Green Mountain Coffee: 10-K Observations

Dec. 2.11 | About: Keurig Green (GMCR)

Green Mountain Coffee (NASDAQ:GMCR) filed their annual 10-K report on Nov. 14th, less than one week after announcing Q4 and full-year 2011 earnings. GMCR shares have rallied a bit since the post-earnings report lows, likely the combination of investor “relief” and a healthy dose of short covering.

As for analysts, the usual suspects have been talking up the stock since the Q4 earnings debacle. William Blair analyst Jon Andersen is the latest, upgrading GMCR to “outperform” on Dec. 1. This follows bullish comments from analysts at Janney and Cannacord back in mid November.

It should also be noted that each of the firms mentioned above are affiliated with underwriters participating in GMCR’s most recent secondary.

Our long-time bearish view of the company is tempered a bit by the fact that management has taken steps to address "material weaknesses in internal controls over financial reporting," including the hire of Steve Gibbs as Chief Accounting Officer back in August 2011.

However, investors are encouraged to pay very close attention to the story being told in the financial statements before giving GMCR the “green” light. Too often, investors reward “growth” stories based on nothing more than its revenues or the prospect(s) of innovative products and services.

Revenue growth is the key to earnings growth and the primary driver for earnings is in the cash-flow(s) generated to support them. More importantly, the quality of a company’s earnings depends on whether or not the “cash-flow” used to build earnings is a result of “actual” operating activity rather than created via balance sheet “maneuvering”.

In the case of GMCR, there is no doubt that its lines of specialty coffees and brand awareness to its Keurig brewing system are wildly popular.

GMCR’s 10-K reveals a company conscious at least, to the allegations and concerns presented by David Einhorn back in October. However, in our examination of the 10-K filing, there remain some glaring contrasts related to changes and relationships within the financial statements.

Let’s start with receivables and inventory. Receivables are one “step” from cash while inventory is two-steps from cash.

Accounts receivable grew 80.21% in 2011 while inventory levels spiked 156.12%. On the statement of cash-flow, the company reported a 323.6% increase in provisions for doubtful accounts and a 60.6% rise in provisions for sales returns (2011 vs. 2010).

Under changes in assets and liabilities, net of effects of acquisitions, receivables declined 53.8%. Inventory “values” declined a whopping 221.2%

Intangibles and Goodwill: In the twelve months ending Sept. 24, 2011, Goodwill jumped 104% and intangible assets (net) rose 140% over the prior 2010 year. On the cash-flow statement, amortization of intangibles rose 176.1%.

The balance sheet displays a 90.71% increase in reported accounts payable for 2011. In contrast, the statement of cash-flow shows a 159% spike in the value assigned to accounts payable for the similar period.

Accrued compensation costs grew 78.49% in 2011 while accrued expenses rose 86.94% over 2010 levels. Yet, on the statement of cash flow, the value assigned to compensation costs mushroomed 222% over 2010 levels. The value assigned to accrued expenses rose a more modest 9.4%.

Fixed assets (net) in 2011 rose 123.7% compared to 2010, but adjustments to depreciation spiked 145% during the similar period.

Green Mountain Coffee Roasters, Inc.

Consolidated Balance Sheets

(Dollars in thousands)

September 24,

2011

September 25,

2010

Assets

Current assets:

Cash and cash equivalents

$

12,989

$

4,401

Restricted cash and cash equivalents

27,523

355

Receivables, less uncollectible accounts and return allowances of $21,407 and $14,056 at September 24, 2011 and September 25, 2010, respectively

310,321

172,200

Inventories

672,248

262,478

Income taxes receivable

18,258

5,350

Other current assets

28,072

23,488

Deferred income taxes, net

36,231

26,997

Current assets held for sale

25,885

Total current assets

1,131,527

495,269

Fixed assets, net

579,219

258,923

Intangibles, net

529,494

220,005

Goodwill

789,305

386,416

Other long-term assets

47,759

9,961

Long-term assets held for sale

120,583

Total assets

$

3,197,887

$

1,370,574

Liabilities and Stockholders’ Equity

Current liabilities:

Current portion of long-term debt

$

6,669

$

19,009

Accounts payable

265,511

139,220

Accrued compensation costs

43,260

24,236

Accrued expenses

92,120

49,279

Income tax payable

9,617

1,934

Deferred income taxes, net

243

Other current liabilities

34,613

4,377

Current liabilities related to assets held for sale

19,341

Total current liabilities

471,374

238,055

Long-term debt

575,969

335,504

Deferred income taxes, net

189,637

92,579

Other long-term liabilities

27,184

5,191

Long-term liabilities related to assets held for sale

474

Commitments and contingencies (See Notes 5 and 19)

Redeemable noncontrolling interests

21,034

Stockholders’ equity:

Preferred stock, $0.10 par value: Authorized—1,000,000 shares; No shares issued or outstanding

Common stock, $0.10 par value: Authorized—200,000,000 shares; Issued and outstanding—154,466,463 and 132,823,585 shares at September 24, 2011 and September 25, 2010, respectively

15,447

13,282

Additional paid-in capital

1,499,616

473,749

Retained earnings

411,727

213,844

Accumulated other comprehensive loss

(14,575

)

(1,630

)

Total stockholders’ equity

$

1,912,215

$

699,245

Total liabilities and stockholders’ equity

$

3,197,887

$

1,370,574

Click to enlarge

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

Summary: While it appears GMCR management is attempting to bring more transparency to what is reported in the financial statements, these numbers are telling us is that the company continues to struggle with generating meaningful (true) cash flow from its operations.

Throw in the 71.67% increase in debt levels (2011 vs. 2010) and a 104% spike in deferred income taxes, it is difficult to justify the valuations investors are granting the stock, even at current levels.

It does not require an abacus to figure why the cheerleader analysts are pounding the table in support of GMCR. These guys were throwing around $90 + price targets on the stock while their firms were pitching the dog and pony show related to the secondary.

Leaves us wondering how due diligence could go so awry; you can put lipstick on a pig, but it will still be a pig!

It’s not the growth story which bothers us. Our concern is that management is not “managing” the growth properly and the lack of liquidity (i.e. operating cash-flow) is a fairly revealing indication of that.

Analysts will argue not to worry about “surging” inventories, suggesting that it is critical to meet demand, particularly for the holiday season. Problem is the company has led investors to believe for some time now that demand remains robust for its products, but supply constraints limited their ability to increase the growth.

Voila ... suddenly the company is awash in inventory.

The bottom line is that at 40 times earnings, GMCR will have to grow 2012 revenues (at minimum) 50% over 2011 levels simply to justify its current valuation. More importantly, margin expansion will require that management lower expenses as a total percentage of sales. 2011 operating expenses (COGS, SGA) were approx. 92% of sales.

However, at the end of the day, GMCR will have to show investors that they can produce viable returns on assets, and in particular, cash-flows generated by paying customers.

Near-term, analyst touts could move shares higher, but investors should tread cautiously. The stock is up almost 32% since the Nov. lows. In this market, a 15% pullback would not be a surprise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Sources: Edgar, merriamreport.com, WSJ online, Reuters