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No. of Recommendations: 16
Really—it is a brilliantly timed move to issue shares. They are trading at record highs and the offering will bring in a fair amount of coin to pay down debt. They paid down $354.7 million of the debt through the last 2 Qs using some of the proceeds from the credit facility entered into for the Van Houtte acquisition.

There are 147.6 million shares outstanding at the end of the quarter The 8.2 million will represent dilution of approximately 6% and is just more of the same as dilution over the last decade has been around 30%.

Green Mountain Coffee Roasters Inc. expects net proceeds of about $559.1 million from a public offering of 8.2 million shares.
The offering was priced at $71 per share, the coffee seller said late Thursday. That was a 3.6 percent discount to its closing price of $73.67 on Thursday.

They will pay some of the outstanding debt under a credit agreement and for general corporate purposes. Closing should be this week. Long-term debt is $1048.4 billion. The debt to capital ratio is 50%. If they spent $500 million on debt the ratio would go to 26%. With interest expense at $16 million, repayment of the debt is critical to keeping EPS growing sufficiently to keep Wall Street happy.

From the CC

This is Fran. In terms of the equity offering as we noted incompetent our press release the Company, we intend to use the net proceeds to repay our outstanding debt and delever fairly significantly, and I think overall over the long-term this helps us in terms of being able to respond to the momentum and demand we see in the business.

This quarter was notable for some incomprehensible reserve accounting. With the high $16 million in interest hitting the P&L this Q we have to wonder at the sudden reversal of the sales reserve of around $22 million this quarter—--well timed. Its reversal was a help in letting GMCR surprise analysts and beat estimates. The timing could not be better as the shares climbed 20% and the share offering will reap the rewards. All in all, a sterling quarter for GMCR.

how they were able to lower reserves for warranty expense

Michelle Stacy --President, Keurig

And in addition one of the things that you will be seeing in the warranty rate, this is Michelle Stacy, Bill, is the fact that we have done a program to cost reduce the brewers that we use for warranty return, in that they are no longer going to be in a shelf ready box, and we have removed several of the promotional materials inside of the box, and believe it or not that was actually a substantial cost reduction on those brewers, and that is also reflected in our warranty return rate in Q2, and that is part of the reason it is down.

I really don’t believe it but OK.

Analysts were expecting 37¢ per share and GMCR delivered 44¢ per share [GAAP]. A couple of things worked in GMCR's favor to help them beat expectations--- the reserve reversal added around 2¢ per share and the price hike added around 4¢.

Back in Q1, there was no estimate of what the price increase would do for margins. Between the price increase and the reversal of the reserve, gross was increased by approximately $46 million. Combining the two “surprise” improvements –reserve reduction and the $64 million in revenue from price increases—-I calculate GMCR created an extra 6¢ per share. Without this, EPS would be 38¢ and while it would have exceeded guidance and expectations, it might not have had the desirable effect of increasing the price per share by 20%. These calculations include the tax benefit that lowered the tax rate from 38% to 35%.

There is not much to say except it was a good quarter and they beat EPS no matter how you slice it. What we can say is that the reserve reversal and the higher prices allowed a spectacular beat and the timing of the share issuance took full advantage of the increase in share price they knew was coming. The worst we can say is the shareholders see more dilution and the other side of that argument is that the equity will allow the slightly over-leveraged capital structure to find better balance. Interest payments will drop and the debt repayment schedule should see some revision.

As a shareholder, you have to like the manipulation in the short-term. If you are short, it’s going to be tough to fight the momentum and the better cash flow, working capital use and the lower leverage the company has set in motion.

The stunning quarter

Green Mountain Coffee Roasters Inc.'s revenue more than doubled in the second quarter to help the coffee seller post better-than-expected earnings. The company also raised its outlook for the full year, sending shares up 20 percent in aftermarket trading.

"We believe healthy post-holiday in-store brewer inventory levels and positive word of mouth from enthusiastic Keurig owners combined to help drive a very strong fiscal second quarter for Green Mountain Coffee Roasters," said Lawrence J. Blanford, president and CEO.

Green Mountain, based in Waterbury, Vt., earned $65.4 million, or 44 cents per share, for the quarter. That's up from $24.1 million, or 17 cents per share, in the same quarter last year. Adjusting for one-time acquisition and legal costs [non-GAAP], the company earned 48 cents per share.

Revenue surged to $647.7 million from $322 million, helped in part by price hikes and the acquisition of Van Houtte.

Analysts polled by FactSet anticipated the company would earn 37 cents per share on revenue of $627.9 million.

The company now expects to earn $1.43 to $1.50 per share for the full year, above analysts' $1.23-per-share estimate and its previous guidance of $1.19 to $1.29.

