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.

Green Mountain Coffee Roasters’ Growing Inventory Levels: Is It a Fumble or a Fraud?

Has Green Mountain Coffee Roasters (NASDAQ: GMCR) fumbled in managing its inventory or has it engaged in an inventory fraud to inflate earnings?

Background

As the criminal CFO of Crazy Eddie, I learned that the overstatement of inventory levels was the easiest way to inflate earnings. Auditors don't always supervise the counting of each and every physical inventory item to confirm their existence. Even if the auditors confirm the physical existence of all inventory items, they don't always trace how every single item arrived in a company's storage facilities. Therefore, the same inventory items can be moved from location to location and counted several times to inflate earnings.

In September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee's revenue accounting practices. Shortly afterwards, a class action lawsuit was filed against the company alleging that it engaged in securities fraud by inflating its inventory numbers to overstate its reported earnings. According to the amended class action lawsuit, several confidential witnesses who worked for Green Mountain Coffee allege that it moved around its inventory from location to location without a document trail to overstate inventory counts and inflate earnings. For example, paragraph 79 of the amended complaint alleges that:

CW7 [confidential witness 7], a lower-level employee in the Company's shipping department in Knoxville Tennessee, who worked at the Company from August 2009 through August 2011, also witnessed GMCR improperly transferring product from one plant to the next for no apparent reason. [Bracketed information added for clarity.]

In October 2011, money manager David Einhorn slammed Green Mountain Coffee's and noted "odd material movements" of inventory to possibly confound its auditors.

If there is inventory growth that is higher than revenue growth over extended periods of time combined with declining inventory turnover trends, it is considered to be a red flag for the possible inflation of inventory numbers and overstatement of earnings. For example, before the Crazy Eddie fraud was uncovered, independent analyst Thornton L. O’glove noted that its inventory levels were growing much faster than revenues. He was suspicious that Crazy Eddie was fraudulently inflating its inventories to overstate its profits. Unfortunately, most investors and analysts ignored the red flags that he spotted. (Source: Wall Street Journal – By the Numbers: How One Analyst Scores Big by Finding the Dark Side, by Jeffrey A. Tannenbaum and Lee Berton, August 4, 1987).

Is Green Mountain Coffee another Crazy Eddie?

Green Mountain Coffee's inventory levels have grown much faster than its growth in revenues in the last seven quarters since the S.E.C started its probe. Therefore, Green Mountain Coffee's inventory turnover rate declined in each quarter reflecting longer periods of time to sell its products. A comparison of Green Mountain Coffee's financial reports reveal that ever larger amounts inventory on hand are required to sell relatively less products quarter-after-quarter and year-after-year. See the chart below comparing Green Mountain Coffee's reported revenue increases compared to its reported increases in inventories. (Click on the table image below to enlarge it.)

Likewise, Crazy Eddie's had a similar pattern of inventory increases that exceeded revenue increases over an extended period of time resulting in declining inventory turnover. It seemed like Crazy Eddie needed ever larger amounts of inventory to sell relatively less product. For example, in fiscal year 1987 Crazy Eddie's reported revenues increased 34% while its inventories increased 82% when compared to the previous fiscal year. Its reported inventories grew at more than twice the rate of reported revenues. In November 1987, new management ousted the Antar's from Crazy Eddie and discovered that most of the inventory on its books did not exist!

Similarly, Green Mountain Coffee's reported inventories grew at more than twice the rate of revenues in the last two quarters. In the most recent quarter ended June 23, 2012, its reported revenues grew 21% while its inventories grew 60% when compared to the previous fiscal year's comparable quarter. In the quarter ended March 24, 2012, Green Mountain Coffee's reported revenues grew 37% while its reported inventories grew 100% when compared to the previous fiscal year's comparable quarter.

Consistent decline in inventory turnover

In each the last seven quarters, Green Mountain Coffee's inventory turnover has decreased when each quarter’s numbers are compared to the same quarter of the previous fiscal year. For example, in the latest quarter ended June 23, 2012, it took Green Mountain Coffee an average of 102.04 days to sell its inventory compared to 72.12 days in the same quarter of the previous fiscal year. In the quarter ended June 26, 2010 it took Green Mountain Coffee an average of only 64.89 days to sell its inventory. (Click on table images below to enlarge them.)

Green Mountain Coffee has claimed that it stocked up on inventories in each quarter in order to meet anticipated customer demand. However, in each of the last seven quarters, Green Mountain Coffee's rate of inventory buildup exceeded its own estimates of anticipated revenues. When it beat its own revenue projections, its inventory turns should have increased because it ended the period with fewer inventories on hand than it had anticipated. However, Green Mountain Coffee's inventory turnover still decreased in those periods.

When Green Mountain Coffee failed to meet its revenue projections, inventory turnover understandably decreased because it had more inventory on hand than it had anticipated. However, even if it had made up for the shortfall in sales by selling more products and depleting more inventory to match its revenue projections, its inventory turnover rate still would have decreased. Therefore, Green Mountain Coffee's consistent decline in inventory turnover rates cannot be explained by its failure to meet revenue projections. In any case, its inventory buildup appears to defy rational explanation.

Inventory turnover declined even when Green Mountain Coffee beat minimum and maximum revenue expectations

In four of the last seven quarters, Green Mountain Coffee's reported revenues exceeded both the minimum and maximum guidance it gave to investors several weeks before the close of the quarter (see green highlighted areas in the table above). Inventory turnover should have been higher because the company pushed its product out the door faster to meet unexpected excessive demand from its customers. However, Green Mountain Coffee’s inventory turnover decreased, reflecting a longer time to sell its inventory despite reporting revenues that exceeded its minimum and maximum projections.

When Green Mountain Coffees sales fell below expectations, inventory turns would have still declined if it had met expectations

In two of the last seven quarters, Green Mountain Coffee failed to meet both its minimum and maximum revenue projections it gave investors just a few weeks before the end of each quarter. Therefore, a decline in inventory turns would be expected because it sold fewer products than it anticipated to its customers and had more inventory on hand than it anticipated at the end of the period. However, even if the company had matched its revenue projections by selling more merchandise, its inventory turnover would have still declined in those same quarters. The decline in inventory turnover cannot be explained by a failure to meet revenue expectations, (See red highlighted areas in the tables above and below).

For example, in the quarter ended March 24, 2012 Green Mountain Coffee’s reported revenues of $885.052 million were $54.052 million short of its minimum revenue expectation and $86.435 million short of its maximum revenue expectations. Green Mountain Coffee reported a gross profit on revenues of 35.37% in that quarter. Therefore, the cost of product that it sold to customers was 64.63% of revenues.

To meet its minimum revenue projection, Green Mountain Coffee needed to sell an additional $54.052 million of products costing it approximately $34.934 million ($54.052 million multiplied by 64.63%). To meet its maximum revenue projection, Green Mountain Coffee needed to sell an additional $86.435 million of products costing it approximately $55.863 million ($86.435 million multiplied by 64.63%).

