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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 CoffeeRoasters Fiscal 2007 Fourth Quarter And Year-End Conference Call. Today's callis being recorded.

At this time for opening remarks and introductions, I wouldlike 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 forjoining us this morning for our fiscal 2007 fourth quarter conference call. Ifyou have not received the earnings press release, it is on our web site atwww.gmcr.com.

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

For further information on risks and uncertainties, pleaseread the Company's SEC filings and the paragraph in today's press release thatbegins with the words "Certain Statements." We also request that youask all of your questions on this call, so that our answers are available toeveryone.

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

Larry Blanford

Thanks, Fran. Good morning, everyone. Joining us withprepared remarks on this call today is Nick Lazaris, the President of ourKeurig subsidiary. After remarks from Fran, Nick and myself, and together withother members of our management team, we will be available to respond to yourquestions.

It is great to be sharing such favorable results again thistoday. 2007 was a year of strong financial returns with net sales and earningsincreasing 52% over the prior year. It was Green Mountain Coffee's 20thconsecutive quarter of double-digit net sales growth and eighth consecutivequarter with growth in excess of 25%. And we delivered that while staying trueto our corporate values and commitment to social responsibility and theenvironment.

We continue to deliver strong sales and earnings growth andthe 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 lineby 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 ourCFO, and I will now turn the call back to Fran who will be followed by Nick andthen myself with prepared comments. Fran?

Frances Rathke

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

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

Although these amounts are not in accordance with or analternative to GAAP, we believe they provide investors with greatertransparency by helping to illustrate the underlying financial and businesstrends relating to the Company's results of operations and financial conditionand 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%. Netincome was $3.6 million in the fourth quarter of 2007, an increase of 133% overlast year.

Net income per diluted share was $0.14 in the fourth quarterof 2007, as compared to $0.06 in the fourth quarter of 2006, an increase of120%.

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

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

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

Prior to the elimination of intercompany sales androyalties, net sales of Keurig included in the Company's fourth quarter offiscal 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 higherbrewer sales with shipments up 99%. The other half of the increase in sales wasdue 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 profitmargin this quarter was due to a significant increase in sales of Keurigat-home brewers, which have lower gross margins than the away from home brewers.

In addition, the Green Mountain Coffee segment gross profitmargin was 31.6% of net sales in the fourth quarter of 2006, as compared to34.6% in last year's fourth quarter.

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

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

The improvement in SG&A margin was the result ofleveraging, selling and organizational expenses on a higher sales base, mostnotably, in the Keurig segments, where SG&A margin was 20.1% in fiscal year2007, as compared to 30% in the prior year fourth quarter.

Pre-tax non-cash stock compensation was $1.356 million inthe 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 Companyin 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 saleswas 8% as compared to 6.6% in the prior year fourth quarter.

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

The improvement in operating income margin this quarter ismostly due to the success of the Keurig single cup brew system and the strongsales 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 fromlast year's fourth quarter rate of 40.6%. Our annual tax rate for 2007 was40.5% as compared to 41.4% in fiscal 2006.

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

Overall, we are extremely pleased with our financialperformance this past quarter and year. For the full year, '07, net sales andnet income increased 52%. Fiscal 2007 includes a full year of consolidating thefinancial results of Keurig as a wholly owned subsidiary as compared to fiscal2006, which included 15 weeks of Keurig's financial results as a wholly-ownedsubsidiary 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 detailedinformation in the management's discussion and analysis section.

I now want to address Green Mountain Coffee businessesoutlook for the full year and first quarter of fiscal 2008. Please note that myremarks and the information contained in the press release are based on currentexpectations.

These statements are forward looking and do involve somevery real uncertainty. Actual results could differ materially. The only updateswe expect to make to you regarding our expectations and performance are onthese routine quarterly conference calls and in the related earnings pressreleases and SEC filings.

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

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

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

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

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

This includes the non-cash stock amortization expensesrelated to the identifiable intangibles estimated to reduce EPS byapproximately $0.11 per share. For comparison purposes, excluding the impact ofthese 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 infiscal 2007.

For the first fiscal quarter of 2008, we expect totalconsolidated net sales growth of 40% to 50%, primarily due to anticipatedstrong sales of Keurig single cup brewers and K-Cups in the office coffeechannel consumer direct and reseller channels. We expect to achieve aconsolidated operating margin in the range of 5% to 6% in the first quarter offiscal 2008, as compared to 7% in the first quarter of fiscal 2007.

