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

F3Q08 Earnings Call

July 31, 2008 8:30 am ET

Executives

Lawrence J. Blanford - President, Chief Executive Officer, Director

Frances G. Rathke - Chief Financial Officer, Vice President, Secretary, Treasurer

R. Scott McCreary - Chief Operating Officer

T.J. Whalen - Vice President of Marketing at Green Mountain Coffee

Dave Manly - Vice President of Marketing at Keurig

[Chris Stevens] - Vice President of Away-From-Home Sales

Analysts

Scott Van Winkle - Canaccord Adams

Mitch Pinheiro - Janney Montgomery Scott LLC

Alton K. Stump - Longbow Research

Mark Astrachan - Stifel Nicolaus & Company, Inc.

Howard Penney - Research Edge

[Julie Amindia] - Piper Jaffray

Operator

Welcome to the Green Mountain Coffee fiscal 2008 third quarter financial results conference call. (Operator Instructions) At this time for opening remarks and introductions I would like to turn the call over to the Vice President and Chief Financial Officer, Frances Rathke.

Frances G. Rathke

I would like to welcome everyone to our third quarter conference call. If you have not received the earnings press release, it is on our website at www.gmcr.com. Before we begin I want to remind everyone that certain statements will be made today that are forward-looking within the meaning of securities laws. Owing to the uncertainties of forward-looking statements, actual results could differ materially. For further information on risks and uncertainties please read the company’s SEC filings and the paragraph in today’s press release that begins with the words certain statements. We also request that you ask all of your questions on this call so that our answers are available to everyone.

And now I would like to turn the call over to our President and CEO Larry Blanford.

Lawrence J. Blanford

Until the position of Keurig President is filled, Fran and I will address both enterprise and Keurig segment related topics. Scott McCreary will speak about our Green Mountain Coffee segment. Also we are joined for the Q&A by additional members of our management team from the enterprise and our two business segments.

I’m pleased to report a very strong third quarter for Green Mountain Coffee Roasters, Inc. In a difficult economy we are driving significant top line and bottom line growth. This is because we are the leader in a growing coffee market trend, single serve gourmet coffee. As a result we generated earnings of $0.25 a share in the quarter up 66% from last year. Third quarter sales were up 43% and our operating income was up 54%. It was an outstanding quarter and Fran will be further highlighting our financials.

I am particularly proud of our performance in today’s business environment. Both business segments, Green Mountain Coffee and Keurig, did an exceptional job in actively managing their SG&A costs while supporting increased demand which contributed to our strong profitability. For the current quarter consolidated SG&A costs were a full 6 percentage points lower than last year at 26.4% versus 32.5% in Q3 of fiscal 2007.

Regarding revenue the Green Mountain Coffee segment successfully implemented a price increase in early May of 8% to 12% which Scott will also touch on. Keurig announced a royalty rate increase of a penny in all system-wide K-Cup portion packs effective August 1 which will support continued growth in advertising and market development. Taking these and other factors into account today for fiscal 2008, we are increasing our guidance for EPS from a previous range of $0.73 to $0.78 to a range of $0.79 to $0.81.

Looking ahead, Keurig has finalized shipment and merchandising plans for the Keurig brewers with our retail accounts for the upcoming holiday season. The Keurig brewer makes an excellent gift, one that is used daily and creates warm memories of the person who thoughtfully provided it. To quantify the importance of the holidays to our razor blade model, we expect to sell close to half of our fiscal 2009 at home brewers in our fiscal first quarter. Importantly we have allowed for a stronger calendar year ending brewer inventory than last season to support post-holiday demand and additional pre-Christmas sales should they be even higher than our expectations.

Therefore regarding our outlook for our next fiscal year beginning October 1, we anticipate continuing to deliver strong sales and earnings growth. We expect in fiscal 2009 to grow net sales in the range of 40% to 45% and to deliver EPS in a range of $1.20 to $1.30 per share. As we have been recently pointing out, we believe there is a true evolution underway in coffee making with Keurig in the lead. First there was percolated coffee; then there was drip; now there is single-cup brewing.

Supporting our belief in this coffee brewing evolution, in a recent consumer survey of Keurig users over 90% of respondents state that our single-cup brewing system is their primary coffee maker and they would recommend the Keurig system to their friends. Keurig enthusiasts rave about everything from its simplicity and ease of use to the wide selection of high quality gourmet coffee, tea and hot cocoas. With this type of consumer satisfaction and advocacy, it’s easy to understand why our patented Keurig single gourmet brewing and proprietary K-Cup portion pack system continues to drive enterprise growth and value creation.

