Are they really that stupid at Green Mountain Coffee Roasters?

There is a saying among white-collar criminals, “When you are caught in the act of doing something wrong, play stupid. Tell them that you made an inadvertent error. Never admit to any deliberate wrongdoing. Being stupid is not a crime in America.” The board of directors and executives running Green Mountain Coffee Roasters (NASDAQ: GMCR) appear to want the Securities and Exchange Commission who is investigating the company, the Judge presiding over class action lawsuits alleging securities fraud, and investors to believe they are incredibly incompetent or grossly negligent, rather than admit to any deliberate wrongdoing. There can be either one of two answers for the continuing mishaps plaguing Green Mountain Coffee. Either they are dumb or they engaged in deliberate wrongdoing. Unfortunately, none of those answers bode well for the company. In any case, a rational question to ask is “Why are these clowns still running a $3.74 billion market cap public company?”

Background

On May 8, 2012, Green Mountain Coffee Roasters (NASDAQ: GMCR) stripped its founder Robert Stiller of his title as Chairman of the Board of Directors and ousted fellow director William Davis from his role as Lead Director. Both Stiller and Davis would no longer serve on any board committees and not receive any future compensation until further notice. The press release said that Stiller and Davis had violated its internal trading policies. In December 2011, the company prohibited its directors from making new pledges of stock as collateral for loans (margining stock), effective January 2, 2012. Stock pledges that were made before January 2 were grandfathered by the board. However, board members were prohibited from selling any stock during certain periods when the trading window was closed (even to satisfy a margin call) pursuant to company policy.

Misleading press release did not mention securities law violation

Green Mountain Coffee’s press release made it appear that Stiller and Davis only violated its internal policies by selling their stock during a period when the trading window was closed the company. It made no mention of possible securities law violations. The press release further mentioned that Davis had pledged new shares of stock after January 1, 2012 in violation of company policies. According to Item 403(b) of the Securities Act of 1993 companies must disclose:

… by footnote or otherwise, the amount of shares that are pledged as security and the amount of shares with respect to which such persons have the right to acquire beneficial ownership as specified in Rule 240.13d-3(d)(1) of this chapter.

When the S.E.C. drafted rules requiring the disclosure of stock pledges, it noted:

...we believe that the existence of these securities pledges could be material to shareholders and should be disclosed. We therefore are amending Item 403 of Regulations S-K and S-B to require this disclosure as well as disclosure regarding directors’ beneficial ownership of qualifying shares. [Emphasis added.]

Robert Stiller's stock pledges were disclosed in by the company in its recent proxy report. However, the proxy report did not include any information about William Davis's stock pledge. Later, Davis acknowledged to the Wall Street Journal that information about the stock pledge was omitted from the proxy report, but the article also did not mention any securities law violation.

Was Robert Stiller incredibly negligent or did he stage a forced margin call?

On May 7, 2012, Robert Stiller violated company policy by selling approximately $123.4 million of stock to satisfy a margin call at a time when the trading window was closed. Forbes Magazine reported that:

The sale… was forced by Deutsche Bank, Stiller explained, after they cut the percentage he was allowed to borrow against his equity stake due to the protracted fall in Green Mountain’s stock price. “They gave me no warning, [they just said] we’re only going to give you 30%,” explained Stiller, referring to how much he could borrow against his shares.
The former billionaire explained that he “has no income” and needs to sell shares to pay for his lifestyle. “But it’s been very hard to sell some of the shares that I have,” he noted, “so I’ve borrowed against them. [Emphasis added.]

However, Stiller’s excuses appear to be contradicted by other facts. It was not hard to sell “some” of his stock. In addition, he had plenty of income and available cash. For example, from March 14, 2011 to March 26, 2012, he gifted 268,609 shares of Green Mountain Coffee stock totaling $14.608 million in market value. From May 4, 2011 to February 23, 2012, he sold another 1.81 million shares of Green Mountain Coffee stock and pocketed $141.210 million in proceeds. He earned another $101,000 in cash compensation and another $74,296 in option awards as a director during the fiscal year ended September 24, 2011.

