Many investors including myself have assumed that operational restructuring at Green Mountain Coffee (NASDAQ:GMCR) is critical to the company's future. From an operating perspective, even some bears might concede that new management and board diversification raise the chances of success going forward.
While Merriam Report research has often been critical of previous management's credibility and accounting practices, an astute comment to our recent GMCR coverage casts new light on current CEO Brian Kelley.
Again, investors have largely embraced the operational and logistics background of Kelley's previous role at Coca Cola (NYSE:KO) for the sense of optimism to the GMCR story going forward.
Yet, prior to his stint at KO, Mr. Kelley was CEO of SIRVA Inc. During his five-year tenure at SIRVA (2002-2007), SIRVA's share price collapsed. Catalyst for the stock implosion was an informal SEC inquiry (in February 2005), which evolved into a formal investigation (June 2005) and a "Wells" notice in May 2007.
It is interesting to note that Kelley resigned from SIRVA "voluntarily" less than one year before SIRVA's delisting and subsequent Chapter 11 bankruptcy filing in February 2008.
In addition, Mr. Kelley was a named co-defendant in a securities class-action suit which was settled by the company for approximately $53 million to end the litigation. It should be noted that the settlement agreement was entered into without any admission of wrongdoing on the part of SIRVA or any of the other defendants, and the defendants would receive a full release of all claims asserted in the litigation.
Not only does Mr. Kelley bring perceived operational skills to GMCR, but he also has intimate experience with regulators and securities litigation. The parallels between SIRVA and GMCR are interesting in that allegations of material misstatements and accounting issues share eerie similarities.
While some investors might view the SIRVA "experience" as a combat-tested benefit to GMCR's ongoing SEC inquiry and pending class-actions securities litigation(s), others might find it disquieting.
If anything, the SIRVA issues reveal that earnings management are embedded in the corporate culture. The irony is that CEO Kelley was amidst the hoopla at SIRVA during his tenure. Now, he's the clean-up guy for GMCR's previous management team and the baggage they left.
GMCR's recent FY 2013 and 4th quarter results offer interesting anecdotal evidence to how the earnings game works. Top-line/bottom-line growth, increased free cash-flows, stock buy-back and a dividend! Sounds like a confident management team.
However, the story not being told is troubling. For example, CFO Fran Rathke offered these comments on operating results:
Turning to operating results, for the quarter and the year SG&A increased 24% over fiscal year 2012 reflecting our R&D and marketing focused investments. Our Q4 non-GAAP EPS of $0.89, a 56% increase over last year's non-GAAP EPS of $0.57 significantly outperformed our guidance of $0.69 to $0.74 per share largely as a result of two factors.
First, stronger sales and corresponding income even while absorbing a 20 million or an approximate $0.09 per share charge we transitioned out of certain brewers in preparation for our new hot platform. And second, a quarterly tax rate of 27.8% compared to our prior estimate of approximately 37% which increased our non-GAAP EPS by $0.12 per share in the quarter. The lower quarterly tax rate was the result of a number of one-time items.
The $20 million mentioned is for write-down of inventory. Yet, the benefit of a lower quarterly tax rate increased non-GAAP earnings by twelve cents during the quarter. The only qualifier to the tax benefit is that it was a result of a number of one-time items. It would be helpful to investors if management explained the litany of "items" included.
Also, there was no mention of the one-time charge related to the planned closure of the company's Toronto facility. The problem with non-GAAP and pro forma emphasis is that it excludes the costs of acquisition related charges and intangibles, depreciation, etc. On the issue of impairment testing the company states the following:
The Company conducted its annual impairment test of goodwill and indefinite-lived intangible assets as of September 28, 2013, and elected to bypass the optional qualitative assessment and performed a quantitative impairment test. That in itself is not a concern, but the determination and assessment of potential impairment involves considerable subjective observations by management.
Considering that Mr. Kelley is no stranger to internal controls and corporate governance issues, GMCR investors will want to see transparency amplified, not obscured. While it does appear GMCR is being more careful in how they explain operational movements, there is still much critical information not being disclosed.
We will give management some credit for clarity with recent inventory changes (which hasn't always been the case) But, if you are going to boast about earnings and revenue growth give investors more color to how this was achieved. What is it costing the company to make their assets sweat harder? What ingredients are baked into the margin story? If working capital has improved, shed some light on the impact of capital productivity.
Before I even think about new product innovation or platform integration, I want to know the structural foundation is capable of producing the anticipated growth going forward. The rosy cash-flow picture and planned dividend certainly will appeal to some investors.
