News Column

GREEN MOUNTAIN COFFEE ROASTERS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 5, 2014

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 unaudited consolidated financial statements and related notes included elsewhere in this report. Overview We are a leader in the specialty coffee and coffeemaker businesses in the United States and Canada . 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®, Vue® , and Rivo® packs ("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 packs including hot apple cider, hot and iced teas, iced coffees, iced fruit brews, hot cocoa and other dairy-based beverages. Unless the context indicates otherwise, the terms "GMCR", the "Company", "we", "our", or "us" refer to Green Mountain Coffee Roasters, Inc. , together with its subsidiaries. The beverage brands we offer include: Arbuckle® Folgers Gourmet Selections® Seattle's Best Coffee® Barista Prima Coffeehouse® Gloria Jean's® SelectionTM Bigelow® Good Earth® Snapple® BrÛlerie Mont-Royal® Green Mountain Coffee® Starbucks® BrÛlerie St. Denis® Green Mountain Naturals® Swiss Miss® CafÉ Adagio Coffee® Kahlua® Tazo® CafÉ Escapes® Kirkland Signature™ Tetley® Caribou Coffee® Lavazza® The Original Donut Shop™ Celestial Seasonings® Lipton® Timothy's® Cinnabon® Market Basket® TK™ Coffee People® McQuarry™ Tully's® Diedrich Coffee® Millstone® Twinings of London® Distinction® Newman's Own® Organics Van Houtte® Donut House Collection® Orient Express® Vitamin Burst® Dunkin' Donuts™ Promenade™ Wolfgang Puck® Eight O'Clock® Red Carpet™ Emeril's® revv® The Bigelow®, Caribou Coffee®, Celestial Seasonings®, Cinnabon®, Dunkin' Donuts™, Eight O'Clock®, Emeril's®, Folgers Gourmet Selections®, Gloria Jean's ®, Good Earth®, Kahlua®, Kirkland Signature™, Lavazza®, Lipton®, Market Basket®, Millstone®, Newman's Own® Organics, Seattle's Best Coffee®, SelectionTM, Snapple®, Starbucks®, Swiss Miss®, Tazo®, Tetley®, 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 serve coffee which can now be enjoyed in a wide variety of places, including home, office, professional, restaurants, and hospitality locations. This growth has been driven by the emergence of specialty coffee shops throughout the U.S. and Canada , the general level of consumer knowledge of, and appreciation for, coffee quality and variety, and the wider availability of high-quality coffee. 22 -------------------------------------------------------------------------------- Table of Contents 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 order to generate ongoing demand for packs in American and Canadian households, foodservice and office location and, in the longer term, globally. As part of this strategy, we work to sell our at-home ("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 packs. In addition, we have license agreements with Breville PTY Limited (producer of Breville® brand coffeemakers), Jarden Consumer Solutions (producer of Mr. Coffee® brand coffeemakers), and Conair Corporation (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 brewer and related packs. In the first fiscal quarter of 2014, approximately 94% of our consolidated net sales were attributed to the combination of packs and Keurig® Single Cup brewers and related accessories. We believe the primary consumer benefits delivered by our Keurig® Single Cup Brewing system are as follows: 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. 3 Choice-with many single serve beverage brands across multiple beverage categories, GMCR offers more than 290 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 iced teas, iced coffees, hot and iced fruit brews, hot cocoa and other dairy-based beverages, in packs. We see these benefits as being our competitive advantage and believe it's the combination of these attributes that make the Keurig® Single Cup Brewing system appealing to 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 the U.S. and Canada , 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. The key elements of our business strategy are as follows: † Growing the current Keurig® Hot system in the U.S. and Canada ; † Expanding our brand offerings, both owned and partner brands; † Expanding in current channels; † Launching new brewer technologies and innovation; † Beginning international expansion. Growing the current Keurig® Hot system in the United States and Canada . While we are positioned as a leader in the single serve hot beverage marketplace, we estimate our current Keurig® Hot system is only in approximately 13% of U.S. households. In order to increase household penetration, we are executing a segmentation strategy to effectively showcase our extensive variety of beverage options. We are also implementing measures to improve the shopping experience at retail to further distinguish the Keurig® brand and enhance brand recognition. Additionally, we are launching targeted marketing campaigns to increase regional household penetration in certain geographic areas through increased awareness, trial and conversion. Expanding our brand offering. We have continued to expand consumer choice in the Keurig® Single Cup Brewing system by entering into or extending a number of business relationships which enable us to offer other strong national and regional coffee and tea brands, and store brands such as Dunkin' DonutsTM, Seattle's Best Coffee®, Starbucks®, The Coffee Bean & Tea Leaf®, Cinnabon®, Tazo®, Eight O'Clock®, Tetley®, Good Earth®, Snapple®, Kirkland SignatureTM and METRO's Irresistibles K-Cup® 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 packs to create additional single serve products that will help augment consumer demand for the Keurig® Single Cup Brewing systems. 