Green Mountain Coffee Roasters, Inc.

Please see disclaimer at bottom of this document

October 13, 2010 ($29.18)                         Review of why Green Mountain would buy Diedrich

The reasoning below is purely an operational discussion. I have not addressed the price paid for Diedrich, and I only discuss the operational reasons they may have had in the purchase of Diedrich.

Prior to purchase of Diedrich, Green Mountain would collect a royalty fee for Diedrich producing K-Cups. Diedrich sells K-Cups to Green Mountain and coffee to other companies. Prior to purchasing Diedrich, Green Mountain would have an expense to Diedrich for purchases of the K-Cups and coffee.

Buying Diedrich eliminated the royalty income recorded and received by Diedrich, but it also eliminated the cost of sales from the expense they incurred in purchases of items to be sold from Diedrich. Hence, Green Mountain in theory would see Gross Margins increase, as Cost of Sales decreased.

The general theory is that the royalty income would be eliminated. Yet, management is aware that royalty income could possibly disappear when the patents expire in 2012( GMCR claims September 2012) . I will emphasize that the loss of royalty stream from patent expiration is a possibility only. GMCR claims to be taking measures to optimize a potential scenario where patent expiration could lead to other companies producing K-cups without a royalty fee.

Yet, and this is very important to know. GMCR will no longer have to pay a vendor for the purchase of coffee and such. This will cause a natural increase to gross margins, via a lower cost of sales, as well as increased revenues.

It is my understanding, prior to purchase of DDRX, that GMCR paid DDRX as a vendor, and that DDRX of course sold to GMCR at a profit. Once GMCR purchased DDRX, GMCR still ultimately incurred cost of sales (coffee, materials, shipping, etc.), but GMCR would be paying for those supplies without DDRX making a profit. Hence, Cost of Sales drops and Gross Margins increase.

Here is an example. Prior to purchase of DDRX, DDRX would by coffee and supplies for $1. They would sell to GMCR for $2. GMCR would sell to customers for $3.

Using that example, GMCR would have a gross margin of 33.33% prior to ownership of DDRX (($3-$2)/3). After GMCR owned DDRX, the cost for supplies and such was still $1, and the sale by GMCR was still $3. Hence gross margin is now 66.67% (($3-$1)/3).

Coffee Price Observation:

Coffee prices materially escalated last quarter. GMCR was not as heavily hedged at June 30, 2010, as they were at the end of F2009.

Average Coffee prices were $142.20 during June 2010.

Average Coffee Prices were as follows for other months.

July 2010                           $153.41
August 2010                      $157.46
September 2010                $163.61

The prices were as follows for average at end of month:

September 2009                  $116.40
December 2009                   $124.96
March 2010                          $125.30

10/11/10                             $154.06

I believe effective this week; GMCR raised their prices 10% to 15%. You can see that coffee prices escalated during this fiscal year. I would imagine that cost of sales will be impacted because of this.

October 7, 2010 ($28.73)                             GMCR Investors should look for the following

If I was long GMCR, or any company in the same situation I would be concerned about the following:

1. Is there any validity to the SEC investigation? Of course, we will not know until there is more information.

2. Will earnings be reduced by further accounting errors, as well as increased legal costs due to the SEC investigation?

I don’t know if the SEC “inquiry” will produce further earnings adjustments. GMCR has the upcoming annual audit by PWC, and we do not know if they will find other issues that need to be reclassified from the first 3 quarters of this fiscal year. Yet, one can say that for many companies. To answer your question, I would not be surprised if there were further unanticipated costs that arise. I think the auditors will look closely at inventory, warranty, inter-company transactions, GMCR’s emphasis to highlight Non-GAAP earnings and revenue recognition.

3. Has there been any change to the $1.35B credit pledge to GMCR?

I do not list Lavazza as a real concern, since one has to fully believe that Lavazza was made well aware of the accounting error and SEC investigation which was known by GMCR prior to the Lavazza closing and funding.

I have been wondering if the actual funding of the $1.35B is being reconsidered. I do not mean to alarm with my thoughts. If I was a long in any company that had this situation, it would be a concern of mine. For all we know, all lending parties of the $1.35Billion were alerted prior, and signed off as no issue and that funding will continue.

