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GMCR > SEC Filings for GMCR > Form 10-K on 28-Nov-2012All Recent SEC Filings




Annual Report

Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations

The following discussion and analysis is intended to help you understand the results of operations and financial condition of Green Mountain Coffee Roasters, Inc. (together with its subsidiaries, the "Company", "GMCR", "we", "our", or "us"). You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report.


We are a leader in the specialty coffee and coffeemaker businesses. We sell Keurig® Single Cup Brewers and roast high-quality Arabica bean coffees including single-origin, Fair Trade Certified™, certified organic, flavored, limited edition and proprietary blends offered in K-Cup® and Vue® packs ("single serve packs") for use with our Keurig® Single Cup Brewers. We also offer traditional whole bean and ground coffee in other package types including bags, fractional packages and cans. In addition, we produce and sell other specialty beverages in single serve packs including hot apple cider, hot and iced teas, iced coffees, iced fruit brews, hot cocoa and other dairy-based beverages. The brands include:

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Arbuckle®                    Eight O'Clock®                Red Carpet™
Barista Prima Coffeehouse®   Emeril's®                     revv®
Bigelow®                     Folgers Gourmet Selections®   Starbucks®
Brûlerie Mont-Royal®         Gloria Jean's®                Swiss Miss®
Brûlerie St. Denis®          Green Mountain Coffee®        Tazo®
Café Adagio Coffee®          Green Mountain Naturals®      The Original Donut Shop™
Café Escapes®                Kahlua®                       Timothy's®
Caribou Coffee®              Kirkland Signature™           TK™
Celestial Seasonings®        Lavazza®                      Tully's®
Coffee People®               McQuarry™                     Twinings of London®
Diedrich Coffee®             Millstone®                    Van Houtte®
Distinction®                 Newman's Own®  Organics       Vitamin Burst®
Donut House Collection®      Orient Express®               Wolfgang Puck®
Dunkin' Donuts™              Promenade™

The Bigelow®, Caribou Coffee®, Celestial Seasonings®, Dunkin' Donuts™, Eight O'Clock®, Emeril's®, Folgers Gourmet Selections®, Gloria Jean's®, Kahlua®, Kirkland Signature™, Lavazza®, Millstone®, Newman's Own® Organics, Starbucks®, Swiss Miss®, Tazo®, Twinings of London®, and Wolfgang Puck® brands are available through relationships we have with their respective brand owners. Each of these brands is property of their respective owners and is used with permission.

Over the last several years the primary growth in the coffee industry has come from the specialty coffee category, including demand for single cup specialty coffee which can now be enjoyed in a wide variety of locations, including home, office, professional locations, restaurants, hospitality and specialty coffee shops. This growth has been driven by the emergence of specialty coffee shops throughout North America, the general level of consumer knowledge of, and appreciation for, coffee quality and variety, and the wider availability of high-quality coffee. The Company has been benefiting from this overall industry trend in addition to what we believe to be our carefully developed and distinctive advantages over our competitors.

Our growth strategy involves developing and managing marketing programs to drive Keurig® Single Cup Brewer adoption in North American households and offices in order to generate ongoing demand for single serve packs. As part of this strategy, we work to sell our AH brewers at attractive price points which are approximately at cost, or sometimes at a loss when factoring in the incremental costs related to sales, in order to drive the sales of profitable single serve packs. In addition, we have license agreements with Breville Group Limited, Jarden Inc., producer of Mr. Coffee® brand coffeemakers, and Conair, Inc., producer of Cuisinart® brand coffeemakers, under which each produce, market and sell coffeemakers co-branded with Keurig®.

In recent years, our growth has been driven predominantly by the growth and adoption of Keurig® Single Cup Brewing systems which includes both the K-Cup® and the Vue® brewers and related single serve packs. In fiscal 2012, approximately 90% of our consolidated net sales were attributed to the combination of single serve packs and Keurig® Single Cup Brewers and related accessories. Additionally, during this time frame we made a number of strategic acquisitions that strengthened our long-term position and contributed to our growth rate.

We regularly conduct consumer surveys to better understand our consumers' preferences and behaviors. In Company surveys, we have learned that consumers prefer our Keurig® Single Cup Brewing systems for three main reasons (which we see as our competitive advantages):

1 Quality-expectations of the quality of coffee consumers drink has increased over the last several years and, we believe, with the Keurig® system, consumers can be certain they will get a high-quality, consistently produced beverage every time.