23 -------------------------------------------------------------------------------- Table of Contents Furthermore, we are expanding the use of our Keurig® Single Cup Brewing system beyond beverages through innovative partnerships, the first of which is with the Campbell Soup Company to produce Campbell's Fresh-Brewed Soup K-Cup® packs which we expect to be available in fiscal 2014. We believe these new product offerings fuel excitement for current Keurig® Single Cup brewer owners and users; raise system awareness; attract new consumers to the system; and promote expanded use of the system. These relationships are established with careful consideration of potential economics. We expect to continue to enter into these relationships in our efforts to expand choice and diversify our portfolio of brands with the expectation that they will lead to increased Keurig® Single Cup Brewing system awareness and household adoption, in part through the participating brand's advertising and merchandising activities. In addition to entering into business relationships with brands that are new to the Keurig® Single Cup Brewing system, we expect to be able to convert a number of unlicensed brands to the Keurig® system on a licensed basis. Expanding in current channels. We have identified and are targeting specific opportunities within our existing channels, specifically the AFH channel, including food service, workplace, higher education and hospitality locations. These are areas where Keurig® has substantial room to grow, considering we are currently in less than one percent of food service outlets. Launching new brewer technologies and innovation. We are also focused on continued innovation in both hot and cold single serve brewing systems. Some of our recent initiatives and planned product introductions include: † An expansion of the Keurig® Hot system with the fiscal 2013 launch of the Keurig® Rivo® Cappuccino and Latte System and Rivo® pack espresso blend varieties, in partnership with Luigi Lavazza S.p.A . ("Lavazza"); † An expansion of the Keurig® Hot system with introduction of a new commercial grade Keurig® Bolt™ platform which, following in-office testing, will be available throughout the U.S. and Canada beginning in fiscal 2014; † An introduction of the next generation beverage platform of the Keurig® Hot beverage system, which will combine the qualities and technologies of our existing K-Cup® and Vue® platforms to offer a wider array of beverages and available sizes, with an estimated launch in late fiscal 2014; and † An estimated launch in fiscal 2015 of the Keurig® Cold system, which will deliver freshly prepared carbonated, sparkling and still beverages. Beginning international expansion. Beginning in fiscal 2014 and continuing into fiscal 2015, we are planning to launch our Keurig® Hot system global platform in targeted markets with the introduction of a specifically designed Keurig® Single Cup brewer. Our business relationships with participating brands are generally established through licensing or manufacturing arrangements. Under licensing arrangements, we license the right to manufacture, distribute and sell the finished products through our distribution channels using the brand owners' marks. For the right to use a brand owner's mark, we pay a royalty to the brand owner based on our sales of finished products that contain the brand owner's mark. Under manufacturing arrangements, we manufacture finished beverage products using raw materials sourced by us or provided by the brand owner. In both instances, once the manufacturing process is complete, we sell the finished product either to the brand owner or to our customers. Under certain manufacturing arrangements, our sole customer is the brand owner and we are prohibited from selling the beverage products to other types of customers through our distribution channels. Under other manufacturing arrangements, in addition to manufacturing the beverage for sale to the brand owner, we have the right to sell the beverages using the brand owner's marks in certain of our channels through a licensing arrangement, as described above. No individual licensing or manufacturing arrangement (including arrangements covering multiple brands) has generated net sales that have been significant to our consolidated net sales (i.e., no arrangement has accounted for more than 10% of our consolidated net sales in any period). We analyze the impact of each arrangement on consolidated net sales on an individual basis. We have determined that it is unlikely that we would lose our licensing or manufacturing rights to multiple brands at the same time. Each of our licensing and manufacturing arrangements are separately negotiated with unrelated parties, and each has distinct terms and conditions, including the duration of agreement and termination rights. Further, based upon the number of business relationships as well as the depth of our owned-brands, it is our belief that no individual business relationship is critical to the execution of our growth strategy. Management is focused on executing our growth strategy to drive Keurig® Single Cup Brewer adoption in households and offices in the U.S. and Canada in order to generate ongoing demand for packs. We compete not only with other widely advertised branded products, but also with private label or generic products that generally are sold at lower prices. In September 2012 , two patents associated with our K-Cup® packs expired, and certain third-parties have launched competing products in the form of established unlicensed national and regional brands and unlicensed private label packs. 