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Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR)

F2Q12 Earnings Call

May 2, 2012 5:00 PM ET

Executives

Suzanne DuLong – VP, IR and Corporate Communications

Larry Blanford – President and CEO

Fran Rathke – CFO

Michelle Stacy – President, Keurig Business Unit

John Whoriskey – General Manager, Keurig At Home Division

TJ Whalen, VP, Marketing of the Specialty Coffee Business Unit

Analysts

Mitch Pinheiro – Janney Capital Markets

Maria Angallam – Bank of America

Scott Van Winkle – Canaccord Genuity

Mark Astrachan – Stifel Nicolaus

William Chappell – SunTrust

Akshay Jagdale – KeyBanc Capital Markets

Jon Andersen – William Blair

Gregory McKinley – Dougherty & Company

Alton Stump – Longbow Research

Nicole Regan – Piper Jaffray

Operator

Good afternoon and welcome to the Green Mountain Coffee Roasters, Incorporated Fiscal Year 2012 Second Quarter Conference Call. Today’s conference is being recorded. At this time I’d like to turn the call over to the company’s Vice President of Investor Relations and Corporate Communications, Suzanne DuLong. Suzanne, please go ahead.

Suzanne DuLong

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

On today’s call our President and CEO Larry Blanford will discuss the business in the quarter; Fran Rathke, our CFO, will discuss effects of the quarter’s financial results. Larry will then conclude the call with a discussion looking ahead over the next several quarters. Following Larry’s remarks we will open the call to questions from the sell-side analysts.

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

To ensure we have the opportunity to address everyone’s call during the time we have allotted we ask that you limit yourself to one question. We will revisit the queue for follow-up questions.

Finally, I’ll remind everyone that certain statements will be made today which are forward looking within the meanings of securities laws. Owing to the uncertainties of forward-looking statements our actual results may differ materially from anything projected in these forward-looking statements. We can give no assurance as to their accuracy and we assume no obligation to update them. For further information on risks and uncertainties please read the company’s SEC filings and the paragraph in today’s press release that begins with the words certain statements. And now I’ll turn the call over to our President and CEO, Larry Blanford.

Larry Blanford

Thanks, Suzanne, and hello, everyone. We appreciate your joining us today. I’ll remind you that my remarks today are supplemented by additional prepared remarks and slides posted to the investor relations section of gmcr.com

Turning to our second quarter results, we continue to see solid growth driven by consumer adoption of the Keurig Single-Cup brewing system and we were pleased to achieve non-GAAP earnings per share growth of 33% despite lower than anticipated portion pack sales and to a lesser degree brewer sales in the quarter. Still, we were disappointed that our second quarter sales growth fell short of what we forecasted.

We spent many hours working to identify what was or wasn’t responsible for Q2’s net sales shortfall, and have identified a number of possible factors. While we sold 1.4 million brewers in the quarter, our brewer sales were lower than anticipated. Historically clearly brewer sales have proven to be very challenging to predict with accuracy. We believe at least part of the delta between actual brewer sales and our forecast resulted from the fact that as intended we achieved a better in-stock inventory position coming into and through the important 2011 holiday season compared to prior years and consequently did not see restocking demand as strong as we had in previous years.

We also had lower than anticipated portion pack sales in the quarter. We think that the unseasonably warm weather experienced in many parts of the U.S. adversely affected sales of our seasonal beverages such as hot cocoa and hot apple cider. While our sales of seasonal varieties were up over last year, they were not up to the extent we anticipated.

This not only impacted our sales for the quarter but also resulted in a higher obsolete inventory. We are currently examining other factors like consumption patterns, weather-related trends, channel shifts, trade inventory levels as well as customer and partner order patterns to better understand each of those inputs variabilities. Given our dynamic business, we continue to make refinements to our portion pack demand estimates as we work through additional analysis on the quarter and our go-forward expectations.

I’ll pass the call to Fran Rathke, talk to more specifically the quarter’s sales and financial results. Fran?

Fran Rathke

Thank you, Larry, and hello, everyone. I’ll cover a number of key points in my remarks, starting first with quantifying the drivers that impacted sales in the quarter and caused our actual net sales to be lower than our prior estimates. Slower than anticipated portion pack sales represented roughly 70% of the net sales variance in the quarter. Looking closely as portion packs, while seasonal varieties represented only 4% to 5% of total net sales we attribute approximately one-third of the portion pack variance to softness in our seasonal beverages across all channels. Approximately 30% of the net sales variance was related to lower than anticipated brewer sales. Though our brewer unit shipments were lower than we anticipated, point of sale data from NPD which tracks consumer purchases shows 41% growth over the prior-year period.

In the second quarter of fiscal 2012 gross margin declined to 35.4% from 37.5% in the prior year period. The decline in gross margin over the prior year quarter primarily was due to the following: approximately 290 basis points due to the combination of underutilization of our current manufacturing base as a result of lower than expected K-Cup pack demand and the resulting efforts to reduce K-Cups pack inventory which together increased average labor and overhead cost per K-Cup pack. Approximately 170 basis points was due to higher green coffee cost.

Approximately 150 basis points due to a higher write down of finished product and anticipated obsolescence of raw material inventory due to lower than anticipated sales of seasonal and certain coffee products. Approximately 50 basis points increase in warranty expense over the prior year quarter which had benefited from a new program which reduced packaging materials on more insulated brewer.

