Is The Caffeine Rush Over? The Post Green Mountain 8-K Hangover
As concerns over Green Mountain, well, mount, here are the first two sellside responses following last night's GMCR 8-K announcement of an SEC inquiry into its "revenue recognition practices and the Company’s relationship with one of its fulfillment vendors."
From Bryan Spillane of BofA (Maintain Underperform and $30 PO):
While details of the SEC inquiry are unclear, key points to consider are: 1) Keurig’s largest order fulfillment company is MBlock & Sons, which processes the majority sales (coffee makers and K-cups) that the Keurig segment makes through the retail channel (e.g. Bed Bath & Beyond, Kohls, etc.). M. Block warehouses the physical inventory, takes the customer orders, ships the product and collects receivables, essentially working as an outsourcing partner for GMCR; 2) In FY09, M.Block accounted for 35.2% of total GMCR sales and 51% of accounts receivables; 3) In our view, the use of a fulfillment company to process orders is not unusual (M. Block also has an arrangement with Tassimo, Nestle, etc) however Green Mountain’s proportion of sales flowing through a fulfillment entity has increased because of its rapid growth. This makes it difficult to use financial statements to make a clean assessment on the relationship between GMCR retail sell in and consumer pull. It does not however, suggest to us anything inappropriate. We do note that retail channel checks and third party data suggest that consumer pull through for Keurig Machines and K-Cups are strong.
From Mark S. Astrachan (Sell, No Price Target)
In an 8-K after the close, Green Mountain Coffee Roasters announced an SEC inquiry concerning certain of the company’s revenue recognition practices and the relationship with one of its fulfillment vendors. Separately, the company disclosed an intercompany accounting error that resulted in an overstatement of net income. We believe the two disclosures are unrelated and view the SEC inquiry as the most concerning. Green Mountain said it is cooperating with the inquiry.
Specifically, we believe the focus of the inquiry will be on various revenue recognition changes made by the company in recent years and on its relationship with M-Block, the fulfillment company Green Mountain sells Keurig brewers and K-Cups to for re-sale to select retailers. M-Block accounted for 35% and 50% of the company’s net sales and accounts receivable, respectively, in F2009. Specifically, Green Mountain has changed revenue recognition policies in recent years relating to sales incentives (i.e., recorded as a reduction of revenue or as an SG&A expense) and when revenue is recognized (i.e., upon shipment or customer receipt). For more on the relationship between Green Mountain and M-Block and recent revenue recognition changes, please see our November 30, 2009 note, “Takeaways from the 10K”.
Notably, Green Mountain disclosed the SEC inquiry in connection with its acquisition of Van Houtte and the marketing of the associated $1.35 billion debt financing. While the merger agreement with Van Houtte has not been filed, we believe the presence of a material adverse change (MAC) clause could enable the lenders or Littlejohn to back out of the agreement. Relatedly, Green Mountain announced it completed its $250 million share sale to Lavazza. We are unsure if Lavazza was notified of the investigation prior to the deal’s closing and/or what, if any, legal recourse the company may have as a result.
Further, GMCR’s fiscal year ends in September. As such, the company’s auditors, PricewaterhouseCoopers, will need to thoroughly examine and have confidence in Green Mountain’s results before signing off on their validity, in our view.
As we see more reports, we will advise readers.