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Executives

Suzanne DuLong - VP of Corporate Communications & IR

Larry Blanford - President & CEO

Fran Rathke - CFO

John Whoriskey - VP and General Manager, At Home Division for the Keurig Business Unit

T.J. Whalen - VP, Marketing for the Specialty Coffee Business Unit

Michelle Stacy - President, Keurig Business Unit

Analysts

Akshay Jagdale - KeyBanc Capital Markets

Bryan Spillane - Bank of America

Bill Chappell - SunTrust

Mitch Pinheiro - Janney Capital Markets

Mark Astrachan - Stifel Nicolaus

Scott Van Winkle - Canaccord Genuity

Greg McKinley - Dougherty & Company

Jon Andersen - William Blair

Tony Brenner - Roth Capital Market

Green Mountain Coffee Roasters Inc. (GMCR) F3Q12 Earnings Call August 1, 2012 5:00 PM ET

Operator

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

Suzanne DuLong

Thank you Robert 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 today with the SEC and will not be read on today’s call. These remarks are available as a PDF in the events section under the investor relations portion of our website. In addition, we've also put the slides that summarize and supplement much of the information we will discuss on this call.

On today’s call, our President and CEO Larry Blanford will provide some brief introductory remarks. Fran Rathke, our CFO, will discuss aspects of the quarter’s financial results. Larry will then conclude the call with a discussion of some key business assumptions and our outlook. 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 Gerard Geoffrion, President of our Canadian business unit; Scott McCreary, President of the Specialty Coffee business unit; Michelle Stacy, President of the Keurig Business Unit; T.J. Whalen, our Vice President of Marketing for the Specialty Coffee Business Unit; and John Whoriskey, our Vice President and General Manager, At Home Division for the Keurig Business Unit.

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

Finally, I’ll remind everyone that certain statements that will be made today 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 information. And now I’ll turn the call over to our President and CEO, Larry Blanford.

Larry Blanford

Thanks, Suzanne, hello, everyone. We appreciate your joining us today. Over the past several years, we've delivered extraordinary revenue and earnings growth driven by consumers' enthusiastic adoption of the Keurig single cup beverage system.

Extraordinary growth however can also bring growing pains. And while it's clear that over the last year, our quarterly results have been higher and lower than our estimates. We believe that it's also clear that demand for our products has been strong and growing.

As we continue to meet that demand and become larger, our growth trajectory will understandably moderate from hyper growth levels to something more in line with other successful growth businesses.

But despite this moderation we still expect to drive double-digit earnings growth and free cash flow as we will discuss today. Additionally, we want to be clear that we're dedicated to mitigating what we believe are short-term growing pains.

In fact over the last 90 days we’ve worked hard to analyze the disconnect between our expectations in single-serve pack demand since our fiscal second quarter and have identified effects that might have impacted our outlook. As a result we've made changes to our forecasting methodology that we believe will help us better predict force and pack demand annually in longer term.

Fran will talk more specifically about the analysis and the resulting changes in her remarks. But I would like to note that the disconnect in single-serve pack demand we experienced relative to our expectations was not due to changes in fundamental consumer behavior. Consumers continue to choose Keurig brewers more frequently than other alternatives and therefore adoption of Keurig single cup brewers continues to grow at healthy rate.

More importantly though, our analysis suggest that the absolute number of households using Keurig brewers continues to grow at a rate that surpasses our overall brewer shipment growth rate.

In addition, data from our customers and other providers of point of sale of data, tells us that single-serve pack purchases per installed household reservoir brewer per day have remained relatively consistent since late 2009.

The bottom line is that consumers are very engaged with their Keurig brewing systems and strong consumer driven long-term demand in our view will position us to work through any shorter-term inefficiencies and plant capacity and inventory.

Based on these factors and what we see right now in the business, we believe we will deliver annual sales growth in the range of 15% to 20% with annual earnings growth in the mid teens over the longer term. While the seasonality of our business among other factors including investments in long-term growth may cause our quarterly results to be above or below that growth rate expectation, on an annual basis we are confident in that range.

As we execute against these targets, we will continue to be mindful of our expense structure. We will invest in infrastructure to support our growth and in our brand related spend in order to drive continued platform adoption, but we also expect to continue to leverage G&A. We also will ensure that our capital allocation decisions match our anticipated growth rates.

To that point based on our strong expected fiscal year 2013 EBITDA, our low debt leverage as well as our expectations for 2013 and 2014 pre-cash flow. As noted in the press release today, our Board of Directors has authorized the company to repurchase up to $500 million of its common shares over the next two years at such times and prices as determined by the company’s management in collaboration with the Board of Directors.

When approaching potential buybacks, we intend to be mindful of the balance between share repurchases and longer-term investments, but if and when market conditions dictate, we will be active. Management and the board will continue to review our capital allocation decisions regularly.

Regarding the board, I am pleased to announce as noted in a separate press release earlier today Norm Wesley, former CEO and Chairman of Fortune Brands has agreed to join our Board of Directors. Mr. Wesley's appointment is the first resulting action from an ongoing governance review overseen by the board’s governance and nominating committee to further enhance the skills, experience and attributes of the Board of Directors as a whole and its individual members as the company evolves.

Our Board is now comprised of nine directors, seven of whom are independent. Ultimately we believe we are focused on strengthening the company and our longer-term goal is to put in place the people, processes and systems that will support our industry leadership position. Finally I would like to reiterate that this company’s management team and its Board of Directors is committed to building on what we have done very well as an organization and that is growing a category that still has significant runaway enhancing our connection with consumers through our flagship brands and adding value and solid economics to our partners day in and day out. This will continue to drive in demand in our view and position our company to create shareholder value over the long run. I will now turn the call over to Fran for our continued discussion. Fran?

Fran Rathke

Thank you, Larry. Hello everyone. Our net sales of $869.2 million and non-GAAP earnings per share of $0.52 were in line with the guidance we provided on May 2nd 2012 when we reported our 2012 second fiscal quarter. Before I discuss our third quarter performance, I will review the results of forecasting methodology and trade inventory analysis we recently completed.

Prior to this year's third fiscal quarter, our demand forecasting was based primarily on two approaches. First a bottoms up forecast from the sales organization and second a higher level forecast based on the estimated installed base and a single-serve pack shipment factor that was informed by our consumer surveys.

This implicitly assumes the point of sale transactions as a proxy for consumption and our customers trade inventory grew at a similar rate. In the second quarter of 2012 however, actual single-serve pack shipments diverged noticeably from our forecast despite the fact that the installed base of brewers continued to grow in line with our expectations.

This focused our attention on developing a process that allowed us to examine more closely system-wide point of sale data and more importantly trade inventory levels. Our analysis showed that our prior forecasting methodology which had been accurately forecasting prior-year shipments with capturing sell-through demand and distribution gains.

As we realize success in penetrating our target channels however, these distribution gains naturally started to slow. Our new forecasting methodology takes into account system wide trade flow and tracks beginning and ending trade inventory balances, point of sale transactions and shipments to our customers.

It also recognizes important seasonal sell through differences. We believe this revised methodology will improve our forecasting. Our analysis also showed recent changes in our customer order patterns, first as consumer purchases began to meaningfully shift to more inventory efficient customers such as grocery, mass and club from specialty retailers and department stores, those latter channels have begun to adjust their inventory levels and order patterns accordingly.

Second, our customers first our customers built their trade inventory levels in our fiscal first quarter 2012 for the holiday season. And we believe due to the past concerns related to capacity constraints. Since we've resolved our capacity constraints customers have recognized they can order with confidence in our ability to ship to match their anticipated demand and in some cases have lowered their forward inventory coverage.

