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Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR)

Q3 2011 Earnings Call

July 27, 2011 5:00 PM ET

Executives

Suzanne DuLong – Vice President, Investor Relations and Corporate Communications

Larry Blanford – President and CEO

Fran Rathke – Chief Financial Officer

TJ Whalen – Vice President, Marketing, Specialty Coffee Business Unit

John Whoriskey – General Manager, Keurig At Home Division

Analysts

Akshay Jagdale – KeyBanc Capital Markets

Scott Van Winkle – Canaccord Adams

Greg McKinley – Dougherty & Co.

Mitch Pinheiro – Janney Capital Markets

Bill Chappell – Suntrust Robinson Humphrey

Bryan Spillane – Bank of America

Mark Astrachan – Stifel Nicolaus

Jon Andersen – William Blair & Company

Tony Brenner – Roth Capital Partners

Alton Stump – Longbow Research

Operator

Good afternoon. And welcome to the Green Mountain Coffee Roasters Incorporated Fiscal 2011 Third Quarter Conference Call. Today’s calling is being recorded. At this time, I’d like to turn the call over to the company’s Vice President of Investor Relations and Corporate Communications, Suzanne DuLong. Suzanne, please go ahead.

Suzanne DuLong

Thank you, Patrick. Welcome everyone. Today’s press release is available on our website at www.gmcr.com. Consistent with past quarters our prepared remarks have been furnished in a Form 8-K filed with the SEC and will not be read on today’s call.

On today’s call our President and CEO Larry Blanford will provide some inductor remarks reviewing the quarter’s results and our business. Following Larry’s remarks we will open the call to questions from the sell side analysts. Several members of our management team are with us for today’s Q&A session, including Fran Rathke, our CFO; TJ Whalen, our Vice President of Marketing for the Specialty Coffee Business Unit; and John Whoriskey, our General Manager of the Keurig At Home Division. Due to scheduling conflicts Scott McCreary and Michelle Stacy cannot be with us today, but the rest of the team will address your questions. Due to time constraints and to make sure we have the opportunity to address everyone’s question during the call we ask that you limit yourself to one question. If time permits we will revisit the queue for follow-up questions.

Finally, I’ll remind everyone that certain statements will be made today 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 assures 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.

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

Larry Blanford

Thanks, Susan and hello, everyone. We appreciate your joining us today to discuss our fiscal third quarter results. I’m thrilled to report we delivered net sales of $717.2 million, a growth rate of 127% over the same period in fiscal 2010. Our non-GAAP earnings per diluted share increased 140% to $0.49 in the third quarter of fiscal 2011, up from $0.21 in the third quarter of fiscal 2010 and exceeded our guidance range largely as a result of stronger than anticipated portion pack driven revenue growth in the quarter.

In addition to continued strong consumer adoption of the Keurig single-cup brewing system, we believe our third quarter results benefitted from our heighted spring advertising and brand support programs. These programs were designed to raise awareness of the Keurig single-cup brewing system and our Brew Over Ice, Perfect Iced Tea and Iced Coffee’s, as we headed into the summer month. Our nationwide television advertising was supported by in-store demonstrations and other merchandising all emphasizing Brew Over Ice as another opportunity to use the Keurig single-cup brewer.

We had a very positive retailer reaction to our efforts and we believe the combination of advertising and retailer merchandising helped derive both portion pack and brewer sales in the quarter. In fact, while still (inaudible) concept in effort during our spring promotional period, Brew Over Ice portion packs represented approximately 5% to 6% of total portion packs sold through our specialty and mass channels during the promotional period.

While difficult to quantify, we also believe we saw a bit of catch-up effect from Q1 and Q2 in our fiscal Q3, as we have continued to add portion pack production capacity in Q3, we were able to fulfill customer demand that has pent-up in the system over the prior two quarters.

Approximately 82% of consolidated net sales in the third quarter were from the Keurig Single-Cup Brewing system and its recurring portion pack revenue including Keurig related accessory sales. This percentage is down from the roughly 88% in the year ago period as a result of the addition of the Van Houtte related revenue to consolidated sales.

During the quarter, we took several steps to strengthen our balance sheet and ensure access to the capital we believe is necessary to grow our business. I’m very pleased with our successful equity offering and our amended credit facility.

Turning to our business value drivers which are detailed in our published prepared remarks, there are three items I want to address directly in my comments today. First increasing portion pack consumption. Beyond our early success with Brew Over Ice our beverage development group is hard at work on new beverages for new occasion. We are very excited about the new products we have in the pipeline, including beverages that could provide functional and/or wellness benefits. We believe there is a meaningful opportunity for beverages beyond hot coffee and tea and we’re looking forward to bringing new beverages to Keurig consumers, we have demonstrated a strong willingness and desire to try them.

Second, on scaling to meet demand, it’s no question that our growth in recent years has been extraordinary. As we planned for fiscal 2012 and beyond, it became clear that anticipated growth of the Keurig single-cup brewing system would continue to drive significant increases to current portion pack production capacity.

An important driver behind our anticipated 2012 CapEx spend is the fact that our internal expectations about our opportunity for brewer sales have increased for a number of reasons. Including the growth we’ve experienced thus far this year. The addition of powerful brands like Folgers, Dunkin’ Donuts and Starbucks to the Keurig Single-Cup brewing system and the fact, that interest in the system is now expanding broader demographics than originally envisioned.

As result of these increased brewer adoption expectations, we believe we will need to continue adding portion pack production capacity at a rapid clip. We expect the majority of our $650 to $720 million in planned 2012capital expenditures will go to scaling our portion pack production capacity enabling us to meet forecasted demand for 2012 and readying us to meet anticipated 2013 demand.

We currently expect to fund our anticipated 2012 CapEx through a combination of cash generated from operations, existing cash on hand and our existing lines of credit. We expect our current production facilities footprint will accommodate some of the additional required capacity, but we expect we will both expand our existing facilities and add two manufacturing sites in the U.S. in fiscal 2012. We noted last quarter that we had begun the site selection process and we are near the final stages for the first of these sites. During fiscal 2012, we expect to incur as much as $30 million in startup expenses related to these new plants.

In addition, we also expect to incur 25 million in staffing and plant operational expense across the system, related to deploying readiness capacity in 2012. In the past we’ve aimed to have enough capacity to meet our forecasted demand plus an additional 7% to 10%.

