Is Green Mountain Coffee’s Management Team Milking Shareholders For Every Last Penny?

In an interview last Monday with veteran investigative reporter and best-selling author Gary Weiss, I described how executives at Green Mountain Coffee Roasters (NASDAQ:GMCR) apparently received higher bonuses in 2011 because computations for annual cash incentive rewards did not take into legal and accounting expenses relating to an ongoing Securities and Exchange Commission probe into its financial reporting and class action litigation alleging securities fraud. Those executives are already indemnified for legal fees to defend themselves in any S.E.C. investigation and class action lawsuit.

It’s equivalent to management double dipping into corporate coffers at the expense of shareholders. While the company has the burden of paying for the ongoing S.E.C. probe and management’s legal defense in class action lawsuits, their bonuses don’t take into account such costs. It’s like tossing a coin and if it lands on heads, management wins, or if it lands on tails, investors still loose.

In addition, the cash incentive plan does not factor in acquisition-related expenses and the cost of amortizing identifiable intangible assets related to those acquisitions. Therefore, management is encouraged to overpay for acquisitions since such costs are not included in calculating annual cash incentive rewards, while they are still borne by the company. The executives running Green Mountain Coffee seem to be milking the company for every last penny they can get in compensation.

Background

On September 28, 2010, Green Mountain disclosed that the SEC started an informal inquiry into its revenue accounting practices and relationship with a certain fulfillment vendor eight days earlier. On that same day, the company reported that it discovered an accounting error involving its K-Cup margin percentages during the preparation of its financial report for the period ended September 25, 2010. Within days, class action lawsuits were filed against the company and certain officers alleging securities fraud.

On November 19, 2010, Green Mountain disclosed that it found four new accounting errors. On that date, the company said it would restate its financial reports issued from 2007 to the period ended June 26, 2010 to correct its errors and conceded that there were material weaknesses in internal controls.

Since then, this blog has detailed ongoing accounting rule violations by the company. Its so-called restated numbers still don’t appear to add up. More recently, money manager David Einhorn has uncovered serious improprieties at the company.

2011 cash incentive rewards plan

On January 17, 2012, Green Mountain Coffee’s preliminary proxy statement revealed details of its “annual incentive awards” paid for key executives (page 18):

We use these two metrics to determine the amount of annual incentive awards earned. For fiscal 2011, these results translated into an achievement of 122% of the bonus targets set for the year, with net sales for fiscal 2011 of $2.7 billion exceeding the prior year’s target by 9% and non-GAAP operating income of $428 million exceeding the prior year’s target by nearly 14%. The Compensation Committee set these targets at challenging levels that it believed would incentivize the executives to perform at the highest levels. [Emphasis added.]

Furthermore, the company disclosed (see page 26):

Consistent with prior years, the Compensation Committee again chose challenging net sales and non-GAAP operating income (as defined in the GAAP to non-GAAP Reconciliation of Consolidated Statements of Operations table as set fourth [spelled incorrectly] in Exhibit 99.1 on the Company’s current report on Form 8-K filed November 9, 2011.) targets as the financial targets against which to measure any annual incentive compensation payable to the named executive officers. Under the Company’s annual incentive plan for fiscal 2011, for any payout to have occurred, the Company’s net sales and non-GAAP operating income had to have been at least equal to the “threshold” amounts as set forth below. At the “threshold,” 20% of an individual’s target bonus opportunity would have been paid. If the Company’s net sales and non-GAAP operating income met the “target” level as set forth below for fiscal 2011, then 100% of the individual’s target opportunity would have been paid. Finally, if the Company’s net sales and non-GAAP operating income for fiscal 2011 had reached the “maximum” levels, as set forth below, then, all else being equal, 150% of the individual’s target bonus opportunity would have been paid. The amounts below are in thousands.

For fiscal 2011, the Compensation Committee set the target percent of base salary for each of our named executive officers to be consistent with the Company’s compensation philosophy and the competitive marketplace data, which are shown below. In addition, the table also shows the target and maximum annual incentive opportunity and the actual annual cash incentive paid to the named executive officers as a result of the Company’s achievement of 122% of the financial goals set by the Compensation Committee at the beginning of the fiscal year. [Emphasis added.]

The company was able to pay higher bonuses to its executives in part because its non-GAAP operating income of $428,693 for the fiscal year ended September 24, 2011 exceeded the $376,100 target set for that year. According to Exhibit 99.1 of the 8-K report referenced in the proxy statement detailed above, non-GAAP operating income excluded legal and accounting expenses related to the S.E.C. inquiry and pending litigation which increased non-GAAP operating income by $7.9 million to $428 million. Therefore, executive bonuses were higher because such costs do not count in computing their annual incentive rewards. See below. (Click on image to enlarge.):

The company’s incentive compensation calculation ignores the cost it incurred due to management incompetence, negligence, and possibly fraud. The company had to restate its financial reports from the beginning to 2007 to June 26, 2010 due to inadequate internal controls and material accounting errors and it now faces on ongoing S.E.C. probe and class action lawsuits.

Chief Executive Officer Lawrence Blanford and Chief Financial Officer Frances Rathke received 18.8% and 15.4% respective raises in base compensation despite signing inaccurate Sarbanes-Oxley certifications claiming that adequate internal controls existed from 2007 to 2010. Their raises were bigger than raises received by other executive officers who did not sign such certifications. So far, no key executive has been held accountable for the company’s financial reporting and legal troubles. See below. (Click on image to enlarge.):

Furthermore, the 2011 cash incentive plan did not take into account acquisition-related expenses and the amortization of identifiable intangibles from those acquisitions. The cash incentive plan encourages management to overpay for acquired companies, since such costs resulting from acquisitions are not included in the calculation of their annual rewards.

Under the 2010 cash incentive plan, the amortization of identifiable intangibles was included in the calculation of cash incentive rewards, unlike the current 2011 plan. Therefore, the 2011 plan was apparently richer for executives than in 2010 because it did not factor in certain costs that were used to calculate annual incentive rewards in the prior year. That contradicts its disclosure that the plan was "Consistent with prior years...." (See Proxy page 26.)

On a lighter note, Green Mountain Coffee’s high-paid executives and high-priced lawyers are advised to use a spell-checker before preparing reports such as the latest proxy statement detailed above. On page 26, they misspelled “forth” as “fourth” in language describing the incentive compensation plan. My Microsoft Word spell-checker was able to flag that error right away.

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. Furthermore, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

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