24 -------------------------------------------------------------------------------- Table of Contents For the first fiscal quarter of 2014, our net sales of $1,386.7 million represented growth of 4% over the first fiscal quarter of 2013 ("the prior year period"). Gross profit for the first fiscal quarter of fiscal 2014 was $464.0 million , or 33.5% of net sales, as compared to $419.2 million , or 31.3% of net sales for the prior year period. For the first fiscal quarter of 2014, selling, operating, and general and administrative expenses ("SG&A") increased 0.3% to $237.4 million from $236.7 million for the prior year period. As a percentage of sales, SG&A expenses decreased to 17.1% in the first fiscal quarter of 2014 from 17.7% in the prior year period. Our operating margin improved to 16.3% in the first fiscal quarter of 2014 from 13.6% in the prior year period. 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. 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 return rate based on historical experience and an evaluation of contractual rights or obligations. 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 modulate, causing warranty or sales returns rates to possibly fluctuate going forward. As a result, future warranty claims rates 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 $272.7 million in cash from operating activities during the thirteen weeks ended December 28, 2013 as compared to $337.1 million during the thirteen weeks ended December 29, 2012 . During the thirteen weeks ended December 28, 2013 we primarily used cash generated from operating activities to reduce our borrowings under long-term debt obligations by $3.2 million , fund capital expenditures of $60.8 million and repurchase shares of our common stock for $122.5 million . We consistently analyze our short-term and long-term cash requirements to continue to grow the business. In addition to funding share repurchases and cash dividends, we expect 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 We have historically managed our operations through three business segments: the Specialty Coffee business unit ("SCBU"), the Keurig business unit ("KBU") and the Canadian business unit. Effective as of and as initially disclosed on May 8, 2013 , our Board of Directors authorized a reorganization which consolidated U.S. operations to bring greater organizational efficiency and coordination across the Company. Due to this combination, the results of U.S. operations, formerly reported in the SCBU and KBU segments, are reported in the Domestic segment and the results of Canadian operations are in the "Canada" segment. As a result of the consolidation of U.S. operations, we have recast all historical segment results in order to provide data that is on a basis consistent with our new structure. See Note 3, Segment Reporting, of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report. We evaluate the performance of our operating segments based on several factors, including net sales to external customers and operating income. Net sales are recorded on a segment basis and intersegment sales are eliminated as part of the financial consolidation process. Operating income represents gross profit less selling, operating, general and administrative expenses. Our manufacturing operations occur within both the Domestic and Canada segments, and 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 and accounting functions are primarily decentralized. Expenses consisting primarily of compensation and depreciation related to certain centralized administrative functions including information system technology are allocated to the operating segments. Expenses not specifically related to an operating segment are presented under "Corporate - Unallocated." Corporate - Unallocated 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 Unallocated expenses also include depreciation for corporate headquarters, sustainability expenses, interest expense not directly attributable to an operating segment, the majority of foreign exchange gains or losses, certain corporate legal expenses and compensation of the Board of Directors. 25 -------------------------------------------------------------------------------- Table of Contents Basis of Presentation Included in this presentation are discussions and reconciliations of net income and diluted earnings per share in accordance with accounting principles generally accepted in the United States of America ("GAAP") to 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 legal and accounting expenses related to the Securities and Exchange Commission ("SEC") inquiry and pending securities and stockholder derivative class action litigation and non-cash acquisition-related items such as amortization of identifiable intangibles, 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 legal and accounting expenses related to the SEC inquiry and pending securities and stockholder derivative class action litigation because these expenses can vary from period to period 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 our performance. 