October 7, 2010 ($28.67)                                         Updating some older notes

1.Questions and discussion with IR between September 1st , 3rd and 21st, 2010: IR Response is indicated with blue italics.

A. How many pounds of coffee are purchased and shipped for the year? Is this information available to monitor? Can this be found for the last 3 years? This information is not released on a regular basis. You can see 2008 information at this link . The F2009 10-K stated that “SCBU sold approximately 40 million pounds of coffee in fiscal 2009.”

B. Verification of IR statement to us, that inventory is made up primarily of brewers. For F2009, the inventory was primarily brewers. IR indicated this probably was the case for prior 2 fiscal years, but would not verify this. I accepted this response, and could always request again. IR mentioned they never released, and hence not real comfortable investigating, and mentioned that divulging such info, could possibly require a REG-FD, so preference not to take the question further.

C. If major retailer did not have sell through, how would this be treated accounting wise with GMCR. GMCR records revenue when shipped, and inventory never hits MBlock and Sons. Yet, receivable does. Hence, what risk does MBlock and Sons encounter. Does GMCR have risk, other than MBlock Accounts Receivable? IR corrected this statement a few days later, please see paragraph following this blurb. IR said they will confirm their discussion with me, whereas they mentioned that GMCR ships directly to major retailer, that is when revenue is recognized. They mentioned MBlock has the receivable because they are the facilitator. Does GMCR have receivable with major retailer? If major retailer does not sell through, GMCR claimed that all risk is born between retailer and GMCR, and that MBlock does not enter into the picture at all. This all needs to be confirmed. GMCR mentioned that MBlock and Sons, never has inventory from GMCR. No inventory is shipped to MBlock and Sons. Per GMCR, no revenue is recognized with MBlock and Sons.

The following was IR correction and confirmation of mention above: MBlock and Sons distributes to major retailers only. MBlock is not at all involved with groceries or office market. IR previously had relayed incorrect information on this. I think this is totally understandable, since it gets a bit complicated. All Major Retailer Inventory is shipped to MBlock. A sale is not recorded by GMCR when inventory is shipped to MBlock. All Major Retailer activity goes through MBlock. MBlock receives orders, pulls and ships inventory FOB. Hence, sale is recorded when inventory is shipped. At that point, GMCR records the sale, and charges MBlock. The Major Retailer owes money to MBlock. If retailer fails to pay MBlock for any reason, IR affirmed that MBlock is still responsible for the monies owed (accounts receivable) to GMCR. GMCR is not aware of any contractual deals which MBlock has with Major Retailer. Once sale is made, sale is final, and GMCR is not contractually obligated to take back any merchandise. This is identified in 10K under Revenue Recognition.

I asked if the Allowance for Doubtful accounts had a higher allocation to MBlock versus other receivables. GMCR, very understandably said it was an interesting question, but declined to comment. The Allowance for Accounts Receivable, since 4Q07, has ranged as low as 4.03% at 4Q07, and as high as 7.08% at 4Q08.

So much of GMCR operations and receivables are tied into MBlock. To my knowledge, we are not privy to any information on MBlock. Hence, analysis of GMCR financial health could be impossible. That is why I have mentioned the term, “black hole.” There is so much data tied into MBlock, which is not available to investors. Hence, much of GMCR’s financial health is potentially not analyzable. One could use the same argument with Berkshire Hathaway, as they have many divisions and consolidated companies, which are not broken up financially to the public.

Revenue processed by MBlock amounted to $282.5 million and $88.6 million and receivables amounted to $46.3 million and $19.6 million at September 26, 2009 and September 27, 2008, respectively.

Receivables from this company were approximately 51% of GMCR consolidated accounts receivable balance at September 26, 2009.

D. What could GMCR theoretical risks with MBlock be. So far, based on discussion with GMCR, I can’t think of any, other than collection of Accounts Receivable. IR concurred.

E. During August 2010, insiders Stacey & McCreary, exercised options and sold those options. Were these shares qualified or unqualified shares? Per IR, these shares are unqualified.

F. Is there a breakdown of Quarterly and Annual Royalty Income? I found this in several Q’s, but many were missing. IR confirmed that the reporting of Royalty Income has been sporadic and inconsistent. Royalties have been decreasing, since GMCR has been buying all the licensees. Yet, now that Smuckers, etal will be selling GMCR goods, royalties will once again increase. This of course was previously strategized, and will expectedly lead to cannibalization.