As of May 8, 2012, Robert Stiller still had 6,529,328 shares pledged as collateral. So far, those shares were not subject to a margin call. It is not publicly known how much in cash proceeds he received from pledging those shares. On Friday, May 18, 2012, Green Mountain Coffee stock closed at $24.05 per share. If we assume a maximum allowable margin of 50% of market value, Stiller could have potentially received as much as $78 million additional cash from pledging his stock (6.5 million shares multiplied by $12 per share cash received from pledging stock). Therefore, between Stiller’s stock gifts, stock sales, director’s fees, and stock pledges to raise cash, he had as much as $234 million in available cash to maintain his lifestyle before he pocketed another $123.4 million from selling his stock to pay for a margin call. If he did not have the available cash, he could have pledged assets other than stock to avoid the margin call.

If we take accept Robert Stiller’s excuse that he was forced to sell his stock on May 7, 2012 to meet a margin call, it appears that he was grossly irresponsible in managing his personal finances. Stiller apparently wants investors to believe that his own negligence in not anticipating the margin call caused him to violate Green Mountain Coffee’s internal trading policies.

Perhaps Robert Stiller is much smarter than he wants anyone to believe? Stiller could have purposely set himself up to face a forced sale of stock to make it appear as though he was not dumping stock in anticipation of a bad outcome to a concurrent Securities and Exchange Commission probe into Green Mountain Coffee’s accounting practices and class action lawsuits alleging that the company falsified profits and that Stiller and others illegally profited from insider trading.

In any case, the forced sale of stock due to a margin call is not a defense against allegations of illegal insider trading. Last week, I told Reuters that I tried that trick at Crazy Eddie and the S.E.C. still fined me for illegal insider trading. (Video of interview.)

Did William Davis deliberately conceal his pledge of stock?

Robert Stiller’s stock pledges were made before January 2, 2012 and were grandfathered by the board of directors when it changed its policy in prohibiting new stock pledges. He violated company rules by selling stock when its trading window was closed. Similarly, from May 4 to May 7, 2012, William Davis also violated company policy by selling approximately $13.8 million of stock to satisfy a margin call at a time when the trading window was closed. Furthermore, unlike Stiller, Davis violated company policy by pledging more shares after January 1, 2012. Robert Stiller’s stock pledges were disclosed in the company’s proxy statement filed on February 2, 2012, but William Davis’s stock pledges were not disclosed. S.E.C. rules require the disclosure of stock pledges.

The Wall Street Journal reported that:

The lack of disclosure was an oversight, says Green Mountain – Mr. Davis had indicated that he’d pledged approximately 775,000 shares, but “an inadvertent clerical error left the information out of the company’s February 2012 proxy statement.” [Emphasis added.]

Apparently, William Davis wants investors to believe that he’s incredibly negligent, but it’s difficult to believe that based on his qualifications. Green Mountain Coffee’s proxy report filed on February 2, 2012 praises Davis’s abilities:

In addition to separate Chairman and Chief Executive Officer positions, we have also elected to have a Lead Director, a position currently held by Mr. Davis. In recognition that our Chairman is not independent under the NASDAQ Rules, and that Mr. Davis, having been a Director of our Company since its founding, has a wealth of knowledge about our Company, has a strong relationship with our Chairman and is otherwise himself a skilled senior executive, we believe that the position of Lead Director is a valuable tool in our Board’s leadership structure. As determined by your Board, the Lead Director’s responsibilities include:
Chair all meetings of the independent and non-management Directors.
Serve as liaison between the Board Chairman and the independent Directors and the Chief Executive Officer and all of the Directors.
Consult with the Board Chairman and the Chief Executive Officer on matters to be presented at Board and committee meetings.
Call meetings of the Board, as appropriate or necessary.
Chair any meeting of the Board when the Chairman is not present or able to preside.
Chair Executive Sessions of the Board. [Emphasis added.]

William Davis was a member of Green Mountain Coffee's audit committee and chaired the governance and compensation committees. The audit committee oversees its compliance with securities laws and accounting rules. The governance committee oversees its compliance with internal policies. In addition, the company deems him to be an “audit committee financial expert.” If William Davis did not deliberately violate Green Coffee’s internal trading policies and inadvertently forgot to report his new stock pledge, then he is incredibly stupid.