2 Convenience-the Keurig® system prepares beverages generally in less than a minute at the touch of a button with no mess, no fuss.

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3 Choice-with many single serve beverage brands across multiple beverage categories, GMCR offers more than 225 individual varieties, allowing consumers to enjoy and explore a wide range of beverages. In addition to a variety of brands of coffee and tea, we also produce and sell hot apple cider, iced teas, iced coffees, iced fruit brews, hot cocoa and other dairy-based beverages, in single serve packs.

We believe it's the combination of these attributes that make the Keurig® Single Cup Brewing systems so appealing to so many consumers.

We are focused on building our brands and profitably growing our business. We believe we can continue to grow sales by increasing consumer awareness in existing regions, expanding into new geographic regions, expanding consumer choice of coffee, tea and other beverages in our existing brewing systems or through the introduction of new brewing platforms, expanding sales in adjacent beverage industry segments and/or selectively pursuing other synergistic opportunities.

In fiscal 2011, we acquired LJVH Holdings Inc. ("Van Houtte") owner of Van Houtte® and other brands, based in Montreal, Canada. This acquisition is providing growth opportunities for us, particularly in Canada, and we believe is further advancing our objective of becoming a leader in the competitive coffee and coffeemaker business in North America.

We have continued to expand consumer choice in the system by entering into a number of business relationships which enable us to offer other strong national and regional coffee brands such as Folgers® and Millstone® (owned by The J.M. Smucker Company), Dunkin' Brands, Inc., Starbucks® coffee and Tazo® tea, Eight O'Clock® coffee, Tetley® tea, Good Earth® tea, and Snapple® teas in single serve packs for use with Keurig® Single Cup Brewers. We also continue to examine opportunities for business relationships with other strong national/regional brands including the potential for adding premium store-brand or co-branded single serve packs to create additional single serve products that will help augment consumer demand for the Keurig® Single Cup Brewing systems. For example, in November 2012, the Company announced it is the exclusive manufacturer of Costco Kirkland Signature™ brand K-Cup® packs for the Keurig® Single Cup Brewing system. We believe these new product offerings fuel excitement for current Keurig owners and users; raise system awareness; attract new consumers to the system; and promote expanded use of the system. These relationships were established with careful consideration of potential economics and with the expectation that these relationships will lead to increased Keurig® Single Cup Brewing system awareness and household adoption through the participating brand's advertising and merchandising activities.

We are also focused on continued innovation both in single serve brewing systems and other single serve beverages. Some of our recent initiatives include:

† An expansion of our Keurig® Single Cup Brewing system to include Keurig® Vue® brewers and related Vue® packs;

† A launch of the Keurig® Rivo™ Cappuccino and Latte System and Rivo™ pack espresso blend varieties (collectively the "Rivo™ System"), in partnership with Luigi Lavazza S.p.A. ("Lavazza"); and

† An introduction of our Wellness Brewed™ collection which includes coffees, teas and Vitamin Burst™ fruit brew beverages that contain added ingredients like antioxidant vitamins.

Management is focused on executing on the above stated growth strategy to drive Keurig® Single Cup Brewer adoption in North American households and offices in order to generate ongoing demand for single serve packs.

For fiscal 2012, the Company's net sales of $3,859.2 million represented growth of 46% over fiscal 2011. Approximately 90% of our fiscal 2012 consolidated net sales were attributed to the combination of single serve packs and Keurig® Single Cup Brewers and related accessories. Gross profit for fiscal 2012 was $1,269.4 million, or 32.9% of net sales, as compared to $904.6 million, or 34.1% of net sales, in fiscal 2011. Fiscal 2012, selling, operating, and general and administrative expenses ("SG&A") increased 31% to $700.5 million from $535.7 million in fiscal 2011. As a percentage of sales, SG&A expenses improved to 18.2% in fiscal 2012 from 20.2% in fiscal 2011. Our operating margin improved to 14.7% in fiscal 2012 from 13.9% in fiscal 2011.

We continually monitor all costs, including coffee, as we review our pricing structure as cyclical swings in commodity markets are common. The recent years have seen significant volatility in the "C" price of coffee (i.e. the price per pound quoted by the Intercontinental Exchange). We expect coffee prices to remain volatile in the coming years. To help mitigate this volatility, we generally fix the price of our coffee contracts for approximately two fiscal quarters, and at times three fiscal quarters, prior to delivery so that we have the ability to adjust our sales prices to marketplace conditions if required.

