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

F4Q07 Earnings Call

November 15, 2007 10:30 am ET

Executives

Frances Rathke - Vice President and Chief Financial Officer

Larry Blanford - President and Chief Executive Officer

Nick Lazaris - President of Keurig, Inc.

Jonathan Wettstein - Vice President of Operations

TJ Whalen - Vice President of Marketing

Scott McCreary - Chief Operating Officer

Analysts

Mark Astrachan - Stifel Nicolaus

Scott Van Winkle - Canaccord Adams

Nicole Miller - Piper Jaffray

Mitchell Pinheiro - Janney Montgomery

Richard Fearon - Accretive Capital

Patrick Stowe - Priority Capital

Operator

Good day, and welcome everyone to the Green Mountain Coffee Roasters Fiscal 2007 Fourth Quarter And Year-End Conference Call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President and Chief Financial Officer, Ms. Frances Rathke. Please go ahead, ma'am.

Frances Rathke

Thank you, Kevin. I would like to thank all of you for joining us this morning for our fiscal 2007 fourth quarter conference call. If you have not received the earnings press release, it is on our web site at www.gmcr.com.

Before we begin, I want to remind everyone that certain statements will be made today that are forward looking within the meaning of securities laws and regulations. Owing to the uncertainties of forward-looking statements, actual results could differ materially.

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

And now, I would like to turn the call over to Green Mountain Coffee Roasters Inc. President and CEO, Larry Blanford.

Larry Blanford

Thanks, Fran. Good morning, everyone. Joining us with prepared remarks on this call today is Nick Lazaris, the President of our Keurig subsidiary. After remarks from Fran, Nick and myself, and together with other members of our management team, we will be available to respond to your questions.

It is great to be sharing such favorable results again this today. 2007 was a year of strong financial returns with net sales and earnings increasing 52% over the prior year. It was Green Mountain Coffee's 20th consecutive quarter of double-digit net sales growth and eighth consecutive quarter with growth in excess of 25%. And we delivered that while staying true to our corporate values and commitment to social responsibility and the environment.

We continue to deliver strong sales and earnings growth and the opportunities for the future are more exciting than ever. Looking forward, for 2008, we are raising our previous guidance and expect to grow our top line by 35% to 40% and to increase our net income and EPS as much or slightly more.

Now discussing numbers is a good lead for discussions by our CFO, and I will now turn the call back to Fran who will be followed by Nick and then myself with prepared comments. Fran?

Frances Rathke

Thank you, Larry. I too am very pleased with our financial performance this past quarter and for our fiscal year 2007. For today's call, I will review our consolidated fourth quarter and full year results and conclude by outlining our future expectations.

There is a table in today's press release that is designed to be helpful in understanding our results for the fourth quarter and full year for 2007 and 2006 on a GAAP and a non-GAAP basis. We use these numbers ourselves to establish and monitor budgets and operational goals and to evaluate the performance of the Company.

Although these amounts are not in accordance with or an alternative to GAAP, we believe they provide investors with greater transparency by helping to illustrate the underlying financial and business trends relating to the Company's results of operations and financial condition and comparability between current and prior periods.

Net sales for our fourth quarter totaled $93 million, up 39% over last year. We delivered even stronger operating income growth of 69%. Net income was $3.6 million in the fourth quarter of 2007, an increase of 133% over last year.

Net income per diluted share was $0.14 in the fourth quarter of 2007, as compared to $0.06 in the fourth quarter of 2006, an increase of 120%.

The Green Mountain Coffee segment, that is without the financial impact of our Keurig subsidiary, delivered sales of growth of 20% this quarter. Sales of Green Mountain K-Cups increased 50% over last year's fourth quarter with the OCS reseller and consumer direct channels driving this growth, as you will see on the chart near the back of today's release.

The supermarket channel grew 12.4%, due to growth of existing customers, as well as some new customers. The food service channel increased 6.1%, with the majority of this growth due to new customers in the Northeast.

Offsetting this growth to some degree was the convenience store channel's 8.8% decline, primarily due to promotional activity during last year's fourth quarter that was not repeated in the current quarter.

Prior to the elimination of intercompany sales and royalties, net sales of Keurig included in the Company's fourth quarter of fiscal 2007 were $42.6 million, up 97% from last year's fourth quarter. Approximately half of the increase in sales this quarter was due to higher brewer sales with shipments up 99%. The other half of the increase in sales was due to higher K-Cup sales and royalty income from the sale of K-Cups.

The gross profit for the fourth quarter of 2007 totaled $32.8 million, or 35.3% of net sales, as compared to $25.2 million or 37.6% during last year's fourth quarter. About half of the decline in gross profit margin this quarter was due to a significant increase in sales of Keurig at-home brewers, which have lower gross margins than the away from home brewers.

In addition, the Green Mountain Coffee segment gross profit margin was 31.6% of net sales in the fourth quarter of 2006, as compared to 34.6% in last year's fourth quarter.

This decline in gross profit margin was due primarily to variations in sales mix, mostly related to the higher percentage of sales of K-Cups which have a lower gross margin than our other coffee products, higher commodity costs and higher manufacturing costs due to the opening of our new K-Cup packaging facility in Essex, Vermont, during this quarter.

In the fourth quarter of 2007, total Company SG&A expenses were up 22%, a rate significantly less than the sales growth, and thus, improved as a percentage of net sales to 27.3% from 31% in the prior year quarter.

The improvement in SG&A margin was the result of leveraging, selling and organizational expenses on a higher sales base, most notably, in the Keurig segments, where SG&A margin was 20.1% in fiscal year 2007, as compared to 30% in the prior year fourth quarter.

Pre-tax non-cash stock compensation was $1.356 million in the fourth quarter of fiscal '07, up from $472,000 in the prior year period. The increase is primarily due to employee stock options assumed by the Company in its acquisition of Keurig.

The operating income in the fourth quarter of 2007, increased to $7.5 million from $4.4 million, and as a percentage of net sales was 8% as compared to 6.6% in the prior year fourth quarter.

Excluding the non-cash amortization expenses related to the identifiable intangibles of approximately $1.2 million in each year's fourth quarter the Company's non-GAAP operating margin was 9.3% in the fourth quarter of 2007 as compared to 8.4% last year.

The improvement in operating income margin this quarter is mostly due to the success of the Keurig single cup brew system and the strong sales and earnings growth derived from K-Cups.

We incurred $1.3 million of interest expense this quarter, or $0.03 per diluted share. Our tax rate this past quarter was 41.3%, up from last year's fourth quarter rate of 40.6%. Our annual tax rate for 2007 was 40.5% as compared to 41.4% in fiscal 2006.

The decrease in our annual tax rate is primarily a result of changes in estimates of R&D credits earned since the acquisition of Keurig and the changes in state tax apportionment.

Overall, we are extremely pleased with our financial performance this past quarter and year. For the full year, '07, net sales and net income increased 52%. Fiscal 2007 includes a full year of consolidating the financial results of Keurig as a wholly owned subsidiary as compared to fiscal 2006, which included 15 weeks of Keurig's financial results as a wholly-owned subsidiary following the close of the acquisition on June 15, 2006.

If you would like more information on our full year results, we expect to file our Form 10-K on December 13 and will include more detailed information in the management's discussion and analysis section.

I now want to address Green Mountain Coffee businesses outlook for the full year and first quarter of fiscal 2008. Please note that my remarks and the information contained in the press release are based on current expectations.

These statements are forward looking and do involve some very real uncertainty. Actual results could differ materially. The only updates we expect to make to you regarding our expectations and performance are on these routine quarterly conference calls and in the related earnings press releases and SEC filings.

While we believe we are well positioned for this holiday season, we are also somewhat concerned about the possibility of an economic slowdown, which would have a potential impact on our sales growth. In addition, recent traffic trends in our North American partners and customers' retail stores reveal mixed results and add to our caution.

