DIAMOND FOODS INC - 10-K/A - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Summary As discussed in Note 15 of the Notes to Consolidated Financial Statements, we have restated our previously issued consolidated financial statements for fiscal 2011 and fiscal 2010; accordingly, this Management's Discussion and Analysis of Financial Condition and Results of Operations has been revised for the effects of the restatement.

We are an innovative packaged food company founded in 1912 and currently focused on building and energizing brands. We specialize in processing, marketing and distributing snack products and culinary, in-shell and ingredient nuts. In 2004, we complemented our strong heritage in the culinary nut market under the Diamond of California® brand by launching a line of snack nuts under the Emerald® brand.

In September 2008, we acquired the Pop Secret® brand of microwave popcorn products, which provided us with increased scale in the snack market, supply chain economies of scale and cross promotional opportunities with our existing brands. In March 2010, we 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 our existing portfolio of brands in the snack industry. In April 2011, we announced that we entered into a definitive agreement with P&G to merge P&G's Pringles business into Diamond. For details regarding the termination of the Pringles merger please refer to Note 17 of the Notes to Consolidated Financial Statements.

In general, we sell directly to retailers, particularly larger national grocery store and drug store chains, and indirectly through wholesale distributors to independent and small regional retail grocery store chains and convenience stores. We sell our products to global, national, regional and independent grocery, drug and convenience store chains, as well as to mass merchandisers, club stores, other retail channels and non-retail channels.

Our business is seasonal. Demand for nut products, particularly in-shell nuts and to a lesser extent culinary nuts, is highest during the months of October, November and December. In sourcing walnuts, we contract directly with growers for their walnut crop. We typically receive walnuts during the period from September to November, and we pay for the crop throughout the year in accordance with our walnut purchase agreements with the growers. We typically receive pecans during the period from October to March, and we pay for our pecan receipts over such period. As a result of this seasonality, our personnel and working capital requirements and walnut inventories peak during the last quarter of the calendar year. We experience seasonality in capacity utilization at our Stockton, California and Fishers, Indiana facilities associated with the annual walnut harvest and seasonal in-shell and culinary product demand. Generally, we receive and pay for approximately 50% of the corn for popcorn in November, and approximately 50% in April. We contract for potatoes and oil annually and receive and pay for supply throughout the year. Generally, demand for potato chips is highest in the months of June, July and August in the United States, and November and December in the United Kingdom. Accordingly, the working capital requirement of our popcorn and potato chip product lines is less seasonal than that of the tree nut product lines. The trends in our restated quarterly operating results for fiscal years 2010 and 2011 are generally consistent year over year.

Critical Accounting Policies Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Our critical accounting policies are set forth below.

Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss has transferred to the buyer (based upon terms of shipment), price is fixed, delivery occurs and collection is reasonably assured. Revenues are recorded net of rebates, introductory or slotting payments, 27 -------------------------------------------------------------------------------- Table of Contents coupons, promotion and marketing allowances. The amount we accrue 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.

Inventories. All inventories are accounted for on a lower of cost (first-in, first-out or weighted average) or market basis. We have entered into walnut purchase agreements with growers, under which they deliver their walnut crop to us during the Fall harvest season, and pursuant to our walnut purchase agreement, we determine the price for this inventory after delivery and by the end of the fiscal year. This purchase price is determined by us based on our discretion provided in the agreements, taking into account market conditions, crop size, quality and nut varieties, among other relevant factors. Since the ultimate purchase price to be paid will be determined subsequent to receiving the walnut crop, we estimate the final purchase price for our interim financial statements. Those interim estimates may subsequently change due to changes in the factors described above and the effect of the change could be significant.

Any such changes in estimates are accounted for in the period of change by adjusting inventory or cost of goods sold if inventory is sold through.

Valuation of Long-lived and Intangible Assets and Goodwill. We periodically review long-lived assets and certain identifiable intangible assets for impairment in accordance with Accounting Standards Codification ("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 our current estimates and assumptions, materially different estimates and assumptions in the future in response to changing economic conditions, changes in our 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, we initiate our 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.