In the last year, we have increased our capital expenditures as we moved through the year and repeatedly hit new records of production as we continue to install capacity. However, we continued to also experience spot outages of portion packs with our customers.

We believe scaling our production to accommodate a measure of flexibility above our current demand forecast is a necessary investment to the business and will enable us to enhance customer service, as well as potentially capture any unplanned upside demand to the extent it materializes.

And thirdly, on graphic expansion, I’m very pleased to report that the integration of Van Houtte continues to move forward as planned. Our Canadian business unit created following the acquisition of Van Houtte on December 17, 2010, contributed $111.7 million to the consolidated net sales in the quarter, representing approximately 16% of total sales.

While the business unit currently consist of the former Van Houtte business beginning with the start of our fiscal year 2012 we will roll our Timothy’s operations based in Toronto and currently part of our specialty coffee business unit into our Canadian business unit results.

Beyond the integration of Van Houtte in pursuit of what we believe is incremental opportunity in Canada, we are evaluating our opportunity outside of North America. We believe, we have opportunities in several geographic regions, but we’re not yet ready to speak to specific plans at this time. As we said previously, our first priority is and will remain capitalizing fully on the opportunity we see in North America.

Touching on enabling initiatives, which are those efforts designed to facilitate growth in the years to come, some of our key initiatives revolve around our alignment with strong coffee and beverage brand in order to support a wide range of consumer choice and taste profiles in the Keurig single-cup brewing system.

I’m pleased to report that our newest relationships with Dunkin’ Donuts, Starbucks and ConAgra continue to move forward smoothly. We began commercial productions of Dunkin’ Donuts brand in portion packs during the third quarter. Production is going well and Dunkin’ will have the products in their U.S. locations sometime in August.

Early consumer feedback from their locations where they have been testing the in-store merchandising of the products has been very positive. Our work with Starbucks also continues to go well and anticipation of a fall 2011 availability of Starbucks branded portion packs in grocery, mass club and retail channels.

Finally, our work with ConAgra to introduce the Swiss Miss brand in the Keurig brewing system continues to move forward with a goal of reaching broad availability on grocery shelves by cooler weather and a peak hot cocoa consumption time.

In addition to expanding consumer choice in the system, we believe these relationships fuel new excitement for Keurig owners and users, raise system awareness and of course, attract new consumers to the system. The rolling out of these brands into our system has been planned and executed in a thoughtful and deliberate manner and is factored into our 2012 guidance.

As we said previously, while we do not expect to disclose the financial terms associated with these relationships, we can say that the high level economics are such that going forward we expect our business model will be fairly indifferent to sales of GMCR branded versus partner branded portion packs. That said, we will of course, continue to work to drive sales of our flagship brand and new beverage products within the system.

Finally, continued innovation is a key contributor to our enabling initiatives. As we discussed previously, in addition to our work with Lavazza to develop a new expresso-based system, we also have a new Keurig filtered coffee brewing platform in development.

Our new Keurig platform is in consumer test currently and we do expect that we will be producing portion packs for the platform in fiscal 2012. As a result, we expect approximately 20% of our anticipated fiscal 2012 CapEx spend will go toward portion pack capacity for this new platform.

In closing, with Keurig Brewing changing the way North America brews and enjoys coffee at home and in the workplace. We are excited and humbled by the opportunity we see ahead for our company.

Isn’t it exciting that a company celebrating its 30th year anniversary has the chance to drive revenue growth of 60% to 65% and implied earnings growth of 53% to 63% in the coming year.

Supporting and enabling that growth remains our most significant challenge and the focus of everyone at GMCR’s employees. I want to take this opportunity to thank our employees and our extended supply chain partners for making our success possible.

Operator, we will now take questions from the sale side analyst, as Suzanne stated in the introduction, we ask that you limit yourself to one question and if time permits we will re-advice the queue for follow-up questions. Operator, will you open the question queue.

Question-and-Answer Session

Operator

Yeah, sir. (Operator Instructions) We’ll take our first question from Akshay Jagdale with KeyBanc Capital Markets.

Akshay Jagdale – KeyBanc Capital Markets

Thank you. Congratulations on another good quarter. Larry...

Larry Blanford

Thank you. Appreciate it.

Akshay Jagdale – KeyBanc Capital Markets

Yeah. Just wanted to ask you about the future growth opportunities beyond coffee, I mean, in terms of your guidance for fiscal ‘12? Can you help us understand how much of it is related to in your opinion like non-coffee related opportunities?

Larry Blanford

Yeah. Akshay, that’s a good question. I think, we’re not providing at this juncture a breakout of our estimate. I think what, we in the ‘12 guidance. So we certainly factored in our thoughts about expanding the Café Escapes product line, Hot Apple Cider, our new barista pre-melted that’s coffee and of course, continuing to drive our Brew Over Ice Teas and coffee products next spring.

So, I think, it’s still a bit early to put a number on all of that, but certainly, new beverage is a key driver. First driver, value driver for our business, certainly is brewer adoption, a very important driver behind that is new beverages and we’re very excited about the opportunity going forward.

Akshay Jagdale – KeyBanc Capital Markets

Perfect. I’ll get back in line. Thanks a lot.

Larry Blanford

Thank you.

Operator

We’ll take our next question from Scott Van Winkle with Canaccord Adams.

Scott Van Winkle – Canaccord Adams

Hi. Congratulations, everyone.

Larry Blanford

Thanks, Scott.

Fran Rathke

Thanks, Scott.

Scott Van Winkle – Canaccord Adams

My one question is in 27 parts. I just -- I would love to dig further into the accelerated revenue growth of the portion packs this quarter versus the last two and I understand pent-up demand being alleviated with capacity -- price added, adding to or price adding 13% to year-over-year revenue from the company.

Can we just exclude brewer revenue and figure out what that 13% is and apply it all to K-Cups? Is a portion of that higher prices or a portion of that mix of K-Cups to Barista Prima? I’m just trying to if you could expand a little bit on how we went from 60% growth seemingly overnight?

Larry Blanford

Yeah. Fran, do you want to address that?

