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

F1Q12 Earnings Call

February 1, 2012, 5:00 p.m. ET

Executives

Suzanne DuLong – VP, IR and Corporate Communication

Larry Blanford – President and CEO

John Whoriskey – VP and GM of Keurig’s At Home Division

R. Scott McCreary – President, SCBU

T.J. Whalen – VP of Marketing

Michelle Stacy – President, Keurig

Frances Rathke – CFO

Analysts

Scott Van Winkle – Canaccord Genuity

Akshay Jagdale – Keybanc Capital Markets

Mitchell Pinheiro – Janney Capital Markets

Jon Andersen – William W. Blair & Co.

Mark Astrachan – Stifel Nicolaus & Co.

William Chappell – Suntrust Robinson Humphrey

Gregory Mckinley – Dougherty & Co.

Bryan Spillane – Bank of America Merrill Lynch

Nicole Miller Regan – Piper Jaffray

Anton Brenner – Roth Capital Partners, LLC

Alton Stump – Longbow Research

Mark Rostick – Williams Capital

Operator

Please stand by, we’re about to begin. Good afternoon, and welcome to the Green Mountain Coffee Roasters, Incorporated, Fiscal 2012 First Quarter Conference Call. As a reminder, today's call 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, Kevin, and 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.

I also call your attention to several other filings we made today, including our Form 10-Q, and an additional Form 8-K which provides supplemental information to a segment reporting change implemented this quarter, as a result of the form [inaudible] and Canadian at home retailer businesses becoming part of our Canadian business unit.

On today's call, our President and CEO, Larry Blanford will provide some introductory remarks reviewing the quarter's results in our business. Following Larry's remarks we'll open up the call to questions from the sell-side analysts.

Several members of our management team are with us today for the Q&A session, including Fran Rathke, our CFO; Michelle Stacy, President of the Keurig Business Unit; Scott McCreary, President of the Specialty Coffee Business Unit; T.J. Whalen, our VP of Marketing for the Specialty Coffee Business Unit; and John Whoriskey, our General Manager of the Keurig At Home Division.

To ensure we have the opportunity to address everyone's question during the time we’ve allotted for this call, we ask that you limit yourself to one question. 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. Only 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'.

Now, I'll turn the call over to our President and CEO, Larry Blanford.

Larry Blanford

Thank you, Suzanne, and hello, everyone. We appreciate you joining us today. I’ll speak to our outstanding fiscal first quarter results and business trends. I’ll then discuss competitive aspects of our business and provide a update on our new platform initiatives.

Before I begin however, I wanted to share some personal news with you. I’m pleased to announced I’ve signed a new contract with GMCR, which extends my employment through December 2013.

My current employment contract with the company was set to expire in May of this year, and I’m thrilled to be able to continue to lead this wonderful organization. When my employment commitment ends, I plan to retire from being a public company CEO, and will move on to the next phase of my life and career. I expect to remain on the Board of Directors through my current term, which runs through March of 2014. While I have no specific plans at this time, I know whatever I pursue will be meaningful and all me to make a contribution, consistent with my values.

For now there is no time to contemplate retirement, given all that we’ve got ahead of us. I do want you to know that the board and I will work together to ensure that the eventual transition to a new CEO is a smooth one, and that we will put the very best possible leadership in place to support GMCR’s business success for many years to come.

When appropriate, we anticipate this process will include the engagement of a execute search firm. At present, my top priority is to continue to build our business, our track record of success and our organization.

Now, turning to our first quarter results. North American consumers continue to embrace the convenient choice and consistent experience of a Keurig Single-Cup brewing system. And as evidenced by our strong holiday sales, appear to be encouraging friends and family to do the same. Revenue in Q1 was very strong, more than doubling over the same period in fiscal 2011, and giving rise to GMCR’s first ever billion-dollar sales quarter.

Gross margin was also strong as a result of price increases implemented in 2011, and due to a higher percentage of portion-pack related revenue in the quarter. Non-GAAP operating margin improved to 13.6%, as a result of the strong gross margin as well as SG&A leverage.

And our non-GAAP net income of $96 million increased 264% over the year-ago quarter resulting in non-GAAP EPS of $0.60.

We believe our holiday sales performance was the result of our effort to insure strong in stock positions on store shelves, excellent retail presentation by many of our customers, as well as growing awareness in the Keurig brand, which has been aided by nationwide advertising.

In fact, because we had adequate portion pack supply this year, we were able to promote portion packs during the important holiday season, when interest in the brewing system is typically at its strongest.

Revenue from K-Cup PortionPacks totaled $715.7 million in the quarter, an increase of 115% over the same period in the prior year.

Together with our licensed partners, we shipped 4.2 million Keurig Single-Cup brewers in the first quarter. That total is more than half of the 6.5 million brewers sold in all of fiscal year 2011. Please note that our brewer shipments do not account for consumer returns.

In addition to our brewer shipment info, one of the metrics we’ve used consistently to add relevant color to our business is data on consumer purchase trends from NPD group. On a month-to-month or quarter-to-quarter basis, we see differences between our shipment data and consumer purchase trends reported by NPD. Historically, the two have been generally similar over longer periods of time.

According to NPD, in our first quarter of fiscal year 2012, brewers with Keurig technology including licensed brewers represented 37.5% of all coffee makers sold in the U.S. in the period. Interestingly, NPD reports that for the first time ever in calendar 2011, sales of all single-serve coffee makers accounted for 50% of the total dollars consumers spent in the U.S. coffee maker category.

In our fiscal first quarter, according to NPD, Keurig brewers and Keurig licensed brewers represented the top six selling brewer models in the total U.S. coffee maker category by dollar share. Now these are exciting results and we provided additional details on this topic in the supplemental slides, posted to the investor relations event section of our website.

Going forward, whether we look at the roughly 90 million U.S. households that have a coffee maker or the approximately 25 million coffee makers we estimate were sold in calendar 2011, we believe there’s a lot of opportunity yet for additional Keurig system adoption.

Our brewer sales in the quarter exceeded our internal goals, and as these brewers come in to use, we expect them to have an impact on future portion pack demand. However, the number of brewers sold in the quarter represents such a large percentage increase relative to the installed base, we simply do not feel comfortable attempting to project exactly what that impact will be at this time.

While we already face the challenge of estimating sales in a very dynamic environment, first quarters brewer shipments, though great news for the business longer-term, add additional complexity to our forecasting.

In the coming months we’ll be working to insure we apply appropriate rigor and analysis to confirm and refine our modeling assumptions and estimates of forward demand.

In the meantime, in addition to growing the install base of brewers, we also continue to work to drive portion pack demand by increasing the breadth of beverage selections available in the system, and their availability.

Consistent with the widening potential of the Keurig Single-Cup brewing system, we’re commitment to our multi-channel distribution strategy, and want to ensure the consumers have a variety of K-Cup packs from which to choose wherever they shop.

For example, while grocery is only a part of our more than 36,000 points of K-Cup pack distribution, recently we have been focused on expansion within the grocery channel, both in terms of growing the number of doors, and also on increasing our shelf presence within those doors.