We offer a one-year warranty on all Keurig® Single Cup Brewers we sell and provide for the estimated cost of product warranties, primarily using historical information and current repair or replacement costs, at the time product revenue is recognized. In addition, sales of Keurig® Single Cup Brewers are recognized net of an allowance for returns using an average

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return rate based on historical experience and an evaluation of contractual rights or obligations. The Company is experiencing warranty claims that are lower than the rates experienced over the prior two years, which had related to a component failing at higher-than-anticipated rates in the later stage of the warranty life. Management believes that the lower rates are the result of improvements made in units produced since mid-2011 that incorporated an updated component that improved later-stage performance. Management's analysis of these claims remains consistent with its previous diagnosis of a later-stage performance issue caused by a component failing at higher-than-anticipated rates. We have incorporated the recent improvement in the rate of warranty claims into our estimates used in the reserve for product warranty costs. We focus some of our research and development efforts on improving brewer reliability, strengthening its quality controls and product testing procedures. As we have grown, we have added significantly to our product testing, quality control infrastructure and overall quality processes. As we continue to innovate, and our products become more complex, both in design and componentry, product performance may tend to modulate, causing warranty or sales returns rates to possibly fluctuate going forward, so that they may be higher or lower than we are currently experiencing and for which we are currently providing for in our warranty or sales return reserves.

We generated $477.8 million in cash from operations during fiscal 2012 as compared to $0.8 million in fiscal 2011. In addition, we completed the sale of our U.S. Coffee Service business, Filterfresh, generating $137.7 million in cash. During fiscal 2012, we primarily used cash generated from operations and from the sale of Filterfresh to reduce our borrowings under long-term debt obligations by $116.5 million, fund capital expenditures of $401.1 million and repurchase shares of our common stock of $76.5 million.

We consistently analyze our short-term and long-term cash requirements to continue to grow the business. We expect that most of our cash generated from operations will continue to be used to fund capital expenditures and the working capital required for our growth over the next few years.

Business Segments

The Company manages its operations through three operating segments, the Specialty Coffee business unit ("SCBU"), the Keurig business unit ("KBU") and the Canadian business unit ("CBU"). In addition, see Note 4, Segment Reporting, of the Notes to Consolidated Financial Statements included in this Annual Report.

Management evaluates the performance of our operating segments based on several factors, including net sales and income before taxes. Net sales are recorded on a segment basis and intersegment sales are eliminated as part of the financial consolidation process. Segment income before taxes represents earnings before income taxes and includes intersegment interest income and expense and transfer pricing on intersegment sales. Our manufacturing operations occur within the SCBU and CBU segments; however, the costs of manufacturing are recognized in cost of sales in the operating segment in which the sale occurs. Information system technology services are mainly centralized while finance functions are primarily decentralized, but currently maintain some centralization through an enterprise shared services group. Expenses related to certain centralized administrative functions including accounting and information system technology are allocated to the operating segments. Expenses not specifically related to an operating segment are recorded in the "Corporate" segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of our senior executive officers and other selected employees who perform duties related to the entire enterprise. Corporate expenses also include depreciation expense on corporate assets, interest expense, foreign exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors.

Effective with the beginning of our third quarter of fiscal 2011, KBU no longer records royalty income from SCBU and CBU on shipments of single serve packs, thus removing the need to eliminate royalty income during the financial consolidation process. Prior to the third quarter of fiscal 2011, we recorded intersegment sales and purchases of brewer and K-Cup® packs at a markup. During the third quarter of fiscal 2011, we unified the standard costs of brewer and K-Cup® pack inventories across the segments and began recording intersegment sales and purchases of brewers and K-Cup® packs at new unified standard costs. This change simplified intercompany transactions by removing the need to eliminate the markup incorporated in intersegment sales as part of the financial consolidation process. These changes were not retrospectively applied.

Effective at the beginning of fiscal year 2012, we changed our organizational structure to align certain portions of our business by geography. Prior to fiscal 2012, sales and operations associated with the Timothy's brand were included in our SCBU segment, and a portion of the AH single cup business with retailers in Canada was included in the KBU segment. Under the new structure, Timothy's and all of the AH single cup business with retailers in Canada are included in the CBU segment. In addition, effective September 25, 2011, single serve pack and brewer inventories are now transferred directly between SCBU and KBU. Intersegment sales are no longer transacted between SCBU and KBU.