Further supporting our belief in the coffee brewing evolution, the single-service category is up approximately 50% in both units and dollars versus the year ago quarter while the coffee brewer market as a whole was up only 4.5% in dollars and actually down about 3% in units. We are very pleased to report that the latest MPD group data for the second calendar quarter also shows that in this growing single-serve segment we are maintaining a strong leadership position. Importantly Keurig has gained further momentum as the market leader both in dollar and unit share in the single-serve segment at retail. The MPD group data now has Keurig with a 66% dollar market share and a 53% unit share in the total single-serve segment as compared to 61% and 49% in the prior quarter respectively. The Keurig single-cup brewing system is an elegant and cost-effective solution to serve consumers in several coffee consuming occasions, in the office, in high end hotels, and in the home. We believe strongly in the synergies of and competitive advantages created by touching the end user in these multiple single-serve locations.

Looking more closely at the away-from-home opportunities, first is office coffee services or OCS. The Keurig system has been very well received in offices for the past 10 years now. We continue to grow steadily in this market where we believe we are the leading single-cup system in terms of brewer unit shipments. As an indication of our growth potential, in New England which is our most mature sales region we estimate that about 30% of office coffee locations serviced by OCS distributors is Keurig brewed versus approximately 6% on a national basis. As we continue to expand geographically you can understand our excitement. In the OCS market we estimate there are 2.6 million brewers installed in offices today supported by office coffee distributors. We estimate 12% of this market is now single-cup brewers with Keurig at about half of that. Consumption patterns in this market vary with size of office, averaging about 10 to 15 K-Cups per working day per machine. The systems’ value proposition is attractive in the office setting and forward-thinking companies realize the system enhances the work place for their employees. It is also attractive to other customer facing situations served by our OCS distributors such as car dealerships, hair salons, and medical offices.

Also, for the away-from-home market we have the B130 brewer which was introduced about a year ago for premium hotel properties. There are about 5 million hotel rooms in North America with about 4 million coffee makers. We believe that over 40% of those coffee makers are in upscale hotels that have a clientele who appreciate the benefits of a Keurig brewing system in their rooms. Conservatively, for every 20,000 hotel rooms with this brewer we estimate more than 2 million annual demonstrations of our brewing technology occur with guests matching our target consumer demographics.

As excited as the OCS and hotel opportunities are, the at home market represents an even larger single-serve opportunity and recently K-Cup portion packs consumed at home began exceeding the numbers sold to the office coffee channel. Today the Keurig at home brewing system is the only single-cup system that offers a good/better/best selection for the consumer with price choices of $99, $149 and $199. This allows it to sell successfully in multiple channels of distribution like department stores, specialty retailers, upscale mass merchants, and wholesale clubs.

In the upcoming fall and winter 2008 holiday season we expect strong demand for our home brewer products. To support accelerated growth and continue to build brand awareness this holiday season, Keurig is investing in its first national TV advertising program. This represents a $6 million investment, double last year’s TV program. Our retail store count is expected to grow from about 10,000 retail stores to over 13,000 by calendar year end. While we are still expanding distribution we expect most brewer sales growth will come from increasing rates of brewer unit sales per store rather than adding new stores. We are happy with year-to-year comp store brewer sales for store chains that share this data with us. The weekly point of sale data from a wide selection of the department stores where our Keurig brewers and K-Cup portion packs are sold continues to trend at greater than 100% season-to-date rate over last year in spite of a challenging retail market. In fact, we are very excited to report based on MPD data that two of our Keurig brewers are best-selling items as measured in dollars in the whole coffee maker category, not just single-cup systems. The B60 special edition model for $149 is the number two best-selling coffee maker and the B40 elite model for $99 is now at number six. In addition to retail stores we also have a significant opportunity to sell our Keurig brewers and K-Cup portion packs through grocery stores which Scott will talk about shortly.

This fall we are introducing a new consumer brewer called the Keurig mini. It will be smaller than the other at home brewers and offered in black, white and red with a retail price of $79. The mini is targeted for consumers who want a Keurig brewer for occasional use in home offices, small kitchens, recreational vehicles, dorm rooms, and so forth. This is a fun product and a tote bag will be available for purchase to carry your brewer and K-Cups wherever you would like to use it.

The market for at home coffee consumption is potentially a huge opportunity. Over 90 million brewers are in homes in the US market with about 20 million brewers or coffee makers sold each year. We believe the target market for Keurig is about 45 million homes with household incomes of $50,000 and above. Today in the early stages of its life cycle single-cup brewing including cartridge and pod systems is approximately a 6% share of the 90 million total coffee brewers in homes. Ultimately our growth potential here is driven by the installed brewers, the number of K-Cup portion packs consumed per day per brewer, and the royalty rate per K-Cup. Again the razor blade model is very compelling.