According to data from Symphony IRI Group, Inc. or IRI. For the 12 weeks ended December 25, 2011, K-Cup packs sold by GMCR reached 90% nationwide ACV. We believe the regional differences in ACV provide additional data points to help demonstrate the potential for continued Keurig system adoption. IRI shows 100% ACV in the Northeast, and an average of 33 items per store contrasted to ACV of 84% in the West, with an average of 15 items per store.

Interestingly, IRI data shows that for the 12 weeks ended December 25, 2011, Single-Cup sales were the fastest growing segment within the center of the grocery store, and in fact, drove all of the growth within the coffee, tea, and hot cocoa categories.

Finally, on increasing the opportunities for portion pack consumption, as mentioned last quarter a constant focus for us is on-going innovation in our portion pack product portfolio, and we’re excited about new products in the pipeline.

During our fiscal first quarter, sales of our specialty beverage portion packs, including hot tea represented 14% of total portion pack units sold, including those we manufacture on behalf of our non-owned brand partners.

Our goal with new beverages is to further delight consumers, and in so doing, increase the opportunity for consumers to use their Keurig brewers. In our fiscal 2012, we expect to test on our consumer direct sites, new hot and brewed-over-ice beverages intended to address a variety of consumption opportunities.

Another on-going effort is to increase consumer choice, awareness, and product availability with our relationships with non-owned brands. Choice of brands has been a key to the consumer value proposition of the Keurig Single-Cup brewing system. Choose, brew and enjoy. Further, we believe new brand relationships can meaningfully expand consumer choice, fuel new excitement for existing Keurig users, raise system awareness, and attract new consumers to the system.

The K-Cup brewing system now supports over 25 owned and non-owned brands, all of which have been strategically introduced to the system. We are very pleased with our execution and the roll-out of Dunkin’ Donuts, Starbucks Coffee, Tazo Tea, and Swiss Miss products; relationships all announced less than one year ago.

Importantly, GMCR continues to hit its marks on production of these products, and as part of our plan production capacity increases in 2012, we are adding capacity to ensure we can meet system wide demand in fiscal 2013 as well.

As expected, we are seeing some portion pack share shipped to these new brands, as we bring them in to the system. There are differences in the economics of the relationships, as you would expect. And the per-penny contribution at the operating profit level of any one on an individual basis, is not necessarily equal to another. However, as we have said previously, we believe at a high level, without focusing on a single brand but looking at them on a combined basis, our business model will be fairly indifferent to whether or not the consumer chooses GMCR-owned or non-owned portion packs.

We will continue to evaluate the addition of new brands to the Keurig Single-Cup brewing system. In addition to economics that makes sense for both parties, when considering new brands, we’ll look at a brands ability to enhance consumer choice, and its ability to help drive incremental brewer adoption, and increase system awareness.

Overall, it’s also been very encouraging to see the growing awareness of the Keurig brand. We recently completed our annual awareness survey measuring Keurig brand awareness both before and after holiday advertising and promotional activity. The awareness study conducted on our behalf by an independent research firm, shows unaided awareness of the Keurig brand in the U.S. rose from 42% in October of 2011, to 57% in January 2012. Over the same time period, aided awareness of the Keurig brand increased from 65% to 78%.

Increased awareness of the system is likely to support the cumulative results of our increased brand support combined with the cumulative impact of non-owned brands, system-related advertising, merchandizing, and promotion.

Also today I’d like to speak to intellectual property and what we see as our additional competitive strength. It’s no secret that two of the patents that cover our K-Cup Packs are due to expire in September of this year. We understand investors focus on the two inspiring patents, but I note that we have a broad intellectual portfolio with patents, patent applications, and proprietary know how, that cover portion pack technology and design, brewer technology and design, and even beverage technology.

While we clearly value intellectual property and will continue to pursue patents, and when necessary, to defend them vigorously, we have worked for several years to successfully compete as if we did not have the protection of patents. So what do I mean by this? We believe that we will continue to face competition from other single-serve system, and possibly from non-license manufacturing of portion packs designed for use with the Keurig Single-Cup system. We believe the opportunity is simply too attractive.

We have, however, worked diligently to develop a number of strength designed to enhance our marketplace position. First, we have substantial institutional knowledge and expertise, developed and refined over years of portion pack manufacturing. This knowledge has enabled us to significantly improve manufacturing yield and efficiency.

Second, we have meaningful manufacturing breadth and scale to support continued consumer adoption and portion pack demand.

Third, we have a solid reputation for quality product with our customers and our consumers. Keurig Brewed is not only a campaign launched to help consumers understand they are purchasing genuine Keurig-approved product, but also an expectation consumers have about the exceptional taste of our beverages. It’s likely the same level of quality and consistency will be expected of potential new entrants.

Fourth, we have more than 200 varieties of portion packs available in the system today from a broad variety of meaningful brands. And that number will only grow as we strategically add new beverages and brands.

Finally, we have the benefit of driving system related innovation, and I assure you, we are not standing still.

Which brings me arguably to our most important strength, that is innovation. In addition to on-going innovation around our current Keurig Single-Cup brewers, portion packs and beverages, we continue our work with Lavazza to develop a new espresso-base system, specifically targeting the North American consumer.

We continue to move forward with design and testing of this exciting new product.

As we have discussed previously, we also have our next generation Keurig filtered coffee brewing platform under development. I am very pleased to say that we have now successfully completed the consumer testing phase for this new platform, and we are looking forward to a product introduction this quarter. We’re excited about this product introduction and encourage you to stay tuned for more information in the weeks to come.

So in summary, we believe we are truly changing the way North America brews and enjoys coffee, and other beverages at home and in the workplace. Supporting and enabling the growth potential we see for the company and the Keurig brewing system remains our most significant challenge and our focus.

We are pleased to have shared this outstanding first quarter with you, and we remain very excited about the future.

Operator, we will now take question from the sell side analyst.

Question-and-Answer Session

Operator

(Operator instructions). We’ll go first to Scott Van Winkle with Canaccord Genuity.

Scott Van Winkle – Canaccord Genuity

Hi, thank you. Congrats on the great Brewer shipment number this quarter and a good quarter overall.

Larry Blanford

Thanks, Scott.

Scott Van Winkle – Canaccord Genuity

I think, you know, when you look through the numbers and we went through this last quarter, the only thing negative people are going to look for, you know, question on this time is the Q2 guidance, at least relative to the street expectations. Can you give us a little more indication of what kind of contribution Filterfresh had made in these winter quarters and on that other income line, can you give us maybe a little indication of what that might look like and then tacking onto that, are you assuming negative impact as a result of this crazy warm weather we’re seeing this year for winter?

Frances Rathke

Sure. Scott, this is Fran. In terms of the Filterfresh, last year Filterfresh contributed approximately $91 million in revenue and that was over the three quarters we owned them last year. So you know, it’s pretty radical business quarter by quarter. We don’t disclose specifically their earnings, but it’s in line with our OTS business.

And I think relative to the guidance for Q2, as we said, you know, we’re anniversering the Van Houtte acquisition so that’s lowering our growth rate on the top line. We also noted, you know, the decrease on – from the growth rate we experienced this past quarter that was so strong coming down a bit in Q2 guidance because of the fact that we’re anniversering also the first price increase we took last year and then we just discussed Filterfresh. Also, we do believe, we just had outstanding Brewer shipment growth rate this past holiday quarter as well as extremely strong Portion Pack sales this past quarter. So that’s the downward shift going from 102% actual growth rate in Q1 down to our guidance for next quarter of 45 to 50.