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. Results of Operations Summary financial data of the Company The following table presents certain financial data of the Company expressed as a percentage of net sales for the periods denoted below: Thirteen weeks ended December 28, December 29, 2013 2012 Net sales 100.0 % 100.0 % Cost of sales 66.5 % 68.7 % Gross profit 33.5 % 31.3 % Selling and operating expenses 12.1 % 12.8 % General and administrative expenses 5.0 % 4.8 % Operating income 16.3 %* 13.6 %* Other income, net 0.0 % 0.0 % Gain on financial instruments, net 0.3 % 0.1 % Loss on foreign currency, net (0.8 )% (0.2 )% Interest expense (0.2 )% (0.4 )% Income before income taxes 15.8 %* 13.1 % Income tax expense (5.8 )% (5.0 )% Net income 10.0 % 8.1 % Net income attributable to noncontrolling interests 0.0 % 0.0 % Net income attributable to GMCR 10.0 % 8.0 %* -------------------------------------------------------------------------------- * Does not sum due to rounding. 26 -------------------------------------------------------------------------------- Table of Contents Segment Summary Net sales and operating income for each of our operating segments are summarized in the tables below: Net sales (in millions) Thirteen weeks ended December 28, December 29, 2013 2012 Domestic $ 1,191.9 $ 1,132.0 Canada 194.8 207.1 Total net sales $ 1,386.7 $ 1,339.1 Operating income (loss) (in millions) Thirteen weeks ended December 28, December 29, 2013 2012 Domestic $ 232.8 $ 191.0 Canada 32.0 26.0 Corporate (38.2 ) (34.6 ) Total operating income $ 226.6 $ 182.4 Thirteen weeks ended December 28, 2013 as compared to the thirteen weeks ended December 29, 2012 Revenue Company Summary The following table presents consolidated net sales by major product category: Net sales (in millions) Thirteen weeks ended December 28, December 29, $ Increase % Increase 2013 2012 (Decrease) (Decrease) Packs $ 931.4 $ 863.7 $ 67.7 8 % Brewers and accessories 375.1 377.3 (2.2 ) (1 )% Other products 80.2 98.1 (17.9 ) (18 )% Total net sales $ 1,386.7 $ 1,339.1 $ 47.6 4 % Net sales for the first quarter of fiscal 2014 increased by $47.6 million , or 4%, to $1,386.7 million . The 4% increase includes the unfavorable impact of foreign currency exchange rates which reduced net sales by approximately 0.8%. The primary drivers of the increase in our net sales were a $67.7 million , or 8%, increase in total pack net sales partially offset by a $2.2 million , or 1%, decrease in Keurig® Single Cup Brewer and accessory net sales, and a $17.9 million , or 18%, decrease in other product net sales. The increase in pack net sales was driven by a 12 percentage point increase in sales volume, offset by a 2 percentage point decrease due to net price realization and a 2 percentage point decrease due to portion pack product mix. The decrease in brewer and accessory net sales was driven by a 4 percentage point increase due to brewer sales volume offset by a 2 percentage point decrease due to brewer net price realization, a 2 percentage point decrease due to brewer product mix and a 1 percentage point decrease due to a decline in accessory net sales. 27 -------------------------------------------------------------------------------- Table of Contents Domestic Domestic segment net sales increased by $59.9 million , or 5%, to $1,191.9 million in the first quarter of fiscal 2014 as compared to $1,132.0 million in the prior year period. The increase is due primarily to a $57.2 million , or 7%, increase related to net sales of packs. Canada Canada segment net sales decreased by $12.3 million , or 6%, to $194.8 million in the first quarter of fiscal 2014 as compared to $207.1 million in the prior year period. The decrease in net sales, excluding a $10.3 million , or 5%, decrease related to the unfavorable impact of foreign currency exchange rates, is due primarily to (i) a $7.1 million , or 13%, decrease related to net sales of Keurig® Single Cup Brewers and accessories, and (ii) a decrease of $10.5 million , or 16%, in net sales of other products, such as coffee sold in traditional package formats, both of which were offset by a $15.6 million , or 18%, increase in net sales of packs, driven by a demand shift from coffee sold in traditional package formats to packs. Gross Profit Gross profit for the first quarter of fiscal 2014 was $464.0 million , or 33.5% of net sales as compared to $419.2 million , or 31.3% of net sales, in the prior year period. The increase in gross margin was primarily attributable to an increase of approximately 390 basis points related to a decrease in green coffee costs, partially offset by (i) a 90 basis point decrease related to price realization primarily associated with brewers; and (ii) a 50 basis point decrease related to price realization primarily associated with packs in the first quarter of fiscal 2014 compared to the prior year period. Selling, Operating, General and Administrative Expenses SG&A expenses increased by 0.3% to $237.4 million in the first quarter of fiscal 2014 from $236.7 million in the prior year period. As a percentage of sales, SG&A decreased to 17.1% in the first quarter of fiscal 2014 from 17.7% in the prior year period. The increase in SG&A over the prior year period is primarily attributed to an increase of $7.2 million