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Green Mountain Coffee’s Numbers Submitted to S.E.C. Examiners Don’t Add Up

Last April, the Securities and Exchange Commission Division of Corporation Finance sent Green Mountain Coffee Roasters (NASDAQ: GMCR) a comment letter requesting certain information about its segment reporting in its 10-K report for the fiscal year ended September 24, 2011. The S.E.C.’s comment letter and the company’s response were just made public this week.

Green Mountain Coffee has three operating segments: Specialty Coffee business unit (“SCBU”), Keurig business unit (“KBU”) and a Canadian business unit (“CBU”). The company provided certain financial information to the S.E.C. examiners relating to its Timothy’s subsidiary for the five quarter period ended September 24, 2011 when it was included in the SCBU reportable segment. However, Timothy’s numbers appear to be erroneous when compared to financial disclosures made by the company in other S.E.C. filings.

If Green Mountain Coffee’s numbers are to be believed, then its income before taxes for its Timothy’s subsidiary exceeded gross profits by $10.7 million in the five quarter period ended September 24, 2011 when it was included in the SCBU segment. That seems highly unlikely given the company’s accounting policies for allocating income and expenses among its reporting segments and consolidated numbers reported for non-operating items. Timothy's financial performance appears to be substantially overstated over that five quarter period. (See calculations.)

Back in September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee’s accounting practices. Afterwards, the company restated its financial reports from fiscal year 2006 to fiscal year 2010 to correct certain violations of Generally Accepted Accounting Principles (GAAP) helped it overstate its reported earnings in previous fiscal years. A class action lawsuit was filed against the company that cited information provided by over a dozen informants who allege that it manipulated earnings and committed securities fraud in fiscal year 2010 and prior years. In addition, the lawsuit cites ongoing violations of accounting rules exposed in this blog.

How income before taxes is computed

Income before taxes is computed by starting with revenues and deducting cost of goods sold to compute gross profits. Operating expenses are deducted from gross profits to compute operating income. Non-operating income is added to operating income to compute income before taxes. Non-operating losses and interest expense is deducted from operating income to compute income before taxes.

Timothy’s questionable numbers

Green Mountain Coffee disclosed on page 8 of its responses to certain questions by the S.E.C. that:

….The components of SCBU as of September 24, 2011 were Green Mountain Coffee Roasters and Timothy’s (which is located in Canada). Timothy’s was operated as a plant for the SCBU prior to the Company’s acquisition in December 2010 of LJVH Holdings Inc. (“Van Houtte”) (which is also located in Canada). Timothy’s is shown separately in the segment managers package because it was acquired by the Company in November 2009 and included in the SCBU segment until September 24, 2011, when it was transferred to the CBU.
For purposes of evaluating economic characteristics of a component of an operating segment, the following criteria for aggregating operating segments in ASC 280-10 should be used:

Green Mountain Coffee claimed that its Timothy’s subsidiary averaged a 33% gross margin in the five quarters ended September 24, 2011. During those five quarters, Timothy’s had $78.3 million of revenues and income before taxes of $36.7 million. If Timothy’s gross margins were 33% as claimed, its gross profits were only $26 million ($78.3 million multiplied by 33% gross margin). Therefore, its income before taxes was $10.7 million higher than its gross profits. (See calculations.)

Furthermore, Green Mountain Coffee made the following disclosure about certain expenses attributed to Timothy’s in its 10-K report page F-23 for the fiscal year ended September 24, 2011:

Amortizable intangible assets acquired include approximately $83.2 million for customer relationships with an estimated life of 16 years, approximately $8.9 million for the Timothy’s trade name with an estimated life of 11 years and approximately $6.2 million for supply agreements with an estimated life of 11 years. The weighted-average amortization period for these assets is 15.2 years and will be amortized on a straight-line basis over their respective useful lives.
The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $69.3 million. The acquisition provided the Company with a Canadian presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment. The goodwill recognized is not deductible for tax purposes.

Based on the above disclosure, Timothy’s incurred $8.2 million of amortization expense in the five quarter period ended September 24, 2011. Those costs were included in its operating expenses (See calculations.)

We need to deduct that $8.2 million of amortization expense, any other operating expenses such as administrative costs, and any non-operating income or losses incurred by Timothy's from its gross profits of $26 million to compute its income before taxes. For the purpose of illustration, let’s be conservative and assume that Timothy’s incurred no other operating costs during that five quarter period. That leaves us with at most $17.8 million of income before taxes, so far. However, Timothy’s income before taxes was reported at $36.7 million. Therefore, Timothy’s would require a minimum of $18.9 million of non-operating income to explain why its income before taxes exceeded its gross profits. However, Green Mountain Coffee does not appear to have $18.9 million of non-operating income to substantiate Timothy’s reported income before taxes numbers.

