deferred taxes  (128,000)  (131,210)
         
Total deferred taxes, net $(114,751) $(120,633)
         

Valuation allowances have been provided to reduce deferred tax assets to amounts considered recoverable. The Company’s valuation allowance was $613 as of July 31, 2011 and 2010.

As of July 31, 2011, the Company had no cumulative federal tax loss carryforwards and $12,657 of cumulative state tax loss carryforwards. State tax loss carryforwards will expire beginning fiscal 2017 through fiscal 2023. The Company also has a foreign net operating loss carryforward of $7,956 with no expiration period.

The state tax credits of $9,801 are California Enterprise Zone Credits, which have no expiration date.

The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company had $65, $49 and $40, net of tax benefit, accrued for interest and $64, $12, and $1 accrued for penalties related to unrecognized tax benefits as of July 31, 2011, 2010 and 2009, respectively.

A reconciliation of the beginning and ending amount of the gross unrecognized tax benefits is as follows:

 

             
  2011  2010  2009 
Balance, beginning of year $2,611  $313  $233 
Tax position related to current year:            
Additions  7,348   2,586    
Tax positions related to prior years:            
Additions  2,575   10   227 
Reductions  (11)      
Settlements     (269)  (46)
Statute of limitations closures     (29)  (101)
             
Balance, end of year $12,523  $2,611  $313 
             

Included in the balance of unrecognized tax benefits at July 31, 2011, July 31, 2010 and July 31, 2009, respectively, are potential benefits of $9,759 $2,611, and $313 respectively, that if recognized, would affect the effective tax rate on earnings.

In the twelve months succeeding July 31, 2011, audit resolutions, lapse of statute of limitations, and filing the amended returns could potentially reduce total unrecognized tax benefits by up to $11,132.

The Company files income tax returns in the U.S. federal and various states, local and foreign jurisdictions. The Company’s income tax returns for fiscal year 2006 through fiscal year 2011 remain open to examination.

 

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(11) Commitments and Contingencies

The Company is involved in various legal actions in the ordinary course of business. Such matters are subject to many uncertainties that make their ultimate outcomes unpredictable. However, in the opinion of management, resolution of all legal matters is not expected to have an adverse effect on the Company’s financial condition, operating results or cash flows.

At July 31, 2011, the Company had $2.6 million of letters of credit outstanding related to normal business transactions and commitments of $10.9 million to purchase new equipment.

Operating lease expense for the year ended July 31, 2011, 2010 and 2009 was $4.9 million, $3.2 million and $2.5 million, respectively.

At July 31, 2011, future minimum payments under non-cancelable operating leases (primarily for real property) were as follows:

 

     
2012 $5,963 
2013  4,248 
2014  2,914 
2015  2,694 
2016  2,117 
Thereafter  4,118 
     
Total $22,054 
     

(12) Segment Reporting

The Company operates in a single reportable segment: the processing, marketing, and distribution of culinary, in-shell and ingredient/food service nuts and snack products. The geographic presentation of net sales below is based on the destination of the sale. The “Europe” category consists primarily of United Kingdom, Germany, Netherlands, and Spain. The “Other” category consists primarily of Canada, South Korea, Japan, Turkey and China. The geographic distributions of the Company’s net sales were as follows for the year ended July 31:

 

              
  2011  2010  2009  
United States $676,063  $553,977  $486,614  
Europe  161,365   64,909   33,743  
Other  128,494   61,276   50,583  
              
Total $965,922  $680,162  $570,940  
              
    
Net sales by channel:             

 

             
  2011  2010  2009 
Snack $553,165  $321,422  $188,900 
Culinary and Retail In-shell  262,906   248,994   276,226 
             
Total Retail  816,071   570,416   465,126 
             
International Non-Retail  119,017   69,206   68,890 
North American Ingredient/Food Service and Other  30,834   40,540   36,924 
             
Total Non-Retail  149,851   109,746   105,814 
             
Total Net Sales $965,922  $680,162  $570,940 
             

 

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The Company does not segregate long-lived assets between geographies for internal reporting. Therefore, asset-related information has not been presented.