Fran Rathke

Well, first just to address overall the price increase. As we said in our press release, dollar sales of portion packs were up 136% and as you noted, Scott, a piece of that price -- a piece of that also is the fact that we now own Van Houtte, as well as for this quarter we had the full quarter of Diedrich where last year we only had them for half the quarter.

So sort of boiling off that all down, I think the price increase I just want to point out as we said in the press release that is estimated to have helped increase our topline by about 13% in total. So if you look at those dollars, most of the price increase effect was really from that earlier price increase that was on portion packs only, whereas the second price increase that took effect late in June was on all coffee products. So I think the majority of that 13% I would describe to the K-Cup sales, so that ends up being closer to almost 20% for the quarter just for the portion pack piece.

So coming down to your point about Q3, I think we were surprised to the upside on the strength of the portion pack sales. Some piece of it is related to as we said, really products we didn’t have to ship out for customer orders in Q2 that we got product in Q3. Also, a little bit of this its hard to measure is the second price increase went into effect in June to the middle of June, so I think we had some customers who tends to order a little bit stronger on the heels of that. But I don’t think that’s a big piece of that. I do think a lot of it is we added a lot of new Keurig households to our installed base coming off of a strong holiday and fiscal or our second quarter in fiscal ‘11.

Larry Blanford

Yeah. Scott, I would just add too, as we referenced in our remarks and my earlier remarks, we really its the first time we launched a national television advertising in the spring and we found, I think that was very positive and it exceeded our expectations as well in terms of creating awareness for the Keurig brewing system as we moved into Mother’s Day, Father’s Day, Grads Day, very strong support from our particular retailers and while we are focused on brewed over ice, I think we drove both brewer sales and additional portion pack sales in general as a result of the strong promotional activity in our own advertising in the spring.

So much so that I think we will incorporate a spring program going forward, so have the power of the holiday drive period, October, November, December and we’ll come back then with a spring drive period behind beverages that are particularly suited for spring and summer, but certainly again creating awareness for the system. So we just had a lot of things working on our behalf in the quarter.

Scott Van Winkle – Canaccord Adams

Yeah. I apologize, what I said 60% to 70% that was my own estimates of unit growth. Would – could you give us maybe just to follow-up, sorry, on the question? The acceleration could you balance it between units and dollars, dollars from mix and from price increase? I know you’re not giving units but were they 50-50, was it more mix and new stuff or -- and just trying to boil it down since there’s lots of things happening with acquisitions and pricing and such and such?

Fran Rathke

Well, I – this is Fran, Scott. So the overall in terms of trying to get to some kind of unit estimate, I think once again the 136% increase in portion pack dollars and if we sort of subtract off of that price, I would say more than 20% or so range and then subtract Van Houtte has historically and I think, continues to be in the 8% to 10% or so of the total consumption out there in terms of the portion packs, that’s something new we have that we didn’t have last year in our number, so if you track that down. And then, once again, I said, we had about half of Diedrich.

So we’re definitely have had an acceleration in unit growth in Q3. Our guidance as we gave Q4, once again we don’t give unit guidance, but I think, we don’t -- we think this quarter was very, very strong as we just kind of tried to outline some of the reasons. I think next quarter we expect strong growth but not as strong as what we saw this quarter, so in terms of boiling that down, we probably, definitely close to the high 90s, 100% range growth wise.

Scott Van Winkle – Canaccord Adams

Thank you very much. Look forwards to seeing you guys at our conference in a couple weeks.

Larry Blanford

Okay, Scott. Part one, part two and part three questions. Okay. So we’ve got. Next?

Operator

We’ll take our next question from Greg McKinley with Dougherty & Co.

Greg McKinley – Dougherty & Co.

Yeah. Thank you. Outstanding results here.

Larry Blanford

Thank you, Greg.

Greg McKinley – Dougherty & Co.

I guess, I wanted to hear your thoughts on sourcing capabilities with the company growing at the rate it has. How do you feel about your distribution partners teeing you up here for the holiday season? Also, I guess, supply of brewers as you think about retail demand?

And then with the K-Cup momentum as it is. Can you comment if there’s been any sort of competitive follow-up that you think may have benefited from it, I know, I’m not seeing cash and all on shows like grocery or mass-market like I used to. Is that playing a role?

Larry Blanford

I would, Greg, this is Larry. I would just say broadly, certainly as mentioned, we have a tremendous efforts going on throughout the company and I’m very proud of our folks working with our partners throughout the supply chain. That can be on procuring coffee, developing capability for Café Escapes, working with in the Tully on brewer production and their suppliers to ensure that they have the adequate parts and components and certainly working with our own plants and our distribution partners to get brewers and coffee to our customers.

And very importantly, working with our customers where this business for them -- for a number of them is getting, so significant that I know a lot of the effort of our sales team is actually working with our customers on their logistics in terms of their ability to receive, to get the product out on the floor, get it merchandised because as we move into the holiday season this product will be moving very quickly through a number of their stores.

So it’s throughout despite. Having said all that, I feel we’re in pretty good shape. We are – we’ve worked very carefully with each of our customers to agree upon a target number of products that we’re going to – we’re committed to supplying them. I think we’re in position to do that. I don’t believe we have in Q1 and Q2 much upside beyond those committed numbers but we are dedicated to supporting our customers to the extent that we have worked with them to come to agreement on the demand forecast and then we’ll be adding capacity through the balance of this year and into next year and we should be in – as we said – as I said in my notes we’re trying to get ourselves to a position ultimately where we have some excess capacity to handle customer needs and potentially upside.

John Whoriskey

Greg, this is John Whoriskey. I would just add to Larry’s comments by saying one of our number one objectives working with all of our retail partners going into the fall holiday season and beyond is space planning to meet the growing needs of our franchise within the retailer stores.

And our position there certainly continues to grow and with space being freed up from other people in the category that certainly helps that process for us. But we worked very hard with our partners to make sure they are prepared for what we all expect will happen in the upcoming months into the holiday season.

Greg McKinley – Dougherty & Co.

Very good. Thank you.

Larry Blanford

Thank you.

Fran Rathke

Thanks, Craig.

Operator

We’ll take our next question from Mitch Pinheiro with Janney Capital Markets.

Mitch Pinheiro – Janney Capital Markets

Hi. Good afternoon.

Fran Rathke

Hi, Mitch.

Larry Blanford

Hey, Mitch.

