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A Double Espresso of Questions for Green Mountain

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Sept. 10: This story has been corrected.

Green Mountain Coffee Roasters’ first-ever investor day is Tuesday, and the company is flying high.

The stock price of the company, which sells coffee machines under the Keurig brand and the little K-Cups that go in them, has soared more than 260 percent in the last year.

Despite persistent questions, most of Wall Street remains resolutely bullish on Green Mountain, which has a market value of $12 billion.

In 2010, the company disclosed it was being investigated by the Securities and Exchange Commission. In 2011, the hedge fund manager David Einhorn, who is betting against Green Mountain’s stock price, delivered a highly critical 110-slide speech at an investor conference, raising questions about the company’s future prospects and, more seriously, its bookkeeping. He followed up a year later with another one.

A class-action lawsuit, which was dismissed, quoted anonymous former employees about suspicious activities. Green Mountain has said it conducted an internal investigation that cleared the company.

Green Mountain operates on a razor/razor blade model — selling brewing machines but making its real money on the K-Cups. It used to disclose exactly how many K-Cups it sold but stopped doing so in 2010. Instead, it tells investors the year-over-year percentage growth. Wall Street has dutifully plugged numbers in to estimate the unit sales.

Last year, Green Mountain faced expirations of the patents that covered its brewing system. Wall Street has been monitoring whether Green Mountain will lose market share to new private-label knockoffs. And indeed, a recent Barron’s article suggested that it was losing share faster than expected.

A recent disclosure from the company’s new chief executive, Brian Kelley, has revived the questions about sales, as do on-the-ground accounts I have received from former factory and warehouse workers.

Because Green Mountain’s investor day will give analysts and shareholders unusual access to company executives, it seems like an opportunity to ask them some hard questions.

Here are a few from me.

Just how many K-Cups has Green Mountain sold year-to-date and is it less than the Street understands?

Going by the average of six analysts’ estimates, Green Mountain should have sold roughly 6.9 billion K-Cups over that time period. But that’s “in the neighborhood of 10 percent” too high, says an outside spokesman for Green Mountain, Darren Brandt, of Sloane & Company.

That puts the K-Cup sales volume at around 6.2 billion. The company says it isn’t surprised there is a wide range of Wall Street estimates because it doesn’t disclose the figure. (To be fair, the Canaccord analyst is pretty close, estimating 6.3 billion. The Longbow and Lazard Capital Markets analysts are far too high, with Longbow projecting 7.3 billion, and Lazard Capital 7.7 billion.)

How wide is the gap between how many K-Cups the company says it has sold and how many have ended up in customer’s hands? And why?

During the company’s third-quarter earnings conference call on Aug. 7, Mr. Kelley disclosed that IRI, a consumer products data tracker, captures “roughly 55 percent” of the company’s K-Cup sales volume in the United States.

IRI tracks sales at some retailers like Bed Bath & Beyond, but not at others, like Costco. It also doesn’t capture things like direct sales to offices (ProPublica’s Keurig machine gets plenty of use).

Roughly 90 percent of Green Mountain’s K-Cup sales are in the United States, based on company disclosures. Using the company’s math, that would add up to 5.6 billion in K-Cup sales so far this year.

IRI, however, has tracked only about 2.6 billion K-Cup sales for the first nine months of the year, according to an analysis I was furnished with. If, as Mr. Kelley says, that 2.6 billion represents 55 percent of the total, then 100 percent would be about 4.7 billion.

That’s a far cry from 5.6 billion. There seems to be a gap in the United States of about 900 million K-Cups.

What’s going on?

Mr. Brandt said the company declined to give its overall sales volume, but said the IRI number that I was furnished with was too low. He said a company analysis indicated that this portion of Green Mountain’s sales should be about 2.7 billion, not 2.6 billion.

Still, even if we use the company’s figure of 2.7 billion, total sales in the United States would be 4.9 billion, or about 700 million K-Cups short of what the company has said. That’s a lot of extra K-Cups sitting in the channel.

Mr. Brandt said that for companies like Green Mountain it was perfectly ordinary for there to be a difference between sales to its customers and end sales to consumers, as tracked by IRI.

