Deloitte caught in Diamond Foods’ glare

21 February 2012 | By Jeffrey Goldfarb

Deloitte can’t seem to avoid the spotlight. Just a few months ago, it became the first of the Big Four accounting firms to be publicly shamed by their U.S. regulator for past failings. And now another client, Diamond Foods, has admitted to botching two years of financial reports. Deloitte could be headed back into the spotlight.

The world’s largest accounting and consulting firm has examined and signed off on Diamond’s numbers since the onetime walnut-grower collective went public in 2005. The snack food company said earlier this month that it logged a total of $80 million of payments incorrectly in the fiscal year ended July 31, 2011, and in the current year. When asked by Breakingviews last September to explain to which period one set of payments applied, a company official said it was “somewhat of a blur.” It’s not an answer that inspires much confidence in the company’s audited figures.

Diamond has tried to draw a line under the matter. The company’s own investigation blamed failures in internal controls for the mistakes, and Diamond replaced its chief executive and chief financial officer. But if past accounting scandals are any guide, more problems could surface that embarrass not just the company’s officials but also, potentially, its auditor.

Aside from the grower payments, there was a curious increase in the estimated cost of its now-dead deal to buy Pringles that was never fully explained. The firm’s capital expenditures may also need clarification. Between August 2010 and February 2011 Diamond announced plans to spend a total of nearly $60 million on three plant expansions. In two of the cases, the expected costs look high compared with the price tags for previous investments at the same plants and the third contained little detail. Diamond provided Breakingviews with additional information, and the company and its auditor may be able to further explain the figures.

Deloitte could have to, one day, especially considering its recent history. After the firm, which declined to comment, was given a year to improve its quality controls and failed, the Public Company Accounting Oversight Board went public last October with an inspection report that is typically kept private. The PCAOB also has been toughening up enforcement in general, including stinging Ernst & Young with a $2 million fine earlier this month, the board’s largest ever.

When Diamond said in December it expected to finish its internal accounting probe by February, one Wall Street analyst considered the news to be a sign the company’s auditor must be standing by its work. “Deloitte’s silence is golden,” he wrote. As it turns out, he might have done better to interpret the silence as deafening.

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Diamond Foods, which said on Feb. 8 it would need to restate earnings for fiscal years 2010 and 2011 because of improper accounting related to payments to walnut growers, announced $56 million worth of plans to expand three plants between August 2010 and February 2011.

In August 2010, Diamond said it would spend $8.4 million to increase capacity at its Salem, Oregon Kettle chips plant by 25 percent. In January 2006, before Kettle Foods was owned by Diamond, the Associated Press reported that Kettle said it would spend $2 million on equipment to increase capacity by 30 percent.

Diamond said in a statement to Breakingviews on Feb. 21 that its Salem expansion costs “came in at closer to $9 million” and included equipment that does more than just add capacity and which serves the entire plant. It said the building cost was about 30 percent of the total cost and equipment 70 percent.

In November 2010, Diamond announced a $38 million expansion to double capacity at its Beloit, Wisconsin Kettle plant. In the same AP article from January 2006, Kettle said it would spend $18 million to build the plant in Beloit.

Diamond said the original plant cost $20 million and that the previous owners invested $8 million more in two expansions in 2009 and an upgrade in potato handling. Diamond also said its own expansion included equipment that serves the entire plant.

“Taking out those two plant-wide pieces of equipment and coming in under budget, the cost of the expansion was approximately $29 million, or $1 million more than the original plant,” the company said.

In February 2011, Diamond said it would spend $10 million to expand a plant in Norwich, in the United Kingdom. The company’s press release did not provide any specifics about the expenditure or whether it would expand capacity at all.

Though Diamond said in September this expansion was due to be completed last fall, it told Breakingviews the work is still under way. “The expansion consists of packaging lines and other equipment as well as expanded employee facilities,” Diamond said.