Partially offsetting this decline in gross margin compared to the prior year was an approximate 390 basis point increase due to net price realization from price increases taken in fiscal 2011 to offset higher green coffee and other input costs and a 90 basis point benefit for recovery under an agreement with a supplier for certain brewer warranty indemnification. I’d not that roughly 50% of the higher obsolescence write down in the quarter was related to hot cocoa and other seasonal products both in raw and finished goods inventory.

Despite the lower portion pack and to a lesser degree, brewer sales in the quarter, we were pleased to have demonstrated good expense control and to have delivered $132.7 million in free cash flow in the quarter. While we expect a combination of our seasonal working capital needs and capital expenditures will prevent us from being cash flow positive for the full year, we believe the quarter’s achievement is worth recognizing. It is too early to call it a trend, but we are starting to see evidence of improved brewer reliability showing up in lower sales return, which allowed us to reduce our sales return rate in the quarter.

Turning to inventories, inventories were $602.1 million at March 24, 2012 compared to $300.8 million in the year-ago period. Included in inventory is $159.7 million or 188% increase in raw materials, most notably from an increase in green coffee volume and a 24% average green coffee cost increase.

In addition, we had a $141.6 million or 66% increase in finished goods inventory with approximately 54% of the increase due to Keurig brewers on hand. You’ll also recall that this time last year we were having trouble meeting orders for both brewers and portion packs. The year-over-year inventory increase reflects our deliberate decision to carry more weeks of portion pack inventory on hand so as to better respond to our customers’ ordering patterns and demand. Specifically, we deliberately increased our portion pack inventory coverage from four weeks to between five and six weeks. Consequently at the end of our second quarter portion pack forward inventory of approximately six weeks is in line with our expectations.

The quarter reflected a small amount of brewer inventory related to the expanding distribution of our new Vue brewer, but brewer forward inventory of approximately 20 weeks was higher than anticipated, primarily as a result of the lower than anticipated brewer shipments in the quarter.

Heading into mom’s, dad’s and grad’s gift giving season, however, we’re not concerned with brewer inventory levels. While higher brewer inventory impacts our working capital short term, given the normal ebbs and flows of brewer shipments we are comfortable with our current brewer inventory. Further, we will be adding to inventory over the spring and summer to get ready for the fall when shipments begin for holiday 2012.

I mentioned previously that brewer sales historically have been choppy and challenging to forecast quarterly. For context around our brewer sales and related trends, we’ve included the slide in our supplemental deck which I’ll walk through briefly. Slide 16 grasps some key brewer related trends over the last fourteen quarters using two sets of data. One, our brewer shipment growth data excluding third party license brewers and two, historic MPD data which we estimate represents 35% to 40% of our retail customers.

The data shows that while brewer shipments are demonstrably choppy, growing anywhere between 16% and 77% over the past two years compared to the relative prior year quarter. MPD data indicates consumer take away of our brewers is fairly steady since the third quarter of fiscal 2010 showing roughly 54% growth on average over the same time period. Supporting this notion, the point of sale data that we receive directly from 90% of our retail customers also shows steady consumer purchase behavior.

What I’d like you to take away from this analysis is that despite what has been and will likely continue to be quarter to quarter volatility in brewer shipments, MPD and point of sale data indicates steady and continued strong consumer purchasing behavior adding to our installed base.

Turning briefly to CapEx before I turn the call back to Larry, the growth of our business requires us to look at the capabilities required to support it both now and in the future. As we’ve moved through the fiscal year we’ve refined our demand forecast and as a result our estimated capital expenditures. For Fiscal 2012 we currently expect to invest a total of between $525 million to $575 million in capital expenditures to support our future growth, down from our prior estimate of $630 million to $700 million. We’ve invested slightly less than half of this total to date.

We expect to allocate the capital approximately as follows: $165 million will be invested to increase our packaging capabilities related to our cured K-Cup brewer platform, $65 million will be invested in packaging capacity related to our View brewer platform, $165 million will be invested in expanding our physical plants, research and development facilities and office space, $90 million will be invested in coffee processing and other equipment and $65 million will be invested in information technology infrastructure and system.

A slide dealing with this information is included in our supplemental slides available in the Investor Relations event section of www.gmcr.com. And now I’ll turn the call back to Larry.

Larry Blanford

Thanks, Fran. Over the last several quarters we have seen a dramatic increase order volatility, which comes, we think, from the dynamic growth of our business, the expansion of brands and varieties in our Keurig Single-Cup brewing platforms and demand shifts between our channels.

In light of this heightened volatility we are focused on more efficiently managing our manufacturing resources. For instance, we are making revisions in the way we plan for an produce seasonal product to mitigate the potential for excess seasonal inventory as was the case this quarter. In addition, in the short term we are looking at smart ways to balance our manufacturing infrastructure with near-term demand. Longer term we are evaluating ways to appropriately staff for seasonality including adding a flexible labor component to our hiring plans.

We continue to believe our manufacturing infrastructure and expertise provides a strategic advantage. We believe that our first mover advantage allows us manufacturing efficiencies and scale to support increasing demand at a lower cost than competitors. Of course we believe our broad and growing intellectual properties portfolio provides some protection against non-licensed portion packs and we’ll continue to seek new patents and to defend existing patents as necessary.