William Davis must have had a role in drafting new internal rules prohibiting future stock pledges, based on his various positions at the company. Therefore, it's improbable that Davis did not know that he violated company rules by pledging his stock. Furthermore, it’s difficult to believe that Davis did not deliberately conceal his stock pledge after January 1, 2012. That's probably why the company failed to report his stock pledge in its proxy report as required by S.E.C. rules.

William Davis was involved in internal investigation that claimed no wrongdoing by Green Mountain Coffee

On September 20, 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). Those accounting violations caused the company to 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 other violations of securities law and accounting rules detailed in this blog, a scathing report issued by money manager David Einhorn and analysis provided in other financial blogs.

Green Mountain Coffee has attempted to derail the S.E.C. investigation and dismiss class action lawsuits by claiming that its independent audit committee, which includes Davis as a member, conducted an impartial internal investigation and found no wrongdoing by the company. Can the audit committee’s internal investigation be trusted in light of William Davis’s subsequent violations of the company’s internal trading rules and his failure to disclose his stock pledges?

Incestuous relationship between Green Mountain Coffee and William Davis

Green Mountain Coffee, Robert Stiller, and William Davis have engaged in some questionable chummy financial dealings in the past when it was a much smaller company. Back in 2000, William Davis served on Green Mountain Coffee’s board of directors and audit committee while he was the CEO and President of ChefExpress.net. At that time, Robert Stiller was Chairman of the Board of Directors, CEO, and President of Green Mountain Coffee. He was only Chairman of the Board of Directors when the company stripped him of his title on May 8, 2012 due to violating its internal trading policies.

On March 21, 2000, ChefExpress.net borrowed $100,000 from Green Mountain Coffee at an interest rate of 8% per annum to mature on or before May 31, 2000. ChefExpress.net had the right to extend the promissory note for a period not exceeding ninety days (until August 29, 2000) without cost or penalty. It agreed to give Green Mountain Coffee an option to convert its loan into an equity investment in a future private placement.

ChefExpress.net could not pay the note balance due at maturity or convert the loan into equity. Therefore, the loan was extended for another ninety days. In its 10-Q report for the quarter ended July 1, 2000, Green Mountain Coffee disclosed that there was a delay in ChefExpress.net’s private placement and “recorded a 50% reserve” against the promissory note.

On September 20, 2000, Green Mountain Coffee finally was able to convert its loan into an equity investment in ChefExpress.net. Despite having already taken a $50,000 reserve against the promissory note, Green Mountain Coffee reported its investment in ChefExpress.net “at its original cost of $104,000 at September 30, 2000” in its fiscal year 2000 10-K report (computed by adding $100,000 promissory note and $4,000 interest earned from March 21 to September 20).

However, in its 10-Q quarter ended April 14, 2001, Green Mountain Coffee reported that “During the second quarter of fiscal 2001, the Company recorded an impairment charge of $52,000 against its $104,000 minority ownership investment in ChefExpress.net, Inc. due to the fact that ChefExpress.net is experiencing a slower than expected sales ramp due to difficulties in raising adequate growth capital.” The $52,000 impairment charge is roughly the same amount of the $50,000 reserve it had previously taken against the note. Finally, in 10-Q report for the quarter ended April 13, 2002, Green Mountain Coffee recorded another “impairment charge of $52,000 against its minority investment in ChefExpress.net, Inc., reducing the value of that investment to zero.”

Closing comment

To date, no director or key executive has been fired or resigned from Green Mountain Coffee because of the S.E.C. probe, class action lawsuits, and restatements of financial reports to correct overstatements of income, and other ongoing improprieties. Robert Stiller and William Davis are still on the board of directors. Only their paltry director fees have been suspended. The same players responsible for continuing mishaps plaguing Green Mountain Coffee are all still at the company.

Written by:

Sam E. Antar

Recommended Reading

May 22, 2012: Philadelphia Inquirer - Crazy Eddie’s one-time CFO offers tips on spotting financial fraud by Erin E. Arvedlund

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.

Green Mountain Coffee Roasters: Is it toxic or is it phantom inventory?

In the days leading up to Green Mountain Coffee's (NASDAQ: GMCR) latest earnings report released yesterday, this blog published two reports warning investors about a toxic level of inventory building up at the company. (Details of those reports here and here.)