I don’t know if in terms of other income, maybe if you could explain what you’re looking at there.

Scott Van Winkle – Canaccord Genuity

Just taking a look at that other revenue line, basically if Filterfresh was doing roughly $30 million a quarter, you know…

Frances Rathke

Yeah, they do, you know, the Filterfresh brings us a lot of business and is in the other products, you know, Coffee Fractional Packs, so 90 million, you know, say 30 million a quarter, so probably at least 60, 70% of it is other, you know, products and Portion Packs.

Scott Van Winkle – Canaccord Genuity

If we think about Filterfresh, we think about, you know, the strong December quarter you just had and not knowing how it’s going to impact March, but it doesn’t sound like, you know, we should think about coffee being softer in a warm winter?

Frances Rathke

Well, that’s – we’ve been asking that ourselves, you know, what has this – the warm weather, we do believe, you know, may have some impact. It’s been exceptionally warm up in the Northeast. But we factored that in. We obviously have our month of January results in so we’re just – that’s factored into the guidance as well.

William Chappell – Suntrust Robinson Humphrey

Great. I’ll get back in the queue. Thank you very much.

Operator

We’ll go next to Akshay Jagdale with Keybanc Capital Markets.

Akshay Jagdale – Keybanc Capital Markets

Thank you. Congratulations again on a good quarter.

Larry Blanford

Thanks, Akshay.

Akshay Jagdale – Keybanc Capital Markets

So I just want to follow up quickly on the previous questions, so what was the pricing contribution to 1Q – sorry 2Q11 earnings? I’m not sure that you gave that out. You called out three items, 30 million roughly we’re thinking of Filterfresh for the quarter. What was the price contribution in Van Houtte in that quarter last year?

Frances Rathke

Sure. In terms of – I’m going to answer this in a different way because – okay, Akshay. So we – for Q1 that we just reported, we noted that in the press release that Van Houtte helped increase our top line by $103 million. So if I take the $100 and 2% growth we realized, back that down as if I didn’t own – we didn’t own Van Houtte, you’d be down around 83, 84% growth rate without Van Houtte. Then in terms of how much did the two price increases we took, if you recall starting in October last year, we took a price increase that actually also started taking effect for the retailer channel I Feb 1 and then we took a second price increase that took effect at the end of June. So relative to those two price increases, how much that helped increase our top line this past quarter, it was approximately the price increases helped by about $71 million, which about, a little more than half of that, you know, a little – no, excuse me, a little more than half of that came in the back half, so probably in order of 25 to $30 million was the benefit from the first price increase that we won’t get next quarter as a help to drive the top line.

Akshay Jagdale – Keybanc Capital Markets

Okay, that’s helpful. And just to follow up, in terms of your guidance, I mean, this was, in my opinion, really an amazing quarter for Brewers and we don’t know exactly how you model it, but you know, your demand model, I’m sure is predicated on that Brewer number. And in the past, the holiday season has really determined your guidance for the year if I just go back and look historically. I mean, can you give me some context here, Larry? I mean, it looks like you’re being very conservative, so I’m trying to understand, you know, you went from making comments last quarter saying you believe in your demand model, et cetera, et cetera and now, you know, you had an absolute blowout quarter on Brewers, which we would think would translate into much higher sales growth for the year. So was there some growth from next quarter in K-Cups that’s pulled forward? I mean, I don’t understand – I’m a little bit confused. Maybe you’re just being conservative, but if you can help us out there, that would be great.

Larry Blanford

Well, I’ll say – this is Larry, I’ll try to help you a little bit. You know, first of all, obviously we’re off to a great start this year and we’re very pleased that our revenue and earnings growth did outpace our own expectation in Q1. And of course, getting off to a great start, we’re comfortable reiterating our revenue and earnings guidance for the year. I think there’s a couple of factors and you’ve kind of touched on them here. One, we do have competence in our model as we back check it and in ’10 and ’11.

It’s just that the number of Brewers sold here are, as we mentioned, very significant relative to the installed base and relative to what we sold last year. And I think we want to have the benefit of some time here over the next couple of months with our survey efforts to make sure that we confirm and we’re refined if necessary the assumptions in our models just because of the incremental growth that we are seeing.

So you know, that is part of it. And it does take us a little while for those brewers that were sold, you know, a lot of those brewers sold in October, November, December are given as gifts and so they don’t really begin to enter in installed base until the holidays or shortly after. Generally, they’ve got Portion Packs either in the brewer box or they also received portion packs that it takes it some time to really understand how those brewers, you know, work their way into the installed base and some time to confirm also consumption trends.

So we want to make sure that we’re using good rigor and analysis in fulling understanding that. So that is one aspect.

I think also, as we mentioned, you know, we weren’t in very good stock position going into the quarter. We did have the opportunity this year to promote more than we have previously in similar quarters because we were, you know, last year and the year before, we didn’t have the same stock position. And so I think we did potentially see some sales as a result of that with consumers when they’re highly interested in the product and we may have seen some sales in Q1 that you know, we may not have been able to get it last year because of our stock position and our ability to promote.

So we’re, you know, certainly trying to be sensitive to that. I think warm weather, you know, may in fact be a factor here, so we’re just, you know, I wouldn’t say overly conservative but we’re trying to do the very best we can taking into account the very dynamic business with a lot of moving parts and try to provide the best estimates that we can.

Akshay Jagdale – Keybanc Capital Markets

I just wanted to make sure I understand. So from years past, the biggest difference is how much the brewer sales exceeded your expectation. Would that be fair? So in years past, you’ve had this holiday quarter has determined sort of your guidance for the year, that’s been the biggest mediation in your guidance. But – so am I understanding that correctly? The only – the biggest difference is you’ve beat your own expectations by a very large amount, which is why you’re being a little bit careful?

Larry Blanford

Well, I think we exceeded our expectations and we just, again, size of the brewer sales relative to the installed base are such that we want to be careful in confirming with good analysis our assumptions in our model. I just, you know, being an engineer, I don’t like to extrapolate beyond where they data has been generated and we’re just, you know, this puts us in a new realm here and we just want to make certain of those model assumptions. It’s just going to take us a couple of months to really understand that.

Akshay Jagdale – Keybanc Capital Markets

Perfect. Thank you very much.

Operator

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

Mitchell Pinheiro – Janney Capital Markets

Good afternoon. Just one question around guidance with really two parts. First, so you know, the K-Cup unit growth was up 81% in the quarter, you know, so we’ve seen a little bit of a seesaw, 90 in the third, up 52 in the fourth and now up 80. So what’s the right trend line here? Was there any sort of over shipment of K-Cups in the sense that, you know, people that buy brewers grab maybe an extra box or two for their gift and stocking stuffers and things like that? And you know, in years past you said it really didn’t have an impact coming into January where I think John Whoriskey many have said, you know, he didn’t see really any change, but should we expect, you know, that some of the 81% was part of the second quarter or how do you think about that?