Even if Green Mountain Coffee had achieved its minimum revenue estimate for the quarter ended March 24, 2012, it would have still taken the company 88.0 days to sell its inventory compared to only 64.06 days in the previous fiscal year. If Green Mountain Coffee had met its maximum revenue estimate for that quarter, it would have still taken the company 83.55 days to sell its inventory compared to only 64.06 days in the previous fiscal year. (Click on the table image below to enlarge it.)

Latest quarter

In the latest quarter ended June 23, 2012, Green Mountain Coffee’s reported revenues exceeded its minimum revenue guidance, but fell short of its maximum revenue guidance. It took an average of 102.04 days to sell its inventory compared to only 72.12 days in the same third quarter of the previous fiscal year. Its revenues increased 21% while its inventory levels increased by 60%. The company had projected a revenue increase of 20% to 25% for the quarter. Even if it had met its maximum 25% increase in revenue projection, it still would have taken an average of 97.55 days to sell its inventory compared to 72.12 days in the previous fiscal year. See the yellow highlighted areas in the tables above and below:

During a conference call with investors, Green Mountain Coffee CFO Fran Rathke attempted to deflect criticism over inventory levels by explaining that it was stocking up on brewers far in advance of the holiday season:

Because of the time it takes to ship brewers to the US from our contract manufacturers in Asia, we must have on hand all of the brewers we expect to sell during holidays by early October to ensure availability on retailer shelves. It is this timing dynamic that necessitates that we begin building brewer inventory starting in Q3 toward anticipated demand.

Green Mountain Coffee reported that total inventory at the end of the quarter had jumped 60% to $667.0 million compared to only $417.5 million in the previous year's comparable quarter. The brewer and accessory portion of the total inventory increased 73% to $301.5 million compared to $174.2 million in the previous year's comparable quarter. However, the balance of the total inventory excluding brewers and accessories grew still grew at 50% over the previous year. As I detailed above, revenues for the quarter only increased by 21% over the previous year's comparable quarter. Brewer and accessory sales increased only 32%, single serve pack sales increased only 31%, and other sales categories declined when compared to the previous fiscal year. Therefore, inventory turnover decreased in every revenue category.

Portfolio manager Ben Strubel took issue with Rathke and noted that the purported buildup in brewer inventories ahead of the holiday season was much higher than the buildup in the previous year taking into account anticipated revenue projections by the company.

On June 6, 2012, Green Mountain CEO Larry Blanford told investors at a Piper Jaffray Consumer Conference:

…But should something like that happen we have a number of tactical responses, one of which could in fact be deciding to raise the price of the K-Cup brewing system.

It appears that both Rathke and Blanford were fibbing to investors. On Tuesday September 26, 2012, Green Mountain Coffee announced that it was offering $50 rebates for its brewers. Investor Daniel Yu noted in his blog that:

GMCR is offering up to a $50 rebate in Keurig brewers, after saying they might raise prices just a few months ago. Should Larry Blanford, CEO of GMCR/Keurig, change his middle name to ‘liar’? Larry Liar Blanford?

Apparently, Green Mountain Coffee had too many brewers on hand ahead of the holiday season and must now cut prices to move them, contrary to previous comments by Rathke and Blanford. Fibbing by management aside, still the question remains as to whether Green Mountain Coffee also inflated its inventory numbers to create fictitious profits. Green Mountain Coffee's inventory buildup does not appear to be solely the result of mismanagement. Its unusual growth in reported inventory levels could be the result of intentional inflation to overstate earnings as alleged in the class action lawsuit.

Was it a fumble or fraud?

No matter how you slice and dice it, Green Mountain Coffee’s troubling growth in inventory levels is not a single quarter fluke. As evidenced by the consistent decline in inventory turnover over the last seven quarters, the company continues to build excessive layers of inventory on top of previous excessive layers of inventory.

The S.E.C. is investigating whether Green Mountain Coffee’s excessive growth in inventory levels resulted from mismanagement or a fraud. However, I caution them that claiming incompetence is the last refuge of the white-collar criminal. Fraudsters know that stupidity is not a crime.

Was it a fumble or fraud? Maybe it is both.

Written by,

Sam E. Antar

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 white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. More recently, I've helped the AICPA Fraud Task Force develop better methods for detecting fraud. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Green Mountain Coffee Roasters securities long or short.

Green Mountain Coffee Roasters: Calling a Bean, a Bean

Written by: Sam E. Antar with Ilene, Editor of Phil's Stock World

Green Mountain Coffee Roasters (NASDAQ: GMCR) is currently under the scrutiny of the Securities and Exchange Commission (SEC) and is facing numerous class action lawsuits alleging securities fraud. In particular, plaintiffs are alleging false and misleading disclosures in violation of federal securities laws.

One troubling issue is that when Green Mountain initially disclosed an accounting error concerning its K-Cup margin percentages, it claimed that the error was “immaterial.” Material and immaterial errors are treated differently.  If an accounting error is immaterial, a public company is required to correct it by making a one-time cumulative adjustment to earnings in the latest quarter. If an accounting error is material, a public company is required to notify investors that its previous financial reports cannot be relied on and that it will restate its affected financial reports to correct that error.

Background

On Monday, 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" affecting financial reports issued from 2007 to June 26, 2010:

In connection with the preparation of its financial results for its fourth fiscal quarter, the Company’s management discovered an immaterial accounting error relating to the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit. Management discovered that the gross margin percentage used to eliminate the inter-company markup resulted in a lower margin applied to the Keurig ending inventory balance effectively overstating consolidated inventory and understating cost of sales. Management determined that the accounting error arose during fiscal 2007 and analyzed the quantitative impact from that point forward to June 26, 2010.

As of June 26, 2010, there is a cumulative $7.6 million overstatement of pre-tax income. Net of tax, the cumulative error resulted in a $4.4 million overstatement of net income or a $0.03 cumulative impact on earnings per share.

After evaluating the quantitative and qualitative aspects of the error in accordance with applicable accounting literature, including Staff Accounting Bulletins published by the SEC, the Company, with the participation of the audit committee of the Board of Directors, has determined that the correction in the margin calculation represents a correction of an error in accordance with Accounting Standards Codification 250 Accounting Changes and Error Corrections, that the correction was not material to the fiscal years and the respective quarters ended 2007, 2008 and 2009 and that the Company anticipates that the correction will not be material to fiscal year 2010 and the respective quarters of fiscal 2010. As a result, the Company anticipates the cumulative amount of the accounting correction will be made in the quarter ended September 25, 2010. [emphasis added.]

Thus, Green Mountain claimed that its K-Cup margin error was “immaterial” and said it would correct that error by making a cumulative adjustment to earnings. If the error had been material, the company would have been required to 1) disclose that its previously issued financial reports cannot be relied upon and 2) restate its financial reports to correct that error.

On Friday 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.

Green Mountain did not identify any specific accounting error as "material" and it marginalized the errors by using carefully crafted language:

The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements.

The adjustments necessary to correct the errors will have no effect on reported cash flow from operations, and are not expected to have a material impact on the balance sheet. [emphasis added.]

