##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended October 31, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 000-51439
 DIAMOND FOODS, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
(State of Incorporation)
    
    20-2556965
(IRS Employer Identification No.)1050 South Diamond Street 
Stockton, California
(Address of Principal Executive Offices)
    
    95205-7087
(Zip Code)209-467-6000
(Telephone No.)
 þ o
  o þ o
 o þ




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##### 



TABLE OF CONTENTS
 PagePart I. FINANCIAL INFORMATION
    
    
    4Item 1. Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    18Item 4. Controls and Procedures
    
    
    18Part II.OTHER INFROMATION
    
    
    20Item 1. Legal Proceedings
    
    
    20Item 1A. Risk Factors
    
    
    20Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    20Item 3. Defaults Upon Senior Securities
    
    
    20Item 4. Submission of Matters to a Vote of Security Holders
    
    
    20Item 5. Other Information
    
    
    20Item 6. Exhibits
    
    
    20SIGNATURE
    
    
    21EXHIBIT 31.01
    
    
    22EXHIBIT 31.02
    
    
    23EXHIBIT 32.01
    
    
    24EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01
  2




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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
   3




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##### Table of Contents



PART
I  FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 DIAMOND FOODS, INC.
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share and per share information)
 (Unaudited )
 October 31,
    
    
    July 31,2006
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,098
    
    
    $
    35,614Trade receivables, less allowance for doubtful accounts of $631
and $598 at October 31, 2006 and July 31, 2006, respectively
    
    
    99,891
    
    
    
    49,536Inventories
    
    
    206,478
    
    
    
    99,177Deferred income taxes
    
    
    3,356
    
    
    
    4,578Property held for sale
    
    
    
    
    
    
    1,728Prepaid expenses and other current assets
    
    
    8,601
    
    
    
    7,329Total current assets
    
    
    325,424
    
    
    
    197,962Property, plant and equipment, net
    
    
    34,957
    
    
    
    34,291Investment in CoBank
    
    
    2,191
    
    
    
    2,191Deferred income taxes
    
    
    4,812
    
    
    
    4,812Goodwill
    
    
    5,174
    
    
    
    5,077Other intangible assets, net
    
    
    3,883
    
    
    
    3,941Other assets
    
    
    4,146
    
    
    
    4,758Total assets
    
    $
    380,587
    
    
    $
    253,032LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    58,129
    
    
    $
    28,371Payable to growers
    
    
    169,178
    
    
    
    81,902Total current liabilities
    
    
    227,307
    
    
    
    110,273Long-term obligations
    
    
    20,000
    
    
    
    20,000Other liabilities
    
    
    12,011
    
    
    
    11,933Commitments and contingenciesStockholders 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; 15,737,194 and 15,737,194 shares issued and
15,735,956 and 15,737,194 shares outstanding at October 31, 2006 and
July 31, 2006, respectively
    
    
    16
    
    
    
    16Treasury stock, at cost: 1,238 shares and none held at October 31, 2006
and July 31, 2006, respectively
    
    
    (21
    )
    
    
    Additional paid-in capital
    
    
    95,221
    
    
    
    93,962Accumulated other comprehensive loss
    
    
    
    
    
    
    (36
    )Retained earnings
    
    
    26,053
    
    
    
    16,884Total stockholders equity
    
    
    121,269
    
    
    
    110,826Total liabilities and stockholders equity
    
    $
    380,587
    
    
    $
    253,032
  4




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##### Table of Contents



DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
(Unaudited)
 Three MonthsEnded October 31,2006
    
    
    2005Net sales and other revenues
    
    $
    169,512
    
    
    $
    178,060Cost of sales
    
    
    141,572
    
    
    
    152,479Cost of sales  NRV amount
    
    
    
    
    
    
    2,770Total cost of sales
    
    
    141,572
    
    
    
    155,249Gross margin
    
    
    27,940
    
    
    
    22,811Operating expenses:Selling, general and administrative (including
$1,259 and $782 of stock-based compensation
for 2006 and 2005)
    
    
    11,533
    
    
    
    9,190Advertising
    
    
    3,237
    
    
    
