Your sister sees the future
Like your momma and yourself
You’ve never learned to read or write
There’s no books upon your shelf
And your pleasure knows no limits
Your voice is like a meadowlark
But your heart is like an ocean
Mysterious and dark
One more cup of coffee for the road
One more cup of coffee ‘fore I go
To the valley below – Bob Dylan
Green Mountain Coffee Roasters (GMCR) doesn’t at first glance seem like the type of company that would need to be “mysterious and dark” but when “pleasure knows no limits” it can go down into a metaphorical valley. How does GMCR, engaged in the specialty coffee and coffee maker businesses, churning out quarterly profits that meet analyst expectations while growing at 61% per year over the past five years, and expected to grow another 35% over the next five years, end up at #18 on the Sabrient VCU short ranking?
The fact that Michelle Stacy, President of Keurig (patented single cup brewing technology for GMCR), exercised 30,000 options at $6.20 on August 13, 2010 and simultaneously sold the shares on the open market at $30.95 for gross proceeds of $928,500, again exercised 5,000 options at $6.20 on September 13, 2010 and simultaneously sold the shares on the open market at $35.40 for gross proceeds of $177,000 and a week later exercised another 5,000 shares from $6.20-$9.14 and simultaneously sold the shares on the open market at $37 for gross proceeds of $185,000 alone isn’t enough to raise any eyebrows or red flags.
There are many reasons that insiders may sell shares which have nothing to do with their perception of the company's prospects or valuation. However, when a week after the last insider sale the company discloses that the SEC is inquiring into the company's methods for accounting for revenues, it starts to look a bit more dark and mysterious. It is worth noting that Keurig accounted for over half of GMCR revenue last year, so when the President of Keurig is selling, it is worth a further look. When the SEC discloses an inquiry into the company's accounting it is worth more than a look. Multiple class-action lawsuits have been filed against GMCR since the announcement by the SEC, yet the stock has rebounded from a low of $26.87 to a close yesterday of $31.31. Rumors of Nestle (NSRGY.PK) having interest in GMCR resurfaced on October 12, despite the SEC's inquiry and pending class-action lawsuits.
When the coffee brewer drips, it pours.
Green Mountain is suing a unit of Treehouse Foods (NYSE: THS) for making unauthorized portion packs that fit in its Keurig single-cup brewers. Reports have Treehouse's knockoffs selling for 20% below its own sanctioned K-Cups in some Wal-Mart (NYSE: WMT) stores.
Both sides are about to enter into legal fisticuffs -- and they each actually have a pretty sound defense.
Perhaps starting to shed some light on the concerns of the SEC, in "Checking for Revenue Tricks at Green Mountain Coffee Roasters", Seth Jayson at Motley Fool showed how accounts receivable (AR) and days sales outstanding (DSO) have increased enough to raise both our eyebrows:
A cloudy crystal ball
I often use accounts receivable (AR) and days sales outstanding (DSO) to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- days worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.
Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)
Our virtual portfolio Dark Horse Hedge initiated a short position in GMCR at the open on Thursday, October 21, 2010. This short is based on our conclusion that where there is smoke, there is usually fire. We started wondering how a company such as GMCR could find its way down into the depths of short candidates with its impressive earnings growth and ability to meet expectations. Perhaps it is a case of “pleasure knows no limits” or simply a case of mistaken identity, but corporate governance scores are an important filter in determining a company's value. GMCR's scores for company governance, and the insider trading preceding the SEC investigation make us skeptical and, for now, the preponderance of evidence leads us to believe the valley is below for GMCR.
One More Cup of Coffee Addendum
There are many reasons that insiders may sell shares which have nothing to do with their perception of the company’s prospects or valuation. However, when a week after the last insider sale, the company discloses that the SEC is inquiring into the company’s methods for accounting for revenues, it starts to look more dark and mysterious. It is worth noting that Keurig accounted for over half of GMCR revenue last year, so when the President of Keurig is selling, it is worth a further look. When the SEC discloses an inquiry into the companies accounting it is worth more than a look...
To further examine our initial observation, we took a guided tour though the SEC filings with Sam Antar, who specializes in reviewing SEC filings. The first thing we discovered on the SEC site was that the last date Michelle Stacy exercised 5000 options and then sold the stock for $37 was September 21, 2010. This transaction was reported in a Form 4 filing on Sept. 23, 2010.
Next, we looked at the most recent 8K Form filed and we found that the disclosure of the SEC inquiry occurred on September 28, 2010. However, notification of the SEC inquiry occurred eight days earlier, on September 20, 2010:
On September 20, 2010, the staff of the SEC’s Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information. Based on the request, the Company believes the focus of the inquiry concerns certain revenue recognition practices and the Company’s relationship with one of its fulfillment vendors. The Company, at the direction of the audit committee of the Company’s board of directors, is cooperating fully with the SEC staff’s inquiry.
This information might lead investors and perhaps others to wonder whether Michelle Stacy knew about the SEC inquiry when these options were exercised and sold on the open market on September 21, 2010.
Disclosure: Our virtual portfolio Dark Horse Hedge initiated a short position in GMCR at the open on Thursday, October 21.