Not much is going well in the region's economy, but Stockton-based nut giant Diamond Foods Inc., has been making nearly all the right moves. When the farm price of walnuts rose, Diamond simply raised the cost of its packaged nuts. Shoppers kept buying. After sales of the firm's Emerald snack line slowed, Diamond decided to grow by acquisition, buying Pop Secret. Analysts cheered.

Now, the strengthening dollar and the global economic slowdown are hammering bulk nut prices. And Diamond is looking at bigger profits. The result: While the Nasdaq is down 41 percent for the year as of Monday's close, Diamond is up 21 percent. Diamond's stock had been substantially higher before a big drop last Thursday � and that bad day brought CNBC's Jim Cramer racing to defend the company's fundamentals on national television.

"What Diamond is doing right is growing its earnings � and that's pretty much all it takes in this environment" to please investors, said Mark Argento, a senior analyst at Craig-Hallum Capital Group LLC in Minneapolis. Still, as Thursday's drop showed, the party may not last. Diamond is having a tough time getting its snack nuts onto store shelves in many grocery chains. And competition in the nut business is getting tougher: Retailers are expanding their lines of lower-priced store-brand nuts, and food giants like Frito-Lay are jumping into the mix.

What's more, Diamond is being sued by some of the 1,600 farmers � including many in the Sacramento Valley � who supply its walnuts and claim they've been underpaid. If the suit recovers even a fraction of the more than $50 million the plaintiffs claim growers are owed, Diamond's profit growth could be wiped out.

Diamond's headquarters sit opposite a huge yard of wood pallets a mile southeast of downtown Stockton. From the outside, the structure resembles a high school built in the 1950s. On a recent morning, the air smelled of honey-roasted nuts. For most of its 96-year history, Diamond was a quiet, if successful, farmer-owned cooperative. It once processed more than half the state's walnut crop and is still the world's largest walnut handler.

When Chief Executive Michael Mendes was hired in 1997, the operation brought in about $180 million annually and sold little besides walnuts. About two-thirds of its revenue came from the relatively low-margin bulk-nut business. The rest came from bagged walnuts generally sold in supermarkets' baking sections. Mendes, just 33 years old when he took the job, decided the future was in higher-margin processed nuts backed by aggressive marketing. "We realized we needed to get into the snack aisle," he said.

In the years since, and especially after the company launched its Emerald snack line in 2004, Diamond's product line has ballooned to more than 800 different flavors, mixes and package shapes and sizes. The company developed the first shelf-stable glazed walnut and a proprietary "cocoa roast" almond. Sales of so-called culinary nuts � marketed for home cooking � have also strengthened

In interviews, Mendes peppers his rapid speech with marketing lingo. He has spent heavily on the company's offbeat television ad campaigns. One featured a pixie-like Robert Goulet dropping in to play pranks on drowsy office workers who didn't eat their Emerald nuts. Diamond also sponsors college football's Emerald Bowl and has run commercials during the Super Bowl in three of the last four years.

Still, Diamond has struggled to elbow out much-larger rival Planters for space on supermarket shelves, Mendes admits. Chicago-based Kraft Foods Inc., which owns the Planters brand, is about 70 times the size of Diamond, with a vast sales force and well-defended turf in virtually every grocery outlet in the nation. After doubling each year for three years straight, Diamond's snack sales grew just 11 percent during the 12 months ended June 30.

To reinvigorate those snack sales, Diamond paid $190 million in August for General Mills' Pop Secret brand. Mendes has already launched a national ad campaign for the microwave popcorn, and analysts are optimistic that Emerald will piggyback on Pop Secret into more grocery stores. "It certainly has played a role in the stock price doing well over the last couple months," said Alton Stump, a food-industry analyst at Longbow Research in Cleveland.

To fund the company's transition to the snack business, Mendes took Diamond public in 2005. But as the company has moved from a cooperative to a shareholder-owned corporation, it has angered some of the farmers who've grown its nuts for decades.

"They've made that stock go up on our backs," said Grant Thompson, 61, who farms 120 acres of walnuts east of Stockton. He's one of more than 40 farmers suing Diamond for paying what they say is as much as 10 cents a pound below market rate � $40,000 a year for Thompson � in violation of their contracts.

Mendes says the company's payments have been both fair and legal. He seems almost personally hurt by the attacks. "I grew up in Oakdale" amidst nut farmers, he said. "We went to high school together." Diamond's dealings with its growers are private, so it's not possible to say what prices it's paying. A San Joaquin County Superior Court judge ruled in the company's favor in August. The farmers have appealed.

Even if some of Diamond's walnut suppliers defect, it may not be a problem for the company. A recent report by research firm BMO Capital Markets estimated Diamond has been selling fewer walnuts over the past four years. Revenue has grown, though, as the company has added other nuts � almonds, cashews, peanuts � and raised prices.

Indeed, what matters most to investors is not the tons of nuts Diamond is selling, but whether the company is making more money doing it. Thanks to a record harvest and weaker overseas demand tied to the stronger dollar, nut prices are dropping. But Diamond likely won't be forced to cut its prices for some time, Stump said, putting the company further into the black.

On Wednesday afternoon, Diamond beat analysts' expectations for the most recent quarter and projected that profits would continue to grow. But Wall Street expects a lot of its darlings. Investors were looking for Mendes to promise more growth in both revenue and profits, and Diamond's shares tumbled 23 percent on Thursday. The stock has bounced back somewhat, recovering nearly a third of that loss.
::Print -->