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Green Mountain Coffee Roasters, Inc. (NASDAQ:GMCR)

F3Q09 Earnings Call

July 29, 2009 5:00 pm ET

Executives

Frances Rathke – Chief Financial Officer

Lawrence Blanford – President, Chief Executive Officer

Michelle Stacy – President, Keurig

Scott McCreary – Chief Operating Officer

John Whoriskey – General Manager Keurig

Dave Manley, General Manger of Keurig

Analysts

Scott Van Winkle – Cannacord Adams

Mitch Pinheiro – Janney Montgomery Scott

Gregory McKinley – Dougherty & Co.

Mark Astrachan – Stifel Nicolaus

William Chappell – SunTrust

Jon Anderson – William Blair

Operator

Welcome to the Green Mountain Coffee's fiscal 2009 third quarter financial results conference call. Today's call is being recorded. At this for opening remarks and introductions, I would like to turn the call over to Chief Financial Officer, Ms. Fran Rathke.

Frances Rathke

Welcome everyone. If you have not received the earnings release, it is on our website at www.greenmountaincoffee.com. Also on our website are slides that summarize much of the information on this call. You can access them through the same link as our webcast from the investor's services page of our web site, and I urge you to view them as they contain key messages and data we are discussing on today's call.

I want to remind everyone that certain statements will be made which are forward-looking within the meaning of Securities Laws. Owing to the uncertainties of forward-looking statements our actual results may differ materially from anything projected in these forward-looking statements. We can give no assurance as to their accuracy and we assume no obligation to update them

For further information on risks and uncertainties, please read the company's SEC filings and the paragraph in today's press release that begins with the words 'certain statements'. We also request that you ask all of your questions on this call so that our answers are available to everyone.

And now I would like to turn the call over to our President and CEO, Larry Blanford.

Lawrence Blanford

Joining Fran and me with prepared remarks on this call today are Michelle Stacy, President of our Keurig Business Unit and Scott McCreary, Chief Operating Officer of our Specialty Coffee business unit. After these remarks, our management team will be available to respond to your questions.

Today, it is exciting to be sharing with you truly outstanding results for our third fiscal quarter. In the quarter, we delivered a 61% increase in sales and 123% year over year increase in net income. On this call, Fran will be talking more about the quarterly financial results and will provide increased estimates for this fiscal year, 2009 and first estimates for 2010.

I'd like to focus for the next few minutes on how we are leveraging the Keurig opportunity to drive long term growth. Recall, on our second quarter conference call in April that we discussed several enabling initiatives including the acquisition of Tully's Wholesale business and brand, the introduction of Café Escapes and the continued expansion of our distribution network and sales channels that target the at-home consumer.

These initiatives which Scott and Michelle will be discussing further are reflected in our growth rates this past quarter and in our future expectations.

In our third quarter we announced two new licensing initiatives. We licensed Con-Air Corporation to launch a Cuisinart branded Keurig brewed coffee maker during the first half of 2010. We also licensed Jardan to launch a brewer under its Mr. Coffee brand expected during the second half of 2010.

These initiatives are consistent with our fundamental razor blade approach to growing the business which focuses on getting brewers into more households in part by providing consumers with more looks, features, brand choices and price points. Both product lines will be co-branded with Keurig and designed to work with the 200 varieties of gourmet coffee, tea and hot cocoa packaged in Keurig's patented K-Cup portion pack.

With Keurig, Cuisinart, Mr. Coffee all offering Keurig brewed technology, we are seeing to maximize the visibility of Keurig and expand choices for the consumer, thus accelerating the adoption of single cup brewing into homes across North America.

Also in the third quarter, we launched a line of Celestial Seasonings Perfect Iced Tea K-Cup portion packs. The introduction of this product line of brewed iced teas tests consumers' willingness to adopt new behavior, brewing over iced. We're in the early of introduction and so far the K-Cup in trial from our web site and consumer comments have been very positive.

These new products should provide new demand for K-Cup portion packs by adding cold beverages to the varieties that consumers already enjoy all with the same quality, convenience and value.

Consumer of this technique creates interesting possibilities such as using the Keurig system to brew and infuse other fresh ingredients into what will become a cold drink beverage as you brew over ice. I'm energized about the potential this method of cold drink preparation which over time, could fuel meaningful new demand for K-Cup portion packs across the growing install base of brewers.

Our initiatives this past quarter also drew upon what I would describe as a core competency and technological innovation at Keurig, underscoring our commitment to continually improve the Keurig brewing system. While Keurig brewers have always received high ratings for consumer satisfaction in terms of quality and convenience, some consumers desire quieter brewing operation.

Consequently our Keurig engineers developed a significantly quieter pump and I am pleased to report that at this month all at-home models we are now manufacturing incorporate our proprietary quiet brew technology.

Equally exciting, we have designed a new generation of the new K-Cup portion pack with the capability to deliver more coffee which can either provide increased brew strength or a larger cup size. By early next calendar year, we expect to provide consumers with a 12 ounce travel mug size of several of their favorite coffees in addition to the current eight ounce size.

Additionally, our goal on about the same time line is to introduce test quantities of teas packaged in a new K-Cup made from renewable material. These advances in system technology demonstrate our commitment and capability to provide the ultimate coffee experience with the Keurig single cup gourmet coffee system.

Operationally, the integration of Tully's over the past quarter into our organization has been executed extremely well by a group of very dedicated employees and our Specialty Coffee business unit working hand in hand with our new associates from Tully's. This integration is only one example of the operational excellence, hard work and commitment that exists through the GMCR organization.

Our employees throughout the country are working extremely hard to expand our manufacturing distribution operations. At the same time, our sales and marketing organizations are striving to enhance our distribution with retailers and in supermarkets, hotels and offices. And, I've already highlighted the technology and new beverage innovations of our engineering and development teams.

These outstanding efforts underscore the strength of our culture and show it has a significant competitive advantage in today's business environment.

Further, our commitment to be a responsible corporate citizen, taps into the preferences of a growing number of consumers who want to support their values by for instance purchasing fair trade products.