In summary, we are the market leader in a growing segment of the coffee market with compelling growth prospects. The enthusiastic endorsement of consumers lends even further credence to our belief that we will continue to deliver strong sales and profit growth for multiple channels for long-term sustainability and shareholder value. Our organization is very focused on the opportunities before us and energized by our increasing ability to have a positive impact in the world through coffee. Our prospects for succeeding at this level while also being a leader in corporate social responsibility or CSR are not only a point of market differentiation but also very motivating and truly gratifying to us here in Waterbury, Vermont and throughout the company.

On a closing note and related to our larger organizational purpose, I want to share with you a recent corporate governance initiative around our commitment to corporate social responsibility. In March we created a new Board of Directors’ subcommittee for corporate social responsibility which underscores our ongoing commitment here. The subcommittee will support our management team’s work on continually strengthening alignment between our strategic business objectives, our social and environmental impact, and the values we deliver to all our stakeholders.

And now I will turn the call over to Scott McCreary, Chief Operating Officer of the Green Mountain Coffee segment, to talk more about our readiness to meet this growth.

R. Scott McCreary

Today I’ll be talking about readiness to meet both Keurig and Green Mountain Coffee growth and also readiness to bring that growth to the bottom line. This focus involves meeting increased capacity and also being solidly in command of the costs of our enterprise especially in today’s business environment.

A key effort in Q3 was the implementation of the price increase where we introduced new account planning tools for customers. Over 3,000 individual account meetings were held to communicate and manage the increase and leverage the new tools. These meetings went well and generated new opportunities to grow our business together with our customers.

One major focus in managing costs is managing green coffee costs. In light of recent trends we are now taking our green coffee hedging positions further out than in the past to reduce cost uncertainty. Today we have a forward-buy on our coffee contracting into February 2009. This six to eight month forward strategy allows us to pause when we see spikes for some price protection.

Net sales for the Green Mountain Coffee segment grew a healthy 27% in Q3 with K-Cup shipments up 49%. Building on the synergy with the Keurig system is our brand strength that distinguishes us from the competition with both the Green Mountain Coffee and Newman’s Own Organics brand. Our coffee is known for excellent quality and continues to score very high on third party coffee ratings.

Our multi-channel distribution is another key factor in our readiness to achieve our growth. We have been testing Keurig brewers and K-Cups in the supermarket channel for about 18 months. The 1,200 supermarket locations selling K-Cup portion packs have helped us increase our share of single-serve coffee in this channel to 28% this past quarter. We’re now ready to launch a new and compact 12-cup box designed to expand our supermarket footprint with 10 varieties of coffee.

One of the most compelling sales channels from a growth perspective is consumer direct. It includes our catalog business as well as our Internet sites www.greenmountaincoffee.com and www.keurig.com which carry the broadest selection of K-Cups. The market success of the Keurig brewer and K-Cup is clearly seen in our consumer direct business which delivered K-Cup portion pack growth of 80% in the third quarter. Sales at www.greenmountaincoffee.com and www.keurig.com now represent about 19% of our year-to-date sales.

In readiness to meet our high growth in fiscal 2008 and 2009 we have invested in K-Cup production lines and a new packaging facility in Essex, Vermont. Our current capacity is approximately 1 billion K-Cups annually. In addition we’re expanding our call center. As we grow geographically we must also expand production and distribution facilities. We’re excited to report that we are finalizing our purchase of a manufacturing and distribution facility in Knoxville, Tennessee. The building is 334,000 square feet effectively doubling our manufacturing square footage and providing space to support our projected growth over the next several years.

Larry has talked about some hefty targeted growth rates next year and beyond. I believe we are ready to meet this growth while continuing to exceed customer expectations and build shareholder value.

On that note I’ll turn the call back over to Fran.

Frances G. Rathke

In the interest of time I will repeat very little of the information contained in the press release we issued earlier today, which is available on our website. Also on our website for the first time is a series of 12 slides that summarize much of the information on this conference call. You can access them through the same link as our webcast from the Investor Services page of our website. And I’d urge you to view them as they contain messages and data we are discussing today relating to our performance and prospects.

Net sales for our third quarter totaled $117.8 million up 43.3% over last year. Each of our two segments Green Mountain Coffee and Keurig contributed about the same amount of net sales gross dollars to drive our top line growth this quarter. Keurig segment net sales were up 79% over last year’s third quarter and Scott already has talked about the healthy growth in our Green Mountain Coffee segment. We have now delivered 23 consecutive covers of double-digit net sales growth and K-Cup growth. Since the acquisition of Keurig, Inc. in June 2006 we have accelerated our top line growth with this quarter marking the eighth consecutive quarter with net sales growth over 39%. Looking more closely at Keurig, half of the increase in Keurig sales this past quarter was due to higher K-Cup sales. This reflects the strong shipments and increase in the install base of Keurig brewers during the last holiday season. And the other half of the increase was due to higher at home Keurig brewer sales and royalty income from the sale of K-Cups.