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

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

We anticipate fully diluted earnings per share for the firstquarter 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 identifiableintangibles estimated to reduce EPS by approximately $0.03 per share. Theseobviously are all forward-looking statements and are based upon beliefs andassumptions 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 strongfourth quarter performance was a great end to the first full year of being awholly owned subsidiary of Green Mountain Coffee Roasters. Keurig brewershipments were up 99% in the fourth quarter of fiscal 2007 versus thecomparable 13-week period in the prior year and up 94% for the year.

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

We launched our first at-home brewing system four years agovia the direct channel using Keurig.com. Then three years ago, we introduced abrewer 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 over10,000 retail stores, grocery stores and coffee shops. Nearly all of theseretail outlets offer K-Cups manufactured by Green Mountain Coffee.

Both away from home and at-home markets have huge growthpotential. Combining both away from home and at-home, the installed base ofbrewers generated demand for K-Cup shipments of 168 million K-Cups by ourroaster partners in the fourth quarter, which were 46% higher than thecomparable 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 ona life-to-date basis. As you will also see in the chart at the back of today'spress release, Green Mountain Coffee continues to be the leading roasterrepresenting 56% of total fiscal year roaster K-Cup shipments.

We are very pleased to report that point-of-sale researchperformed by the NPD Group shows that Keurig was the market leader in dollarand unit share in the single cup category at retail, in the third calendarquarter of 2007.

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

We continue to expect another strong holiday season forKeurig 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 lastyear 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 Statesand Canada.

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

There are a lot of reports now about the uncertaintyrelative to the strength of consumer spending this coming holiday season. WhenFran talks about factors creating risks and uncertainty, the economy and itseffect on the holiday season spending is right up there.

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

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

As previously announced, we will be running a $3 million TVadvertising campaign in 16 markets during the holiday season. The ads areintended to further reinforce retail sell through and we will be monitoringtheir effectiveness to help us better plan next year's holiday marketingprograms.

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 unitshipments.

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

Brewer product innovation is not only driving growth in theexisting AFH office coffee segment, but has also opened up the in-room hotelchannel for us. We began shipping; the new B130 hotel brewers in September andto 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 substantialprogress in this channel during fiscal 2008.

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

For each 10,000 brewers installed, and assuming each is used300 days a year, we would yield 3 million demonstrations annually. We believethat this will positively impact both our away from home and our at homebusinesses in fiscal 2008 and beyond.

In summary, we continue to be pleased that Keurig hascontributed meaningfully to Green Mountain's success in fiscal 2007. Lookingforward to fiscal 2008 we believe that Keurig will continue to deliver stronggrowth 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 favorableresults today. We have accelerated our top and bottom line growth this year,driven by well differentiated and defensible strategies including, andespecially with, Keurig.

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

More specifically, our objective was to first align tomaximize the single cup brewing opportunity, and secondly, to explore thesynergy of the Green Mountain Coffee brand and organization in terms of bothhow Green Mountain Coffee can help achieve single cup growth and leadership andhow the single cup category can grow the Green Mountain brand of specialtycoffees.

The synergy between Keurig and Green Mountain CoffeeRoasters is increasingly apparent. Keurig's single cup brewers provide anoutstanding trial opportunity for our brand, particularly outside our coremarket.

At the same time, the Green Mountain Coffee organizationuses its existing relationships with customers to get wider Keurig brewer andK-Cup placement.

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

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

First and foremost, we will deliver great coffee and aconvenient, fun experience for consumers. We will continue to encourage Keurigbrewing systems market share momentum, both at home and away from home recognizingthe synergistic interplay between these markets.

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

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

We will continue to innovate, advancing consumer meaningfuldimensions of the single cup or make brewing experience, and we will alsoselectively 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 wecan achieve our objectives while continuing to maintain or improve our marginson a year-to-year basis. We are extremely committed to holding our leadershipposition in this category as it represents the source of significant valuecreation for our many constituencies.

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

Our multi-channel marketing strategy surrounds the consumerwith 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 ourbrand even more.

New products are also key to our success. For our grocerychannel, we are launching a new line of single origin coffees to buildexcitement in sales. Each single origin coffee is sourced directly from aparticular area, farm or estate, known for the high quality and the distinctivetaste 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 willbe expanded to other packaged coffees in fiscal 2008.