What explains the unusual movements of Green Mountain inventory described by some former company workers and associates?

I spoke to Tim Jackson, 43, who worked for Green Mountain in its Knoxville, Tenn., facility as a material handler and in the shipping department from August 2009 to August 2011.

He acknowledges that he was dismissed for not getting to work reliably. But he said Green Mountain moved its inventory in ways he found strange.

“A lot of things seemed kind of hinky,” he said. “Inventory levels were pushed to extremes and then they transferred them around from one sister company to the next.”

He added: “These are finished products, finished cartons, ready for the shelves. Why transfer the product? Why not sell it straight from here? Why pay for the shipping?”

Sometimes, he said, he would see the same pallet of boxes come back to the Knoxville facility. Mr. Jackson said he had worked in similar facilities at other companies and hadn’t seen that before.

Mr. Jackson said such transfers were “more predominant before inventory audit.”

Frank DeStefano, 32, worked as a production planning manager for M. Block and Sons, which handles Green Mountain’s warehousing and logistics in Bedford, Ill. He worked there about seven months and said that after he started asking questions, he was let go in March 2011.

M. Block did not respond to a request for comment.

Though he worked for M. Block, he said, “I was told by Keurig what to do with everything.”

He echoed Mr. Jackson’s account. “As far as the coffee went,” he said, “it wasn’t moving as quick, always being transferred from one warehouse to another warehouse.”

Mr. DeStefano said that on two occasions, before an audit, Green Mountain filled large orders from QVC, the home shopping channel. “We would shove it all inside trucks and ship a bunch to QVC. After the audit was done, more than half was sent back.”

QVC did not respond to a request for comment.

“They would say just buyer’s remorse,” he said. “That seems kind of strange that half of those would come back.”

A company spokeswoman said that any movements between company units and with third-party logistics companies were not booked as sales and that the company adheres to proper revenue recognition rules.

“These allegations from former employees are unfounded,” a company spokeswoman said in a statement. “The allegations surrounding suspicious sales of brewers to QVC prior to an audit were first raised in a complaint filed in the litigation. As we responded, they are so logistically implausible that one cannot conclude that the source’s statements are reliable.”

The company said it was cleared by an internal investigation. And the United States District Court in Vermont dismissed the class-action suit with prejudice, ruling that there was no evidence that suggested knowledge of the allegations by the top executives.

What is happening with the S.E.C.’s investigation of Green Mountain, which the company has said involves its accounting practices?

The company’s latest quarterly filing says the inquiry continues.

The new head of the S.E.C., Mary Jo White, has said publicly that one of her main goals is to put more resources into fighting accounting fraud. Keeping an investigation over a company’s head for years is unfair for everyone involved. Resolving the long investigation into Green Mountain one way or the other would do a great service for the investing public.

Not to mention caffeine lovers.

Correction (9/10): An earlier version of this column misidentified one of the Wall Street firms that published estimates of sales of Green Mountain's K-Cups. It is Lazard Capital Markets, not Lazard. (Lazard Capital split off from Lazard in 2005 as part of its former parent's initial public offering.)

The authors must! work for Einhorn or got paid for this.

Bruce J Fernandes

Sep. 10, 2013, 1:56 p.m.

The coffees taste terrible and inferior in quality.  I admit to being a coffee snob and have been a Peetsnik for almost ever.  Given the price paid per K-cup the coffee quality should be a lot better than it really is which raises the entire question of quality.

Peet’s was always clear with its customers that it was unwilling to compromise quality and believed there isn’t enough quality coffee out there to simply offer inferior coffee.

My own view is Green Mountain offers cheap quality coffee to the masses who do not know any better.

Two comments:
1.  I will agree with Mr. Fernandes that most of the K-cup coffee tastes like hot water.  However, the company’s Barista Prima brand is very good, although I doubt it accounts for much volume due to its premium pricing.  Even Peet’s has gotten into the K-cup act and it is fairly good.
2.  Much more importantly, investors and other observers should always look with great suspicion on any company that decides to no longer publish a vital statistic, such as, in this case, the number of cups sold.  Most likely, the company started to see a downturn in individual cup sales back in 2010 and some genius in finance or PR floated the idea of just eliminating the number from the reporting. I have seen this done at companies in the past and it never fools the analysts or other outside observers, as is evident by the story above.

