Sunday, February 13, 2011

Green Mountain Coffee Roasters: Murky Financial Disclosures

Updated

Just about every time, I examine financial reports issued by Green Mountain Coffee Roasters (NASDAQ: GMCR), I find new troubling accounting practices and financial disclosures. For example, in my last blog post I questioned whether the company correctly considered a certain accounting error as an "immaterial accounting error" when it was originally reported to investors. In this blog post, I will examine Green Mountain's segment reporting and non-GAAP financial presentations and raise questions whether they properly comply applicable accounting and SEC disclosure rules. In addition, I will discuss other new reporting errors disclosed by Green Mountain in its latest 10-Q report.

Last Saturday, fellow Seeking Alpha contributor Jason Merriam noted in his article that, "The accounting practices at Green Mountain Coffee Roasters (GMCR) are not baffling...they are downright ludicrous." I think Green Mountain's financial disclosures are both baffling and ludicrous.


Background

On September 20, 2010, the SEC notified Green Mountain Coffee Roasters that it was conducting an informal inquiry. It requested information concerning “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” Eight days later, on September 28, 2010, Green Mountain surprised investors by disclosing news of the SEC inquiry in an 8-K filing.

In that 8-K report, Green Mountain also disclosed that it discovered an "immaterial accounting error" involving its K-Cup margin percentages which resulted in a $7.6 million cumulative overstatement of pre-tax income in financial reports issued from 2007 to June 26, 2010. Since Green Mountain determined that its K-Cup margin error was immaterial under accounting rules, it disclosed that it was going to correct that error by making a one-time cumulative adjustment to earnings in the latest quarter.

On November 19, 2010, Green Mountain disclosed three new overstatements totaling $3.2 million pre-tax income and one new understatement of $0.7 million in pre-tax income. These errors plus the K-Cup margin error resulted in a total overstatement of $10.1 million in pre-tax income. This time, the company said it would restate its financial reports issued from 2007 to 2010 to correct its errors.

In my last blog post, I questioned whether Green Mountain correctly determined that its K-Cup margin error was an "immaterial accounting error" when it was initially disclosed on September 28, 2010. Under SEC Staff Accounting Bulletin No. 99, an individual accounting error that overstates profits and causes a company to beat analysts' consensus earnings expectations for any reporting period should be considered a material accounting error.

My analysis showed that the K-Cup margin error caused Green Mountain to overstate profits and beat analysts' consensus earnings expectations in the quarter ended March 27, 2010. Therefore, Green Mountain should have considered its K-Cup margin error as a material accounting error on September 28, 2010 and it should have immediately disclosed to investors that it was going to restate its financial reports from 2007 to 2010 to correct that error. Instead, Green Mountain waited until November 19, 2010 to inform investors that it was going to restate its financial reports.

Below, I will examine certain other financial disclosures by Green Mountain and raise questions whether the company properly complied with GAAP and other applicable SEC disclosure rules.


Restating segment numbers without disclosing it

I compared Green Mountain’s segment reporting in its Q1, Q2, and Q3 2010 10-Q reports with the previously year’s corresponding 10-Q reports and found certain inconsistencies in amounts reported for income before taxes, total assets, and depreciation and amortization. For example, in its Q3 2009 10-Q report, Green Mountain originally reported the following selected segment information for the 39 weeks ended June 27, 2009:


In its Q3 2010 10-Q report, Green Mountain reported different segment numbers for the same period ending June 27, 2009:


In its Q3 2009 10-Q, Green Mountain reported that “Income before taxes” for the Keurig segment was $29.725 million for the “Thirty-nine weeks ended June 27, 2009.” However, in the Q3 2010 10-Q, Green Mountain reported that “Income before taxes” for the Keurig segment was $26.116 million for the same “Thirty-nine weeks ended  June 27, 2009” or $3.609 million less income than previously reported.  Apparently, Green Mountain revised its earnings for its Keurig segment by shifting $3.609 depreciation and amortization expense from Corporate and reallocated it to its Keurig segment.

SCBU and Keurig segment total assets

In the Q3 2009 10-Q, Green Mountain reported “total assets” of $412.413 million for its SCBU segment, $112.857 million for its Keurig segment, and $99.565 million for Corporate  as of June 27, 2009. However, in its Q3 2010 10-Q, Green Mountain reported “total assets” of $236.181 million for its SCBU segment, $240.859 million for its Keurig segment, and $14.936 million for Corporate as of June 27, 2009.