That said, given the vitality of the Keurig and the Green Mountain Coffee brands, our brewer and coffee category strengths, and our diversified multi-channel business model, we continue to anticipate that the sales guidance for 2008 originally provided in August and now increased today to 35% to 40% will still be achieved.

Our expectations are, however, not without some very real uncertainty. Keeping these caveats in mind, for full year fiscal '08, we expect total consolidated net sales growth of 35% to 40%, up from our prior guidance of 25% to 35%.

We expect to achieve a consolidated operating margin in the range of 8% to 9% in fiscal 2008, up from 8% in 2007. Other key factors including interest expense, tax rates, capital expenditures, and annual depreciation and amortization are contained in today's press release.

Incorporating these estimates we anticipate fully diluted GAAP earnings per share will be in the range of $0.70 to $0.75, which is at a similar to slightly higher rate of growth in our guidance for the top line growth of 35% to 40%.

This includes the non-cash stock amortization expenses related to the identifiable intangibles estimated to reduce EPS by approximately $0.11 per share. For comparison purposes, excluding the impact of these non-cash expenses, our non-GAAP EPS is estimated to be in the range of $0.81 to $0.86 in fiscal '08 as compared to non-GAAP EPS of 63% per share in fiscal 2007.

For the first fiscal quarter of 2008, we expect total consolidated net sales growth of 40% to 50%, primarily due to anticipated strong sales of Keurig single cup brewers and K-Cups in the office coffee channel consumer direct and reseller channels. We expect to achieve a consolidated operating margin in the range of 5% to 6% in the first quarter of fiscal 2008, as compared to 7% in the first quarter of fiscal 2007.

The primary reason for this change is that we anticipate higher selling and marketing expenses as a percentage of net sales during this first quarter, due to increased marketing programs expected to facilitate increased sales of Keurig single cup at-home brewers this holiday season.

These marketing programs include a $3 million TV advertising campaign in 16 markets, in-store demonstration programs, and cooperative advertising support in the retail stores. We believe that success of these marketing initiatives will lead to higher K-Cup sales and earnings in the following three quarters.

We anticipate fully diluted earnings per share for the first quarter of fiscal 2008 to be in the range of $0.10 to $0.14 per share, including the non-cash amortization expenses related to the identifiable intangibles estimated to reduce EPS by approximately $0.03 per share. These obviously are all forward-looking statements and are based upon beliefs and assumptions that involve very real uncertainty and risk.

Now, I will turn the call over to Nick.

Nick Lazaris

Thanks, Fran and good morning, everyone. Keurig's strong fourth quarter performance was a great end to the first full year of being a wholly owned subsidiary of Green Mountain Coffee Roasters. Keurig brewer shipments were up 99% in the fourth quarter of fiscal 2007 versus the comparable 13-week period in the prior year and up 94% for the year.

Shipments of 179,000 brewers, this past quarter brought our total brewer shipments to 953,000, since we launched in 1998. A break out of away from brewer shipped and at-home brewers shipped is presented in a table in the last page of today's press release.

We launched our first at-home brewing system four years ago via the direct channel using Keurig.com. Then three years ago, we introduced a brewer for sale through the retail channel and quickly expanded that to a good, better, best offering.

Today, our at-home brewers and K-Cups are sold in over 10,000 retail stores, grocery stores and coffee shops. Nearly all of these retail outlets offer K-Cups manufactured by Green Mountain Coffee.

Both away from home and at-home markets have huge growth potential. Combining both away from home and at-home, the installed base of brewers generated demand for K-Cup shipments of 168 million K-Cups by our roaster partners in the fourth quarter, which were 46% higher than the comparable 13-week period the prior year and up 42% on a fiscal year basis.

In total, our roasters have shipped over 2 billion K-Cups on a life-to-date basis. As you will also see in the chart at the back of today's press release, Green Mountain Coffee continues to be the leading roaster representing 56% of total fiscal year roaster K-Cup shipments.

We are very pleased to report that point-of-sale research performed by the NPD Group shows that Keurig was the market leader in dollar and unit share in the single cup category at retail, in the third calendar quarter of 2007.

For the second consecutive quarter, the NPD Group data has Keurig with a 48% dollar market share in the total single cup category, up from a 26% share in the prior year's comparable quarter. The NPD data also shows Keurig with a 33% unit share in the single cup category versus 18% in the prior year's comparable quarter.

We continue to expect another strong holiday season for Keurig with solid growth over last year. By the end of the calendar of 2007, our retail store count is expected to grow from about 7,000 retail stores last year to over 9,000 and together with roaster coffee shops and grocery stores, we expect to have over 10,000 retail outlets for K-Cups in the United States and Canada.

Most of our brewer sales growth will continue to come from increasing rates of brewer unit sales per store, rather than by adding new stores. We are pleased with the very strong year-to-year comp store brewer sales for retail store chains that share this data with us.

There are a lot of reports now about the uncertainty relative to the strength of consumer spending this coming holiday season. When Fran talks about factors creating risks and uncertainty, the economy and its effect on the holiday season spending is right up there.

That said, at this time, we are anticipating a strong fiscal first quarter for the Keurig business. Our optimism is based on what we hear from our retailer partners, who remain very positive about Keurig sales this holiday season and beyond.

We believe the demographics of our affluent target customer and their very high degree of satisfaction with our products are working in our favor, even in this environment of uncertainty.

As previously announced, we will be running a $3 million TV advertising campaign in 16 markets during the holiday season. The ads are intended to further reinforce retail sell through and we will be monitoring their effectiveness to help us better plan next year's holiday marketing programs.

In addition to our success in the at-home consumer market, we continue to grow rapidly in the away from home or AFH office coffee market, where we believe we are the leading single cup system in terms of brewer unit shipments.

This has been a tremendous year for our AFH sales and marketing group, with brewers sold to Keurig distributors doubling over the prior year. The three new small, medium and large away from home office brewers launched in the last 18 months have helped our distributors increase market penetration.

Brewer product innovation is not only driving growth in the existing AFH office coffee segment, but has also opened up the in-room hotel channel for us. We began shipping; the new B130 hotel brewers in September and to date have shipped about 10,000 units.

Our first installations included 19 Loews Hotels nationwide, as well as the new Liberty Hotel in Boston. We expect to make substantial progress in this channel during fiscal 2008.

The direct financial impact of hotel sales will not be great, given the low unit brewer pricing and take up consumption. However, with each use in room, the Keurig system concept will be demonstrated to a prospective Keurig office or home user.

For each 10,000 brewers installed, and assuming each is used 300 days a year, we would yield 3 million demonstrations annually. We believe that this will positively impact both our away from home and our at home businesses in fiscal 2008 and beyond.

In summary, we continue to be pleased that Keurig has contributed meaningfully to Green Mountain's success in fiscal 2007. Looking forward to fiscal 2008 we believe that Keurig will continue to deliver strong growth in sales and profits.

And now, I will turn the call back over to Larry.

Larry Blanford

Thanks, Nick. It's great to be sharing such favorable results today. We have accelerated our top and bottom line growth this year, driven by well differentiated and defensible strategies including, and especially with, Keurig.

This past year has been a year of great progress, as we have laid the ground work for accelerating our rate of growth and profitability. We completed a summer long and extensive project this past quarter to align the organization behind the compelling value creation of single cup brewing.

More specifically, our objective was to first align to maximize the single cup brewing opportunity, and secondly, to explore the synergy of the Green Mountain Coffee brand and organization in terms of both how Green Mountain Coffee can help achieve single cup growth and leadership and how the single cup category can grow the Green Mountain brand of specialty coffees.

The synergy between Keurig and Green Mountain Coffee Roasters is increasingly apparent. Keurig's single cup brewers provide an outstanding trial opportunity for our brand, particularly outside our core market.

At the same time, the Green Mountain Coffee organization uses its existing relationships with customers to get wider Keurig brewer and K-Cup placement.

Let me be clear that we are continuing to pursue a category penetration model and are focused on driving new customers into the category to grow single cup and Keurig. Why? We believe the size of the opportunity is large.