Each year, we allocate at least 5% of our pre-tax profits towards social and environmental projects. As an example of how these resources are deployed, last week we committed $140,000 over the next three years to Dartmouth College's Global Health Initiative. The grant which is part of our coffee community outreach effort will support a student run project aimed at improving health, sanitation and energy supplies in Tanzania.

We also recently dedicated a senior level employee as Vice President of Organizational Culture and Internal Communications to help ensure that we protect and enhance a corporate culture that is both personally rewarding and a distinct competitive advantage. I believe our culture, manifested in our values and principals have played an important role in delivering an average sales growth rate of 56% over the past 12 quarters.

In summary, in our third quarter we announced several enabling initiatives and intend to continue to pursue additional opportunities to grow our business. Enabling initiatives take several forms and can include new distribution expansion, co-branding opportunities, joint development arrangements and strategic acquisitions.

At the same time, we will continue to focus on quality products and operational excellence with a strong sense of social responsibility. This approach makes us unique and fosters a collaborative environment that dries our passion and desire to win. Taken all together, we believe we have a powerful strategy for success that builds value for shareholders and all our constituencies.

And now I will turn the call back over to Fran.

Frances Rathke

It certainly was another outstanding quarter for Green Mountain Coffee Roasters. Net sales totaled $190 million, up 51% over the last year with each business unit contributing strong sales growth. After inter-company elimination, the Keurig business unit net sales were up 97% to $90 million and the Specialty Coffee business unit net sales were up 39% to $100 million. Please look at Slides 3 through 6 for these and more financial highlights.

The primary driver of the increase in net sales is the continued growth in K-Cup sales which were up over 79% on a consolidated basis. Sales related to the Tully's brand represented approximately 5.5% of the 61% increase in consolidated net sales and are included in the Specialty Coffee business unit results for the first time.

Our multi-channel distribution model continues to serve GMCR well and enabling us to take advantage of the best opportunities in different economies including the current difficult one. While our high sales growth is driven by the Keurig system and accompanying K-Cup portion packs, the bulk of that growth has shifted from away from home venues to the at-home marketplace.

Looking at our Specialty Coffee business unit, our coffee pound sales to supermarkets and club stores were up 56%, yet pound sales to the office coffee services channel were up only 10%, still a very healthy growth rate by most company's standards, but clearly not leading the growth at GMCR right now.

Similarly, looking at the Keurig business unit, the away from home channel is well established and continues to contribute to sales and profitability with a steady stream of new brewer and K-Cup sales. But it is the at-home business that is delivering the impressive growth rate these days.

To better help you understand the marketplace dynamics here; I would add that we are seeing a clear geographic trend in our office coffee. In regions such as Metro New York and Southern New England, we clearly are seeing lower growth right now for office coffee. We believe it's partially a customer and field feedback, but this trend may be due to severe economic impact in the greater New York City and Boston areas combined with the fact that this is where we already have the highest Keurig penetration in the country.

In our relatively less mature geographies and in more rural areas such as the Mid-Atlantic and Northern New England, we are continuing to experience double digit growth rates for office coffee.

Net income this quarter was up 123%. On a per diluted share basis, it increased 117% to $0.36 per share as compared to $0.16 in the third quarter of 2008. This was significantly above our previous estimates of $0.25 to $0.28 per share on a post three for two split basis primarily as a result of much stronger than anticipated gross margins within the Specialty Coffee business unit.

We did not invest as quickly in additional West Coast capacity as part of the Tully's integration as previously anticipated during the third quarter which resulted in less gross margin and erosion. We will be ramping up our investment in the new Seattle factory starting in August 2009.

In addition, the 34.7 tax rate is lower than our prior estimate for fiscal 2009 of 39.5%, and increased EPS by just about $0.03 over our prior year third quarter EPS estimate.

Inventories increased as planned this quarter by 64% over the prior year corresponding quarter to $103 million. Long term debt increased to $126 million at June 27, 2009 from $188.7 million at March 2009 primarily to fund capital expenditures.

Cash flow from operations in the third quarter funded this quarter's increase in inventories and other working capital needs. On June 29, 2009 the company exercised the increase option under its existing $225 million revolving credit facility in the form of a $50 million term note. This $50 million term loan is priced at 350 basis points above LIBOR and has the same terms as the current credit facility. All borrowings under our credit agreement including this new term loan are due on December 3, 20102.

In addition, we were able to remove the capital expenditures limitation covenant and modify the definition of the fixed charge coverage ratio. We believe these covenant changes will allow the company to have less stringent restrictions on the deployment of capital to fund our growth.

Now, I'd like to touch upon our latest financial estimates. Looking forward please keep in mind that my remarks and the information contained in the press release and today's slides are based on current expectations and our belief that we can achieve such growth despite many risks and uncertainties not the least of which is the uncertain economy.

As Larry has already noted, we are raising our estimates for earnings growth for this fiscal year. These higher expectations for the full year are a result of the stronger than anticipated performance in the third quarter of fiscal 2009.

For fiscal 2009 we expect total consolidated net sales growth of 58% to 61% including the Tully's acquisition estimated to add about 2% to 3% of growth to our top line. We anticipate fully diluted GAAP earnings per share in the range of $1.37 to $1.41 per share as detailed in our press release.

Excluding the Kraft litigation settlement, we now expect fully diluted non-GAAP EPS in the range of $1.10 to $1.14 per share, up from prior estimates of $0.98 to $1.02 per share.

For the fourth fiscal quarter of 2009, we expect total consolidated net sales growth of 60% to 63% including the Tully's acquisition estimated to add about 5% growth to our top line. We estimated that fully diluted GAAP earnings per share for the fourth quarter will be in the range of $0.30 to $0.34.

With respect to fiscal 2010, we are in the midst of putting together our detailed budget. Keurig has finalized shipments and merchandising plans for the Keurig brewery with our retail accounts for the upcoming holiday season. Overall, we anticipate continuing to deliver strong sales and earnings growth in 2010.