Our analysis shows that currently our at home customers trade inventories are at appropriate level. The point of sale data which informs our new trade flow methodology shows that sales per brewer has remained relatively consistent since late 2009.

Our new trade flow forecasting factor is about 20% less than our previous shipment factor. Turning back to our Q3 results, I will touch on several of the key metrics prior to reviewing our guidance. Gross profit for the third quarter of fiscal 2012 was $303.3 million or 34.9% of net sales as compared to $264.1 million or 36.8% of net sales in the prior year period.

Unfortunately, our prior demand forecast assumptions led to what we believe is the temporary under utilization of labor and capacity which primarily played out in our fiscal second and third quarters and will also affect our fourth quarter as our guidance suggests.

However, we expect these issues to be largely resolved over the remainder of the fiscal year at which time labor and capacity will be better aligned with consumer demand. Rather than go over the highlights of the various factors for the decline in this quarter’s gross margin as compared to last year’s gross margin, please refer to today's third quarter earnings press release for this information.

Turning to operating expenses, as a percentage of sales on a non-GAAP basis, SG&A improved slightly to 18.3% in the third quarter of fiscal 2012 from 18.4% in the prior year period as we leveraged G&A expenses on a higher sales base.

In general, we are doing a good job managing our G&A expenses in line with our growth. The increase in SG&A over the prior year period is primarily attributed to additional $17.7 million of advertising, promotions and certain marketing expenses including costs associated with the roll out of our new Vue platform.

$3.9 million of additional salaries and related expenses and $2.2 million of legal and accounting expenses associated with the SEC inquiry and pending litigation. Inventories were $667 million at the end of Q3 compared to $417.5 million in the year ago period. Included in inventory is a $126.1 million, 108% increase in raw materials most notably from an increase in green coffee.

In addition, we had a $123.4 million or 41% increase in finished goods inventory, all due to an increase of Keurig brewers on hand.

Inventory of single-serve packs was down 7% over last year’s third quarter inventories. Sequentially, single-serve packs inventories declined $33 million from our second quarter amount as we focused on reducing our weeks on hand to our target level of approximately five weeks.

At this point, we're pleased to be at our target level of single-serve pack inventory at the end of our third quarter.

In today’s press release, we've provided additional detail on inventory and its components. As we have for the last several years, we have deliberately begun to build brewer inventory during fiscal Q3 and we will continue to do so during fiscal Q4 to ensure we’ve adequate brewer supply to meet fall shipments for holiday 2012.

Overall, although we always work towards inventory efficiency, when we're talking about brewer inventory, efficiencies are trumped by the need to meet consumer demand during the holiday season.

During last year’s holiday season, according to NPD, Keurig Brewers represents 34.8% of all coffee and our espresso makers unit sold from October to December. Because of the time it takes to ship brewers to the US from our contract manufacturers in Asia, we must have on hand all of the brewers we expect to sell during holidays by early October to ensure availability on retailer shelves. It is this timing dynamic that necessitates that we begin building brewer inventory starting in Q3 toward anticipated demand.

Turning to our outlook for fiscal fourth quarter 2012, we anticipate total net sales in the range of $889.9 million to $925.5 million or net gross of 25% to 30% from $711.9 million in the fourth quarter of fiscal 2011. We anticipate fourth quarter 2012 non-GAAP earnings per diluted share in the range of $0.45 to $0.50 per diluted share, excluding the non-GAAP items as noted in today's press release.

Last year's fourth quarter tax rates were 23.7% that’s compared to this year's fiscal 2012 year-to-date tax rate of 37.7%. The lower fiscal 2011 fourth quarter tax rate is primarily attributable to the release of valuation allowances related to $17.7 million capital loss carry forward and a $5.4 million net operating loss carry forward in the fourth quarter of fiscal 2011.

We anticipate the fiscal 2012 fourth quarter tax rates to be similar to the 37.7 year-to-date tax rates. For fiscal 2012, we anticipate total net sales in the range of $3.79 billion to $3.84 billion or net gross of 43% to 45% from $2.65 billion in fiscal year 2011.

Fiscal year 2012 non-GAAP earnings per diluted share in a range of $2.21 to $2.26 per diluted share excluding the non-GAAP items as noted in today's press release.

In terms of 2013, our guidance assumes our brewer installed base continues to grow and makes assumptions for the entrance of additional unlicensed single serve tax and increases in the percentage contribution from value priced offerings with our tier brand portfolio and pricing structure. For fiscal 2013, we anticipate total net sales growth in the range of 15% to 20% over fiscal 2012.

Fiscal year 2013, non-GAAP earnings per diluted share in the range $2.55 to $2.65 per diluted share excluding the non-GAAP items as noted in today's press release. As you think about the full year guidance, I note that it incorporates our expectation of increased brand spend in fiscal first quarter behind new products this year compared to last year.

This is a necessary investment that will likely put pressure on our earnings per share for the first quarter despite regaining some ground relative to under utilization of our manufacturing capacity. One last point on guidance, while we expect to refine or revise our outlook as needed, next year we will opt to address four [tier] on our fourth quarter call as compared to this year's third quarter.

And our desire to be as accurate as we can be, we think the extra time can only benefit the process. Turning briefly to CapEx before I turn the call back to Larry, with a couple of months left in this fiscal year, we slightly refined our fiscal 2012 CapEx requirements. We expect we will invest a total of between $475 million to $525 million in CapEx in 2012, down from our prior estimate of $525 million to $575 million.

The decrease is largely attributable to our revised revenue and profitability assumptions. The reduction improves our cash flow outlook for the year, but the combination of CapEx and anticipated seasonally driven working capital needs will cause us to have slightly negative free cash flow for fiscal 2012.

For fiscal 2013, we currently expect to invest $380 million to $430 million in CapEx and are forecasting free cash flow in the range of $100 million to $150 million. Incorporated in our fiscal 2013 cash flow assumptions is the expectation that our capital investment as a percent of sales will be at a lower level compared to 2012.

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

Larry Blanford

Thanks Fran. I would like to offer additional context around the assumptions underlying our guidance and comment on why we believe we will continue to grow the opportunity for brewers and single serve packs.

Let's start with the consumer; fundamentally, growth in the installed base of Keurig Brewers is happening as expected. And K-Cup pack sell-through rates are stable. At the end of our fiscal second quarter, research conducted on our behalf indicated we had 10.8 million to 12.2 million brewers active in US households representing a relatively small percentage of the estimated 90 million US households that have coffee maker of some kind.

Interestingly, the growth implied in our installed base correlates to information from the National Coffee Association which in its recently published 2012 National Coffee Drinking Trend Study noted that the consumer adoption of the single-cup brewing format continues to increase. The NCA report notes that ownership of single-cup brewers increased to 10% from 7% in the prior year. Despite quarter-to-quarter fluctuations in brewer shipment, NPD and point-of-sale data correlate with our own point-of-sale data and indicate strong and steady growth of our installed brewer base.

For the three month period ending June 2012, NPD reports that with growth of 47% over the prior year, sales of Keurig branded brewers continue to fuel coffee and espresso maker category dollar sales growth. Keurig branded brewers continue to demonstrate strong unit share growth, increasing share of the category to 24.7% of total units from 16.6% in the same period last year. Importantly, Keurig branded brewers were the top four selling brewers in the category by dollar share for the period.