Accounting at Green Mountain has never been an easy thing to follow. They were required to restate results as they had failed to properly categorize third party Kcup sales. The restatements also include accounts on the cash flow statement for sales reserves that were not here previously. This is how we were able to see reserves dropping from $27 million in Q1 to $5 million in Q2

Quietly buried in the footnotes is the reminder that the SEC is not done with them and their accounting. After the restatements and the bounce back from $27 when the SEC announced the investigation, this little matter just disappeared from the minds of investors. It has kept me [sadly] from buying shares. Since it is buried and forgotten, shares have resumed their normal course straight up

From deep in the footnotes

As previously disclosed on a Current report on Form 8-K dated September 28, 2010, the staff of the Securities and Exchange Commission’s (“SEC”) Division of Enforcement informed the Company that it was conducting an inquiry into matters at the Company. The Company, at the direction of the audit committee of the Company’s board of directors, continues to cooperate fully with the SEC staff’s inquiry.

I still selfishly hope there have been some serious shenanigans afoot. We can only wait and see. Fraud is interesting and findings of malfeasance would make for a great case study.

Accounting has been weak and remediation necessary. The end is not in sight:

Management has been actively engaged in the planning for, and implementation of, remediation efforts to address the material weaknesses related to the Company’s financial statement consolidation process and the Company’s accruals related to marketing and customer incentive programs, as well as other identified areas of risk.

As of the end of the fiscal quarter ended March 26, 2011, management had not yet completed its full remediation efforts and any remediation actions put in place must be effective over a period of time, fully documented and tested.

Q2 results

Revenue was helped by the Van Houtte acquisition and by Deidrich’s that has not anniversaried yet. Deidrichs was a May 2010 acquisition.

Revenue in Q2 increased 101% to $647.7 million, up from $322.0 million in 2010. If we back out the VH and Deidrich 2011 additions to revenue, growth is 62% and that’s not terrible. The organic growth continues to be impressive and as long as it keeps up shorts are going to be disappointed. Van Houtte contributed approximately $100.5 million in revenue.

Since GMCR sells brewers and K-Cups mainly, increased sales of these drove increases. K-Cups net sales increased 94% or around $200 million [includes VH] and brewers sales were up 86% -- $53.8 million.

Total K-Cup sales were $411.8 million and total Keurig brewer and accessory revenue was $116.2 million.

The October 11, 2010 price increase on K-Cups accounted for 10% or around $64 million of the 2011 revenue increase.

By segment


SCBU sells K-Cups and coffee beans. Its revenue increased $98.1 million or 63%. The result was largely the result of K-Cup sales


Keurig net sales increased by $117.2 million -- 70% -- to $284.0 million. Brewers were up 86%, or $51.1 million. K-Cup sales to retailers and consumers increased 70%.


The Van Houtte acquisition created the CBU or Canadian Business Unit. Now GMCR has 3 segments. For the thirteen weeks ended March 26, 2011, CBU segment net sales were $110.4 million.

Rest of the P&L story


Q2/11 Q1/10 Q4/10 Q3/10 Q2/10
gross 38% 25% 30% 34% 33%
EBIT 18% 4% 11% 12% 12%
net 10% 1% 7% 6% 7%

Gross was $242.9 million with margins at 38% compared to 33% in March 2010. The increase is attributed to the 10% price increase for K-Cups. Warranty expense and sales returns as a percent of revenue was lower than 2010. GMCR had been increasing reserves for higher levels of warranty expense and sales returns related to a quality issue with brewer models produced primarily in late calendar 2009.

The reversal appears to be $22 million per the cash flow statement. Adjusting that back in gives us 34% margins that would be nearly flat.

SG&A increased 82% to $123.2 million. Most of that was brought over with VH. SG&A was 19% of revenue. It historically runs around 20%-22%. SG&A included $1.9 million of transaction-related expenses for the Van Houtte , $0.4 million in legal and accounting expenses associated with the SEC inquiry and pending litigation, and $11.7 million in amortization of intangibles

Interest expense was $16.7 million compared to $0.8 million in 2010 due to the debt incurred for the VH acquisition. The company appears to be in a hurry to get this paid down. Roughly the reserve reversal subjected to 18% margins would have offset the $16 million in interest by $4 million making the earnings before taxes slightly better. The sooner they can get this off the P&L the better it will be for earnings. This Q, the impact was softened by 25%.

The effective income tax rate was 35.5% compared to the annual estimated tax rate of 38.4%. The difference was primarily due to earnings from the Canadian operations being taxed at a lower rate than earnings from U.S. operations and the safe harbor deduction for 70% of success-based acquisition fees paid in the Van Houtte acquisition, which resulted in approximately $2.2 million of income tax benefit.

We begin to better understand the reasons for the upward earnings surprise

Net increased 172% to $65.4 million compared to $24.1 million in 2010.

Non-GAAP net income for the March 26, 2011 quarter excludes transaction-related expenses, amortization of intangibles related to acquisitions and legal and accounting expenses increased 147% to $71.5 million from $29.0 million non-GAAP net income in 2010.