For brand intangible assets not subject to amortization, we test 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, we compare 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.

We perform our annual goodwill impairment test required by ASC 350 as of June 30th of each year. In testing goodwill for impairment, we initially compare the fair value of our single reporting unit with the net book value of the Company since it represents the carrying value of the reporting unit. We have one operating and reportable segment. If the 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 28 -------------------------------------------------------------------------------- Table of Contents determined by first allocating the fair value of the reporting unit to all assets and liabilities and then computing the excess of the reporting unit's 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, we would recognize an impairment loss in the amount of such excess. We also consider the estimated fair value of our reporting unit in relation to our market capitalization.

We cannot guarantee that a material impairment charge will not be recorded in the future. To the extent our market capitalization results in a fair value of our common stock that is below our net book value, or if other indicators of potential impairment are present, then we will be required to take further steps to determine if an impairment of goodwill has occurred and to calculate an impairment loss.

Employee Benefits. We incur various employment-related benefit costs with respect to qualified and nonqualified pension and deferred compensation plans.

Assumptions are made related to discount rates used to value certain liabilities, assumed rates of return on assets in the plans, compensation increases, employee turnover and mortality rates. Different assumptions could result in the recognition of differing amounts of expense over different periods of time.

Income Taxes. We account for income taxes in accordance with ASC 740, "Income Taxes." This guidance 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 our 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.

There are inherent uncertainties related to the interpretations of tax regulations in the jurisdictions in which we operate. We may take tax positions that management believes are supportable, but are potentially subject to successful challenge by the applicable taxing authority. We evaluate our tax positions and establish liabilities in accordance with the guidance on uncertainty in income taxes. We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly.

Accounting for Stock-Based Compensation. We account for stock-based compensation arrangements, including stock option grants and restricted stock awards, in accordance with the provisions of 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. We use the Black-Scholes option pricing model to determine the fair value of stock options at the date of grant.

This model requires us to make assumptions such as expected term, 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 our assumptions and judgments used in estimating these factors, we may be required to increase or decrease compensation expense, which could be material to our results of operations.

Results of Operations Fiscal 2011 Compared to Fiscal 2010 Net sales were $966.7 million and $682.3 million for fiscal 2011 and fiscal 2010, respectively. The increase in net sales was primarily due to increased snack sales (including Kettle Foods). Sales incentives (primarily promotional allowances, coupons and slotting) as a percentage of gross sales were flat year over year. The impact of foreign exchange on our net sales was not significant for fiscal 2011 and fiscal 2010.

29-------------------------------------------------------------------------------- Table of Contents Net sales by channel (in thousands): Year Ended July 31, % Change from 2011 2010 2010 to 2011 Snack $ 553,676 $ 323,620 71.1 % Culinary and Retail In-shell 263,161 248,960 5.7 % Total Retail 816,837 572,580 42.7 % International Non-Retail 119,017 69,206 72.0 % North American Ingredient/Food Service Other 30,834 40,540 -23.9 % Total Non-Retail 149,851 109,746 36.5 % Total Net Sales $ 966,688 $ 682,326 41.7 % The increase in retail sales for fiscal 2011 primarily reflects higher sales of snack products (including Kettle Foods). Retail sales for fiscal 2010 included only four months of Kettle Foods sales. The volume of snack sales, other than sales of Kettle Foods products, increased by 14% from fiscal 2010 to fiscal 2011. Culinary and retail in-shell sales increased in fiscal 2011 as a result of price increases that were partially offset by an 11% decrease in volume.

International non-retail sales increased in fiscal 2011 due to 28% higher sales volume, mainly as a result of a record walnut crop that was sold to customers in international markets after servicing retail customer demand. North American ingredient/food service and other sales decreased primarily because the United States Department of Agriculture school lunch program was not offered in fiscal 2011.

Gross profit. Gross profit as a percentage of net sales was 22.4% and 21.2% for fiscal 2011 and fiscal 2010, respectively. The increase was mainly due to retail sales mix, greater scale in snack products and manufacturing efficiencies, which collectively offset commodity price increases, and increased slotting and promotion for our Emerald Breakfast on the go! products.