Under SEC Staff Accounting Bulletin No. 99, accounting errors are material when they meet certain quantitative or qualitative criteria such as causing the "financial statements taken as a whole" to be "materially misstated" or "materially misleading." Whether or not accounting errors have a material impact on the balance sheet is not by itself a test for materiality in determining whether it is necessary to disclose the errors and restate results.

Timing

Green Mountain waited until November 19, 2010 to inform investors that it was going to restate its financial reports.

Let’s go back to September 28, 2010, when Green Mountain disclosed its K-Cup margin error which caused “a cumulative $7.6 million overstatement of pre-tax income” from 2007 to June 26, 2010. Because the company claimed that its K-Cup margin error was “immaterial,” it was not required to restate its previously issued financial reports to correct that error. Instead, Green Mountain said it would make a one-time adjustment to earnings for the quarter ended September 26, 2010 to correct its K-Cup margin error. Green Mountain claimed that it evaluated “the quantitative and qualitative aspects of the error in accordance with applicable accounting literature, including Staff Accounting Bulletins published by the SEC….”

Material vs. Immaterial accounting errors

According to SEC Staff Accounting Bulletin No. 99:

Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are...  whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise….

In determining whether multiple misstatements cause the financial statements to be materially misstated, registrants and the auditors of their financial statements should consider each misstatement separately and the aggregate effect of all misstatements. [emphasis added]

Public companies must evaluate each accounting error both individually and together in determining materiality. The effects of an overstatement of income cannot be reduced by the effects of an understatement of income, in determining the materiality of the errors.

If Green Mountain’s K-Cup margin error “hides a failure to meet analysts' consensus expectations for the enterprise” in any previous reporting period from 2007 to June 2010 (whether in a quarterly or annual period) that error should be considered material. If Green Mountain’s K-Cup margin error caused it to overstate income and meet or exceed analysts’ consensus EPS forecasts, it should be considered a material accounting error under SAB No. 99. In such a case, Green Mountain’s claim that its K-Cup margin error was “immaterial” was arguably incorrect.

Was Green Mountain’s K-Cup margin error material or immaterial?

We would argue that Green Mountain’s K-Cup margin error was material because it overstated income and caused the company to meet analysts’ consensus earnings estimates for the quarter ended March 27, 2010.

On January 27, 2010, Green Mountain reported its first quarter financial results and provided the following initial guidance for its second quarter ending March 27, 2010:

Fully diluted GAAP earnings per share in the range of $0.56 to $0.61 per share. The fully diluted GAAP earnings per share estimates … exclude any one-time acquisition-related transaction expenses for the pending Diedrich acquisition above the amount incurred in the first quarter of fiscal 2010. [emphasis added]

Green Mountain excluded “any one-time acquisition-related transaction expenses for the pending Diedrich acquisition” from its earnings guidance to analysts. Analysts revised their earnings estimates to adjust for the acquisition-related transaction expenses.

On April 28, 2010, Green Mountain reported its financial results for the quarter ended March 27, 2010.

According to Generally Accepted Accounting Principles (GAAP), net income for the second quarter of fiscal 2010 totaled $24.7 million or $0.54 per fully diluted share. …the Company incurred approximately $5.0 million, or $0.06 per diluted share, of transaction expenses related to the pending Diedrich Coffee, Inc. (“Diedrich”) acquisition…. Excluding the transaction-related expenses, non-GAAP net income for the second quarter of fiscal 2010 increased 114% to $27.8 million, or $0.60 per diluted share, from $13.0 million, or $0.33 per diluted share, in the second quarter of fiscal 2009. [emphasis added]

Green Mountain reported $0.54 fully diluted earnings per share. Excluding “one-time acquisition-related transaction expenses” fully diluted earnings per share was $0.60, meeting consensus analysts’ estimates for the quarter ended March 27, 2010. Its matching estimates of $0.60 was relayed by the financial news.

BusinessWeek reported:

Also on Wednesday, Green Mountain said it earned $24.7 million, or 54 cents per share, on revenue of $324.9 million. Excluding costs related to a recent acquisition and other items, Green Mountain earned 60 cents per share, matching analyst estimates.

In addition, RTT news reported:

Excluding items, net income more than doubled to $27.8 million from $13 million, while earnings per share increased to $0.60 from $0.33 in the prior-year quarter. On average, 10 analysts polled by Thomson Reuters expected the company to earn $0.60 per share for the quarter. Analysts' estimates typically exclude special items.

On December 9, 2010, Green Mountain Coffee issued its 2010 10-K report and provided additional details about its accounting errors and their affect on previous reporting periods. This additional information allows us to surmise the magnitude of the original error disclosed on September 28th. Until Green Mountain issued its 10-K report, there was insufficient information for an outsider to calculate the impact of the K-Cup margin error on quarterly earnings due to insufficient information in previous filings (September 28 8-K report and November 19 8-K report).

The company originally reported net income of $24.7 million for the quarter ended March 27, 2010. Considering information contained in Green Mountain’s 10-K report, two accounting errors under the category “Inter-Company Elimination Adjustments” reduced its net income by $1.378 million.

(Note: On May 18, 2010, Green Mountain had a three-for-one stock split and subsequent financial reports reflect that split in earnings per share computations. Therefore, diluted earnings per share for the quarter ended March 27, 2010 were adjusted from $0.54 as originally reported to $0.18 before the effects of any accounting errors. We are using the numbers prior to the split for ease in making comparisons.)

Green Mountain’s “Inter-Company Elimination Adjustments” came from two accounting errors:

(1) The K-Cup margin error originally reported by Green Mountain in its September 28, 2010 8-K report:

A $7.4 million overstatement of pre-tax income ($4.5 million after tax), cumulative over the restated periods, due to the K-Cup® portion pack inventory adjustment error previously reported in the Company’s Form 8-K filed on September 28, 2010. This error is the result of applying an incorrect standard cost to intercompany K-Cup portion pack inventory balances in consolidation. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. Rather than correcting the cumulative amount of the error in the quarter ended September 25, 2010, as disclosed in the September 28, 2010 Form 8-K, the effect of this error has been recorded in the applicable restated periods. [emphasis added]

(2) An accounting error due to “applying an incorrect standard cost to intercompany brewer inventory balances,” reported in Green Mountain’s November 19, 2010 8-K report:

A $0.7 million overstatement of pre-tax income ($0.4 million after tax), cumulative over the restated periods, due to applying an incorrect standard cost to intercompany brewer inventory balances in consolidation. This error was identified during the preparation of the fiscal year 2010 financial statements and resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. [emphasis added]

Both of the above accounting errors reduced Green Mountain’s previously reported net income of $24.7 million for the quarter ended March 27, 2010 by $1.378 million. Unfortunately, Green Mountain did not provide information about how each of those individual “Inter-Company Elimination Adjustments” separately impacted earnings for each reporting period.

Calculating the impact of the K-Cup margin error on earnings for the quarter ended March 27, 2010

Green Mountain disclosed that its K-Cup margin error resulted in a:

…$7.4 million overstatement of pre-tax income ($4.5 million after tax), cumulative over the restated periods ….