Mitch Pinheiro – Janney Capital Markets

So my question is around your fiscal ‘12 guidance. What type of coffee price assumption do you have for fiscal ‘12 or what type of increase or decrease year-over-year do you expect?

Fran Rathke

Mitch, this is Fran. In terms of our estimates, we’re assuming that there would be no substantial change in the pricing that we now have taken the second price increase that went into effect in late June. That -- those prices -- average selling prices, et cetera will not really change in fiscal ‘12.

Larry Blanford

Yeah. Having said, if I could just add to Fran, Mitch, as I think we’ve talked before that is what’s in our current estimates. However, what we’ve said is that should coffee prices or other material costs spike, we will certainly consider price increases as necessary. We certainly hope that we do not have to cover one again next year, but our objective long-term is attempting to maintain our gross margin as we would see input costs come along.

Mitch Pinheiro – Janney Capital Markets

Okay. So that will -- are you hedged in your typical fashion in terms of…

Larry Blanford

Yeah. As we’ve said that we typically hedge six to nine months out in front. We are -- hedge meaning that we’ve contracted for coffee. We are pretty well fix, I think through Q2 of the next fiscal year and we’re beginning to buy coffees in -- for Q3 and obviously, we have seen coffee prices back off a little bit from the highs. I think we got actually what we saw in the market was something that got and the (inaudible) price got a little over $3 an we are in, I think 250 range right now and we’re taking advantage of that as we’re starting to buy coffee for the third quarter of next fiscal.

Mitch Pinheiro – Janney Capital Markets

Okay. And then just following up on the fiscal ‘12 guidance, the $30 million in startup expenses and the $25 million in staffing and other operating expenses, they are -- is that SG&A or is any of that in CapEx and then is this -- these are in your 255, 265 guidance?

Fran Rathke

Mitch, this is Fran. The $30 million in startup expenses and the $25 million in staffing and operating expenses is essentially plant related and that is in cost of goods sold and that is the expense essentially getting everything up and running and incurring things before we really are turned on, fully at the plants and the CapEx, it is not CapEx, that’s separate.

Mitch Pinheiro – Janney Capital Markets

Okay. And these $55 million of additional costs are factored -- it’s included in the -- in your current guidance?

Fran Rathke

That is correct.

Mitch Pinheiro – Janney Capital Markets

And then just the last question related to guidance. Does the development of next gen, your new brewer and also whether, you haven’t really announced or maybe have at the Lavazza partnership, that I think expresso type of brewer? Are they also factored into your numbers and are they a drag at all on the size of these expenses here that we just talked about? Are they drag on on fiscal ‘12?

Fran Rathke

Mitch, this is Fran. Yeah. We do have anticipated sales and rollout of our new platform, as well as on potential, I would say not material costs associated with Lavazza but it’s really more about the next gen platform. So I think it is not something that is, I would say an incremental, it’s more of a drag on earnings not an addition to earnings as we sort of startup and roll out that platform.

Mitch Pinheiro – Janney Capital Markets

So. Okay. So and so the new brewer, you’re not really -- it’s neutral to negative to earnings in 2012 or do you think at all it has any potential to be incremental positively?

Fran Rathke

I think our sense is it’s a new platform. We have new lines in our CapEx, approximately 20% or so of that number that we gave as an estimate is related to new packaging lines associated with the new platform portion pack. And I think as we get started we anticipate and these are in our estimates that that would not be as cost effective right out of the gate. So we -- I think it’s much more a high probability this would be a drag on earnings rather than a help to earnings.

Mitch Pinheiro – Janney Capital Markets

Okay. All right. That’s very helpful. Thank you very much.

Fran Rathke

You’re welcome.

Operator

We’ll take our next question from Bill Chappell with Suntrust Robinson Humphrey.

Bill Chappell – Suntrust Robinson Humphrey

Good afternoon.

Larry Blanford

Hi, Bill.

Bill Chappell – Suntrust Robinson Humphrey

Larry, obviously congratulations on the quarter and the guidance. Could you mind just kind of talking on kind of how you see knock-off private label kind of affecting the market over the next couple years? I mean, you don’t need to talk about lawsuits or anything per se, but clearly the patents roll off in a year and there might be some kind of me too type products out there?

I mean, how do you see that evolving and then just as a one-off follow-up, Fran, can you talk about what the tax rate will be next quarter and next year? Thanks so much.

Larry Blanford

Okay, Bill. I’ll deal with your question at a high level. First of all, with respect to our patents and intellectual property, we have a broad portfolio of patents on portion packs, on brewers, on system of both portion packs and brewers and certainly to the extent that, any other product might infringe on our intellectual property we take that very seriously and we would, in fact, rigorously defends our intellectual property.

Having said that, we are first and foremost building our business on meeting and exceeding consumer expectations and that’s with the brewing system and with the beverages and brands of beverages that are within the system. I think the categories that we’re participating in brands, beverage brands, compete every day with private label products overwhelmingly consumers in traditional categories, choose brands and I think that’s likely to be the case in our system as well. So those are a couple of factors I think related to the consumer.

Then beyond that as we think about our business, we have tremendous credibility and momentum with our retail customers and of course, we’re as we’ve just announced, we already have scale and we’re investing a lot of money in additional plant and equipment and we are in an excellent position to serve, I think the growing demand that we are seeing in the marketplace. So I think you sit back and look at all those factors, we’re -- I think we’re in very good shape. Your second question.

Fran Rathke

Second question on tax, Bill, in our prepared remarks by the way we note that for fiscal ‘11 overall we think we’re going to come in around 37.6% on the tax rate. For ‘12, I guess, approximately 38% to 37% fixed as known on discrete benefit items, so I would use 38%.

Bill Chappell – Suntrust Robinson Humphrey

Great. I’ll get back in the queue. But thanks for the color.

Larry Blanford

All right, Bill.

Operator

And we’ll take our next question from Bryan Spillane of Bank of America.

Bryan Spillane – Bank of America

Hey. Good afternoon.

Larry Blanford

Hey, Bryan.

Bryan Spillane – Bank of America

Trying to figure out which one question to ask, but I think just relative to the guidance, I guess to follow-up the line of questioning that Mitch went through. The capital spending, it’s -- right now the fixed assets on your balance sheet are about $499 million and so you’re going to -- the plan is to spend, somewhere in the neighborhood of $700 million next year.