We also believe that we have competitive strength aside from our manufacturing expertise and our intellectual property portfolio that enhance our business and mitigate the potential material impact on our financial position and results operations in the future arising from patent expirations.

For example, we have increasing brand recognition and not only for our Keurig brand, but also of other core brands including Green Mountain Coffee. We were very pleased to learn last week that Green Mountain Coffee was named coffee brand of the year in the 2012 Harris Poll EquiTrend study. Harris Poll EquiTrend indicated that while Green Mountain Coffee may be less well known among consumers than other national brands, it earned the highest quality and purchase consideration ratings within the category.

In addition, with now 30 brands and more than 200 varieties and growing, we’re confident that consumers will continue to find the choice and variety along with the quality and performance they’ve come to expect in licensed products with the official Keurig brewed seal, the only mark of genuine Keurig quality. And what’s more, we believe we are in a unique position to further expand customer choice within the system as a result of our manufacturing scale. We will continue to evaluate the opportunity to add new license brands to the system. Our relationship Eight O’clock Coffee announced today is a great example.

In addition to the potential for new licensed brands in the system we continue to broaden consumer choice by refining and expanding our own brand offerings. For instance we are introducing a line of Diedrich brand K-Cup packs for our specialty retail channel. This product line initially consists of French roast and morning edition varieties and will be augmented with additional new varieties in the fall. We have positioned this new product line to become our new opening price point brand for department store channels.

So let’s talk about private label for a moment. If we look at the broader coffee category in the grocery channel for instance we see that private label has historically represented roughly about 10% of total category sales. We believe this is a reasonable and potentially conservative proxy for the private label potential within the Keurig system. In addition, as we said previously, we are evaluating the potential for licensed store brand private label opportunities.

In doing so we naturally will consider the additional system choice that any particular store brand private label could bring for the consumer in concert with its potential to increase system awareness and brewer adoption. We balance those factors with the value component of private label and the lowering operating margins generally associated with selling these products. We would only entertain license private label opportunities if we believe they create long term value for our shareholders.

Given our scale and expertise in consistently manufacturing portion packs which meet exacting specifications we believe we could likely produce store brand private label portion packs more economically than others with less capacity and less experience and can offer them the use of the Keurig brewed logo, a sign of quality and system performance.

Looking forward, we’re pleased to report we had a great housewares show in March with strong interest in our new Keurig View brewer. Briefly on view, the product became available on our consumer direct websites in April. We are now broadening retail distribution into stores in addition to Bed, Bath and Beyond ahead of moms, dads and grads season with product in store at multiple retailers to support current and planned seasonal advertising. While we are increasing distribution and availability of the at-home Keurig View brewer, we are also working towards a launch of VUE with RFID technology for the away-from-home channel this fall. Initial discussions and product introductions have been conducted with our authorized distributors and reception thus far has been enthusiastic.

In addition, customers have expressed strong support for our spring Brew Over Ice advertising and merchandising. As we did last year, we are running national television advertising to introduce consumers to the Keurig system’s Brew over Ice Beverages. And Christmas, 2012 is pretty much planned with retailers. We’re expecting strong support of both the Keurig K-Cup and Keurig Vue platforms.

On the new beverage front, we’re excited about a number of new products in the pipeline and we’ve highlighted a number of those in our prepared remarks. Of note, we expect to introduce the first in what will be a series of delicious, familiar coffees, cocoas and teas intended to address a variety of consumers’ health and wellness needs.

Finally, we are growing increasingly excited about our joint development work with Lavazza. We believe our efforts are on track to deliver a high pressure espresso system with functionality and performance that will surpass marketplace alternatives as we know them today. And we expect the product will be shipping in limited availability for holiday, 2012.

In summary, we believe we are truly changing the way North America brews and enjoys coffee and other beverages at home and in the workplace. Over the past several years we’ve achieved a strong net sales growth rate driven by consumers’ rapid acceptance of our innovative Keurig Single-Cup brewing system.

Additionally, during this timeframe we made a number of strategic acquisitions that strengthened our long-term position and contributed to our growth rate. Based on the consumer survey conducted on our behalf, we estimate our U.S. Keurig Single-Cup brewer install base has increased to between 10.8 million and 12.2 million brewers in use in households as of March, 2012, representing a substantial increase from where we believe our install base was just one year ago.

As we continue to move forward on the adoption curve, we believe we may experience a more moderated growth trajectory for both Keurig brewer and K-Cup pack sales and our revised 2012 estimates reflect as much. However, given the sheer volume of brewers sold, we continue to expect a significant growth in the installed brewer base. Given our estimated installed base represents a relatively small percentage of the total estimated 90 million U.S. households with a coffee maker we remain enthusiastic about the long term opportunity for continued Keurig K-Cup brewer adoption and portion pack consumption as well as the potential contribution of our recently introduced Keurig Vue brewer.

Operator, we will now take questions from the sell side analysts. As Suzanne stated in the introduction we ask that you limit yourself to one question. We will revisit the queue for follow-up questions. Operator, will you please open the question queue?

Question-and-Answer Session

Operator

Absolutely and thank you. (Operator Instructions) And we do have our first question from Mitch Pinheiro from Janney Capital Markets.

Mitch Pinheiro – Janney Capital Markets

Hey. Good afternoon.

Larry Blanford

Hey, Mitch.