Our gross profit for the third quarter of 2008 totaled $42.5 million or 36% of net sales as compared to $34.1 million or 41.4% during last year’s third quarter. The decline in gross margin was largely due to the significant increase in sales of lower gross margin Keurig at home brewers as a percentage of total net sales. In addition, higher green coffee and other commodity costs and higher manufacturing costs due to the continued capacity investment in the company’s new Essex, Vermont packaging facility contributed to the decline in gross margin.

Earlier Larry highlighted our substantial improvement in SG&A as a percentage of net sales. I’ll add here that this improvement was achieved even though as planned the company incurred litigation expenses of approximately $800,000 or $0.02 per share this past quarter. These expenses were related to the patent infringement suit filed against Kraft. The company’s operating income increased 54% and our operating margin this quarter improved to 9.6% from 8.9% during last year’s third quarter. This was driven by the lower percent for SG&A.

The company’s tax rate this quarter was 36.3% as compared to 38.2% during last year’s third quarter. This was primarily due to the realization of foreign tax credits for royalties earned from our Canadian licensed roasters. We anticipate our fiscal 2008 annual effective tax rate to be 39.2%.

Net income was $6.3 million in the third quarter of 2008 an increase of 72% over last year. Net income per diluted share was $0.25 in the third quarter of 2008 as compared to $0.15 in the third quarter of 2007 and was higher than our previous guidance of $0.19 to $0.22 per share. This was primarily due to a lower tax rate this quarter than anticipated and stronger operating profit generated by the Keurig segment due to lower SG&A expenses than previously forecasted.

Overall we are extremely pleased with our financial performance this past quarter.

Looking forward to our business outlook for the full year and fourth quarter of 2008 and fiscal 2009, please keep in mind that my remarks and the information contained in the press release are based on current expectations. These statements are forward-looking and do involved some very real uncertainty. Actual results may differ materially. The only updates we expect to make to you regarding our expectations and performance are on these routine quarterly conference calls and in the related earnings press releases and SEC filings.

For fiscal 2008 we expect to grow our top line by 43% to 46%. Today we are increasing our guidance for EPS to grow at a similar rate to slightly higher rate of growth of between 44% and 54%. With regard to both full year and fourth quarter expectations we have included in our financial estimates the impact of higher coffee and other commodity costs as well as the previously-announced 8% to 12% price increases on our Green Mountain Coffee segment which was effective on May 5. Consistent with previously-issued guidance we have incorporated the August 1 royalty rate increase of a penny from approximately $0.054 to $0.064 on all system-wide K-Cup portion packs. As we weigh these many factors and their impact on our sales growth and gross margin combined with continued anticipated SG&A leverage, we anticipate our full year operating margin will be in a range of what we achieved in fiscal 2007 which would be a range of around 7.9% to 8.3% for the year. As a result of these expectations we believe we can grow earnings in 2008 at a rate similar to slightly higher than sales.

For the full year fiscal 2008 we are increasing our guidance from previously provided guidance for EPS. We are increasing it to $0.79 to $0.81 per share from prior guidance of $0.73 to $0.78 per share. This range includes the non-cash stock amortization expenses related to the identifiable intangibles estimated to reduce EPS by approximately $0.11 per share. We estimate that capital expenditures for fiscal 2008 will be in the range of $46 million to $50 million up from previously-reported estimates of $37 million to $41 million due to the expected $10.5 million purchase of the Knoxville, Tennessee building and land. I would add that we amended our credit agreement a few weeks ago to increase the maximum amount of annual capital expenditures permitted in fiscal year 2008 and each fiscal year thereafter to $60 million.

As Larry already said, looking further out to fiscal 2009 our outlook anticipates a net sales growth rate in the range of 40% to 45% and EPS in a range of $1.20 to $1.30 per share. We are sharing this early look at fiscal 2009 to aid our investors yet please keep in mind my earlier caveats that any forward-looking statements we make today involve uncertainty and actual results could differ materially. Other key factors including interest expense and annual depreciation and amortization are contained in today’s press release.

The details of our fourth quarter expectation are also contained in today’s press release so I will not repeat them here. Again, please keep in mind that our forward-looking statements are based on beliefs and assumptions that do involve very real uncertainty and risk.

Now I will turn the call back over to Larry.

Lawrence J. Blanford

Fran, Scott and I are joined today by T.J. Whalen, Vice President - Marketing at our Green Mountain Coffee segment, and from our Keurig segment, Dave Manly, Vice President of Marketing, and [Chris Stevens], Vice President of Away-From-Home Sales. We realize this is a busy time for all of us and all of you and therefore plan to complete the call by no later than 9:30 this morning. We’ll now start the question queue.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Scott Van Winkle - Canaccord Adams.