due to continued investments in research and development and innovation related to our product pipeline, partially offset by a decrease of $6.7 million in marketing and sales related expenses. Segment Operating Income (Loss) Operating income for the Domestic segment increased by $41.8 million , or 22%, primarily attributable to higher sales volume for packs and brewers as well as lower green coffee costs. Operating income for the Canada segment increased by $6.0 million , or 23%, primarily attributable to lower green coffee costs and a reduction in fulfillment related expenses, partially offset by the impact of unfavorable fluctuations in foreign exchange rates. The Operating loss for Corporate - Unallocated increased by $3.6 million , or 10%, primarily due to increased expenses related to information technology. Gain on Financial Instruments, Net We recorded $4.6 million in net gains on financial instruments not designated as hedges for accounting purposes during the first quarter of fiscal 2014 as compared to $1.1 million in net gains during the prior year period. The net gains were primarily attributable to the fair value adjustment of our cross currency swap, which hedges the risk in currency movements on an intercompany note denominated in Canadian currency. Loss on Foreign Currency, Net We have certain assets and liabilities that are denominated in Canadian currency. During the first quarter of fiscal 2014, we incurred net foreign currency losses of approximately $10.6 million as compared to net losses of $2.7 million during the prior year period. The net foreign currency losses primarily related to re-measurement of certain intercompany notes with our foreign subsidiaries which fluctuate due to the relative strength or weakness of the U.S. dollar against the Canadian dollar. Interest Expense Interest expense was $2.6 million in the first quarter of fiscal 2014, as compared to $5.7 million in the prior year period. The decrease in interest expense was primarily due to lower average outstanding debt in the first quarter of fiscal 2014 as compared to the average outstanding debt during the prior year period. 28 -------------------------------------------------------------------------------- Table of Contents Income Taxes Our effective income tax rate was 36.6% for the first quarter of fiscal 2014 as compared to a 38.4% effective tax rate for the prior year period. The decrease was primarily attributable to an increase in domestic production activities qualifying for deduction under IRS Section 199 in the first quarter of fiscal 2014. Net Income, Non-GAAP Net Income and Diluted Earnings Per Share ("EPS") Net income in the first quarter of fiscal 2014 was $138.2 million , an increase of $30.6 million or 28%, as compared to $107.6 million in the prior year period. Non-GAAP net income (when excluding legal and accounting expenses related to the SEC inquiry and pending securities and stockholder derivative class action litigation as well as non-cash related items such as amortization of identifiable intangibles) increased 26% to $146.1 million for the first quarter of fiscal 2014 from $116.0 million non-GAAP net income in the prior year period. Diluted EPS was $0.91 per share in the first quarter of fiscal 2014, as compared to $0.70 per share in the prior year period. Non-GAAP diluted EPS was $0.96 per share in the first quarter of fiscal 2014, as compared to $0.76 per share in the prior year period. The following tables show a reconciliation of net income and diluted EPS to non-GAAP net income and non-GAAP diluted EPS for the thirteen weeks ended December 28, 2013 and December 29, 2012 (in thousands, except per share data): Thirteen weeks ended December 28, December 29, 2013 2012 Net income attributable to GMCR $ 138,227 $ 107,583 After tax: Expenses related to SEC inquiry (1) 236 444 Amortization of identifiable intangibles (2) 7,642 7,951 Non-GAAP net income attributable to GMCR $ 146,105 $ 115,978 Thirteen weeks ended December 28, December 29, 2013 2012 Diluted income per share $ 0.91 $ 0.70 After tax: Expenses related to SEC inquiry (1) 0.00 0.00 Amortization of identifiable intangibles (2) 0.05 0.05 Non-GAAP net income per share $ 0.96 $ 0.76 * -------------------------------------------------------------------------------- * Does not sum due to rounding. (1) Represents legal and accounting expenses, net of income taxes of $0.1 million and $0.3 million for each of the thirteen weeks ended December 28, 2013 and December 29, 2012 , respectively, related to the SEC inquiry and pending securities and stockholder derivative class action litigation classified as general and administrative expense. See Note 14, Legal Proceedings, of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report. Income taxes were calculated at our effective tax rate. (2) Represents the amortization of intangibles, net of income taxes of $3.5 million and $3.6 million for each of the thirteen weeks ended December 28, 2013 and December 29, 2012 , respectively, related to our acquisitions classified as general and administrative expense. Income taxes were calculated at our deferred tax rates. 