We are a category leader and we believe the single cup category is still early in its life cycle. To grow the single cup category, and maintain share leadership, I will share the following elements of our strategy.

First and foremost, we will deliver great coffee and a convenient, fun experience for consumers. We will continue to encourage Keurig brewing systems market share momentum, both at home and away from home recognizing the synergistic interplay between these markets.

We will frequently evaluate the brand composition of the K-Cup roaster portfolio. As an example, this past year we added Caribou Coffee Company to the family of brands providing coffee in K-Cups.

As a strong Midwest brand, Caribou invites its loyal consumers to also consider the Keurig single cup brewing experience. We will also smartly expand distribution to appropriately make the Keurig system conveniently available for consumers throughout North America.

We will continue to innovate, advancing consumer meaningful dimensions of the single cup or make brewing experience, and we will also selectively supplement the collection of available coffees, hot cocoa and teas, beverages that take advantage of the Keurig single cup brewer's technology.

Importantly, as we have molded our strategy, we believe we can achieve our objectives while continuing to maintain or improve our margins on a year-to-year basis. We are extremely committed to holding our leadership position in this category as it represents the source of significant value creation for our many constituencies.

Discussing growth more broadly, we are also excited that much of our growth in recent years has been from outside the New England region because it indicates our brand is gaining national acceptance.

Our multi-channel marketing strategy surrounds the consumer with opportunities to enjoy our coffee, whether it's at the supermarket, convenience store, work place or nearby restaurant. Cross channel awareness, supported by Keurig, ExxonMobil and other trial opportunities helps us grow our brand even more.

New products are also key to our success. For our grocery channel, we are launching a new line of single origin coffees to build excitement in sales. Each single origin coffee is sourced directly from a particular area, farm or estate, known for the high quality and the distinctive taste of its beans.

Four to six single origin coffees are fair trade certified, and all of them invite consumers to feel a direct connection with the farmers. With this line, we introduced our new look and 10-ounce packaging, which will be expanded to other packaged coffees in fiscal 2008.

Our line of Newman's Own organic coffee also had has had a makeover. New packaging and new vanilla-caramel flavor have lead to double-digit increases in sales and volume year-over-year. Overall, sales of our fair trade certified and fair trade certified organic coffees continue to increase in the supermarket channel through new business with customers such as Pathmark, one of the nation's leading supermarket retailers.

We maintained our K-Cup leadership by adding six new selections of Green Mountain Coffee and Newman's Own organic coffees and Celestial Seasoning's tea in 2007. In April 2007, we were the first to bring a hot cocoa K-Cup to market. In September, hot cocoa was the top selling K-Cup on Keurig.com.

Looking forward, we are focused on continuing to deliver strong sales growth and improve our operating margins for long term sustainability and shareholder value. For 2008, as previously mentioned, we expect to grow our top line by 35% to 40% and to increase our net income and earnings per share at the same or even faster rate than the growth in net sales.

Fran, Nick and I are joined today by Scott McCreary, Chief Operating Officer; TJ Whalen, Vice President of Marketing; and Jon Wettstein, Vice President of Supply Chain, and we would be glad to respond to your questions.

As Fran stated at the start, we urge you to ask all of your forward-looking and other questions during the Q&A portion of this call so that everyone will have the same access to our answers. We will now start the question queue. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from the line of Mark Astrachan with Stifel Nicolaus. Your line is now open.

Mark Astrachan - Stifel Nicolaus

Good morning, everyone.

Larry Blanford

Good morning, Mark.

Mark Astrachan - Stifel Nicolaus

I guess starting off, Larry, you touched on the Fran, too, you touched on the SG&A leverage in the quarter. I guess my question is, how should we think about that going forward?

I'm assuming that as you realign the business and take in some synergies there, it seems like this is sustainable? Is that true?

Frances Rathke

Mark, this is Fran. You know, as we gave guidance for Q1, we noted we are going to have increased SG&A as a percentage of sales than we had in the first quarter of last year, as we described our marketing programs that we think are really key to get brewers out the door this holiday season.

But as we look for the full year, on an SG&A level, we are anticipating improving our operating income margin. This year we ended up at 8.0%. Our range for fiscal '08 guidance is 8% to 9%. I think a lot of that improvement is on leveraging on the SG&A.

Mark Astrachan - Stifel Nicolaus

That's great. And then on the cost side, you talked about half of it being mix from K-Cups and Keurig. How is that on the other side in terms of coffee pricing and other commodity and other costs that may not be related to mix?

Can you give us some idea about what your thoughts are there? Obviously, coffee pricing is up considerably. So can you buy, for the future, an idea about where you stand there and what your expectations are in terms of this cost outlook?

Larry Blanford

John?

Jonathan Wettstein

Hi, Mark, this is Jon. And related to the past quarter when Fran talked about the 3 percentage point gross margin impact, a little over half of that was related to green coffee costs and another 0.4 of a percent or so of that was related to our start up of the Essex facility.

So when we think about those going forward, green coffee costs the, the higher green coffee costs have been built into our base plan at the same time we are seeing the market go still a little bit higher from, there although it's backed off in the last two weeks.

And then secondly, the Essex start up, those expenses have increased a bit, as we've continued to staff the operation fully, and then we will see that impact decline through the year as the volumes ramp.

Mark Astrachan - Stifel Nicolaus

So in terms of the coffee pricing and how do you feel in terms of your buy in for fiscal '08 at this point, in terms of your prices?

Jonathan Wettstein

This is Jon again. We don't go too far out where we would have the potential of being too long with a big market drop, which was always possible for this year. So we are in a range where we need to maintain our view of pricing and other costs as we see how to market the sea market sorts out from this point on.

Mark Astrachan - Stifel Nicolaus

Great. Okay. And then is switching over to sales of your fair trade and organics. It seems like, and maybe I'm just doing the math wrong, but it seems like sequentially in the quarter, growth had decelerated a little bit, versus what we had seen in the first three quarters of the year. Is that right or am I doing something wrong there?

TJ Whalen

Hi, Mark. This is TJ Whalen. Thanks. I will try to answer your question there. Sales of fair trade coffee did taper off a bit in the back half of the year. A couple of reasons for that one of our larger customers, Wild Oats, as you know, going through a bit of a transition there.

Second reason is we went through a restage of our Newman's Own organics line of coffees, and as Larry mentioned, we introduced a new variety and came out with some new packaging and as that transition took place, there was a little bit of a dip in volume and now we are seeing that line accelerate again in the past four-week data from IRI, indicates some very positive momentum there, so we see that moving back in a positive direction as we move forward into the year.

Mark Astrachan - Stifel Nicolaus

Great. Final question is just simply the increased focus that we have seen from some of the larger players in the coffee category in particular, as it relates to the single cup category, like Kraft getting a little bit more focused there teaming with Starbucks on some of their single cups.

Can you talk about what that means to you all and what have you seen in terms of a store-by-store comparison and what you see in terms of just the overall makeup of the category going forward?

Nick Lazaris

Mark, this is Nick. Thank you for the question. As it relates to the Tassimo system, and Starbucks. Our view of this and what we hear from retailers is it's good for the category, the more attention that's given to single cup, the more people are aware of the single cup category, and what single cup technology can deliver, the better it will be for Keurig.

We do very well with in-store demonstrations. We have a very competitive system and we feel good about that. So as it relates to Tassimo, we think that will help. The other big players that have played in single cup in the past in one way or another, whether it was P&G through the Home Cafe or even Sara Lee with some sale don't seem to be having that much of an impact on our business that's why our market share has been growing.

Mark Astrachan - Stifel Nicolaus

Great. Thank you all.

Frances Rathke

Thanks, Mark.

Operator

We will take our next question come from the line of Scott Van Winkle with Canaccord Adams. Your line is now open.

