"Even though management did not perform the evaluation of Sleepy’s internal controls over financial reporting, we became aware of the following material weaknesses that existed at the end of Sleepy’s fiscal year 2015 and are still unremediated:
- Sleepy’s does not adequately document its vendor agreements relating to incentives offered by vendors and does not document changes to its vendor agreements.
- Sleepy’s does not adequately document its agreed upon firm prices for, and does not timely bill for the sale of, damaged, clearance, outlet and obsolete inventory to third parties.
During the first quarter of 2016, we identified a material weakness in our controls over financial reporting related to the accounting for significant transactions that occurred during the quarter. Specifically, we did not design and maintain effective controls related to the recording of the expense for the flow through of the inventory step up fair value adjustment in the Sleepy’s acquisition. We believe the financial statements included herein properly reflect the correct amount and proper classification of the flow through of the Sleepy’s inventory step-up adjustment."
Given the extent of other issues previously outlined at length around MFRM, this is yet another red flag that could potentially be quite significant. There's a lot of ambiguity around the way the above is worded, but basically it sounds like MFRM's diligence around Sleepy's 'missed' a few things related to Sleepy's treatment of clearance/obsolete inventory and vendor incentives. Given the significant downward revision to full year guidance that was rolled out with the Q1 release, putting the pieces of the puzzle together gives the impression that margins are going to suffer a previously unforeseen hit during FY 2016.
Despite the sharp move downward already, these developments could be a catalyst for a further move, now that momentum is squarely to the downside.