So it’s a pretty significant increase in your asset base. I understand some of it is to put in production for the new -- the next gen K-Cups but or portion packs. But the, I mean, is it, I mean, basically it’s, by looking at the spending levels you’d be roughly doubling your capacity on K-Cups. Is that the right way to think about it?

Larry Blanford

Yeah, Bryan. I think what I would say is over the last four years to put this in perspective we’ve worked, this is Larry, very diligently on putting in place the, let’s say pillars of growth for our business. That would include acquisitions, partnerships both with other brewer manufacturers and of course, with branded beverage manufacturers and marketers, as well as investing aggressively for what was a small company becoming lager in R&D and new beverages and new brewers and portion packs.

And I think what we’re saying is, as we sit here and look forward and certainly, we’ve provided our first estimates for ‘12, but we are seeing as indicated in my comments that for a number of reasons brewer sales are going to be larger than we had ourselves anticipated. We’ve learned recently as an example that the biggest driver quantitatively of brewer sales are consumers who already own brewers.

So brewers beget brewers, so as our installed-base growth, word-of-mouth spreads and that drives more brewers sales and of course, we’ve also seen an expansion in the demographics from where we initially started and the demographics that we targeted originally we’ve seen that demographic now that is interested and excited about the brewing system expand.

So for a number and then of course we’ve added these new partners which bring a lot of excitement to the system. So for all those reasons what we’re trying to do now is make sure we’re in a position to capitalize on all of these pillars of growth we’ve put in place here these last several years and the capital that we’re talking about here certainly supports ‘12, but as I mentioned, really is to support what we think is continued growth in fiscal 2013.

Bryan Spillane – Bank of America

Is it fair to say, just to characterize up until now when you were -- when it was -- when you were smaller company you could kind of plan your CapEx a year forward and the numbers are too big, the constituents are too many, you just can’t do that anymore. Is that, you can’t go through having customers on allocation or you got to be able to meet the demand and so you’re demand forecast is bigger and you need to really start scaling up for that. I mean, that’s essentially the point you’re at now?

Larry Blanford

I think there’s some truth in what you’re suggesting. Obviously, as we’re getting bigger, retail customers are holding us accountable we’re not necessarily the little company from Vermont any longer and we certainly as the numbers get bigger to ensure that we do have adequate capacity and whether again it’s in the production of brewers or portion packs and working with our -- and distribution capability, et cetera, et cetera that we talked about before, we really do have to go further out in our thinking and our planning. So I think your observation is a good one.

Bryan Spillane – Bank of America

And then just one last follow-up, just in terms of the capacity additions given that you’re going to have -- you’ve got some pretty sizeable partners that you’re working with, is there a plan to actually put packaging capacity in or very near the roasting facilities for Dunkin’ and Starbucks and Folgers and much of what you call Swiss Miss, it’s not roasting, whatever you called?

Larry Blanford

Yeah. In all of our -- all of those agreements we will be doing the packaging for all of the product that goes into portion packs for those brands and initially we’ll be utilizing our existing facilities. We do a very good job, I think of using linear programming models to try to optimize our overall manufacturing framework for North America, which takes into account all forms of demand where our distribution centers should be, how many plants we should then how supporting those distribution centers.

And so, well, I would not say necessarily that we would set up a packaging plant down necessarily adjacent to one of our branded partners. I think in general as we look at the North American market and we continue to build out our North American manufacturing infrastructure, we certainly want to make sure that we take advantage of transportation efficiencies between their roasting plants and our packaging facilities and our packages facilities and our distribution centers across the North American infrastructure. Most of these folks do have, multiple sites themselves, roasting coffee and we certainly would take advantage of that.

Bryan Spillane – Bank of America

All right. Thank you, Larry.

Larry Blanford

You’re most welcome.

Operator

We’ll take our next question from Mark Astrachan with Stifel Nicolaus.

Mark Astrachan – Stifel Nicolaus

Thanks. And good afternoon, everybody.

Larry Blanford

Hey, Mark.

Fran Rathke

Hi Mark.

Mark Astrachan – Stifel Nicolaus

One follow-up and one new question. I guess given the moving part can you give the benefit from pricing and acquisitions to non-GAAP EPS in fiscal 3Q and or for fiscal 2011 or at least help me directionally understand the benefit? And then on fiscal 2012 guidance can you discuss the puts and takes of sales growth and margins just given recent brewer growth and by my math you’re not anticipating a lot of margin expansion at least net margin expansion?

Fran Rathke

Sure. Mark, this is Fran. In terms of your first question, in terms of the impact on -- from pricing, I think we mentioned, last quarter in our press release we had information about that first price increase that started to take effect in the first quarter and then also on February 1 for our additional channels for a K-Cup portion packs and that ended up, I think its around a 10% or so price increase.

The second one for Q3 on portion packs contributed about 20% of the increase of $136, I don’t know. And then in terms of acquisitions I think we mentioned that Van Houtte this quarter was the primary increase. I think sales were approximately $111 million to the topline as an addition and as you know, Van Houtte’s business is not as heavy K-Cup portion packs as Diedrich’s or Timothy. So I think approximately 9% to 10% of our units historically have been Van Houtte and that still remains about the same number for this quarter.

Mark Astrachan – Stifel Nicolaus

Well, I guess, I’m trying to get a little bit deeper beyond the topline because it’s just really difficult to model the business given the information that you provide. So I’m trying to understand a bit more on what the impact is from below the topline on some of these deals like acquisitions or from pricing like. How closely does increase in coffee cost mirror the pricing that you’re taking and then what does Van Houtte or Diedrich contribute beyond the topline?

Fran Rathke

I think in terms of price -- for this quarter the price increase we took into effect this quarter essentially covered the coffee increase costs. So I think the main reason for the gross margin increase this year over the prior year was due to the mix, the sales mix shift, away from brewers to much heavier weighting towards portion packs and bag coffee.

In terms of contribution to operating income from Van Houtte I know, we’ll be filing our Q next week. Also, so you can see some of the data but overall as we noted on a segment basis Van Houtte, as I said was approximately $111 million in sales and in terms of bottom line, hold on, I’m pulling out the Q draft, the segment -- income before income taxes for this quarter, the Canadian business units contributed about $13.4 million.