Michelle Stacy

Mitch, this is Michelle Stacy and let me try to give a little bit of perspective on the flow of the year. For most of our major retailers, the big events are really our Q1 events, our fiscal Q1 events in support of the holiday season and then they really come back with big in-store events once again during Q3, which is the spring promotions that support mom, dad and grads and our brewed-over-ice program. So it’s not unusual that our business is going to sort of flow into some of those quarters as those are the quarters where we’re investing both media dollars, promotional dollars, we’ve got a lot of retailer activity to really support those big events.

So I think that one of the things that we’re looking at is how does our promotions flow with all our major retailers flow from quarter to quarter and how does the consumer react in terms of what they take off the shelf and how much pantry inventory they might have as well. So I think that’s what’s flowing the demand in to those two quarters.

Frances Rathke

And Mitch, just to reiterate, last year, as you said, we had – especially going from Q3 – or Q3, we had a very strong unit K-Cup Pack growth rate. And we attributed that to a couple of factors, you know, one was getting back into stock, two was having, to Michelle’s point, a, you know, a much more robust spring campaign that we never had before. So the retailers really got behind that, ordered a lot of the K-Cups as well as grocery, brew-over-ice and then we also had announced the second price increase so we knew there was some kind of buy in. We tried to measure that. And then, we came into Q4 as we had a significant shift downward and we found there was much more dynamic inventory patterns in terms of what our customers order versus what the POS data, whether it’s the retailers or what the grocery store was.

So I think our business is going to be more difficult to predict on a short-term basis month to month or end of quarter, but overall, we’re feeling like last year, I think, overall, our, you know, K-Cup grow was in the 70 to – unit growth, more the 70 to I think 72% or so, unit growth.

Mitchell Pinheiro – Janney Capital Markets

Okay, so the trend line, you know, you still feel that the trend line, it remains solid and there’s some nuance, you know, plus or minus depending on the promotional activities in the quarter and that sort of thing? Is that correct?

Frances Rathke

Yes, this is Fran, yes. And if we have new accounts and – or new activity, that obviously – new products rolling out, that affects it like any kind of CPG company.

Larry Blanford

Mich, this is Larry, support what Michelle had said earlier too. Remember, last year, really, was our first year to get behind the spring promotion; Moms, Dads and Grads. And so that was very productive for us. We’re going to be repeating it this year. We learned a lot last year. We’re going to be doing it, I think, with even better execution and in some bigger ways, we’re very excited about the upcoming spring as well.

So these are patterns that, you know, as the business continues to grow and develop, you know, we’ll continue to learn as we go forward.

Mitchell Pinheiro – Janney Capital Markets

And I guess so the second part to the question is guidance. How do we think about the next gen within your 60 to 65% revenue growth rate? I mean, how do we parse that out? Next gen and potentially even, you know, I don’t know, you hadn’t said anything about Lavazza in particularly in terms of launch, but how do we parse that out?

Frances Rathke

Mitch, this is Fran. In terms of the launch, as we said, we’ll be – we’re excited to start the launch this quarter we’re in. And we anticipate, you know, relatively, compared to the rest of our business in terms of brewers and K-Cup packs, it’s a fairly small number for this year. We do have startup costs, both getting the packaging line for the new portion packs going as well as we’re going to be marketing and communicating with new significant product launch starting with this quarter we’re in.

So with the combination of the under absorbed overhead for the new, you know, startup of the manufacturing capacity as well as the product launch, this will be a drag in terms of the new brewer system, a drag on earnings in fiscal ’12 staring really this quarter. So that’s factored in our estimates as well.

Mitchell Pinheiro – Janney Capital Markets

And when you launch, will you have a – I imagine when you – will you have sort of updated guidance related to that or is it you’re just going to keep it inside your overall revenue guidance?

Frances Rathke

I think overall, we anticipate, you know, just having it in our numbers and if it’s something we want – we feel significant that people want to know what’s going on in terms of, you know, at this point, we’re only launching to a small number of customers and I think we’ll have to see what we decide is material enough to disclose.

Mitchell Pinheiro – Janney Capital Markets

Okay. All right, thanks for your time.

Larry Blanford

Thank you, Mitch.

Operator

We’ll go next to Jon Anderson with William Blair.

Jon Andersen – William W. Blair & Co.

Good afternoon.

Frances Rathke

Hey, Jon.

Larry Blanford

Hey, Jon.

Jon Andersen – William W. Blair & Co.

Hi, guys. Congratulations. I have a quick question on pricing. I guess it’s a little bit bigger picture question. You know, with the introduction of the new partner brands in some of the many products you’ve bought to market and I’m thinking [inaudible] here is one example, it seems like, you know, K-Cups are kind of touching – you’ve got a broader range of price points across the portfolio. I guess my question is, it’s kind of on segmentation. Do you foresee more kind of price segmentation to come across the portfolio, and that could be either additional pricing in the near or medium term or maybe positioning, you know, certain brands, maybe [inaudible] brands if given the potential for more competition down the road as you said, Larry? Thanks?

Larry Blanford

Yeah, kind of – Jon, this is Larry. It’s kind of all the above. I think, you know, on the last call I talked a little bit about kind of the ecosystem here that we have tried to build. The – we do expect that we will have more price tiers going forward, you know, with the addition of premium and super-premium brands and price points. It gives us an opportunity to think about more price tiers. I think generally speaking, if you historically look at health CPG categories, you will see a number of price tiers, that’s generally a sign of a healthy category. We anticipate that continuing to evolve amongst K-Cup.

Also, you know, as we mentioned, in addition to coffee, we are continue to bring additional new product categories to market and those will also avail themselves to various price levels and price tiers in brands owned and non-owned.

I think, again, the kind of the bottom line of all that, which I think indicated on the last quarter’s call, was that we really have a high degree of confidence that within that ecosystem of brand and channel and product, that we have flexibility to both continue to drive volume as well as to help maintain and grow margin to kind of maximize profitability. And so the marketing teams are hard at work on thinking about that and putting plans in place as we go forward.

Jon Andersen – William W. Blair & Co.

Thanks, that’s very helpful.

Larry Blanford.

Great question.

Jon Andersen – William W. Blair & Co.

Appreciate the color. I’ll get back in the queue.

Operator

We’ll go next to Mark Astrachan with Stifel Nicolaus.

Mark Astrachan – Stifel Nicolaus & Co.

Hi, everybody.

Larry Blanford

Hey, Mark.

Mark Astrachan – Stifel Nicolaus & Co.

[Inaudible] question first and then more of a strategic question second. Where do you think retailer inventories are for brewers in K-Cups right now? You sold 4.2 million units, but it seems like the takeaway is slower than that. So where is it for brewers and K-Cups? And do you anticipate positive brewer growth in the March quarter?

Also, housekeeping wise, how much revenue do you anticipate for the new system in Fiscal 2012 and then just the strategic question is, I realize that it’s early, but how do you think about K-Cup possibility evolving through 2013, especially concerning what could be potentially increasing competition?

Larry Blanford

Okay, there were several question there, Mark. On the Keurig brewers, John, do you want to try to address that?

John Whoriskey

Sure. Hi, Mark, this is John Whoriskey. You know, coming out of the holiday season, I think one was we were well stocked and well positioned and I think that certainly helped us meet all the of demand that was out there for the first time really in the history of the system. We were able to meet all that demand. So I think we come out with very reasonable inventory levels and we’re well positioned as we go through the – getting ready for the spring season. So I think we’re in a terrific position going forward.