(13) Valuation Reserves and Qualifying Accounts

 

                 
  Beginning

of Period

  Charged to

Expense

  Charged to

Reserve

  End of

Period

 
Allowance for Doubtful Accounts                
Year ended July 31, 2009 $441  $269  $(210) $500 
Year ended July 31, 2010  500   106      606 
Year ended July 31, 2011  606   55   (19)  642 

(14) Retirement Plans

Diamond provides retiree medical benefits and sponsors two defined benefit pension plans. One of the defined benefit plans is a qualified plan covering all bargaining unit employees and the other is a nonqualified plan for certain salaried employees. The amounts shown for pension benefits are combined amounts for all plans. Diamond uses a July 31 measurement date for its plans. Plan assets are held in trust and primarily include mutual funds and money market accounts. Any employee who joined the Company after January 15, 1999 is not entitled to retiree medical benefits.

In March 2010, the Company determined that the defined benefit pension plan for the bargaining unit employees would be frozen at July 31, 2010 in conjunction with the execution of a new union contract. This amendment was accounted for in accordance with ASC 715, “ Compensation — Retirement Benefits .”

Obligations and funded status of the remaining benefit plans at July 31 were:

 

                  
  Pension Benefits  Other Benefits 
Change in Benefit Obligation 2011  2010  2011  2010 
Benefit obligation at beginning of year $24,186  $20,832  $2,204  $2,360  
Service cost  79   728   65   63  
Interest cost  1,258   1,198   107   133  
Plan participants’ contributions        27   74  
Plan amendments     (412)       
Actuarial loss (gain)  1,809   2,253   61   (267) 
Benefits paid  (464)  (413)  (195)  (159) 
                  
Benefit obligation at end of year $26,868  $24,186  $2,269  $2,204  
                  

 

                 
  Pension Benefits  Other Benefits 
Change in Plan Assets 2011  2010  2011  2010 
Fair value of plan assets at beginning of year $13,144  $12,120  $  $ 
Actual return on plan assets  1,771   1,320       
Employer contribution     117   168   85 
Plan participants’ contributions        27   74 
Benefits paid  (464)  (413)  (195)  (159)
                 
Fair value of plan assets at end of year $14,451  $13,144  $  $ 
                 
Funded status at end of year $(12,417) $(11,042) $(2,269) $(2,204)
                 

 

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Assets (liabilities) recognized in the consolidated balance sheets at July 31 consisted of:

 

                 
  Pension Benefits  Other Benefits 
  2011  2010  2011  2010 
Current liabilities $  $  $(114) $(117)
Noncurrent liabilities  (12,417)  (11,042)  (2,155)  (2,087)
                 
Total $(12,417) $(11,042) $(2,269) $(2,204)
                 

Amounts recognized in accumulated other comprehensive income (pre-tax) as of July 31 consisted of:

 

                  
  Pension Benefits  Other Benefits 
  2011  2010  2011  2010  
Net loss (gain) $9,545  $9,120  $(5,086) $(5,942) 
Prior service cost  87   102        
                  
Total $9,632  $9,222  $(5,086) $(5,942) 
                  

The accumulated benefit obligation for all defined benefit pension plans was $24,400 and $21,772 at July 31, 2011 and 2010.

Information for pension plans with an accumulated benefit obligation in excess of plan assets as of July 31 was as follows:

 

         
  2011  2010 
Projected benefit obligation $26,868  $24,186 
Accumulated benefit obligation  24,400   21,772 
Fair value of plan assets  14,451   13,144 

Components of net periodic benefit cost for the year ended July 31 were as follows:

 

                          
  Pension Benefits  Other Benefits 
  2011  2010  2009  2011  2010  2009  
Net Periodic Benefit Cost / (Income)                         
Service cost $79  $728  $475  $65  $63  $103  
Interest cost  1,258   1,198   1,062   107   133   284  
Expected return on plan assets  (1,031)  (952)  (1,059)          
Amortization of prior service cost  16   26   26           
Amortization of net (gain) loss  643   517   37   (795)  (824)  (539) 
Curtailment cost     3              
                          
Net periodic benefit cost / (income) $965  $1,520  $541  $(623) $(628) $(152) 
                          

The estimated net loss and prior service cost for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $792 and $16, respectively. The estimated net gain and prior service cost for the other defined benefit postretirement plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $771 and nil, respectively.