Mitch Pinheiro – Janney Capital Markets

Looking just at sort of the (audio gap) at the third quarter, by my calculations K-Cup growth was sort of matching maybe slightly below your installed base growth. Are you seeing relative to your guidance which suggests that K-Cup units are slowing, is there anything peculiar in the third quarter that is offsetting the system like K-Cups growth number?

Fran Rathke

Mitch, this is Fran. In terms of Q3 our guidance relative to the growth rate last year’s Q3 was exceptionally strong. If you remember we noted for our portion packs for April we had three main drivers of exceptionally strong growth in Q3 of last year. They were first. We really got into moving from four weeks to six weeks of portion pack inventory during the quarter and we were able to really ensure that we met all of our customer orders. In addition, last year was really the first time we put forth a very robust advertising campaign for the spring season. That also got our retailers and customers excited about both Brew Over Ice but also just the whole portion pack opportunity for sales in the quarter.

And then third we also had announced a price increase that went into effect the end of the quarter that we believe did pull, if you will, sales from the fourth quarter customers ordered ahead. So as we move from Q3 last year to Q4, we had a significant drop in terms of growth rate on portion pack, but for the six months it sorted weighted into more of our average growth rate. So I think relative to this quarter that – or Q3 projections, I would say we’re not anticipating a significant decline in the brewer – in the portion packs that we just sold in Q2 but I think it’s more the growth rate is significantly lower because of the prior-year comparison.

Operator

Our next question comes from Bryan Spillane with Bank of America.

Maria Angallam – Bank of America

Thanks. This is Maria Angallam. Good afternoon.

Fran Rathke

Good afternoon.

Larry Blanford

Hey, Maria.

Maria Angallam – Bank of America

In terms of the reduced CapEx guidance, how much of it is motivated by sort of slower growth expectations versus a desire for cash conservation?

Fran Rathke

This is Fran. I would say that we’re working with the supply chain team. Its primarily a response to the – our lower guidance for the year, not so much I think short term cash preservation.

Maria Angallam – Bank of America

Okay. And of the swing factors that impacted your gross margins in the quarter, which ones are expected to affect the balance of the year? I think previously you mentioned that coffee costs should start to moderate, so that should be a tailwind going forward?

Fran Rathke

Marie, this is Fran again. In terms of go-forward impacts on our gross margin relative to this quarter, the first item we brought up in our press release was the underutilization of our plant capacity, essentially. I think we are going to continue to see some of that in Q3 but we do expect – we tend to have stronger portion pack sales starting in the September period especially for the holiday. So I think we’ll still have some of that in the back half of the year. And then in addition we would anticipate a significantly lower charge for the quarter for any obsolescence. We’re obviously monitoring that closely. As we mentioned, about 50% of that was really tied to the hot cocoa sales and the apple cider, the seasonal products, and we don’t usually forecast those sales to be strong during the summer.

And then the coffee costs, we have locked in our coffee cost into Q1 of next year, and I think we’ve had some moderation in the cost but primarily in the fourth quarter. So I don’t think that’s going to be a big change in Q3 in terms of an improvement in margin due to coffee. I think those are the main drivers.

Operator

Thank you, and as a reminder please limit yourself to one question. And our next question is from Scott Van Winkle of Canaccord Genuity.

Scott Van Winkle – Canaccord Genuity

Hi. Thanks. You promise about complexity of the manufacturing and such in the quarter. Is there any thought to rather than taking up the number of SKUs available in K-Cups to bringing that down and make it a little more simple? You have a very broad offering and would reduce everything from mid-forecasting a demand of a single K-Cup to carrying inventory for each of those. How do you go through that thought process to how many SKUs are the right number?

Larry Blanford

Scott, this is Larry. That’s an excellent question. We actually have managed to take out a number of SKUs particularly I would say related to the acquisitions that we made prior to when the companies that we acquired were independent. They were all broadening their product lines. Since acquisition we’ve been able to get very focused on each of the acquired brands, what their fundamental positioning is and their target market, and then reduced the number of varieties so that their very much focused on meeting the target needs of those consumers.

So while we have been on one hand adding additional partners, on the other hand we have been taking out SKUs as we’ve gone along, but certainly the business is a complex one. We are in one sense fortunate that we start in a sense with a very complex company having both brewer technology and CPG technology within the same company. It’s also our challenge. I think what I mentioned in my comments, one other point to your question, is that we’re really focused now very much on manufacturing flexibility and I do think that will also help us deal with the growing variability that you mentioned.

Operator

Our next question is from Mark Astrachan with Stifel Nicolaus.

Mark Astrachan – Stifel Nicolaus

Good afternoon, everybody.

Larry Blanford

Hey, Mark.

Mark Astrachan – Stifel Nicolaus

Trying to figure out while you’re still expecting inventories to increase over the balance of the fiscal year when sales slowed this quarter and are expected to remain weak in both the June quarter and in the September quarter, like from an ability to forecast demand, it obviously seems like you’re stretched.

But I guess I’m just sort of wondering why inventories are going to go up? And then secondly, unrelated, the Vue roll-out has substantially ramped by my check, including product already available at Target, Kohl’s, Wal-Mart and a number of department stores I’ve seen, so I guess I’m curious about how it went from exclusive test at Bed, Bath into this much bigger roll-out quickly? And then I guess I also don’t understand why this is material to results, particularly sales, over the balance of the year?