Larry Blanford

And then you had a question on the next generation I think? Fran?

Frances Rathke

Yes. We are not, as I said, the next generation launch this year is not a big – we don’t anticipate it a significant contributor to the top line. So we have not disclosed our estimates on specifically sales of the new brewer system.

Mark Astrachan – Stifel Nicolaus & Co.

So do you think you’re going to see positive brewer growth in the March quarter based on where the inventories are at retail right now?

Frances Rathke

We – in terms of our brewer growth rate for Q2, we do anticipate having growth, but nowhere near what we had this holiday season.

Larry Blanford

Right. We typically, you know, we have a pretty good pattern here of having our most significant brewer growth rates quarter over same quarter prior year in that first holiday quarter and I think, you know, also, we did have and we’ll see how this plays out, last year I would say this goes back to an earlier point, Mark, that we were talking about. The – we saw some, you know, strong support by our retailers in the Moms, Dads and Grads period last year in our Q3 and we would anticipate having strong support there again. And I would think while our – the focus of our promotion is brewed over ice, it tends to also give us a lift on brewer sales to the consumer. The brewer, you know, kind of fits right in with the comments Michelle was making earlier?

Frances Rathke

Larry, just to add to that. Mark, just you know, while our brewer percentage growth rate coming off of this very strong holiday season growth rate, it’s – we anticipate the law of large numbers to start really playing out in terms of we’ll see a moderation in terms of quarterly growth rates on brewer unit shipments. But we do expect to add in 2012 a greater number of brewers than we added in the prior year to the install base.

Larry Blanford

And it’s really that install base growth is, I'm sure you’re aware that really is very important to driving, of course, demand and ultimately our sales and earnings.

Mark Astrachan – Stifel Nicolaus & Co.

So, but before going to the possibility question, I guess just to clarify then, so you’re expecting greater brewer shipped in 2012 than in 2011, but that sort of sounded like it’s expected to slow for the balance of the year then pretty dramatically?

Frances Rathke

I think, Mark, the brewer growth rate in terms of the next few quarters, we do not anticipate as strong of brewer unit shipment growth rate of what we had this holiday season. But the overall absolutely units of brewers will be substantial compared to the install base.

Mark Astrachan – Stifel Nicolaus & Co.

The second question on K-Cup profitability evolving through 2013?

Frances Rathke

We don’t give out specific data on K-Cup profitability. As we stated, our goal, and we believe our model is, you know, as we continue to grow the install base and offer a host of different portion packs, we will overall see our operating income margin, our operating margin improve.

Mark Astrachan – Stifel Nicolaus & Co.

Okay, does that mean you think profitability can remain where it is on a per-unit basis?

Larry Blanford

Well, I think we will strive, you know, we can’t guarantee, Mark. I think what we talked about earlier was, you know, within the model architecture, we have opportunities to drive volume and drive profitability and obviously, we try to manage both of those to optimize overall profitability for the system and for the company. I think we will be, as I mentioned, spreading out across tiers. I can see we may have some products, you know, at lower price, some at higher price as we spread those tiers in the market place to help, again, maybe extend the demographic reach of the K-Cup platform from a volume standpoint and then obviously, we’ll try to maintain profitability with new products in new categories with pricing of certain brands or products.

It’s an optimization and we’re working at it all the time and we strive, obviously, to optimize profitability by driving both volume –managing that balance between volume and price. I would not want to, you know, project out in to ’13 at this point. We certainly feel good about our estimates at this point.

Mark Astrachan – Stifel Nicolaus & Co.

Thank you.

Operator

We’ll go next to Bill Chappell with Suntrust.

William Chappell – Suntrust Robinson Humphrey

Good afternoon. Just to keep it fairly simple with one question, but trying to understand inventory on the K-Cups, especially capacity from [inaudible] comments of really the capacity constraint and I think you had in the past said by the time we got into the spring there was a chance that you could be capacity constrained. I mean, will you have the CapEx done in time and, I mean, from that standpoint with the huge brewer shipment, I mean, should we expect the K-Cups to match that or be able to match that over the next couple quarters?

Larry Blanford

Bill, this is Larry. I’ll start and Fran can jump in if she wants. I think, overall, you know, certainly we have been adding capacity, adding floor space, I think we mentioned our remarks you know, we’ve been adding space at all of our plans and the two very significant floor additions, one here in Vermont at our Essex plant and then our next plant near Norfolk. So – and we’ve been ordering packaging lines and trying to leave ourselves in the process as we’ve talked before, a bit of an upside machine capacity because this market is so dynamic. I think we’re feeling, even with the brewer numbers, I think we’re feeling right now overall that we’ll be able to support the demand that we would see in ’12 relative to Starbucks, remember that that product line utilizes the advance K-Cup portion pack and that product is run on new lines, different lines. And so our existing lines were not able to run that product and we’ve been certainly working very hard since inking the agreement with Starbucks to put into place the advanced K-Cup portion pack packaging equipment.

I think we have met all of our commitments to Starbucks and we still – both organizations see opportunities ahead. We’re working very hard to put new lines in place to support the continued rollout of Starbucks products. So that’s kind of a separate capacity issue inside the overall capacity issue.

William Chappell – Suntrust Robinson Humphrey

Okay, and then just a follow up on the new platform. Would that be expected to be dilutive to kind of this quarter in terms of launch and I assume on the brewers it’s similar economics to the Keurig machine?

Frances Rathke

Bill, it’s Fran. Yes, it would be. We’re estimating it slightly dilutive in Q2 and each Q3 and Q4.

William Chappell – Suntrust Robinson Humphrey

Okay, great. Thanks so much.

Operator

We’ll go next to Greg Mckinley with Dougherty and Company.

Gregory Mckinley – Dougherty & Co.

Yes, thank you. I wanted to make sure I understand the impact of the margins and revenues of Filterfresh in the quarter. That transaction, I think was October 3rd. So to what degree did Filterfresh have a revenue impact in the quarter? And then can you help me reconcile from the 29% margin rate you reported to what it would have been excluding that business?

Frances Rathke

Oh, the Filterfresh business as we said, it’s about 30 million a quarter. We sold it on October 3rd, so you know, overall…

Gregory Mckinley – Dougherty & Co.

So was there almost nothing in the quarter related to Filterfresh?

Frances Rathke

Not a material, overall material amount. It’s really when you compare it to last year’s Q2, that’s where we were just talking about, we won’t have Filterfresh at around 30 million bucks.

Gregory Mckinley – Dougherty & Co.

Yeah, okay. But for fiscal Q1, Filterfresh had almost no impact?

Frances Rathke

Essentially [inaudible].

Gregory Mckinley – Dougherty & Co.

Great. And then you know, you obviously had just outstanding brewer deliveries in the quarter and yet I’ve said, look, we’re going to start running into this large, large numbers and we need to digest how these brewers are going to be used in the market. Even given the large shipments that occurred, would it still be your expectation that as we look at revenue mix in 2012 we see brewer and accessory revenues represent a smaller portion of total revenues than was the case in 2011?

Frances Rathke

Great, overall, that is what we would anticipate for next year, is a continued shift towards more portion pack sales at a higher percentage of our overall sales.

