To the Securities and Exchange Commission: Green Mountain Coffee Roasters selectively spills the beans and its numbers still don't add up

Note to readers:

Over the last four weeks, I sent several letters to Mary Schapiro, Chairman of Securities and Exchange Commission detailing, what I believe, are Regulation FD violations and questionable financial reporting by Green Mountain Coffee Roasters (NASDAQ: GMCR). Currently, the company's financial reports are being probed by two separate divisions of the SEC: The Enforcement Division and the Division of Corporation Finance. Yet under the SEC's nose, the company is apparently continuing to engage in improper behavior. After reading excellent investigative reporting by best-selling author Roddy Boyd in his blog today, it seems that Green Mountain Coffee is an $11 billion market cap company operating like a penny stock. --- Sam E. Antar


To Mary Schapiro (Chairman of the Securities and Exchange Commission):

Starting around May 9, 2011, Green Mountain Coffee Roasters (NASDAQ: GMCR) provided certain material non-public financial information about its sales returns reserves to a few selected analysts and investors that were not disclosed in financial reports filed with the SEC. Those analysts and investors were concerned about questions raised by CNBC Senior Stocks Commentator Herb Greenberg and this blog about factors contributing to the company's reduction in sales returns reserves in the thirteen-week period ended March 26, 2011. As I will describe below, the non-public numbers that Green Mountain Coffee used to explain its reduction in sales return reserves simply don't add up. In addition, the company admitted that its financial reports from one period to the next period were "...apples to oranges." Furthermore, Green Mountain Coffee's selective disclosure of material non-public information apparently violated Securities and Exchange Commission Fair Disclosure Regulations (Regulation FD).

Background

On May 5, 2011, CNBC Senior Stocks Commentator Herb Greenberg raised questions about the quality of Green Mountain Coffee's earnings for the thirteen-week period ending March 26, 2011. It appeared that Green Mountain Coffee had a negative $22.259 million provision for its sales returns. Normally, the provision for sales returns reflects amounts added to that reserve and should be a positive number, rather than a negative number. Greenberg wanted to know if there was a certain adjustment to reserves ("a reversal") that helped Green Mountain Coffee beat analysts' earnings estimates. At the time, the company was not available to comment because it was busy on a road show selling stock to investors.

On May 9, 2011, I followed-up on Greenberg’s questions with a blog post in an effort to answer questions about Green Mountain Coffee’s sales returns accounting. According to my calculations, Green Mountain Coffee made an adjustment and reversed a significant overstatement of its sales returns reserves in the latest thirteen-week period ended March 26, 2011 from the previous thirteen-week period ended December 25, 2010. Those calculations showed that such an adjustment of reserves probably added over $20 million in revenue to its latest quarter.

See below (Click on image to enlarge):

Calculations 

In making my calculations, I started by examining sales returns disclosures in Green Mountain Coffee’s fiscal year ended December 25, 2010 10-K report. The company‘s reconciliation of its sales returns reserves showed $40.139 million “Charges to Costs and Expenses” during the fiscal year ended September 25, 2010 (See Page F-67). In its Statement of Cash Flows, the $40.139 million amount was reflected as an addition to “Cash flows from operating activities” under the caption “Provision for sales returns” (See Page F-8).

The company did not provide a reconciliation of its sales returns reserves in its subsequent 10-Q reports for periods ended December 25, 2010 and March 26, 2011. The company combined the balances of its sales returns reserves and allowance for doubtful accounts in its Balance Sheet disclosures in both subsequent 10-Q reports, instead of reporting such amounts separately.

In its December 25, 2010 10-Q , Green Mountain Coffee reported a $27.521 million “Provision for sales returns” in its Statement of Cash flows for the thirteen-week period ended December 25, 2010. It reported a combined balance of allowance for doubtful accounts and sales returns reserve of $28.989 million on its Balance Sheet. 

In its March 26, 2011 10-Q , Green Mountain Coffee reported a $5.262 million as “sale returns” in its Statement of Cash Flows for the twenty-six week period ended March 26, 2011. It reported a combined balance of allowance for doubtful accounts and sales returns reserve of $20.565 million on its Balance Sheet.

My computations showed that Green Mountain Coffee had a negative $22.259 million provision for its sales return and positive $13.810 deductions from its reserves during the thirteen-week period ended March 26, 2011 ($5.262 million minus $27.521 million). In other words, it appeared that both the provision and deduction numbers went in the opposite direction. Therefore, I reported that the Green Mountain Coffee apparently added over $20 million to revenues through a “reversal” of previously overstated reserves in its latest thirteen-week period.

In the above calculations, I assumed that Green Mountain Coffee was consistent in its presentation of “Provisions for sales returns” in its 10-K report and subsequent 10-Q reports as required under GAAP and SEC rules. Unfortunately it wasn’t

Green Mountain Coffee violated Regulation FD by selectively disclosing material financial information about its sales returns reserve to certain analysts and investors

Other analysts and investors drew the same conclusions based on Green Mountain Coffee’s murky financial disclosures and made inquiries to the company. The company did not respond to Herb Greenberg, but responded to them:

It’s a bit of apples and oranges as with Q2’11 we modified the presentation in our cash flow to better show the change in the sales return reserve.