Our new Keurig Vue platform is performing in line with our expectations as we’ve stated previously will not be material -- as we've stated previously, it will not be material to our performance in fiscal 2012. In its first partial quarter of sales, NPD notes that Vue came in seventh in dollar sales in the overall brewer and espresso maker category and was the best selling brewer in its price range by two times that of its closest competitor.

This is a great showing given its initial $249 price point and effected sales as tracked by NPD didn’t begin until late April of 2012. That said, we believe the appeal of the Vue platform will widen as we move forward with our previously announced intentions to introduce models with lower price points in fiscal 2013.

As a variety of patented Vue packs increases and as we are able to introduce Vue brewer models with lower price points, we do expect that overtime consumers may naturally migrate from the K-Cup platform to the Vue platform, because we believe that the Vue platform offers enhancements in delivering a better cup of coffee and provides more beverage options over the longer-term. That said, we expect to continue to support and innovate in both systems for sometime.

The steady Keurig Brewer adoption rate we've seen combined with research conducted on our behalf by the Cambridge Group, a wholly owned subsidiary of the Nielsen Company has helped us estimate the addressable opportunity for single serve filtered coffee platforms.

Consequently, we now estimate the size of the addressable single filtered coffee brewer opportunity to be approximately 35 million brewers in the U.S. by the end of 2016, which is more than three times our estimated installed base, which you will recall was roughly 11.5 million active brewers in U.S. households as of the end of our fiscal second quarter.

We believe that by the end of next year, our installed Keurig Brewer base in U.S. will be approximately 17 million and growing to roughly 25 million brewers by the end of fiscal 2014. This is incorporated into our fiscal 2013 guidance along with some realistic assumptions about competitive dynamics including potential single serve pricing pressure as well as considerations associated with driving Vue adoption.

So to follow-up on Fran’s comments on guidance, we strive to be as accurate as possible when providing an outlook. As we sit here in August of 2012, our guidance has factored in both our marketplace leadership and changes to the competitive landscape.

With that said, we believe our outlook is realistic, but there is leverage in our business in either direction. So in our guidance we have identified a number of risk factors as Fran referenced that bring us to the mid-teens earnings growth rate. Should those risk factors vary materially from our assumptions, we will adjust our plans and actions accordingly. But again, we don’t expect that.

We’ll obviously no more as the year unfolds, so let’s talk about how we see our opportunity evolving. As I just noted, we believe that growth in sales and system wide single serve packs will generally follow the growth in the installed base of brewers’ overtime. There are several reasons why we believe this including analysis that shows that consumers K-Cup pack consumption habits are largely unchanged overtime and data that shows no significant difference in the behavior of new adopters versus earlier ones.

With two of the several patents associated with K-Cup packs expiring in September 2012; we have anticipated for some time that unlicensed brands or manufacturers will look to take some share of future K-Cup packs. Some have already announced and others may, but our view of the likely impact on the broader opportunity has not changed and will take time to develop.

So at this point, we are assuming that the total of all unlicensed K-Cup packs will represent roughly 5% to 15% of the system starting at the lower end of the range in 2013 and potentially increasing towards the top end of the range as we look two to three years out. Although, unlicensed participants will likely pose competition, we believe we will continue to be the leader in single serve beverages for several reasons.

One, our believe in the strength of our broad licensed brand offering, with 30 brands and more than 200 varieties at a range of price points and growing, we are confident that consumers will continue to find the choice and variety along with the quality and performance they have come to expect in licensed products with the official Keurig brewed seal. We also add value to our partners’ everyday as evidenced by the full term introduction of Folgers and Starbucks brands into our Vue platform this fall which adds further strength to these multi-year relationships.

Two, the significant manufacturing expertise that we enjoy which allows us to leverage economies of scale to support increasing demand.

Three, GMCR is uniquely positioned to continue to expand consumer choice within the system including the potential for adding premium store brand or co-branded single serve packs to the system produced by GMCR. We believe our broad and joint intellectual property portfolio will continue to offer important protections against non-licensed single serve packs and as we have demonstrated, we intend to defend our intellectual property.

Finally, and perhaps most importantly, we are continually innovating as a license participant of the system. Our partners are in a position to take advantage of future single-serve pack and brewer developments and innovations.

As it relates to unlicensed single-serve pack competition, our stance on private label has been consistent. First, the consumers have clearly demonstrated, they will pay a premium for great tasting coffee, clearly establishing coffee as a brand driven category. Research has shown, this is particularly the case with Keurig consumers. As a result, we continue to believe that roughly 10% of total category sales in grocery and mass represented by private label is in traditional package coffee is a reasonable proxy for the private label potential within the Keurig system.

As we have with named brands, we will evaluate the potential for strategically licensing store brands based on the brands’ ability to expand awareness and adoption of the system. Importantly, where we are seeing unlicensed private label products appear on the shelf, they are most often appearing as customers are expanding available space for the category including significant commitments to our brands and offerings.

In other words we have no indication that store brand products will crowd our licensed or own products. There's obviously speculation that our efforts to expand the demographic reach of the system and/or the emergence of new unlicensed portion packs will adversely impact pricing and the margin structure within the system.

While we have factored in a shift to a higher percentage of value offerings in our product mix with lower average selling prices and EBIT margins, here's why we think that shift will be manageable. Within the licensed brands of the system, we already have taken steps to create a tiered brand and pricing structure ensuring that we provided a range of options for consumers whether they are brand conscious or value oriented.

For brand conscious consumers, the variety and range of specialty coffee brands in the Keurig system is unmatched. For value oriented consumers, we've created price points to appeal to their sensibilities and our offerings to these consumers are likely to continue to expand as the system demographics expand.

In addition to the potential for adding new license brands in the system, we continue to broaden consumer choice by refining and expanding our value brand offerings. For instance last quarter we introduced a line of Diedrich brand K-Cup packs for our specialty retail channel and in the fall, we will launch Eight O'Clock brand K-Cup packs under our license agreement in grocery and mass channels.

Both of these brands are positioned to appeal to the value-conscious consumer and will be positioned at the opening price point in the respective channels. We also continue to build consumer awareness and understanding of the Keurig brewed logo as a symbol of quality and fit for use for today's or tomorrow’s improved Keurig branded brewers which will only be available to our licensees and partners. In short our guidance factors in the competitive dynamics that we expect to face.

Before I conclude my remarks, let me spend just a few minutes on some of the things we are excited about. Make no mistake our short-term priority is mitigating the effects of the growing teams I referenced at the beginning of my remarks. The bigger picture, we continue to believe we have an exciting opportunity moving forward.

First, we continue to see opportunity for long-term growth in a number of adjacent spaces along three primary axes, beverage categories for our current systems, the second would be new channel applications for current technology platforms and finally a third leveraging the power of the Keurig brand in new systems that target adjacent beverage categories.

I will touch on each of these briefly. In adjacent beverage categories, for our current systems we are excited about our new Vitamin Burst, brewed over ice products as well as Sweet & Creamy brewed over ice coffees. Vitamin Burst, Ice Fruit Brew vitamin-fortified beverage is the first in what we expect would be a series of wellness brewed beverages.

As for the pursuit of adjacent channel applications for our current systems we are moving forward with our plans to debut, Keurig Vue platform for the away from home channel this fall. The away from home Vue incorporates the use of RFID technology on the single-serve packs providing for optimum user experience, even for users that maybe unfamiliar with our brewer and its numerous customization options.

Of note, RFID is not the only interactive technology we're exploring in our efforts to continually improve the total Keurig consumer experience on both brewing platforms, at home and away from home.