Larry Blanford

And Greg, while we’re talking brewers, I might just have John Whoriskey – we didn’t speak – all of the discussion we’ve had on brewers has been related to the U.S. but there’s also a very good story here regarding Canada which of course we got a later start on but our – I think we’re building strong momentum now with GMCR Canada. And John, or Steve, you had some numbers on Canada?

John Whoriskey

We’ll talk about Canada since you’re talking about Filterfresh. In this past quarter, the Keurig brand was the number one coffee brand with 35% market share. So again, we’re seeing some very impressive growth in Canada, dollar share.

Gregory Mckinley – Dougherty & Co.

Great.

Larry Blanford

We’re very pleased with the development of our business in Canada as well.

Gregory Mckinley – Dougherty & Co.

Okay, so just a quick recap, in 2011, brewers and accessory revenues, those were maybe about 20% of revenues. Even with the dramatic start we saw out of brewers here in Q1, we would expect 2012 to be a lower mix. And then just to confirm that my understanding is correct with your answer. And then secondly, can you maybe just give us an update on your CapEx progress, you know, whatever infrastructure you’re needing to put into place, you know, what major projects, other update so major projects that are that you can provide us with?

Frances Rathke

In terms of fiscal ’12 the mix of brewers and accessories would be a lower percentage of our overall sales for fiscal ’12. And in terms of CapEx, I think we’re on schedule and overall with our plans to, as we know, a big effort is on adding capacity this year. With Virginia, we did close on buying that facility. We have a major expansion going on up in Vermont right now and you know, as Larry mentioned, we’ve been purchasing and installing K-Cup Portion Pack lines and we do have the next gen lines running now, albeit not with huge volume it them at this point.

Gregory Mckinley – Dougherty & Co.

Thank you.

Larry Blanford

Just to add on to that, we are feeling very confident about the investments that we’re making and still consistent with the capital guidance that we’ve talked about that are going into the facilities and the packaging lines that we need to support the growth and that’s all still on track as guided.

Gregory Mckinley – Dougherty & Co.

Thank you.

Larry Blanford

Thank you.

Operator

We’ll go next to Bryan Spillane with Bank of America/Merrill Lynch.

Bryan Spillane – Bank of America Merrill Lynch

Good afternoon. Just a couple of – just a couple of points of clarification I guess. One is gross margins in the quarter, I think if I read this in the 10-Q correctly, pricing on K-Cups with a 460 basis point benefit and then green coffee costs, the increase, the inflation was a 250 basis point drag. So that applies that pricing now with all the pricing that’s in place, you’re more than covering the inflation in green coffee. Is that, am I reading that right?

Frances Rathke

Yes, for this past quarter, yes. As we head into Q2, we will continue to have the same rough impact on the portion packs from the two price increases we took last year. We will – we anticipate a little bit higher coffee cost we’re going to consume in Q2 over sequentially this past quarter.

Bryan Spillane – Bank of America Merrill Lynch

So the price per pound or the price you’re paying for green coffee sequentially on average would be higher – would be reflected, is going to be higher in the second quarter than it was in the first quarter?

Frances Rathke

Yes. Slightly higher.

Bryan Spillane – Bank of America Merrill Lynch

Okay. And then eventually that should start to moderate, right?

Frances Rathke

Correct.

Bryan Spillane – Bank of America Merrill Lynch

Okay. And then I guess in terms of just following on I guess Mark Astrachan’s question, I want to make sure I was clear. Retail inventory for K-Cups and brewers, there’s nothing unusual I guess, that’s – they’re pretty much – they’re relatively normal levels or at a level that’s normal relative to what you would see this time of the year, is that right?

John Whoriskey

Yes. This is John Whoriskey again. I would say yes, coming out of the holiday season, I think we were well stocked going into the season and we come out in a very good inventory position to go foward as now we prepare for our spring season.

Bryan Spillane – Bank of America Merrill Lynch

Okay, great. And then Larry, just in terms of the launch of the new brewer, just how will you approach positioning it relative to the existing system? I guess, you know, I guess you could think about what’s been done in razor blades or in razors, right, where the next one comes in but the previous one is still available? If you could just talk a little bit more how you’re thinking about how to position it. Also, trial, like will you put it in – is there a chance you’ll put it in the hotels or make it available in offices in order to try to build trial? Like just what the path is like in terms of approach that launch relative to the new system.

Larry Blanford

Yes, that’s a great question. I’ll deal with it a high level and probably save some more details for our launch, which we’re not too far away from. But at a high level, I’ve spoken to this before, but it’s important, I’m glad you asked the question. So as we introduced the next generation filtered coffee platform, you know, our intention is a premium system and our intention is that we will target a higher demographic, really a demographic similar to what we originally targeted with the Keurig K-Cup platform. And then of course, as we built momentum with our existing platform, we’ve been able to expand the reach of that system beyond where we started.

So the two systems are met to work in a very complementary fashion. We would certainly expect that there will be people in the existing platform who will be very – who are very passionate about their Keurig brewing systems who will want the latest and the greatest and they will, I think I’m confident that some of our sales will go to existing Keurig households. But really, the opportunity for us is to have both of these platforms working in a complementary way and while we bring in the new system, at that kind of higher demographic in the premium system, we want to actually expand the demographic reach of the current K-Cup platform.

The more folks we can get into Keurig, the better off, obviously, we are going to be. That is our objective. And then, you know, over time, we have then significant let’s say flexibility as to how we might want to play the two systems. But certainly as we get started in for the near term, we would see these working very complimentary.

Bryan Spillane – Bank of America Merrill Lynch

That’s helpful. And Larry, just one more, just in terms of your – I guess your decision, signing the contract and then deciding to retire afterwards, first, I wasn’t sure if I should congratulate you for retiring because I don’t want you to retire yet.

Larry Blanford

Thank you. I appreciate that.

Bryan Spillane – Bank of America Merrill Lynch

But just why – I guess why leave now? Why decide to leave, not that you’re leaving now, but why make the decision to leave, you know, in the future and I guess if you think about the succession planning and the types of candidates, is part of it just the nature of the business is changing and – just a little bit more color in terms of that decision would be great, please.

Larry Blanford

Well, I’ll try to give you a little more color. I would say that I do have a number of thoughts and have had about another phase of my career in my life. And you know, as we were coming up on my contract expiration in May, we naturally began to discuss contract, the Board and myself. And you know, it just seems to me that two years made a lot of sense, both for me personally and for the company.

In November of ’13, I will turn 60 and it seems to me that that was kind of a good transition point for me to pursue some of these other interests that I have. And then secondly, you know, as certainly as we’ve talked over time with governance specialists, you know, they strongly suggest two years or so for Board to be able to successfully work through a transition process. And I certainly wanted to make sure that the company had the benefit of that time. So I think from both perspectives, it really made just a lot of sense. And I, you know, really am totally focused on right now. There is so much that I want to get done now that we have kind of put an end date, my team is smiling at me here, on my time with the company, I now need to accelerate maybe something’s that I wanted to otherwise get done.