Scott Van Winkle - Canaccord Adams

Hi. Thank you. I hope everybody is doing well. A few questions. Nick, you shared some NPD data. I wonder if I could try and dig some more out of you like, what was the market share of one-cup brewers in general versus total coffee brewers shipped in the quarter? Do you have that?

Nick Lazaris

I don't have that. But I would say that single cup as a category continues to grow as it relates to unit and dollar sales, and the big shift that we started seeing a year or so ago, where capsule systems like Keurig, Tassimo, versus pod systems, like the Senseo Home Cafe, the dominance of capsule systems with over 70% share continues to be the case today.

When we talk to our major retail partners, one of the things that we hear, Scott, is depending on the retail partner, relative to their dollar sales of single cup as a percent of their total coffee maker sales and this will vary by retailer but, it is not unusual to hear 15% to 20% already in dollar sales and when we talk about potential they see a great deal of growth potential over the next two or three years.

Scott Van Winkle - Canaccord Adams

So if I had to guess say 15% to 20% of dollars is probably something maybe close to 10% of units? Would that be fair?

Nick Lazaris

I wouldn't speculate on that now, but I would say it's lower, because the average price of a single cup system obviously is higher. So I’ll let you do the speculation there, but you are headed the right direction.

Scott Van Winkle - Canaccord Adams

Okay. Great. And another one for you Nick. You talked about selling into hotels and obviously you want placements and you are not taking a lot of margin on those units being sold to hotels. The hotels, even though it's a good sampling model you are still getting the same type of margin on K-Cups, aren't you?

Nick Lazaris

Well, in the hotel market place, we are distributing brewers like we do in our normal away from home, in other words channel. We sell brewers to distributors who call on hotels. Those distributors purchase K-Cups from roasters and so the channel, Keurig does not derive profitability on those K-Cups.

Keurig derives royalties on those K-Cups, and the point in my comments was the number of K-Cups per day in hotels is low but we are getting that demonstration. As it relates to the margins on the K-Cups through our roaster partners, it's probably close to what they get in terms of selling to distributors for office coffee channel.

Scott Van Winkle - Canaccord Adams

Okay. Great. Great. And then, Fran, a question for you. The 12.4% supermarket growth in pounds shipped. What was that in dollars? And I guess what I'm asking is with green coffee product costs running higher where do we stand today versus a year ago on pricing in the supermarket channel?

Frances Rathke

This is Fran. In terms of the we didn't have for fiscal '07, we did not have any material price changes to our supermarket business. So in terms of dollar growth for this quarter, it's similar to the 12.4%. In terms of promotional activity and such, I would say we had probably similar levels as we had last year's fourth quarter. So a lot of this growth this quarter really came from a lot of new customers we have added.

Scott Van Winkle - Canaccord Adams

Okay. Okay. And is that the case across all of your channels' distribution, that pricing is relatively flat on a year-over-year basis?

Frances Rathke

Yes.

Scott Van Winkle - Canaccord Adams

Okay. And if I could dig a little further into the talk about gross margin. I think Jon, you mentioned that some of the inefficiencies now in the new plant who dissipate over the year. I guess in a bigger sense, how did that gross margin, how is it affected by mix throughout the year?

As we go throughout the year, maybe this is what you meant and I apologize if I didn't hear it correctly. As we go throughout the year, does the gross margin pick up because as we get away from the holidays there will be a lower mix of Keurig at-home brewers sold?

Jonathan Wettstein

Scott, this is Jon. I will take the first part of that, related to the coffee segment. And so what I was just trying to say is our Essex facility as we staff it up to a fixed level to be ready for the year, will become increasingly productive as we go through fiscal year '08. So the other mix issues in the coffee segment, one is green coffee costs.

Which was just spoken to, and then the overall mix of K-Cups as their costs in total are a bit higher as a percentage of sales the way they are costed and priced. So those are sort of the three big factors for the coffee segment. I think the other question might have to do with the enterprise in the Keurig segment around brewers.

Frances Rathke

This is Fran. I was thinking to help on the I think, Scott, what I'm hearing you ask specifically on Q1 outlooks for margin?

Scott Van Winkle - Canaccord Adams

Well, I what I'm trying to get at, you know to get to your earnings guidance based on the revenue guidance, I think we have to assume some gross margin improvement from the fourth quarter level. So the Essex facility doesn't sound like it was a significant piece of it, and so I assume the mix will shift not away from K-Cups but away from consumer Keurig units as the year progresses. So the gross margin is higher towards the back end of the year, is that correct?

Frances Rathke

Yes, I think yes. I think in terms of Q1, for example, on margin, we have another quarter where we have an incredible amount of anticipated at-home brewers being shipped out.

Scott Van Winkle - Canaccord Adams

Which do not have a significant gross margin. So I think that's part of this quarter we discussed in terms of half or roughly half of the margin decline. That as you can imagine this is also impacting our estimates for Q1 '08. As we, to your point, as we go quarter-by-quarter throughout the year, we will see an up tick, especially in the quarters that are much more heavily as a percentage of sales focused on K-Cups and other products.

Scott Van Winkle - Canaccord Adams

Okay. So just ballpark, it we might be the same type of gross margin in the first quarter that we just saw in Q4. But you might be into the high 30s when you get into the Q2, the Q3 and the Q4 where you are not selling as many consumer machines or at least in Q2 and Q3?

Frances Rathke

Correct. Similar to what happened this year our quarter-to-quarter, I have it right in front of me was 38% in Q1, 39.2% in Q2, 41.4% in Q3 and then we had 35.3% in Q4. We would anticipate something similar.

Scott Van Winkle - Canaccord Adams

Okay.

Frances Rathke

Specifically Q1 is lower than last year's because we are anticipating a lot more brewer shipments.

Scott Van Winkle - Canaccord Adams

All right. Now, was the mix shift similar in the fourth quarter of last year for Keurig? Obviously, Keurig was a smaller percentage of Green Mountain sales last year, so we didn't see it as much in the financial results.

But did we see the same type of shift in the fourth quarter of last year to a little lower gross margin because of the at-home brewers? Or has the pricing changed on the at-home brewers a little bit?

Frances Rathke

I think Q4 '06, I have in front of me. We did have Keurig last, okay this year we discussed how there's a lot of brewer shipments in our fourth fiscal quarter. In addition we owned them last year, Q4 of '06 for the whole year.

That was also a quarter where there was a lot of shipments going into the retail channels, but as you can see when we have a 99% increase in brewer shipments, we had a really big increase as a percentage of sales of the total driven by shipping out brewers where we don't have much margin.

Scott Van Winkle - Canaccord Adams

So, I guess what I'm asking is I recognize that because the higher percentage sales this quarter will be more impact on the total Company's gross margin. In the fourth quarter of last year, if you look just at Keurig's gross margin did we see the same type of drop-off?

And then, what I’m really getting at is with new brewers being shipped into the at-home market and some new products there. I'm not sure the B40 was available last year. Have we seen any change in the gross margin for Keurig at-home brewers this year versus last?

Frances Rathke

Okay. In terms of 'Q4 '06, Keurig's gross margin versus Q4 '07, we did see a decline as we noted. We had last year our fourth quarter '06, okay, Keurig as a segment had a 36% roughly gross margin and this quarter it was more in the 32.2%.

Scott Van Winkle - Canaccord Adams

Okay. And that decline I apologize if I…

Frances Rathke

It's all because of the at-home brewers.

Scott Van Winkle - Canaccord Adams

The at-home brewers.

Larry Blanford

This is Larry Blanford. I think your point is an important one particularly going forward, as Fran described in her commentary.

The fundamental seasonality, if you will, or nature of our business now is changing because of our efforts to move in aggressively to the at-home market with the strong holiday, very important holiday season for driving at-home brewers, which do not carry the margins.

So, this is very important and particularly going forward in the first quarter, as Fran has already indicated the impact over previous years.

Scott Van Winkle - Canaccord Adams

Okay. And last question is also somewhat Keurig related. You mentioned the door growth, the 10,000 or the 10,000 versus 7,000 last year. What about for K-Cups? How many doors are now selling K-Cups, the replenishment side of the K-Cups, not just the sampler that is maybe sold on the shelf right next to a new machine?