Our line of Newman's Own organic coffee also had has had amakeover. New packaging and new vanilla-caramel flavor have lead todouble-digit increases in sales and volume year-over-year. Overall, sales ofour fair trade certified and fair trade certified organic coffees continue toincrease in the supermarket channel through new business with customers such asPathmark, one of the nation's leading supermarket retailers.

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

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

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

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

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question fromthe 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 insome 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, wenoted we are going to have increased SG&A as a percentage of sales than wehad in the first quarter of last year, as we described our marketing programsthat 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, weare anticipating improving our operating income margin. This year we ended upat 8.0%. Our range for fiscal '08 guidance is 8% to 9%. I think a lot of thatimprovement is on leveraging on the SG&A.

Mark Astrachan - Stifel Nicolaus

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

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

Larry Blanford

John?

Jonathan Wettstein

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

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

And then secondly, the Essex start up, those expenses haveincreased a bit, as we've continued to staff the operation fully, and then wewill 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 termsof 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 wouldhave the potential of being too long with a big market drop, which was alwayspossible for this year. So we are in a range where we need to maintain our viewof pricing and other costs as we see how to market the sea market sorts outfrom this point on.

Mark Astrachan - Stifel Nicolaus

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

TJ Whalen

Hi, Mark. This is TJ Whalen. Thanks. I will try to answeryour question there. Sales of fair trade coffee did taper off a bit in the backhalf 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'sOwn organics line of coffees, and as Larry mentioned, we introduced a newvariety 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 lineaccelerate again in the past four-week data from IRI, indicates some verypositive momentum there, so we see that moving back in a positive direction aswe move forward into the year.

Mark Astrachan - Stifel Nicolaus

Great. Final question is just simply the increased focusthat we have seen from some of the larger players in the coffee category inparticular, as it relates to the single cup category, like Kraft getting alittle bit more focused there teaming with Starbucks on some of theirsingle cups.

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

Nick Lazaris

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

We do very well with in-store demonstrations. We have a verycompetitive system and we feel good about that. So as it relates to Tassimo, wethink that will help. The other big players that have played in single cup inthe past in one way or another, whether it was P&G through the Home Cafe oreven Sara Lee with some sale don't seem to be having that much of an impact onour 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 ScottVan Winkle with Canaccord Adams. Your line is now open.

Scott Van Winkle - Canaccord Adams

Hi. Thank you. I hope everybody is doing well. A fewquestions. Nick, you shared some NPD data. I wonder if I could try and dig somemore out of you like, what was the market share of one-cup brewers in generalversus 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 acategory continues to grow as it relates to unit and dollar sales, and the bigshift that we started seeing a year or so ago, where capsule systems likeKeurig, Tassimo, versus pod systems, like the Senseo Home Cafe, the dominanceof capsule systems with over 70% share continues to be the case today.

When we talk to our major retail partners, one of the thingsthat we hear, Scott, is depending on the retail partner, relative to theirdollar sales of single cup as a percent of their total coffee maker sales andthis will vary by retailer but, it is not unusual to hear 15% to 20% already indollar sales and when we talk about potential they see a great deal of growthpotential 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 probablysomething maybe close to 10% of units? Would that be fair?

Nick Lazaris

I wouldn't speculate on that now, but I would say it'slower, because the average price of a single cup system obviously is higher. SoI’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 aboutselling into hotels and obviously you want placements and you are not taking alot of margin on those units being sold to hotels. The hotels, even though it'sa 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 brewerslike we do in our normal away from home, in other words channel. We sellbrewers to distributors who call on hotels. Those distributors purchase K-Cupsfrom roasters and so the channel, Keurig does not derive profitability on thoseK-Cups.

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

Scott Van Winkle - Canaccord Adams

Okay. Great. Great. And then, Fran, a question for you. The12.4% supermarket growth in pounds shipped. What was that in dollars? And Iguess what I'm asking is with green coffee product costs running higher wheredo 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 interms of dollar growth for this quarter, it's similar to the 12.4%. In terms ofpromotional activity and such, I would say we had probably similar levels as wehad last year's fourth quarter. So a lot of this growth this quarter reallycame from a lot of new customers we have added.

Scott Van Winkle - Canaccord Adams

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

Frances Rathke

Yes.

Scott Van Winkle - Canaccord Adams

Okay. And if I could dig a little further into the talkabout gross margin. I think Jon, you mentioned that some of the inefficienciesnow 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 meantand 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 therewill 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 ourEssex 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 theother mix issues in the coffee segment, one is green coffee costs.