Bruce J Fernandes

Sep. 10, 2013, 2:42 p.m.

Green Mountain has another issue which is the patent life of their k-cup machine which ran out and low and behold they come up with a new proprietary machine.  It gave Green Mountain new life in terms of investment value to momentum shareholders that have driven this stock to the moon.

When this new machine’s patent life expires do we get yet another new machine?  I don’t think consumers will look kindly on that particular option.  It appears Green Mountain is playing for time and it is one bad quarterly earnings report from being slammed down hard.

Starbucks, Peet’s and let’s just say better/superior coffee brands will win the day over the long term because the mediocrity of their main Green Mountain brand will become clearer to users over time.  I haven’t tried Barista Prima because I figure it will in time go the same way as the Green Mountain coffees/blends….. to mediocrity.

I don’t bother with any of the Green Mountain coffees anymore because it is clear they are unable to procure enough good coffee to maintain a high standard.

The SEC is not protecting investors and should require that Green Mountain disclose quarterly K-Cup sales since this is the ONLY WAY for an investor to really understand the company’s financial statements.

What’s next?  Will the SEC allow public builders to tout revenue and earnings growth without disclosing the number of homes they sold?

Bruce J Fernandes

Sep. 10, 2013, 4:08 p.m.

The SEC has no duty to force companies to provide metrics that are not directly related to GAAP accounting.

Investors best decision is to avoid companies that refuse to offer such an important metric.  I have never owned GMC nor will I ever own it because of their refusal to provide that metric.  It is my view that GMC is one bad quarterly report from a huge price fall.  It has happened before and I expect it to happen again sooner rather than later.

GMC is telling investors everything they need to know about GMC.  They will not provide the most basic information therefore your investment decision is to run like the wind and stay free and away from GMC.

Robert E Crysler

Sep. 11, 2013, 7:17 p.m.

Recently my small town library in upstate NY removed the machine from the offering. It was the only kind of coffee available and was being offered for $1.50 per K-Cup. The K-Cup displays are still on the counter, but the machine and it’s $1.50/cup sign have been removed. More to follow on this I imagine.
I suspect that a company such as this is being forced to realize that in the world of large numbers and global market places, consumer value is the market sweet spot however it is always in a state of fluid change and especially so as intellectual property rights evolve and change over time.
I personally thought the coffee offering was over priced for it quality standard and I myself stopped purchasing it in the library ( plus I needed to cut down on my java intake ).

There is a big environmental issue with this kind of coffee delivery system - these “K cups” - and that is the amount of excess and unnecessary waste created compared to other methods of making coffee, whether the very basic espresso with no filters or a drip method with one filter that could be a simple unbleached or a cloth or metal reusable or whatever - but not a single plastic little cup for each brew! Ridiculous! And why was this “new invention” even called for?  Other methods make superior coffee without yet another new way of fouling up the environment!

The environmentalists got on this one with the waste and plastic K cups for sure. buy the single use filter for the machine, not the solo single cup filter as it spills grounds into the cup. these single brewer machines sell for $99.00 still and the individual cups ARE NOT environmentally friendly. Too bad.  wash out the filter cup and used ground coffees. This disposable society is criminal.  Oh and Green Mountain coffee tastes like toxic waste. You can buy your own ground coffee, but don’t use too fine grounds or it will clog the piercer, and it pays to rinse the machine with white vinegar as in all coffee makers, anyway.  $99. “even on sale” is WAY to much for a heat pump/brewer. Get real, stop being so greedy.

Bruce J Fernandes

Sep. 15, 2013, 1:28 p.m.

Janet,

If we went through the entire list of environmentally incorrect goods and services sold in our economy and said to get rid of it where would like millions of workers no longer working to be working?  Should government create jobs based upon the nonmarket mechanisms they already use so unsuccessfully?  Should we create nothingness in an economy rather than what consumers want and are willing to pay the price asked for in the market?  Government just takes our money for next to nothing in the way of services. 