Scott Van Winkle - Canaccord Adams

Really the primary question is how are you building your forecast for the Keurig business, particularly the brewer sales? Obviously the K-Cups going to be related, but are you taking input from retailers or from your primary distributor that sits between you and the retailers?

Lawrence J. Blanford

Yes Scott, we continue to work on our modeling. We have pretty extensive models and the models do take into account forecasts from our retailers. For the at home business we actually start planning with our retailers in February for the upcoming year beginning kind of in the fall season. So that work for this upcoming holiday season really started in February of this year. And those plans then continue to get refined throughout the course of the year and pretty well get locked down because we are producing those brewers to very specific order quantities that have been agreed to with our retailers.

Scott Van Winkle - Canaccord Adams

And your marketing spend that you planned for the holiday period, that’s already set I assume as where the spend’s going to be?

Lawrence J. Blanford

Yes, we’ve already established where that spend is going to be. That would include our national advertising and also other supporting marketing and advertising communications such as planning demonstrations of the brewer system with key retailers, circular advertising, support by those retailers carrying the system. All of that is part of the planning process with each retailer and it’s pretty well locked down.

Operator

Our next question comes from Mitch Pinheiro - Janney Montgomery Scott LLC.

Mitch Pinheiro - Janney Montgomery Scott LLC

One of the surprises in the quarter was the strength of your margins and with Green Coffee up, energy in efficiencies at Essex, the higher non-cash stock compensation; all that factored in. Your margins were quite strong. What is driving that? Is it merely selling leverage and operating expense leverage and as you look forward is there some plan or a step-up in expenses or should we anticipate continued margin expansion as a result of this higher sales base?

Frances G. Rathke

In terms of our improvement in operating margin, the major driver is the SG&A leverage. And in terms of how we see the future for the rest of this year as well as into fiscal 09, we do believe that’s where we’re going to continue to see the improvement especially as we’re building such a strong base of brewers and the K-Cup royalty stream coming in. That’s one thing that’s going to improve our gross margin but I think we also are going to be selling a lot of brewers where we really don’t have much gross margin at all. So we don’t anticipate improving our gross margin dramatically but continuing to work on areas to improve there, but it’s really going to be driven by the SG&A leverage.

Mitch Pinheiro - Janney Montgomery Scott LLC

I would also imagine the new Knoxville plant when it’s up and running with roasting, there’s less bean transportation, you’re closer to your end markets. Is that also going to be a positive margin event?

R. Scott McCreary

Initially we anticipate some forward investment that we’ll need to make in equipment and in people and in training to get that facility up and running, but then absolutely you’re correct that we see some significant transportation and logistics savings as we look at our models of where our customer growth is and that will help us from a gross margin standpoint.

Mitch Pinheiro - Janney Montgomery Scott LLC

Is that like a fiscal 2010 event, your margin improvement there?

Lawrence J. Blanford

That would be reasonable. What will happen in fiscal 2009 is the similar ramp to what we’ve experienced in Essex where over the course of the year I would expect that we’ll have seven production lines installed and go from maybe 10 employees up to 100 employees, something like that. And that’s at a point where then we’ll be getting good, at least reasonable utilization of that site and then starting to leverage those high-speed machines.

Mitch Pinheiro - Janney Montgomery Scott LLC

Going to Keurig, I tend to overestimate system-wide K-Cup sales and I know the model is quite extensive, a lot of factors and variables. But with your K-Cup sales trailing like prior quarter brewer sale growth rates, is that a function you think of obsolescence or are there any changes in K-Cup consumption trends per brewer? Could you talk about that a little bit?

Dave Manly

I would say first of all to answer your question we do see no changes in our at home brewer usage per day. It’s remained constant since we entered the at home business in 2003, so no change there. Away-from-Home we see no changes either. Once the brewers are in the office we’re pretty confident with each brewer we sell into offices how many K-Cups go through them. One point you touched on is obsolescence and that is one that we have less of a handle on in our away from home business. We have estimates of how many of our away from home businesses that we’ve shipped life-to-date are still in service but we continually have to go back to the market place and check those numbers out. We’re about to do that again so I’d say that’s the one area that is more gray. But usage per brewer remains constant.

Mitch Pinheiro - Janney Montgomery Scott LLC

In the first half you had brewer growth of well in excess of 100%. Is that going to flow through in the upcoming quarters at that kind of rate or how should we look at that?