Larry Blanford

Mark, this is Larry. I’ll get started and others can jump in. I think – I don’t think we said total inventory is necessarily going up, I think we – our comment, I believe, was related to brewers where we said that we would be continuing to add to brewers as we move through the spring and summer, as we traditionally have done, to make sure that we have adequate brewer inventory going into the fall season.

I think we indicated that we had a year ago made a decision to overall increase those forward weeks of portion pack inventory and to the extent that we were – we would maintain that five to six weeks as we would approach the fall, again, I guess the total quantity might go up even though we would maintain the weeks because we typically see a seasonal growth. But I think that, that might help explain that one.

On the blowout of the Keurig Vue, we had not ever had a – necessarily an exclusivity. We had – and as we did follow through with Bed, Bath, we definitely looked at them as our lead partner. And we did lead with Bed, Bath into the marketplace. And then as the availability of Vue brewers manifest itself we then began to roll out to other retailers. And always we wanted to make certain that we had appropriate inventory in our key retailers to support advertising that is planned for Mother’s Day, Father’s Day and Graduation. So – and I’m very pleased with where we are in terms of getting that inventory positioned in all of those key retailers to support moms, dads and grads.

And again even though we’re very excited I just want to emphasize very, very important, the launch of Keurig Vue is to our business in the long term and I’m very proud of the team. It was really a three year forced march to bring that product to market. I think as we’ve said in the remainder of this year, to your third question, this fiscal year we don’t see it being particularly material. Certainly in the long term it’s very, very important to our business.

Michelle Stacy

I think what I would add to what Larry has said, this is Michelle, is that the Vue brewer was extremely well received by all of the retailers and it went out on schedule to all of them in time for moms, dads and grads. I think we always do have to keep in mind that it’s a very premium priced brewer for this year priced at $249.00 and that in and of itself is probably why we won’t see the type of huge brewer sale that you might see at a more lower price point. That’s why it would not be material to this year.

Operator

And our next question comes from Bill Chappell with SunTrust.

Larry Blanford

Hey, Bill.

William Chappell – SunTrust

Good afternoon. I guess help me understand the change on the outlook for K-Cups and brewers in terms of the commentary on moderation and from what you’ve said in the quarter there was some seasonal issues, some other pricing issues. But you’re making a long term as the business is slowing and then we’re trying to couple that with household penetration only being ten to twelve million homes. First help me understand what you saw in the quarter which changed that outlook? And then second, if that’s the case, why not dramatically cut back CapEx? It seems like you’ve been building for a higher trajectory. Why not cut that in half since your primarily building for K-Cups going into next year? Thanks.

Larry Blanford

Bill, this is Larry. I think you had a couple of questions in there. I think related to the demand we certainly, as I mentioned and Fran mentioned, we certainly were able to understand a portion of the demand, our mix against our estimates for Q2 related to brewers and the seasonal products which we learned a lot on seasonals this particular quarter that we won’t forget as temperatures across the country were very, very unseasonably warm and we learned a lot about the fact that hot cocoa is a – is very much temperature sensitive. So a big learning for us and we’ll manage that better going forward.

The rest of the mix, as Fran indicated, we’re still trying to really understand and we have a number of efforts underway to better really understand the overall portion pack demand. And those include consumption patterns of consumers, weather related, did weather in fact cause even some issues with our coffee sales in the quarter, channel shifts that are going on, trade inventory levels, customer and partner order patterns. These are all things – and I’d say also we’ve taken two 10% price increases over the last year. And we’re trying to understand the sensitivity of consumption to pricing as well. So these are all factors. We don’t honestly know to what degree each of those contributed to our mix in Q2, or to what extent they will manifest themselves as we go forward in Q3 and Q4.

We basically determine our sales forecast by rolling up our estimates from our sales organizations bottoms up for the next quarter out and I think the numbers that we have projected for Q3 are from that process. And I think all of us are trying to take into account the – kind of these underlying factors and we’re still trying to understand them. So that’s the honest answer and as we get more information we’ll certainly be able to comment on it. Fran, you want to talk about the Vue?

Fran Rathke

Bill, then as regards to as we continue to refine our estimates, and as Larry said, we’re really looking into a number of factors to get a better understanding as to how to continue to better estimate portion pack demand, I think what we’ve done in terms of our revised CapEx is – for example is our prior estimate for K-Cup portion package lines was around 160 – $225 million, now we’re at $165 million. So we have cut that back. I think we do continue to see, as we noted, MPD data for sample-on brewers throughout the quarter was up 41%. Although our shipment data’s down we do believe that we continue to see very strong interest in adoption at homes for the brewer.

So we have taken down our overall estimates for K-Cup portion packs this year but we still added a lot to the install base. We are mod – I think the work moderating we’ve used over the last few years relative especially brewer growth rates, given we’re hitting we believe large numbers. But as you look at 40% and what is embedded in the MPD data is just about 30% to 35% of our customers are also seeing some of the other customers who don’t report through MPD actually showing higher growth rates of brewers right now through their POS data. So that gives us comfort and some evidence that we’re going to continue to need to manufacture and expand our K-Cup packaging manufacturing base.

John Whoriskey

Could I – Bill, this is John Whoriskey. I just would comment further on some of Fran’s points around the underlying growth drivers on our Brewer business and penetration. If you look at the MPD data last year, basically out of 25 million coffee makers sold the MPD would indicate we’re one in three as we come out of the holiday season.