GAAP EPS was $0.44 compared to $0.17 last year.

Non-GAAP diluted EPS was $0.48 compared to $0.21 per share in 2010

Cash flow, cash, and debt

GMCR has $1.1 billion in debt and just $33.7 million in cash and cash equivalents Acquiring VH increased debt by $907.8 million, net of cash acquired.

CFFO for 26 weeks was $125.3 million compared to $65.3 last year.
CFFO was helped by a vast improvement in receivables from ($31.6) to ($11.2). Net income was higher and D&A added back was $49 million. The amortization of deferred financing was $5.2 million.

If we take CFFO and subtract the acquisition and capex, we get ($881.54) million for 6 months.

CFFO/net income was 1.8X. It has not been above 1 since 2007. This particular red flag is gone.

At the end of the Q, debt was $250.0 million and $550.0 million under term loans A and B, respectively and $263.4 million was outstanding under the revolver

Term loans A and B require quarterly principal repayments and have maturities of December 2015 and December 2016, respectively.

Repayment of $354 million in the last 6 months was related to the old debt refinanced and paid off with new debt and supposedly they were due to pay $1.6 million March 31 2011 on the new debt. The repayment schedule requires principal to be paid every Q

Date Amount
March 31,2011 $1,562,500
June 30,2011 $1,562,500
September 30,2011 $1,562,500
December 31,2011 $1,562,500
March 31,2012 $1,562,500
June 30,2012 $1,562,500
September 30,2012 $1,562,500
December 31,2012 $1,562,500
March 31,2013 $3,125,000
June 30,2013 $3,125,000
September 30,2013 $3,125,000
December 31,2013 $3,125,000
March 31,2014 $4,687,500
June 30, 2014 $4,687,500
September 30,2014 $4,687,500
December 31,2014 $4,687,500
March 31,2015 $6,250,000
June 30,2015 $6,250,000
September 30,2015 $6,250,000

Working capital

Working capital is actually looking better this quarter.

3/2011 12/2010 9/2010 6/2010 3/2010
DIO 64.2 56.3 77.3 61.1 46.5
DSO 32.7 32.6 36.8 37.0 38.1
DPO 34.1 30.4 44.2 44.3 37.0

VH did bring inventory to the company but since March allows a full quarter of performance from VH, IMO it counts

DIO is up but the company swears they want it there as they have in the past been short of brewers after Christmas and need increased inventory to sell through the spring and summer.

Mark Astrachan

Wondering if you comment on the increase in inventory days and decrease in days payable

Fran Rathke – CFO

Mark, this is Fran. In terms of your first question about inventory, our inventories are about $300 million at the end of March 2011 compared to about $100 million a year ago. The $200 million increase about $35 million of that is due to having Van Houtte onboard, and also last year we didn't own Diedrich's either. I don't have the exact number there, but that is probably $10 million to $15 million, and then in addition the majority of the increase is definitely coming from brewers. Brewer dollars.

And I think when we look back on last year's coming out of the holiday season, we were extremely low on inventory of brewers, and this year we made a concerted effort to have in our inventory an appropriate level to keep supporting our customers. There was also some increase in K-Cups but moat of the growth in the inventory is the brewers, and also another more smaller piece is our actual coffee inventory, green coffee because as we noted the seize up so tremendously that has also added dollars to our inventory over last year's March quarter.

The same trend was in place last Q and that is inventory increases due in part to much more expensive green coffee

When we announced our last price increase in September of 2010, coffee prices had increased roughly 30% from $1.45 to $1.90 per pound over the course of roughly three months.

Since then costs have continued to escalate recently hitting historic highs of more than $3 a pound, a nearly 60% increase since September. In an attempt to offset rising Green Coffee costs, as well as increases in other input costs, we are currently in the process of raising prices for all package types purchase as the result of this price increase. We expect to see the full benefits of this price increase during our fiscal fourth quarter of 2011.

These metrics look good with inventory and receivables over revenue at improved level

3/11 12/10 9/10 6/10 3/10
Inventory/revenue 46% 47% 70% 56% 31%
recievables/revenue 35% 41% 46% 41% 40%
sga/revenue 19% 21% 19% 22% 21%

The same trend was in place last Q and that is inventory increases due in part to much more expensive green coffee

Green Mountain is back in the groove with organic growth at the same high levels that keep investors paying premium prices. Would that I had bought it at $27 when accounting questions brought it down. Even with the SEC overhang, it was still a growth story and will continue so it seems at least in 2011. The SEC investigation is not weighing on the price at all and seems entirely forgotten. It may come to nothing in which case all of the investors who took advantage of the sale are seeing their faith in this long-time momentum favorite pay off in spades

Those who went short are going to have to wait longer for a day of reckoning. Without something truly catastrophic happening and with 2011 growth looking strong, GMCR is unlikely to end up on the ash heap any time soon.
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