Which was just spoken to, and then the overall mix of K-Cupsas their costs in total are a bit higher as a percentage of sales the way theyare costed and priced. So those are sort of the three big factors for thecoffee segment. I think the other question might have to do with the enterprisein 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 yourearnings guidance based on the revenue guidance, I think we have to assume somegross margin improvement from the fourth quarter level. So the Essex facilitydoesn't sound like it was a significant piece of it, and so I assume the mixwill shift not away from K-Cups but away from consumer Keurig units as the yearprogresses. So the gross margin is higher towards the back end of the year, isthat correct?

Frances Rathke

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

Scott Van Winkle - Canaccord Adams

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

Scott Van Winkle - Canaccord Adams

Okay. So just ballpark, it we might be the same type ofgross margin in the first quarter that we just saw in Q4. But you might be intothe high 30s when you get into the Q2, the Q3 and the Q4 where you are notselling as many consumer machines or at least in Q2 and Q3?

Frances Rathke

Correct. Similar to what happened this year ourquarter-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 areanticipating a lot more brewer shipments.

Scott Van Winkle - Canaccord Adams

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

But did we see the same type of shift in the fourth quarterof last year to a little lower gross margin because of the at-home brewers? Orhas 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 Keuriglast, okay this year we discussed how there's a lot of brewer shipments in ourfourth fiscal quarter. In addition we owned them last year, Q4 of '06 for thewhole year.

That was also a quarter where there was a lot of shipmentsgoing into the retail channels, but as you can see when we have a 99% increasein brewer shipments, we had a really big increase as a percentage of sales ofthe 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 thehigher percentage sales this quarter will be more impact on the total Company'sgross margin. In the fourth quarter of last year, if you look just at Keurig'sgross margin did we see the same type of drop-off?

And then, what I’m really getting at is with new brewersbeing shipped into the at-home market and some new products there. I'm not surethe B40 was available last year. Have we seen any change in the gross marginfor 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 itwas 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 importantone particularly going forward, as Fran described in her commentary.

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

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

Scott Van Winkle - Canaccord Adams

Okay. And last question is also somewhat Keurig related. Youmentioned 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 replenishmentside of the K-Cups, not just the sampler that is maybe sold on the shelf rightnext to a new machine?

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

Nick Lazaris

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

In the beginning, when we launched three years ago, as Imentioned, most retailers would carry four to six varieties. We now have someretailer partners that carry up to 15 varieties in their stores. So, what wefind is that whenever brewers are sold, it's good to have K-Cups and in groceryimpact whenever K-Cups are sold it's advantageous to promote the system byhaving some brewers there, as well.

So, it's really a system sale and we have very broaddistribution. 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 NicoleMiller 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 corechannels and the pricing there. You said that was flat year-over-year, can youjust remind us, quickly, is there any seasonality or is the pricing typicallyflat throughout all four quarters?

TJ Whalen

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

Nicole Miller - Piper Jaffray

Okay. Can you guys talk about the second plant and what wasthe capacity increase, what are you currently running at capacity and then Iguess basically for how many and what's outlook for the support of productionon the current capacity?

Scott McCreary

Hi, Nicole. This is Scott McCreary. Thanks for yourquestion. With the investment that we've made in Essex, we have leased an87,000 square-foot building there and we invested in the infrastructure to getthat set up for seven high speed K-Cup lines and six of our earlier packaginglines that we call PL100. And so right now, we have two out of those sevenhigh-speed lines installed in Essex.

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

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

Nicole Miller - Piper Jaffray

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

Scott McCreary

An easy way to think about it, because we have differentmachines at different speeds, was we basically had five equivalent high-speedlines 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 about80 million K-Cups per high-speed line on an annual basis. So that would say onan annual basis, right at this moment in time, we have capacity for 800 millionK-Cups.

That obviously gets phased a little bit depending on how westaff 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 fiscalyear?

Scott McCreary

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

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

Nicole Miller - Piper Jaffray

And just so I'm clear, it sounds like you have 10 high-speedequivalent 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 atopen those machines?