G. I asked for some clarity on patent expirations and so forth. I didn’t ask till after our conversation, and left a message. Per IR, this is still an unknown. I asked if worst case scenario would be that patents expire in 2012, and that others could produce without any royalty or fee of such to GMCR. I also mentioned perhaps patents are extended, or new technology or such, and that would force continuation of GMCR K-Cups. IR confirmed both as potential scenarios. IR indicated that GMCR is taking measures now to try and optimize either scenario. IR mentioned that 9/12 is a long time away. IR mentioned that they don’t even know the answer. I mentioned that it seems nearly impossible to review and determine outcome.

H. I asked about EZ-Cups and EZ-Cup Filters. IR was not real familiar with them. I mentioned they were being sold at Kings and here is a link more IR mentioned that GMCR has no revenue sharing arrangement or such with any of those technologies. IR didn’t sound at all concerned. It seems like a decent alternative, for cost savings and for your own coffee.

I. IR also explained that 90%-92% of business is contracted within the organization. I might not be writing this correctly, but basically GMCR works within its organization primarily, whereas much of the purchasing and so forth would go through, say a Diedrich. GMCR has bought all of those companies. The only remaining company, which does currently account for 8% to 10% of their purchasing is via Van Houtte. (Our discussion was prior to the announcement of GMCR to purchase Van Houtte).

August 28, 2010 Barron’s Bearish Article on GMCR

“UNLIKE THE REST OF THE MARKET, Green Mountain Coffee Roasters (ticker GMCR) is enjoying a splendid summer. Shares rallied this month to an all-time high above 33, up more than 1,000% in less than four years, and even an 8% pullback since mid-August is quickly billed as a buying opportunity.

Coffee is hot right now, and Green Mountain is milking its hottest trend: the already-well-documented shift toward brewing coffee in single servings. You’ve seen its Keurig brewers stacking up everywhere from Bloomingdale’s to Wal-Mart, and the Waterbury, Vt., company prices the units aggressively, making little to no money on them so it might penetrate the market and pave the way for recurring—and far more lucrative—sales of its single-serve portion packs. Last quarter, it shipped 846,000 Keurig brewers, up 91% from a year ago, while its K Cup portion packs increased 72% to 683 million.

These staggering numbers, however, mask risks that increase with the stock price. Barron’s has been wary about Green Mountain before, and has been proven wrong as the pricey stock got pricier. Much as I’d like to avoid calling attention to our prior mistakes, I’d be remiss if I steered clear of Green Mountain.

For a start, coffee prices have jumped 24% this year, far more than cattle, cotton and even gold. Coffee accounts for 24% of Green Mountain’s cost of goods sold, and net profit margins of just 7% are at risk now that the company has stopped, since late last year, using coffee futures to hedge its exposure to rising costs.

Margins are also threatened by inventories pushing record highs just as its stellar sales growth begins to slow, says the forensic accounting research firm CFRA. For example, it would take 84 days to move the company’s inventory at the end of its recent fiscal third quarter, up from 74 days a year ago. Revenue is up an enviable 64% from a year ago, but that’s slower than growth rates of 77% late last year and 68% earlier this year. Will Green Mountain need to mark down its merchandise, given coffee’s shelf life?

Already, the company has warned investors to expect lower per-share profits of 18-20 cents this quarter, versus the 21 cents analysts were expecting, and shares might have been walloped if management hadn’t distracted investors with an ambitious forecast–predicting profits of $1.15 to $1.20 in 2011, more than the $1 analysts had penciled in. Can management deliver on this promise?

Keurig brewers were a popular gift last Christmas, and hopes for an even bigger splash this year fail to consider the maturing market and the waning novelty of yet another Keurig under the tree. Consumers also aren’t brewing as enthusiastically as bulls might like, and the ratio of K Cups used relative to brewers has been declining. Meanwhile, the single-cup market runneth over with competitive offerings from the likes of Kraft Foods (KFT) and Sara Lee (SLE).

Two principal patents associated with its K Cups will expire in 2012, and while Green Mountain is diligently concocting—and patenting—new variations of its old winner, the clamor for this hot stock could turn tepid in 2011, especially if margins begin to shrink.