Selling, general and administrative. Selling, general and administrative expenses consist principally of salaries and benefits for sales and administrative personnel, brokerage, professional services, travel, non-manufacturing depreciation and facility costs. Selling, general and administrative expenses were $97.5 million and $64.6 million, and 10.1% and 9.5% as a percentage of net sales, for fiscal 2011 and fiscal 2010, respectively. The increase was primarily due to the addition of Kettle Foods, including the associated intangible amortization for customer relationships, as well as workforce additions.

Advertising. Advertising expenses were $45.0 million and $33.7 million, and 4.7% and 4.9% as a percentage of net sales, for fiscal 2011 and fiscal 2010, respectively. The increase was primarily due to increased media spending associated with the launch of our Emerald Breakfast on the go! products, as well as incremental Kettle Foods brand support.

Acquisition and integration related expenses. Acquisition and integration related expenses include items such as transaction related legal and consulting fees, as well as business and systems integration costs. Acquisition and integration related expenses associated with the proposed Pringles merger and Kettle Foods acquisition were $20.4 million for fiscal 2011. Acquisition and integration related expenses associated with Kettle Foods were $11.3 million for fiscal 2010.

Interest expense, net. Net interest expense was $23.9 million and $10.2 million, and 2.5% and 1.5% as a percentage of net sales, for fiscal 2011 and fiscal 2010, respectively, reflecting primarily borrowings used to fund the Kettle Foods acquisition.

Other expense, net. There was no net other expense for fiscal 2011. Net other expense for fiscal 2010 was $1.8 million, representing a loss on debt extinguishment when we replaced our existing credit facility with a new secured credit facility to fund the Kettle Foods acquisition.

30-------------------------------------------------------------------------------- Table of Contents Income taxes. Our effective tax rates for fiscal 2011 and fiscal 2010 were 10.5% and 32.5%, respectively. Our effective tax rates were lower than the U.S.

federal statutory rate primarily due to earnings taxed at lower rates in the United Kingdom (UK) tax jurisdiction. Our fiscal 2011 effective tax rate was also impacted by discrete tax benefits, primarily deferred tax adjustments for enacted tax law change in the UK, Wisconsin and California. In fiscal 2010, our effective tax rate was lower than the U.S. federal statutory rate due, also and primarily, to earnings taxed at lower rates in the UK. The decrease was offset, partially, by an effective tax rate increase in fiscal 2010 due to non-deductible acquisition costs related to the Kettle acquisition.

Fiscal 2010 Compared to Fiscal 2009 Net sales were $682.3 million and $570.9 million for fiscal 2010 and fiscal 2009, respectively. The increase in net sales was primarily due to increased snack sales (including Kettle Foods). This was offset in part by lower culinary and retail in-shell sales.

Our net sales were as follows (in thousands): Year Ended July 31, % Change from 2010 2009 2009 to 2010 Snack $ 323,620 $ 188,900 71.3 % Culinary and Retail In-shell 248,960 276,226 -9.9 % Total Retail 572,580 465,126 23.1 % International Non-Retail 69,206 68,890 0.5 % North American Ingredient/Food Service Other 40,540 36,924 9.8 % Total Non-Retail 109,746 105,814 3.7 % Total Net Sales $ 682,326 $ 570,940 19.5 % The increase in retail sales for fiscal 2010 resulted from higher sales of snack products (including four months of sales for Kettle Foods), which increased by 71%. Excluding Kettle Foods, increases in snack net sales volume were partially offset by lower pricing. The decrease in culinary and retail in-shell sales for fiscal 2010 resulted from lower pricing and a 5% decrease in sales volume partially attributable to elimination of low value added SKUs. International non-retail sales were relatively flat despite a volume decline of 5%. North American ingredient/food service and other sales increased primarily as a result of a 50% increase in sales volume and partially offset by lower pricing.

Gross profit. Gross profit as a percentage of net sales was 21.2% and 23.7% for fiscal 2010 and fiscal 2009, respectively. Gross profit decreased mainly as a result of higher commodity costs related to walnuts.

