Green Mountain Coffee Roasters (NYSE:GMCR) — Faces New SEC Inquiry

Green Mountain Coffee Roasters Inc. (NYSE:GMCR), the Vermont-based specialty coffee and coffee maker company, is facing a new SEC inquiry on its revenue recognition and a particular vendor relationship. It’s already hurt the share price, and today Dan Amoss, Agora Financial’s editor of the Strategic Short Report, provides insight into how this brush with the law is likely to have come about for Green Mountain:

“Green Mountain Coffee Roasters (NYSE:GMCR), our ‘coffee bubble’ company, announced an SEC inquiry after the closing bell last night.

“‘Based on the [SEC’s] request [for information],’ says Green Mountain’s 8-K filing, ‘the focus of the inquiry concerns certain revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.’

“We can make a good guess at which fulfillment vendor this involves. According to the latest 10-K, Green Mountain relies on M. Block & Sons, ‘to process the majority of orders for our At-Home single-cup business sold through retailers. We sell a significant number of brewers and K-Cups® to this third party fulfillment company for re-sale to certain retailers. Receivables from this company were approximately 51% of our consolidated accounts receivable balance at September 26, 2009.’

“Management won’t give any detail beyond this 8-K disclosure until next quarter’s earnings report in November. There’s plenty of room for revenue recognition shenanigans in this relationship, since M. Block warehouses physical inventory of Keurig machines and K-Cups, takes orders from retail customers, ships the products, and collects receivables.

“Here is just one possible reason behind the SEC inquiry (only an educated guess): a series of ‘bill-and-hold’ transactions initiated by Green Mountain. In such a transaction, Green Mountain would book both revenue and accounts receivable for sales of Keurigs and K-Cups to M. Block, yet continue to store the merchandise in its own warehouses. Such a transaction is compliant with FASB rules if M. Block initiated it due to inadequate warehouse capacity. But it’s against FASB rules if it were initiated by GMCR solely for the purpose of accelerating revenue and ‘beating’ earnings in a given quarter.

“Again, this is just one possibility among many. I’m only describing one potential reason for the SEC inquiry. But the market isn’t waiting around for more detail, and many shareholders are selling this morning.

“In another development, on Monday JPMorgan published a note after meeting with Starbucks CEO Howard Schultz. It seems the rumors of a possible forthcoming Starbucks-branded single-cup brewer are accurate:

CEO Howard Schultz was vehement about the success of VIA in the US… More interesting was the willingness to accept the single-cup brewing platform – most obviously represented by Nespresso and Keurig machines – as a major growth opportunity long term. Schultz openly complimented the Keurig offering due to its low cost of hardware and open platform. However, Starbucks was clear to not “bless” the Keurig platform as the necessary platform for them. In fact, the company has argued that over 80% of Starbucks customer base does not have a single cup brewer at home, almost implying that a competing hardware format of which Starbucks may participate in (and hugely legitimize) may be forthcoming.

“Tougher competition is inevitable in the single-serving coffee market. Starbucks isn’t going to sit still and allow Green Mountain to dominate this growth market.”

Dan Amoss believes that many growth fund managers will decide to abandon this stock, and value investors are only likely to grow interested in GMCR at a fraction of today’s stock price. To receive Amoss’ exact trading recommendations you should subscribe to the Strategic Short Report. It’s available through the Agora Financial reports page, found here.

Best,

Rocky Vega,
The Daily Reckoning

[Nothing in this post should be considered personalized investment advice. Agora Financial employees do not receive any type of compensation from companies covered. Investment decisions should be made in consultation with a financial advisor and only after reviewing relevant financial statements.]