Such looming risks might be overlooked if the stock were cheap. Alas, six of the 10 analysts who cover it already rate the shares Buy, and have bestowed optimistic estimates on it. Still, the stock trades at 44 times projected 2010 profits, far higher than already-caffeinated multiples of 19 for Starbucks (SBUX), 22.5 for Caribou Coffee (CBOU), 27 for Peet’s Coffee & Tea (PEET), not to mention just 15 times for the packaged-food sector. Green Mountain’s enterprise value is now 26 times its cash flow, well above the 9.5 median over its nearly 17 years as a public company, as well as its highest ever. How will Green Mountain top this high?”

September 29, 2010 ($31.27) SEC Investigating GMCR?

1.GMCR issued an 8K disclosing the sale to Lavazza, a $0.03 overstatement of earnings from 2007, and an SEC investigation. GMCR believes the investigation is based on revenue recognition with a fulfillment company.

The following is some data I collected based on such. Much of what is discussed in the data was previously presented by us in the notes below; specifically in relation to MBlock and Sons.


“As concerns over Green Mountain, well, mount, here are the first two sellside responses following last night’s GMCR 8-K announcement of an SEC inquiry into its “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.”

From Bryan Spillane of BofA (Maintain Underperform and $30 PO):

While details of the SEC inquiry are unclear, key points to consider are: 1) Keurig’s largest order fulfillment company is MBlock & Sons, which processes the majority sales (coffee makers and K-cups) that the Keurig segment makes through the retail channel (e.g. Bed Bath & Beyond, Kohls, etc.). M. Block warehouses the physical inventory, takes the customer orders, ships the product and collects receivables, essentially working as an outsourcing partner for GMCR; 2) In FY09, M.Block accounted for 35.2% of total GMCR sales and 51% of accounts receivables; 3) In our view, the use of a fulfillment company to process orders is not unusual (M. Block also has an arrangement with Tassimo, Nestle, etc) however Green Mountain’s proportion of sales flowing through a fulfillment entity has increased because of its rapid growth. This makes it difficult to use financial statements to make a clean assessment on the relationship between GMCR retail sell in and consumer pull. It does not however, suggest to us anything inappropriate. We do note that retail channel checks and third party data suggest that consumer pull through for Keurig Machines and K-Cups are strong.

From Mark S. Astrachan (Sell, No Price Target)

In an 8-K after the close, Green Mountain Coffee Roasters announced an SEC inquiry concerning certain of the company’s revenue recognition practices and the relationship with one of its fulfillment vendors. Separately, the company disclosed an intercompany accounting error that resulted in an overstatement of net income. We believe the two disclosures are unrelated and view the SEC inquiry as the most concerning. Green Mountain said it is cooperating with the inquiry.

Specifically, we believe the focus of the inquiry will be on various revenue recognition changes made by the company in recent years and on its relationship with M-Block, the fulfillment company Green Mountain sells Keurig brewers and K-Cups to for re-sale to select retailers. M-Block accounted for 35% and 50% of the company’s net sales and accounts receivable, respectively, in F2009. Specifically, Green Mountain has changed revenue recognition policies in recent years relating to sales incentives (i.e., recorded as a reduction of revenue or as an SG&A expense) and when revenue is recognized (i.e., upon shipment or customer receipt). For more on the relationship between Green Mountain and M-Block and recent revenue recognition changes, please see our November 30, 2009 note, “Takeaways from the 10K”.

Notably, Green Mountain disclosed the SEC inquiry in connection with its acquisition of Van Houtte and the marketing of the associated $1.35 billion debt financing. While the merger agreement with Van Houtte has not been filed, we believe the presence of a material adverse change (MAC) clause could enable the lenders or Littlejohn to back out of the agreement. Relatedly, Green Mountain announced it completed its $250 million share sale to Lavazza. We are unsure if Lavazza was notified of the investigation prior to the deal’s closing and/or what, if any, legal recourse the company may have as a result.

Further, GMCR’s fiscal year ends in September. As such, the company’s auditors, PricewaterhouseCoopers, will need to thoroughly examine and have confidence in Green Mountain’s results before signing off on their validity, in our view.”

September 2, 2010 ($31.12) Cash consumed over last 45 months

Here is some data for the period October 1, 2006 through June 26, 2010.