For calculation of retiree medical benefit cost, prior service cost is amortized on a straight-line basis over the average remaining years of service to full eligibility for benefits of the active plan participants. For calculation of net periodic pension cost, prior service cost is amortized on a straight-line basis over the average remaining years of service of the active plan participants.

 

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Assumptions

Weighted-average assumptions used to determine benefit obligations at July 31 were as follows:

 

                          
  Pension Benefits  Other Benefits 
  2011  2010  2009  2011  2010  2009  
Discount rate  5.00%  5.28%  5.80%  4.70%  5.00%  5.80% 
Rate of compensation increase  5.50   5.50   5.50   N/A   N/A   N/A  

Weighted-average assumptions used to determine net periodic benefit cost for the year ended July 31 were as follows:

 

                          
  Pension Benefits  Other Benefits 
  2011  2010  2009  2011  2010  2009  
Discount rate  5.28%  5.80%  7.00%  5.00%  5.80%  7.00% 
Expected long-term return on plan assets  8.00   8.00   8.00   N/A   N/A   N/A  
Rate of compensation increase  5.50   5.50   5.50   N/A   N/A   N/A  

The expected long-term rate of return on plan assets is based on the established asset allocation.

Assumed trend rates for medical plans were as follows:

 

             
  2011  2010  2009 
Health care cost trend rate assumed for next year  9.0%  9.5%  10.0%
Rate to which the cost trend rate assumed to decline (the ultimate trend rate)  5.0   5.0   5.0 
Year the rate reaches ultimate trend rate  2028   2020   2020 

Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:

 

         
  One

Percentage

Point

Increase

  One

Percentage

Point

Decrease

 
Effect on total of service and interest cost $24  $(20)
Effect on post-retirement benefit obligation  250   (215)

Plan Assets

Effective July 31, 2010, Diamond adopted the provisions of ASU No. 2010-06 on employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The fair values of the Company’s pension plan assets by asset category were as follows (see Note 2 for description of levels):

 

                 
    Fair Value Measurements at July 31, 2011 
  Total  Level 1  Level 2  Level 3 
Asset Category:                
Cash and cash equivalents $419  $  $419  $ 
Mutual funds — equity:                
Domestic  5,681   5,681       
International  2,180   2,180       
Mutual funds — debt:                
Government  1,909   1,909       
Corporate  3,547   3,547       
Other  715   715       
                 
Total $14,451   $14,032   $419   $—    
                 

 

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    Fair Value Measurements at July 31, 2010 
  Total  Level 1  Level 2  Level 3 
Asset Category:                
Cash and cash equivalents $178  $  $178  $ 
Mutual funds — equity:                
Domestic  5,445      5,445    
International  1,456      1,456    
Pooled Funds  6,065      6,065    
                 
Total $13,144   $—     $13,144   $—    
                 

Pension obligations and expenses are most sensitive to the expected return on pension plan assets and discount rate assumptions. Other post retirement benefit obligations and expenses are most sensitive to discount rate assumptions and health care cost trend rate. Diamond determines the expected return on pension plan assets based on an expectation of the average annual returns over an extended period of time. This expectation is based, in part, on the actual returns achieved by the Company’s pension plan in prior periods. The Company also considers the weighted average historical rates of return on securities with similar characteristics to those in which the Company’s pension assets are invested.

The investment objectives for the Diamond plans are to maximize total returns within reasonable and prudent levels of risk. The plan asset allocation is a key element in achieving the expected investment returns on plan assets. The current asset allocation strategy targets an allocation of 60% for equity securities and 40% for debt securities with adequate liquidity to meet expected cash flow needs. Actual asset allocation may fluctuate within acceptable ranges due to market value variability. If fluctuations cause an asset class to fall outside its strategic asset allocation range, the portfolio will be rebalanced as appropriate.