The brewer standard cost accounting error resulted in a:

…$0.7 million overstatement of pre-tax income ($0.4 million after tax), cumulative over the restated periods….

Therefore, about 92% of the “inter-company elimination adjustments” from 2007 to 2010 resulted from the K-Cup margin error ($4.5 million after tax divided by $4.9 million after tax).

For purposes of illustration, let’s assume that 92% or about $1.267 million of the $1.378 million adjustment to net income for the quarter ended March 27, 2010 came from the K-Cup margin error. In this case, the K-Cup margin error added $0.03 per share to its earnings (pre-stock split) and Green Mountain would have reported $0.57 diluted earnings per share excluding “one-time acquisition-related transaction expenses.” This would have caused it to miss estimates, as analysts were looking for $0.60 per share (pre-stock split).

In any case, the entire brewer standard cost error (from 2007 to 2010) amounted to a mere $0.4 million after tax. If we assume the entire error occurred exclusively in the quarter ended March 27, 2010, then $0.978 million (total inter-company elimination adjustments of $1.378 million minus brewer standard cost error of $0.4 million) of the adjustment to earnings in that quarter came from the K-Cup margin error. In this case, if Green Mountain had properly computed its K-Cup margin percentages, it would have reported $0.58 diluted earnings per share excluding “one-time acquisition-related transaction expenses” compared to consensus analysts’ estimates of $0.60 per share (pre-stock split).

Based on the analysis above, Green Mountain’s assertion that the K-Cup margin error was “immaterial” in its September 28, 2010 8-K report appears to be wishful thinking. According to SEC Staff Accounting Bulletin No. 99, “Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are...  whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise….” The K-Cup margin error caused Green Mountain to overstate income and meet analysts’ consensus expectations for earnings in the quarter ended March 27, 2010.

Green Mountain claims that it properly evaluated “the quantitative and qualitative aspects of the error in accordance… Staff Accounting Bulletins published by the SEC.” It would be interesting to know how its management came to that conclusion. While outsiders could not have performed these calculations until Green Mountains 10-K was released on December 9, 2010, presumably, Green Mountain would have had the information on September 28, 2010.

Closing comment

Arguably, Green Mountain should have identified the K-Cup margin error as a material accounting error in its September 28, 2010 8-K report, and it should have informed investors that its previous financial reports could not be relied on.  Under SEC rules, a material accounting error is required to be disclosed on Form 8-K within four business days. It wasn’t until November 19, 2010 that Green Mountain disclosed that its financial reports could not be relied upon by investors and that it would restate its earnings reports issued from 2007 to 2010 to correct accounting errors.

Disclaimer:  This article represents the opinions and analysis of Sam E. Antar, and not the opinions of Phil's Stock World and its employees, agents and affiliates.  Posting of the article does not represent an endorsement.


Ilene's disclosure

Ilene is the editor of Phil’s Stock World, a fellow Seeking Alpha contributor.  She does not own any Green Mountain Coffee Roasters securities, long or short.

Sam's 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.

Green Mountain Coffee Roasters: The Foul Aroma of Michelle Stacy's Stock Sales

On Thursday, March 10, 2011, Green Mountain Coffee Roasters (NASDAQ: GMCR) announced a “strategic relationship” with Starbucks (NASDAQ: SBUX). On that same day, Green Mountain Coffee granted stock options to certain insiders at its “Board of Directors meeting simultaneously following the Company’s Annual Meeting of Shareholders.” On Friday, MarketWatch reported:

Green Mountain insiders miss big option gain
Options priced after Green Mountain stock jumps 41% in single day

SAN FRANCISCO (MarketWatch) —March 10 was options day for insiders at Green Mountain Coffee Roasters. Too bad it was the day the stock hit a record high and the options are presently worthless.

Their latest batch of stock options were priced Thursday as Green Mountain(GMCR 58.86, -2.85, -4.62%)  shares ran up 41% on news the company had struck a deal for Starbucks (SBUX 36.56, -1.41, -3.71%)  to make coffee for its Keurig single-cup coffee brewers. Read Starbucks, Green Mountain brew K-Cup deal.

According to filings Friday afternoon with the Securities and Exchange Commission, eight directors were each granted 2,300 stock options at Thursday’s closing price of $61.71 a share — a record high on a split-adjusted basis. The previous day the stock had closed at $43.64.

Were all of Green Mountain Coffee’s insiders as unfortunate as the MarketWatch story implies? The answer is no. One insider, Michelle Stacy who is President of Green Mountain Coffee's Keurig Division seems to have made out like a bandit. She exercised 9,375 options at $6.20 per share and simultaneously sold them at $55.54 per share. Stacey sold her stock at $11.90 per share higher than the previous day's closing price. Sometimes I wonder, is Michelle Stacy a shrewd insider, a psychic, or just plain lucky?

Timing of Michelle Stacy’s stock sales

On August 13, 2010, Michelle Stacy exercised 30,000 options at $6.20 per share and simultaneously sold those shares at $30.95 per share. On September 13, 2010, exercised 5,000 options at $6.20 per share and simultaneously sold those shares at $35.20 per share. Seven days later, on September 20, 2010, Green Mountain Coffee claimed that it was notified by the Securities and Exchange Commission (SEC) of an informal inquiry concerning its “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” However, the company did not disclose news of the SEC inquiry to investors until seven days later.

On September 21, 2010, Michelle Stacy exercised 4,375 options at $6.20 per shares and simultaneously sold her shares at $37 per share. In addition, Stacy exercised another 625 options at $9.14 per share and simultaneously sold those shares at $37 per share. Seven days later, after the market closed on September 28, 2010, Green Mountain Coffee finally disclosed news of the SEC inquiry to investors. In addition, the company 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.

Maybe seven is a lucky number for Michelle Stacy? On September 13, she sold 5,000 shares seven days before Green Mountain Coffee claims it received notice of an SEC on September 20. On September 21, she sold another 5,000 shares seven days before Green Mountain Coffee disclosed news of the SEC inquiry to investors on September 28. That same day, Green Mountain Coffee reported that it overstated pre-tax income by $7.6 million dollars.

On September 29, 2010, the next trading day, Green Mountain Coffee stock dropped $5.95 per share to close at $31.06 per share as investors reacted to news of the SEC inquiry, a 16.1% drop in market value that day. By October 11, 2011, the market value of Green Mountain Coffee’s shares dropped to $26.87 per share, far below the price per share that Stacy sold her stock on August 13 ($30.95), September 13 ($35.20), and September 21, 2010 ($37.00).

In a blog post dated October 21, 2010, I expressed my concern about the possibility of illegal insider trading by Michelle Stacy based on the timing of her stock sales. Seven days later, on October 28, 2010, Stacy belatedly filed amended Form 4 reports and claimed she established a Rule 10b5-1 trading plan on August 13, 2010. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold. She amended certain SEC Form 4 filings for her stock sales on September 13 and September 21 to reflect her 10b5-1 trading plan. However, her sale of 30,000 shares on August 13 was not pursuant to a 10b5-1 trading plan. According to Stacy's amended SEC filings, her 10b5-1 trading plan only covered future stock transactions.