First, lets get those k-cups to be recyclable…. then encourage people to use the coffee for your garden or compost.  I found a Jamaican Blue Mountain k-cup that is wonderful in balance and taste.  Finally, lets stop trashing every business opportunity where there is a demand and a supply and willing consumers buying product.  We can’t all work for politically correct government and provide government services to each other although I am certain there are a few diehard socialists leaning toward communism that still cant’ bring themselves to accept the Soviet Union and its bloc of countries collapsed into itself precisely because of the belief that government was the be all, end all, and everything in between.

they knew it was environmentally a hazard before they started. Get real. so, it’s not ok to trash them, but they can trash the environment? Ever see the short movie, MidWay about the uninhabited island home to birds starving due to washed up plastic lids, containers and their decomposing bodies with the plastic in their stomachs from obstruction and starvation? They know they are over priced, toxic coffee though the machine is supposed to be BPA free. 
Are you saying gov’t created these jobs?  How can there be demand and supply if the company is re arranging it’s inventory and the honest ones are being fired for speaking up about it and the numbers don’t add up? I can see through this one already.

Bruce J Fernandes

Sep. 15, 2013, 3:09 p.m.

Janet,

Now you want to ascribe the irresponsible behavior of our fellow humans that refuse to throw away trash in a responsible manner.  Make up your mind instead of putting forth specious arguments.

So now if we outlaw every business that produces too much waste as you and the environmentalists define as too much OR businesses whose waste is thrown away irresponsibly I would say we have another 10M people unemployed.  I suppose you believe the government can create 10M green jobs and we can all build each other solar panels or wind turbines.

From the beginning of humanity we generate waste and when societies like the Mayans or Romans abused the environment those societies paid horrible prices.

I am all up for Green Mountain Coffee which I agree makes horrible coffee should do PSAs about responsible disposal of k-cups or find some way ala Starbucks to recycle.  Encourage coffee grounds to be used in gardens, etc.  Peet’s leaves big containers of used grounds in their stores for people to take and put in their compost piles.  We always take advantage whenever we are in CA.

I could make an argument that virtually everything that is not recyclable can be labeled as a hazard.  Do we stop all of it?  Do we stop making diapers and Depends and everything else humanity makes in order to make our lives easier and better to live?  I don’t think so…..

It appears you are on a rant about GMC’s accounting methods too.  I will let the SEC and others decide what is really happening but it is a peripheral issue to your lead issue of environmental issues.

GMC’s lying about accounting methods.  When we all see how much the first ten years of ObamaCare is going to cost in excess of all those CBO presentations.  You let me know if GMC’s questionable inventory methods pale in comparison.

Bernie Madoff was heard to say he didn’t understand why he did anything wrong inasmuch as government has been engaged in Ponzi games since the beginnings of the New Deal and the first Social Security recipient paid in $75 and got over $9000.