    6,594Restructuring and other costs, net
    
    
    (664
    )
    
    
    Gain on curtailment of defined benefit plan
    
    
    (3,039
    )
    
    
    Total operating expenses
    
    
    11,067
    
    
    
    15,784Income from operations
    
    
    16,873
    
    
    
    7,027Interest expense, net
    
    
    281
    
    
    
    24Other
    
    
    (30
    )
    
    
    213Income before income tax expense
    
    
    16,622
    
    
    
    6,790Income tax expense
    
    
    6,981
    
    
    
    2,716Net income
    
    $
    9,641
    
    
    $
    4,074Earnings per share:Basic
    
    $
    0.61
    
    
    $
    0.26Diluted
    
    $
    0.61
    
    
    $
    0.26Shares used to compute earnings per share:Basic
    
    
    15,737
    
    
    
    15,556Diluted
    
    
    15,737
    
    
    
    15,634
  5




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DIAMOND FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited )
 Three Months Ended October 31,2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIESNet income
    
    $
    9,641
    
    
    $
    4,074Adjustments to reconcile net income
to net cash used in operating activities:Depreciation and amortization
    
    
    1,826
    
    
    
    1,117Deferred income taxes
    
    
    1,222
    
    
    
    2,716Gain on curtailment of defined benefit plan
    
    
    (3,039
    )
    
    
    Stock-based compensation
    
    
    1,259
    
    
    
    782Gain on sale of property held for sale
    
    
    (1,193
    )
    
    
    Gain on foreign currency
    
    
    36
    
    
    
    Changes in assets and liabilities:Trade receivables
    
    
    (50,355
    )
    
    
    (56,277
    )Inventories
    
    
    (107,301
    )
    
    
    (95,557
    )Prepaid expenses and other current assets
    
    
    1,767
    
    
    
    (1,510
    )Other assets
    
    
    612
    
    
    
    786Accounts payable and accrued liabilities
    
    
    29,960
    
    
    
    25,889Payable to growers
    
    
    87,276
    
    
    
    113,653Other liabilities
    
    
    78
    
    
    
    347Net cash used in operating activities
    
    
    (28,211
    )
    
    
    (3,980
    )CASH FLOWS FROM INVESTING ACTIVITIES:Net proceeds from sale of property held for sale
    
    
    2,927
    
    
    
    Purchases of property, plant and equipment
    
    
    (2,642
    )
    
    
    (2,176
    )Payment of additional acquisition costs
    
    
    (97
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    188
    
    
    
    (2,176
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payment of notes payable, net
    
    
    
    
    
    
    (569
    )Payment to members for membership interest
    
    
    
    
    
    
    (17,329
    )Dividends paid
    
    
    (472
    )
    
    
    Purchase of treasury stock
    
    
    (21
    )
    
    
    Net cash used in financing activities
    
    
    (493
    )
    
    
    (17,898
    )Net decrease in cash and cash equivalents
    
    
    (28,516
    )
    
    
    (24,054
    )Cash and cash equivalents:Beginning of period
    
    
    35,614
    
    
    
    49,035End of period
    
    $
    7,098
    
    
    $
    24,981Supplemental disclosure of cash flow information:Cash paid during the period for:Interest
    
    $
    224
    
    
    $
    215Income taxes
    
    
    11
    
    
    
    15Non-cash investing activity:Accrued capital expenditures
    
    
    178
    
    
    
    Non-cash financing activity:Accrued liability exchanged for options
to acquire common stock
    
    
    
    
    
    
    640
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DIAMOND FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the quarters ended October 31, 2006 and 2005
(in thousands, except share and per share information)
 (1) Organization and Basis of Presentation
    (2) Recent Accounting Pronouncements
 Accounting for Certain Hybrid Financial Instruments  An Amendment of FASB Statements No. 133 and
140.
 Accounting for Uncertainty in Income Taxes  an
interpretation of FASB Statement 109, Accounting
for Income Taxes.
 Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements
 7




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Fair Value Measurements
 (3) Stock Plan Information
 Share-Based
Payment. Accounting for Stock Issued to
Employees. Accounting for Stock-Based Compensation-Transition and Disclosure, an
amendment of FASB Statement No. 123
 Accounting for Stock-Based Compensation
 Three Months Ended October 31,2006
    