Selling, general and administrative. Selling, general and administrative expenses consist principally of salaries and benefits for sales and administrative personnel, brokerage, professional services, travel, non-manufacturing depreciation and facility costs. Selling, general and administrative expenses were $64.6 million and $61.0 million, and 9.5% and 10.7% as a percentage of net sales, for fiscal 2010 and fiscal 2009, respectively. The improvement as a percentage of net sales was primarily driven by greater scale in snack sales and higher costs during fiscal 2009 associated with the Pop Secret acquisition.

Advertising. Advertising expense was $33.7 million and $28.8 million, and 4.9% and 5.0% as a percentage of net sales, for fiscal 2010 and fiscal 2009, respectively. The increase in advertising was primarily due to increased media spending associated with the snack brands (including Kettle Foods).

Acquisition and integration related expenses. Acquisition and integration related expenses include items such as transaction related legal and consulting fees, as well as business and systems integration costs. Acquisition and integration related expenses associated with Kettle Foods were $11.3 million for fiscal 2010. There were no acquisition and integration related expenses for fiscal 2009.

31 -------------------------------------------------------------------------------- Table of Contents Interest expense, net. Net interest expense was $10.2 million and $6.3 million, and 1.5% and 1.1% as a percentage of net sales, for fiscal 2010 and fiscal 2009, respectively. The increase was primarily attributable to the borrowings used to fund the Kettle Foods acquisition.

Other expense, net. Net other expense was $1.8 million for fiscal 2010. The expense represented a loss on debt extinguishment when we replaced our existing credit facility with a new secured credit facility to fund the Kettle Foods acquisition. Net other expense was $0.9 million for fiscal 2009 reflecting a $2.6 million payment on the early termination of debt, partially offset by a gain on the sale of emission reduction credits of $1.7 million.

Income taxes. The combined effective federal and state tax rate for fiscal 2010 was 32.5%. Our effective tax rates were lower than the U.S. federal statutory rate primarily due to earnings taxed at lower rates in the UK tax jurisdiction. For fiscal 2009, the combined effective federal and state tax rate was 38.6%, and included the effect of discrete tax items, primarily the recognition of certain state tax credits.

Proposed Pringles Merger Subsequently Terminated On April 5, 2011, Diamond entered into a definitive agreement with The Procter & Gamble Company ("P&G") to merge P&G's Pringles business into the Company; on February 15, 2012, Diamond and P&G mutually agreed to terminate this proposed merger. No "break-up" fee or other fees were paid in connection with the termination, which included a mutual release. In fiscal 2012, the Company recorded acquisition related expenses associated with the Pringles termination of $7.0 million, the majority of which were primarily capitalized in fiscal 2011 and subsequently expensed in fiscal 2012, and primarily included contract termination costs related to facilities and software that were no longer needed due to the termination of the merger.

Liquidity and Capital Resources Our liquidity is dependent upon funds generated from operations and external sources of financing.

Cash provided by operating activities during fiscal 2011 was $66.7 million compared to $1.8 million of cash used in operating activities during fiscal 2010. The increase in cash provided by operating activities was primarily due to improved working capital as accounts payable increased by $31.5 million partly due to Pringles merger costs as well as a $20.2 million increase in accounts payable to growers driven by a larger and more costly walnut crop. Cash used in investing activities was $43.2 million in fiscal 2011 compared to $626.6 million in fiscal 2010. The higher cash used in investing activities for fiscal 2010 was mainly due to the acquisition of Kettle Foods. Fiscal 2011 investing activities included an increase in purchases of property, plant and equipment related to Kettle Foods facility expansions and software implementations. Cash used in financing activities was $26.1 million in fiscal 2011 compared to $609.1 million provided by financing activities in fiscal 2010. The change from prior year was primarily attributable to long-term borrowings and the equity offering used to fund the Kettle Foods acquisition.