Eventually, Green Mountain Coffee’s stock price recovered from its low point of $26.87 per share on October 11, 2010 to close at $34.63 per share on November 5, 2010. On that same day, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $35 per share.

On February 7, 2011, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $40.00 per share. In addition, she exercised another 5,561 options at $9.14 per share and simultaneously sold those shares at $40 per share.

Seven days later, on February 14, 2011, Green Mountain Coffee stock opened for trading at $42.14 per share. At 11:00 AM Reuters reported:

Green Mountain Coffee Roasters Inc's (GMCR.O) shares fell as much as 4 percent after Starbucks Corp (SBUX.O) said it plans to announce a new product for the single-cup coffee market, a move that could threaten Green Mountain's dominance in the fast-growing sector.

The stock price of Green Mountain shares dropped to a low of $41.53 per share in intra-day trading.

Later that day, at around 3:34 PM, Reuters citing an unnamed source reported:

Starbucks Corp (SBUX.O) and Green Mountain Coffee Roasters (GMCR.O) are in partnership negotiations, a source close to the talks told Reuters on Monday, sending Green Mountain shares surging.

The Wall Street Journal reported:

Unusually fast movement – up or down 10% in less than five minutes – leads to a five-minute trading pause. This trading break is one of the fixes implemented after the Flash Crash last spring. In the case of Green Mountain, its shares shot to 47.88 from 41.81 – a 14% move in about five minutes.

[Snip]

Reuters reported in the afternoon that the two coffee companies are chatting about a possible partnership, which might have triggered a big enough stampede to get shorts covering positions in earnest.

On that same day, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $45.13 per share.

On February 15, 2011, the Associated Press reported:

Shares of Green Mountain Coffee Roasters Inc. slumped in early trading after coffee chain giant Starbucks Corp. announced a single-cup coffee deal with a rival company.

Market speculation that coffee chain giant Starbucks Corp. would soon announce a partnership with Green Mountain had jacked up the single-serve brewer maker's shares -- the stock jumped $2.89, or 6.7 percent, to $46.35 Monday and have risen about 48 percent in the past three months.

On February 15, 2010, the market value of Green Mountain Coffee stock eventually closed at $43.53 per share, a drop of $2.82 per share from the previous day's closing price of $46.35 per share. On the previous day, Michelle Stacy sold 10,000 Green Mountain Coffee shares at $45.13 share.

On Wednesday, March 9, 2011, Green Mountain Coffee shares closed at $43.64 per share. On Thursday, March 10, 2011, Green Mountain announced a “strategic relationship” with Starbucks. In reaction to the news, the market value of Green Mountain Coffee common stock rose $21.07 per share to close at $61.71 per share, or a 46% increase from the prior day’s closing price. That same day, Michelle Stacy exercised 9,375 options at $6.20 per share and simultaneously sold them at $55.54 per share, $11.90 per share higher than the previous day's closing price per share.

Class-action litigation alleges illegal insider trading

Is Michelle Stacy a shrewd insider, a psychic or just plain lucky? Perhaps the people who designed and administer her purported 10b5-1 trading plan are geniuses? Lawyers representing plaintiffs in a class-action lawsuit against Green Mountain Coffee don’t think so. They are alleging that Michelle Stacy and certain other insiders engaged in illegal insider trading.

According to amended class-action complaint (download here):

68. Moreover, although the September 28, 2010 Form 8-K indicates that, "[o]n September 20, 2010, the staff of the SEC's Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information," the above-noted former employee has stated that by no later than the first week of May 2010, he/she was contacted by Company employees who asked if he/she had been had been the whistleblower in an SEC investigation of GMCR.

69. Accordingly, Company employees contacted the confidential witness concerning an SEC investigation five months prior to the issuance of the September 28, 2010 Form 8-K, which disclosed that the SEC informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information on September 20, 2010. 

In other words, the amended class-action complaint alleges that Green Mountain Coffee knew that the SEC was poking around as early May 2010 or three months before Michelle Stacy claims she adopted a 10b5-1 trading plan. If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations.

The amended class-action complaint took issue with the timing of Michelle Stacy‘s stock sales and the timing of her 10b5-1 trading plan:

103. Prior to these sales, there had not been significant insider trading activity since June 2009. Not only did both division presidents sell the majority of their shares, but Stacy did so the day after the SEC's information request and one week before GMCR made the SEC inquiry public.

104. Even worse, in October 2010, Stacy amended her Form 4s for the August and September sales, claiming that she forgot to include in the original Form 4s that the sales were made pursuant to a Rule 10b5-1 trading plan adopted on August 13, 2010. Not only did the Company fail to inform the SEC of the plan on the day it was adopted, but it failed to disclose the plan when Stacy's Form 4 for the $928,500 sale was filed a mere four days after its adoption.

Michelle Stacy did not amend her Form 4 for her August 13 exercise and simultaneous sale of 30,000 shares of stock. She adopted her 10b5-1 trading plan that same day to cover her future sales of stock. That error in the class-action amended complaint aside, Michelle Stacy has a lot of explaining to do. A significant amount of Green Mountain Coffee's accounting errors which caused it to restate its financial reports resulted from material weaknesses in internal controls over financial reporting in the Keurig division headed by her. What did she know about financial reporting problems on August 13, 2010? If she knew nothing, was she incompetent or dumb?

Written by,

Sam E. Antar

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 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.

Green Mountain Coffee Roasters, Time to Spill the Beans?

To truly exonerate itself after the discovery of certain material violations of Generally Accepted Accounting Principles (GAAP), Green Mountain Coffee Roasters (NASDAQ: GMCR) needs to come clean with investors and disclose exactly when it found certain accounting errors. In addition, Green Mountain needs to provide clearer and more transparent disclosures to investors about the Securities and Exchange Commission (SEC) inquiry and the discovery of those errors.

Timing of certain disclosures

On Monday, September 20, 2010, the SEC notified Green Mountain Coffee Roasters that it was conducting an informal inquiry and requested it voluntarily submit 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 with the SEC. In that same 8-K report, Green Mountain disclosed that it discovered an "immaterial accounting error" affecting financial reports issued from 2007 to 2010:

In connection with the preparation of its financial results for its fourth fiscal quarter, the Company’s management discovered an immaterial accounting error relating to the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit. Management discovered that the gross margin percentage used to eliminate the inter-company markup resulted in a lower margin applied to the Keurig ending inventory balance effectively overstating consolidated inventory and understating cost of sales. Management determined that the accounting error arose during fiscal 2007 and analyzed the quantitative impact from that point forward to June 26, 2010.

As of June 26, 2010, there is a cumulative $7.6 million overstatement of pre-tax income. Net of tax, the cumulative error resulted in a $4.4 million overstatement of net income or a $0.03 cumulative impact on earnings per share.