Lawrence J. Blanford

I think you’re question has to do with the growth rate in brewer sales versus the growth rate in K-Cup sales. Remember that the brewer growth rate now is in total being driven by at home brewers and now hotel brewers are starting to add to that, and those brewers’ utilization of K-Cups per day as we’ve said is in the 2.2 to 2.3 K-Cups per day per brewer. But in that base of brewers that are already out there are machines of course that were early on more reflective of our away from home business where those machines consumed 10 to 15 K-Cups per day. So I think what you’re seeing here is a natural phenomenon at the math that as we drive brewer growth rates with at home brewers primarily, the growth rate of brewers will exceed the growth rate of K-Cups. But it doesn’t mean that anything’s wrong; it’s just the math.

Mitch Pinheiro - Janney Montgomery Scott LLC

The inventories are up 25 million. How is that comprised? Is that green coffee or is that brewers?

Frances G. Rathke

In terms of the increase it’s predominantly the brewers as we planned to build inventory in Q3 and into Q4 for the heavy shipments that’s going to kick in around September as we get the holiday season seated for the strong sales. So the majority of the increase this quarter is due to primarily the at home brewers. We did increase green inventory approximately $4 million. We took in title to a lot of fair trade organic coffee just because of how the crop season worked in our planning there.

Mitch Pinheiro - Janney Montgomery Scott LLC

When it comes to the supermarkets, supermarkets had some nice year-over-year pound growth. What is driving that? Is that just normal ground and whole bean coffee or is there a K-Cup factor in that number?

T.J. Whalen

Yes, a good chunk of that, I’d say a majority of that is related to K-Cup sales and as Larry mentioned in his remarks that’s gone quite well for us. We also have seen some pickup in our bag business as we’ve restaged the Newman’s line and introduced our Single Origin line over the past year. And as I think we’ve mentioned previously, later this summer we’re rolling out a restage of the entire packaged line under the Green Mountain brand and we’re looking forward to retailers’ receipt of that.

Mitch Pinheiro - Janney Montgomery Scott LLC

And T.J., are there any other plans to increase from 1,200 supermarkets your K-Cup and mini brewer or brewer sales this fall?

T.J. Whalen

Yes, our intent is to expand grocery distribution of K-Cups. We have a brewer specifically slated for the grocery channels to mitigate any potential conflicts with the retail channel. It’s not the $79 mini but rather at a slightly higher price point geared towards grocery shoppers and is well merchandised with the K-Cups that go along with that in their new 12-pack format.

Mitch Pinheiro - Janney Montgomery Scott LLC

Will that be in excess of 1,200 store doors?

T.J. Whalen

We sure would hope so.

Lawrence J. Blanford

We’re right now in the process of having meetings with key supermarkets/groceries and we are certainly expecting for that number to grow but we’ve not provided any guidance on how fast we think that distribution will grow. As we kind of get a better handle on things we’ll certainly be in a better position to give you a sense of that.

Operator

Our next question comes from Alton K. Stump - Longbow Research.

Alton K. Stump - Longbow Research

The one question I have is on the shipments being 153,000 which are down quite a bit sequentially; it looks like you do feel very confident on the top line growth number heading into full year 09. Was there anything that was of throwing that number around versus what the shipments were in 2Q overall for Keurig?

Frances G. Rathke

In terms of your question as to our growth rate for Keurig brewers this quarter we were up 61% and last quarter we were up 144%, so I think your question is have we seen a slow down. I would say yes it’s a lower rate of growth but this is a quarter we knew in our model we anticipated pretty much this number and the at home channel was up 55% this quarter is not one of the heavy up quarters in terms of growth. Our first fiscal quarter is where the big giving season is so we feel in terms of year-to-date we’re up on the at home 124% and that’s in line with what we anticipated. And we also this past quarter have been running through the older models that we’re changing out some of our models as we mentioned on our script for this holiday seasons, so we wanted to make sure we didn’t have any inventory changes there.

Alton K. Stump - Longbow Research

If there’s any commentary on overall market demand, obviously there’s a lot of concern in terms of consumer spending power right now. Are you seeing any impact from that or do you think that we’re still seeing Keurig overcome that trend?

Frances G. Rathke

In terms of what we’re seeing through the MPD data and we also put a slide as we mentioned on our website just to show that, we’re very pleased number one with the category of single-cup this quarter. It showed strong growth in a tough market as we all read about. And we are very pleased with Keurig in terms of continuing to gain market share and be the leader in a growth category. When we look at our data per week in our key retailers, we’re continuing to see year-over-year growth rates of 100% or so. So we’re not seeing a slowdown in terms of consumers’ interest in buying into Keurig systems.

Alton K. Stump - Longbow Research

On the pricing front, it looks like the commodity price of coffee has come down a bit of late after coming back up a month or two ago. If needed, is there a possibility that if we do see costs go back up that you could take additional pricing heading into full year 09 on top of the 12%? If you could maybe give me some commentary there if we do see costs pick back up?