Cash used in operating activities during fiscal 2010 was $1.8 million compared to $53.4 million provided by operating activities during fiscal 2009. The decrease in cash from operating activities was primarily due to increased inventory, offset by increased grower payables. Cash used in investing activities was $626.6 million in fiscal 2010 compared to $198.1 million in fiscal 2009. This increase was mainly due to the acquisition of Kettle Foods for approximately $616.2 million. Cash provided by financing activities was $609.1 million in fiscal 2010 compared to $95.2 million in fiscal 2009. The increase was primarily attributable to long-term borrowings used to fund the Kettle Foods acquisition and to our equity offering.

At July 31, 2011, we had a total of $3.1 million in cash and cash equivalents.

Of this balance, $2.7 million was held in the United Kingdom in foreign currencies. It is our intention to indefinitely reinvest all current and future foreign earnings at these locations in order to ensure sufficient working capital and expand operations. We have not recorded a deferred tax liability of approximately $8.7 million related to the U.S. federal and state 32-------------------------------------------------------------------------------- Table of Contents income taxes and foreign withholding taxes on approximately $25 million of undistributed earnings of foreign subsidiaries indefinitely invested outside the United States. In the event that management elects for any reason in the future to repatriate some or all of the foreign earnings that were previously deemed to be indefinitely reinvested outside of the United States, we would incur additional tax expense upon such repatriation.

In February 2010, we entered into an agreement to replace our existing credit facility with a five-year $600 million secured credit facility (the "Secured Credit Facility") with a syndicate of lenders. We used the borrowings under the Secured Credit Facility to fund a portion of the Kettle Foods acquisition and to fund ongoing operations. In March 2010, we issued 5,175,000 shares of common stock priced at $37.00 per share. After deducting the underwriting discount and other related expenses, we received total net proceeds from the sale of our 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.

Borrowings under the Secured Credit Facility initially bear interest, at our option, at either a fluctuating rate per annum (the "Base Rate") plus a margin of 2.50%, or the London Interbank Offered Rate ("LIBOR"), 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 earnings before interest, taxes, depreciation and amortization ("EBITDA"). Substantially all of our tangible and intangible assets are considered collateral security under the Secured Credit Facility. Our Secured Credit Facility initially consisted of a $200 million revolving credit facility and a $400 million term loan. In March 2011, the syndicate of lenders approved our request for a $35 million increase in our revolving credit facility to $235 million, under the same terms. In August 2011, the syndicate of lenders approved our request for a $50 million increase in our revolving credit facility to $285 million, under the same terms.

On December 20, 2010, Kettle Foods obtained, and we guaranteed, a 10-year fixed rate loan with respect to our Beloit, Wisconsin plant expansion (the "Guaranteed Loan") in the principal amount of $21.2 million, of which $20.4 million was outstanding as of July 31, 2011. Principal and interest payments are due monthly throughout the term of the loan. The Guaranteed Loan is being used to purchase equipment for our Beloit, Wisconsin plant expansion. Borrowed funds were placed in an interest-bearing escrow account. Withdrawals from the escrow account were restricted to reimburse, dollar-for-dollar, approved expenditures directly related to equipment purchases. As the cash is being used to purchase non-current assets, such restricted cash is 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. Initially, there was a limit to our debt to EBITDA ratio to no more than 4.35 to 1.00, and our fixed charge coverage ratio to no less than 1.05 to 1.00. As a result of the errors identified causing the restatement of our consolidated financial statements, we were in default with certain financial and reporting covenants, which non-compliance was waived as of July 31, 2012. In addition, the financial covenants within the Guaranteed Loan were reset to match those in the Third Amendment, as defined below.

As of July 31, 2011, the revolving credit facility had $235 million in capacity, of which $161 million was outstanding, while the term loan facility had $400 million in capacity, of which $350 million was outstanding. Scheduled principal payments on the term loan were $40 million for fiscal 2012 and each of the succeeding two years (due quarterly), and $10 million for each of the first two quarters in fiscal 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.