Scott McCreary

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

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

Nicole Miller - Piper Jaffray

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

Jonathan Wettstein

Nicole, this is Jon again. What I'd say in general, ourpolicy is to carry about half a quarter's inventory and then to hedge forwardin the two to six month range. So, I won't go any further than that. Butthat'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 perday, talking specifically about the Keurig side of the business, if you cansegment 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 homemarket in 2003, we started surveying our customers then and trying to estimatehow many cups a day, etcetera, and it's been remarkably constant during thetime we've been in market, no trend really up or down. No real differencewhether 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-homeside. In the away from home side it is more complicated. It's not that thenumber of cups per brewer changes. It's that each of our brewers, whetherlarge, medium or small, have different applications in offices.

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

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

Nicole Miller - Piper Jaffray

That's very helpful. Does 10 to 15 in the away from homeside 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 adspend or should I understand that that's just for the first quarter and thenwhat should advertising look like for the rest of year?

Nick Lazaris

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

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

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

Nicole Miller - Piper Jaffray

As you think about break even on the ad spend, if you gotmore than whatever your break even, whatever the return profile is you arelooking 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 Daythrough Father's Day, Graduation period is a good period. We actually did sometesting there with television a year ago, as we also a year and a half ago, aswe also tested in the holiday season that's upcoming.

And clearly this upcoming holiday season is a much, muchstronger gift giving season than that Mother's Day to Graduation, but that isthe number two and would be something we might take a look at. Larry, did youwant 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 sometesting of various vehicles this holiday season. So, yes, we do have thetelevision umbrella, but underneath that, we are looking at some other vehicleslike drive-time radio and targeted catalogs and we really have set up sort of astatistically relevant test to try to better understand how to drive thisbusiness and how to best spend our money.

I think we going to learn a fair amount from that, and thenthat will play into how we think about driving the business going forwardthrough 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 littleconfused about the channels. There was 5,000 doors and 7,000 and 10,000. Iguess, let's just put that in perspective. Like, who has the brewers, the poundversion and then the K-Cups; I guess I was a little bit confused by that thismorning.

Nick Lazaris

Okay. As it relates to the retail, this is Nick again. As itrelates to the retail store channel, last holiday season, we were in about7,000 stores and this holiday season we expect to be in about 9,000 retailstores. Virtually all of those stores, not only sell brewers of one model oranother, or multiple models, but they sell a selection of K-Cups.

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

And between grocery and the retail coffee shops, there areover 1,000 more points of distribution for brewers and K-Cups. And that'srelatively 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 ahuge opportunity. So, it sounds like you are in I guess, 1,000 doors basicallyis 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 shouldbe able to be close to the 10,000 where you are at in terms of retail, theretail number?

Larry Blanford

Hey, Nicole, this is Larry. No, your point that it's anopportunity is absolutely correct. We are selectively increasing distributionin grocery, which is consistent with the strategic objective of drivingcategory penetration. Category penetration, in my view does require broaddistribution.

We have to do that smartly and we want to make sure that allof our important distributors are sharing in the success and stay motivated tocontinue 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 oftheir 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 mostconsistent with this brewing system, and we try to encourage and have beensuccessful in getting placement of and display of brewers and coffee, whichjust adds another great point of interest for consumers and draws them in andallows them to better understand and have another opportunity to understandwhat this single cup brewing system is all about.

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

Nicole Miller - Piper Jaffray

I guess, when you say smartly, are you trying to, should weassume that then sliding fees are a barrier to entry or how are we thinkingabout that? And then also any color that you can provide. I have seen thesedisplays, this tiered system where you stack the brewers against the K-Cups inthe 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 betterthan 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 ofthe grocers with the target demographics for the single cup brewer. Just likewith 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 inevery grocer. So, by smartly, that's what I was referring to. In terms of thesell through, TJ may have some comments on that, but I think they are prettygood. TJ?

TJ Whalen

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

So the fact that these K-Cups are working into our top 10items on a velocity basis signals some real great momentum and as we arelooking forward, we see increasing velocity and momentum, as well as increasingpenetration of new grocery accounts, both in our territory and more broadly ona 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 ofpercentage and dollar, maybe it's dollar and units, I don't remember, marketshare?

Frances Rathke

On the NPD data?

Nicole Miller - Piper Jaffray

Yes.

Frances Rathke

Yes, I can just, Nick noted in his remarks that for thethird 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 unitshare versus 18% in the prior year comp quarter.

Nicole Miller - Piper Jaffray

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

Scott McCreary

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

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

Nick Lazaris

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

That taught us a big lesson and we were beginning to planthis holiday season last January/February and as we worked through the year wenot only looked at what production levels were required for this holidayseason, but looking into calendar 2008 with our vendor to make sure that theproduction capacities were where we needed them to be.