As for new systems that address adjacent beverage opportunities, the first example is our ongoing joint development work with Lavazza. We remain on track to deliver our Keurig branded high pressure espresso system and Lavazza espresso based beverages in limited availability for holiday 2012 and we’re confident this system's feature and functionality will deliver superior beverage to current market place alternatives.

In closing, on behalf of the entire management team and Board of Directors, I would like to reiterate our unfaltering belief in the company and our opportunity. We feel confident in our outlook and we'll execute our plan in a way that stresses efficient capital allocation and a focus on earnings, free cash flow and building in what we see a sustained consumer demand for our products.

Operator, we’ll 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 open the question queue please.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Akshay Jagdale of KeyBanc Capital Markets.

Akshay Jagdale - KeyBanc Capital Markets

Thank you for your extra disclosure on your long-term algorithm. It's very helpful first of all. So thank you for that. My question is regarding your long-term growth projections. So it looks like you're saying the installed base is going to grow at 20% plus for the foreseeable future. You're saying K-Cup attachment rate per brewer is stable since 2009, your sales growth guidance is somewhat in line with that top line projection, but your EPS growth is lower.

So, I know you've talked about a lot of risk factors, which you're incorporating, but can you conceptually just elaborate on that? Why shouldn't EPS growth exceed and maybe even exceed by a wide margin in your sales growth, given you can leverage the G&A on this growing sales pace?

Larry Blanford

Yeah, Akshay, that's an excellent question particularly given that our history has been in fact to do that. But I would just go back to my comments in the prepared remarks where I tried to deal with a number of the factors. We've run a number of scenarios and have tried to be very realistic and prudent in our assessment of the various factors that I did mention such as the potential for unlicensed private label or other manufacturers' brands.

And potential margin pressure on the system with the enhanced competition. Also the rollout of Vue, I would remind you, while we're very excited about the rollout of that product as we've indicated on previous calls, it's going to take us 18 to 24 months to kind of come down to the manufacturing scale curve and get the economies of scale to improve our margins on that product.

And while not material this year, we do see Vue as we introduce additional brewers at lower price points beginning to grab hold as we move into -- not this holiday season, but next holiday season. So, when we kind of put all of that together and try to sit back here in August of 2012 and take what we believe is a realistic and prudent view, we come out with the estimates that we have provided.

Clearly Akshay, there's a lot of leverage in the model both ways. And yes, our feeling is and as we've looked at various scenarios, we've identified a number of actions and initiatives that we might take going forward depending on the competitive landscape that we find ourselves in.

Operator

And we will take our next question from Bryan Spillane of Bank of America.

Bryan Spillane - Bank of America

Just a question about the guidance for 2013. I think if I assume you execute about half the share buybacks for fiscal 2013, it implies that EBIT margins would contract. So I guess you know when I look at 2013 first our share repurchase is actually incorporated into your EPS outlook for next year.

And then also in terms of that implied margin contraction, how much of that is just SG&A spending versus some outlook on gross profit, the negative effect of having may be some margin degradation on K-Cup?

Fran Rathke

Just to point out when we provided the guidance for EPS for next year it does not factor in any anticipated company share repurchases. So that's not in there. So as we plan to execute that we will provide actual repurchase date in our queue and then we will update you know what that meant for EPS. So that's not in there. And then to your point about just overall trend for ’13 I think as Larry said I think we've worked very hard to put together a series of scenarios for next year. We believe these are very much realistic and I think overall as I noted in my remarks, we are going to see the business grow into the capacity and we will start improving overall the gross margins as we head into the early part of next year from what we've been experiencing Q2 and Q3 and what we expect for Q4 this year.

Bryan Spillane - Bank of America

I suppose in terms of that margin you've got some tailwind on green coffee costs which should offset if there's going to be some promotion or price reduction there's going to be some tailwind benefit from green coffee cost coming down?

Fran Rathke

That's true, we've got at least, we definitely will begin to see some benefit from lower coffee cost sequentially each quarter I mean we notably had slightly better or improved lower coffee cost this year third quarter versus last year’s third quarter we are going to continue to see slightly lower in Q4 and especially as we head into the first half of ’13. So that is factored in.

Operator

And we will take our next question from Bill Chappell of SunTrust.

Bill Chappell - SunTrust

Maybe just help me a little more clarity on CapEx and I am just trying to understand the lower expectation with this year and your outlook for next year, was there some push out and is that in line with kind of your 15% growth projections and I say that just because this year will be up 57%. I am just trying to understand when you kind of get the optimal capacity?

Fran Rathke

Bill, this is Fran. In terms of the fiscal ’12, where we anticipate you know, closing out the year in the range of 475 to 525. So far we spend about for the first nine months, about $300 million to $350 million when you add in what's still in our [APN] if you’re looking at statement in cash flows. So we anticipate this fourth quarter to be a heavy CapEx quarter and that’s fairly typical with us because we really go to get the capacity online for the anticipation of the demand coming from post to holiday season as well as during the holiday season. So I think in terms of modification from the prior guidance for ’12. You know, we are fairly similar. We took it down somewhat mostly in the packaging line area and I think for ’13, when we look at ’12 for example where we said we have an investment year especially in the manufacturing lower space and copy processing essentially to because we run out of space and we really needed to gear up for that this year in ’12. So we see that come down a bit in ’13 and I think as a percentage of sales, our CapEx is going down from our estimate for ’12 about 13% of sales, down to more like 9%, albeit its not as low as it was, you know, in 2008, 2009 at about 6% of sales but its definitely coming down quite a bit from ’13 and I think we continue to invest in our new technology platform such Vue, we also have a number of other innovative platforms where looking in to it as well.

Bill Chappell - SunTrust

So just a follow up. Longer-term, do you think getting back to sixth is kind of the target?

Fran Rathke

Well, I think if, I got data in front of me, like the fiscal ’09 we were at 6% and then '10 we were at 9% and 11%. This year we think we’re going to end it 13 and the next year, 9%. I think the key was the capital is to drive, enable us to drive our growth for you know, for the future. I think on the other thing of note in the prior years when we started kind of ramping up as we bought the licenses. We then became the sole manufacturer of the portion pack. So it was a bit of step up there as well. So I think it will start to come down but I can’t tell you that exactly 14, it comes down to 6, but I think it will start trailing down a bit.

Larry Blanford

This is Larry, just also real quickly adding to that, I mean the engineering manufacturing teams are very sensitive to capital expenses, and particularly on Vue, which is as we look to the future, a fair amount of our capital will go. They’re working very, very hard to reduce the capital required for each packaging line. And so you can imagine the first line to be developed just fairly expensive and we’re already seeing some significant progress in combining unit operations and getting that overall cost down, but there is a lot of work to be done on that, but that will help us as we go out over the next few years as well.

Operator

And we will take our next question from Mitch Pinheiro of Janney Capital Markets.

Mitch Pinheiro - Janney Capital Markets

So just a follow-up on Bill’s question and Larry you sort of said regarding Vue capital spending next year of the $400 million or so where is it the majority or can you frame that in anyway?

Fran Rathke

Mitch its Fran. I think as we do have investor slides too by the way in our press release. I think we note that Vue portion packs for this year it’s about $65 million I think as we look towards next year its anticipated being north of the $65 million as we continue to build up that installed base. I wouldn’t say it’s half but it’s definitely moving up from 65.

Mitch Pinheiro - Janney Capital Markets

Okay. And then when you look at my question is just on brewer growth for this holiday and actually the coming year. How should we think about that when you are selling 8 million brewers or a lot more than a third of all the units that are out there I mean are you are we now at the point where year-over-year brewer sales basically sort of flatten out and obviously they are incremental for the installed base and then within that how would you think about the percentage of brewers being Vue versus the existing system next year?