On March 21, 2012, we reached an agreement with our lenders to forbear from seeking any remedies under the Secured Credit Facility with respect to specified existing and anticipated non-compliance with the credit agreement and to amend our credit agreement ("Second Amendment"). Under the amended credit agreement, we had continued access to our existing revolving credit facility through a forbearance period (initially through June 18, 2012) subject to our compliance with the terms and conditions of the amended credit agreement. During the forbearance period, the interest rate on borrowings increased. The amended credit agreement required us to suspend dividend payments to stockholders. In addition, we paid a forbearance fee of 0.25% to our lenders. The forbearance period concluded on May 29, 2012, when we closed agreements to recapitalize our balance sheet with an investment by Oaktree Capital Management, L.P.

("Oaktree").

33 -------------------------------------------------------------------------------- Table of Contents The Oaktree investment initially consists of $225 million of newly-issued senior notes and warrants to purchase approximately 4.4 million shares of Diamond common stock. The senior notes will mature in 2020 and will bear interest at 12% per year that may be paid-in-kind at our option for the first two years. Oaktree's warrants will be exercisable at $10 per share, and would constitute a fully diluted ownership level of approximately 16.4% of Diamond.

The Oaktree agreements provide that if we secure a specified minimum supply of walnuts from the 2012 crop and achieve profitability targets for our nut businesses for the six-month period ending January 31, 2013, all of the warrants will be cancelled and Oaktree may exchange $75 million of the senior notes for convertible preferred stock of Diamond (the "Special Redemption"). The convertible preferred stock would have an initial conversion price of $20.75, which represents a 3.5% discount to the closing price of Diamond common stock on April 25, 2012, the date that we entered into our commitment with Oaktree. The convertible preferred stock would pay a 10% dividend that would be paid in-kind for the first two years. Diamond does not currently anticipate that the Special Redemption will occur.

On May 22, 2012, we entered into a Waiver and Third Amendment to our Secured Credit Facility ("Third Amendment"), which provided for a lower level of total bank debt, initially at $475 million, along with substantial covenant relief until October 31, 2013. At that time, these covenants will become applicable at revised levels set forth in the Third Amendment (initially 4.70 to 1.00 for the senior leverage ratio, declining over four quarters to 3.25 to 1.00 in the quarter ending July 31, 2014 and thereafter, and 2.00 to 1.00 for the fixed charge coverage ratio for each fiscal quarter). Prior to the Third Amendment, as of July 31, 2011, our debt to EBITDA ratio was limited to no more than 4.25 to 1.00 and our fixed charge coverage ratio to no less than 1.10 to 1.00. As a result of the errors identified causing the restatement of our consolidated financial statements, we were non-compliant with these financial ratio covenants, which non-compliance was waived as a result of the Third Amendment.

The Third Amendment includes a new covenant requiring that we have at least $20 million of cash, cash equivalents and revolving credit availability beginning February 1, 2013. In addition, the Third Amendment required a $100 million pre-payment of the term loan facility, while reducing the remaining scheduled principal payments on the term loan facility from $10 million to $0.9 million.

The Third Amendment also amends the definition of "Applicable Rate" under the Secured Credit Agreement (which sets the margin over LIBOR and the Base Rate at which loans under the Secured Credit Agreement bear interest). Initially, Eurodollar rate loans will bear interest at 5.50% plus the LIBOR for the applicable loan period, and Base Rate loans will bear interest at 4.50% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the Prime Rate, or (iii) Eurodollar Rate plus 1.00%. The LIBOR rate is subject to a LIBOR floor, initially 1.25% (the "LIBOR Floor"). The margins over LIBOR, the LIBOR floor, and the Base Rate will decline if and when we achieve specified reductions in our ratio of senior debt to EBITDA. The Third Amendment also eliminates the requirement that proceeds of future equity issuances be applied to repay outstanding loans, and waives certain covenants that we were non-compliant with in connection with our restatement of our consolidated financial statements.

The Secured Credit Facility and the Securities Purchase Agreement, dated as of May 22, 2012, by and between Diamond and OCM PF/FF Adamantine Holdings, Ltd.