I detailed how in every quarter since the start of fiscal year 2011, Green Mountain Coffee's inventory turnover had decreased when each quarter’s numbers are compared to the same quarter of the previous fiscal year. In four of those five quarters, Green Mountain Coffee's reported revenues exceeded the guidance it gave investors just weeks earlier. Its inventory turnover should have increased because it delivered more products than anticipated to its customers before the close of each quarter to meet unexpected excess demand. Instead, Green Mountain Coffee’s inventory turns decreased, reflecting a longer time to sell its inventory despite reporting revenues that exceeded it projections.

Yesterday, Green Mountain Coffee's reported that its second quarter of fiscal year 2012 revenues were below the guidance it gave to investors just a few weeks before the close of the quarter. However, the company's reported inventory levels ended up much higher than it should have been, even if revenues had matched its low end or high end revenue guidance.

Why is there an excessive build up in inventory levels? Does Green Mountain Coffee have a problem managing its inventory levels or is their phantom inventory on its books? A class action lawsuit filed against the company alleges that it engaged in securities fraud by inflating its inventory numbers to overstate its reported earnings. The Securities and Exchange Commission is investigating Green Mountain Coffee's accounting practices.

Second quarter fiscal year 2012 inventory turnover decreases compared to the second quarter of fiscal year 2011

Yesterday, Green Mountain Coffee reported that its second quarter fiscal year 2012 revenues (quarter ended March 24, 2012) increased 37% to $885.1 million compared to second quarter fiscal year 2011 (quarter ended March 26, 2011) revenues of $647.7 million. On February 1, 2012, Green Mountain Coffee had projected "Net sales growth of 45% to 50%" in the second quarter of fiscal year 2012. Its revenues growth was 8% less than the low end projection and 13% below the high end projection.

Green Mountain Coffee’s inventory turnover decreased to 0.95 times in the second quarter of fiscal year 2012 compared to 1.42 times in the second quarter of fiscal year 2011 and 1.89 times in the second quarter of fiscal 2010. It took Green Mountain Coffee an average of 96.15 days to sell its inventory in the first quarter of fiscal year 2012 compared to 64.06 days in the second quarter of fiscal year 2011 and just 48.23 days in the second quarter of fiscal year 2010. It took the company 50% longer to sell its inventory in the second quarter of fiscal year 2012 compared to the second quarter of fiscal year 2011. In addition, it took the company 99% longer to sell its inventory in the second quarter of fiscal year 2012 compared to the second quarter of fiscal year 2010. (See my calculations here.)

Since Green Mountain Coffee had more inventory on hand due to its failure to meet its revenue projections, we would expect the company to report lower inventory turnover in the second quarter of fiscal year 2012 compared to the second quarter of fiscal year 2011. However, even if Green Mountain Coffee's reported revenues had equaled its low end or high end revenue target, its inventory turns would have still declined in the second quarter of fiscal year 2012 compared to the second quarter of fiscal year 2011!

Second quarter fiscal year 2012 inventory turnover still would have decreased compared to the second quarter of fiscal year 2011 even if company did not fail to meet its guidance

Let's assume that Green Mountain Coffee's second quarter fiscal year 2012 reported revenues equaled its minimum or maximum revenue projections. (Click on image to enlarge.)


If the company's reported revenues had equaled its minimum revenue guidance, its inventory turnover would have been 1.03 times in the second quarter of fiscal year 2012 compared to 1.42 times days in the second quarter of fiscal year 2011. It would have taken Green Mountain Coffee an average of 88.00 days to sell its inventory in the second quarter of fiscal year 2012 compared to 64.06 days to sell its inventory in the second quarter of fiscal year quarter of fiscal year 2011. It would have taken the company 37% longer to sell its inventory in fiscal year 2012 compared to fiscal year 2011.

If the company's reported revenues had equaled its maximum revenue projection, its inventory turns would have been 1.09 times in the second quarter of fiscal year 2012 compared to 1.42 times in the second quarter of fiscal year 2011. It would have taken Green Mountain Coffee an average of 83.55 days to sell its inventory in the second quarter of fiscal year 2012 compared to 64.06 days to sell its inventory in the second quarter of fiscal year quarter of fiscal year 2011. It would have taken the company 30% longer to sell its inventory in fiscal year 2012 compared to fiscal year 2011.