29 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources We principally have funded our operations, working capital needs, capital expenditures and share repurchases from net cash flows from operating activities and borrowings under our credit facilities and capital lease and financing obligations. At December 28, 2013 , we had $259.8 million in outstanding debt, and capital lease and financing obligations, $348.7 million in cash and cash equivalents and $925.1 million of working capital (including cash). At September 28, 2013 , we had $251.0 million in outstanding debt and capital lease and financing obligations, $260.1 million in cash and cash equivalents and $924.4 million of working capital (including cash). As of December 28, 2013 , we had approximately $177.2 million of undistributed international earnings, most of which are Canadian-sourced. With the exception of the repayment of intercompany debt, all earnings of our foreign subsidiaries are considered indefinitely reinvested and no U.S. deferred taxes have been provided on those earnings. If these amounts were distributed to the U.S. in the form of dividends or otherwise, we would be subject to additional U.S. income taxes, which could be material. Determination of the amount of any unrecognized deferred income tax on these earnings is not practicable because such liability, if any, is dependent on circumstances existing if and when remittance occurs. Operating Activities: Net cash provided by operating activities is principally comprised of net income and is primarily affected by the net change in working capital and non-cash items relating to depreciation and amortization. Net cash provided by operating activities during the thirteen weeks ended December 28, 2013 was $272.7 million as compared to $337.1 million for the prior period. We generated $138.5 million in net income for the thirteen weeks ended December 28, 2013 . Significant non-cash items primarily consisted of $59.1 million in depreciation and amortization. Other significant changes in assets and liabilities affecting net cash provided by operating activities were decreases in inventories of $205.6 million due primarily to seasonal holiday selling activity and decreases in accounts payable and accrued expenses of $71.4 million . Investing Activities: Investing activities primarily include capital expenditures for equipment and building improvements. Capital expenditures were $60.8 million for the thirteen weeks ended December 28, 2013 as compared to $83.5 million for the comparable prior year period. Capital expenditures incurred on an accrual basis during the thirteen weeks ended December 28, 2013 consisted primarily of $13.1 million related to increasing packaging capabilities for Keurig® beverage platforms, $23.2 million related to facilities and related infrastructure, and $12.4 million related to information technology infrastructure and systems. Of the $23.2 million in capital expenditures related to facilities and related infrastructure, $12.1 million relates to fixed assets acquired under capital lease and financing obligations. In fiscal 2014, we currently expect to invest between $400.0 million to $450.0 million in capital expenditures to support our future growth. Financing Activities: Cash used in financing activities for the thirteen weeks ended December 28, 2013 totaled $119.9 million . Cash generated from operations was used to reduce our debt and capital lease obligations by $3.6 million , principally under our term loan A facility. We also used $122.5 million of cash to repurchase approximately 1.7 million of our common shares during the first quarter of fiscal 2014. Cash flows from operating and financing activities included a $4.5 million tax benefit primarily from the exercise of non-qualified options and disqualifying dispositions of incentive stock options. As stock is issued from the exercise of options and the vesting of restricted stock units, we will continue to receive proceeds and a tax deduction where applicable; however we cannot predict either the amounts or the timing of any such proceeds or tax benefits. On July 30, 2012 , our Board of Directors authorized a program (the "2012 Share Repurchase Program") for the Company to repurchase up to $500.0 million of our common shares over two years, at such times and prices as determined by our management. On November 19, 2013 , our Board of Directors approved and authorized the repurchase, on or prior to December 1, 2015 , of up to an aggregate amount of $1.0 billion of the Company's outstanding common shares (the "2013 Share Repurchase Program"), at such times and prices as determined by the Company's management. The 2013 Share Repurchase Program will become effective upon completion of the 2012 Share Repurchase Program. The shares will be purchased with cash on hand, cash from operations, and funds available through our existing credit facility. See Note 12, Stockholders' Equity, of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report. 