So we’re going to be working very hard and very aggressively here over the next period of time. And then I’m going to continue, you know, to serve my term on the Board and – but this is a great company, a great culture, tremendous future and it’s just been fantastic to be able to take it to the next step. Bob [inaudible] is a great transition as he passed the keys to me and I want to have an equally great transition to the next leader.

Bryan Spillane – Bank of America Merrill Lynch

All right. Well, thank you, Larry. I look forward to seeing you guys at [inaudible].

Larry Blanford

Great. Thank you, Bryan.

Operator

We’ll go next to Nicole Miller Regan with Piper Jaffray. Nicole, your line’s now open. And Nicole if you could check the mute function on your phone, we can’t hear you.

And hearing no response, we’ll go next to Tony Brenner with Roth Capital Partners.

Anton Brenner – Roth Capital Partners, LLC

Thank you. In your filings, you’ve indicated that you’ve identified the problem of the brewer components that have caused such a high frequency of returns and warranty expense. And that brewers shipped since a year ago January basically eliminated that problem. So my question is, hence forth, might we expect those returns and warranty expense to stabilize or decline? And in addition, with the launch of two new brewer platforms, how will that complicate that whole warranty issue?

Larry Blanford

Thanks, Tony. This is Larry. Yes, so we did talk about this a year ago, we had identified the problems and made some important adjustments beginning in early January of last year and through that first quarter as we were producing the product. Recall that that product once produced is four weeks getting over the water and then into inventory and then ultimately into our customers hands and the ultimately to the consumer. So it unfortunately, when you have a – particularly when you have a late-stage reliability issue, which this was, it takes some time for that to ultimately work it’s way out of the system and for the new product to work it’s way in. So we are – we still remain confident although in the modifications that we made, although we’re continuing to monitor our quality data and we would expect that that particular problem in terms of how it’s manifesting itself in returns would reduce.

As we go forward with more platforms, obviously it further does complicate our live in terms of more systems, but I would also say we’re learning a tremendous amount and have significantly increased our processes and our approaches to design and engineering and to quality management. Michelle, I don’t know if you had – wanted to comment on it some, but …

Michelle Stacy

I think you’ve done a very good job of answering the question and we are constantly working on the overall reliability of our brewers and continue to add consumer simulation testing centers. We’ve continued to increment the number of home use tests we’re running at the time that we run those home use tests. We’re continuing to put everything in place that we can to ensure that we continue to improve the overall quality of our brewers and importantly, to delight the consumer in every way we can all the time.

Larry Blanford

Another important process that we’ve put in place, and Michelle and her team is reverse logistics, so we’re bringing back a number of the brewers now from a number of the retailers, not all but a number that the brewers are returned. They end up coming back to us and we’re able to then inspect them and determine – get another set of data as to why brewers might be being returned, that then goes right into our engineering organization so that they can certainly incorporate any design changes or component changes as necessary as they see that data coming back.

Anton Brenner – Roth Capital Partners, LLC

So as it here, I mean, I understand there were many more brewers being shipped, so is it fair to assume that at the very least, the rate of increase in that line item expense should subside going forward?

Larry Blanford

I would just say, look, we’re very hopeful that that’s the case. I think with an abundance of caution, we would suggest that just because of the complexity of the brewers that, you know, we would suggest that we’re holding right now our – going forward, our warranty and return rate, but we keep working at it.

Anton Brenner – Roth Capital Partners, LLC

So we put an abundance of caution on one more line item. One other question if I might very quickly. Everyone is observed that the shelf space and floor space in a number of retailers have picked up – in brewers, has expanded meaningfully, but I buy K-Cups on your website because I can choose from 250 varieties. I don’t know any retailer that has that and I’m wondering if the proportion of sales from your website – first all, what is that share, and secondly, has it changed up or down as a proportion of total K-Cup sales? Thank you.

Larry Blanford

T.J. Whalen is going to address that.

T.J. Whalen

Hi, Tony. This is T.J. You know, the web business is really important to us. We like the margins, we use it as a testing ground and a proving ground for a lot of our new items. It’s a way to keep in touch with consumers and we actually use that as a means to drive their behavior and introduce new products and in some cases, direct them to purchase those products in other channels. So it’s got real strategic value to us. It helps us build a database of our installed brewer households, but ultimately as this has really become a widely popular proposition, the vast majority of the portion pack sales will come through traditional channels. Probably the early adopters in the system were maybe a bit more likely to shop online than subsequent new entrants to the systems. You know, it’s really now kind of a mass product and the vast majority of result in portion packs sales will flow through more traditional channels.

Michelle Stacy

I would just build a little bit onto what T.J. said, that – this is Michelle, our website, we do expect to see more people going through the traditional retail channels. However, on the Keurig.com site, we continue to have more people visiting the site than the prior year. We are capturing more of them and driving them to a purchase. When they are purchasing, they’re purchasing the larger shopping basket than in prior years and in addition to that, they’re coming back for multiple purchases. So we do see at Keurig.com that we’re continuing to do a good job if interacting with our consumers and our – in terms of keeping them engaged in the website even though we are seeing more of the purchasing at retail in traditional channels. We are doing a very good job of attracting them and keeping them engaged on Keurig.com as well.

Anton Brenner – Roth Capital Partners, LLC

Thank you very much.

Operator

We’ll go next to Alton Stump with Longbow Research.

Alton Stump – Longbow Research

Thank you. This is [inaudible] calling in for Alton. Good afternoon. Just two quick questions. First on Starbucks, we talked about it a little bit before, but now that Starbucks K-Cups have been out there in the market for a couple months, do you have any sense what kind of cannibalization rate you’re experiencing versus what’s incremental to K-Cup sales? I guess in other words, do you think you’re bringing new people to the category?

Larry Blanford

This is Larry. I think it’s still early, too early for us to get a read on that. And recall too, that Starbucks is still in a rollout phase and I think their merchandising marketing support, et cetera behind the introduction, I think will really pick up once we are able to have sufficient capacity to support their store rollout, which will occur later this year.

And I think as it gets into their stores, then you know, we’re certainly hopeful that Starbuck’s strategy of being able to leverage all of the consumer visits that they receive every day to create awareness around new interesting products will manifest itself. So I think at this juncture it’s just a little hard to read, but over the long-term we certainly expect that Starbucks in the system will certainly add to brewer awareness and adoption and greater overall demand.

Alton Stump – Longbow Research

Okay, that’s helpful. And just a quick follow up. You might have mentioned this earlier. If you did, I apologize. But what do you estimate your total installed brewer base is now?

Larry Blanford

We did not update it. I think we had previously said we were in the 7 to 9 million range. That was prior to this last quarter and as I said, because of the significant growth of the brewers, the size of brewer sales relative to the install base, you know, we want to have the benefit of checking our assumptions. So we’ve not updated that at this point and maybe in the future we’ll be able to do that.

Alton Stump – Longbow Research

Okay, great. Thanks a lot. Congratulations on a great quarter.

Operator

Well, go next to Mark Rostick with Williams Capital.

Mark Rostick – Williams Capital

Hi. Good afternoon, everyone. I just wanted to clarify something just to make sure that I heard this correctly. You’d mentioned on average coffee pricing, coffee cost pricing that you were looking at the peak being the quarter that I guess we’re in now as opposed to the one that was just reported. And then I supposed subsequently then falling off after that. Is that – did I hear that correctly?

