Tuesday, April 24, 2012

Is Green Mountain Coffee’s Inventory a Toxic Brew?

Does Green Mountain Coffee Roasters (NASDAQ: GMCR) have a problem managing its inventory levels or is the company inflating its inventories to overstate its reported profits as alleged in a class action lawsuit against the company? The Securities and Exchange Commission is investigating Green Mountain Coffee's accounting practices.

Decreasing inventory turnover

Over the last two fiscal years, Green Mountain Coffee’s inventory turnover substantially decreased to 3.74 turns per year in the fiscal year ended September 24, 2011 compared to 4.72 turns per year in the previous fiscal year ended September 25, 2010. It took the company an average of 97.69 days to sell its inventory in fiscal year 2011 company compared to 77.36 days to sell its inventory in fiscal year 2010. In other words, it took about 22 days longer for the company sell its inventory in fiscal year 2011 than in fiscal year 2010.

The above consolidated numbers appear to mask the full extent of Green Mountain Coffee’s declining inventory turnover issues. We need to remove the effects of the Van Houtte acquisition made in December 2010 (during the first quarter of fiscal year ended September 24, 2011) to make an apples-to apples comparison with the previous fiscal year.

If we remove the effects of the Van Houtte acquisition, it took Green Mountain Coffee an average of 107.14 days to sell its inventory in fiscal year 2011. On an apples-to-apples basis, it took the company about 30 extra days to sell its inventory in fiscal year 2011 compared to fiscal year 2010. Therefore, it took 38% longer to sell its inventory in fiscal year 2011 after factoring out the effects of the acquisition. (Download my calculations here.)

Troubling decrease in first quarter fiscal year 2012 inventory turnover despite revenues that exceeded expectations

As of December 24, 2011 (end of first quarter of fiscal year 2012), Green Mountain Coffee reported that its inventory was $606.679 million compared to $269.132 million of inventory as of December 25, 2010 (end of first quarter of fiscal year 2011). Its revenues increased to $1.158 billion in the first quarter of the current fiscal year compared to $574.148 million of revenue in the previous fiscal year first quarter. Its cost of sales increased to $821.612 million in the first quarter compared to $430.548 million cost of sales in the previous fiscal year quarter.

Green Mountain Coffee's inventory increased 125.4% compared to both a 101.7% increase in revenues and a 90.9% increase in related cost of sales in the first quarter of fiscal year 2012. Therefore, inventory turnover continued to decline during the first quarter of fiscal year 2012 because reported inventory grew faster than revenues and cost of sales. (Source: 10-Q report for period ended December 24, 2011.)

On November 9, 2011, 46 days into the 91 day first quarter of fiscal year 2012, Green Mountain Coffee gave the following guidance:

Fiscal first quarter consolidated net sales growth of 85% to 90%.

Its first quarter fiscal year 2012 revenues exceeded its guidance by $67 million to $96 million. Based on Green Mountain Coffee's gross profit on revenues of 29.1% in the first quarter, it delivered an extra $48 million to $68 million of product, at cost, to meet demand above the company's expectations.

The company’s inventory growth exceeded both its actual and expected revenue growth. Inventory turnover should have been higher as the company pushed its product out the door faster to meet unexpected excessive demand during the remaining 45 days of the quarter. However, inventory turnover was lower in the first quarter of fiscal year 2012 compared to the first quarter of fiscal year 2011.

Green Mountain Coffee red flags similar to Crazy Eddie

A combination of excessive increases in inventory levels coupled with declining inventory turnover are generally considered to be a red flag for possible overstatements of inventory and earnings among forensic accountants.

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 other analysts ignored his concerns as Crazy Eddie's revenues and profits consistently beat Wall Street analysts' expectations. (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).

Ultimately, O’glove was proven correct. Crazy Eddie was over-counting its inventory. It engaged in a massive fraud to overstate profits and fleece investors. Is Green Mountain Coffee another Crazy Eddie? The similarities between the two companies are troubling.

Written by,

Sam E. Antar

Recommended reading

Business Insider: Here's David Einhorn's Presentation That Absolutely Destroys Green Mountain Coffee by Eric Platt

The Long Short Trader: GAAP-uccino 1.5 Part IIa

Seeking Alpha: My Notes From The Green Mountain Class Action Lawsuit by Yaron Ron Reuven

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. I do not seek or want 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.

Monday, April 09, 2012

Green Mountain Coffee Roasters Disclosure Controls: Have They Really Improved?

