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Exclusive: Walnut growers seek to stop sales to Diamond

By Mihir Dalal and P.J. Huffstutter

(Reuters) - Some California farmers plan to stop selling their walnuts to Diamond Foods Inc in the wake of an accounting scandal over grower payments that has claimed the jobs of the snack company's chief executive and chief financial officer.

Six small walnut growers told Reuters they would stop supplying Diamond when their contracts expire because they say the company has been underpaying farmers. Three of those growers said they hoped to break their contracts early.

Diamond declined to comment on its relationship with growers. The company this week said it had to restate earnings for 2010 and 2011 after its audit committee found that it had improperly accounted for payments to walnut growers.

The walnut growers Reuters spoke to said they know of more than a dozen other growers who also want to terminate their relationships with Diamond. While that is still a fraction of the roughly 1,000 growers who supply Diamond, if there is an exodus, it could hurt the company's ability to fulfill orders or force it to pay more in an increasingly competitive market.

"Their prices are just not competitive," said Guy Harris, whose family has sold walnuts to Diamond for 45 years. "In 2010, they were 25 percent below a lot of other buyers."

Harris, who sells about 400 tons of walnuts every year and owns Diamond shares, said he will not renew his contract when it expires later in February. He said he knew of at least three other growers who were looking to exit their contracts.

Diamond is being investigated by the U.S. Securities and Exchange Commission and, according to the Wall Street Journal, U.S. prosecutors have launched a criminal probe. The maker of Emerald nuts, Kettle chips and Pop Secret popcorn this week placed Chief Executive Michael Mendes and Chief Financial Officer Steve Neil on administrative leave.

Critics have said that Diamond delayed certain payments in orders to boost its earnings while it was negotiating to buy the Pringles potato chip business from Procter & Gamble Co, a deal which is now not expected.

But growers have also said that they have long been underpaid by Diamond.

Sally Kafkares, who farms 40 acres in Rio Oso, California, said she would not be renewing her contract in April. She and her husband have sold nuts to Diamond since 1999. They delivered less than 200,000 pounds of nuts to Diamond last year and plan to sell to Fisher nut processor John B. Sanfilippo & Son Inc from this year onward, she said.

Sanfilippo and other Diamond rivals have been trying to increase their share of the California walnut market, which is booming amid growing demand from China and elsewhere in Asia.

"Recently, we have had a number of Diamond growers come over to us," said Bobby Tankersley, senior vice president of procurement and commodity risk management at Sanfilippo.

Tankersley declined to say how many growers have come on board, but his company is not the only one benefitting from Diamond's troubles.

"It's open season right now," said Don Barton, president of GoldRiver Orchards in Oakdale, California, which buys and grows walnuts. "I know that we're heavily recruiting growers right now, and we're not the only ones."

"The growers are very concerned with what's happened and they want to find a stable home," added Barton, who runs GoldRiver's marketing and processing divisions.

SHORT END OF THE STICK

Diamond started as a California walnut growing cooperative in 1912 and went public in 2005, turning co-op members into both shareholders and suppliers with multi-year contracts.

Many of these contracts allow Diamond to buy the nuts at below-market rates, sources say, but many growers accepted the rate since Diamond would take an entire season's crop.

Still, not all growers were happy about it.

Before Diamond went public, Matt Conant used to sell his entire supply -- over 1 million pounds -- of walnuts to Diamond. But when the company was looking to go public, it asked growers to sign new contracts, which Conant said were "very vague" about prices. With the land that owned, he decided not to renew his contract, which expired in 2007.

"I was afraid growers would get the short end of the stick," said Conant, who currently supplies some 200,000 pounds of walnuts to Diamond from land that he leases from and farms for an elderly woman.

"I'm trying to get the owner out of the contract because we are just frustrated with the whole situation. I don't know if Diamond will agree, because there are still three years left."

Conant, who owns 21,000 shares of Diamond stock, said he knows of at least five other growers looking to get out of their contracts with Diamond, and that several other farmers did not renew their contracts last year.

Kafkares, who sold her Diamond stock in 2009, said she knows five growers looking to get out.

Conant was on the Diamond Advisory Council -- which used to elect the organization's board -- before the then co-operative went public in 2005. Conant said he had cast a "no vote" in a ballot that decided if Diamond should go public -- despite efforts by the then CEO Mendes to convince him to vote in favor -- partly due to Conant's concerns about how the company would treat walnut growers.

A recent spike in walnut prices, fueled by exports and a growing domestic interest in healthier foods, has exacerbated the gap between market rates and Diamond's rates, sources say.

Agricultural exports are hitting record levels, with U.S. farm exports reaching a record $136.3 billion in 2011. California, known for nuts including walnuts, almonds and pistachios and stone fruits like peaches and plums, is benefitting from this boom.

Diamond Foods, based in San Francisco, California, is the one of the biggest walnut processors in California. Diamond's biggest rivals include C.R. Crain & Sons and Crain Walnut Shelling in Los Molinos, Mariani Nut Co in Winters, Poindexter Nut Co in Selma, the Gustine operations of Illinois-based Sanfilippo and ShoEi Foods USA in Olivehurst.

Diamond shares, which closed at $23.52 on Friday on the Nasdaq, have tumbled 76 percent from their high of $96.13 touched in September.

(Writing by Martinne Geller in New York; Editing by Bernard Orr)

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