Cash Collected via Stock Options $21,156
Cash Collected Via Public Offering $386,688
Net Change in Revolver -$17,799
Proceeds from Long Term Debt $190,045
Repayment of Long Term Debt -$4,130
Total $575,960

Net cash collected from either loans, employees and stock offerings for the last 45 months by GMCR is $576M. Total cash balance as of 6/26/10 is $10M.

During the above periods mentioned Green Mountain purchased a variety of businesses. The following is the cash spent on those businesses during the same time period mentioned above.

Tully’s Coffee $ 41,361
Timothy’s Coffee of the World $154,208
Diedrich Coffee $305,261
Total $500,830

August 31, 2010 ($30.85)                                          Valuation Discussion

Our valuation spreadsheets are really not useful here. Our valuation analysis goes out 15 years. GMCR is such an unknown, and hence any valuation stab, would have a tremendous error rate. Many think GMCR will continue to gather market share. Merrill expects 18%+ penetration in all households that drink coffee by 2015. I think other bulls expect penetration up to 40%. Also, GMCR has not really had a presence internationally. Hence, our short thesis could be killed with continued growth rates, which would translate into shareholder value.

On the other hand, I have different expectations. I do not think that penetration will hit the 18% level. Yet, I am by far not an expert. I think the rise in coffee costs will have an adverse affect on earnings. I also think the brewer shipments will slow down. Consumer confidence should have some affect on Brewer sales. I think that K-Cup sales will unexpectedly slow down, as consumers realize that their home brew via single serve is not a bargain by any means.

I project F2010 GAAP eps to be $0.58. That is on the lowest end of all guidance I have seen. GMCR in their July conference call, projected F2010 NON-GAAP eps between $0.69 – $0.71. Interestingly, GMCR projects F2010 Depreciation and Amortization to be $44M to $46M. This would be an increase over prior quarter of $2M – $4M. This is not surprising since capex has been building, and that will account for greater depreciation. Just speculating here, but The Street in theory might look at such an expense as higher than expected, and perhaps stock price suffers? Yet, cash would not be impacted.

Also, our projections do not include any funding or dilution during the quarter for Luigi Lavazza. Recall that Lavazza will be putting in around $250M this quarter.

Current Thesis:
  1. Margin pressures to start to appear in 4Q10. As of 8/31/10, coffee prices at 12 year highs. Coffee index ended June at $1.422. As of August 30, 2010, price was $1.5947. Coffee prices are up 11% so far this quarter, and 13.5% in the quarter ending June 26, 2010.
  2. Consumers will not buy Keurig units with same velocity as past.
  3. Competition to start to bloom. I was thinking of another brewer or possibly another system of delivering coffee via single serve. Yet, I have not heard much out there, other than minor speculation that SBUX was coming out with single serve brewer. I also am not familiar with patent issues and if that could lead to competition, or possibly a benefit of some type to GMCR?
  4. P/E ratio high. Yet, if growth rate remains high, GMCR could safely fit into P/E. Looking at Graham’s P/E matrix (GrahamandDoddPEMatrix.html ) , with interest rates so low – 30 YR bond at 3.52% ), a P/E of 46 could be supported with a 15% growth rate. If growth rate was higher, of course a much greater P/E could be supported. Yet, a rise in interest rates could squeeze the P/E. Priced for perfection.
  5. Some insider selling during August. Yet, not at all necessarily a sign of anything.
  6. Inventory build and potential for lack of sell through.
  7. I consider Accounts Receivable with MBlock and Sons, to be only a remote risk.
  8. Potential under-accrual of Inventory obsolescence and warranty reserves. Perhaps higher than anticipated of the 1.5M brewers sold in 1Q10 will be part of the brewer problem.
  9. Capex guidance has been increasing. Most recent guidance is for $122M to $140M. That is a substantial % increase over the past. Yet, bullish scenario is necessary build out to fit demand.
  10. F2011 guidance may turn out to be too optimistic.