As we look at the latest quarterly results in MPD we’re growing at over 400%. And as we’re planning – as we start planning out the holiday season with all of our retail partners coming out of the housewares show, we feel very confident that we’re in that range of where we see the future growing. So I think the underlying demand, what’s going to drive, ultimately drive the system in portion pack growth is household penetration and brewer sales. So those growth rates are still very strong.

Operator

Our next question comes from Akshay Jagdale with KeyBanc Capital Markets.

Akshay Jagdale – KeyBanc Capital Markets

Good afternoon.

Larry Blanford

Hey, Akshay.

Akshay Jagdale – KeyBanc Capital Markets

Hi. So Larry, I’m a bit confused here, on the one hand you are talking about introducing new products. You had a really amazing brewer quarter sales last quarter. And on the other hand you’re reducing sales; your stock is showing down 40%. You’ve talked a lot about shareholder value, can you first quantify to me what do you mean by moderated growth trajectory? I mean does that mean we’re going to go from 40% growth that we’re seeing to 10% and 2% and 5%? Can you give us some context? And how much confidence do you have in that?

And then the follow up is what does having as much capacity as you do, what does that do to your profitability given all the moving parts? You got competition, you just mentioned you’re willing to do private label, you’re signing new deals with other companies but you’re not really telling us what returns you’re expecting from that. So clearly there’s a disconnect here between sort of what your shareholders think in terms of value creation and what you’re saying.

You’re telling a good story on the product side but your numbers are telling a different story right now and I just wanted to help bridge that gap. Is this a broken growth model on the top line? Because that’s how the market is viewing this. And then on the bottom line do you still continue to expect profitability to move up despite all the dynamics related to competition? Thanks.

Fran Rathke

Akshay, this is Fran. I’m just going to start on the overall comment about what do we mean by moderating growth. I think clearly the growth rate for Q3, this is just one quarter out, as I noted we had an exceptionally strong quarter last year. So the growth rate in and of itself is going to be much lower. For the year in terms of our projections and our estimates we have updated our year for top line growth of 45% to 50%.

I’ll be it with a very, very strong Q1. That would imply that Q4 is in the range of approximately 30% to closer to 50%. And I think from an earnings standpoint we believe we’ll be growing our non-GAAP EPS at approximately the same rate as sales for the year. Q3 we definitely are not showing in our guidance much growth at all on the earnings primarily that is due to what we’ve talked about we’re really going to be focused on the Vue launch and supporting the moms, dads and grads season.

So we continue to believe we’re going to have some pressure on gross margin next quarter and the higher level of SG&A spend sequentially coming off of this quarter which brings down our earnings. But we believe Q4 based on our estimates will be back to more profits in line with our top line.

And then in terms of the forward forecasts that give us confidence to invest in capital, invest in our business I think we are mindful of looking at our overall returns and we believe as we add new brands and even as we noted today welcoming in Eight O’clock Coffee as well as considering other brands, store brands, et cetera into the system, I think it’s really to continue to allow more consumer choice and have an exceptionally strong system out with all of our customers and our consumers.

Larry Blanford

Yeah, Akshay, this is Larry. I think you’re comment on broken top line is a bit misrepresentation of the situation. I think we are saying that we are looking carefully at all the factors that relate portion packs again to our installed base. We are feeling, as we said, very, very good about the continued consumer interest in this product line. We’re feeling very good about the sale of brewers, our share of total coffee makers and brewers. It’s phenomenal, phenomenal what we have accomplished in these last five years and how we are positioned right now for the future. And we believe that the installed base is going to continue to grow.

All we’re saying is that we need, with this increased, continued increase in installed base to take pause and try to understand more carefully what that rising installed base will generate in terms of portion pack demand. And it might be a bit less than what we have historically experienced; that doesn’t mean we’re going to fall off the fact of the cliff here. So it’s a bit of a pause and we are certainly adjusting our capital expenditures, as Fran mentioned, as we go forward. But this is still a very strong business.

And by the way, on private label as well, we had said previously that we would consider private label, store brands, we would use the same criteria that we used to evaluate other brands. And we’re just, again, underscoring that we’re willing to consider that. We’ll see how that plays out.

But I assure all of our investors we would not do that unless we felt that there was value creation for our shareholders and that the rate of return on pursuing that business would more than achieve our cost of capital therefore creating value. So I think we’re very positive about this business going forward but there’s a lot of moving parts. We continue to invest in our abilities to try to predict it. There’s just a lot of moving parts. And we’ll continue to work at it. But I’m very proud of what we’ve accomplished and I’m very proud of where we are currently sitting as we look forward to the future. Our view is just very important and I’m very proud of the team having delivered it, as an example.

Akshay Jagdale – KeyBanc Capital Markets

Just one follow-up, so what do you think the market is missing then? I didn’t mean to put your comments out of context but I’m just looking at the stock reaction and it clearly implies that it’s a broken growth model and that it’s going to come under pressure.

Larry Blanford

That’s your words, Akshay. It’s not our – I can’t comment on the stock price. We are running this business for the long term. I think we’re making all the appropriate preparations and decisions. I think we have made a series of what has proven to be outstanding decisions over the last five years as we have positioned ourselves to truly be the leader in this category.