Cash Flows

Estimated future benefit payments, which reflect expected future service, as appropriate, expected to be paid are as follows:

 

         
  Pension

Benefits

  Other

Benefits

 
2012 $549  $114 
2013  4,515   126 
2014  648   155 
2015  738   162 
2016  753   159 
2017 — 2021  4,481   826 

 

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Defined Contribution Plan

The Company also recognized defined contribution plan expenses of $1,151, $720 and $524 for the years ended July 31, 2011, 2010 and 2009, respectively.

(15) Quarterly Financial Information (unaudited)

 

                 
  First

Quarter

  Second

Quarter

  Third

Quarter

  Fourth

Quarter

 
Year ended July 31, 2011                
Net sales $252,566  $257,592  $222,991  $232,773 
Gross profit (1)  63,596   70,856   59,588   57,107 
Operating expenses (2)  36,071   34,916   42,035   45,145 
Net income  14,214   19,720   7,733   8,544 
Basic earnings per share  0.65   0.90   0.35   0.39 
Basic shares (in thousands)  21,489   21,565   21,604   21,652 
Diluted earnings per share  0.64   0.87   0.34   0.37 
Diluted shares (in thousands)  21,947   22,221   22,341   22,577 
Year ended July 31, 2010                
Net sales $180,641  $184,169  $138,734  $176,618 
Gross profit (3)  45,491   40,578   31,093   43,839 
Operating expenses (4)  19,789   27,488   32,991   28,503 
Net income (loss)  14,930   8,814   (4,273)  6,740 
Basic earnings (loss) per share  0.90   0.53   (0.22)  0.31 
Basic shares (in thousands)  16,269   16,280   19,313   21,503 
Diluted earnings (loss) per share  0.88   0.52   (0.22)  0.30 
Diluted shares (in thousands)  16,685   16,764   19,313   22,097 

 

(1)Diamond revised its estimate for expected commodity costs to reflect change in market conditions. Accordingly, cost of sales resulted in a pre-tax decrease of approximately $1.5 million and a pre-tax increase of approximately $1.2 million, in the quarters ended April 30, 2011 and January 31, 2011, respectively, reflecting the impact on sales recognized during the previous quarters of fiscal year 2011. There was no change in the quarter ended July 31, 2011.
(2)Includes acquisition and integration related expenses of $0.5 million, $0.9 million, $5.9 million and $9.5 million for the quarters ended October 30, 2010, January 31, 2011, April 30, 2011 and July 31, 2011, respectively.
(3)Diamond revised its estimate for expected commodity costs to reflect change in market conditions. Accordingly, cost of sales resulted in a pre-tax decrease of approximately $1.1 million and $2.6 million in the quarters ended April 30, 2010 and January 31, 2010, respectively, reflecting the impact on sales recognized during the previous quarters of fiscal year 2010. There was no change in the quarter ended July 31, 2010.
(4)Includes acquisition and integration related expenses of $10.2 million and $1.3 million for the quarters ended April 30, 2010 and July 31, 2010, respectively.

 

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A. Controls and Procedures

We have established and currently maintain disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that any material information relating to the Company is recorded, processed, summarized and reported to our principal officers to allow timely decisions regarding required disclosures.

We acquired Kettle Foods on March 31, 2010, and as a result, we updated our internal control over financial reporting (as defined in Rule 13a-15(f) under the 1934 Act) during our fiscal year ended July 31, 2011, to include specific controls for Kettle Foods. Otherwise, there were no changes in our internal control over financial reporting during the year ended July 31, 2011 which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In conjunction with the close of each fiscal quarter, we conduct a review and evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial and Administrative Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Our Chief Executive Officer and Chief Financial and Administrative Officer, based upon their evaluation as of July 31, 2011, the end of the fiscal quarter covered in this report, concluded that our disclosure controls and procedures were effective.

 

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