Larry Blanford

Mitch, this is Larry our may be I get started in others can jump in. In terms of the estimate of the installed base brewers that we referenced as we were talking about at least US marketplace, the numbers that we discussed in our remarks would not require actual increase in the brewer sales growth. So very importantly even as brewers would flatten in terms of year-over-year, the installed base continues to grow fairly significantly. So you know that conceptually how we are thinking about it again you know could be might get a some upside on that but that's kind of how we are thinking about at least the first quarter of our next fiscal year which of course is very important to us.

John Whoriskey

This is John Whoriskey. I would just comment I think if you look at the NPD data for the latest quarter you will see that we continue to grow after reaching a level, our share is up 44% in the most recent quarter. So how our expectation is still continued growth as well but it will flow overtime and I would just say going into the holiday season with all of our key retailers again we are going to be the featured brand in the appliance section again this holiday and we expect to continue increases in advertising and merchandising support for the holiday so we are expecting very strong sales for this Christmas.

Mitch Pinheiro - Janney Capital Markets

And how does the Vue, I mean what kind of what would be the mix of Vue brewers next year?

Larry Blanford

Yeah Mitch, I don't think we are prepared to speak to that right now. We certainly would expect that Vue will continue to gain marketplace acceptance as we go through the early part of fiscal ’13. We are going to be spending behind that platform this Holiday Season, so as we do advertise in our important Holiday quarter, you will see advertising both for the Keurig K-Cup platform and the Vue platform.

But I think then it will be after we introduce the lower price points which we’re targeting for mid ’13 to or prior to anyway the next year’s Holiday Season before we are really going to have a good handle on what we think that split will be. We are running a number of scenarios and trying to make sure that we prudently assess that situation, but not ready to yet give you a mix on the split.

Operator

And we will take our next question from Mark Astrachan of Stifel Nicolaus.

Mark Astrachan - Stifel Nicolaus

You gave some assumptions of fiscal 2013 guidance, what are your expectations for K-Cup price reduction, increased competition and then slotting fees that you are going to be paying? Also, what is the specific EPS benefit next year from lower input cost and then its sort of related, continued CapEx increases next year, what is your anticipated K-Cup, the half utilization rates?

Larry Blanford

Yeah so Mark, this is Larry; we are not going to breakout the specifics at this point with regard to those factors. We will be positioned to maybe talk about them more as the year goes on. I do think though I would just bring you back to our comments where we did address all of them and those factors are all baked into the estimates that we are providing for fiscal ’13.

Your last question I didn't quite pickup?

Mark Astrachan - Stifel Nicolaus

What is the specific EPS benefit from lower input costs and then the capacity utilization rate with the CapEx increases?

Fran Rathke

Mark, this is Fran. We don't typically disclose capacity utilization rates. We just noted again that we’re going to continue to have some pressure in Q4 due to underutilization and then as we head into the beginning of fiscal ’13 we are going to definitely be improving those utilizations as we see increased demand.

Mark Astrachan - Stifel Nicolaus

Is there any help on the input cost piece like ballpark how big of a benefit it is?

Fran Rathke

We’re not breaking that out separately. As we said, overall next year we see an improved gross margin percentage from where we ended in ’12, but we’re not giving out guidance on that.

Mark Astrachan - Stifel Nicolaus

What about the amount of K-Cup capacity you have planned for next year?

Fran Rathke

We don't disclose that; typically, we've been able to meet our capacity, as we said, we started to build in extra capacity because of the projections, we headed into this year with and we’re going to be growing into that as we head into next year. So typically we try to ensure that capacity is in place for the next anticipated 12 months or so.

Operator

We will take our next question from Scott Van Winkle of Canaccord Genuity.

Scott Van Winkle - Canaccord Genuity

You know, first of all, back to Akshay’s comments about the quality of the content of this call, as it’s the best span in years. So thank you for that. I have lots of question, I may have to pick one; I guess I just wanted to dig in to the channel shift and we can all see what's been happening with the shift from specialty in the supermarkets and you know, even some of the build-up and placements of SKUs for the holidays and the full back post the holidays for those mall based retailers.

But it’s hard to gauge how significant it is from the outside, because we don't know the channel mix; I mean can you ballpark this and just give us an idea how meaningful without naming any customers obviously, that the channels there would be obvious to loose share in the long-term to supermarkets, mass, club or people shop normally for coffee, how significant that is as far as the mix?

Larry Blanford

Yeah, this is Larry; you know, here is kind of how I would size up the situation. Certainly, as the K-Cup platform has continued to expand it's demographic reach and the overall system adoption has grown, then obviously there was both the opportunity and consumer demand to be able and desire to be able to purchase portion packs that where they normally do their grocery shopping. So we've had obviously over this last 18, 24 months some very significant expansion of K-Cup portion packs to those types of retail entities and indeed that expansion will continue a bit here as we go into the Holiday Season.

But the opportunity for our traditional department store based retailers is to now really get behind the Keurig Vue platform and I think it will be some time before the overall installed base of Vue brewers is efficient to want, even thinking about grocery distribution just to help those on the call, I mean it was a number of years after we went into the at home market with the Keurig K-Cup platform that we ultimately did introduced portion packs into grocery and we have talked before about sequencing cadence, sequence kind of how we think about introducing these new platforms by channel and retail or cadence how kind of quickly they grow. And I will just suggest, you will see the same thing on the Keurig Vue platform.

So our retailers are very important to us; our department store retailers are very important to us still today on obviously selling K-Cup brewers and K-Cup portion packs, but they have a tremendous opportunity here to drive the Keurig Vue platform.

Scott Van Winkle - Canaccord Genuity

Okay. And follow-up on last question about, Fran I think you answered my questions about growing into capacity on K-Cups next year. Do you also grow into your G&A spent?

Fran Rathke

The G&A, I mean we’ve been I think Scott overall we have been doing I think a good job about managing G&A and showing continued leverage there. You know I think we continued the need to invest in people and systems and processes to run the business, but I think overall we continue to see as we look out with the growth we are seeing you know continued leverage on G&A.

Larry Blanford

I was just going to add, historically we’ve grown brand spend in R&D at about the same rate of as our sales growth and we’ve leverage nicely general and administrative expenses. I think what we are facing here as we look at the first quarter, clearly as we mentioned we got a make sure that Keurig Vue gets appropriate support and we also as we mentioned are launching the third platform with Lavazza which will also take some support. So in the near-term we are, while we still leverage G&A, we are going to see some increase in brand spend that is necessary to support these new products.

Operator

We will take our next question from Greg McKinley of Dougherty & Company.

Greg McKinley - Dougherty & Company

I wonder if you could talk a little bit about your initial experience with your price ratification with the K-Cups; anything surprising you there in terms of consumer behavior trading down from mid to higher price brand into more entry level brand. And based on what you are seeing there how does that in front of you for sort of price realizations driven growth in 2013 versus 2012.

Larry Blanford

I will start and maybe T.J. can jump in. I think we've been working hard here for some time to tier our pricing. When we first rolled K-Cup portion packs out broadly, we actually were single lining our price meaning they were all sold at the same price. And we've worked hard down, I think we have approximately six tiers out there today and I would say that a lot of work to get that done, but very much accepted by our retail trade and grocery trade.

And I think it’s a little early to declare victory, but we are very optimistic that it will as we said in our remarks offer a great choice of brands and at premium prices to consumers who are brand oriented and more value oriented brands to the consumers whose sensibilities lie there.