We are striving to continue to do that and striving to continue to make all the right decisions for long term competitiveness and I feel we’re doing that. And we’re going to continue to do that and I think the stock price is the stock price. I think it will eventually reflect what I think is a great business that we have built in our building. But I can’t comment specifically on the stock price today or how shareholders are viewing that. We’re focusing long term.

Akshay Jagdale – KeyBanc Capital Markets

Thank you for taking my questions.

Operator

Our next question comes from Jon Andersen with William Blair.

Jon Andersen – William Blair

Good afternoon.

Larry Blanford

Hey, Jon.

Jon Andersen – William Blair

I guess I had another question on the issue of sales variances that we’ve seen. I guess it’s been three quarters now with some significant sales variances on the brewer and K-Cups. It seems to me you’ve lost at least some control of your ability to predict the business here and that comes at a time even before the expiration of patents and potentially some additional competition, as you noted. So why do you think this is? And I guess what can you do or are you doing to try and improve visibility going forward so that we can have more confidence in the outlook?

Larry Blanford

John, this is Larry. It’s a very good question; it’s a very appropriate question. And all I can do is try to give you some perspective on it. This is my seventh public company. I have dealt in trying to predict demand forecast in a number of different businesses, and I would say overall if I look at our – the quality of our processes and the tools that we’re deploying, we’re pretty good. That doesn’t mean we don’t have room for improvement, we do. But this is not like trying to predict a CPG business that has been established for 20 years, it’s growing at GDP plus two. I can do that on a spreadsheet pretty easily. That’s not what this high-growth business has been about.

I would say we’re not losing control, but I would say it’s gotten even increasingly more difficult and I would point to a few factors. One, as we mentioned, we are seeing some fairly significant channel shifts, so we have certain channels that – where the growth has increased significantly and they are trying to figure out how they need to order themselves to manage that growth.

I think certainly we’ve brought on some important new partners, and I think they also are learning this business and learning how to themselves get their arms around demand, and demands by channel and demand by pack size. And so we’ve just got a lot of moving parts. And I think we continue to increase our capability, but it’s gotten even more difficult to put our arms around.

I think over time I would hope that some of this settles out and we become better at predicting the top line. But it’s certainly not for a lack of trying or a lack of investing in people and processes and tools to try to do that. So I wish I could give you more – a better answer. I wish I could give you more confidence.

The honest answer is we’re going to continue to try our best. We’ve missed high and we’ve missed low. The good news is this business continues to grow and continues to increase in the profits that it is generating and continue to increase in, I believe, the intrinsic value of the business, and we’ll keep on working it. I just don’t know what else I can tell you to give you more confidence at this point, but it’s an excellent question.

Operator

Our next question is from Greg McKinley with Dougherty & Co.

Gregory McKinley – Dougherty & Company

Yeah. Thank you. Regarding inventories, if you look at where you sit from a raw-materials standpoint, I think 188% or so in raw materials, how do you feel about the aging of that product as it sets up over the next six to nine months? And does your position there expose you to any potential needs to market down products should obsolescence or staleness become an issue later in the year?

Fran Rathke

Greg, this is Fran. In terms of our raw materials on hand at the end of the second quarter, we, consistent with every quarter and we review the components of what’s in the inventory and whether, if they have code dates or best-used-by dates, we obviously have to analyze what our forward demand forecast is at the time and is any of it subject to a question about is it excess or not. We’ve done quite a bit of that work.

Again, as we noted this quarter, we’ve never really had any kind of significant issue with ABSO. I think this is the first quarter that we’ve really had a purely significant amount. As I said, about 50% of it was tied to either finished goods of hot cocoa or the seasonal products or some of the raw material. So we’d examine that and we feel comfortable that we don’t have any issues with our raw material other than what we’ve prepared for. Most of the raw material balance in the $600 million is really green inventory; and green inventory, what happens in our industry is we procure that, take title to it in the burlap bags, if you will, and this product has a very long shelf life so that we don’t (inaudible) and we make sure it’s stored properly. So I think that has very minimal risk.

Gregory McKinley – Dougherty & Company

Okay. Thank you. And then what was the impact of the change in the sales reserve rate?

Fran Rathke

The impact in the sales reserve rate. Hold on a second. That ended up, just a moment – just a sec – I think the sales – the overall – our rate for sales returns and I’m calculating that by what we had for the expense for sales returns, that’s in net sales, it was 9%, that expense as measured as a percentage of our brewer and accessories sales.

Gregory McKinley – Dougherty & Company

Okay. And what...

Fran Rathke

That compares to last quarter, it was 16%.

Gregory McKinley – Dougherty & Company

One-six?

Fran Rathke

Correct.

Gregory McKinley – Dougherty & Company

Okay. And that’s percentage of brewer and accessory. Okay. Thank you.

Fran Rathke

You’re welcome.

Operator

Our next question comes from Alton Stump with Longbow Research.

Alton Stump – Longbow Research

Yes, thank you. Good afternoon...

Larry Blanford

Hey, Alton.

Alton Stump – Longbow Research

My questions – hi, Larry – have been answered. But just as you look back to the 4 million brewers that were shipped last quarter, was obviously a big number and I think what is most confusing with K-Cups being light this quarter, was just after it had such a huge brewer shipment last quarter, but do you have any evidence that there might have been more at time gift purchases during calendar 4Q? And so that might explain why there wasn’t not the incremental flow through of K-Cups during this quarter? Or is there anything else that you could have or that you have heard that could explain why after that huge number, that we didn’t see better K-Cup flow through?

