Green Mountain Coffee Roasters (NASDAQ:GMCR) has provided a lot of fascinating action over the past six months. One aspect of the company that bears have been emphasizing is that in September 2012, the patents protecting GMCR's K-Cup will expire, and the resulting competition will result in lower sales and margins. In his now-famous "GAAP-ucino" presentation, David Einhorn of Greenlight Capital, on slides titled "Competition Expected in September 2012" and "The Reality of GMCR's Patent Position," stated:
- Both patents (patent 5,325,765 and patent 5,840,189) are set to expire
- Any aspect of the K-cup that was revealed in either patent falls into the public domain
- Competitors will be able to produce K-Cups
GMCR, on the other hand, paints a very different picture of the patent situation. Here is what they had to say in their 2011 annual report:
In the United States, patents associated with some of our current generation K-Cup portion packs presently used in Keurig brewers will expire in 2012 and/or 2017.
And if you go to your cupboard and look at a box of K-Cups, you will likely see something similar to:
Covered by U.S. Patent Numbers 5,325,765 and 5,840,189 and other U.S. and foreign patents pending.
So what is the truth of the matter - does K-Cup competition show up in 2012, 2017, or later?
The Early Keurig Patents
Two patents are cited above - numbers 5,325,765 and 5,840,189 (sometimes referred to as the "765 patent" and "189 patent", respectively). The US Patent and Trademark Office website is the authoritative source for information on patents. As of this writing, if you search the site for all patents assigned to Keurig, you will get a list of 38 issued patents, with the 765 and 189 patents being the first granted. The 765 patent was filed on September 16, 1992, and issued on July 5, 1994. Patents filed before June 8, 1995 expire 17 years after the date of issue, or 20 years after the date of the application, whichever is later. So the 765 patent will expire on September 16, 2012. This patent covers a lot of the basic K-Cup concept, and can be read at USPTO. It can be difficult to view the patent images at the US Patent Office website, but they can be seen here and here at Google.
The 189 patent is the more interesting one in determining if the K-Cup competition will show up in 2012 or 2017. It was filed on August 20, 1997, and issued on November 24, 1998. Patents filed after June 8, 1995 expire 20 years after the application date. So it would seem that the 189 patent expires on August 20, 2017, giving GMCR another five years of patent protection on K-Cups. But not so fast! There is a sentence in the issued 189 patent that changes everything:
This is a continuation of application(s) Ser. No. 08/527,770 filed on Sep. 13, 1995 now abandoned, which is a continuation-in-part of Ser. No. 08/192,409 filed on Feb. 4, 1994, now abandoned, which is a divisional application of Ser. No. 07/945,746 filed on Sep. 16, 1992 now U.S. Pat. No. 5,325,765.
The "divisional application" wording is what links the 189 patent to the 765 patent, and ties the expiration of the 189 patent to that of the earlier 765 patent. Divisional patents get the same protection period as their "parent" patent. OK, well that clears it up then - the bears are right, and the 189 patent expires with the 765 patent in a few months.
But again, not so fast! There is another key phrase in this chain of applications that seems to have been overlooked by the GMCR bears - "continuation-in-part." Basically, as Keurig (prior to being bought by GMCR) was preparing and filing the 189 patent application, they filed, abandoned, perfected, and re-filed a series of applications, which makes the pedigree a bit convoluted. But at the point where one of the applications was continuation-in-part, they were basically reiterating and perfecting the claims of the original 765 patent, but also adding new features to the original invention. And according to Patent Lens, and some other on-line sources, for continuation-in-part patent applications, the aspects of the invention covered by the parent patent retain the parent patent's expiration date, but any new aspects disclosed get their own period of patent protection, based on the date of the newer application. However, be warned that some sources claim that both patents will share the expiration date of the earlier patent.
So it appears that it isn't quite as clear-cut as the bears would like, and that the parts of the 189 patent that were originally included in the 765 patent will expire in 2012, but the aspects of the 189 patent not included in 765 patent may not expire until 2017. This is consistent with, and also seems to also explain, the somewhat ambiguous "2012 and/or 2017" language quoted above from GMCR's last annual report.
OK, so what does this mean? Is there anything new in the 189 patent, but not in the older 765 patent, that would stop the competition for another five years? There are a number of differences between the two, some are pretty subtle, while others are pretty obvious. To my eye, the biggest addition in the 189 patent, and the one that seems to put up the biggest roadblock for knock-offs, is most easily seen by comparing the figures (found here and here). Figures 1 through 4 are extremely similar between the 189 and 765 patents, in fact almost identical.
These images show something that looks a lot like a current K-Cup, with one glaring exception - the lid. Figures 1 through 4 in both patents show a solid, domed lid, with its own mating flange that appears to fit in to the bottom of the K-Cup. That design doesn't look anything like the K-Cups on my shelf. In fact, I question if something like that would even work in the existing Keurig brewers. The K-Cups that I have seen all have a thin foil top that is attached to the top lip of the lower part of the K-Cup. And what a coincidence, that design first shows up in Figure 5 of the newer 189 patent. That bears repeating - the current thin-top K-Cup design is not shown in the older 765 patent, but is in the newer 189 patent!
Is this difference enough to stop a competitor from making and selling unlicensed K-Cups until 2017? Well, a patent can't really stop anyone from doing anything. So perhaps a more interesting question would be if a competitor made and sold unlicensed K-Cups before 2017, would they expose themselves to a successful lawsuit from GMCR? At this time it is a hypothetical question, but I know what I would do if I were in charge of GMCR's cadre of lawyers. And as discussed in the next section, GMCR has a rich history of utilizing the courts to vigorously defend their intellectual property.
