Tuesday, May 01, 2012

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.

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