(the "Oaktree SPA") provide for customary affirmative and negative covenants, and cross default provisions that may be triggered if we fail to comply with obligations under our other credit facilities or indebtedness. The Secured Credit Facility and the Oaktree SPA include a covenant that restricts the amount of other indebtedness (including capital leases and purchase money obligations for fixed or capital assets), to no more than $25 million. The accounting treatment for the seven-year equipment lease for our Salem, Oregon plant (the "Kettle US Lease") and the five-year equipment lease for our Norfolk, UK plant (the "Kettle UK Lease") caused us to be in default of the covenants limiting other indebtedness. These defaults were waived, with respect to the Kettle UK Lease on July 27, 2012, and with respect to the Kettle US Lease on August 23, 2012. Additionally, the Secured Credit Facility and the Oaktree SPA were each amended to allow the Company to incur up to $31 million of capital leases and purchase money obligations for fixed or capital assets, which amount will be reduced from and after December 31, 2013 (a) to $25 million under the Secured Credit Facility and (b) to $27.5 million under the Oaktree SPA.

34-------------------------------------------------------------------------------- Table of Contents Working capital and stockholders' equity were $52.4 million and $420.5 million at July 31, 2011, compared to $62.6 million and $376.5 million at July 31, 2010.

The decrease in working capital was due to an increase in accounts payable and accrued liabilities related to higher commodity costs and acquisition expenses, offset by an increase in receivables, associated with higher sales levels.

We believe our cash and cash equivalents, cash expected to be provided from our operations, in addition to borrowings available under our Secured Credit Facility, the Oaktree investment and restricted cash provided by the Guaranteed Loan, will be sufficient to fund our contractual commitments, repay obligations as required and fund our operational requirements for at least the next 12 months.

Contractual Obligations and Commitments Contractual obligations and commitments at July 31, 2011 were as follows (in millions): Payments Due by Period Less than 1-3 3-5 More than Total 1 Year Years Years 5 Years Revolving line of credit $ 161.3 $ - $ - $ 161.3 $ - Long-term obligations 370.4 41.7 83.7 234.1 10.9 Interest on long-term obligations (a) 44.0 13.3 22.0 7.4 1.3 Capital leases 6.3 0.9 1.9 1.9 1.6 Operating leases 22.0 5.3 6.2 3.8 6.7 Purchase commitments (b) 167.4 161.4 6.0 - - Pension liability 26.9 0.5 5.2 1.5 19.7 Long-term deferred tax liabilities (c) 132.5 - - - 132.5 Other long-term liabilities (d) 3.7 0.8 0.9 0.4 1.6 Total $ 934.5 $ 223.9 $ 125.9 $ 410.4 $ 174.3 (a) Amounts represent the expected cash interest payments on our long-term debt.

Interest on our variable rate debt was forecasted using a LIBOR forward curve analysis as of July 31, 2011.

(b) Commitments to purchase inventory and equipment. Excludes purchase commitments under Walnut Purchase Agreements due to uncertainty of pricing and quantity of future deliveries, but includes payments to walnut growers for walnuts delivered prior to July 31, 2011, but paid after that date.

(c) Primarily relates to intangible assets of Kettle Foods.

(d) Excludes $0.7 million in deferred rent liabilities. Additionally, the liability for uncertain tax positions ($11.2 million at July 31, 2011, excluding associated interest and penalties) has been excluded from the contractual obligations table because a reasonably reliable estimate of the timing of future tax settlements cannot be determined.

Off-balance Sheet Arrangements As of July 31, 2011, we did not have any off-balance sheet arrangements, as defined in Item 303(a) (4) (ii) of SEC Regulation S-K.

Effects of Inflation The most significant inflationary factor affecting our net sales and cost of sales is the change in market prices for purchased nuts, corn, potatoes, oils and other ingredients. The prices of these commodities are affected by U.S. and world market conditions and are volatile in response to supply and demand, as well as political and economic events. The price fluctuations of these commodities do not necessarily correlate with the general inflation rate.

Inflation is likely to however, adversely affect operating costs such as labor, energy and materials.

35 -------------------------------------------------------------------------------- Table of Contents 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. The Company early adopted this amendment for fiscal 2011 and will apply this guidance to business combinations going forward.

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. We do not believe that the adoption of this guidance will have a material impact on our 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. We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.

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