    
    2005Net income, as reported
    
    $
    9,641
    
    
    $
    4,074Total stock-based compensation recorded in the statement
of operations, net of related tax effects
    
    
    730
    
    
    
    469Total stock-based compensation expense determined under fair
value based method for all awards, net of related tax effects
    
    
    (996
    )
    
    
    (722
    )Pro forma net income
    
    $
    9,375
    
    
    $
    3,821Net income per common equivalent share:Basic  as reported
    
    $
    0.61
    
    
    $
    0.26Basic  pro forma
    
    $
    0.60
    
    
    $
    0.25Diluted  as reported
    
    $
    0.61
    
    
    $
    0.26Diluted  pro forma
    
    $
    0.60
    
    
    $
    0.24
 Stock Option Awards:
 Three Months Ended October 31,2006
    
    2005Average expected life, in years
    
    
    6
    
    
    
    6Expected volatility
    
    
    30.00
    %
    
    
    27.50
    %Risk-free interest rate
    
    
    4.75
    %
    
    
    4.15
    %Dividend rate
    
    
    0.79
    %
    
    
    0.71
    %
 8




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##### Table of Contents



WeightedaverageNumber of
    
    Weighted
    
    remaining
    
    AggregateShares
    
    average exercise
    
    contractual life
    
    intrinsic value (in(in thousands)
    
    price per share
    
    (in years)
    
    thousands)Outstanding at July 31, 2006
    
    
    1,648
    
    
    $
    17.43Granted
    
    
    3
    
    
    
    14.63Exercised
    
    
    
    
    
    
    Cancelled
    
    
    (24
    )
    
    
    17.63Outstanding at October 31, 2006
    
    
    1,627
    
    
    
    17.42
    
    
    
    8.9
    
    
    $
    3,124Exerciseable at October 31, 2006
    
    
    474
    
    
    
    17.04
    
    
    
    8.8
    
    
    $
    910
   WeightedNumber of
    
    average grantShares
    
    date fair value(in thousands)
    
    per shareNonvested at July 31, 2006
    
    
    1,307
    
    
    $
    5.80Granted
    
    
    3
    
    
    
    5.14Vested
    
    
    (133
    )
    
    
    5.62Cancelled
    
    
    (24
    )
    
    
    5.74Nonvested at October 31, 2006
    
    
    1,153
    
    
    
    5.81
  Restricted Stock Awards:
 WeightedNumber of
    
    average grantShares
    
    date fair value(in thousands)
    
    per shareOutstanding at July 31, 2006
    
    
    529
    
    
    $
    17.52Granted
    
    
    
    
    
    
    Vested
    
    
    (4
    )
    
    
    17.30Cancelled
    
    
    
    
    
    
    Outstanding at October 31, 2006
    
    
    525
    
    
    
    17.52
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Employee Stock Purchase Plan:
 Three Months Ended October 31,2006
    
    2005Average expected life, in years
    
    
    0.75
    
    
    
    0.75Expected volatility
    
    
    27.50
    %
    
    
    27.50
    %Risk-free interest rate
    
    
    5.10
    %
    
    
    4.15
    %Dividend rate
    
    
    0.67
    %
    
    
    0.71
    %
 (4) Earnings Per Share
  (5) Balance sheet items
  October 31,
    
    
    July 31,2006
    
    
    2006Raw materials and supplies
    
    $
    139,696
    
    
    $
    32,484Work in process
    
    
    10,483
    
    
    
    16,148Finished goods
    
    
    56,299
    
    
    
    50,545Total
    
    $
    206,478
    
    
    $
    99,177
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October 31,
    
    
    July 31,2006
    
    
    2006Accounts payable
    
    $
    39,670
    
    
    $
    19,090Accrued salaries and benefits
    
    
    5,952
    
    
    
    4,496Accrued promotion
    
    
    5,456
    
    
    
    3,477Income taxes payable
    
    
    2,594
    
    
    
    Accrued other
    
    
    4,457
    
    
    
