Green Mountain Coffee Roasters reported 64 cents per share in non GAAP earnings which beat analyst estimates by 16 cents. However, it appears that changes in inventory obsolescence may have contributed heavily to Green Mountain beating estimates.
The FY2012 Q3 10-Q states on page 37 and 38:
Gross profit for the 2012 YTD period was $953.0 million, or 32.7% of net sales, as compared to $650.5 million, or 33.5% of net sales, in the prior year period. Gross margin declined approximately (i) 290 basis points due to under-utilization of our current manufacturing base as a result of lower than expected manufacturing through-put primarily due to lower K-Cup® pack demand and lower-than-planned production levels which increased average labor and overhead costs per K-Cup® pack, (ii) 140 basis points due to higher green coffee costs, and (iii) 100 basis points due to a higher write down of finished product and anticipated obsolescence of raw material inventory due to lower than anticipated sales of seasonal and certain coffee products. The decrease in gross margin was partially offset by (i) a 290 basis point increase due to net price realization primarily from price increases taken in fiscal 2011 to offset higher green coffee and other input costs that were experienced in fiscal 2011 and the first half of fiscal 2012, (ii) a 40 basis point increase due to price increases on Keurig® Single Cup Brewers in fiscal 2011,
and (iii) a 40 basis point increase due to the decrease in 2012 YTD warranty expense related to Keurig® Single Cup Brewers. [emphasis mine]
To find out the exact amount of inventory obsolescence charged to the cost of goods sold account, you take the sales for the period and multiply by the amount of the charge. In this case, for thirty-nine weeks ended June 23, 2012, Green Mountain reported sales of $2,912,462,000. Multiplying the sales figure by 100 basis points gives you a charge of $29,124,620.
But then things become odd when looking at Green Mountain’s latest 10-K. The 2012 10-K states on page 32:
Gross profit for fiscal 2012 was $1,269.4 million, or 32.9% of net sales, as compared to $904.6 million, or 34.1% of net sales, in fiscal 2011. Gross margin declined approximately (i) 220 basis points due to higher labor and overhead manufacturing costs associated with the ramp-up in our manufacturing base, (ii) 80 basis points due to higher green coffee costs, (iii) 70 basis points due to a higher write down of inventories, including finished goods and raw materials, due to lower than anticipated sales of seasonal and certain coffee products, and (iv) 50 basis points due to the launch of our new Keurig® Vue® Brewing system that has a lower gross margin than the Keurig® K-Cup® Brewing system. The decrease in gross margin was partially offset by (i) a 260 basis point increase due to net price realization primarily from price increases taken in fiscal 2011 to offset higher green coffee and other input costs that were experienced in fiscal 2011 and the first half of fiscal 2012, and (ii) a 40 basis point increase due to the decrease in fiscal 2012 warranty expense related to Keurig® Single Cup Brewers. [emphasis mine]
For the fifty-three weeks ended September 29, 2012, Green Mountain reported sales of $3,859,198,000. Multiplying the sales figure by the 70 basis points gives you $27,014,386. A table showing the computation and changes is below.
So for the cumulative thirty-nine weeks ended June 23, 2012, Green Mountain charged approximately $29M in obsolete inventory to the cost of goods sold account. By the time the end of the year rolled around the charge was only $27M, $2M less than it took for the thirty-nine week period. What happened to account for the $2M difference in inventory obsolescence between the end of the third quarter and the end of the fiscal year? Shouldn’t the number have gone higher not lower.
Days Sales in Inventory Is Still Increasing
The $2M difference is especially curious in light of Green Mountain’s ever-increasing Days Sales in Inventory. Indeed, both Sam Antar and I have blogged extensively about Green Mountain’s inventory issues. This quarter contained more of the same issues, Days Sales in Inventory increased to 112 days from 108 days for the same quarter last year as shown in the table below.
It’s also important to note that this rise in inventory occurred despite Green Mountain beating its own estimates for sales. If Green Mountain sold more products than they anticipated, Days Sales in Inventory should have decreased rather than increased.
How can Green Mountain incur obsolescence charges for inventory for the first nine months of the year, have an increase in inventory levels for the next three months, and not incur any additional inventory obsolescence charges? Is it possible Green Mountain relied on reducing or reversing inventory obsolescence charges to beat earnings estimates?
How Much Did the Inventory Obsolescence Reversal Help Green Mountain Beat Estimates?
The table below shows Green Mountain’s pro forma GAAP and non GAAP net income and EPS if inventory obsolescence charges followed historical patterns.
I took Green Mountain’s reported GAAP Net Income of $91.9M and non GAAP Net Income of $101M and subtracted the $2.1M difference from the first nine months and full year inventory obsolescence charges that were discussed above.
I then looked at Green Mountain’s historical rate of inventory obsolescence charges for the first nine months of fiscal 2012. Green Mountain took a total of $29,124,620 in charges over a nine-month period. This comes out to an average of about $746,785 in charges per week.
If we assume Green Mountain continued taking charges at the same rate (which I believe is reasonable if Green Mountain beat their own estimates for sales but inventory levels still increased), then we would have fourteen weeks of charges times $746,785 or approximately $10.5M in additional charges for the fourth quarter.
As you can see by the table, it appears Green Mountain relied heavily on changes to inventory obsolescence to greatly exceed analyst estimates for the most recent quarter.
Unfortunately, for investors seeking additional information, an important disclosure item has disappeared from Green Mountain’s 10-K. Green Mountain’s 2011 10-Kincluded a supplementary inventory obsolescence reserve table on page F-52.
(click to enlarge)
The 2012 10-K includes no such table. In fact, much additional information has been stripped out of the 2012 10-K. The 2011 10-K was 116 pages long (including exhibits), but the 2012 10-K is only 95 pages long (again, including exhibits).
Instead, investors are left to wonder what is happening with Green Mountain’s ever-increasing inventory levels and strange change in inventory obsolescence charges for the latest quarter.
By Ben Strubel of Strubel Investment Management, LLC
Disclosure: You should do your own research and due diligence before making any investment decision with respect to any of the securities mentioned herein. As of the publication date one or more of the following: Strubel Investment Management, our clients, our employees, and/or funds we advise are short Green Mountain Coffee Roasters (GMCR) and stand to realize significant gains in the event that the price of GMCR declines. Following the publication of this article we intend to continue transacting in GMCR and we may be long, short, or neutral any time after the date of publication. We undertake no obligation to update or supplement this article or disclose changes in our position in GMCR securities.