Larry Blanford

Yes. This is Larry. I think our Q3, I think we will still be experiencing fairly high coffee costs, not any dramatic change in Q3 and then some further decrease in Q4.

Mark Rostick – Williams Capital

Okay, so if we’re looking at which quarter might be, I suppose the peak of the year, then that would be Q2, correct?

Frances Rathke

Yes, Q2.

Mark Rostick – Williams Capital

Okay. Excellent. Ship figures to some of the retail. I wanted to get a sense of if you could share with us if you’re experiencing some additional search for product differentiation or things of that nature as far as retailers trying to find ways to maybe offer a product that may be – that some of their peers may not have or assortment?

Larry Blanford

This is Larry. We, as I mentioned before, we have this broad array of grand channels and products and while in general we want to make those brands and products generally widely available and we do, there are opportunities both in terms of timing of launch of new products and certain of the brands which are more suited for grocery maybe or for high-end retail or for mall-based department stores like the Gloria Jean’s brand. We have opportunities to provide across the various channel partners where it makes sense. Some opportunities for them to differentiate their offering and we worked hard at that as well and again, the plethora of brands and products that we have gives us the opportunity to do that. But very good question.

Mark Rostick – Williams Capital

Thank you very much.

Operator

We’ll take a follow up question from Akshay Jagdale with Keybanc Capital Markets.

Akshay Jagdale – Keybanc Capital Markets

Thank you for taking the question. I appreciate it. I just wanted to ask about the inventories. You gave a lot of data on it, but if I can ask you what was the inventory position on K-Cups in weeks because you’ve talked about that in the past. You know, you were sort of constrained in the first half of ’11 and then the last quarter of ’11 you were sort of one week ahead of where you wanted to be in terms of the inventory. I’m looking at a number that’s four weeks now compared to six weeks in the last quarter in terms of K-Cup inventory. Am I in the ballpark or how should…

Frances Rathke

Akshay, it’s Fran. I think the reduction coming off of last quarter where we reduced our inventories by about $100 million, that primarily came from brewers as planned. And then the portion pack, we did make some strides in reducing from the seven weeks forward estimate that we had last quarter end to about a week we dropped it by, but not all the way down to four weeks.

Akshay Jagdale – Keybanc Capital Markets

Okay, great.

Larry Blanford

Four would be below our target, Akshay. I think we would, at this juncture, maybe someday we’re good enough to get the inventory down to that level, but I think in the 5 to 5 ½ weeks is kind of where we think we would be. So we’re not, you know, we did make progress, we’re not quite really where we want to be, but you know, we’re continuing to manage that.

Akshay Jagdale – Keybanc Capital Markets

And just on in terms of free cash flow, obviously this quarter I think was, in my estimation, very good surprisingly. Can you just update us on free cash flow and also CapEx? I mean, the one, you know, what I’m really interested in knowing is you had said tha you would fund part of your CapEx with operating cash, right. And the remaining with I guess revolver. But can you give us an update on where you are given now that you have the first quarter in on that and then how does such a good quarter on brewers impact your outlook on free cash flow and how does – how is your, you know, the launch of your new system, was it faster than you expected and how did that impact CapEx going forward?

Frances Rathke

Akshay, it’s Fran. I’m going to answer these fairly quickly. I’m going to go backwards. I’m going to start at the end. In terms of the launch of the new platform, it’s essentially on plan with what we had expected when we put our budgets and forecasts together for fiscal ’12. In terms of our free cash flow, well, cash flow from operations as we said, this fiscal year, ’12, we will generate free cash flow from operations much stronger than we delivered last year because we don’t need to build up the inventories from around four week portion packs to more like six weeks. We’ve taken care of that as a step up. And I think we anticipate that we will use the cash flow from operating activities and our existing credit facility to fund our cash needs for the business as well as CapEx.

Akshay Jagdale – Keybanc Capital Markets

Great. I’ll pass it along. Thank you very much.

Operator

And we’ll take a follow up from Scott Van Winkle with Canaccord Genuity.

Scott Van Winkle – Canaccord Genuity

Hi. Thanks. So Fran, if I look at that Q2 guidance, you know, the revenue growth is going to exceed the EPS growth kind of in mid-point in the range. You’ve talked about higher green coffee costs so I assume you expect the lower gross margin on a year-over-year basis. Is there any other expense item we should consider, you know, maybe it’s a negative variance versus the prior year on a percentage of sales basis?

Frances Rathke

In terms of the EPS guidance growing at a lower rate than our top line for Q2, what factored in there is, yes, lower gross margin especially with the higher coffee costs as you noted. And then also last year to just sort of elevate that, last year’s Q2, if you go backwards, we have a very tough comp on the gross margin line. We had a very high gross margin relative to historical levels last year in Q2 because we had the Q2 price increase going into effect for that quarter and we didn’t – we saw coffee costs going way up, that’s why we had to take the price increases. However, we’d already locked in at lower coffee costs, so we have a very strong, the strongest gross margin quarter in Q2 last year.

In addition, going down the P&L, we do expect a drag on our operating margin due to this launch of the new brewing system and we also have some new beverage varieties launching this past quarter.

Also, just back on the gross margin, we do have startup costs staring to take effect to build up the capacity that we talked about on the last call when we gave guidance for the year.

Scott Van Winkle – Canaccord Genuity

Okay, fair enough. And then back on that 4.2 million brewers shipped this quarter, I mean, I just – it was an incredible number relative to my expectations and kind of what I saw when I do checks throughout the quarter and I thought obviously, they were good and good sell through, but nowhere close to that. Maybe could John talk about, you know, anything he saw about channel shift or what have you? Obviously all the brewers seem to do well from a market share standpoint. Was there anything that popped out or – to me it looked like the department stores may have had the most significant growth year over year. Is that fair?

John Whoriskey

No. Hi, Scott, it’s John. I would say it was really across the board and I think that we had such a well-orchestrated marketing campaign that was supported by the product that was needed, so the combination of our advertising along with all of our partner advertising and our own brands here as well at Green Mountain as well as tremendous merchandising and in-store demonstration and advertising with our retail partners, so I think it was a combination. As well as, I think we saw similar success in Canada in the support that was put behind the brand up there as well. So I just think it was really the first season where we could fully support all the demand going up into the Christmas period where we were not running out of stock positions and so on, and the sell through was very good. And as I said, and I’ll reiterate, I think we come out of the holiday season now in a good inventory position as well for people coming back even after the holiday, after Christmas. So I think that was also very helpful for us.

Scott Van Winkle – Canaccord Genuity

Is there any way to measure that? Like say last year 20% of stores were out of stock post-holiday and this year there’s 2%? Is there some metric that we can measure that with?

John Whoriskey

I really wouldn’t speak to exactly what that means. I think that we do track our retail movement by retailer every week and I think it certainly varies by retailer, by area of the country as well. So we certainly got a lift because of that, because of our stock position.

Scott Van Winkle – Canaccord Genuity

Thank you very much.

Larry Blanford

Well, we were really pleased to bring to you an outstanding first quarter. I’d like to thank all of you on the call today for joining us and for your continued support of our company. Thank you.

Operator

And ladies and gentlemen, that does conclude today’s call. We do appreciate everyone’s participation.

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