30 -------------------------------------------------------------------------------- Table of Contents On November 19, 2013 , our Board of Directors declared the Company's first regular quarterly cash dividend of $0.25 per common share, payable on February 14, 2014 , to shareholders of record on January 17, 2014 . On February 3, 2014 , our Board of Directors declared a regular cash dividend of $0.25 per common share, payable on May 2, 2014 , to shareholders of record at the close of business on April 4, 2014 . Under our Amended and Restated Credit Agreement ("Restated Credit Agreement"), we maintain senior secured credit facilities consisting of (i) an $800.0 million U.S. revolving credit facility, (ii) a $200.0 million alternative currency revolving credit facility, and (iii) a term loan A facility. At December 28, 2013 , we had $167.8 million outstanding under the term loan A facility, no balances outstanding under the revolving credit facilities and $6.2 million in letters of credit with $993.8 million available for borrowing. The Restated Credit Agreement also provides for an increase option for an aggregate amount of up to $500.0 million . The term loan A facility requires quarterly principal repayments. The term loan and revolving credit borrowings bear interest at a rate equal to an applicable margin plus, at our option, either (a) a eurodollar rate determined by reference to the cost of funds for deposits for the interest period and currency relevant to such borrowing, adjusted for certain costs, or (b) a base rate determined by reference to the highest of (1) the federal funds rate plus 0.50%, (2) the prime rate announced by Bank of America, N.A . from time to time and (3) the eurodollar rate plus 1.00%. The applicable margin under the Restated Credit Agreement with respect to the term loan A and revolving credit facilities is a percentage per annum varying from 0.5% to 1.0% for base rate loans and 1.5% to 2.0% for eurodollar rate loans, based upon our leverage ratio. Our average effective interest rate as of December 28, 2013 and September 28, 2013 was 3.5%, excluding amortization of deferred financing charges and interest on capital leases and financing obligations, and including the effect of interest rate swap agreements. We also pay a commitment fee on the average daily unused portion of the revolving credit facilities. All of our assets and the assets of our domestic wholly-owned material subsidiaries are pledged as collateral under the Restated Credit Agreement. The Restated Credit Agreement contains customary negative covenants, subject to certain exceptions, including limitations on: liens; investments; indebtedness; mergers and consolidations; asset sales; dividends and distributions or repurchases of our capital stock; transactions with affiliates; certain burdensome agreements; and changes in our lines of business. The Restated Credit Agreement requires us to comply on a quarterly basis with a consolidated leverage ratio and a consolidated interest coverage ratio. At December 28, 2013 , we were in compliance with these covenants. In addition, the Restated Credit Agreement contains certain mandatory prepayment requirements and customary events on default. We are party to interest rate swap agreements, the effect of which is to limit the interest rate exposure on a portion of the loans under our credit facilities to a fixed rate versus the 30-day Libor rate. The total notional amount of these swaps at December 28, 2013 was $130.0 million . The fair market value of the interest rate swaps is the estimated amount that we would receive or pay to terminate the agreements at the reporting date, taking into account current interest rates and the credit worthiness of the counterparty. At December 28, 2013 , we estimate we would have paid $5.4 million (gross of tax), if we terminated the interest rate swap agreements. We designate the interest rate swap agreements as cash flow hedges and the changes in the fair value of these derivatives are classified in accumulated other comprehensive income (a component of equity). During the thirteen weeks ended December 28, 2013 and December 29, 2012 , we incurred $0.8 million and $1.1 million , respectively, in additional interest expense pursuant to interest rate swap agreements. We believe that our cash flows from operating activities, existing cash and our credit facilities will provide sufficient liquidity to pay all liabilities in the normal course of business, fund anticipated capital expenditures, service debt requirements through the next 12 months, and fund any purchases of our common shares under the repurchase programs authorized by the Board of Directors, and pay dividends. We continuously evaluate our capital requirements and access to capital. We may opt to raise additional capital through equity and/or debt financing to provide flexibility to assist with managing several risks and uncertainties inherent in a growing business including potential future acquisitions or increased capital expenditure requirements. 31 -------------------------------------------------------------------------------- Table of Contents A summary of cash requirements related to our outstanding long-term debt, future minimum lease payments and purchase commitments is as follows (in thousands): Operating Capital Lease Financing Long-Term Interest Lease Obligations Obligations Purchase Debt Expense (1) Obligations (2) (3) Obligations Total Remainder of 2014 $ 9,826 $ 4,446 $ 14,191 $ 2,559 $ 1,475 $ 497,224 $ 529,721 FY 2015 - FY 2016 159,358 7,667 27,820 7,675 18,241 286,581 507,342 FY 2017 - FY 2018 901 71 14,644 7,674 19,245 219,810 262,345 Thereafter 231 9 20,335 31,980 113,722 - 166,277 Total $ 170,316 $ 12,193 $ 76,990 $ 49,888 $ 152,683 $ 1,003,615 $ 1,465,685 -------------------------------------------------------------------------------- (1) Based on rates in effect at December 28, 2013 . (2) Includes principal and interest payments under capital lease obligations. (3) Represents portion of the future minimum lease payments allocated to the building which will be recognized as reductions to the financing