The Patent Lawsuits
Back in January of 2007, GMCR sued Kraft (KFT) for patent infringement regarding the T-Discs used in their Tassimo brewing system. About 22 months later, Kraft settled with GMCR for the right to keep making their T-Discs, to the tune of $17,000,000. While that seems like a modest sum, remember that overall GMCR sales the quarter before the suit was filed were only about $82M, and the Tassimo's market share was (and still is) miniscule compared to the Kuerig system. By comparison, GMCR sales last quarter were $885M, over a ten-fold increase. One can only imagine the damages that would be due with today's sales levels, and if the infringement was directly against the current K-Cup system. As of today, GMCR is batting 1.000 on their intellectual property lawsuits.
Right now, GMCR has two patent infringement lawsuits filed against companies that build cartridges for use in Keurig brewers. The two defendants (Sturm Foods, Inc. and JBR, Inc) each decided to skirt the 189 and 765 patents by creating something that doesn't work like the standard K-Cup, but are still targeted toward Kuerig brewers.
In the case of Sturm Foods, they put instant coffee in a K-Cup-like container and run hot water through it. This doesn't infringe on the 765 or 189 patents, since the cartridge is only comprised of a single chamber (i.e. there are no coffee grounds that need to be filtered out), which is a key aspect of the original patents. Rather, GMCR sued Sturm for violating patents 7,165,488 ("Brew chamber for a single serve beverage brewer," expires December 12, 2023), and 6,606,938 ("Two step puncturing and venting of single serve filter cartridge in a beverage brewer," expires April 1, 2022), among several other complaints over trademarks, false advertising, etc.
JBR, Inc. took a different approach with their product. They produce what is basically a K-Cup that is not sealed on the bottom, with the filter element exposed to the open air. By building a cartridge that is not sealed for freshness, they don't infringe on the "separate chambers" aspects of the original 765 or 189 patents. JBR is being sued for infringing on patent D502,362 ("Disposable beverage filter cartridge," expires March 1, 2019), patent 7,165,488 (as with the Sturm lawsuit above), and patent 7,347,138 ("Brew chamber for a single serve beverage brewer", a continuation-in-part of patent 7,165,488, expires December 12, 2023 and/or August 23, 2024). Patent D502,362 is for an unenclosed design, with the filter exposed like the JBR cartridges.
Patents 7,165,488, 6,606,938, and 7,347,138 are particularly interesting, as they don't cover the cartridge per se, but are geared toward the interaction of the cartridge with the brewer. In other words, they are focused on the intended interface between the cartridges and the patent-protected Keurig brewers. GMCR's hopes for winning these lawsuits were likely buoyed with the recent patent court ruling upholding Nestle's interface patents, and shutting out makers of competing coffee "capsules" for their Nespresso machines. It is worth noting that these three patents would be equally applicable to protecting fully enclosed, divided chamber K-Cup clones.
GMCR has gained a lot of experience in manufacturing K-Cups, and patented a key part of the manufacturing process with patent 6,440,256 ("Method of forming and inserting filter elements in cup-shaped containers," expires June 20, 2020). Creating K-Cups efficiently requires high-speed manufacturing lines, with filter manipulation a key part of the process. GMCR patented the process for creating the filters from two parallel plies sharing a common fold, crimping them for a seal, trimming the wastage, inserting them into the K-Cups, and sealing them to the K-Cup bottom before the coffee is inserted. That's right, this patent even covers heat sealing ("welding") the filter into the bottom of the K-Cup. Any potential K-Cup competitor would need to come up with an alternate manufacturing method that doesn't infringe on this patent.
As noted above, GMCR currently owns 38 Keurig patents. Most of these cover the brewers, and ensure that there won't be any unlicensed Keurig brewer clones until after 2020. Having complete control over the brewer platform provides considerable leverage in the future of K-Cups. For example, if GMCR phases out the older K-Cup brewers and makes a strong move toward their newer Vue brewers and Vue Packs, there are a whole new set of patents covering the brewers and cartridges until well after 2020. And if GMCR stops making K-Cup brewers, it would be pretty pointless for competitors to keep pumping out K-Cup clones for an obsolete system.
The claim that there is an open road for K-Cup competitors starting in September 2012 appears to be a fundamental misrepresentation of reality. Based on the numerous references cited above, it appears that:
- While patent 5,325,765 and parts of patent 5,840,189 expire in September 2012, some key aspects of patent 5,840,189 may not expire until August 2017, depending on the legal interpretation of continuation-in-part expiration dates.
- Based on this, and existing lawsuits filed by GMCR, a third-party unlicensed K-Cup manufacturer would likely be sued by GMCR for infringing on some combination of patents 5,840,189; 7,165,488; 6,606,938; and 7,347,138.
- An unlicensed K-Cup manufacturer that duplicates GMCR's K-Cup manufacturing process would likely be sued by GMCR for infringing on patent 6,440,256.
- GMCR controls the brewer platform patents until well past 2020, and can enforce a transition away from the K-Cup system as they see fit. This would certainly affect potential competitors' willingness to invest in K-Cup manufacturing lines.
So what does this mean for the investor? Well, a big part of the current short-side thinking is that sales and margins will drop this fall, when low-cost K-Cup knock-offs hit the shelves. Given the huge drop in GMCR share price in recent months, the market seems to have already priced in reduced market share and profitability. However, with these patents continuing to serve as a barrier to entry for potential competitors, GMCR's control of K-Cup market appears very much intact.
I am not a patent attorney. If you make investing decisions based solely on the advice of strangers, you will probably go broke. Verify the information presented above, and draw your own conclusions.
Disclosure: I am long GMCR.