- Q1’11 shows the $27,521 on the cash flow as “Provision for sales returns”. That is the total provision for sales returns.
- Q2’11 shows the $5,262 on the cash flow as “Sales returns”. That is the CHANGE in the reserve from the beginning of fiscal Q1’11 to the end of fiscal Q2’11.
- Q1’11 beginning reserve of $13 million. Q2’11 ending reserve of $18 million. The $5 million in the cash flow is the increase or CHANGE.
- The sales return provision in Q2’11 was $12 million.
- There was no reversal, no change in cash from operations and no impact to the statement of operations.

I hope that’s of help.

Suzanne

Note: Suzanne's full name is Suzanne DuLong. She is the Vice-President of Investor Relations and Corporate Communications at Green Mountain Coffee

Green Mountain Coffee explained to those analysts and investors that the reduction in its sales return reserves for the thirteen-week ended March 26, 2011 did not result from reversing an overstatement of it reserves in the previous reporting period ended December 25, 2010:

There was no reversal, no change in cash from operations and no impact to the statement of operations

In my opinion, the company violated Regulation FD since it provided certain material non-public financial information about its sales returns reserves to selected analysts and investors that were not disclosed in its SEC filings. It wanted to make its case and counter the above calculations provided in my blog. According to the Securities and Exchange Commission:

Regulation FD is also designed to address another threat to the integrity of our markets: the potential for corporate management to treat material information as a commodity to be used to gain or maintain favor with particular analysts or investors.

For example, Green Mountain Coffee did not disclose the balance for its sales returns reserve in its 10-Q report for the period ended March 26, 2011. The company reported the combined balances of its sales returns reserve and allowance for doubtful accounts was $20.565 million in its Balance Sheet disclosure (See page 1). However, the company disclosed to certain analysts and investors that the separate balance for its sales returns reserve was $18 million:

Q2’11 ending reserve of $18 million.

In addition, it selectively disclosed to certain investors and analysts that:

The sales return provision in Q2’11 was $12 million.

Such material information about its sales returns were not disclosed in its 10-Q report for the period ended March 26, 2011, but was disclosed to certain selected investors and analysts.

Did Green Mountain Coffee fail to properly disclose inconsistencies in its financial reporting of sales returns reserves?

As I detailed above, I assumed that Green Mountain Coffee was consistent in its presentation of its provisions for sales returns in its fiscal year 2010 10-K reports and subsequent 10-Q reports, as required under GAAP and SEC rules. According to "Financial Accounting: The Impact on Decision Makers" by Gary A. Porter and Curtis L. Norton, "Consistency means that financial statements can be compared within a single company from one accounting period to the next." (See page 58). However, as detailed below, Green Mountain Coffee made changes in its Statement of Cash Flows without disclosing them to investors.

Green Mountain Coffee included the “Provision for sales returns” in its Statement of Cash Flows as an addition to “Cash flows from operating activities” in both its fiscal year 2010 10-K report and its subsequent 10-Q report for the period ended December 25, 2010. The company included a line item called “Sales returns” totaling $5.262 million in its Statement of Cash Flows as an addition to “Cash flows from operating activities” in its 10-Q report for the period ended March 26, 2011.

Like many other analysts and investors, I assumed that the line item “sales returns” listed in its Statement of Cash Flows in its 10-Q report for the period ended March 26, 2011 was the same as its “Provision for sales returns” in the Statement of Cash Flows in its previous 10-Q and 10-K reports. It turns out that the "Sales returns" line item was not a "Provision for sales returns." Instead, the "Sales returns" line item reflected the total change in the sales returns reserve from the period ended December 25, 2010 to the period ended March 26, 2011.

In other words, Green Mountain Coffee deceptively changed its presentation of its sales returns reserve numbers in its Statement of Cash Flows without telling investors. It could have used the term “Change in sales returns reserve” instead of “Sales returns reserve” to avoid misleading and confusing investors. It didn’t.

The company conceded that it confused investors by telling certain analysts and investors that:

It’s a bit of apples and oranges as with Q2’11 we modified the presentation in our cash flow to better show the change in the sales return reserve.

[Snip]

Q2’11 shows the $5,262 on the cash flow as “Sales returns”. That is the CHANGE in the reserve from the beginning of fiscal Q1’11 to the end of fiscal Q2’11. [Emphasis added.]

In its 10-Q report for the period ended March 26, 2011, the company made the following disclosure:

The Company has revised the classification of certain information presented in its fiscal 2010 audited consolidated financial statements [10-K report] to conform to its fiscal 2011 presentation. [Bracketed information added for clarity.]

However, when the company detailed its revision of its Statement of Cash Flows, it failed to mention any change in presenting its sales returns numbers from previous reporting periods. See below:

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 fiscal 2010 financial statements are next issued. [Emphasis added].

None of the revisions disclosed by the company relate to its change in presenting its sales returns reserve numbers in the Statement of Cash Flows in its 10-Q reports.