Changes in computing profits and assets for segments

In its Q3 2009 10-Q, Green Mountain disclosed that:
Corporate expenses also include interest expense, amortization of identifiable intangibles related to the acquisition of Keurig, as well as certain corporate legal expenses and compensation of the board of directors. All of the Company’s goodwill for the Keurig business unit and intangible assets related to the Keurig business unit are included in Corporate assets. [Emphasis added.]
However, in its Q3 2010 10-Q Green Mountain disclosed that:
Corporate expenses also include interest expense, certain corporate legal and acquisition-related expenses and compensation of the board of directors. In addition, fiscal 2009 corporate expenses are offset by $17,000,000 of proceeds received from a litigation settlement with Kraft. Corporate assets include cash and short-term investments.
Goodwill and intangibles related to the Frontier Natural Products Co-op, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU reporting unit of the Company. Goodwill and intangibles related to Green Mountain Coffee Roasters, Inc.’s acquisition of Keurig are included in the Keurig reporting unit of the Company. [Emphasis added]
According to Green Mountain's Q3 2009 10-Q report, its "Corporate expenses" included “amortization of identifiable intangibles related to the acquisition of Keurig.” According to Green Mountain's Q3 2010 10-Q report, those same expenses were apparently “included in the Keurig reporting unit of the Company” instead of being considered as "Corporate expenses." In 2009, Green Mountain considered goodwill and intangible assets related to the Keurig as part of "Corporate assets." In 2010, those same goodwill and intangible assets were no longer "Corporate assets" but were included in the Keurig segment's balance sheet.

The re-allocation of goodwill and intangible assets seems to be the reason behind Green Mountain’s revision of its reported income before taxes for the thirty-nine weeks ended June 27, 2009 for its Keurig segment from $26.116 million in its Q3 2009 10-Q report to $29.725 million for the same period in its Q3 2010 10-Q report. In addition, the re-allocation of goodwill and intangible assets seems to explain why Keurig’s total assets as of June 27, 2009 was revised upward from $112.857 million in its Q3 2009 10-Q report to $240.859 million in its Q3 2010 10-Q report for the same June 27, 2009 date.

Green Mountain’s murky financial disclosures do not seem to explain why the company made downward revisions of its total assets for its SCBU segment as of June 27, 2009 from $412.413 million in its Q3 2009 10-Q report to $236.181 million in its Q3 2010 10-Q report.

Did Green Mountain comply with segment reporting rules under GAAP?

According to Statement of Financial Reporting Standards No. 131 (SFAS No. 131):
31. An enterprise shall provide an explanation of the measurements of segment profit or loss and segment assets for each reportable segment. At a minimum, an enterprise shall disclose the following…. d. The nature of any changes from prior periods in the measurement methods used to determine reported segment profit or loss and the effect, if any, of those changes on the measure of segment profit or loss.
However, Green Mountain made no reference to any change in its "measurement methods" used to determine profit and losses for its segments from 2009 to 2010. The company did not disclose that it revised 2009 earnings for its Keurig segment. As detailed above, Green Mountain revised its income before taxes for the thirty-nine weeks ended June 27, 2009 for its Keurig segment from $26.116 million in its Q3 2009 10-Q report to $29.725 million for the same period in its Q3 2010 10-Q report. According to SFAS No. 131, Green Mountain Coffee should have disclosed that it changed its computations for reporting profits for its Keurig segment. The company effectively restated its segment numbers without telling anyone.

Compensation issues

In its latest proxy statement Green Mountain disclosed that:
Our incentive compensation plans are typically based on corporate and business unit performance, measured by a range of objective and subjective criteria, and not solely on individual performance.
I was unable to determine from Green Mountain's financial disclosures if it made any compensation adjustments resulting from it revising profits for its Keurig segment for the thirty-nine weeks ended June 27, 2009.

Green Mountain’s Non-GAAP Disclosures

Over the last couple of years, I’ve identified many instances of public companies violating of Securities and Exchange Commission (SEC) Regulation G governing non-GAAP financial measures. In each case, those companies corrected their financial reports to properly comply with Regulation G after I notified them about their violations.  As I will detail below, Green Mountain needs to revise its presentation of non-GAAP net income to comply with SEC Regulation G.