Our outlook for fiscal 2010 anticipates a net sales growth rate of 45% to 50%, shipments of system wide K-Cup portion packs to increase in the range of 65% to 70% and fully diluted GAAP EPS to be in the range of $1.70 to $1.80 per share.

We are sharing the early look at fiscal 2010 in today's press release to aid our investors. Yet please keep in mind my earlier caveat that any forward-looking statements we share involve uncertainty, meaning that actual results could differ materially.

And now I will turn the call over to Michelle Stacy.

Michelle Stacy

Good afternoon everyone. I'm very pleased with Keurig's 97% sales growth this past quarter. This is the second quarter in a row where we have posted sales greater than 95%. Keurig brewers had a very strong quarter due to the outstanding performance of the brand at Mother's Day and the continued expansion of the brand's assortment at key retailers.

As a result, sales of brewers by the Keurig business unit were up 187% for the quarter. Keurig continues to emerge as an increasingly significant factor in the overall mainstream coffee maker marketplace. MPD data confirm that Keurig expanded in the total coffee maker category in both units and dollars on a year over year and on a sequential quarter basis.

Our dollar share was up 9.7 points from 7.4% in the year ago quarter to 17.1% this period. The spring quarter is a major gift giving season, and Keurig's successful Mother's Day and Father's Day programs resulted in a share gain from the prior period from 14.3% to 17.1%. Unit share more than doubled, rising from 2.7% I the prior year quarter to 7.5% this quarter.

Keurig's MPV unit sales posted 174% increase versus the same period a year ago. This result is consistent with our reported at-home brewer unit sales growth. Retailers not reported in MPV and other channels represent the remainder of the brand's strong growth.

The strength of the brand is further illustrated in that the top three brewers in the category on a dollar volume basis were all Keurig brewers. The Keurig Special Addition was a top selling brewer with the Mini as the number two brewer and the Elite holding the number three position. The Platinum brewer was also in the top ten in the number six position. As you can see, Keurig is an increasingly significant player in the coffee maker marketplace.

Additionally during the quarter, we rolled out distribution to 3,000 Wal Mart stores. These stores are selling the Elite brewer for $99.00 and an assortment of between three to six K-Cup varieties depending on the store. The launch of the Elite brewer kicked off the Mother's Day advertising circular. The Wal Mart stores were set with the Keurig brewer and the K-Cup later during the month of may.

At this stage in the brand's development at Wal Mart we are pleased with the product's movement. It is important to note that while Wal Mart is a key account, several other retailers are currently positioned as the destination retailers for our product. Bed Bath and Beyond, Kohl's, Target and several other major retailers expanded both their brewer offerings by adding new brewers and colors along with expanding their K-Cup offerings and in store merchandising.

During the quarter, we reconfirmed that consumers remained extraordinarily satisfied with the Keurig brewer system. Our quarterly research reconfirmed a top two box satisfaction score that exceeded 92% for all brewer models.

In addition, during the quarter we continued to build our R&D and organization capabilities in order to deliver both future innovation and continued operating excellence at high growth rates.

In summary, our third quarter performance was outstanding. The Keurig brand has significant momentum and is poised for the upcoming holiday season. We are confident that the Keurig system has a very promising future.

And now I will turn the call over to Scott McCreary.

Scott McCreary

The Specialty Coffee business unit also had a very successful third quarter as the Keurig system continues to fuel growth across multiple distribution channels. We delivered a 39% increase in net sales driven by strong take up sales to grocery and club stores and on Greenmountaincoffee.com.

We are now selling the 12 count K-Cup package for supermarkets in 4,800 stores with about half of these locations also selling the Keurig brewer. This fall we will have 24 items available to supermarkets, allowing us to execute an impressive four foot shelf set of K-Cups and brewers with a select group of customers. See Slide 14 for a picture of brewers merchandise below, and a broad selection of K-Cups above.

Looking at IRI data, K-Cup portion packs continue to show rapid growth and we anticipate this will continue as more grocers realize the opportunity that K-Cups represent. Year over year dollar sales of our K-Cup brands are up 151% in grocery. This strong growth is due to two factors; our significant distribution gains and the growing demand for K-Cup portion packs.

We have increased distribution of K-Cups to warehouse club stores nationwide to 775 stores, leveraging our family of brands in the geographies where they are strongest; Green Mountain in the east, Tully's in the west, Keurig in the Midwest, and Newman's Own Organics across the country.

We are making good progress with the integration of Tully's and have effectively established new relationships with key customers. We introduced Tully's K-Cups this quarter to supermarkets this quarter and already are selling five Tully's K-Cups to 500 new supermarkets with plans to expand this fall.

We have worked closely with the Tully's roasting team to match the roast profiles and are now also roasting and packing Tully's K-Cups in Vermont to provide capacity and reduced transportation costs.

We have identified a new manufacturing and distribution location just south of Seattle. The new facility will support the significant growth we are planning for the Tully's business and we expect all west coast operations will move to the new site by the end of September.

In addition to our investment in the west, we have leased additional space in Vermont to support the growing distribution, fulfillment and variety pack production requirements. Roasting and grinding equipment is being installed in Knoxville Tennessee to support production this fall.

We also have six K-Cup production lines on order to be delivered between August and January to support our fiscal 2010 growth. This will provide K-Cup machine capacity of over 2 billion K-Cups annually.

These investments are critical to our future growth and I'm pleased that we've been able to deliver very profitable growth while continuing to invest in our future. Through continuous process improvement we are focused on superior execution of our plans to ensure we continue to exceed our customers' expectations.

Before closing, I want to share another key milestone. During our third quarter we exceeded our year end goal for Café Express, our continuity club membership. At the end of the quarter, there were 138,000 active members. In addition to the rapid growth of Café Express, Internet Retailer Magazine recently named us the tenth fastest web retailer based on our sales growth.

We know that our consumer direct business is also a great venue for brand expansion and product introductions. For instance, Larry spoke about our new line of Celestial Seasonings Perfect Iced Tea K-Cups. This line was first launched on July 2, on Greenmountaincoffee.com. Since then they've been selling extremely well, contributing significantly to our optimism about the potential for these new products.