Mark Astrachan – Stifel Nicolaus

And that’s non-GAAP?

Fran Rathke

To operate, net income before tax.

Mark Astrachan – Stifel Nicolaus

That’s GAAP, non-GAAP?

Fran Rathke

That is a non, I mean, excuse me, a GAAP number, because that includes the incremental and that includes the amortization for the identified intangibles of Van Houtte.

Mark Astrachan – Stifel Nicolaus

Great. And then for fiscal 2012 guidance any color there, please?

Fran Rathke

I don’t -- we don’t break it out specifically but I think overall we’re feeling comfortable that Van Houtte in terms of as an acquisition will be slightly accretive or to accretive to earnings next year.

Mark Astrachan – Stifel Nicolaus

What about in terms of the puts and takes on sales growth and then the margin expectations?

Fran Rathke

Overall, in terms of next year, we don’t give out the specific margin guidance. But I think in general our topline guidance for fiscal ‘12, 60% to 65% topline growth with EPS growth pretty similar maybe slightly lower due to the investment spend on the manufacturing capacity.

Mark Astrachan – Stifel Nicolaus

Okay. Great. Thank you.

Fran Rathke

Thanks, Mark.

Larry Blanford

You’re welcome, Mark.

Operator

We’ll take our next question from Jon Andersen with William Blair & Company.

Jon Andersen – William Blair & Company

Good afternoon and congratulations.

Larry Blanford

Thanks, Jon.

Fran Rathke

Thanks, Jon.

Larry Blanford

Good afternoon to you too.

Jon Andersen – William Blair & Company

Quick two part question. I know you’ve recently indicated that, I think, your best estimate would suggest that you’ve got about $7 or $9 million brewers placed in U.S. consumer homes, which would put the penetration rate I think in the high single-digit range.

First question is, is there any update to that number at present and more importantly as you kind of have indicated that awareness and interest in the system is growing faster and I guess more broadly from a demographic perspective than you had imagined. How are you thinking about the household penetration rates and the opportunity there over the next few years?

Larry Blanford

Yeah, Jon. Good question. I would say that we have been talking 7% to 9%. We just basis brewers that we sold in the last quarter, given there is $90 million households that have coffee makers or brewers in the United States. We probably need to raise that about one percentage point, so it’s probably 8% to 10% at this juncture in terms of the installed base.

On the forward potential for household and/or office adoption, we have refrained from ever providing our estimates. We certainly have our own thinking and estimates about what the ultimate penetration rates maybe, but we have refrained from providing those.

What, again, I would point to is, though, kind of the best or at least one way of thinking about it is to, continue to look at MPD data where if you look now at the last four quarters we’re on a units share basis we’re well in the mid teens of all coffee makers and brewers being sold. So, which is certainly and that’s still growing. And so, I think if you, certainly that share, units share which is still growing is higher than our installed-base, which gives us comfort that we still have significant upside, if that’s helpful.

Jon Andersen – William Blair & Company

It is, quick follow-up on that, I mean, have you done any independent or separate maybe purchase intent studies in the consumer marketplace that would provide additional insight to when a consumer goes back to purchase or replace their existing brewer how many may intend to migrate do a single serve technology?

John Whoriskey

Yeah. Bryan, this is John Whoriskey. I’ll just speak to two parts of that is that we have done extensive market research and consumer work on segmentation studies, potential penetration of purchase intent, future purchase intent for the product. So inherent in our guidance going forward that’s incorporated but we’re not going to release the details of our internals around that. But we’d say we feel very comfortable about where we’re projecting our future business growth to be.

And I think to Larry’s points about unit share, unit share continues to grow and last Christmas season fourth quarter we were 25% of coffee maker -- units coffee maker sales in the U.S. So and we’re continuing to grow as you see on a quarterly basis at roughly 50% or so today. So, I think that’s fairly good guidance for you to be thinking about what the future could be and that would probably be enough said on that subject.

Larry Blanford

Yeah. Our growth in the quarter...

John Whoriskey

In the quarter, yeah...

Larry Blanford

50% or so.

John Whoriskey

Yeah. 54% is...

Larry Blanford

54% unit share growth in the quarter just completed versus -- and that’s only -- ship sales as well. That does not include our licensed partner sales units...

John Whoriskey

Great point. It does not include our partners.

Jon Andersen – William Blair & Company

Thanks a lot. That’s helpful and congratulations again.

Larry Blanford

John, thank you. I appreciate it.

Operator

We’ll take our new question from Tony Brenner of Roth Capital Partners.

Tony Brenner – Roth Capital Partners

Thank you and good afternoon.

Larry Blanford

Hey, Tony.

Tony Brenner – Roth Capital Partners

I’m curious about the price increase or increases that you talked and the fact that immediately there after coffee prices have rolled over by 15% to 20%. And I’m wondering to what extent retailers and particularly in the grocery channel are requesting or demanding due backs for some portion of that?

TJ Whalen

Tony, this is T.J., thanks for your question. As Larry mentioned, you know, we’ve seen the C as high as north of $3, but even with its relatively recent retreat to around 250, which frankly was where -- where it was when we started thinking about pricing action, it’s -- I think somewhere on the order of 50% to 70% higher year-over-year. So it’s a very significantly elevated coffee market at the basic C level and then take into account the differentials that we continue to pay to secure the highest quality coffees around the world, you know, our actual costs are very significantly above where they were when we took our first pricing action.

And so, you know, our goal, I think, as Larry said is to recover that cost in pricing and I think we’ve been successful with that strategy in the marketplace and then from a future buying standpoint continue to fix in the six to nine month range, which gives us time to evaluate how things are going to shape up in the future.

Tony Brenner – Roth Capital Partners

Okay. Thank you.

Fran Rathke

Thanks, Tony.

TJ Whalen

Thank you, Tony.

Operator

We’ll take our next question from Alton Stump with Longbow Research.

Alton Stump – Longbow Research

Thank you. Good afternoon and good job with the quarter and the outlook.

Larry Blanford

Thanks, Alton.

Alton Stump – Longbow Research

You know I said -- a quick question if you get back to the K-cup acceleration not just try to beat a dead horse here, but with the capacity that came online was there any channel fill benefit there? I know you mentioned Fran that you thought the growth would come down a bit in 4Q for K-Cup versus 3Q is that what you are pointing to and if so any color you could provide as to how big that channel fill might have been if it was there?