For example, in its Q1 2011 10-Q report the Green Mountain presented the following reconciliation of its GAAP net income and non-GAAP net income:



According to Regulation G, Green Mountain's non-GAAP net income is required to be reconciled to its most directly comparable GAAP measure, which in this case is GAAP net income. Accordingly, Green Mountain showed how its non-GAAP net income did not include acquisition-related expenses, SEC inquiry expenses, and amortization of identifiable intangibles. However, according to SEC Regulation G Compliance & Disclosure Interpretations, Green Mountain cannot provide side-by-side reconciliations of GAAP and non-GAAP numbers in such a way that it presents a full non-GAAP income statement. See below:
Question 102.10
Question: Is it appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures?
Answer: Generally, no. Presenting a full non-GAAP income statement may attach undue prominence to the non-GAAP information. [Jan. 11, 2010].
For example, NightHawk Radiology Holdings, Inc. made a similar reconciliation of GAAP and non-GAAP numbers and provided a full non-GAAP income statement in its 8-K report dated filed on February 17, 2010. See below:


On April 2, 2010, the SEC Division of Corporation Finance reviewed NightHawk Radiology Holdings 8-K report:
1. We note that you have presented an alternative income statement which excludes certain items recorded in your GAAP-basis Statements of Operations. This represents a full non-GAAP income statement which does not appear to be consistent with Regulation G. Please confirm in future Exchange Act filings you will remove such presentation or tell us why you believe it is appropriate. For additional guidance, refer to Question 102.10 of the Compliance & Disclosure Interpretations regarding Non-GAAP Financial Measures.
On April 14, 2010, NightHawk Radiology Holdings responded to the SEC Division of Corporation Finance:
The Company confirms that it will remove from future filings the presentation referred to above in this Comment 1 and replace it with a reconciliation table that is consistent with the guidance provided in the Answer to Question 102.10 of the Compliance & Disclosure Interpretations regarding Non-GAAP Financial Measures.
On May 6, 2010, NighHawk Radiology Holdings issued its 10-Q report and made a proper reconciliation of its non-GAAP adjusted net income to GAAP net income in compliance with Regulation G:


This time, NighHawk Radiology Holdings reconciled its non-GAAP adjusted net income to GAAP net income without providing a full non-GAAP income statement. Green Mountain should do the same.

Continuing financial reporting problems

In its Q1 2011 10-Q report, Green Mountain disclosed that it made errors in its previously audited fiscal year-end consolidated statement of cash flows:
Revision to Fiscal 2010 Year-End Consolidated Statement of Cash Flows
In preparing the consolidated financial statements for the thirteen weeks ended December 25, 2010, management identified that certain amounts previously disclosed within the Consolidated Statement of Cash Flows for the fiscal year ended September 25, 2010 required reclassification. These misstatements had no effect on the Company’s cash and cash equivalents. Specifically, the supplemental disclosure of fixed asset purchases included in accounts payable and not disbursed was overstated by approximately $8.2 million. This resulted in an $8.2 million understatement on the capital expenditures for fixed assets line and net cash used for investing activities category for fiscal 2010 and a corresponding understatement of the change in accounts payable line and an overstatement of net cash used in operating activities. The Company will make this immaterial correction when the 2010 financial statements are next issued.
The company reported continuing material weaknesses in internal controls over financial reporting for its latest quarter:
Under the supervision of and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, as of December 25, 2010. Based on that evaluation and the material weaknesses referenced above, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of December 25, 2010. [Emphasis added].
Closing comment

In its Q1 2011 10-Q report, Green Mountain disclosed that it was spent about $6 million on "legal and accounting expenses related to the SEC inquiry, the Company’s internal investigation and pending litigation" or approximately $46,000 per week during the quarter. According to Green Mountain's latest proxy statement, the combined annual base salaries for fiscal 2010 of its top five executive officers are just $2.01 million. In other words, in a single quarter Green Mountain spent three times the annual base salaries of its five top executive officers on legal and accounting issues arising from its restatements of financial reports.

The company's Audit Committee and Board of Directors recommended that "shareholders ratify the Audit Committee’s appointment of PricewaterhouseCoopers LLP" as its auditors. From 2007 to Q3 2010, every single financial report issued by Green Mountain which was audited or reviewed by PricewaterhouseCoopers needed to be restated due to material accounting errors. To date, no member of Green Mountain's board, none of its executive officers and certainly not its auditors have been held accountable for any errors in financial reporting.

Written by:

Sam E. Antar

Recommended reading:

February 11, 2011: Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

1 comment:

DSaid said...

Sam-

What's the bottom line here...are GMCR's executives incompetent, criminal, or both.

Shouldn't PWC shoulder most of the blame as every financial statement in recent years has had to be restated due to errors?

And amidst this, GMCR's chart is gorgeous. It's up 500% since Jan '09, 70% since Jan '10, and 40% this month!

Why does Wall Street not care in the slightest about these errors?

Again, thanks for what you do.

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