Brewing The Books In Brazil: Accounting Irregularities At DE Master Blenders 1753, Impacts Hilshire Brands, As Well

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That was quick. Weeks after its spinoff from Hilshire Brands(HSH), the former Sara Lee, DE Master Blenders 1753(DEMBF) announced today that it had found accounting irregularities, and would be restating results. These are definitely words no investor wants to hear, and they tend to get bigger the more they get looked at. Here is how the company describes the problem:

identified adjustments related to the previously reported historical carve-out combined financial statements for fiscal years 2009-2011 and first half fiscal year 2012 as well as items that will result in adjustments to its upcoming results for fiscal 2012.  These adjustments are not expected to affect the company’s financial performance in fiscal 2013.

These adjustments, which all involve the company’s Brazilian operations, are partly caused by accounting irregularities involving uncollectible accounts receivable and incorrect sales recognition.  In addition, the company has taken provisions on inventory levels and made other corrections, including additional tax provisions.

The adjustments are expected to reduce the company’s shareholders’ equity by approx. ? 85-95 mln and are expected to reduce the company’s fiscal 2012 net result by approx. ? 45-55 mln, of which approx. ? 20-25 mln is expected to be accounted for within operating profit.  Currently, the company expects that the cash-out impact will be limited.

A comprehensive investigation of the accounting irregularities referred to above is being conducted.  The company plans to take appropriate actions to reinforce and enhance the internal control over financial reporting and governance procedures in its Brazilian operations.

D.E MASTER BLENDERS 1753’s carve-out combined financial statements previously included in filings with the U.S. Securities and Exchange Commission should no longer be relied upon.  The company expects to file its audited financial statements for the fiscal year ended June 30, 2012, including restated historical carve-out combined financial statements, at the end of September 2012.  D.E MASTER BLENDERS 1753 intends to publish its preliminary fiscal 2012 results on August 28, 2012.

Hilshire Brands responded with its own press release, announcing it would be revising its historical numbers to reflect the Brazilian irregularities:

The Hillshire Brands Company (NYSE: HSH) responded to D.E MASTER BLENDERS 1753 N.V.’s announcement today that it has identified accounting irregularities and other adjustments within its Brazilian operations. D.E MASTER BLENDERS 1753 N.V. (D.E MASTER BLENDERS) and its Brazilian operations were previously part of Sara Lee Corporation, the predecessor company to Hillshire Brands, and were spun off from Sara Lee prior to the end of fiscal year 2012. D.E MASTER BLENDERS’ announcement states that the required adjustments are expected to reduce its shareholders’ equity by approximately €85-95 million and result in a charge to its fiscal 2012 net results of approximately €45-55 million.

D.E MASTER BLENDERS has informed Hillshire Brands that it is conducting a comprehensive investigation related to these accounting irregularities.

As a result of the spin-off, Hillshire Brands has classified the historical results of its pre-spin international coffee and tea operations, including the affected Brazilian operations, as discontinued operations. The accounting irregularities cited are expected to impact Hillshire Brands’ historical financial statements for fiscal years 2009 through 2011 and for the first three quarters of fiscal year 2012. Hillshire Brands expects the restatement related to the Brazilian operations to impact primarily discontinued operations. The restatement is not expected to impact Hillshire Brands’ results in fiscal year 2013.

Based on the results of the D.E MASTER BLENDERS investigation to date and in accordance with the rules of the SEC, previously issued financial statements for Sara Lee Corporation’s fiscal 2009 through the third quarter of fiscal 2012 should no longer be relied upon. Hillshire Brands currently intends to file its Annual Report on Form 10-K for the 2012 fiscal year ended June 30 by the end of August, pending the conclusion by D.E MASTER BLENDERS of its investigation. Hillshire Brands currently intends to release its fourth quarter and year-end earnings on August 9, 2012, as previously announced. In light of the ongoing investigation by D.E MASTER BLENDERS, Hillshire Brands will limit its August 9th release to financial information through operating segment income.

We would be very wary of continuing to own DE Master Blenders 1753 here, given the uncertainty in the company’s actual financial performance. We’re particularly skeptical of the claim that there will be no 2013 impact. We’re more sanguine about the prospects for Hilshire, which has no businesses impacted. However, if the scandal at DE Master Blenders 1753 should worsen significantly, Hilshire may have exposure. The market seems unbothered by the announcement- neither stock has moved more than 1% since the news came out.

Disclosure: The author owns shares in HSH and DEMBF

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