After evaluating the quantitative and qualitative aspects of the error in accordance with applicable accounting literature, including Staff Accounting Bulletins published by the SEC, the Company, with the participation of the audit committee of the Board of Directors, has determined that the correction in the margin calculation represents a correction of an error in accordance with Accounting Standards Codification 250 Accounting Changes and Error Corrections, that the correction was not material to the fiscal years and the respective quarters ended 2007, 2008 and 2009 and that the Company anticipates that the correction will not be material to fiscal year 2010 and the respective quarters of fiscal 2010. As a result, the Company anticipates the cumulative amount of the accounting correction will be made in the quarter ended September 25, 2010. [Bold and italicized emphasis added.]

Green Mountain did not disclose exactly when it discovered the margin error but only that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter…..” Green Mountain’s fiscal year ended on September 25, 2010. Usually companies prepare for their year-end audits up to two months in advance.

Two scenarios

If Green Mountain had discovered the margin error before it was notified about the SEC inquiry, on September 20, 2010, why didn’t the company disclose the margin error to investors earlier, instead of waiting until it filed its 8-K report September 28, 2010?

If Green Mountain discovered the margin error after it was notified about the SEC inquiry, on September 20, 2010, why was the company able to find an accounting error within eight days or by September 28, 2010, when it didn't find the error during the previous fiscal years (2007 to 2010)? This scenario is possible, but it would be very coincidental.

The unknown timing of Green Mountain’s discovery of its margin error raises the question: did the company disclose the error to investors when it was discovered or did the company wait?

Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza S.p.A.

In that same September 28, 2010 8-K report, Green Mountain disclosed that it closed its Common Stock Purchase Agreement with Luigi Lavazza S.p.A. See below:

On September 28, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (the “Company”), completed a sale of 8,566,649 shares (the “Shares”) of its common stock, par value $0.10 per share (“Common Stock”), to Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), for an aggregate purchase price of $250,000,000. The sale of the Shares was effected pursuant to the Common Stock Purchase Agreement, dated as of August 10, 2010 (the “SPA”), by and between the Company and Lavazza. The execution of the SPA was previously reported by the Company in its Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission (the “SEC”) on August 11, 2010, and the full text of the SPA was filed as Exhibit 10.1 thereto. 

In connection with the stock purchase agreement, Green Mountain provided certain warranties that the Company and its auditors have not identified and are not aware of:

(A) any significant deficiency or material weakness in the design or operation of internal control over financial reporting utilized by the Company; (B) any illegal act or fraud, that involves the Company’s management or other employees; or (C) any claim or allegation regarding any of the foregoing that would have a Material Adverse Effect. [Bold and italicized emphasis added.]

According to Statement of Auditing Standards No. 115:

.07 A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.

A material weakness in internal controls generally arises when accounting errors have a “reasonable possibility” of causing a company to restate its financial reports to correct those errors. A "significant deficiency" in internal controls arises when accounting errors are not material enough to cause a restatement of financial reports, but are instead corrected by making a cumulative adjustment to the latest period’s financial reports.

Initially, Green Mountain claimed that its margin error was “immaterial” and disclosed that it would correct that error by making a cumulative adjustment to its Q4 2010 financial reports, rather than restate its financial reports issued from 2007 to 2010. At the very least, that margin error appeared to result from a “significant deficiency” under auditing rules. It could be a breach of warranty under Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza, though Green Mountain never told investors that may have breached a key warranty under its agreement with Luigi Lavazza.

Green Mountain initially entered into its agreement to sell shares to Luigi Lavazza on August 10, 2010. On the following day, Green Mountain disclosed to investors that:

On August 10, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (“Green Mountain” or the “Company”), and Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), entered into a Common Stock Purchase Agreement (the “SPA”). Pursuant to the terms of the SPA, Lavazza has agreed to make a $250,000,000 investment (the “Investment”) in Green Mountain’s common stock, par value $0.10 per share (“Common Stock”), at a purchase price per share equal to the volume-weighted average price of the Common Stock for the 60 trading days before the closing of the Investment, less 7.5% (the “Shares”). [Bold and italicized emphasis added.]

Thus, Lavazza's "purchase price per share would be equal to the volume-weighted average price of the Common Stock for the 60 trading days before September 28, 2010, less 7.5% (the “Shares”).” If the share price were to have dropped prior to Sept. 28, it would be reflected in Lavazza's final purchase price.

Based on the agreed upon terms, Luigi Lavazza paid $250 million to purchase 8,566,649 shares, or an average price per share of $29.18 which was computed as follows:

$31.55 gross volume-weighted average price of the Common Stock less 7.5% discount or $2.37 equals $29.18.

On September 28, 2010, Green Mountain closed its Common Stock Purchase Agreement with Luigi Lavazza. Later that same day, after the stock market closed, the company finally disclosed the SEC inquiry and the discovery of the margin error to investors.

On September 29, 2010, Green Mountain stock dropped $5.95 per share to close at $31.06 per share, a 16.1% drop in market value that day in reaction to news of the SEC inquiry and accounting error. The stock continued to drop to $26.87 per share on October 11, 2010.

Green Mountain’s gross "volume-weighted average price" per share of stock in the sixty trading days prior to closing its Common Stock Purchase Agreement with Luigi Lavazza was about $31.55 per share. Apparently, if Green Mountain had waited to close the deal until after it disclosed news of the SEC inquiry and margin error, Luigi Lavazza would have paid less money per share to the company. This leads to the question: did Green Mountain purposely delay disclosure to investors of the SEC inquiry, the margin error, significant weaknesses in internal controls, and possible breaches of representations and warranties under its agreement with Luigi Lavazza?

Or did Green Mountain give early warning to Luigi Lavazza under the terms of their confidential agreement? (See Common Stock Purchase Agreement Section 7). In such case, did Luigi Lavazza not care about the probable negative impact on the stock price after the SEC inquiry and margin errors were disclosed to investors? And if so, why not?

More accounting errors discovered

On November 19, 2010, Green Mountain filed an 8-K report updating investors about the margin error it disclosed on September 28, 2010 and also disclosed additional accounting errors:

["Margin error"] A $7.6 million overstatement of pre-tax income, cumulative over the restated periods, due to the K-Cup inventory adjustment error previously reported in the Company’s Form 8-K filed on September 28, 2010. This error is the result of applying an incorrect standard cost to intercompany K-Cup inventory balances in consolidation. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. Rather than correcting the cumulative amount of the error in the quarter ended September 25, 2010, as disclosed in the September 28, 2010 Form 8-K, the effect of this error will be recorded in the applicable restated periods.

A $1.4 million overstatement of pre-tax income, cumulative over the restated periods, due to the under-accrual of certain marketing and customer incentive program expenses. The Company also has corrected the classification of certain of these amounts as reductions to net sales instead of selling and operating expenses. These programs include, but are not limited to, brewer mark-down support and funds for promotional and marketing activities. Management has determined that miscommunication between the sales and accounting departments resulted in expenses for certain of these programs being recorded in the wrong fiscal periods.

