Green Mountain is once again plumbing new depths as it sinks to lows not seen since the fall of 2010 when the SEC announced its interest in Green Mountain’s accounting. At the time, that represented a buying opportunity as Green Mountain rebounded from around $27 to $110 one year later -— a three-fold gain. It has given back all those gains in the past six months as bad news and short-sellers chase it down. Do current prices give us a buying opportunity this time? Not as likely.
The David Einhorn Effect
In October 2011 in a detailed presentation, Einhorn gutted the company.
• lack of transparent accounting,
• maturing market and less expansive growth going forward lack of cash flow in spite of super-charged growth
• changing business model to a manufacturer
• patent expirations
• expensive acquisitions
• high capital expenditures
• uneven sales of K-cups
Inventory and revenue recognition
When I looked at them in October 2010, the most troubling aspect of Green Mountain was its accounting and the shifting relationship with M. Block & Sons variously described as a fulfillment entity and/or a vendor. GMCR has called it both. Fulfillment means M.Block & Sons (MBlock) takes orders from retailers and fills them for GMCR holding its inventory; a vendor buys product and resells it. MBlock processes nearly 50% of GMCR receivables and is unfortunately a black box neither we nor the SEC has been able to crack. A change in revenue recognition in 2009 allowed GMCR to recognize the revenue on shipment rather than delivery and that makes MBlock a great place to store high levels of product that are counted as revenue, but not necessarily sold.
MBlock can absorb tremendous amounts of inventory that we can’t adequately track allowing GMCR to grow revenue while citing production capacity constraints--all that inventory was presumably at some point sold--or not. Rate limiting manufacturing bottlenecks give GMCR a plausible motive for increasing capital spending. Is it really necessary? Over the past two years, there has always been 6 weeks of inventory on the books making the need for high cash-flow-eating capital spending questionable.
No cash flow
The capital spending has resulted in negative free cash flow in the last five out of six years creating capacity that now appears to be in excess of demand. Capital expenses can be subject to creative accounting and include expenses that should rightfully be counted as operating expenses. Much like MBlock, it can be a black box. Was it? Coincidentally, while capex was growing, SG&A declined allowing expansion of operating margins. Were some operating expenses transferred to capex spending? Green Mountain’s comment was they overestimated costs and were pleasantly surprised at the margin expansion in the most recent quarter.
GMCR has always managed to increase inventory in the six-month period before Christmas to new highs, sell through Christmas at record revenue and continue to increase sales of both brewers and K-cups post December at 60% or greater revenue growth. In fact, days in inventory actually increased in last years Q2, March 2011, from 50 days to 68, indicating adequate inventory.The shelves were not bare.
If capacity was more than adequate and MBlock continued to soak up excess inventory, it should come as little surprise to investors (although management expressed bafflement at the March 2012 Q2 results) that K-cup sales declined sequentially from Christmas and brewer sales dropped precipitously and left GMCR with a big pile of expiring K-cups, dusty Keurig brewers and MBlock unable to take more product and that would allow high revenue growth. Normally K-cup sales increase sequentially in Q2 as the new brewers expand the single serve user base. Capacity, it would appear, is sufficient. [more]