How many, I know grocery stores are now carrying it certainly here in the Boston market. I'm wondering about the growth of the K-Cup availability at grocery?

Nick Lazaris

Scott, this is Nick, and in that 10,000, which was a mix of roaster coffee shops, grocers and of, course, our retail partners, virtually every one of them carries a selection of K-Cups.

In the beginning, when we launched three years ago, as I mentioned, most retailers would carry four to six varieties. We now have some retailer partners that carry up to 15 varieties in their stores. So, what we find is that whenever brewers are sold, it's good to have K-Cups and in grocery impact whenever K-Cups are sold it's advantageous to promote the system by having some brewers there, as well.

So, it's really a system sale and we have very broad distribution. And as I mentioned earlier, in almost all of those retailers, there's a Green Mountain manufactured K-Cups as part of the offering.

Scott Van Winkle - Canaccord Adams

Excellent. Thank you.

Operator

We will take our next question from the line of Nicole Miller with Piper Jaffray. Your line is now open.

Nicole Miller - Piper Jaffray

Good morning.

Larry Blanford

Hi, Nicole.

Nicole Miller - Piper Jaffray

I just want, Fran, you got asked a question about the core channels and the pricing there. You said that was flat year-over-year, can you just remind us, quickly, is there any seasonality or is the pricing typically flat throughout all four quarters?

TJ Whalen

Hi, Nicole. It's TJ. It depends on competitive activity in the market situation, but and also costs, of course. But in general, it's relatively flat throughout the year.

Nicole Miller - Piper Jaffray

Okay. Can you guys talk about the second plant and what was the capacity increase, what are you currently running at capacity and then I guess basically for how many and what's outlook for the support of production on the current capacity?

Scott McCreary

Hi, Nicole. This is Scott McCreary. Thanks for your question. With the investment that we've made in Essex, we have leased an 87,000 square-foot building there and we invested in the infrastructure to get that set up for seven high speed K-Cup lines and six of our earlier packaging lines that we call PL100. And so right now, we have two out of those seven high-speed lines installed in Essex.

And over these last five months, we have installed five more high-speed K-Cup lines, three of them in Waterbury and two up in Essex, which essentially doubled our total K-Cup capacity.

And so, it puts us in quite a good standing in terms of overall capacity. We're in the process of adding more crews, getting people trained and bringing those lines up to speed. And so, as I say we have more than doubled our capacity over these last five months with plans in our capital budget for another five lines this coming fiscal year.

Nicole Miller - Piper Jaffray

So just so I understand, you had how many at the original plant?

Scott McCreary

An easy way to think about it, because we have different machines at different speeds, was we basically had five equivalent high-speed lines in May. And now since then, we have gone to 10 high-speed lines.

And, again, a simple way to do the math is we estimate about 80 million K-Cups per high-speed line on an annual basis. So that would say on an annual basis, right at this moment in time, we have capacity for 800 million K-Cups.

That obviously gets phased a little bit depending on how we staff up those lines and how quickly we get them up to speed.

Nicole Miller - Piper Jaffray

And then you are adding five more lines during this fiscal year?

Scott McCreary

Correct. So those added five lines are mostly in preparation for fiscal '09, as we see those brewers get out there, but we wanted to phase the installation and the start-ups of those lines throughout the year so we get people up to speed and ramp that capacity up in an appropriate safe way.

And then also have sufficient system capacity to help out in case there are any hiccups system wide.

Nicole Miller - Piper Jaffray

And just so I'm clear, it sounds like you have 10 high-speed equivalent lines. What is the capacity you are running at? Are they running on, like, three shifts a day? Are they running around the clock? Where are you at open those machines?

Scott McCreary

In the Waterbury plant, we run those machines basically seven days a week and close to 24 hours a day. And that has been our ongoing mode of operation for a number of years.

In the Essex facility, with that being added capacity, we are running seven days a week, but at this moment, only on day shift, and now we are in the process of moving ahead with night shift. So I would say Essex right now is at about half capacity.

Nicole Miller - Piper Jaffray

Okay. Thank you. I know there was a question earlier, but I'm just not quite clear on the green coffee, the commodity side, what do you either have in the warehouse or locked in at a fixed rate, for what percentage of 2008 needs?

Jonathan Wettstein

Nicole, this is Jon again. What I'd say in general, our policy is to carry about half a quarter's inventory and then to hedge forward in the two to six month range. So, I won't go any further than that. But that's, we are consistent with our general policy as we speak today.

Nicole Miller - Piper Jaffray

Okay. Can you give us an update on consumption rates per day, talking specifically about the Keurig side of the business, if you can segment the office and the at-home and if you have a number to put to it, otherwise is it increasing or decreasing?

Nick Lazaris

Nicole, this is Nick. I mentioned, we launched in the home market in 2003, we started surveying our customers then and trying to estimate how many cups a day, etcetera, and it's been remarkably constant during the time we've been in market, no trend really up or down. No real difference whether someone bought a $99 brewer or a $199 brewer.

And we are in the range of 2.25 to 2.5 cups a day in the at-home side. In the away from home side it is more complicated. It's not that the number of cups per brewer changes. It's that each of our brewers, whether large, medium or small, have different applications in offices.

By and large there, the trend has been fewer cups per day per machine in offices, because the fastest growing part of our brewer sales mix has been our small and medium-sized brewers that we launched in the last few years and have allowed our distributors to go after those smaller offices.

So, from a big picture point of view, the at home side is stable and the away from home side is fewer cups per day because our distributors are placing brewers in smaller offices.

Nicole Miller - Piper Jaffray

That's very helpful. Does 10 to 15 in the away from home side still sort of fit within that range?

Nick Lazaris

Yes, that would be the range.

Nicole Miller - Piper Jaffray

Okay. Thank you.

Nick Lazaris

You're welcome.

Nicole Miller - Piper Jaffray

And on the ad spend for 2008, is $3 million the total ad spend or should I understand that that's just for the first quarter and then what should advertising look like for the rest of year?

Nick Lazaris

This is Nick again, Nicole. That ad spend is for the holiday season only. And at this point, there is no substitute for this holiday season relative to when consumers are out buying products like this.

So, as we think about future ad spends, it's really any large numbers will be focused on FQ1 of 2009. That doesn't mean that we are not supporting our retailers throughout the year with demonstrations and cooperative advertising, and that does happen and it's a bit seasonal with retail.

But the TV spending is something new for us, in terms of we did some tests last year, but new this year, and I think the primary focus is holiday season spending.

Nicole Miller - Piper Jaffray

As you think about break even on the ad spend, if you got more than whatever your break even, whatever the return profile is you are looking for on that investment, then would you consider doing it all year long, maybe not to the same degree, but of some nature?

Nick Lazaris

I think it wouldn't be all year long relative to other week, but we would look at other gift giving periods, for example, the Mother's Day through Father's Day, Graduation period is a good period. We actually did some testing there with television a year ago, as we also a year and a half ago, as we also tested in the holiday season that's upcoming.

And clearly this upcoming holiday season is a much, much stronger gift giving season than that Mother's Day to Graduation, but that is the number two and would be something we might take a look at. Larry, did you want to add some comments?

Larry Blanford

Yes, Nicole, this is Larry. Just to add to Nick's comments, as I think he mentioned actually in his prepared remarks, we are doing some testing of various vehicles this holiday season. So, yes, we do have the television umbrella, but underneath that, we are looking at some other vehicles like drive-time radio and targeted catalogs and we really have set up sort of a statistically relevant test to try to better understand how to drive this business and how to best spend our money.

I think we going to learn a fair amount from that, and then that will play into how we think about driving the business going forward through the year and then also as we plan the holiday season for next year.

