On September 20, 2010, the Securities and Exchange Commission (SEC) started an informal investigation of the Green Mountain Coffee Roasters (NASDAQ: GMCR). Since that time, I’ve written several blog posts critically examining Green Mountain’s compliance with certain accounting and disclosure rules.
My question is based on the following computations
On November 13, 2009, Green Mountain acquired Timothy’s Coffee of the World and its operations were integrated into the company’s SCBU segment. In the quarter ended December 26, 2009 10-Q report, Green Mountain reported the following financial results for Timothy’s:
For the thirteen-weeks ended December 26, 2009, Timothy’s contributed approximately $7,141,000 in revenue and $902,000 of income before taxes.
In the quarter ended March 27, 2010 10-Q report, Green Mountain reported the following year-to-date financial results for Timothy’s:
For the twenty-six weeks ended March 27, 2010, Timothy’s contributed approximately $26,288,000 in revenue and $5,422,000 of income before taxes.Therefore, Timothy’s revenues were $19,147,000 and income before taxes was $4,520,000 for the thirteen-weeks ended March 27, 2010 (Timothy’s revenue and income before taxes for the twenty-six weeks ended March 27, 2010 minus its revenue and income before taxes for the thirteen-weeks ended December 26, 2009).
How Timothy’s income before taxes exceeded revenues during the thirteen-weeks ended June 26, 2010
In the quarter ended June 26, 2010 10-Q report, Green Mountain reported the following year-to-date financial results for Timothy’s:
For the thirty-nine weeks ended June 26, 2010, Timothy’s contributed approximately $28,586,000 in revenue and $10,112,000 of income before taxes.Therefore, Timothy’s revenues were $2,298,000 and income before taxes was $4,690,000 for the thirteen-weeks ended June 26, 2010. (Timothy’s revenue and income before taxes for the thirty-nine weeks ended June 26, 2010 minus its revenue and income before taxes for the twenty-six weeks ended March 27, 2010.)
In other words, income before taxes exceeded revenues by $2,392,000 for the thirteen-weeks ended June 26, 2010. How can that happen? I will present three scenarios below. First, let’s discuss some basic accounting.
How is income before taxes computed?
Income before taxes is computed by starting with revenues and deducting operating expenses to compute operating income. Non-operating income is added to operating income to compute income before taxes. Non-operating losses and interest expense are deducted from operating income to compute income before taxes.
Scenario 1: Good for Green Mountain
Under this scenario, the reason that Timothy’s income before taxes exceeded revenues during the thirteen-weeks ended June 26, 2010 is due to it having non-operating income. Green Mountain did not specifically disclose any non-operating items for Timothy’s. However, on a consolidated basis, non-operating income was only $27,000 for the thirteen-weeks ended June 26, 2010, nowhere near $2,392,000. It is still possible that Timothy’s had over $2 million of non-operating income, but only if such income was offset by non-operating losses in other subsidiaries.
However, any non-operating income from Green Mountain’s Timothy’s subsidiary cannot come from investment income. According to the company’s 10-Q report for the quarter ended June 26, 2010, Timothy’s financial results are included as part of its SCBU segment. The company disclosed that:
Expenses not specifically related to either operating segment are shown separately as “Corporate”. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to our entire enterprise. Corporate expenses also include interest expense, certain corporate legal and acquisition-related expenses and compensation of the board of directors. In addition, fiscal 2009 corporate expenses are offset by $17,000,000 of proceeds received from a litigation settlement with Kraft. Corporate assets include cash and short-term investments. [Emphasis added.]If “Corporate expenses also include interest expense” and Corporate assets include cash and short-term investments”, then likewise investment income should be a corporate expense, too. Therefore, Timothy’s non-operating income would have had to result from non-operating income which is not investment income, such as gains on the disposal of assets. It's possible, though I personally don't think that it's likely.
Scenario 2: Not good for Green Mountain
If Timothy’s did not have any non-operating income, the $2,392,000 excess of income before taxes over revenues for the thirteen-weeks ended June 26, 2010, could have resulted from understating revenues in that quarter.
On September 28, 2010, Green Mountain disclosed that the SEC started an informal inquiry into its accounting practices eight days earlier. On that same day, the company reported an accounting error involving its K-Cup margin percentages. On November 19, 2010, Green Mountain disclosed four new accounting errors. On that date, the company said it would restate its financial reports issued from 2007 to 2010 to correct its errors.
Even if we assume that those accounting errors which were corrected by Green Mountain also corrected an overstatement of Timothy's revenues in the thirteen-weeks ended June 26, 2010, why didn't the company find that revenue overstatement earlier? When operating income that exceeds revenues, it is certainly a major red flag for close scrutiny by management and its auditors.
Scenario 3: Very bad for Green Mountain
If Timothy's did not have any non-operating income and its revenues were correctly reported, the $2,392,000 excess of income before taxes over revenues for the thirteen-weeks ended June 26, 2010 could only come from its operating expenses. However, in this case, operating expenses would have increased operating income, rather than reducing it, because operating expenses would have exceeded revenues by $2,392,000 for the thirteen-weeks ended June 26, 2010.
In other words, Timothy’s would have had negative operating expenses for that quarter. Negative operating expenses are normally caused by an adjustment to the current period’s operating expenses, because of an error in a previous reporting period. Therefore, Green Mountain may have been aware of material weaknesses in internal controls as early as June 2010 and not on November 19, 2010 when it first admitted to such problems.
In addition, none of the errors reported by Green Mountain involved any adjustment to operating expenses for the thirteen-weeks ended June 26, 2010. Therefore, there may be another undisclosed accounting error for Green Mountain to report to investors.
Missing a major overstatement of Timothy’s revenues and income back in 2009
In any case, Green Mountain missed a major overstatement of revenues and income before taxes in its Timothy’s subsidiary for the thirteen-weeks ended December 26, 2009 (the first quarter it was integrated into the company's operations).
In the quarter ended December 26, 2009 10-Q report, Green Mountain reported the following financial results for Timothy’s:
For the thirteen-weeks ended December 26, 2009, Timothy’s contributed approximately $7,141,000 in revenue and $902,000 of income before taxes.In the quarter ended December 25, 2010 10-Q report, Green Mountain reported the following revised financial results for Timothy’s in 2009:
For the thirteen weeks ended December 26, 2009, the Timothy’s acquisition resulted in an additional $4.1 million of revenue and $0.0 million of income before income taxes.Therefore, Green Mountain overstated revenues for Timothy’s by about $3 million and income before taxes by $900,000 in its 2009 10-Q report. How could Green Mountain miss a 75% overstatement in revenues in a single subsidiary? It's a very big error in a small subsidiary. The revenue overstatement should not have been hard to find.
Closing comment for Frances G. Rathke
If you respond to my question, I will post your answer in my blog. If you find additonal time, please respond to my blog post questioning your compliance with SEC Staff Accounting Bulletin No. 99 on materiality and my last blog post questioning your segment reporting and compliance with SEC Regulation G.
I hope you had a happy Valentine's day and I truly love reading Green Mountain's financial disclosures. Very truly yours, Sam E. Antar
Recommended reading: February 11, 2011: Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum
Disclosure I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.
If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.
There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.
Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).
I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.