To build on our strong momentum in the Specialty Coffee business unit, we continue to significantly increase our R&D capability with focus on new beverage development. It's a very exciting time to be at GMCR and we are feeling confident that our aggressive product development and consumer marketing plans will help to expand our brand portfolio awareness coast to coast.

At the same time, we continue to focus very much on expenses and profitability to deliver strong earnings growth as well as sales growth to our stockholders.

And now I'll turn the call back over to Larry.

Lawrence Blanford

Fran, Michelle, Scott and I are joined today by John Whoriskey, General Manager of Keurig At-home business, Dave Manley, General Manger of Keurig away from home business and also from our Specialty Coffee business unit; we have T.J. Whalen, Vice President of Marketing, Jim Travis, Vice President of Sales and John [Bustein], Vice President of Supply Chain Operations.

We will now start the question queue.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Scott Van Winkle – Cannacord Adams.

Scott Van Winkle – Cannacord Adams

Michelle, you mentioned some MPD data. Does that MPD data, was it affected by Wal Mart?

Michelle Stacy

Wal Mart does not report to MPD just as they don't report to IRI or Neilson.

Scott Van Winkle – Cannacord Adams

Not like any panel data or anything like that. So that share excludes the 3,000 Wal Marts.

Michelle Stacy

Yes. It does exclude the Wal Mart. It also excludes several other retailers.

Scott Van Winkle – Cannacord Adams

What was Tully's contribution to inventory in the quarter?

Frances Rathke

In terms of inventory for Tully's it was probably $2 million or so. I think we needed to build more K-Cup inventory overall this quarter, so we've been working hard building up, especially Tully's but just in general our inventory of K-Cups.

Inventories were up $31 million. Of that, $20 million is the brewers, the at-home side and about $8 million of it was K-Cup of which Tully's is a piece of that and we also had probably about at $2 million to $3 million build in raw materials.

Scott Van Winkle – Cannacord Adams

So last couple of quarter's inventory days have been falling pretty significantly year over year and this time they were relatively flat. I just assumed that the last couple of quarters you were below the inventory levels you wanted to be?

Frances Rathke

I wouldn't say below. I would say we've been lean or leaner on K-Cups. I think definitely when we bought Tully's for example, we did need to significantly improve their inventory levels. They were I think we bought them it was about $2 million of inventory and we really needed to get that to a $3 million to $4 million number.

And right now, as we do pretty much every year, we really have to ramp the At-home brewer shipments to get ready for the holiday season, so you can see just for this quarter that was a major planned increase.

Scott Van Winkle – Cannacord Adams

As you probably know to the outsiders, a tough company to kind of forecast and model, but I have a question. So if I look at the Keurig revenue sequentially after eliminations, it went from $102 million in Q2 to $90 million which is down about 12% I believe, but if you look at K-Cups, K-Cup shipments were down about a little less than 10% I think sequentially and brewer shipments were down a few percent. It looked like the revenue was down a little more sequentially than the numbers, the brewers and the K-Cups. Should we assume that there's a channel shift towards grocery or specialty revenue collecting more of the K-Cups than Keurig sending them through their wholesale channels? How should I think about that?

Frances Rathke

In terms of sequential quarter to quarter, we definitely have seasonality. In the Keurig numbers, a lot of those K-Cup numbers, they're continuing to see very, very strong K-Cup shipments and sales into the retail channel, so that as we noted was very strong.

Consumer direct in terms of the Keurig side for example, that is definitely growing at the same rate as our system wide K-Cup numbers and I think in terms of the absolute dollars, the growth rate is very similar quarter to quarter. So I think it's more of a seasonal factor.

Lawrence Blanford

If I'm not mistaken, our third quarter was sequentially a little less than our second quarter last year, but versus same quarter prior year, the numbers are really outstanding.

Frances Rathke

Growth rates are very consistent. It's just the absolute numbers, either take up shipments or brewer shipments in the third quarter tailed down a little bit and that's been happening as expected each year.

Michelle Stacy

Let me see if I can build on that. I think there are two factors that happen from the consumer perspective. One of the things that happens is after strong Christmas sales of brewers, consumers come back in the market and they're faced with a tremendous choice and variety of K-Cups. And so they tend to buy quite a bit to fill their pantry.

And so there's a build in the consumer At-home inventory of K-Cups that happens right after the Christmas season. That then impacts to a more normalization of the purchasing cycle as you move into the second quarter of the year which is our third fiscal quarter.

The other thing that happens as well, there is seasonality to K-Cup purchasing. Consumers do tend to drink more coffee and warm beverages during the colder winter months, particularly in the Northeast and you know that tends to be our strongest region. And as you move into the spring, there is seasonality to our business as they tail off on some of their hot beverage drinking.

Those two things affect the quarter to quarter view, but if you go back and look at the year over year view, you'll see that we have very, very strong growth year over year which continues to show the vitality of the system. This seasonality is something that we've experienced in previous years as well.

Scott Van Winkle – Cannacord Adams

I was just trying to figure out, I try to forecast off an average selling price of the K-Cup and the brewer, I'm just trying to see if that went down sequentially, if that was the reason I was off on my number.

Lawrence Blanford

If I could just add also, just very quickly, going forward and that's another reason we're very interested in the brewed over iced teas, we would expect assuming this continues to go as well as it is in our first few weeks, that it could very well help pick up those summer months, the warm summer months as we go into next year. So just another point as we think about the future.

Scott Van Winkle – Cannacord Adams

Last quarter you talked about how productive, I think you were positively surprised how productive the Mini brewers were. It really seems to me like that product is incredibly successful. Are you surprised at how well the Mini is selling or the share of brewers that are Mini's? I assume I'm right that it seems to be putting up some very good numbers.

John Whoriskey

It is really where we had planned it to be. It's doing what we had expected and consumers are very satisfied using that product. Understand the application is different without a reservoir for that product.