Nicole Miller - Piper Jaffray

Okay. And then on the retail store side, I got a little confused about the channels. There was 5,000 doors and 7,000 and 10,000. I guess, let's just put that in perspective. Like, who has the brewers, the pound version and then the K-Cups; I guess I was a little bit confused by that this morning.

Nick Lazaris

Okay. As it relates to the retail, this is Nick again. As it relates to the retail store channel, last holiday season, we were in about 7,000 stores and this holiday season we expect to be in about 9,000 retail stores. Virtually all of those stores, not only sell brewers of one model or another, or multiple models, but they sell a selection of K-Cups.

We are also, over the last year, via Green Mountain sales team have penetrated the grocery store market and our roasters who have retail coffee shops have been merchandising Keurig brewers and K-Cups in those stores, as well.

And between grocery and the retail coffee shops, there are over 1,000 more points of distribution for brewers and K-Cups. And that's relatively new. That would have been maybe less than half of that last year. So, there's been some growth there, too. Does that answer your question?

Nicole Miller - Piper Jaffray

Yes, The grocery just has to be, what I'm looking at as a huge opportunity. So, it sounds like you are in I guess, 1,000 doors basically is what you are saying of brewers and K-Cups in the grocery aisle?

Nick Lazaris

Yes.

Nicole Miller - Piper Jaffray

What is the targeted focus there? Because that alone should be able to be close to the 10,000 where you are at in terms of retail, the retail number?

Larry Blanford

Hey, Nicole, this is Larry. No, your point that it's an opportunity is absolutely correct. We are selectively increasing distribution in grocery, which is consistent with the strategic objective of driving category penetration. Category penetration, in my view does require broad distribution.

We have to do that smartly and we want to make sure that all of our important distributors are sharing in the success and stay motivated to continue to drive our products. So, we are being smart about how we do that, but grocery is an opportunity, given that most consumers still buy a lot of their coffee in grocery.

As Nick did point out earlier, also as we move into grocery, we are targeting the grocers that have the demographics that are most consistent with this brewing system, and we try to encourage and have been successful in getting placement of and display of brewers and coffee, which just adds another great point of interest for consumers and draws them in and allows them to better understand and have another opportunity to understand what this single cup brewing system is all about.

So, it is a very important opportunity and we are certainly trying to mine that opportunity as we go forward.

Nicole Miller - Piper Jaffray

I guess, when you say smartly, are you trying to, should we assume that then sliding fees are a barrier to entry or how are we thinking about that? And then also any color that you can provide. I have seen these displays, this tiered system where you stack the brewers against the K-Cups in the grocery stores on the East Coast.

Larry Blanford

Yes.

Nicole Miller - Piper Jaffray

What's the sell through been on that or is it selling better than expected for you or for the grocery store?

Larry Blanford

Yes. Let me address here your first question about smartly. When I say smartly, I'm talking about matching up really the demographics of the grocers with the target demographics for the single cup brewer. Just like with on the retail side it doesn't make sense for us to be in every retailer.

It doesn't necessarily make sense for this product to be in every grocer. So, by smartly, that's what I was referring to. In terms of the sell through, TJ may have some comments on that, but I think they are pretty good. TJ?

TJ Whalen

Hi, Nicole. This is TJ. Yes; the sell through has been great. In fact, now previous four weeks two out of our top 10 items in grocery are now K-Cups, and as both Larry and Nick mentioned, distribution on those K-Cups is relatively limited as compared to our bagged grocery business.

So the fact that these K-Cups are working into our top 10 items on a velocity basis signals some real great momentum and as we are looking forward, we see increasing velocity and momentum, as well as increasing penetration of new grocery accounts, both in our territory and more broadly on a national basis.

Nicole Miller - Piper Jaffray

Okay. And then, Fran, you've shared share data in the past, do you have, what you are guys are currently at on Keurig in terms of percentage and dollar, maybe it's dollar and units, I don't remember, market share?

Frances Rathke

On the NPD data?

Nicole Miller - Piper Jaffray

Yes.

Frances Rathke

Yes, I can just, Nick noted in his remarks that for the third calendar quarter of 2007, Keurig was 48% dollar market share, up from 26% in the prior year third quarter, and also 48% on the dollar and 33% on the unit share versus 18% in the prior year comp quarter.

Nicole Miller - Piper Jaffray

Okay. And then just as you looked at inventory levels both on brewers and K-Cups by flavor or packaging, have you had any shortages or is anything on back order going into the holiday season?

Scott McCreary

Hi, Nicole. This is Scott. I can talk a little bit on the K-Cup side. We have seen very strong demand on K-Cups and as I talked to you about the production lines that we've put in place, we are moving as quickly as we can to get those ramped up.

So, we have had some spot shortages over these last six or eight weeks and we expect that will continue for another few weeks. For the most part, we’re getting products out the door, but particular SKUs might be missing at any one point in time.

Nick Lazaris

Nicole, this is Nick. Relative to your question, our inventory levels and production planning for brewers, you might remember that this time last year, we thought we were appropriately inventoried with our retailers and we had just a terrific holiday season which left our retailers short of stock. And it took us several months to get caught up out in the market place.

That taught us a big lesson and we were beginning to plan this holiday season last January/February and as we worked through the year we not only looked at what production levels were required for this holiday season, but looking into calendar 2008 with our vendor to make sure that the production capacities were where we needed them to be.

We do have a partner that has tremendous resources and willingness to work with us, to ramp up. And so we go into this holiday season in good shape at retail and with a nice supply line behind it, together with an optimistic look of what we think our volumes will be next year, working very closely with our vendor and vendors to our vendor to make sure that the parts supply line are well in order. So we feel pretty good about that right now.

Operator

We'll take our next question have the line of Mitchell Pinheiro, with Janney Montgomery. Your line is now open.

Mitchell Pinheiro - Janney Montgomery

Good morning. Can you hear me?

Frances Rathke

Hi, Mitch.

Larry Blanford

Hi, Mitch.

Mitchell Pinheiro - Janney Montgomery

Hey, a couple of things. A lot of questions have been asked. I will jump around here. When it comes the commercial brewer growth 20,000 versus 7,000, is that a replacement cycle with the B3000? Is that what you are saying or are you seeing new offices?

Nick Lazaris

Well, I think there's a mix there, Mitch. This is Nick, but primarily the growth is with our smaller brewers, the B140 and B200 that continue to support our distributors' desire to increase penetration with smaller accounts, but certainly with our B3000 brewer and all the features and advantages that it has had, I think a number of our distributors do hear from their office customers, we would like to the newest and the best. So probably some of that is replacement, but I think when it comes to B200 and B140, that's incremental.

Mitchell Pinheiro - Janney Montgomery

Okay. In terms of a, Nick, you had mentioned in NPD, I was looking at the sequential growth. Your share on units was 33 this quarter, last quarter was 36. It was down in terms of unit share. Is that I mean, it's a modest decline, and is there any color on that?

Nick Lazaris

Yes, a little bit of color, Mitch. Again, this is Nick. When we report our NPD data to you, we do it for the whole single cup category, upscale and mass as opposed to breaking out the segments.

If we did break out the segments, you would see an even stronger data as it related to the upscale market. There was a mass single cup brewer launched by a competitor in that mass channel that had sold through in the calendar third quarter that had some success.

So overall, it did impact our share of the total category, but if you were looking at the portion of the category that we concentrate on, the upscale market, we wouldn't see that decline.

Mitchell Pinheiro - Janney Montgomery

Okay, thanks. And in terms of gross margin on the brewers themselves, is there still a positive gross margin on brewer sales?

Nick Lazaris

You might remember, this is Nick again, from prior comments that there's a small gross margin on the at-home brewers and a very nice gross margin on the away from home brewers, and that with the new brewers that we launched in the last 18 months there was a dramatic increase in our gross margin on those away from home brewers, together with, I think you know, we lowered our wholesale prices as we brought out new brewers.

So the new technologies that we launched, together with our new partner overseas allowed us to lower wholesale prices and increase our away from home margins. But on the at-home side it's a slim margin, indeed.