A $1.0 million overstatement of pre-tax income, cumulative over the restated periods, due to changes in the timing and classification of the Company’s historical revenue recognition of royalties from third party licensed roasters. Because royalties were recognized upon shipment of K-Cups by roasters pursuant to the terms and conditions of the licensing agreements with these roasters, Keurig historically recognized these royalties at the time Keurig purchased the K-Cups from the licensed roasters and classified this royalty in net sales. Management has determined to recognize this royalty as a reduction to the carrying cost of the related inventory. The gross margin benefit of the royalty will then be realized upon the ultimate sale of the product to a third party customer. Due to the Company’s completed and, when consummated, pending acquisitions of third party licensed roasters, these purchases and the associated royalties have become less of a factor, since the post-acquisition royalties from these wholly-owned roasters are not included in the Company’s consolidated financial statements.

An $800,000 overstatement of pre-tax income, cumulative over the restated periods, due to applying an incorrect standard cost to intercompany brewer inventory balances in consolidation. This error was identified during the preparation of the fiscal year 2010 financial statements and resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales.

A $700,000 understatement of pre-tax income for the Specialty Coffee business unit, due primarily to a failure to reverse an accrual related to certain customer incentive programs in the second fiscal quarter of 2010. The over-accrual was not identified and corrected until the fourth fiscal quarter of 2010.

In addition to the errors described above, the Company also will include in the restated financial statements certain other immaterial errors, including previously unrecorded immaterial adjustments identified in audits of prior years’ financial statements. [Bold and italicized emphasis added.]

Green Mountain also claimed that:

… these errors were discovered by management during the course of its preparation of the year-end financial statements and audit, as well as during the course of an internal investigation initiated by the audit committee of the Company’s board of directors in light of the previously disclosed inquiry by the staff of the Securities and Exchange Commission’s (“SEC”) Division of Enforcement. [Bold and italicized emphasis added.]

In its September 28, 2010 8-K report, Green Mountain claimed that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter.” Presumably, the additional errors listed in the November 19, 2010 8-K report were discovered during the internal investigation after the SEC notified the company of it informal inquiry.

We still don’t know exactly when Green Mountain discovered the margin error, whether it was before or after the company learned about the SEC inquiry on September 20, 2010. However, we now know that Green Mountain found several new accounting errors about sixty days after it was notified of the SEC inquiry. It also appears that Green Mountain is taking the position that its errors were "immaterial."

Materiality of accounting errors

Originally on September 28, 2010, Green Mountain disclosed that it overstated pre-tax income from 2007 to 2010 because of the margin error. The company claimed that the margin error was “immaterial” and said it would correct that error by making a cumulative adjustment to earnings “in the quarter ended September 25, 2010.”

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, making a total overstatement of $10.1 million in pre-tax income. This time, the company announced that it would restate its financial reports issued from 2007 to 2010 to correct all of its errors:

On November 15, 2010, the board of directors of Green Mountain Coffee Roasters, Inc. (the “Company”), based on the recommendation of the audit committee and in consultation with management, concluded that, because of errors identified in the Company’s previously issued financial statements for the fiscal years ended September 29, 2007, September 27, 2008 and September 26, 2009 and the first three fiscal quarters of 2010, the Company will restate its previously issued financial statements, including the quarterly data for fiscal years 2009 and 2010 and its selected financial data for the relevant periods. Accordingly, investors should no longer rely upon the Company’s previously released financial statements for these periods and any earnings releases or other communications relating to these periods. [Bold and italicized emphasis added.]

Green Mountain did not identify any specific accounting error as "material." However, under SEC Staff Accounting Bulletin No. 99, accounting errors are material when they cause the "financial statements taken as a whole" to be "materially misstated" or "materially misleading." Such errors must be corrected by restating financial reports, instead of using a cumulative adjustment to the latest quarter's report to correct those errors.

How Green Mountain tried to spin the materiality issue

In its November 19, 2010 8-K report, Green Mountain tried to minimize to seriousness of its accounting errors by using carefully crafted language claiming that:

The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements.

The adjustments necessary to correct the errors will have no effect on reported cash flow from operations, and are not expected to have a material impact on the balance sheet.

Such errors can still be cause "financial statements taken as a whole" to be "materially misstated" or "materially misleading." SAB No. 99 directly addresses that issue:

If the misstatement of an individual amount causes the financial statements as a whole to be materially misstated, that effect cannot be eliminated by other misstatements whose effect may be to diminish the impact of the misstatement on other financial statement items. To take an obvious example, if a registrant's revenues are a material financial statement item and if they are materially overstated, the financial statements taken as a whole will be materially misleading even if the effect on earnings is completely offset by an equivalent overstatement of expenses.

Even though a misstatement of an individual amount may not cause the financial statements taken as a whole to be materially misstated, it may nonetheless, when aggregated with other misstatements, render the financial statements taken as a whole to be materially misleading. [Bold and italicized emphasis added.] 

For example, Company A and Company B are both competitors and each company has $100 of revenue, $100 of expenses, and zero profits. Both companies make only cash sales to customers and pay all of their expenses in cash. Each company started and ended the year with $100 in cash because they had zero profits.

Company A wants to make it appear that it has more market share (revenues) than company B and it inflates revenues and expenses by $100 each to report $200 of revenues, $200 of expenses, and but still zero profits. At the end of the year both companies report zero profits, zero cash flows from operations, and $100 cash on their balance sheets.

Company A's inflation of revenues and expenses did not change its reported profits, cash flow from operations, or balance sheet. However, Company A materially overstated both its revenues and expenses. Therefore, Company A's financial statements "taken as a whole" were "materially misleading."

Green Mountain said that "The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements." However, Green Mountain made no specific mention that its "financial statements taken as a whole" were "materially misstated" or "materially misleading."

Green Mountain should explain its decision to consider the margin error as an "immaterial accounting error"

When Green Mountain issues its restated financial reports, it should provide a thorough analysis and explain to investors why, originally on September 28, 2010, it considered the margin error “immaterial” and initially decided to use a cumulative adjustment to Q4 2010’s financial report to correct that error instead of restating its financial reports.

When the SEC Division of Corporation Finance conducts periodic reviews of public company financial reports and finds accounting errors, it requires the companies to provide a detailed materiality analysis using criteria under SAB No. 99. The analysis is later made publicly available in company filings after the review is completed. At the very least, Green Mountain should provide this analysis to investors when it files its 2010 annual 10-K report.

According to SAB No. 99:

Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are –  

• whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate 
• whether the misstatement masks a change in earnings or other trends   
• whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise   
• whether the misstatement changes a loss into income or vice versa  
• whether the misstatement concerns a segment or other portion of the registrant's business that has been identified as playing a significant role in the registrant's operations or profitability  
• whether the misstatement affects the registrant's compliance with regulatory requirements
• whether the misstatement affects the registrant's compliance with loan covenants or other contractual requirements   
• whether the misstatement has the effect of increasing management's compensation – for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation 
• whether the misstatement involves concealment of an unlawful transaction. 