We do have a partner that has tremendous resources andwillingness to work with us, to ramp up. And so we go into this holiday seasonin good shape at retail and with a nice supply line behind it, together with anoptimistic look of what we think our volumes will be next year, working veryclosely with our vendor and vendors to our vendor to make sure that the partssupply 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 MitchellPinheiro, 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 20,000versus 7,000, is that a replacement cycle with the B3000? Is that what you aresaying or are you seeing new offices?

Nick Lazaris

Well, I think there's a mix there, Mitch. This is Nick, butprimarily the growth is with our smaller brewers, the B140 and B200 thatcontinue to support our distributors' desire to increase penetration withsmaller accounts, but certainly with our B3000 brewer and all the features andadvantages that it has had, I think a number of our distributors do hear fromtheir office customers, we would like to the newest and the best. So probablysome of that is replacement, but I think when it comes to B200 and B140, that'sincremental.

Mitchell Pinheiro - Janney Montgomery

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

Nick Lazaris

Yes, a little bit of color, Mitch. Again, this is Nick. Whenwe 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 evenstronger data as it related to the upscale market. There was a mass single cupbrewer launched by a competitor in that mass channel that had sold through inthe 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 brewersthemselves, is there still a positive gross margin on brewer sales?

Nick Lazaris

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

So the new technologies that we launched, together with ournew partner overseas allowed us to lower wholesale prices and increase our awayfrom 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. Wetalked about K-Cup capacity. How are you doing in terms of roasting capacity andgrinding and other related potential, whatever other capacities you look at?

Jonathan Wettstein

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

At the same time, we are looking ahead so that we are notwaiting until the end of our roasting capacity is available as we think aboutwhere we go next, how do we support the growth of this business, as it heads tothe 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 thenext six months and going into next fall, but we need to be doing things forthe years after that.

Mitchell Pinheiro - Janney Montgomery

Yes. Interestingly, I was I don't want to say surprised, butI'm curious to know, understand why you open up Essex with K-Cups and why notin 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 weredeveloping our strategies. As we saw the acceleration in brewer sales and K-Cupgrowth, Essex was the fastest way and the lowest cost way for us to ensure thatquality coffee that goes into the K-Cups was where it needs to be.

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

Mitchell Pinheiro - Janney Montgomery

Okay. Have you, it was this quarter, did you have any impactwas there any co-packers for grinding or co-packers, third parties for K-Cupsthat 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 utilizea co-packer out of Tennessee for some small amount of volume. They are aco-packer that helps with the whole Keurig system.

Mitchell Pinheiro - Janney Montgomery

Okay.

Scott McCreary

And then we been exploring some testing with some fracproduction with some partners there, and they, the concept was making sure wehave sufficient roasting and grinding capacity here in Waterbury and if we needto move some frac production to other locations then, it again keeps us in agood position here and then related a little bit to the cost was the up frontinvestment 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, poundgrowth was up about 11%. And, it trailed your core Green Mountain growth, salesgrowth by; it looks like 15% or so, is there how do I think about volume fornext year? You didn't give any guidance on that. Is that going to trail shouldthat match Green Mountain core growth next year? I mean, how do we think aboutthat?

Scott McCreary

I'm not sure.

Mitchell Pinheiro - Janney Montgomery

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

Frances Rathke

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

So clearly the reason we are up so much more on dollars isnot because of price increases, rather once again, just the increased sales mixto 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-Cupsand we are, though, very excited about the grocery channel, both for K-Cups, aswell as what Larry touched upon with our re-launch of the Newman's Own and ournew single origin line.

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

Scott McCreary

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

Mitchell Pinheiro - Janney Montgomery

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

Scott McCreary

Hi, Mitch, this is Scott. For this coming year, it will beabout 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 ourK-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 faras how many customers are on Cafe Express this year versus last year?

TJ Whalen

Hi, Mitch. It's TJ. Yes. That program continues to performvery well for us. It's grown significantly in the past year and we expect it tocontinue to do so. We ended up the year closing fiscal '07 with more than50,000 consumers on that program and we expect that number to grow in thefuture.

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 iswe 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. Keurigbrewers, Nick, you just mentioned that you didn't want to get caught without astock so there's an inventory fill here. What would you say the actual retailtakeaway was in the quarter? Was it up at the same level as last year? Do yousee what I'm saying?