    1,308Total
    
    $
    58,129
    
    
    $
    28,371
 (6) Acquisition of Assets of Harmony Foods Corporation
  Business Combinations.
 Pro Forma  Financial Information
  2005Net Sales
    
    $
    186,962Net Income
    
    $
    2,845Diluted earnings per share
    
    $
    0.18
 (7) Credit Facilities
   11




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##### Table of Contents



(8) Retirement Plans
   Pension Benefits
    
    
    Other Benefits2006
    
    
    2005
    
    
    2006
    
    
    2005Service cost
    
    $
    568
    
    
    $
    590
    
    
    $
    29
    
    
    $
    63Interest cost
    
    
    477
    
    
    
    449
    
    
    
    77
    
    
    
    136Expected return on plan assets
    
    
    (566
    )
    
    
    (580
    )
    
    
    
    
    
    
    Amortization of prior service cost
    
    
    (71
    )
    
    
    (72
    )
    
    
    
    
    
    
    Amortization of net loss
    
    
    153
    
    
    
    219
    
    
    
    (113
    )
    
    
    5Net periodic benefit cost / (income)
    
    
    561
    
    
    
    606
    
    
    
    (7
    )
    
    
    204SFAS 88 curtailment gain
    
    
    (3,039
    )
    
    
    
    
    
    
    
    
    
    
    Total benefit cost / (income)
    
    $
    (2,478
    )
    
    $
    606
    
    
    $
    (7
    )
    
    $
    204
 Termination of Defined Benefit Plan
  Defined Contribution Plan
  (9) Restructuring and Other Costs, Net
  12




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(10) Contingencies
   
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
    Critical Accounting Policies
  Revenue Recognition.
 Inventories.
 13




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Valuation of Long-lived and Intangible Assets and Goodwill.
   Employee Benefits.
 Income Taxes. Accounting for
Income Taxes
 Accounting for Stock-Based Compensation. Share-Based Payment
 Non-GAAP Financial Information
  14




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Three Months Ended October 31,2006
    
    
    2005(Unaudited)(in thousands)Net sales and other revenues
    
    $
    169,512
    
    
    $
    178,060Cost of sales
    
    
    141,572
    
    
    
    152,479Gross margin
    
    
    27,940
    
    
    
    25,581Operating expenses:Selling, general and administrative
    
    
    11,533
    
    
    
    9,190Advertising
    
    
    3,237
    
    
    
    6,594Total operating expenses
    
    
    14,770
    
    
    
    15,784Operating income
    
    
    13,170
    
    
    
    9,797Interest expense
    
    
    281
    
    
    
    24Other (income), expense
    
    
    (30
    )
    
    
    213Income before income tax expense
    
    $
    12,919
    
    
    $
    9,560
  2006
    
    
    2005GAAP income before income tax expense
    
    $
    16,622
    
    
    $
    6,790Adjustment to cost of sales to remove one time
impact of accounting for certain inventories
on NRV basis
    
    
    
    
    
    
    2,770Adjustment to remove restructuring and other
costs and gain on curtailment of defined
benefit plan
    
    
    (3,703
    )
    
    
    Non-GAAP income before income tax expense
    
    
    12,919
    
    
    
    9,560GAAP income tax expense
    
    
    6,981
    
    
    
    2,716Adjustment to reflect tax effects of Non-GAAP
adjustments
    
    
    (1,555
    )
    
    
    1,108Non-GAAP income tax expense
    
    
    5,426
    
    
    
    3,824Non-GAAP net income
    
    $
    7,493
    
    
    $
    5,736
 About Diamonds non-GAAP Financial Measures.
   15




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
    
    A one-time charge to costs of sales that we incurred in connection with our conversion.
As an agricultural cooperative association, we were required to use net realizable value
(NRV) accounting for certain inventories; as a for-profit corporation we are required to
use the lower of cost or market method to value all inventories. As a result of using NRV
accounting, certain inventories were valued higher than they would have been under the
lower of cost or market method. Therefore, as these inventories were sold, the amount
charged to cost of goods sold was higher. We excluded this charge because it is
non-recurring and is not indicative of ongoing operations.
    