And also we should note that that product is in multiple colors too, so it's not just one SKU and some of our major retailers end up with three colors now on the shelf. So I would say it's performing at the level we would expect and obviously it's a price point of under $100 which is attractive as well.

Lawrence Blanford

I think the surprising thing on the Mini was that the usage of K-Cups you've seen came in a little bit stronger than what we had projected, which we had reported a couple of quarters ago. But overall, we are very, very pleased with the Keurig Mini, no question about it.

Scott Van Winkle – Cannacord Adams

As you went through the initial guidance for 2010 and thank you for giving it to us nice and early, are you assuming incremental distribution of brewers? I assume you're probably expecting some more distribution of K-Cups in grocery. I'm just wondering if you could walk through the major inputs that drove your guidance for next year.

Lawrence Blanford

As I have spoke to the opportunity for distribution, what we have been saying and still are is that over the 18 months or so we would expect that retail distribution as we define it would continue to expand up to about 20,000 or so locations and that grocery supermarket over again 18 months or so we would expect to expand to 10,000 to 12,000 locations going forward.

So not all of those will occur in the 2010 fiscal year necessarily, but we would expect continued expansion of distribution as we go out throughout the year. I think importantly though, in addition to that distribution is increased sales velocity through those grocers and retailers that already have the product.

In that regard we see just very significant commitment by our key retailers across the board, additional brewers and SKU's of portion packs etc. And so we're very, very excited about that as we go into this next holiday season and beyond.

Operator

Your next question comes from Mitch Pinheiro – Janney Montgomery Scott.

Mitch Pinheiro – Janney Montgomery Scott

On the brewer's side, can you quantify or help us understand what the sell in to a Wal Mart would be or how that affected this quarter and next quarter's brewer growth?

Michelle Stacy

We really cannot share our retailer individual plans. That's not our privilege to do. What I think I can say is that Wal Mart is one of several retailers and we have many other retailers who are destination retailers along with Wal Mart and our brewer growth that we saw came from all of our retailers participating during the quarter.

Mitch Pinheiro – Janney Montgomery Scott

Would you expect any deceleration in the growth in Q4 just as a result of having such a large customer take on your brewers for the first time, or are you seeing sell through at a rate that you would expect deceleration?

Michelle Stacy

I would expect, once again I can't comment on any individual retailer. What I can say is that the pipeline to Wal Mart will not be a factor in impacting our quarter to quarter growth rates.

Mitch Pinheiro – Janney Montgomery Scott

The away from home side, was there brewer growth in away from home?

Dave Manley

What I would say about that, we don't separate out our numbers on at at-home and away from home basis, but what I would say is remain bullish about the long term prospects of our away from home business. This year and this quarter we continue to add to our install base of brewers, albeit in a down economy, and our away from home K-Cups continue to grow.

And also, as Fran indicated, nationally about 7% of all office coffee goes through a Keurig brewer but in some markets, it's as high as 25% to 30%. So there continues to be a lot of room to grow. We're putting plans together to do that, and as soon as the recession is over, we expect, we hope that business will grow significantly.

Mitch Pinheiro – Janney Montgomery Scott

Looking at your F'10 guidance for K-Cup growth, 65% to 70% which is sort of acceleration. What type of brewer growth is sort of implied in that or is there any way you could help us understand how the base of install brewers could grow?

Frances Rathke

In terms of our 2010 plans, as I said we've done a lot of work in terms of the budget. From an At-home standpoint, the At-home team has already essentially done all the pre-work for the holiday season, so we have a good sense of what our Q1 2010 will be. We don't give out estimates on brewer growth rates because they are more difficult to predict and they tend to be, they come at different times in different quarters.

So what we are factoring in though is continued strong growth in the At-home channel and for brewers and we anticipate that we from an absolute number of brewers, we will definitely see growth over this past year. In terms of whether we would have something like 100% or higher or lower, we're not giving out estimates, but we believe we will continue to see strong growth.

And then on the K-Cup side, the reason for the increase in the growth rate in 2010 from what we're estimating for 2009, a lot of that is just from the strong At-home growth we've seen this year. It tends to have a quarterly lag or two where we start seeing the K-Cups. So as you know, year to date, our K-Cup brewer sales are up 144%. That bodes well for the K-Cup growth next year.

Mitch Pinheiro – Janney Montgomery Scott

When I looked in your release in the Keurig section, the 112% sales growth for Keurig in the K-Cups that would be somewhat representative for capturing the type of growth rate that your major retailers are looking? Is that fair as opposed to the overall K-Cup growth this quarter which is lower than that.

John Whoriskey

That growth rate of 112% would be representative of the retail distribution we have as well as our Keurig.com website sales. It's a combination of both.

Mitch Pinheiro – Janney Montgomery Scott

Embedded in your fiscal '10 guidance, what type of marketing spending do you think you have in there versus where you were a year ago?

Michelle Stacy

In answer to your question, we have put together our Christmas program. Last year we spent about $6.6 million in media and we saw an immediate bump in our sales on the day we went on air and we also saw significant increase in our unaided brand awareness. So be believe our advertising program was really very effective in the market.

As we look forward in this Christmas period, we have augmented the number of GRP's, or what we call growth rating points that we will be spending by a little over 60%. That doesn't mean our spending has gone up by 60% though because it is a very advantageous market in the fourth quarter for purchasing media.

In addition, we certainly added to our marketing program by increasing the number of in store demo's that we will be doing in mall demo's along with doing some very targeted in four top markets where we would like to see some accelerated growth rates.

So we have a very strong marketing program that's planned for this Christmas season based upon the very strong success of last year's Christmas season.

Mitch Pinheiro – Janney Montgomery Scott

You recently raised prices on your brewers. What drove those price increases?

John Whoriskey

We actually raised price on the Mini brewer effective, that was in June, so that was the only brewer price change that we made of an increase.

Mitch Pinheiro – Janney Montgomery Scott

What drove the increase? Is it a function of helping position the overall line for future entrance like the Cuisinart's and Mr. Coffee's or is the demand so strong that you're trying to slow it down?