Green Mountain Coffee's excessive inventory levels cannot be explained by its failure to report revenues matching its revenue guidance. There are two plausible explanations: (1) an inability to manage inventories levels or (2) an inflation of inventory numbers to cook the books if we assume that allegations in the class action lawsuit are true. Is Green Mountain Coffee another Crazy Eddie?

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.

Is Green Mountain Coffee's Inventory Approaching Toxic Levels?

In four of the last five quarters since the beginning of fiscal year 2011, Green Mountain Coffee’s (NASDAQ: GMCR) reported revenues exceeded the revenue guidance it gave investors just weeks before the close of each quarter. In those quarters, its inventory turnover should have increased compared to the same quarter of the previous year because it delivered more products than anticipated to its customers before the close of each quarter to meet unexpected excess demand. Instead, Green Mountain Coffee’s inventory turns decreased, reflecting a longer time to sell its inventory despite reporting revenues that exceeded it projections.

Furthermore, in every quarter since the start of fiscal year 2011, Green Mountain Coffee's inventory turns have increased when each quarter’s numbers are compared to the same quarter of the previous fiscal year. It's taking Green Mountain Coffee longer to sell its inventory when you compare each quarter to the same quarter of the previous fiscal year.

See the chart below and calculations here. Click on image to enlarge:

Additional Note: The yellow highlighted areas are periods when Green Mountain Coffee's revenues exceeded projections its projections. I compared each quarter to its previous year comparable quarter. For example, the first quarter of fiscal year 2012 (quarter ended December 24, 2011) was compared to the first quarter of fiscal year 2011 (quarter ended December 25, 2010). Dollar amounts in $000s.

On September 20, 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). Those violations caused the company to 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. The amended complaint cites certain forensic accounting analysis provided in this blog detailing violations of accounting rules by the company before and after the S.E.C. started its probe. In addition, it cites a scathing report issued by money manager David Einhorn and analysis provided in other financial blogs.

Excessive increases in inventory levels coupled with declining inventory turnover are generally considered to be a red flag for possible inflation of inventory numbers and overstatements of earnings among forensic accountants. In every quarter after the S.E.C. started probing Green Mountain Coffee's accounting practices, its inventory turns have decreased reflecting longer periods to sell its product, even in quarters where its revenues exceeded its projections.

For example, on November 9, 2011, 46 days into the 91 day first quarter of fiscal year 2012, Green Mountain Coffee projected a revenue increase of 85% to 90% over the previous fiscal year’s comparable quarter. The company later reported that its revenues increased 101.7% to $1.158 billion in the first quarter of fiscal year 2012 compared to $574.148 million reported in the previous fiscal year first quarter. Its first quarter fiscal year 2012 revenues exceeded its low end guidance by $67.335 million and it exceeded its high end guidance by $96.042 million.

Based on Green Mountain Coffee's gross profit on revenues of 29.1% in the first quarter of fiscal year 2012, it delivered an estimated extra $68 million of product (at cost) above its low end guidance or $48 million of product (at cost) above its high end guidance to meet unexpected excess customer demand. However, its inventory increased 125.2% to $606.679 million at the end of the first quarter of fiscal year 2012 compared to only $262.132 million at the end of the first quarter of fiscal year 2011.

Green Mountain Coffee’s inventory turns decreased to 1.28 times in the first quarter of fiscal year 2012 compared 1.62 times in the first quarter of fiscal year 2011. It took an average of 70.83 days for the company to sell its inventory in the first quarter of fiscal year 2012 compared to 56.17 days in the first quarter of fiscal year 2011 (14.66 days or 26% longer to sell its inventory).

Two years ago, in the quarter ended December 26, 2009, it took Green Mountain Coffee an average of only 45.43 days to sell its inventory. It took 25.40 days longer (a 56% longer period of time) for Green Mountain Coffee to sell its inventory in the quarter ended December 24, 2011 compared to the quarter ended December 26, 2009.

Does Green Mountain Coffee Roasters have a problem managing its inventory levels or is the company inflating its inventories to overstate its reported profits as alleged in the class action lawsuit? The S.E.C. probe of the company is ongoing.

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.