Brian P. Kelley brings to Green Mountain Coffee (GMCR) an impressive resume for his new role as CEO at the Vermont based coffee company. Mr. Kelley is set to replace retiring GMCR CEO Larry Blanford, who had announced his intention to retire last February.
While Mr. Kelley's strong and diverse operational background at Coca Cola (KO) will be a welcome addition to GMCRs executive management team, his plate will be heaping-full before he steps through the door.
The usual suspects include competitive pressures, patent expirations, margin concerns and other perceived risks that potentially threaten GMCR's dominance in single-cup brewed coffee and beverages.
However, firmly planted in GMCR's history is a litany of other concerns which to some analysts and investors include more consequential risks:
Serial acquisitions not satisfactorily rationalized: Between 2006-2010, GMCR made a series of acquisitions for a total combined consideration of $ 1.506 billion.
Announced: May 2, 2006
Closed: June 16, 2006
Total consideration: $104.3 million
Tully's Coffee Inc.
Announced: September 15, 2008
Closed: March 30, 2009
Total consideration: $40.3 million
Timothy's Coffees of the World, Inc.
Announced: November 13, 2009
Closed: November 13, 2009
Total consideration: $157 million
Diedrich Coffee, Inc.
Tender offer announced: November 23, 2009
Closed: May 11, 2010
Total consideration: $300 million
LJVH Holdings Inc. ("Van Houtte")
Announced: September 14, 2010
Closed: December 17, 2010
Total consideration: $905 million
Concerns about these acquisitions include questionable treatment of amortization for intangibles, unjustifiable levels of goodwill and the high cost of leverage employed to buy companies that could become competitors.
Inventory Levels: There are well-chronicled concerns regarding GMCR's surge in inventory levels and the company's own admission of poor forecast modeling. In the Q3 2012 earnings call, President and CEO Larry Blanford made this statement in his opening remarks:
In fact over the last 90 days we've worked hard to analyze the disconnect between our expectations in single-serve pack demand since our fiscal second quarter and have identified effects that might have impacted our outlook. As a result we've made changes to our forecasting methodology that we believe will help us better predict force and pack demand annually in longer term.
This admission by management seems to contradict explanations regarding prior year inventory builds (see comments by CFO Fran Rathke) as a circumstance of capacity constraints. Last year inventory build was due to the belief (by management) that customers were concerned about supply availability. The belief this year is that with capacity issues resolved, customers are less inclined to order forward inventory.
Of course, considering that GMCR was taken to task on alleged improper shipping/vendor practices with its fulfillment vendor MBlock several years ago, is blaming inventory issues on customer ordering habits a better alternative? Bottom line though, inventory is always two-steps from cash. Excess inventory builds on lower sales tells us the distance between those two steps has become wider.
Revenue recognition and other accounting issues: One of the more obvious concerns to some critics of GMCR is how they were able to report such heady growth in revenues and earnings during the past several years, yet have nothing to show for it in the way of free cash-flow.
It should also be noted that the company's outlook for fiscal 2012 anticipates slightly negative free cash-flow. More to the point, reconciliations of capital expenditures do not pencil in for some analysts who have picked through the company's financial statements. I also have been skeptical about the legitimacy of the Green Mountain growth story for several years.
Investors should also be mindful of the fact that the SEC probe into GMCR remains ongoing since GMCR first disclosed it was being investigated in September 2010.
New CEO Brian Kelley: Incoming CEO Kelley looks to have all the credentials necessary to fix operational deficiencies at GMCR. At Coca Cola he wore many hats with roles in supply-chain management, purchasing, manufacturing, bottling, procurement, warehousing, distribution, etc. Prior to his KO stint, Kelley held executive positions at units of Ford Motor Co. (F) and before that was VP of General Electric's (GE) appliance business. However, he will be taking the reigns of a company facing more than competitive, marketing or margin issues. What can be expected of Mr. Kelley?
His compensation package appears to quite generous given what he left to pursue the CEO spot at GMCR. Whether or not Kelley is ultimately successful in leading GMCR is not the pressing issue. But, he will be well-paid while running the helm.
We would have to assume that Mr. Kelley believes the SEC issues (while not yet resolved) are non-life threatening to GMCR going forward. Yet, it does not preclude CEO Kelley from using his "new guy on the block" role advantageously.
One place to start would be to clean up the overhang of Green Mountain's previous buying binge(s) via pre-emptive write-downs or asset impairment charges...sooner than later. Given the potential of additional earnings restatements that might result from any adverse SEC outcome, proactive actions initiated by Kelley would likely be viewed favorably by regulators.
In the case of GMCR, asset impairment charges would likely be associated with goodwill and intangibles (result of aforementioned acquisitions). A history of negative cash-flow does not help matters either, but any sizable write-down would have an equivalent hit to shareholder equity.
With former Chairman Robert Stiller largely out of the picture and current CEO Larry Blanford about to step-down, will Mr. Kelley face legacy and/or legal obligations resulting from actions that occurred under his predecessors' watch?
Mr. Kelley will also inherit stockholder litigation (currently 3 putative class actions and 3 putative stockholder derivative actions; see page 28) alleging violations of securities laws, fraud, material disclosure violations, etc. While the executives involved in the SEC probe and class action complaints are likely indemnified for legal fees, the company and ultimately shareholders would bear these expenses. Litigation is always costly!
Hit the Ground Swinging: It's easier for a new CEO to step into a job by aggressively cleaning up somebody else's mess. The perception being that painful steps are necessary "now" for the long-term benefit of the company and its shareholders. If Kelley is successful, he will likely be championed as a rock star.
Other chatter on the street asks whether Kelley might be the guy who can facilitate a buyout for GMCR shareholders. Also interesting is the timing of the CEO announcement only ten days before GMCR is scheduled to report Q4 and fiscal 2012 earnings. Interpret at will, but it would not be a surprise if next week's earnings report has a lit fuse attached.
Conclusion: Mr. Kelley seems ideally suited to fix the GMCR engine. Perhaps CEO Kelley sees a future for GMCR as an independent enterprise. Maybe he sees a company that would make a potentially strategic fit to a deeper pocketed acquirer.
Regardless, investors should not assume that Kelley's CEO appointment is justification to run out and buy the shares with both hands; at least not now. While we view Mr. Kelley as probably the best hope for GMCR to come down the pike in quite a while, there will be plenty of the company's baggage awaiting his arrival.
How to play earnings? Some analysts believe GMCR is coming into earnings with substantial revenue momentum. Others fear discounting will compress margins. Between the sizable share float held short and the loyal bull/momentum crowd eager to squeeze bears, you might as well flip a coin next Tuesday.
What do we think? Until we see clarity regarding the accounting, a discernible improvement in earnings quality and something resembling cash-flow (other than stock and debt offerings), we will stay clear of this name.
GMCR is set to announce fiscal year and Q4 2012 earnings on Tuesday November 27, 2012.
Disclosure: I am long GE.