Mitchell Pinheiro - Janney Montgomery

Okay. Thank you. To Jon, you were talking about capacity. We talked about K-Cup capacity. How are you doing in terms of roasting capacity and grinding and other related potential, whatever other capacities you look at?

Jonathan Wettstein

Good question, Mitch. This is Jon. Let's talk about roasting capacity first. We are in good position with our roasting capacity looking out over the next 12 to 18 months. Our grinding capacity is where we are tightest at the moment. We have a new machine that we'll be bringing in, in the next couple of months. And that will help us out greatly there.

At the same time, we are looking ahead so that we are not waiting until the end of our roasting capacity is available as we think about where we go next, how do we support the growth of this business, as it heads to the potential it has under this penetration model that Larry spoke of earlier.

So, please note that we are on those questions these days, certainly to think about our roasting and grinding capacity not just for the next six months and going into next fall, but we need to be doing things for the years after that.

Mitchell Pinheiro - Janney Montgomery

Yes. Interestingly, I was I don't want to say surprised, but I'm curious to know, understand why you open up Essex with K-Cups and why not in another part of the country where to help offset distribution costs?

Scott McCreary

Hi, Mitch, this is Scott.

Mitchell Pinheiro - Janney Montgomery

Hi, Scott.

Scott McCreary

Yes, that, in fact, was in our long-term plans as we were developing our strategies. As we saw the acceleration in brewer sales and K-Cup growth, Essex was the fastest way and the lowest cost way for us to ensure that quality coffee that goes into the K-Cups was where it needs to be.

And we have identified some roasting partners that we could work with in other parts of the country, and absolutely you're right, there's some opportunity to save on distribution costs and that's really what we'll follow up on with regards to Jon's comments.

Mitchell Pinheiro - Janney Montgomery

Okay. Have you, it was this quarter, did you have any impact was there any co-packers for grinding or co-packers, third parties for K-Cups that you needed to use that would have maybe lowered margins in the quarter?

Scott McCreary

Hi, Mitch, this is Scott again. Very minimal we did utilize a co-packer out of Tennessee for some small amount of volume. They are a co-packer that helps with the whole Keurig system.

Mitchell Pinheiro - Janney Montgomery

Okay.

Scott McCreary

And then we been exploring some testing with some frac production with some partners there, and they, the concept was making sure we have sufficient roasting and grinding capacity here in Waterbury and if we need to move some frac production to other locations then, it again keeps us in a good position here and then related a little bit to the cost was the up front investment we need to make in people and training, and preparations in Essex.

Mitchell Pinheiro - Janney Montgomery

Okay. When I look at volume growth in the quarter, pound growth was up about 11%. And, it trailed your core Green Mountain growth, sales growth by; it looks like 15% or so, is there how do I think about volume for next year? You didn't give any guidance on that. Is that going to trail should that match Green Mountain core growth next year? I mean, how do we think about that?

Scott McCreary

I'm not sure.

Mitchell Pinheiro - Janney Montgomery

I don't know if you gave a core revenue growth for Green Mountain. You gave the full sales of 35% to 40%.

Frances Rathke

Mitch, this is Fran. We have not; we do not provide segment guidance for '08 as to growth rates. A lot of the growth, as you know, is related to the K-Cup volume. And in terms of we noted this quarter; Green Mountain's segment was up 20%, with volume up 11.2%.

So clearly the reason we are up so much more on dollars is not because of price increases, rather once again, just the increased sales mix to the higher revenue per pound of K-Cups.

Mitchell Pinheiro - Janney Montgomery

Okay.

Frances Rathke

And being up 50% this quarter. In terms of guidance for '08, we really a lot of the Green Mountain segment growth is really tied to K-Cups and we are, though, very excited about the grocery channel, both for K-Cups, as well as what Larry touched upon with our re-launch of the Newman's Own and our new single origin line.

That's primarily where we see our growth coming from for next year, but we have not and I don't think we are really planning on giving out volume growth guidance right now.

Scott McCreary

But dollar revenue growth will continue to out pace the growth rate in pounds because of the K-Cup phenomenon.

Mitchell Pinheiro - Janney Montgomery

Okay. Another, just another detail. What approximately what percentage of Green Mountain's K-Cup sales goes through consumer direct?

Scott McCreary

Hi, Mitch, this is Scott. For this coming year, it will be about 35%. It will go through consumer direct and the reseller channels.

Mitchell Pinheiro - Janney Montgomery

And the reseller?

Scott McCreary

Yes. So those two combined which means about 65% of our K-Cups go through our away from home and office opportunities.

Mitchell Pinheiro - Janney Montgomery

Okay. I forget the name of your loyalty program, you monthly …

Scott McCreary

Cafe Express.

Mitchell Pinheiro - Janney Montgomery

Cafe Express. Thank you.

Larry Blanford

Unison. How about that, Mitch?

Mitchell Pinheiro - Janney Montgomery

Harmonized. Is there any numbers that you can share as far as how many customers are on Cafe Express this year versus last year?

TJ Whalen

Hi, Mitch. It's TJ. Yes. That program continues to perform very well for us. It's grown significantly in the past year and we expect it to continue to do so. We ended up the year closing fiscal '07 with more than 50,000 consumers on that program and we expect that number to grow in the future.

Mitchell Pinheiro - Janney Montgomery

Okay. And 50,000 is up double-digit? Just roughly. Is it up?

TJ Whalen

I don't have that at my fingertips, but my recollection is we started the year with something like 30,000.

Mitchell Pinheiro - Janney Montgomery

Okay. And then if I look at, I apologize for jumping around. In terms of the K-Cup sales in this quarter or brewers, excuse me. Keurig brewers, Nick, you just mentioned that you didn't want to get caught without a stock so there's an inventory fill here. What would you say the actual retail takeaway was in the quarter? Was it up at the same level as last year? Do you see what I'm saying?

Nick Lazaris

This is Nick. I think you're asking a question about how we felt about sell through in the fiscal fourth quarter at retail? Is that your question?

Mitchell Pinheiro - Janney Montgomery

Yes, was that up as much in percentage as what your shipments were? Was it any color there?

Nick Lazaris

I think, the way you characterize it is pretty good. In other words, our sell in growth rate is what we are seeing reported to us from retailers who supply us with that information, in terms of sell through.

We have been seeing that during the year much like you see the 93% fiscal year at-home brewer growth rate. We are not feeling the channel in some way. It is selling through, and that's why the retailers continue to feel very good about Keurig in this, uncertain holiday season.

When we talk to the retailers, we are talking to them now not so much about the holiday season at all. Those programs are set. We are finalizing spring programs and what I can tell you is our key retailer partners are feeling very good about the continuing growth of Keurig as part of their program, and as appealing to their consumer base.

Mitchell Pinheiro - Janney Montgomery

Terrific. One last question, and a concern on the balance sheet and working capital. So number one, Fran, is interest expenses going to be up year-over-year. So I assume that a bunch of your free cash flow is going towards funding inventory and accounts receivable? Otherwise, I would have expected some decline in overall debt balances. Can you …?

Frances Rathke

Sure, Mitch. This is Fran. Obviously, these are estimates. What we are anticipating is since year-end, where we were at $90 million and, as you know, we paid down about $11 million, $12 million, right from year-end ago.

Mitchell Pinheiro - Janney Montgomery

Right.

Frances Rathke

So we were at $90 million. We have increased that since September, primarily it's a factor, really of two things. Building using working capital to build inventory, primarily the brewers. And then the second piece is spending on CapEx, and what we are anticipating this year is a little bit of a different flow on working capital.

As Nick mentioned, we have spent a lot of time working with our partner overseas to work on a brewer-manufacturing plan, literally by months to ensure that they can handle spikes in demand we can handle it.

So we have done a lot of work there, and we are anticipating building more inventory in, for example, the spring than we did this past year, primarily with the away from home brewers to ensure, that especially in the summer months as we head into the heavy retail shipping season, they can handle if we end up giving them more volume, they can handle the spikes.