Fran Rathke

Alton, this is Fran. In terms of -- there’s one -- in terms of channel fill I think one thing that happened as we said is we had -- for us a significant increase in a spring advertising campaign. So I think, a lot of our customers as we planned for that got very excited about that. So, it wasn’t just portion packs but also brewers I think, we got a lot of, you know, space, demos, advertising, I think a lot of awareness. So I think, it wasn’t necessarily channel fill, but I think it was through support and advertising campaign and demos there was strong sales to our customers for portion packs, especially brew-over-ice.

Second, I think, coming off of Q2, we definitely had shortages or outages of certain products. So as you know we had a backlog that we fulfilled in Q3 on -- so that was a piece of it. So, I feel what we’ve been seeing and hearing from all of our accounts is that, during Q3 we got back into a place where we knew we had appropriate inventory levels and they felt comfortable, they were getting appropriate inventory levels for the products.

So I think we’re in good shape. So we don’t have any of that anticipated to happen in Q4 and I think -- and then I think that’s why I gave the guidance into Q4 that I don’t expect as strong a growth rate.

Alton Stump – Longbow Research

Okay. That’s all I had. Thank you, Fran.

Larry Blanford

Thank you, Alton.

Operator

And we do have a few follow-up questions. We’ll go first to Akshay Jagdale with KeyBanc Capital Markets.

Akshay Jagdale – KeyBanc Capital Markets

Thanks for taking the follow-up. Larry, just again another market sizing question and your comments on the brewers were very helpful, but I just wanted to -- if you -- just -- people have asked a lot of questions about market size and obviously you are very sensitive to giving out what you think it exactly is, but just roughly, I mean, what inning of growth do you think we’re in on -- in terms of coffee and you getting to the potential of your share of that market and where are we in the non-carbonated beverage market?

And my guess is that in the non-carbonated beverage consumption you’re in very early stages, but if you look at the dollars that you’re projecting in K-Cup sales, it makes things a little bit confusing because the coffee market is roughly $10 billion market and you’re projecting about 4 billion in sales now. So it gets really confusing at the dollar level and I’ve tried to look at things from a volume perspective. So just trying to get a feel of where you think we are in terms of the growth opportunity for Green Mountain and if you could break that into sort of coffee versus non-coffee, that would be very helpful. Just trying to get a feel?

Larry Blanford

Akshay, interesting question. I think maybe you sort of answered it to a degree yourself. I think relative to hot coffee and tea, I think we still feel there is a lot of upside growth. So, we are in, I think still early innings, but obviously, as we think about other beverages we are in the first inning, particularly if we start looking at a broader array of non-carbonated beverages.

And as we have -- interestingly I think the way we are now talking about our business to your point that we increasingly see our business as a single-serve beverage business sitting on top of a very innovative and disruptive technology which is, of course, the Keurig brewing system and the way we think about going forward is trying to increase our share of broadly non-carbonated beverage consumption in the home or away from home. And certainly we have -- we’re in a very early innings of some of these new beverages under Cafe Escapes and hot apple cider, brewed-over-ice coffee and tea and we certainly alluded to others categories that are under development where we’ve not yet even put products in test market.

So, if you sit back and look at the value drivers of the business, I think we still have again a long way to go on brewer adoption in home and away from home and then beyond that many opportunities to enhance consumer enjoyment of the system and obviously drive portion pack sales with new beverage categories. I guess beyond that I really can’t be any more specific.

Akshay Jagdale – KeyBanc Capital Markets

That’s helpful. So does that mean that the dollars being spent are highly incremental? I mean, that’s essentially what I’m seeing is the money being spent on K-Cups is incremental to category growth? Is that -- does your research support that?

TJ Whalen

Akshay, this is T.J. Thanks. Yeah. So there are a number of moving dynamics here. So, one of which is the size of the category and depending on whose data you look at when you factor in the value of retail spending on coffee, you know, from coffee shops, I think some data sources would suggest that the category is significantly larger than the $10 billion that you referenced.

Grocery alone, you know, based on IRI would be north of 3 and then consider what people pay on a per cup basis when they receive coffee in this form they’re obviously placing a much higher value on that experience given the quality, the speed, the convenience and the consistency of the experience versus what they would place as a value of a cup of a coffee when they buy it say in bag form to use in a traditional brewer.

And then as Larry said layer on top of that, the incremental consumption opportunities that are available to us once we earn our space on those consumer counter tops and we are, you know, if we’re in the early innings in coffee, we’re really, just getting suited up for the field in some of these other beverages in my personal opinion.

Take for example the fact that in Cafe Escapes we’ve only just right now made this product available to all of our Away-From-Home customers. We just haven’t had either the production capacity or the raw material availability to even get into making some of these products available to our customers let alone see how they perform fully in the marketplace.

Akshay Jagdale – KeyBanc Capital Markets

Perfect. That one -- quick one for Fran. What shares outstanding and interest expense are you assuming for fiscal ‘12?

Fran Rathke

Akshay, this is Fran. I would say around 160 million, 161 million shares for fiscal ‘12 and in terms of interest, you know, I think we -- approximately $30 million to $35 million.

Akshay Jagdale – KeyBanc Capital Markets

Perfect. Thank you very much.

Fran Rathke

Okay.

Akshay Jagdale – KeyBanc Capital Markets

I’ll pass it on.

TJ Whalen

Thank you, Akshay.

Operator

We’ll go next to Mitch Pinheiro with Janney Capital Markets.

Mitch Pinheiro – Janney Capital Markets

Just two quick questions. What are your marketing plans, expense plans, for the fourth quarter and for fiscal ‘12?

Larry Blanford

Yeah. Higher. But let me turn it over.

Fran Rathke

We haven’t provided.

Larry Blanford

No. We haven’t actually spoken to it. But I think John can talk in broad terms. John?

John Whoriskey

Yeah, Mitch. I would just speak to -- I think you know what we have -- we had done in this past holiday season and the expectation would be that, but I think it will be more than that when you consider what some of our licensed partners will be spending now that Dunkin’ Donuts will be in the system in their stores.

We have Folgers and Starbucks and I think in addition to our licensed brewer brands. So I think the combination of marketing investment across the whole system will be much higher than where it was a year ago and that will certainly be driving more brewer adoption for the holiday season and that’s really what we’re preparing our retailers for.