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Selected financial data for segment results for fiscal years 2011 and fiscal 2010 have been recast to reflect Timothy's and the AH single cup business with retailers in Canada in the CBU segment.

Basis of Presentation

Included in this presentation are discussions and reconciliations of income before taxes, net income and diluted earnings per share in accordance with accounting principles generally accepted in the United States of America ("GAAP") to income before taxes, net income and diluted earnings per share excluding certain expenses and losses. We refer to these performance measures as non-GAAP net income and non-GAAP net income per share. These non-GAAP measures exclude transaction expenses related to our acquisitions including the foreign exchange impact of hedging the risk associated with the Canadian dollar purchase price of the Van Houtte acquisition; any gain from the sale of Filterfresh U.S. based coffee services business including the effect of any tax benefits resulting from the use of net operating and capital loss carryforwards as a result of the Filterfresh sale; legal and accounting expenses related to the SEC inquiry and pending litigation; and non-cash related items such as amortization of identifiable intangibles and loss on extinguishment of debt, each of which include adjustments to show the tax impact of excluding these items. Each of these adjustments was selected because management uses these non-GAAP measures in discussing and analyzing its results of operations and because we believe the non-GAAP measures provide investors with greater transparency by helping to illustrate the underlying financial and business trends relating to our results of operations and financial condition and comparability between current and prior periods. For example, we excluded acquisition-related transaction expenses because these expenses can vary from period to period and transaction to transaction and expenses associated with these activities are not considered a key measure of our operating performance.

We use the non-GAAP measures to establish and monitor budgets and operational goals and to evaluate the performance of the Company. These non-GAAP measures are not in accordance with, or an alternative to, GAAP and should be considered in addition to, and not as a substitute or superior to, the other measures of financial performance prepared in accordance with GAAP. Using only the non-GAAP financial measures to analyze our performance would have material limitations because their calculation is based on the subjective determination of management regarding the nature and classification of events and circumstances that investors may find significant. We compensate for these limitations by presenting both the GAAP and non-GAAP measures of its results.

Acquisitions and Divestitures

On October 3, 2011, all the outstanding shares of Van Houtte USA Holdings, Inc., also known as the Van Houtte U.S. Coffee Service business, or "Filterfresh" business, were sold to ARAMARK Refreshment Services, LLC ("ARAMARK") in exchange for $149.5 million in cash. Approximately $4.4 million of cash was transferred to ARAMARK as part of the sale and $7.4 million was repaid to ARAMARK upon finalization of the purchase price, resulting in a net cash inflow related to the Filterfresh sale of $137.7 million.

On December 17, 2010, we acquired the Van Houtte business through the purchase of all of the outstanding capital stock of LJVH Holdings, Inc., a specialty coffee roaster headquartered in Montreal, Quebec, for $907.8 million, net of cash acquired. The acquisition was financed with cash on hand and the Company's credit facility.

Van Houtte is reported in the CBU segment, as was Filterfresh, prior to being sold.

On May 11, 2010, we acquired all of the outstanding common stock of Diedrich for approximately $305.3 million, net of cash acquired. The acquisition was financed using available cash on hand, our then existing credit facility and a $140.0 million term loan.

On November 13, 2009, the Company acquired all of the outstanding stock of Timothy's, which included its brand and wholesale coffee business for an aggregate purchase price of approximately $155.7 million. The acquisition was financed using available cash on hand.

Summary Financial Data of the Company

Our fiscal year ends on the last Saturday in September. Fiscal years 2012, 2011 and 2010 represent the years ended September 29, 2012, September 24, 2011 and September 25, 2010, respectively. Fiscal 2012 consists of 53 weeks and fiscal years 2011 and 2010 each consist of 52 weeks.