This is not an exhaustive list of the circumstances that may affect the materiality of a quantitatively small misstatement. Among other factors, the demonstrated volatility of the price of a registrant's securities in response to certain types of disclosures may provide guidance as to whether investors regard quantitatively small misstatements as material. Consideration of potential market reaction to disclosure of a misstatement is by itself "too blunt an instrument to be depended on" in considering whether a fact is material. When, however, management or the independent auditor expects (based, for example, on a pattern of market performance) that a known misstatement may result in a significant positive or negative market reaction, that expected reaction should be taken into account when considering whether a misstatement is material.

If Green Mountain's margin error fell under any of the criteria listed above, it should have been considered a material accounting error under SAB No. 99, rather than an "immaterial accounting error" as originally claimed by the company.

Insider sales of stock

In a previous blog post, I detailed how on September 21, 2010, a day after Green Mountain was notified of the SEC inquiry, but seven days before the SEC inquiry was disclosed to investors, executive officer Michelle Stacy exercised 5,000 options and immediately sold her shares at $37 per share. At that time, Michelle Stacy's Form 4 disclosure did not reflect that she sold her shares pursuant to a Rule 10b5-1 trading plan. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold.

About five weeks after that blog post, on October 28, 2010, Stacy belatedly filed an amended Form 4 report and disclosed that:

This Form 4 has been amended to note that these sales were affected pursuant to a Rule 10b5-1 trading plan adopted by Ms. Stacy on 08/13/2010. 

In addition, Michelle Stacy filed another amended Form 4 report to reflect that her September 13, 2010 option exercise and sale of stock was also "affected pursuant to a Rule 10b5-1 trading plan." That option exercise and sale took place just seven days before Green Mountain was notified by the SEC on an inquiry.

At the very least, Michelle Stacy’s filing of amended Form 4 reports displays a continuous pattern of problematic financial reporting by Green Mountain and its officers and which increases investor uncertainty about the integrity of the company’s SEC filings.

Many responsible companies voluntarily disclose their insider's 10b5-1 trading plans as they are adopted, even though such disclosure is not required under existing SEC rules. The existence of 10b5-1 trading plans are only required to be disclosed on Form 4 as insiders purchase or sell their stock pursuant to such plans. However, voluntary disclosure at the inception of a 10b5-1 trading plan by insiders increases corporate transparency.

On August 13, 2010, Michelle Stacy exercised 30,000 options and immediately sold her shares at $30.95 per share. Not till October 28 did Stacy file amended Form 4 reports to reflect that her September 13th and 21st option exercises and sales of stock were carried out pursuant to a Rule 10b5-1 trading plan. Stacy claimed that she adopted a 10b5-1 trading plan on August 13. On August 13th, Stacy exercised options and sold stock, but she still does not claim that those transactions were made pursuant to a 10b5-1 trading plan.

If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations. If it turns out that Michelle Stacy had non-public knowledge of any of those issues affecting Green Mountain before adopting her 10b5-1 trading plan, she could be charged by the SEC with alleged insider trading violations. Several lawsuits seeking class action status have already alleged securities law violations by Green Mountain and its officers.

Usually 10b5-1 trading plans call for the purchase or sale of stock by insiders at regular intervals.  Michelle Stacy’s plan doesn't appear particularly regular. On Monday, September 13, 2010, she exercised options and sold 5,000 shares of Green Mountain stock. Eight days later on Tuesday, September 21, 2010 (and a day after Green Mountain received notification of the SEC inquiry) she exercised options and sold another 5,000 shares of Green Mountain stock. Forty-five days later, on November 5, 2010, Michelle Stacy exercised options and sold 10,000 shares of Green Mountain stock. In the interest of transparency, Michelle Stacy should explain how the timing of option exercises and sales were determined under her 10b5-1 plan.

PricewaterhouseCoopers

PricewaterhouseCoopers is Green Mountain’s current auditor and it is now evident that it missed a growing list of accounting errors covering fiscal years 2007 to 2010. Likewise, until 2009 PricewaterhouseCoopers was Overstock.com’s (NASDAQ: OSTK) auditors, too. Every single initial financial report issued by Overstock.com from 1999 to 2009 had to be restated at least once and as many as three times due to accounting errors. Therefore, PricewaterhouseCoopers missed accounting errors by Overstock.com in each and every audit it performed of the company.

In 2009, I identified certain violations of Generally Accepted Accounting Principles (GAAP) which ultimately caused Overstock.com to restate its financial reports for the third time in three years, after the SEC intervened and forced to company to correct its accounting errors. During the ongoing SEC investigation, PricewaterhouseCoopers defended Overstock.com’s improper accounting treatment of cost recoveries from vendors and as it turns out, they were wrong.

Prematurely proclaiming the absence of wrongdoing 

In its November 19, 2010 8-K report, Green Mountain claimed that none of the financial statement errors implicate misconduct with respect to the Company or its management or employees:

The internal investigation is nearly complete, and the Company continues to cooperate fully with the SEC. None of the financial statement errors implicate misconduct with respect to the Company or its management or employees. In addition, none of the financial statement errors are related to the Company’s relationship with M.Block & Sons, the fulfillment vendor through which the Company makes a majority of the at-home orders for the Keurig business unit’s single-cup business sold to retailers. [Bold and italicized emphasis added.]

It is premature for Green Mountain to proclaim the absence of any wrongdoing while the SEC inquiry is still ongoing and it admits that its own internal investigation is not fully completed. The SEC inquiry began on September 20 and has not been concluded. That statement will come back to haunt Green Mountain if the SEC decides to conduct a formal investigation.

In any case, I am naturally suspicious of self-proclaimed absences of wrongdoing without thorough outside independent examination. Back in the old days at Crazy Eddie, we conducted a similar internal inquiry with help from our auditors into certain allegations of wrongdoing involving a supplier and proclaimed ourselves clean. The auditors falsely claimed to both our audit committee and the SEC that they thoroughly checked out those allegations and found no wrongdoing. Management and auditors have little incentive to report their own foul-ups.

Final comment

Every financial report issued by Green Mountain and certified by PricewaterhouseCoopers from 2007 to 2010 had to be restated because of accounting errors. In addition, Green Mountain CEO Lawrence J. Blanford and CFO Frances G. Rathke signed Sarbanes-Oxley certifications covering those reports. So far no one has been held accountable by Green Mountain for its financial misstatements – not its auditors, CFO, or CEO.

While I personally like the smell of Green Mountain's coffee, I don't like the smell of its financial disclosures. A little more enthusiasm in cleaning up its financial reporting (like it devotes to cleaning up the environment) and a little more transparency would go a long way.

Written by,

Sam E. Antar (with research assistance from Ilene)

Recommended reading about issues with 10b5-1 trading plans

February 1, 2009: Stanford University Graduate School of Business - Sec Rule 10b5-1 and Insiders' Strategic Trade by Alan D. Jagolinzer

July 2009: Stanford University Graduate School of Business - Research Underpins SEC Scrutiny of Scheduled Insider Trades by Bill Snyder

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 those companies is a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.