Mitch Pinheiro – Janney Capital Markets

So you think it’s -- as a percentage of sales it’d be the same or lower in fiscal ‘12?

TJ Whalen

Mitch, this is T.J. I think, we’ve done a good job of demonstrating SG&A leverage as we’ve increased scale here. We haven’t necessarily pulled that from marketing and we continue to invest in marketing, R&D and other drivers of future growth.

So I’m not sure that we’ve been explicit in terms of marketing spend levels, but what I would say is that in my estimate and observation we’ll continue to aggressively invest in growth drivers that includes marketing spending and I think you see some of the results of that work delivered here in Q3 with this brew-over-ice effort and so as John said, we would expect to continue to aggressively scale that as it continues to demonstrate it’s ability to deliver growth.

Mitch Pinheiro – Janney Capital Markets

Okay. That’s helpful. And then just last -- maybe Larry what percentage of your K-Cups are not the hot coffee and tea? So, you know, brewed-over-ice plus your Naturals and Escapes and things likes that?

TJ Whalen

Mitch, this is T.J. So that does continue to move around a little bit depending on the season and what we’re promoting at the time, as well as timing of introductions of these items. I think, kind of broadly speaking today you might characterize that as roughly 15% of the business as being none-hot coffee. And as the pie scales, we would expect that 15% slice to scale faster than the overall rate of growth of the system as we continue to aggressively invest in delivering consumer experiences that help consumers find new utility in the brewers that we are putting on the countertop.

Mitch Pinheiro – Janney Capital Markets

And where do you think that was last year? None-hot coffee?

TJ Whalen

I don’t have that with me at my fingertips, Mitch, but I would say it’s something less than what it is today.

Mitch Pinheiro – Janney Capital Markets

Okay. All right. Thank you very much. I appreciate it.

Larry Blanford

Thank you, Mitch.

Operator

We’ll take our last question from Bryan Spillane with Bank of America.

Bryan Spillane – Bank of America

Hi. Thanks for taking the follow-up. Just a couple ones, I guess, for Fran. First, depreciation and amortization for 2012, any guidance on that?

Fran Rathke

You know we’re not -- I don’t think we’re giving that out per se.

Bryan Spillane – Bank of America

Anything unusual about how the CapEx, I guess will be depreciated, just trying to figure out, given the -- it should move significantly given the CapEx. So, I was just trying to get a feel for how to model it?

Fran Rathke

Yeah. I think Bryan in terms of as we close our fiscal ‘11, I think heading into ‘12 I think a lot is when do we -- what we mentioned we’re very close to a new site for manufacturing. So then, that’s just getting a site going. I think when you turn on the equipment and all of that, it’s going to happen that would be probably in the mid part of the year and then we’re looking at another site as well as we mentioned that’s probably more later in the year.

Bryan Spillane – Bank of America

Okay.

Fran Rathke

So I think a lot of the decrease is going to be more about FY ‘11’s CapEx layering in the incremental and then we mentioned we had more P&L hits for start-up costs. And then amortization I think is pretty much what we have today for this quarter.

Bryan Spillane – Bank of America

Okay.

Fran Rathke

Not major changes there.

Bryan Spillane – Bank of America

Okay. And then in terms of how some of the -- I’m trying to get an idea of just how the flow will be for earnings in fiscal ‘12 and I know it’s early. But the lumpiness in like the start-up costs -- a lot of that will hit you later in the year? Is that -- you know we are trying to -- I’ll have to make my own assumption for how I think your revenues will flow and kind of the ongoing business. But I’m just trying to figure out where to put like the $55 million of kind of start-up related type costs. Is that more second half type weighting or….

Fran Rathke

I don’t think it’s all -- I would start -- I would start layering it in, especially starting in Q2. I mean what we’re finding is we like to have hiring and training and on-boarding employees, especially starting up a new plant. We’re already looking at really getting the management team hired, ready to go. So, you know and then start getting staff ready, so I think that takes a quarter, if you will.

Bryan Spillane – Bank of America

Okay. And then just in terms of kind of where you stand today with capacity and capacity utilizations, how far forward are customers ordering from -- for -- having to order now? Is it order cycle two months -- like your orders in hand today as you are kind of looking at the quarter like just how far forward is it?

John Whoriskey

This is John Whoriskey and maybe I will speak to some of our typical large customer that we do business with. We are planning very far out with them in terms of joint business plans and projections, but their ordering is routine every week through their electronic data interchange and so on. So, the key is really planning the business of what’s expected out there so that we’re planning our capacity and availability well in advance of when they actually write the orders. So we’re really -- really honestly I think we are beyond six months of planning with a lot of our key customers today. So --

Bryan Spillane – Bank of America

So do you feel like you have the capacity that you need for the orders that they’re expecting to place over the next six months? I’m just trying to get a sense for -- there’s a lot of the marketing at the holidays. Are you going to have -- to actually deliver on all the demand that could be there?

Larry Blanford

Yeah. Bryan, this is Larry. Right now as we said with the catch-up that -- a little bit of the catch-up in Q3, I think our customers are appropriate inventories, we’re appropriate inventories and we’re working to make sure we are well positioned going into the holidays. As I indicated earlier and referencing the planning, the detailed planning we do with our major customers as John was referencing, we have their numbers. We are committed to trying to deliver those forecast numbers, but it will be Q1 and Q2 will be tight and we don’t have a lot of room for any upside.

So, we are working very carefully with all of our customers. We’ve good communications. We have plans as to rolling in inventories appropriately to get them ready for the holidays in front of our television advertising that will kick in, in the U.S. and Canada. But we will be tight in Q1, Q2 as we continue to add capacity pretty aggressively now and into well through -- fiscal ‘12.

Bryan Spillane – Bank of America

Okay. Great. That’s very help. Thank you.

Larry Blanford

Okay. Great. Is that it?

Operator

Sir, we have no further questions. I’d now like to turn the call back over to our speakers for any closing remarks.

Larry Blanford

Well, great. I’d like to thank all of you for joining us today on the call and again, we were thrilled, we were able to announce great results for the quarter. We do appreciate your continued support of our company. Thank you.

Operator

That concludes today’s conference. We thank everyone for their participation.

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