    Restructuring and other costs and non-recurring gains which are principally related to
(1) the closure of our Lemont facility and the costs incurred to consolidate operations in
our Fishers facility, (2) a gain on the sale of the Lemont facility. Our management
believes it is useful to investors to exclude these amounts since they are non-recurring in
nature and are not reflective of the operating results of Diamond on an on-going basis.
    
    Amounts associated with curtailing and terminating our administrative pension plan due
to its non-recurring nature.
  Results of Operations
   October 31,
    
    % Change from2006
    
    2005
    
    2005 to 2006North American Retail (1)
    
    $
    110,669
    
    
    $
    107,330
    
    
    
    3.1
    %International
    
    
    35,981
    
    
    
    45,008
    
    
    
    (20.1
    )North American Ingredient/Food Service
    
    
    22,169
    
    
    
    24,536
    
    
    
    (9.6
    )Other
    
    
    693
    
    
    
    1,186
    
    
    
    (41.6
    )Total
    
    $
    169,512
    
    
    $
    178,060
    
    
    
    (4.8
    )%
 
 (1)
    
    North American Retail represents sales of our culinary, snack and in-shell nuts in North
America.   October 31,2006
    
    
    2005Walnuts
    
    
    61.7
    %
    
    
    67.7
    %Other nuts
    
    
    38.3
    %
    
    
    32.3
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 16




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##### Table of Contents



Gross margin.
 Selling, General and Administrative.
 Advertising.
 Restructuring and Other Costs, Net.
 Gain on Curtailment of Defined Benefit Plan
 Interest.
 Income Taxes.
 Liquidity and Capital Resources
      17




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Contractual Obligations and Commitments
  Payments Due by PeriodLess than
    
    1-3
    
    3-5
    
    More thanTotal
    
    1 Year (c)
    
    Years
    
    Years
    
    5 YearsLong-term obligation (a)
    
    $
    20.0
    
    
    $
    
    
    
    $
    
    
    
    $
    8.0
    
    
    $
    12.0Interest on long-term obligations
    
    
    7.2
    
    
    
    0.7
    
    
    
    3.0
    
    
    
    2.3
    
    
    
    1.2Operating leases
    
    
    16.7
    
    
    
    0.7
    
    
    
    4.2
    
    
    
    5.2
    
    
    
    6.6Purchase commitments (b)
    
    
    1.1
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    45.0
    
    
    $
    2.5
    
    
    $
    7.2
    
    
    $
    15.5
    
    
    $
    19.8
 
 (a)
    
    Excludes $2 million in letters of credit outstanding related to normal business transactions.(b)
    
    Commitments to purchase equipment.(c)
    
    Represents obligations and commitments for the remaining nine months of fiscal 2007. Effects of Inflation
  Recent Accounting Pronouncements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  18




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  Total number of
    
    
    Approximate DollarTotal number
    
    
    Average price
    
    
    shares repurchased as
    
    
    value of sharesof shares
    
    
    paid per
    
    
    part of publicly
    
    
    that may yet be purchasedPeriod
    
    repurchased
    
    
    share
    
    
    announced plans
    
    
    under the plansRepurchases from October 1
through October 31, 2006
    
    
    1,238
    
    
    $
    16.98
    
    
    
    
    
    
    
    Total
    
    
    1,238
    
    
    $
    16.98
    
    
    
    
    
    
    
    
 
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  Filed with this
    
    
    Incorporated by referenceNumber
    
    
    Exhibit Title
    
    10-Q
    
    
    Form
    
    
    File No.
    
    
    Date Filed31.01
    
    
    Certification
of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
    
    
    X31.02
    
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
    
    
    X
 20




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##### Table of Contents



Filed with this
    
    
    Incorporated by referenceNumber
    
    
    Exhibit Title
    
    10-Q
    
    
    Form
    
    
    File No.
    
    
    Date Filed32.01
    
    
    Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
    
    
    X
 
 SIGNATURES
  DIAMOND FOODS, INC.Date: December 8 , 2006
    
    By:
    
    /s/ Seth Halio
Seth HalioChief Financial Officer and dulyauthorized officer
 21