I think just in general, if you look at other categories generally, they are considered healthy when they do have a pretty significant tiering of price points across brands. T.J., is there something you would like to add?

T.J. Whalen

So given the size of the category you know we've really broadened the demographics that the Keurig proposition reaches and if you would walk down a coffee aisle today, you would see virtually all of our grocery customers pretty significantly expanding the spaced allocation and it has a lot to do with the productivity of that space.

Well as that space has expanded and we've driven more consumers down the aisle, we've had an opportunity to give them a broader range of shopping experiences to both cater to different need state as well as different consumer segment.

We've played out that price stratification plan across a variety of channels and as we went into it, we executed a bunch of discrete choice modeling, work to understand how consumers might behave and in general the consumer showing up in the way that we frankly had anticipated.

As Larry mentioned, it is a very brand-driven category, given that it is such a big category and there are so many different types of consumers within the category with so many different needs. So, while we're seeing consumers show up for the different price points and the different brands, we're also experiencing a little bit of transition with certain customers in particular, club where consumer might have been interested in a particular variety and have been willing to pay a particular price if that variety comes out of distribution. It has a little bit of effect, but again we've anticipated that in terms of the guidance that we are offering here.

And I think we are very well positioned for this future where more consumers are showing up.

Greg McKinley - Dougherty & Company

Thank you and so I don’t know if this is a level of detail you are willing to talk about, but just so we can understand how you've sort of risk considered that in your guidance, are you generally feeling like realized price will be relatively flat in that guidance. Or you expect some level of declines due to some trade down into more value oriented brands?

And then I guess my last question, if I could just real quick. Fran, did I correctly understand that your guidance for 2013 includes some assumption for G&A leverage as well as gross margin leverage? And if so, does that then mean the earnings growth view for the year is lot more backend loaded because of making up for some capacity under utilization and brand spending early in the year?

Larry Blanford

On the first question, so we have baked into our estimates considerations for, I would say an increased mix of value brand and value priced offerings, from the perspective that those are in fact, we are increasing the number of skews and brand varieties that are available at those price points versus our history.

So we did build in a mix shift and certainly those products at opening price points would have some impact on average selling price and some on our EBIT margins, but that is factored into our estimate. And Fran can address your last question.

Fran Rathke

Sure, so Greg in terms of the first G&A from 2013, we definitely expect continued leverage there. In terms of gross margins, we expect some, but not huge, but some improvements from what we had been seeing in the last two quarters and what we expect for Q4.

And also as we noted earlier, we got the positives from Green Coffee and also growing into essentially the capacity that we've got seated now. And then on the trends, I think we noted that in Q1 our holiday quarter, we very much wanted to continue to invest in our brand spend to drive the brewers.

So you are going to see us spend there. We're also got Vue on and we also as we noted will have some communication and brand spend for the Lavazza as well, the Lavazza system, the espresso based system.

So I think Q1, we definitely will have very higher percentage in terms of the brand variable and the selling and operating. And then the back half I think would be more moderate, but I think the trend is Q1 would probably going to see tougher earnings comparison, especially if you remember last year's Q1 was exceptionally strong and had improved back half.

Operator

And we will take our next question from Jon Andersen of William Blair.

Jon Andersen - William Blair

I just have a question on some of the external data that we look at, NPD being once source, Nielson being another. Your shipments and sales have continued quite strong as reflected in the syndicated data that your own shipments may be have trailed that in the past couple of quarter. I am just wondering you know that obviously suggest that their inventory adjustments perhaps going in the channel.

What visibility do you have on that at present and when do you think we'll begin to see stronger correlation between end demand and kind of your selling going forward?

Larry Blanford

So we can deal with that both in terms of brewers and then go ahead.

Fran Rathke

Brewers, Jon I think, are you referring strictly to brewers?

Jon Andersen - William Blair

Well I think for the NPD data, clearly I am referring to brewers and then on the other (inaudible) side, it is more of the K-cups.

Fran Rathke

Okay on the brewer side, I think we continue to see very consistent brewer growth rate in the POS data tracked through NPD and it's been running in the mid 40% or so. For the last nine months, the NPD data which we notice is about in between 35% to 40% of our customer base is up at about 45%.

We have a lot more volatility in our shipment data as we talked about over the last year or so where we had 77% growth rate in Q1 to 16% last quarter, 24% or so this quarter. If you average the last nine months, it's very, very similar to the NPD nine months at 48%.

I think your question about is there an inventory, is that all driven off of customers ordering inventory especially. I think yes this past holiday season, they definitely ordered a lot. I think they had great data sell through, but they definitely were weaning off of some or lowering their inventory levels last quarter and then somewhat Q2. I don't know, John Whoriskey wants to comment.

John Whoriskey

Yeah, Jon I will just add to Fran’s comments. This past holiday season was the first Christmas season where we were not on allocation of product supply to our retailers. So retailers were free to order to their needs and of course none of them wanted to lose the sale due to holiday season for the first time. And so consequently some probably brought a little bit more inventory than they needed.

And I would say through the last six months now, we have brought our weeks of supply in line with their POS and also because we are now more reliable suppliers and brewers and we are not allocating product. They can now take their weeks of supply down as well. So we are just in a much better position from a supply standpoint and a capacity standpoint and so on. So I think appropriately we are planned for this holiday season knowing those factors.

Jon Andersen - William Blair

One quick follow-up. Larry you mentioned that you are estimating the size of the opportunity for brewers in the US at about $35 million I think household by 2016, can you just talk a little bit more about how you are estimating that, what's some of the underlying sources, assumptions are and it is that kind of all single-serve or you can considering that your opportunity within a broader single term opportunity?

Larry Blanford

Yeah, the number we quoted is for all single-serves. So that would be our system and competitive systems. In terms of kind of some of the methodology and insights around that I am going to have Michelle Stacy, our President of Keurig Business Unit speak to that. Michelle?

Michelle Stacy

Yes, thank you. So it looks first of all single-served coffee. So its really the brewed coffee opportunity. In addition, what we start with as we look at the consumer behavior across different segments, we gain their knowledge and we look at their awareness, the Cambridge Group has done all these work for us. They look at the awareness of the system, the inclination of the consumers by various segments to purchase it and their intent to purchase that within the next six to 12, 18 and 24 months.

This then is put into their modeling system and they can give us an understanding of the overall potential of the system and what will then become sort of an annualized number of new households coming into the system. So it’s a very extensive study. We've done the study two years in a row in both years we've had similar results however we've seen the opportunity grow from the first year to this year as more consumers become aware and more consumers have a propensity to want to buy.

Larry Blanford

I think that’s an important point, Michelle, just that quite interesting that opportunity may grow beyond the $35 million as we go forward, in terms of the out years we only talked about the next couple of years in terms of our household adoption but we’re pretty confident in those numbers basis the unit shares that we currently enjoy and the competitive landscape that we currently see.

Operator

And we will take our next question from Tony Brenner from Roth Capital Market.

Tony Brenner - Roth Capital Market

Larry, you mentioned that you would -- the Vue brewer and the away-from-home channel. With (inaudible) technology, and I presume in order for that to be effective, you would also put a chip on portion packs for those brewers, I wonder if you could discuss what the purpose of that might be? How you would use it and what that employed for what you potentially you could do with the current platform? Thank you.

Larry Blanford

Great question. I’ll start in and maybe Michelle or John can jump in but the technology is an interactive technology that allows for communication between the portion pack and the brewer and so to your point, there is a very, very small chipset if you will or chip that is applied to the lid of the portion pack as it is coming down the packaging line. Once that communication is linked is then established there is obviously an opportunity to enhance the consumers' enjoyment of it and of the system. I will now let Mitchell or John maybe expand on that a little bit.