Bruce Fernandes, you are very aggressive in your rather bullying comments directed at “janet”. You seem to confuse the activities of recycling versus taking out the trash versus reducing use of materials made of, for example, plastic.  Among the most basic precepts of responsible environmental behaviors are reduce, reuse, recycle. This method of coffee-making does none of those and it is irrelevant to introduce other items that people use - such as your non-sequitur use of “Depends”, for example - since what we are talking about is this method of coffee-brewing. It is one area of life in which need was manufactured - as in contrived - marketing was vigorous and lemming-consumers responded. Yes, of course, in a (relatively) free capitalistic-consumer society with disposable income, such purchases are a matter of personal decision. To express the wish, shall we say, that people would re-think such decisions with heightened environmental awareness of their actions is a far cry from your hypothetically posed idea that environmentalists (most anyway) have an associated wish that there would be laws forbidding such purchases. However, eventually the “laws of nature” will make such decisions for us - perhaps not in your lifetime, so you can relax and continue to enjoy your Depends and any other plastic/petro-chemical accoutrement for which your heart and wallet are satisfied (and presumably your conscience is always untroubled by anything you choose to do, so that goes without saying) - but in the not so distant future; nature will out, paraphrasing Shakespeare. Many of us will live to see the day when the very idea of throwaway single plastic containers to make a beverage or purchasing water in throwaway plastic bottles will seem like a relic of high crime and venal sin and many will look back and say, “why did they do that?”  Not you though, quite obviously.  People who cry out “Jobs! The jobs!” whenever an environmental issue is raised amaze me. For the sake of argument, let’s say that all the people who claim that the new method of hydraulic fracturing for natural gas (different from already destructive natural gas drilling with this new version of natural gas drilling, “fracking”, being the same new technique as is used in horizontal deep-water oil drilling - you know, like that of Halliburton and BP in the Gulf of Mexico) are right and it is a serious threat to, among other things, water - the water we need to drink and to live. When the fresh water is gone, do you think people will cry out for “jobs” or “water”? When America’s soil, woods, air and waters and natural beauty are ruined, do you think Americans will enjoy moving to China for the jobs? China, where the environment has already been devasted and desertified. You really should lift up your eyes now and then, away from your bank statement and your wallet and your safe deposit box and your false view of what ‘freedom” means and THINK. Now and then, just THINK. When a coffee-drinker can make a delicious and easy cup of coffee without adding to already overwhelming stream of waste, particularly plastic waste, then why would any thinking person choose to add to that waste stream, willingly and knowingly?
You say: because they can, because we’re free, because it’s a choice. When do individual choices that are destroying the planet that we ALL share become a matter for a sensible society to stop?
Believe me, I do realize and I do know full well that no human being lives on this Earth without leaving a footprint, without doing damage; it is impossible. But to simply suggest the idea that we consider the slightest mitigation of that damage seems to be anathema to you. I suggest to you that that is a point of view that leads us in the wrong direction.

Bruce J Fernandes

Sep. 16, 2013, 6:31 a.m.

DA

Just exactly how naïve are you?  This globe has been here for untold billions of years and has self-corrected for more extremes than any of us will ever know or understand. 

You too suggest that every business model should be vetted by the government before being allowed to exist.  If we do that I simply asked Janet if the government was going to employ the millions of additional people who are never working in the private sector because some new massive governmental framework will look at every last aspect of a private sector’s business plan and rework it so that it is 100% environmentally correct.

Maybe you think that is the right answer.  To give government more power when it cannot handle what it has on its plate now.  I have no problem with these protestations and I do think GMC has a responsibility to find a k-cup that can break down better or be recycled.

I watched a show on Bloomberg TV last night where an entrepreneur is making clothes out of plastic bottles that would otherwise go into the land fill.  The person involved is a person of gravitas from the sports world and he has the backers and the money to see it through.

If you are right about what I am saying why did Janet drift off into GMC’s accounting issues which have zero to do with the environment?  Frankly, I am impressed that she is aware of these accounting issues which are followed by people like me but it was a drift from environmentalism into a discussion about whether GMC has a right to exist.

I am not crying out for jobs.  I am saying that all these protestations have to lead to government intervention into the business plans of every business and a government rework of every business’s business plan before allowing that business to come into existence.  The materials being used by GMC are used by many other businesses in many other forms.

You are challenging me on incorrect grounds.  If you believe as you believe this is the only way to take charge of the environment.  We are beginning the end of king coal in the US.  Tens of thousands of jobs will eventually be lost as a result.  At least West Virginia is talking about putting a portion of royalties and taxes received from natural gas into a trust fund for transition and long term government stability.

You cannot suddenly shift or destroy businesses without impacting thousands of jobs.  Or, again, I ask if we all should be working for government providing services to each other and have absolutely nothing to purchase because its hard to go through a day without seeing how much waste we all generate.

Climate change has been so politicized we are not going to get anywhere until we get a generation of scientists performing work without a political agenda as the basis for doing scientific work on something very important.  Tainted scientists are not trusted and politicians can never be trusted when there is a sense that government sees every solution and outcome must include total governmental control of everything.  One more time, we already have millions under employed or unemployed and work force participation is down to levels from the 1970s.  What do we do with the millions more that would be unemployed if the government wants to render on the worthiness of every new business that would like to come into existence.

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)