R. Scott McCreary

Yes, if we see continued pressure on commodities and other costs, we will take an additional price increase and follow that on. We’re sensitive to the pricing that our customers have to then pass on to their consumers and we want to make sure that we continue to be a good value, so we’ll watch that closely.

Operator

Our next question comes from Mark Astrachan - Stifel Nicolaus & Company, Inc.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

The first question relates to what you’re seeing on the brewers and K-Cups that you’re shipping versus what the retailers are selling? I guess I’m trying to figure out what type of visibility basically you have on the sales at retail versus what you’re selling in them?

Dave Manly

I would say we have very good visibility to what is sold at retail via the MPD data that we get. We know exactly how many brewers we sell in the retail and how many K-Cups are sold under retail and the MPD data gives us the movement data that comes out of retail per brewer. I would say that on average retail when a consumer buys a brewer they buy about 75 to 100 K-Cups and then we see that as they have the brewers and come back to retail, they are averaging a little bit less than three K-Cups a day per brewer of retail brewers. So we are able to see that per brewer and see it directly at retail.

T.J. Whalen

Just to build on Dave’s comments, we also see through IRI data the dynamics in the supermarket channel. For example we could tell you that the top 33 items of single-serve coffee in the grocery channel in terms of dollar velocity are K-Cups and so we see our performance putting together basically a great story in that channel for potential expanded distribution.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

Going back to that, in terms of my understanding of some of the growth rates in the most recent quarter specifically from a brewer sales standpoint but also I think from a K-Cup standpoint, the numbers seemed like they were more robust than what you reported. So I guess I’m just trying to figure out where there’s the disconnect, if any. I guess what I’m saying is if you’re shipment date is showing stronger growth and call it 55% for at home brewer sales, I’m just trying to figure out where the disconnect is.

Frances G. Rathke

I understand your question. We’re showing 55% at home brewer shipments this quarter. So we shipped those then. I think what we’re seeing in the stores during the quarter there was in the key retailers we sell to where we get weekly data, we are seeing strong velocity; as I said approximately 100% up in a lot of these key retailers. So I think what happened somewhat this quarter is we shipped in less brewers; we’re going to have a strong Q4. In Q2 a lot of brewers we shipped out were sold through in Q3; those were as we mentioned Keurig models that were changing out in the next quarter to a newer version. We had good sales per store per week during the quarter but we had less shipments this quarter as we were weaning down on some of the older models of the brewers.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

And you said that you expect 50% of your brewer sales in the fiscal first quarter, is that right?

Frances G. Rathke

Close to half of our at home brewers are in our first fiscal quarter with the heavy giving season.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

In terms of some of the cash flow numbers, can you just give us some of those - cash flow operations, working capital, and cap ex?

Frances G. Rathke

I’ll have to get back to you with details. We’ll be filing our Q on Thursday next week with a detailed cash flow model. In terms of cap ex, I know depreciation and amortization I can give you quickly for the quarter was $4.6 million for the quarter. From an EBITDA standpoint we had about a 41% increase of about $17 million of EBITDA over Q3 last year and for cap ex I think it was similar to what we spent in Q2. We’re going to be closing momentarily on Tennessee we believe so that will in Q4 see the significant purchase of that $10.5 million going out. I gave guidance for the year of upped the number to cap ex of $46 million to $50 million so I think a lot of that’s going to be spent in Q4, the increase.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

In terms of your longer term cap ex outlook looking out into the next fiscal year and beyond, where do you see those numbers coming in, because obviously we’ve seen this trend going upward?

Frances G. Rathke

In terms of fiscal 09 with our forecast for what we’re going to be putting in for packaging lines for Keurig as well as getting roasting started to be installed or set up to be installed at Tennessee, I anticipate that fiscal 09 will be in a similar range of the $46 million to $50 million.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

From brewer sales in the quarter, did that include any of the brewer sales for the mini?

Frances G. Rathke

There were no sales for the mini. The mini is anticipated to go out at the end of August.

Mark Astrachan - Stifel Nicolaus & Company, Inc.

On the coffee hedging, could you talk about what prices you’ve roughly been buying at? Are we talking increases versus last year, increases versus where we were in the first quarter, just generally speaking where those hedges that you’re buying are?

R. Scott McCreary

As we tracked the coffee market over the last few months we generally buy out a portion of our requirements and then a portion we buy as needed. And the thinking there is that it’s too high of a risk and we don’t have enough certainty of knowing what the right time is to pull the trigger on a full year. Overall this year we’re averaging around $1.50. We’ve seen in terms of the [C] and then we pay quality premiums above that and then our fair trade in organic differentials on top of that. So it just gives you an idea though in terms of how we’re tracking. We have seen the [C] market come down recently and we’ve continued to extend our buying out further to provide that cost certainty that we’re looking for.