So we will build more inventory for brewers this year than we did this past year. That will, therefore, tap in and require more interest expense. So that's where our estimates are coming from.

And then I think, we gave guidance on CapEx, pretty much most of the CapEx is, as Jon touched upon, both on the roasting/grinding side, but also Scott mentioned the additional five high-speed lines coming in, as well.

Mitchell Pinheiro - Janney Montgomery

Hey, I lied. I said that was my last question. Just McDonald's, are you participating at all in the new specialty coffee program that they are going to roll out?

TJ Whalen

Hi, Mitch. It's TJ. Our program in New England is the same as it has been for the past couple of years, primarily under the Newman's brand but also the Green Mountain brand is present there.

That's their hot coffee program, as well as their iced coffee program in New England. They are exploring specialty beverages as you probably heard and seen and how that unfolds across the country is an ongoing dialogue between corporate and the regions and the franchisees and their distribution partners.

Mitchell Pinheiro - Janney Montgomery

Okay. Thank you. Hey, I appreciate the level of detail you guys provide. It's very, very helpful to us. Thank you

Frances Rathke

Thank you.

TJ Whalen

Thank you, Mitch.

Operator

And we will take our final question from the site of Richard Fearon of Accretive Capital.

Richard Fearon - Accretive Capital

Good morning. Congratulations on a very good quarter.

Larry Blanford

Thanks, Richard.

Richard Fearon - Accretive Capital

Just a question, point of clarification. The number of grocers, existing grocers right now to which you sell coffee, what percent actually carry the K-Cups, as well?

TJ Whalen

Hi, Richard. TJ Whalen here. I would say at this point in time, about 20% of our doors that we sell coffee into now also have K-Cups. That's just kind of rough numbers.

Richard Fearon - Accretive Capital

Okay. And when you talk about growth on the grocery side, it does seem like there's an extraordinary opportunity there, just with existing doors. When you talk about growth, how does it break out between K-Cup penetration of existing doors and opening new grocery doors?

Are you looking at the majority of that coming from now that there's a terrific installed base of brewers that you can go ahead and penetrate with K-Cups, or are you looking at the growth coming from new doors or a combination of both and how does that break out?

Larry Blanford

Yes, Rich, this is Larry Blanford. Up to this point the introduction of K-Cups and brewers into grocery have been primarily with existing doors, existing customers, where we already have a presence with Green Mountain Coffee in bags.

So, we still have some opportunities to mine there, but certainly as we go forward, there is a real opportunity to leverage the installed base of brewers in K-Cups along with our other coffee offerings to open up new grocery points of distribution for not only brewers and K-Cups but also our bagged coffee.

And so we will continue to work to expand our geographic footprint. That's part of the leverage and synergy that exists between being both in the, let's call it, more traditional specialty coffee business and in the single cup brewing business. There's just a great interplay between the two.

Richard Fearon - Accretive Capital

Yes. And of the potential grocery market, what percent do you think you have penetrated? Overall?

TJ Whalen

In terms of ATV for the Green Mountain brand?

Richard Fearon - Accretive Capital

Correct.

TJ Whalen

Somewhere in the neighborhood of 25%.

Richard Fearon - Accretive Capital

Okay. And…

TJ Whalen

We have a lot of growth ahead of us there.

Richard Fearon - Accretive Capital

Yes, it certainly sounds like it, with respect to the restaurant channel, you talked about McDonald's briefly. Can you just add a little color to the existing contract and if there's any opportunities to expand that?

TJ Whalen

Hi, Richard. We really as much as I would like to be able to provide some better color there now, we really can't talk specifically about specific customer contracts.

Richard Fearon - Accretive Capital

Okay.

Larry Blanford

We have not built any additional store growth into our numbers going forward. We have an excellent relationship. We are very pleased to serve McDonald's and should we get the opportunity to expand, we most certainly would very much want to pursue that. But we do not have any store expansion built into our forward numbers.

Richard Fearon - Accretive Capital

Have you built any other franchise expansion into your numbers outside of McDonald's?

Larry Blanford

Nothing, this is Larry again. Nothing of any significance.

Richard Fearon - Accretive Capital

Okay. So there is opportunity as you see it, both within McDonald's and with other restaurant chains?

Larry Blanford

let me say this, there's certainly opportunity but it is not as we go forward here in the next 18 or 24 months, a primary area of focus for us. Again, what we are attempting to do is really take advantage of this window of opportunity that single cup brewing represents.

And so in our traditional coffee business, Richard, we really are focused on those channels that can best both support single cup brewing and/or where we have synergy with it. So that would primarily be in the office coffee channel and in the grocery channel.

Now, those other channels are still very important to us and we will continue to participate in those, but in terms of our growth, right now we are really trying to align all of our energies around single cup and the synergy between the two businesses, which are those two channels that I mentioned.

Richard Fearon - Accretive Capital

Okay, well, obviously, that's a terrific opportunity for you all. I was just trying to better understand whether there was some expectation down the road that restaurant could be as exciting as single cup brewing, but…

Larry Blanford

It's a great question and I appreciate your question.

Richard Fearon - Accretive Capital

Okay, well, thanks for your answer, and thank you for a terrific quarter.

Larry Blanford

Thank you.

Frances Rathke

Thanks, Richard.

Operator

We do have a question from the site of Patrick Stowe of Priority Capital. Go ahead.

Patrick Stowe - Priority Capital

Good morning.

Larry Blanford

Good morning.

Patrick Stowe - Priority Capital

Thanks for taking the time. I didn't know if I was going to squeeze in there. Since we've covered a lot of detailed information, I wondered if I could just ask you a big picture question in the single serve category? Obviously, you're growing at a tremendous rate in the at-home market.

What is the biggest obstacle you see over the next five years as this category grows? Has it been a perceived quality issue? Is it awareness? Maybe if you could just give us a big picture outlook on that, and maybe if you have any thoughts as to the potential size of this market and how you might track that?

Nick Lazaris

This is Nick, Richard, and from the big picture long-term perspective, we do view single cup as revolutionary and when we talk about single cup we usually start by referring to Joe DiMaggio back in 1971 when he was promoting filtered coffee systems from Mr. Coffee to replace percolators and what happened over the next 10 or 20 years is percolators went to the wayside and drip coffee systems became standard in U.S. households, 90 million U.S. households.

We see the same thing happening with single cup. And the challenge there, it's been interesting. Keurig has benefited greatly from our multi-billion dollar competitors spending hundreds of millions of dollars, or at least upwards of $100 million educating people on the concept of single cup.

But what we're finding is that people who say they are aware of single cup really aren't truly aware of what the Keurig gourmet single cup system can deliver. It's not just speed and convenience. It's great taste.

And so a lot of what we expect top learn with our TV advertising and, as Larry mentioned, other forms of marketing research should, I think, help us better understand how to educate people who might feel they have awareness of single cup, but really don't appreciate the benefits.

So that's why for Keurig, when we launched in holiday 2004 critical to our success was in-store demonstration. When our system is demonstrated people really understand speed, convenience, taste, how easy it is to use. So I think, as I mentioned earlier, as perhaps other competitors help educate, as well, it will be good for single cup. We think single cup has a tremendous opportunity over the long term.

Patrick Stowe - Priority Capital

All right, great. That's helpful. Thanks for the detail.

Nick Lazaris

Thank you.

Operator

And I'd be happy to return the call back to Mr. Larry Blanford.

Larry Blanford

Well, thank you very much for your attendance on our call. We really appreciate your support. I'll just close by saying that as you do your holiday shopping please keep in mind that Keurig brewer makes an excellent gift. Always the salesman. So, again, we appreciate your interest and thank you for joining us.

Operator

Thank you. This does conclude our conference call for today. You may now disconnect your lines and everyone, have a great day.

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Source: Green Mountain Coffee Roasters F4Q07 (Qtr End 9/29/07) Earnings Call Transcript
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