A sample analysis for GMCR:

As of Date August 31, 2010
EV Analysis June 26, 2010
Share Outstanding 137,898.25
Share Price $30.82
Market Capitalization $4,250,024.16
Less: Cash and Short Term Investments ($9,921.00)
Add: Long Term Debt $252,380.00
Enterprise Value $4,492,483.16
EV per share $32.58
Stockholders’ Equity $662,133.00
Goodwill ($386,416.00)
Other Intangibles ($225,481.00)
Net Stockholders’ Equity $50,236.00
Adjusted Book Value per Share $0.36


Quick Projections 2010 June 26, 2010
Revenue $1,341,000.00
Net Margin % before tax 10.00%
Net Margin before taxes $134,100.00
Tax Rate 40.00%
Corporate Taxes $53,640.00
Net Income after Taxes $80,460.00
Net Margin % 6.00%
Shares Outstanding 137,898.25
eps $0.58


FV of current equity and future earnings 26-Jun-10
Adjusted Stockholder’s Equity $50,236.00
Net Profit $80,460.00
Growth Rate of Net Profit for 10N 10.00%
Growth Rate of Net Profit after 10N through 15N 5.00%
FV of Net Profit in 10N $208,692.52
FV of Net Profit in 15N $266,350.41
FV of tangible book value plus Net Profits for 10N $1,412,624.43
FV of tangible book value plus Net Profits for years 11 – 15N $2,956,064.42
Current Enterprise Value $4,492,483.16
FV of tangible book value plus Net Profits for 10N ($1,412,624.43)
Years 10
ROI on tangible book value plus Net Profits for 10N -10.93%
FV of tangible book value plus Net Profits for 10N $1,412,624.43
FV of tangible book value multiplier 3.00
FV of Tangible Book Value using BV multiplier in year 10 $4,237,873.29
Current Enterprise Value $4,492,483.16
FV of tangible book value plus Net Profits for years 11 – 15N ($2,956,064.42)
Years 15
ROI on tangible book value plus Net Profits for 15N -2.75%
FV of tangible book value plus Net Profits for 15N $2,956,064.42
FV of tangible book value multiplier 3.00
FV of Tangible Book Value using BV multiplier in year 15 $8,868,193.25
Potential Future EV using BV multiplier above
Current Enterprise Value $4,492,483.16
FV of Tangible Book Value using BV multiplier in year 10 ($4,237,873.29)
Years 10
ROI on FV of Tangible Book Value using BV multiplier in year 10 -0.58%
Current Enterprise Value $4,492,483.16
FV of Tangible Book Value using BV multiplier in year 15 ($8,868,193.25)
Years 15
ROI on FV of Tangible Book Value using BV multiplier in year 15 4.64%
Sanity Checks:

P/E in Future

FV of Net Profit in 15N $266,350
P/E estimate 20.00
Market Cap on above -$5,327,008
Years 15
Current Enterprise Value $4,492,483
ROI in 15N using above 1.14%
Potential Revenue Growth
Current Revenues $1,341,000
Growth Rate of Revenues for 10N 10.00%
Growth Rate of Revenues after 10N through 15N 5.00%
FV of Revenues in 10N ($3,478,209)
FV of Revenues in 15N $4,439,174
FV of Revenues in 15N $4,439,174
Revenue Multiplier based on Al Meyer Rule of Thumb net margins 1.1
Possible Market Cap year 15 ($4,883,091)
Years 15
Current Enterprise Value $4,492,483
ROI in 15N using above 1%