John Whoriskey

I would say it's a combination of factors. In terms of as we move forward and as we look to our product line and our licensed partners coming into our program in the next year or so, those are all considerations for what we're doing and there will be in the future, certainly there will be other changes and new products that we'll be launching as well.

Lawrence Blanford

There is a lot of considerations as we manage the product line. We certainly want to increase the overall number of models available to retail given the large number of retailers in grocers and others carrying the product and given the success of this product category, we want to certainly increase our heft on the store shelves.

So managing the entire product line, features, price points, etc. and now with the advent now of both the Cuisinart and Mr. Coffee brand it gives us an opportunity to do that. So there's a lot of factors that are driving our product line management.

I think overall I would say I am very pleased with the work of both of our organizations in managing a fairly complex distribution model. It's working very, very well for us.

Operator

Your next question comes from Gregory McKinley – Dougherty & Co.

Gregory McKinley – Dougherty & Co.

I'm wondering if you could give us a little bit of a snapshot in terms of how your retail partners changed the way they're merchandising your product recently, be it number of SKU facings or square footage allocations etc., if there's any trend there you saw in the June quarter. And then given some of the discussion you've had with them, maybe competitively ready you're not ready to talk about it, but how should we expect Green Mountain Coffee products to be merchandised differently if at all as we approach the fall here compared to what we're used to seeing?

John Whoriskey

I think if you look into the slides we shared with you, you'll see a couple of examples of what really is prevalent in the marketplace and whether you're in a Bed Bath and Beyond or a Kohl's or a Target, our positioning in all these stores is really now front and center in the department with multiple facings of our K-Cups and the expansion of our K-Cup program along with the expansion of our brewer lineup is really happening across the board in all of our key retail partners.

I think it speaks to the success and the acceptance of Keurig single cup brewing as a significant improvement over drip coffee and so therefore we are gaining more and more space in all these key retailers and I think you're probably also seeing the impact of being on the front page of Macy's whether it's Mothers Day and Fathers Day, the significant advertising we're getting from other retailers like Bed Bath.

I think it's all indicative of the momentum we are building and the growth rates that you're seeing. And certainly we are planned through Christmas at this point and that is going to continue go grow and expand even further.

So there's a lot of momentum in place for us going into the Christmas selling season, and that is in spite of a very challenging retail market as you all know. If you look at comp sales at all these key retailers, I think you pretty much know where it is this latest month.

So we see that trend continuing in our expansion of our product, more SKU's on the shelf and with our new licensed partners coming in next year we see that's going to expand even further. There's going to be more choices in single serve to take the place of drip coffee makers on the shelf.

Gregory McKinley – Dougherty & Co.

Regarding the single cup market more broadly, can you talk a little bit about what you're seeing from a competition standpoint either from the brewers available on the market or anticipated to become available on the market? I would imagine some of your success here is likely drawing greater interest from those who have maybe participated but not as successfully in the past. Any thoughts in terms of what you're expecting? Your thoughts on new brewer introductions as the year progresses, and then maybe also some thoughts in terms of what you're seeing from the coffee itself. Are you seeing anything change? Are you expecting anything to change this year?

John Whoriskey

I won't comment specifically on competitors but I will say that if you're in stores and checking what's on the shelf in all the key retailers, I think you instinctively know what's happening in the category is that we're becoming a much bigger factor in coffee and those competitive products in single serve are diminishing.

I think we're benefiting significantly from that and I think the fact that we have such a superior product with high satisfaction levels is really driving that success versus our competitors today.

Gregory McKinley – Dougherty & Co.

Any thoughts you can share on your outlook for commodity prices in the coffee market and how you're positioned there?

Scott McCreary

We have seen through this fiscal year coffee prices come down and we've talked about in the past our coffee buying strategy which is to forward buy about six to nine months out and that's what we've continued to do. So we have a decent portion of 2010 already locked at the favorable prices that we're seeing now in the market and so we're feeling pretty good about that.

There are some signals that later in 2010 as the economy starts to pick up, commodity prices will start to rise and we've incorporated that into our plans for 2010.

Operator

Your next question comes from Mark Astrachan – Stifel Nicolaus.

Mark Astrachan – Stifel Nicolaus

On the Keurig segment disclosures, in terms of what you disclosed this quarter, it's not the same as what you disclosed last quarter in terms of before or after inter-company sales. I was wondering if you could reconcile those numbers between the two quarters so we have a better idea what the performance looks like.

Frances Rathke

We felt it was easier for people to understand if we report after elimination entries and just so everybody understand, when we talk about inter-company elimination for example on the Keurig segment, this quarter before elimination, they had $108 million of sales and then we eliminate any sales that are in that $108 million that come from the sister unit, Specialty Coffee business unit, and that is primarily the royalty income that is recorded in that $108 million. And the inter-company elimination amount in that sale is $17.7 million for Keurig.

So if you don't eliminate that amount and let the before sales of $108 million, the sales were up 98% versus the 97% that's in the press release.

Mark Astrachan – Stifel Nicolaus

So if you say the difference between the two we should assign to royalty?

Frances Rathke

Yes. It's essentially royalties. There are some brewers that the Specialty Coffee business purchased from Keurig that we also have to eliminate. Those are primarily the brewers that go then into the grocery stores where the Specialty Coffee unit is the primary sales unit for that.

Mark Astrachan – Stifel Nicolaus

In terms of ball park are we talking 10%, 20%, less that 10%?

Frances Rathke

I'm sorry; I don't understand what you're asking.

Mark Astrachan – Stifel Nicolaus

In terms of what's not included in royalty, in terms of what's going into brewer sales or what's going from the other side.

Frances Rathke

It depends on the quarter in terms of how many brewers, but I would say the majority of it you can pretty much calculate the royalty, the inter-company royalty by estimating as we said in the press release, in the back of the press release in our table that the K-Cup sales, that the Specialty Coffee business units sales shipped in the quarter is in a range of 58% to 61% of the system wide K-Cups.

If you take an average of that approximately $0.06 a K-Cup is royalty. That would pretty much get you to the royalty income that the Keurig division records and then we have to eliminate.