Green Mountain Coffee's troubling explanation of impact of changes in sales returns reserve on cash flows

Green Mountain Coffee claimed that:

It’s a bit of apples and oranges as with Q2’11 we modified the presentation in our cash flow to better show the change in the sales return reserve.

The company explained to certain analysts and investors that:

Q2’11 shows the $5,262 on the cash flow as “Sales returns”.

[Snip]

The $5 million in the cash flow is the increase or CHANGE.

It's hard to see how Green Mountain Coffee's financial reporting was improved by modifying its presentation of cash flows. The $5.262 million change in its sales returns reserve balance is not, by itself, an addition to cash flows from operating activities in the Statement of Cash Flows for the twenty-six week period ended March 26, 2011. The change in the sales returns reserve reflects the difference between provisions for sales returns and deductions from the sales returns account. 

The provision for sales returns is supposed to reflect amounts that are added to the sales returns reserve for estimated future product returns. The accounting entry increases the sales returns reserve and reduces revenues. Therefore, the provision for sales returns can be reflected as an addition to cash flows from operating activities in the Statement of Cash Flows. 

When customers return products to the company, the accounting entry reflects a deduction in the sales returns reserve and either increases accounts payable (liability to the customer) or reduces accounts receivable (amounts owed to the customer). Deductions from the sales return reserve are not additions to cash flows from operating activities in the Statement of Cash Flows since it has no effect on cash or net working capital.

Since the $5.262 million change in sales returns reserve includes deductions from that reserve, it is not an addition to cash flows from operating activities in the Statement of Cash Flows. Certain analysts and investors asked the company about the discrepancy, but the company did not respond to them.

A new can of worms – numbers that don’t add up

As I detailed above, Green Mountain Coffee reported separate balances for its sales returns reserve and for its allowance for doubtful accounts in the fiscal year ended September 25, 2010 10-K of $12.742 million and $1.314 million. However, Green Mountain Coffee combined the balances of its sales returns reserves and allowance for doubtful accounts in its Balance Sheet disclosures in its subsequent 10-Q reports for the periods ended December 25, 2010 and March 26, 2011. In both subsequent 10-Q reports it showed a beginning September 25, 2010 combined balance of both reserves totaling $14,056 million. The combined balance its sales returns reserve and its balance for the doubtful accounts was $20.565 million in twenty-six week period ended March 26, 2011 10-Q report.  The combined amount of both reserves increased $6.509 million during the twenty-six week period ($20.565 million minus $14.056 million). See excerpt from Balance Sheet below (Click image to enlarge):

In both its fiscal year ended September 25, 2010 10-K 2010 report and its subsequent 10-Q report for the period ended December 25, 2010, it included a “Provision for doubtful accounts” in its Statement of Cash Flows as an addition to “Cash flows from operating activities.” In its March 26, 2011 10-Q , Green Mountain Coffee reported $0.400 million as “Bad debts” in its Statement of Cash Flows for the twenty-six week period ended March 26, 2011. Now that the company has clarified its reporting of sales returns numbers, we can assume that the $0.400 million amount listed as “Bad debts” in the Statement of Cash Flows is the change in that reserve balance for the twenty-six week period ended March 27, 2011 and not a “Provision for doubtful accounts”. See excerpt from Statement of Cash Flows below (Click on image to enlarge):

  

Green Mountain Coffee claimed to certain analysts and investors that its sales returns reserve increased $5.262 million during the twenty-six week period ended March 27, 2011. Likewise, the allowance for doubtful accounts increased $0.400 million during the same period. The total increase in both reserves should be $5.662 million ($5.262 million plus $0.400 million). However, according to the Balance Sheet in the March 27, 2011 10-Q report, the combined amount of both reserves increased $6.509 million during the twenty-six week period. Therefore, there is a $0.847 million discrepancy in the company’s reserve numbers.

See my revised calculations below, based on the company's selective disclosures to certain analysts and investors (Click on image to enlarge):

The numbers add up for the previous year's thirteen-week period ended March 27, 2010 but don't add up for the current year's period ended March 26, 2011.


Recommendations

The Securities and Exchange Commission must require Green Mountain Coffee to file an 8-K report so that all analysts and investors are privy to the same information it selectively provided to certain analysts and investors. The company should be required to clarify its misleading sales returns reserve disclosures and discrepancies in its numbers, too. Further, the SEC should investigate and subpoena all of Green Mountain Coffee’s emails to analysts and investors for possible additional FD violations. The ball is in your court!

Respectfully,

Sam E. Antar

Other reports

June 6, 2011: StreetInsider.com - Green Mountain Coffee (GMCR) Falls After Blogger Sends Reg FD Violation Report to SEC

June 6, 2011: Benzinga - Financial Investigator Warns About Green Mountain Coffee Roasters by Paul Quintaro

June 6, 2011: The Financial Investigator - GMCR: From Small Beans Big Trouble One Day Brews by Roddy Boyd


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 as an independent whistleblower. I teach about white-collar crime for government entities, 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.