An investor can be forgiven for thinking that Green Mountain Coffee Roasters (GMCR) is the perfect stock. The reasons are many. The Waterbury, Vt.-based maker and distributor of coffee and coffee-makers – its signature products are the individual serving coffees and machines that are prevalent in so many workplaces – has a business that is understandable for the average investor and its products are widely used. Its financial results have been consistently solid and actually managed to improve as the credit crisis progressed.
So it should be no surprise that the share price has had rocket fuel under it, ceaselessly rewarding its investors while crushing critics in its wake. But for a company that has an $11.25 billion market cap, Green Mountain acts a lot like a small-cap company that needs every penny of share price to stay listed.
Consider the way Green Mountain has handled the otherwise routine matter of a shift in accounting policy. It starts with a May 5 mention by CNBC’s Herb Greenberg of a change in how Green Mountain accounted for its sales returns for the March quarter. A few days later on May 9, Sam Antar, an accounting expert, former crook and all around corporate filings gadfly, followed up with a critical blog post.
On first pass – and quite a few others as well – the company’s 10-Q appeared to show that it had reversed out a $22.25 million provision for sales returns, helping it beat analyst estimates. (Greenberg says his query to the company about this was not returned.)
The accounting shift hit right on top of one of the long-running questions critics have had about Green Mountain: Despite the popularity of single-serving coffee, its brewers have a track record of frequently breaking down. Hedge fund analysts, seeing mounting levels of return provisions, supposed that consumers would get fed up with the unreliable brewers and chose other options, leading to a decline in revenues. The thesis hasn’t work out; Green Mountain has steadily increased sales and even struck a partnership with Starbucks (SBUX).
To critics, despite the quarter-after-quarter pounding they take, this seemed too cute by half. In just three months, they thought they were being asked to believe that one of Green Mountain’s core challenges had ceased to exist. It was a proverbial dog whistle since draining reserves for things like product returns is a well-known accounting tactic to pretty up a financial statement.
Yet rather than addressing these issues head on in an 8-K – since it had either solved a long-standing headache or made a serious change in accounting policy – Green Mountain chose to simply ignore the issue.
Except it didn’t ignore it. Like many companies, Green Mountain chose to thread a needle between addressing the questions of influential market players and ignoring critics like CNBC’s Greenberg to avoid complex or unpleasant explanations to its shareholders. Though the SEC’s Regulation FD is designed to present just this sort of selective disclosure from happening, the rule also affords companies wide latitude in determining what constitutes materiality.
So rather than opening a wide-ranging discussion of what has been a toothache for Green Mountain, the company simply dealt directly (and discreetly) with various hedge funds via e-mail. Here is the body of an explanatory note sent on May 9 to an independent analyst who has researched Green Mountain for several years, from director of investor relations Suzanne DuLong. (For legal reasons, the research analyst asked to remove the name's of his firm and himself. The research shop’s e-mail was prompted by the questions of one of its paying clients, who in turn forwarded it to several other hedge funds.)
DuLong also reached out to reassure the brokerage community, whose analysts traditionally prove highly receptive to corporate explanations of complex accounting problems. Brokers have not been shy about pounding the table on behalf of Green Mountain over the last year, and the rising share price – and trading commissions – has made their loyalty worthwhile. Bank of America Merrill Lynch, whose research analysts had recommended the purchase of Green Mountain shares after the SEC raised questions about its accounting in November -- thus stopping a sharp slide in the stock price -- was given the mandate to lead a secondary stock offering several weeks ago.
Here’s a research note from Dougherty & Co., a Minneapolis-based brokerage and market maker in Green Mountain stock, sent to another hedge fund, arguing how wrong Greenberg is. Note the similarity between it and DuLong’s e-mail to the analyst above.
There is a real world cost to this, however. Green Mountain’s policy of dealing only with influential investors and brokers means that analysts or investors who aren’t in some private feedback loop have a material disadvantage in analyzing the company’s cash flows. From an accounting perspective, this is almost certainly a violation of the principles of consistency and comparability, which is a long-winded way of saying that all financial filings should be able to be readily compared with each other. Unless GMCR actually knew that comparing sales return provisions was “apples to oranges” it would have had no way to reconcile the two periods.
Fairness requires us to note that Green Mountain’s accentuation of the positive is hardly a crime, nor is minimizing the negative a terrible idea, especially since the company had a secondary offering under way. Yet getting it to discuss any of this over was another matter entirely. We repeatedly called and e-mailed Pamela Martin, the head of public relations for its U.S. coffee unit, to no avail.
Reaching out to DuLong got a reply that the matter was being taken under advisement; nor was an attempt to reach PR chief Sandy Yusen successful. All in, we spent about two weeks seeking a comment.
As referenced above, Green Mountain, for all its success, has a whole lot of accounting headaches. In late September, the SEC launched an inquiry into the way it accounts for its revenues with an eye towards its relationship with M. Block & Sons, the order fulfillment company that handles about 97% of its business. A class action suit, filed February 23, cites seven different confidential witnesses who in aggregate paint a grim portrait of shoddy operational controls and accounting shenanigans between Green Mountain and M. Block. Here is the company’s motion to dismiss in reply.
Green Mountain deserves plenty of critical scrutiny. Not because of the way it shifted its accounting of a little more than $22 million among line items, but because it seems to play best on an unlevel playing field. Companies like that often see their headaches turn into something more traumatic for all involved.