However, the cash-flow "progress" was aided by numerous balance sheet items including rising levels of accounts receivable, accounts payable and accruals. Lower capex spend also helped the cash-flow scenario. The practice of balance sheet maneuvering to enhance "cash-flow" is widely practiced. When used sparingly, the balance sheet provides a cushion for companies facing short-term liquidity constraints.
The announcement of a dividend was a surprise, but it appears to play a role in management's desire to evoke confidence in its expectations. Management also emphasized the dividend was not intended to replace future growth prospects.
However, it is the "expectation" which is worrisome as historical growth rates have moderated significantly in the last year. If a company is not spending on capex, waiting longer to get paid from customers and stretching payments owed to vendors then how is the growth expected to play-out going forward?
GMCR is not a build it and they will come scenario. Rather, it is a fix-it first and hope they will come-back for more in the future story. The SIRVA connection to current GMCR CEO Kelley is not a vilification or indictment of his operational or leadership capability.
However, it provides an interesting twist to the GMCR story. Not only will he be operationally involved, but Mr. Kelley obviously has first-hand experience with regulatory scrutiny and class-action securities litigation.
Knowing how to dance with regulators and experience with shareholder lawsuits may well be advantageous to the outcome of GMCR's current S.E.C. inquiry and legal proceedings. Yet, if Mr. Kelley is so confident about GMCR's future, why not provide investors with relevant details?
If a management team is reluctant to disclose basic unit sales and volume of its products (K-cup units for instance) then how are investors expected to understand the profitability picture?
CEO's are expected to play the role of spin-doctor in any turnaround story. We have no problem with current GMCR management keeping their cards close to the vest. Previous management also found it difficult to connect the dots. If shareholders can't see the cards being dealt at least show them how many chips you've got. In the annals of corporate malfeasance, Al "Chainsaw" Dunlap remains high on our wall of shame of naughty CEO's.
Dunlap was brought into Sunbeam for a restructuring. He had made a career out of turnaround stints, but Dunlap played aggressive poker at Sunbeam. Unfortunately, his deck of cards was marked and all his chips were in his pockets, not shareholders. His motivation was greed, but he self-destructed as a result. The Sunbeam story was my first formal examination into forensic accounting practices as an intern with Pfizer's former Finance Director Robert J. Westervelt.
Dunlap was never prosecuted for his accounting practices, but he was the king of channel stuffing and inventory juggling. I still have a dartboard with his toothy mug on it.
With GMCR, all we have to chew on now is a drive to enhance efficiencies and hopes of product innovations to grow future earnings. We do not expect GMCR to be CEO Kelley's "Dunkirk", but we do hope he has advanced in the learning curve sufficiently to show investors that internal controls and corporate governance are taken seriously.
Unfortunately, our bearish view on the company will remain intact until the financial statements begin to resemble what management is telling investors. The bull camp is quick to point out how GMCR bears argue the same old story. Opposing reader comments to our previous GMCR examinations have out-numbered the compliments by a wide margin.
Share buybacks and recent insider purchases by directors do bring some optimism into the GMCR picture. However, old stories remain so until new stories come to light. As turnaround stories go, current GMCR management has written the introduction to their vision and objectives.
It will be interesting to see how the first few chapters unfold, but investors should not assume it will be a best-seller. Somewhere in the story, a recapitulation of the past needs to be explained clearly. Momentum traders don't care much for details, but any investor considering GMCR as a long-term holding should be aware of the company's past.
We always congratulate those who have been in with low cost basis' and who have held the shares throughout its storied volatility. Yet, we also suggest that taking profits is a good thing too.
This isn't CEO Kelley's first rodeo, but it will take more than share buy-backs and a dividend bone to keep investors interested in the stock. Start by explaining what productivity improvements will help the company achieve a goal of $70 million in cost savings expected during fiscal 2014.
If management expects closure of Toronto to be immaterial to results, why not break down the numbers or provide a ballpark range? Reconciling previous acquisitions are often complex matters, but the Toronto announcement was made four months ago.
Mr. Kelley knows all too well the burden of the discovery process. Defendants in the SIRVA suit turned over more than 2.5 million documents to the lead plaintiff. Perhaps his previous experience through the SEC inquiry and investigative processes offer hope that GMCR's issues will not result in adverse action.
David Einhorn briefly discussed Kelley and SIRVA in his recent Q3 letter to partners. If it were not for the comment from Seeking Alpha contributor Bernard Dessault regarding Kelley's issues at SIRVA, my due diligence would likely remain focused on his operational roles at GE and Coke.
Ultimately, the SIRVA issues add new complexity to the GMCR story. Kelley's previous regulatory travails could be relevant in some way to those facing GMCR. What are your thoughts?
Quoted references were obtained from SA earnings transcripts and SEC 10-K/A filing for FY and Q4 2013
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.