Mark Astrachan – Stifel Nicolaus

In terms of just clarifying, the K-Cup sales to retailers and to consumers, what exactly is included in that number aside from what it says. Are we talking about, I understand the royalty K-Cups are including both side of the Specialty segment as well as the Keurig segment, but are we essentially double counting and backing out that number as well?

Frances Rathke

In terms of the components after elimination entries, that's why we reported that in our press release, the Keurig business unit K-Cup sales are all licensed brand K-Cups including the Specialty Coffee business unit direct sales to third party retailers or off of Keurig.com. That's where we reference K-Cup sales to third parties were up 112%.

Mark Astrachan – Stifel Nicolaus

Does that include K-Cups that are given away with brewers or is that just K-Cup sales?

Frances Rathke

No, we do not count in the system wide K-Cup numbers free K-Cups that are given away with the brewer box.

Mark Astrachan – Stifel Nicolaus

Shifting to an inventory standpoint, you discussed what the composition was in terms of the increase, but when you generally just think about inventory levels or finished goods, how do you think about it as it flows through the system. Meaning what are you holding in terms of days on hand versus what M block is holding days on hand versus how your retail partners are holding days on hand?

Francis Rathke

In terms of our balance sheet, we typically have on hand about two to two and a half weeks of K-Cups on our balance sheet. And when we ship to a retailer, that is when they typically take an order and we send the K-Cups for many of them directly to each store so they don't typically have back stock.

In terms of what they carry, it varies by retailer. Some like to carry one week. Some like to carry more than that. That's their choice.

In terms of M block, they don't carry any inventory. The inventory at M block is 100% our inventory.

Mark Astrachan – Stifel Nicolaus

I just want to go back to the K-Cup sales for a second. Just in term of reconciling that number, if you talk about what the K-Cup sales were in the quarter in terms of K-Cups shipped, you have 64% in terms of the K-Cups sold and revenues at 112%? I guess I'm just struggling between trying to reconcile the two numbers.

Francis Rathke

In terms of the system wide K-Cups, those are all licensed roasters, what they shipped out to various customers and channels. Within the mix of K-Cups that get shipped out and sold to the different channels, the retailer channel as we've disclosed and showed in our slides, they are doing an exception job merchandising and expanding the number of SKU's and space for this business.

That channel as well as the consumer direct channel are growing similar to the rate of the system wide, about 64% those sales of K-Cups. But it is the retailer channel where we're seeing much higher growth and that is why the Keurig business K-Cup sales were up 112%.

The reason for that faster growth rate is primarily due to the At-home channel and specifically the retailer channel growing very rapidly.

Operator

Your next question comes from William Chappell – SunTrust.

William Chappell – SunTrust

A little bit more on the expansion of the credit facility. $50 million is a fair amount of change. Is there anything specific you're looking to do with that or are there major CapEx plans over the next six to 12 months?

Frances Rathke

In light of the purchase of Tully's for $40 million, we felt it was appropriate to access the accordion feature and tap into our credit feature facility and allow us to have more room in the facility to continue to provide funds to pay for CapEx and fund our growth over the life of the facility.

William Chappell – SunTrust

Moving to the brewer shipments, just trying to understand, if you're not making a whole lot of money in selling brewers at your price points, then how does a Mr. Coffee or Cuisinart through the same facility and make a reasonable margin?

John Whoriskey

We're not at liberty to discuss how they're going to price the product and how they'll modify it to meet the way they want to position the product on the shelf. But obviously there's a profit opportunity for them and that's why they're part of the system.

William Chappell – SunTrust

Going to the facility, one of the things I had a question on Wal Mart. It seemed like the roll out of Wal Mart was a little bit slower in getting to the stores than originally expected. Even if I go the Wal Mart site online right now it seems the product is out of stock. Is that more of a customer specific issue or are there any capacity constraints that at your Chinese manufacturer that would slow down the overall growth.

Michelle Stacy

It's not a capacity aspect at all. We are fully ready to continue to meet the growth on brewer demand. The set in the Wal Mart store, they traditionally set their appliance section towards the end of May every year so the stores were set in accordance with the timing we had negotiated with Wal Mart and that Wal Mart was expecting.

William Chappell – SunTrust

I was under the impression it was supposed to be there before Mothers Day.

Michelle Stacy

We had distribution. We shipped before Mothers Day, however the actual store set, when you can actually get the product on the shelf and the stores prepared to reset the appliance section, that module of set as Wal Mart would call it was planned three weeks later into the month of May.

William Chappell – SunTrust

In terms of normal in stock or out of stock as more customers specific, there's still room to add additional vendors, additional suppliers going forward.

Michelle Stacy

Absolutely. We've got plenty of capacity.

Lawrence Blanford

It's true on the portion pack side as well as Scott talked in his comments. We are very well positioned to support K-Cup demand through the fall season.

William Chappell – SunTrust

On the commodity outlook for 2010, would you expect coffee costs to be a little bit higher, lower, about the same, and then I assume you're going to have lower ad spend with other costs. Do you expect a tail wind going into next year?

Scott McCreary

In general I think coffee costs will be a little bit more favorable in 2010 that what we saw in 2009. 2009 started the year quite high then it's come down. We see going into 2010 with coffee costs lower and then potentially coming up towards the end of the year. But with our forward buying strategy, we feel pretty good about managing those costs and putting estimates there.

Could you repeat the second part of your question?

William Chappell – SunTrust

On the overall input costs beyond just straight coffee costs, be it freight, manufacturing, other things going into 2010, I imagine it's still a tail wind in terms of margins.

Scott McCreary

I think so, especially in the first half. We're going to see lots of benefits because of commodity costs affecting our other raw materials and packaging and transportation costs. I think you're right. We're going to see a benefit there.

And then as we get further into the year we will have increased our capacity and further improved our efficiency. Our Essex facility for example will be fully staffed and fully utilized and we're going to make significant progress in Knoxville as well, so I think we will see a tail wind as the year continues.