Non-operating income and expenses don't substantiate reported numbers

In the five quarter period ended September 24, 2011, there were only four non-operating items effecting income before taxes that were reported by Green Mountain Coffee: interest expense, loss on foreign currency, loss on financial instruments, and other income. The company did not attribute certain non-operating items such as interest expense and foreign exchange gains to its reportable segments and underlying subsidiaries. Therefore, they cannot be used in computing Timothy’s income before taxes. Green Mountain Coffee’s 10-K report for the fiscal year ended September 24, 2011 explains the allocation of costs among its segments:

Expenses not specifically related to the SCBU, KBU or CBU operating segments are recorded in the “Corporate” segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to the entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors. In addition, fiscal 2009 corporate expenses are offset by $17.0 million of proceeds received from a litigation settlement with Kraft. Corporate assets include primarily cash, short-term investments, deferred tax assets, income tax receivable, certain notes receivable eliminated in consolidation, deferred issuance costs and fixed assets.

The only other non-operating items that are potentially attributable to Timothy’s are other income and the loss on financial instruments. However, the inclusion of any of those items in Timothy’s financial results cannot explain why its income before taxes exceeds its gross profit by $10.7 million.

For the purpose of illustration, let’s assume that other income is fully attributable to Timothy’s. As I detailed above, Timothy’s had a gross profit of $26 million in the five quarter period ended September 24, 2011. The amortization expense totaling $8.2 million that was attributed to Timothy’s during that five quarter period should be deducted from gross profits to compute income before taxes. Consolidated other income was only $0.596 million during those five quarters. It would be added to gross profits to compute income before taxes. That leaves Timothy’s with income before taxes of $18.4 million compared to $36.7 million reported in its S.E.C filings, leaving an $18.3 million discrepancy.

The inclusion of the loss on financial instruments in Timothy's financial results would increase the discrepancy in its income before taxes numbers. It is a loss which further reduces the income before taxes calculation below the number reported in other S.E.C. filings. Green Mountain Coffee had a $6.245 million loss on financial instruments during the five quarter period ended September 24, 2011. If that amount is deducted Timothy’s gross margins to compute income before taxes, it would reduce Timothy’s income before taxes to only $12.2 million compared to $36.7 reported in various S.E.C. filings, leaving a $23.3 million unexplained discrepancy.

The non-operating income numbers reported by Green Mountain Coffee cannot substantiate Timothy’s reporting $10.7 million of income before taxes in excess of gross profits. Therefore, it appears that Timothy’s reported income before taxes in S.E.C. filings is substantially overstated and an erroneous number.

The only other way that Timothy’s income before taxes could have exceeded its gross profits was if its operating expenses were negative. Such a scenario could only be possible if there were undisclosed accounting errors from previous periods that were corrected in those five quarters by making offsetting adjustments (reversing positive operating expenses to negative). If that happened, then Green Mountain Coffee failed to make proper disclosures to investors about accounting errors.

Written by:

Sam E. Antar

Recommended Reading

Accounting Today - Crazy Eddie’s Cousin Sam Sees Greater Potential for Fraud by Michael Cohn

National Association of Corporate Directors (NACD Directorship) - Freudian Thinking to Prevent Fraud by NACD Editors

Financial Executives International Financial Reporting Blog - Fraud, Freud and Superheros by Edith Orenstein


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. 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. My ongoing investigation of Green Mountain Coffee Roasters documented in this blog is a freebie for the Securities and Exchange Commission.


Longshorttrader said…
this is hilarious, great work!
Sam E. Antar said…
Thank you! Looking forward to your next GMCR investigative report.
Letitride2 said…
Don't mess with Sam! This is outstanding analysis. Of your ability I'm jealous. Thanks for sharing. Time for another locate.
7/23 will be fun.
David Zurbuchen said…
The crux of the issue here is the 33% profit margin assumption. Isn't it possible that the average profit margin disclosed was calculated as:

(Q1 Profit Margin + Q2 PM + ...Q5 PM) / 5

not as you had assumed:

(Q1 Gross Profit + Q2 GP +...Q5 GP) /(Q1 Revenues + Q2 Rev + ... Q5 Rev) which case there may not be any problem with the numbers.
hello, best wishes of you

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