obligation and interest expense upon completion of construction. In addition, we have $23.5 million in unrecognized tax benefits primarily as the result of acquisitions of which we are indemnified for $12.6 million expiring through June 2015 . We are unable to make reasonably reliable estimates of the period of cash settlement, if any, due to the uncertain nature of the unrecognized tax benefits. Recent Accounting Pronouncements In July 2013 , the Financial Accounting Standards Board (the "FASB") issued an Accounting Standards Update ("ASU") No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). ASU 2013-11 was issued to eliminate diversity in practice regarding the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under ASU 2013-11, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. Otherwise, to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU will become effective for the Company beginning in fiscal 2015. The adoption of ASU 2013-11 is not expected to have a material impact on our net income, financial position or cash flows. In March 2013 , the FASB issued ASU No. 2013-05, "Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity" ("ASU 2013-05"). ASU 2013-05 provides clarification regarding whether Subtopic 810-10, Consolidation - Overall, or Subtopic 830-30, Foreign Currency Matters - Translation of Financial Statements, applies to the release of cumulative translation adjustments into net income when a reporting entity either sells a part or all of its investment in a foreign entity or ceases to have a controlling financial interest in a subsidiary or group of assets that constitute a business within a foreign entity. The amendments in this ASU will become effective for the Company beginning in fiscal 2015. The adoption of ASU 2013-05 is not expected to have a material impact on our net income, financial position or cash flows. In February 2013 , the FASB issued ASU No. 2013-04, "Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date" ("ASU 2013-04"). ASU 2013-04 provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors as well as any additional amount the reporting entity expects to pay on behalf of its co-obligors. ASU 2013-04 also requires an entity to disclose the nature and amount of those obligations. The amendments in this ASU will become effective for the Company beginning in fiscal 2015. The adoption of ASU 2013-04 is not expected to have a material impact on our net income, financial position or cash flows. 32 -------------------------------------------------------------------------------- Table of Contents Factors Affecting Quarterly Performance Our business is subject to seasonal fluctuations, including fluctuations resulting from the holiday season. As a result, total inventory, and specifically, brewers and accessories finished goods inventory is considerably higher during the last fiscal quarter than other quarters during the fiscal year, as we prepare for the holiday season. Due to the shift in product mix toward brewers and accessories in the first quarter of our fiscal year, gross margin, as a percentage of net sales, is typically lower in the first fiscal quarter than in the remainder of the fiscal year. Historically, in addition to variations resulting from the holiday season, we have experienced variations in sales from quarter-to-quarter due to a variety of other factors including, but not limited to, the cost of green coffee, competitor initiatives, marketing programs and weather. Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year. Forward-Looking Statements Certain information in this filing constitutes "forward-looking statements." Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believes," "expects," "anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future or conditional verbs, such as "will," "should," "could," "may," "aims," "intends," or "projects." However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. These statements may relate to: the expected impact of raw material costs and our pricing actions on our results of operations and gross margins, expected trends in net sales and earnings performance and other financial measures, the expected productivity and working capital improvements, the success of introducing and producing new product offerings, the impact of foreign exchange fluctuations, the adequacy of internally generated funds and existing sources of liquidity, such as the availability of bank financing, the expected results of operations of businesses acquired by us, our ability to issue debt or additional equity securities, our expectations regarding purchasing shares of our common stock under the existing authorizations, projections of payment of dividends, and the impact of the inquiry initiated by the SEC and any related litigation or additional governmental inquiry or enforcement proceedings. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company's historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in Part I, "Item 1A. Risk Factors," and Part II "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our fiscal 2013 Annual Report filed on Form 10-K, as amended, and elsewhere in this report and those described from time to time in our future reports filed with the Securities and Exchange Commission . 33 -------------------------------------------------------------------------------- Table of Contents


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