Operator

Your next question comes from Jon Anderson – William Blair.

Jon Anderson – William Blair

Just a minute on Wal Mart. I know it's still early. You're just a couple of months into it since the late May reset, but how would you characterize the sell through that you've seen so far? I'm sure you're seeing weekly point of sale from Wal Mart. Is it in line with better than expected or maybe lighter than expected relative to your initial expectations?

Michelle Stacy

I would basically say that our Wal Mart movement is exactly in line with our expectation. The Wal Mart distribution as you know with the $99.00 Elite brewer and either the three or six K-Cup variety. We began our plans with putting those items together in the appliance section of the store and we're seeing exactly the type of movement we would have expected and we can compare that to other retailers similarly at that stage of their development.

So it does take awhile for the consumer to understand the system, for the consumer to find the product in the store and we would expect that as Wal Mart continues, and the consumer continues to become educated about the product being in that store, we would expect to see movement increased along with potentially longer term, more SKU's in the store.

Jon Anderson – William Blair

So that adoption curve that you referred to is consistent with, as you've added new distribution at other retailers over time?

Michelle Stacy

Absolutely.

Jon Anderson – William Blair

Are there plans for Wal Mart to add additional units?

Michelle Stacy

As the business continues to develop at Wal Mart we may consider expanding the offering as well as increasing the number of K-Cups and where the K-Cups appear in the store. As I mentioned, right now K-Cups are only in the appliance section of the store. That is certainly a potential as we move throughout the year.

We do have to be sensitive to when Wal Mart has the capabilities of adding SKU's. They're very specific about their open, the windows for adding new SKU's and setting new store modules up in the store. So we are looking forward into 2010 on ways that we could continue to grow with them.

Jon Anderson – William Blair

I think the distribution at retail as you define it is about 17,000 locations today?

Michelle Stacy

That's correct.

Jon Anderson – William Blair

Heading into 20,000 over the next 18 months at least as a target. What are the additional opportunities, the additional 3,000 or so on location.

John Whoriskey

I'll just comment that some of the significant opportunities are in the office superstore channel, as an example and we have some programs that are going to be in place for this Christmas season there. And beyond that, I think we are going to be very selective. There are other channels of opportunity that would have to fit strategically with the brand positioning and the price points of our product.

But there's certainly possibilities to achieve the kind of number that we're talking in terms of store growth.

Jon Anderson – William Blair

It sounds like the initial results from the Perfect Iced Tea program have been positive. Are the economics of the cold beverage K-Cups, are your margins on those products similar to the base hot beverage business?

Lawrence Blanford

Yes, they are. Again, it's early but as I indicated in my opening remarks, I am very, very excited about this product line. The initial pick up in trials as I mentioned has been very good. Consumer comments have been very strong.

It really represents I think a significant opportunity. If consumers in fact adopt brewing over ice, we think we have a number of opportunities to capitalize on that going forward. So we'll continue to watch it, but so far we're very excited and the margins are very similar.

Jon Anderson – William Blair

Coming back to the co-branding relationships with Con-Air and Jordan and Mr. Coffee, is the strategy there, obviously it's tied into the razor blade model and pushing the penetration rate of the brewers. Is that also a signal that maybe you have less interest in the mechanics of producing the brewers? Obviously a lot of interest in the R&D and technology of what goes into them, but also gives you the ability to focus more on the consumable side of the business, K-Cup, portion pack piece which is where a lot of the profitability is generated?

Lawrence Blanford

We see a tremendous opportunity in bringing both of those brands on and expanding the features and choice and brands available to consumers but let me underscore strongly that we are absolutely committed to driving Keurig brewing technology going forward as well as under the Keurig brand as well as providing technology to our partners.

We think we have some very significant opportunities. I mentioned a couple of those in my comments, but I would say, and we've talked before, but I think we have this unique competitive advantage in that we have under one corporate umbrella the brewing technology and the beverage development technology.

And the opportunity is to bring those together and deliver products to the marketplace that the consumer can really enjoy and value. So we are very committed to developing technology and I will say by the way on the development front, we are in 2010 looking to significantly increase our R&D investment in both the Keurig side of the business as well as in the Specialty Coffee business unit side of the business because we think we do have some great opportunities ahead of us.

Jon Anderson – William Blair

The past three or four quarters your per unit growth has been obviously quite strong, north of 100% year on year but the system wide K-Cup shipments have been in the 50%, 65%, 75% range. I'm just wondering, is that a timing issue that you referred to where there's a lag between K-Cup shipments and brewer unit shipments or does it reflect something else happening there with respect to usage rates or mix shift in the business.

Lawrence Blanford

There's several factors there. One is to remind you, the K-Cups that are in our demand base, there is still a significant portion that are being driven by our office coffee brewers and the usage rate per brewer per day in the office is obviously significantly larger than it is for an At-home brewer. So you have to sell a lot more At-home brewers which is really driving our brewer growth in order to create equivalent demand of an average office coffee brewer.

So you basically still have going on to a degree, somewhat of a mathematical downshift as we move more and more At-home brewers and their much lower consumption rates per brewer per day. Although even at those rates, that is a very profitable business and obviously we're demonstrating that with our numbers.

There are other factors. Certainly delays from when we ship to retailers and when they get it on the shelf and they sell it to the consumer and the consumer gets it home and the consumer goes through their initial quantity of free K-Cups. There is a delay there. It differs by model, by retailer, by channel. We try to take all of that into our demand modeling and then provide to you and others our best estimates of what we think the overall K-Cup demand will be going forward.

So a number of factors, but those are the primary ones.

Operator

That's all the time we have for questions at this point. I'll turn the call back over to Larry Blanford for any additional or concluding remarks.

Lawrence Blanford

It's been a pleasure to talk with all of you today about our great results in the quarter for GMCR and our continued very strong performance and exciting prospects. We very much appreciate your interest in the company, and again thank you for joining us today.

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Source: Green Mountain Coffee Roasters, Inc. F3Q09 (Qtr End 6/27/09) Earnings Call Transcript
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