Larry Blanford

Alton, I think that’s a question that we’re trying to answer. I mean I think the number of brewers that worked their way into the installed base from those sales as they did sell through, I mean we’re very encouraged about nominally the midpoint, 11.5 million brewers now on the installed base and we provided a range around that. But I think we’re feeling very good about the brewer sell through and the brewers that are moving into the installed base. So I don’t think we feel we have an issue there.

I think we’re trying to understand to the extent that we do seem to have a bit of a moderation in portion patent demand. Is there something, again either about consumer consumption? Or response to price? Or all those other factors that I mentioned earlier and we’re working it, we’re working it hard. I just don’t want to go out and communicate that we understand it and then a quarter from now, have to change that. We’re working to try to understand it. I think we feel very good about the brewers sold, the sell through and how they’re moving in the installed base and that installed base keeps growing. So we’ll – I wish I had an answer to your question, but we are working it.

Alton Stump – Longbow Research

Okay. Thank you.

Operator

Our next question comes from Nicole Miller Regan from Piper Jaffray.

Nicole Regan – Piper Jaffray

Good afternoon. One quick one; I was just wondering if you would be willing to commit or comment about that away-from-home market, and the future ability to make money on those machines, versus the at-home market. And then, any trends you have seen or would expect to see in terms of whether pattern to effect the at-home, or excuse me, the away-from-home channel, the same way they do to at-home channel. Thank you.

Larry Blanford

On the away-from-home business, just a quick comment. And Michelle may want to jump in here. But I mean the away-from-home business is still a very important part of our business, both from a strategic standpoint in that it continues to represent a great way for our customers to get exposed to the brewer. But that business does continue to grow nicely in terms of installed brewers. And we do tend to make a bit of money on those brewers. We’ve not articulated what those margins are, but we do make some money on the brewer sales. But we’ve continued to experience very nice growth in the office coffee market as well. And if anybody else wants, or had any other comments. TJ?

TJ Whalen

Sure. Hi, Nicole, it’s TJ Yeah, as Larry said, the away-from-home business on K-Cup portion packs is a steady double-digit growth business. Brewer installations have been very robust this year. Demand is, frankly, a little bit more predictable in the away-from-home environment.

People show up in their office day after day after day, and you can kind of understand how that’s a little bit easier to forecast. That part of our business has also been around longer, frankly. So there’s a much more established base that we’re working off of, and so it’s a little bit to predict than, for example, in grocery, which our portion packs in grocery are up this winter. For example, 90%-plus. And so, while we might have expected that to have been 100%-plus, you know, and it’s disappointing to only have 90%-plus growth.

But the variability is more challenging, and then you compound that with, as Larry mentioned, some of the seasonality of the new products that frankly are in greater concentration in the at-home market. And so, you have a winter like this and you look at, whether it’s tea, hot cocoa or cider, categories frankly being down. And our products are up materially, but they’re just not up as high as we would have expected. So the variability is naturally greater and more difficult to predict than the away-from-home market.

Operator

Our next question comes from Scott Van Winkle with Canaccord Genuity.

Scott Van Winkle – Canaccord Genuity

Larry, you said – you gave us the household penetration. What was the number a year ago and was it measured at the same time using the same rate? I just thought it would have been a little bit higher and I think some other questions allude to that but the comparison would be great.

Larry Blanford

I don’t know exactly what it was a year ago. I think the last time we had reported, which was before our first quarter at the end of Q4, I think we were in the – if I’m not mistaken – I think the range we gave was seven million to nine million, so call it nominally eight million. So we’ve moved from nominally eight million to nominally 11.5 million. But I don’t have it exactly 12 months previous.

Scott Van Winkle – Canaccord Genuity

You said surveys. I’m trying to think how you go about doing that. Is that...

Larry Blanford

We actually feel very good about the survey data, Scott, on brewer adoption. We used an on-the-bus study, a research tool from a major research firm, and they go out and I think it’s, what, a thousand or so interviews?

John Whoriskey

Hi, Scott. It’s John. We have over 40,000 contacts through the research that we’ve collected over time and we’re doing this on a routine basis now. So I don’t want to quote you a number exactly from a year ago today to where we are today because I don’t have them in front of me. But this is a tool now that we continually improve upon and it’s a routine process now that we have in place and it’s a fairly simple question to ask if you own and use a brewer that’s a Keurig system brewer. That’s a pretty simple question to answer, so – and we feel good about the tool.

Larry Blanford

It’s a very discreet choice and it’s either yes or no. You do own – yes or no, you are using – we think we can – we feel pretty confident in our estimates of the active installed base.

Scott Van Winkle – Canaccord Genuity

Okay. Thanks, guys.

Larry Blanford

Okay. Thank you.

Operator

That is all the time we have for questions. At this time I’d like to turn the call back over to Larry Blanford for closing remarks.

Larry Blanford

Well again, I’d like to thank all of you for joining us today and for your continued support in our company. I believe we are managing here for the long term and I’m very confident in the future of the company. I do think the future is very bright. Thank you again.

Operator

That does conclude today’s call and we appreciate your participation.

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