Michelle Stacy

So on the Vue system when it appears in a customer facing environment take a card dealership or health club where consumer might not know how to utilize the brewer. We felt that it was important to simplify the overall customization of the brewer. So the chip on the portion pack tells the brewer whether it’s a coffee, a brew over ice tea or a two step beverage like cappuccino or a latte and then the brewer automatically goes to the screen to tell the consumer this is how you brew the product.

This allows for consumers who may not be familiar with the Vue system the first time approaching it to really pick up exactly how to get the best cup of coffee, and we felt this was very important in the office environment when you get a Vue brewer into the home you very quickly learn how to brew your favorite beverages. We felt that consumers approaching the brewer for the first time would enjoy having the smart technology that we put into this brewer. Longer term this gives us a lot of opportunities to have our portion packs actually interact with our brewers and have what we call smart technology in our brewers.

Tony Brenner - Roth Capital Market

One of the opportunities for that is what seem to me would be that the lack of such a chip in a portion pack would make that brewer inoperable why wouldn’t you use that technology in a clear platform?

Larry Blanford

Well actually as I mentioned in our remarks Tony, we are working on other technologies, interactive technologies as well. Our rough idea is very robust right now, at a little on the expensive side and we are working on other technologies that could be utilized in K-Cup platform or Vue cup platform and you know we think there are opportunities as Michelle just described with respect to our commercial Vue platform to enhance consumer benefits as we would apply those technologies to either the K-Cup platform or at home models of Vue or K-Cups.

Operator

And we will take our next question from Akshay Jagdale of KeyBanc Capital Markets

Akshay Jagdale - KeyBanc Capital Markets

Thanks for taking the follow-up. I state discipline the first time I'll try to keep it at two questions, but Larry you mention manufacturing expertise as one of your competitive advantages and there is a view out there that you are that spending more per packaging line then some of these potential private label manufacturers which might be the case but from my understanding, your buying line that more efficient and they can produce more K-Cups per line and it is my understanding that over the last seven or eight years your efficiency rates per line or however you want to define them have going up quite a bit. So can you I know you don’t want to quantify some of these things but at least conceptually can you help us understand or quantify sort of what is your cost advantage right now in terms of producing a K-Cup relative to your competition on a per unit basis?

Larry Blanford

Akshay, I can't give you that data specifically. I would just say that your general comments are correct and we've been working very hard for a number of years to increase the throughput of the line. So that's a combination of both speed, line speed as well as improvements to many of the unit operations that enhance the first time quality of the product as its coming through the line.

And we continue to do that. I would also say that what impacts the overall efficiency is certainly the overall planned environment in terms of you've got to make sure you've got coffee and materials at the line at the right time and we continue to work on those aspects of overall manufacturing efficiency and effectiveness as well. So the work continues we have a team of engineers that focus exclusively on improved, continuing to improve throughputs of our packaging lines and then we have engineers in each of our factories that work with our central engineering group on those issues. We do feel that our packaging technology, the innovations they are continuing to be a significant competitive advantage and we continue to invest in them.

Akshay Jagdale - KeyBanc Capital Markets

And then just another issue you brought up is the brands that you already have in your portfolio. And again one of the concerns out there is that these brands such as Starbucks you know, have the opportunity to at some point go away from the Keurig system and start making their own K-Cups or other capsule. So can you, I know again you don't want to be specific to any particular brand in your comments, but can you just talk about why some of these very large brands decided to sign manufacturing agreements with you, because that will give us some insights into the competitive advantage or the risk. So just strategically, you know, why did these brands decided to sign up with you and what’s the ongoing benefit of staying with Green Mountain as opposed to going out at it themselves and manufacture?

Larry Blanford

Yeah, I think there is a number of benefits that we provide. Certainly, the first is you know great expertise with the K-Cup platform, the continued investment in technology, packaging lines that we're talking about a few minutes ago, but also in the portion pack technology as well. I'll remind you that the portion pack that we're using for Starbucks as an example as well as Barista Prima Coffee House and some other products, you know, was only recently developed in the last few years and we have applied for patents or eight patent on that portion pack, which allows for putting more coffee into the portion pack.

I think, you know, certainly the Keurig logo, we believe is increasingly meaningful to consumers because they see that logo on the package and they know that that product has been designed to quality standards that are in concert with the brewer platforms that are out there in the marketplace today and maybe out there in the marketplace tomorrow. You know, obviously we just have the Keurig system, just has significant momentum with all of our retail accounts and grocery accounts.

So I think in the long-term, as I have said before, I think our ability to maintain and hold our partners will be based on our ability to continue to bring value and we think our innovation both in the K-Cup platform and certainly now the new Keurig Vue platform in fact do that. And I think as long as we’re continuing to be the leader in single serve technologies, I would expect that we will enjoy really good partnerships and long lasting partnerships going forward.

Akshay Jagdale - KeyBanc Capital Markets

And one last one for Fran; just on the 4Q guidance, from what was implied by your previous guidance, it looks like your 4Q EPS expectations are lower than you were previously expecting. So can you just talk a little bit about what is driving that specifically in the fourth quarter and more generally, I mean these investments, your EPS growth being lower than sales growth; should we just longer-term be thinking of that as these are long-term investments for future growth?

Fran Rathke

Sure, Akshay. I think you know, overall as we discussed on our prepared remarks, you know, we spent a lot of time last few months really on getting into a review of our methodology for trying to really predict more accurately our demand. And I think our new trade flow model that we discussed has been really a key to resetting what we anticipated Q4 volumes to be and then that therefore modified essentially our earnings estimates.

And I think in terms of looking at our overall investments over the next years, I think our CapEx is to drive as we noted most importantly our platforms; Vue being our lead now and I would anticipate that overtime we are going to continue to reduce CapEx as a percentage of sales, but it’s really key these technologies to ensure we invest in them over the long term to be as Larry even noted just being really the innovator for the single serve marketplace.

Operator

We will take our next question from Bryan Spillane of Bank of America.

Bryan Spillane - Bank of America

I have two questions about K-Cup sales; one about sales in the quarter and then the second just more general in terms of pricing. Since we have been taking trade inventories or normalizing trade inventories, is it reasonable for us to assume that your shipment levels are below what consumption would have been in the quarter?

Larry Blanford

Bryan this is Larry. They would have been a bit below in Q2 and Q3 as there was some adjustment of inventory and the retail trade. We were maybe offsetting that a little bit in Q2 still rolling out Starbucks, so there probably would have been a little natural build there. But overall, I think in those two quarters we did see some inventory reduction. We think where we need to be at this point, so I just say that in Q4 as Fran may have mentioned earlier, we would expect shipments in this quarter to pretty well match point-of-sale.

Bryan Spillane - Bank of America

And then in terms of pricing, I guess just taking a step back, there has been I think there has been a lot of analysis and maybe reaction in the market at least to the concept that there has been some promotional activity in K-Cups and part of it is if you had some inventory to move you know would it stand to reason that there will be some promotion.

But I guess there two other things that despite your view on, one is if you look at the roast and ground coffee market, you know it’s got to a point the middle of last year where they finally get price that should be well and green coffee cost have come down, you have seen like Maxwell House and Folgers discount to bring some demand back and that seems to have worked. And so it just stands to reason that given all the pricing you have seen in K-Cups that also maybe there is a little bit of a price elasticity thing that you had seen with the rest of the coffee category.