Green Mountain Coffee Roasters (NASDAQ: GMCR) claims to have gone to great lengths to remediate its internal control and compliance problems since the Securities and Exchange Commission started an inquiry of the company in September 2010 and since it restated its financial reports due to material accounting errors. However, certain contradictory disclosures by the company call into question the sincerity of its remedial efforts.

In a press release dated February 22, 2011, Green Mountain Coffee announced:

WATERBURY, Vt.--(BUSINESS WIRE)-- Green Mountain Coffee Roasters, Inc. (NASDAQ: GMCR), a leader in specialty coffee and coffee makers, announced today the appointment of Linda Kazanova as Vice President and Chief Human Resources Officer effective Thursday, February 17, 2011. [Emphasis added.]

On November 14, 2011 Green Mountain Coffee filed its fiscal year ended September 24, 2011 10-K report with the Securities and Exchange Commission. On page F-43, the company reiterated that Linda Kazanova started her employment as the Vice President, Chief Human Resources Officer on February 17, 2011. In addition, it disclosed that she was awarded certain non-qualified stock options on the same day:

On February 17, 2011, Ms. Linda Longo-Kazanova commenced her employment as the Vice President, Chief Human Resources Officer. Pursuant to the terms of the employment, the Company made an inducement grant on February 17, 2011, to Ms. Longo-Kazanova of a non-qualified option to purchase 30,000 shares of the Company’s common stock, with an exercise price equal to fair market value on the date of the grant. The shares subject to the option will vest in 25% installments on each of the first four anniversaries of the date of the grant, provided that Ms. Longo-Kazanova remains employed with the Company on each vesting date. [Emphasis added.]

In the same 10-K report on pages 24-25, the company contradicted both its February 2011 press release and disclosures in the same 10-K report on page F-43. It claimed that Linda Longo-Kazanova joined the company in February 2011, but did not serve as Vice President, Chief Human Resources Officer until March 2011:

Linda Longo-Kazanova joined the Company in February 2011 and has served as Vice President, Chief Human Resources Officer since March 2011. [Emphasis added.]

However, as of April 9, 2012, Linda Kazanova’s Linkedin profile says that she started her employment as “Vice President, Chief Human Resources Officer for Green Mountain Coffee Roasters, Inc.” in February 2011:




Why did Green Mountain Coffee attempt to move the date that Linda Longo-Kazanova started working as the Vice President, Chief Human Resources Officer from February 17, 2011 to March 2011? Was this part of a bungled effort to cover up a delinquent filing of a Form 3 report? Evidence suggests the company would rather deceive shareholders than admit to a late insider filing.

On March 15, 2011, Linda Longo-Kazanova filed a Form 3 Initial Statement of Beneficial Ownership of Securities with the S.E.C which disclosed her stock option grant on February 17, 2011. The exercise price of $40.71 per share matches the closing price on February 17, 2011.

According to S.E.C. instructions on filing Form 3 reports:

This Form must be filed within 10 days after the event by which the person becomes a reporting person (i.e., officer, director, ten percent holder or other person). This Form and any amendment is deemed filed with the Commission or the Exchange on the date it is received by the Commission or the Exchange, respectively. [Emphasis added.]

Green Mountain Coffee’s February 22, 2011 press release, 2011 10-K report page F-43, and Linda Kazanova’s Linkedin profile say that she commenced her employment as Vice President and Chief Human Resources Officer on February 17, 2011. The 10-K report said that she received her stock option grant on the same date. If those disclosures are accurate, then the Form 3 report should have been filed with the S.E.C. ten days later on February 28, 2011 (February 27 was on a Sunday). However, the Form 3 report was filed on March 15, 2011. It appears to have been filed 15 days late.

On February 12, 2012 Green Mountain Coffee filed a proxy report with the S.E.C. which claimed that:

Based solely on its review of the copies of such reports received and written representations from reporting persons, the Company believes that with respect to fiscal 2011 all reporting persons timely filed the required reports.

If Linda Longo-Kazanova started her employment as Vice President and Chief Human Resources Officer on February 17, 2011, then Green Mountain Coffee’s proxy claiming that it believes that “all reporting persons timely filed the required reports” cannot be accurate. It had to know the exact date she started work as Vice President and Chief Human Resources Officer and its lawyers should have known that her Form 3 report was filed late. Even her Linkedin profile as of April 9, 2012, seven weeks after the proxy report was filed, says that she commenced her employment as Vice President and Chief Human Resources Officer in February 2011. The company cannot seem to get its story straight and provide accurate disclosures to investors.

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. I do not seek or want 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.