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.

Can Green Mountain Coffee Roasters explain those missing beans?

Green Mountain Coffee Roasters (NASDAQ: GMCR) can't seem to get its act together. It appears to have made a significant error in a recent revision of its segment numbers. Specifically, $15.2 million of purported revenue adjustments for a twenty-six period in 2011 are unaccounted for. Its revenue adjustments do not match revenue numbers disclosed in other financial reports.

Background

Green Mountain Coffee Roasters operates its business under three segments: Specialty Coffee business unit (“SCBU”), Keurig business unit (“KBU”) and a Canadian business unit (“CBU”). Starting in fiscal year 2012, GMCR moved its Timothy’s subsidiary out of the SCBU segment and into the CBU segment. At the same time it moved a portion of the At Home ("AH") single cup business from its KBU segment to its CBU segment.

In subsequent 10-Q reports issued during fiscal year 2012, Green Mountain Coffee revised its previous fiscal year 2011 segment numbers to show Timothy’s as part of the CBU segment. Likewise, it revised its fiscal year 2011 segment numbers to show the AH single cup business as part of the CBU segment. The company revised its previous fiscal year segment numbers to make them comparable on a year-to-year basis. Therefore, items such as revenues, expenses, income, assets and liabilities that had been previously included in the SCBU segment for Timothy’s and the KBU segment for the AH single cup business should have been included in the CBU segment numbers when it reported its revised fiscal year 2011 numbers.

Those revisions reveal discrepancies in Green Mountain Coffee’s segment numbers. Specifically, Timothy’s sales to unaffiliated customers (outside customers) that were subtracted from the SCBU segment and added to the CBU segment should have matched its contribution to consolidated revenues that were disclosed in previous financial reports. Those revenue numbers don’t match up. $15.2 million of those revenue adjustments are unaccounted for.

Green Mountain Coffee's revised segment numbers compared to originally reported segment numbers

In the 10-Q report (page 12) for the period ended March 24, 2012, Green Mountain Coffee described its revision of the previous fiscal year 2011 segment numbers:

Effective at the beginning of fiscal year 2012, the Company changed its organizational structure to align certain portions of its business by geography. Prior to fiscal 2012, sales and operations associated with the Timothy’s brand were included in the SCBU segment and a portion of the AH single cup business with retailers in Canada was included in the KBU segment. Under the new structure, Timothy’s and all of the AH single cup business with retailers in Canada are included in the CBU segment.

Furthermore, it disclosed:

The following tables summarize selected financial data for segment disclosures for the thirteen and twenty-six week periods ended March 24, 2012 and March 26, 2011. Selected financial data for segment disclosures for the thirteen and twenty-six weeks ended March 26, 2011 have been recast to reflect Timothy’s and the AH single cup business with retailers in Canada in the CBU segment. [Emphasis added.]

In that same March 24, 2012 10-Q report (page 14), Green Mountain Coffee presented the following revised segment revenue numbers for the previous fiscal year twenty-six weeks ended March 26, 2011. (Click on image to enlarge.)

Originally, Green Mountain Coffee had reported the following segment numbers in the previous fiscal year 2011 10-Q report (page 14) for the same twenty-six weeks ended March 26, 2011. (Click on image to enlarge.)

In the March 24, 2012 10-Q report, the SCBU segment’s sales to unaffiliated customers for the previous year's twenty-six week period ended March 26, 2011 was revised $42.424 million lower. The revision should have reflected the removal of Timothy’s sales to unaffiliated customers from the SCBU segment into the CBU segment. However, in the March 26, 2011 10-Q report (page 20) Green Mountain Coffee reported only $27.2 million of sales to unaffiliated customers for Timothy’s. (Click on image to enlarge.)

The "additional $27.2 million of revenue" were sales to unaffiliated customers because it "contributed" to consolidated revenues. Timothy's sold product to both unaffiliated customers (outside customers) and affiliated customers (units within Green Mountain Coffee). Its sales to unaffiliated customers are an addition to consolidated revenues. 

The company subtracted $42.4 million of Timothy’s sales to unaffiliated customers from the SCBU segment for the twenty-six weeks ended March 26, 2011 to reflect its removal from that segment even though it previously reported that such sales were only $27.2 million. How could Green Mountain Coffee remove $15.2 million in sales to unaffiliated customers from the SCBU segment that it did not have?

Back in September 2010, the Securities and Exchange Commission started a probe of Green Mountain Coffee’s accounting practices. Afterwards, the company reported that it found material weaknesses in internal controls over financial reporting. It restated its financial reports from fiscal year 2006 to fiscal year 2010 to correct certain violations of Generally Accepted Accounting Principles (GAAP) that helped it overstate its reported earnings in previous fiscal years. In its most recent 10-K report (page 57), the company maintained that it has "effective internal controls over financial reporting." I doubt it.

Written by,

Sam E. Antar

Recommended reading

NACD Directorship - Freudian Thinking to Prevent Fraud by NACD Editors

Financial Executives International - Sam E. Antar, Jonathan Marks, Address Anti-Fraud Collaboration by Edith Orenstein

The LongShortTrader: Green Mountain Coffee Roasters' Profits: Overstated or Misunderstood

The LongShortTrader: GMCR Refuses to Explain Exactly How the LongShortTrader's Report is Flawed

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 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. Hopefully, they will put in a good word for me on judgment day.

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

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 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.

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.

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.