So I guess my first question is that true and if there is some natural sort of increase in promotional levels that just would have gone -- been the reaction to that elasticity and green coffee cost coming down. So I guess just your view on that would be helpful?

Larry Blanford

I would say all true Bryan, so I think in part there were some you know promotional activity, some products sold at certain retailers where we were trying because we had gotten a little bit long in inventory and we’re trying to manage those down. We did provide, did sell some products through discount retailers to help move that product. But beyond that there is some price elasticity in the market for portion packs and we have increased a bit our promotional activity on a more routine basis in our retail channels.

T.J., do you want to talk about that a little bit?

T.J. Whalen

Sure. Thanks Larry. Building on Larry’s comments here for you Bryan, the overall coffee category and because it’s a very large category and there's lots of different types of shopping, both behaviors and shopping environment, it’s a fairly promotional category as much as it is brand driven. The consumer likes a range of variety, a range of acceptable choices within their brands that and they like to shop across that set of what they view as acceptable choices.

I think the total coffee category percent promoted is a little bit more than 40% and then similar to a lot of big categories. You would see lower levels of promotional activity in terms of percent on deal in single-cup than you would in the overall category and at the same time its been increasing a bit overtime for the factors that Larry mentioned, but also just because the category is broadening.

And so these promotional levels that you see in terms of the feature in display activity as it becomes a bigger and bigger part of each of these retailers, both assortment and revenue mix, its going to be a more promoted category than it has been, it will probably be a bit less promotional than coffee as a total category on the whole.

Bryan Spillane - Bank of America

And if I could just one more on pricing. Looking at what your expectations are for how big a private label could potentially be in terms of a single cup. It also stands the reason then that the traditional price gap between private label and branded coffee is roughly 20%.

And there is no reason from what I've seen at least or the conversation that I've have expected, that retailers were thinking any differently about that with K-Cup. So I guess, implicit in what you'd expect private label shares could get to in terms of single cup, is it also imply that there is a normal price gap between private label and branded?

Larry Blanford

Yeah, I think, your comments are right on, Bryan. It's in our view a little bit less than 10% of category dollars today. I think, as Michelle mentioned that total coffee category view is pretty different than the consumers that are within the Keurig brewing system.

But even putting that aside, I think the price spread that you mentioned is relatively realistic, what we do see of the unlicensed portion packs that support to work in our system is on or around that type of a price difference, maybe even a little less. So, I don't expect much beyond what you see within those parameters here going forward.

Operator

And we will take our next question from Scott Van Winkle of Canaccord Genuity.

Scott Van Winkle - Canaccord Genuity

Following up on Bryan's question, but more from the standpoint of your wholesale prices, this quarter you've commented in the press release about a 28% point increase in sales volume and 3% point increase in K-Cup packs, net price realization.

On the K-Cup size, how do we think about the rising mix of third-party brands that you are do in pulling contract manufacturing for and how that impacts that price realization on K-Cups or your price realization I should say.

Larry Blanford

Yeah so I can let Fran speak to the current quarter. But I think what I was trying to communicate in my earlier remarks, Scott is that as we go forward and as we kind of looked at a number of scenarios, as we are planning to increase the number of value brand offerings either under manufacturers' brand labels or possibly selectively some store brand opportunities, that we would expect the mix of the value brand to grow in our overall product assortment.

And that we would see as we go out in time, some impact on average selling prices and on our EBIT margins. So, we have again factored that into the estimates that we think are very realistic and very prudent, that we have provided you today.

Scott Van Winkle - Canaccord Genuity

Yeah Larry, I'm sorry. I should have been more clear. I guess when I was thinking about the current quarter, I was thinking most of the brands that are a share of your total K-Cup shipments are premium price brands. Yet you're realizing a contract manufacturer type of price point and maybe that's the part for Fran.

I'm wondering when we look at a 3% increase in the price realization, how do we think about how much of that is mix from the contract manufacturing economics and how much of that is the increase in Green Mountain Coffee owned average wholesale price points?

Fran Rathke

Sure so as in terms of the three overall impact this quarter, net price realization benefited us by about 3% points. If you know I would say that the mixed piece is very low single digits of that so in other words our price realization on our products that we raised prices last year is just slightly higher than the three and the mix piece to your point about the code we call co-manufacturing on behalf of Starbucks and (inaudible) and Duncan and selling it to them at newer ASP you know that brought that down to about three percentage points but it is pretty minimal the next piece.

Scott Van Winkle - Canaccord Genuity

Okay, I was thinking that probably it would be a little more of disparity that has been at, okay. And you know kind of bigger picture question Larry to the very beginning of this call you talked growing and you talked the last 90 days where we put a lot of effort into improving forecasting etcetera, etcetera and I assume you gathered a lot of members of your team and came up with plan and some new thoughts, are you done with process and let's not to say you do it on an ongoing basis but you are 65% or you are 95% done with this kind of reinvigorated efforts to get your hands around what is going to happen in the intermediate term?

Larry Blanford

That’s a great question. I would say there is still a lot of activity going on to make sure we really have our arms around our ability to forecast business going forward. We have done I think a good job pulling this together but we still need to support it now with some systems so that we can make the trade flow model a bit more automatic than it is right now but it is alive and well and we are continuing to pursue it. I would also just say more broadly I mean of the tremendous, when we did understand in Q2 that we had an issue, we certainly have not been neglecting going after every element of cost throughout the organization that we can identifying it and laying out initiatives to try to get after and also I think we've done a pretty good job of managing down our capital spend to the extent that we can, but certainly we will always be working to improve our efficiencies and effectiveness as you suggest and on the business we will continue to evolve as we grow.

Scott Van Winkle - Canaccord Genuity

And then just still one more since late in the call, but Fran did you say or maybe I read in the press release and figuring it now over the call which was today's release that you expected free cash flow to be modestly negative this year in 2012?

Fran Rathke

For the first nine months we had positive free cash flow, I think about a $183 million but we expect to be slightly negative for this year as the CapEx comes in and we start, we continue to build the brewer inventory for the holiday.

Scott Van Winkle - Canaccord Genuity

If I do that math so we call the $180 million to make it easy free cash flow year-to-date and you are going to spend $180 million roughly on CapEx kind of midpoint of your guidance in the fourth quarter, that would apply the working capital is maybe just slightly negative in Q4 and the past history is that its meaningfully negative because of the inventory build. I know you talked about brewer inventories rising, but to make sure we see a measurably lower inventory build sequentially in Q4 from Q3 then we have historically?

Fran Rathke

No, I think we’ve got – we’ll be definitely building brewer inventory. We are pleased to see the portion pack number come down. I think we’re overall at good target levels. So I don’t think we’re going to have a big sequential drop from where we stand now for portion packs by the end of September. So I think, I don’t know exactly your model, but we’ve got the CapEx and the brewer inventory as the primary driver and then we have obviously just earnings estimates.

Scott Van Winkle - Canaccord Genuity

For example, last year you had $250 million in working capital, by my math that number this year would have to be more like a $150 million or less?

Fran Rathke

Yes, so if you are comparing to last year’s Q4, we definitely build a lot more brewer inventory I think in Q4, I think we have taken a more – we built more in Q3 to help and we sort of tried to even out the manufacturing of the holiday brewers in Q3 and then Q4 than we did last year.

Operator

Please go ahead with your closing remarks.

Larry Blanford

Yes, thank you. Again, thanks everyone for your continued support of our company. We really appreciate your interest and your time on the call this evening. Thank you.

Operator

And once again that does conclude today’s conference call. We would like to thank everyone for your participation and have a wonderful day.

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