Operator

Our next question comes from Scott Van Winkle - Canaccord Adams.

Scott Van Winkle - Canaccord Adams

In last quarter’s 10Q there was a change in control benefit severance plan filed. Can you give us what the details behind that were?

Frances G. Rathke

The change in control benefit plan is related to the plan that was filed to incorporate if there was a change in control. Our stock option plans currently call for if there was a change in control options would be accelerated and I think that was firming up that in a plan document as well as providing severance plans for the senior team I believe.

Scott Van Winkle - Canaccord Adams

I didn’t know if there was maybe an event that occurred that caused you to put that filing out, maybe someone giving you a call having an interest in acquiring the company.

Lawrence J. Blanford

There was no such event that precipitated that modification to our plan.

Operator

Our next question comes from Howard Penney - Research Edge.

Howard Penney - Research Edge

In response to an earlier question about the relationship between your cost of goods sold and SG&A, you said that relationship would be maintained through 2009 and I also heard incremental advertising expenses and geographic expansion. I just want to make sure I heard that correctly that you will leverage that SG&A line and you will continue to see pressure on the gross margin in 2009?

Frances G. Rathke

Yes, you did hear that correctly that we will be increasing our marketing support for the Keurig brewing system in our fiscal first quarter of 2009. And with that still we feel we will be improving our SG&A margin which will be the key driver for improvement in our operating margin.

Lawrence J. Blanford

And that would be over the course of the year. The first fiscal quarter is of course heavily influenced by our promotional advertising spending. When we’re talking about the leverage on the SG&A we are talking about over the course of the fiscal year 09. But we would expect over the course of that full year to certainly see some continued leverage of our volume and as Fran indicated we would expect not to see a lot on the gross margin side.

Operator

Our next question comes from [Julie Amindia] - Piper Jaffray.

[Julie Amindia] - Piper Jaffray

I know you talked about building up the inventory for the holiday period. I’m just wondering what is the general timing for retailers to order inventory including brewers and K-Cups for holiday 08. When do they kind of start to submit those orders?

Lawrence J. Blanford

Those orders basically as I indicated earlier Julie we’ve been working on the plans for those starting in February, but those orders are in now. We’ll begin shipping in the latter part of August and heavily in September to support their fall season.

[Julie Amindia] - Piper Jaffray

And early indications seem to be strong just from increased inventory?

Lawrence J. Blanford

Well early indications of the fall season basis the plans of our retailers and our continued sell through give us a lot of confidence and we’re very excited about the prospects for this holiday season.

[Julie Amindia] - Piper Jaffray

I know we have the mini brewer launch coming in August and September. Can you talk about any promotions you’re planning for that and when the holiday promotions are going to start and kind of what those promotions will include?

Dave Manly

We’re very excited about the mini. The brewer’s going to be sold at $79.95 and it’s the first time we’ll have a brewer with three different colors. Consumers have found out about it already and they’re contacting us, so we are very positive about this brewer launch. We’re going to launch it on www.keurig.com about September 1 and that’ll be the first place that it’ll really show up where consumers can buy it. At the same time we’re shipping it to our major retail partners and only a couple of colors actually, so www.keurig.com will have all three colors, the retailers will only have two colors, but all of our major retail partners will have it. They’ll start merchandising it probably late September or early October and then through the holiday season. We will have special advertising accrual allowances on the brewer as we do with other brewers. We expect it to be positioned very strongly as a gift opportunity at retail and also on our respective websites. So we’re very excited about it and think it adds a new leverage point in single-cup for Keurig.

[Julie Amindia] - Piper Jaffray

For just measuring returns on marketing investments, can you tell us what mediums are working best and how you specifically measure these returns?

T.J. Whalen

Thanks for the question. It’s a good one especially given our emphasis on growing this market here. Over the past year we’ve conducted a series of tests including multi-variant regression analyses to understand the appropriate balance of market spending by vehicle by market and by brand. And I do feel that we have a fairly strong understanding of how these tools work together. Not surprisingly they tend to work in concert with one another with really the hammer if you will being our TV spend that drives some excitement at both the retailer and the consumer levels. And then we leverage that spend and augment it with other vehicles on a selective basis to drive some activation. Does that make sense?

Operator

That does conclude the question and answer session at this time. For any additional or closing remarks I’ll turn the conference back over to you.

Lawrence J. Blanford

It’s been a pleasure to talk to you today about this quarter and our plans going forward. We really appreciate your interest in the company and we thank you very much for joining us this morning.

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Source: Green Mountain Coffee Roasters, Inc. F3Q08 (Qtr End 06/28/08) Earnings Call Transcript
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