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The following table presents certain financial data of the Company expressed as a percentage of net sales for the periods denoted below:

                                              Fiscal 2012    Fiscal 2011    Fiscal 2010
Net sales                                           100.0 %        100.0 %        100.0 %
Cost of sales                                        67.1 %         65.9 %         68.6 %
Gross profit                                         32.9 %         34.1 %         31.4 %
Selling and operating expenses                       12.5 %         13.2 %         13.7 %
General and administrative expenses                   5.7 %          7.1 %          7.4 %
Operating income                                     14.7 %         13.9 %*        10.2 %*
Other income (expense), net                           0.0 %          0.0 %          0.0 %
Loss on financial instruments, net                   (0.1 )%        (0.2 )%         0.0 %
Gain (Loss) on foreign currency, net                  0.2 %         (0.1 )%           -
Gain on sale of subsidiary                            0.7 %            -              -
Interest expense                                     (0.6 )%        (2.2 )%        (0.4 )%
Income before income taxes                           14.9 %         11.4 %          9.8 %
Income tax expense                                   (5.5 )%        (3.8 )%        (4.0 )%
Net Income                                            9.4 %          7.6 %          5.9 %*
Net income attributable to noncontrolling
interests                                             0.0 %          0.1 %            -
Net income attributable to GMCR                       9.4 %          7.5 %          5.9 %

* Does not add due to rounding

Segment Summary

Net sales and income before taxes for each of our operating segments are summarized in the tables below. Effective the beginning of fiscal 2012, Timothy's and all AH single cup business with retailers in Canada are included in the CBU segment. Prior to fiscal 2012, Timothy's was included in the SCBU segment, and a portion of the AH single cup business with retailers in Canada was included in the KBU segment. Segment net sales and income before taxes for fiscal years 2011 and fiscal 2010 have been recast to reflect Timothy's and the AH single cup business with retailers in Canada in the CBU segment.

                                                                      2012 over 2011               2011 over 2010
                            Net sales (in millions)               $ Increase    % Increase     $ Increase    % Increase
                  Fiscal 2012     Fiscal 2011     Fiscal 2010     (Decrease)    (Decrease)     (Decrease)    (Decrease)
SCBU             $     1,550.4   $       963.7   $       571.6   $      586.7           61 %  $      392.1           69 %
KBU                    1,683.3         1,188.7           699.3          494.6           42 %         489.4           70 %
CBU                      625.5           498.5            85.9          127.0           25 %         412.6          480 %
Corporate                    -               -               -              -            -               -            -
Total Company    $     3,859.2   $     2,650.9   $     1,356.8   $    1,208.3           46 %  $    1,294.1           95 %

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                                                                                       2012 over 2011                 2011 over 2010
                                 Income (loss) before taxes (in millions)         $ Increase     % Increase      $ Increase     % Increase
                               Fiscal 2012      Fiscal 2011      Fiscal 2010      (Decrease)     (Decrease)      (Decrease)     (Decrease)
SCBU                          $       371.2    $       249.9    $       104.9    $      121.3            49 %   $      145.0           138 %
KBU                                   153.2            126.2             75.7            27.0            21 %           50.5            67 %
CBU                                   116.9             72.9             11.3            44.0            60 %           61.6           545 %
Corporate                             (65.2 )         (121.0 )          (44.1 )          55.8           (46 )%         (76.9 )         174 %
Inter-company eliminations                -            (25.2 )          (14.6 )          25.2          (100 )%         (10.6 )          73 %
Total Company                 $       576.1    $       302.8    $       133.2    $      273.3            90 %   $      169.6           127 %


Company Summary

The following table presents consolidated net sales by major product category:

                          Net Sales (in millions)             2012 over 2011               2011 over 2010
                      Fiscal      Fiscal      Fiscal      $ Increase    % Increase     $ Increase    % Increase
                       2012        2011        2010       (Decrease)    (Decrease)     (Decrease)    (Decrease)
Single Serve Packs   $ 2,708.9   $ 1,704.0   $   834.4   $    1,004.9           59 %  $      869.6          104 %
Brewers and
Accessories              759.8       524.7       330.8          235.1           45 %         193.9           59 %
Other Products and
Royalties                390.5       422.2       191.6          (31.7 )         (8 )%        230.6          120 %
Total Net Sales      $ 3,859.2   $ 2,650.9   $ 1,356.8   $    1,208.3           46 %  $    1,294.1           95 %

53rd Week

In fiscal 2012, we had an additional week of sales (53rd week) due the fact that our fiscal year ends the last Saturday of each September. The 53rd week increased net sales by approximately $90.0 million and net income by approximately $11.0 million (net of income taxes of $5.8 million), or $0.07 per share.

Fiscal 2012

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