Nick Lazaris

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

Mitchell Pinheiro - Janney Montgomery

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

Nick Lazaris

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

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

When we talk to the retailers, we are talking to them nownot so much about the holiday season at all. Those programs are set. We arefinalizing spring programs and what I can tell you is our key retailer partnersare feeling very good about the continuing growth of Keurig as part of theirprogram, and as appealing to their consumer base.

Mitchell Pinheiro - Janney Montgomery

Terrific. One last question, and a concern on the balancesheet and working capital. So number one, Fran, is interest expenses going tobe up year-over-year. So I assume that a bunch of your free cash flow is goingtowards funding inventory and accounts receivable? Otherwise, I would haveexpected 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-endago.

Mitchell Pinheiro - Janney Montgomery

Right.

Frances Rathke

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

As Nick mentioned, we have spent a lot of time working withour partner overseas to work on a brewer-manufacturing plan, literally bymonths 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 anticipatingbuilding 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 thesummer months as we head into the heavy retail shipping season, they can handleif we end up giving them more volume, they can handle the spikes.

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

And then I think, we gave guidance on CapEx, pretty muchmost 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, aswell.

Mitchell Pinheiro - Janney Montgomery

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

TJ Whalen

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

That's their hot coffee program, as well as their icedcoffee program in New England. They are exploring specialty beverages as youprobably heard and seen and how that unfolds across the country is an ongoingdialogue between corporate and the regions and the franchisees and theirdistribution partners.

Mitchell Pinheiro - Janney Montgomery

Okay. Thank you. Hey, I appreciate the level of detail youguys 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 RichardFearon 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 ofgrocers, existing grocers right now to which you sell coffee, what percentactually carry the K-Cups, as well?

TJ Whalen

Hi, Richard. TJ Whalen here. I would say at this point intime, 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, itdoes seem like there's an extraordinary opportunity there, just with existingdoors. When you talk about growth, how does it break out between K-Cuppenetration of existing doors and opening new grocery doors?

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

Larry Blanford

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

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

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

Richard Fearon - Accretive Capital

Yes. And of the potential grocery market, what percent doyou 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 therestaurant channel, you talked about McDonald's briefly. Can you just add alittle color to the existing contract and if there's any opportunities toexpand that?

TJ Whalen

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

Richard Fearon - Accretive Capital

Okay.

Larry Blanford

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

Richard Fearon - Accretive Capital

Have you built any other franchise expansion into yournumbers 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 withinMcDonald's and with other restaurant chains?

Larry Blanford

let me say this, there's certainly opportunity but it is notas we go forward here in the next 18 or 24 months, a primary area of focus forus. Again, what we are attempting to do is really take advantage of this windowof opportunity that single cup brewing represents.

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

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

Richard Fearon - Accretive Capital

Okay, well, obviously, that's a terrific opportunity for youall. I was just trying to better understand whether there was some expectationdown 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 aterrific quarter.

Larry Blanford

Thank you.

Frances Rathke

Thanks, Richard.

Operator

We do have a question from the site of Patrick Stowe ofPriority 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 tosqueeze in there. Since we've covered a lot of detailed information, I wonderedif 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 fiveyears as this category grows? Has it been a perceived quality issue? Is itawareness? Maybe if you could just give us a big picture outlook on that, andmaybe if you have any thoughts as to the potential size of this market and howyou might track that?

Nick Lazaris

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

We see the same thing happening with single cup. And thechallenge there, it's been interesting. Keurig has benefited greatly from ourmulti-billion dollar competitors spending hundreds of millions of dollars, orat 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 awareof single cup really aren't truly aware of what the Keurig gourmet single cupsystem 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 TVadvertising and, as Larry mentioned, other forms of marketing research should,I think, help us better understand how to educate people who might feel theyhave awareness of single cup, but really don't appreciate the benefits.

So that's why for Keurig, when we launched in holiday 2004critical to our success was in-store demonstration. When our system isdemonstrated people really understand speed, convenience, taste, how easy it isto use. So I think, as I mentioned earlier, as perhaps other competitors helpeducate, as well, it will be good for single cup. We think single cup has atremendous 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. LarryBlanford.

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 doyour holiday shopping please keep in mind that Keurig brewer makes an excellentgift. Always the salesman. So, again, we appreciate your interest and thank youfor 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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