Company Green Mountain
Symbol GMCR
Report Date 31-Aug-10
Report Used rbco
Base Year 2010
Price 30.820
30 year Bond Rate (AAA) 4.00%
S & P Bond Rate
Sales Per Share 9.71
Price/Sales 3.17
Projected R & D 0.00
Growth Flow Ratio (<12=nrml) 46.00
Cash Flow Per Share 1.00
Capital Expend Per Share 0.85
Net Cash Flow Per Share 0.15
Price/Cash Flow 30.82
Price/ Net Cash Flow 205.47
Cash King (s/b > 10 % ) 1.54%
Total Interest Coverage 7.4
Growth Rate 15.00%
Earnings Per Share 0.67
Projected EPS Year 2 1.00
Projected EPS Year 3 1.15
Projected EPS Year 4 1.32
Projected EPS Year 5 1.52
Dividends Per Share 0.00
Dividend Yield 0.00%
Book Value Per Share 4.80
Intangibles Per Share 4.44
Net Book Value Per Share 0.36
Price/ Net Book Value 85.61
Return on Shr. Equity 11.50%
ROE/PE (current) 25.00%
ROE/PE Year 2 37.31%
Working Capital 164191
LT Debt 252380
Shr. Equity 662133
LT Debt / Working Capital 153.71%
LT Debt / Shr. Equity 38.12%
Cash 9921
Current Assets 356071
Inventory 186262
Current Liabilities 191880
Short Term Debt 19058
Quick Assets 169809
Current Ratio 1.86
Quick Ratio 0.88
Flow Ratio (s/b < 1.25 ) 2.00
P/E Ratio Current 46.00
P/E Ratio Year 2 30.82
P/E Ratio Year 3 26.80
P/E Ratio Year 4 23.30
P/E Ratio Year 5 20.26
Inverse P/E Current 2.17%
Inverse P/E Year 2 3.24%
I/P/E to Bond Rate (Current) 54.35%
I/P/E to Bond Rate Year 2 81.12%
Div Yield / AAA Bond 0.00%
PEG Ratio (Current) 3.07
PEG Ratio Year 2 2.05
PEG Ratio Year 3 1.79
PEG Ratio Year 4 1.55
PEG Ratio Year 5 1.35
PEGY Ratio (Current) 3.07
PEGY Ratio Year 2 2.05
Graham Ratio (current) 3938.11
Graham Ratio Year 2 2638.53
Highest P/E Avg 5 + Years 42.00
P/E (current) to High P/E 1.10
P/E Year 2 to High P/E 0.73
Intrinsic Value (current) 28.37
Price / Intrinsic Value(current) 108.62%
Intrinsic Value Year 2 42.35
Price / Intrinsic Value Year 2 72.77%
Intrinsic Value Year 3 48.70
Intrinsic Value Year 4 56.01
Intrinsic Value Year 5 64.41

August 27, 2010 ($30.44)

Employment agreements are listed in 3/28/09 10-Q. Could be handy for future reference.

Notes from 7/28/10 Conference Call

GMCR was asked,

“I’m wondering if we could talk just a little bit about two different topics. Number one help us understand a little bit your commodity positioning right now as it relates to what’s happening with spot prices how far out your purchased on your coffee and how that might impact your P&L over time if those prices were to sustain at a higher rate?”

Wettstein, GMCR VP of Operations, responded, “I will speak to the coffee cost question first. Our policy for some time now has been to fix out in the range of six to nine months forward for our coffee contracting. And with that we, as I’m sure many on the phone have seen the market not come down when it might traditionally do that after — midway through the brazil harvest and not seeing risk of frost, so we’re watching this very closely. The benefit of our having forward coverage like this is it does give us the chance to see if the market movements are long term trends or short term trim and then with the forward coverage while we do have some time to assess then what we might want to do after we’ve seen that for a bit.”

Dougherty analysts asked, “And was there a poor harvest a couple areas of the world that are causing some of this? Is it really supply related or, why do you think the move has occurred that’s happened?”

Wettstein responded with, “I think there are various views on the physical potential. We certainly know we are in the middle of the larger harvest right now in brazil but what the market is doing and telling us as we look forward is that there is anticipation of potential tightness and we’ll see how that really unfolds and then of course on top of the traders that are in the business then there’s always the potential for others to be very involved and in some ways exaggerate market moves.

So I think again we have the time to watch the market for longer and think about how this might affect us.”

Thoughts on Gross Margin:

Coffee prices have escalated from June till now.

I refer below to ICO Composite Price

At the end of F2009 coffee prices were $1.1640. As of 7/31/10, they were $1.5341.

Hedging only goes out 9 months max. Yet, GMCR has taken off all of their futures hedging since the end of F2009 (through 6/30/10). I do not think that will have a devastating impact. I estimate (back of envelope) that lack of hedging could affect 10% of annual coffee purchases (assuming ~1B lbs purchased).

I would expect to see margin pressures to start showing up in next quarterly release.

So far through yesterday, the August 2010 coffee price was as high as $1.6319, and as low as $1.4955. Price closed yesterday at $1.5318.

There has been a continual gross margin decline since F2007, through F2009.

On a positive note, I think margins will increase via the purchase of Diedrich.

Review of F2009 10-K


Inventories consist primarily of green and roasted coffee, including coffee in portion packs, purchased finished goods such as coffee brewers and packaging materials. I spoke with GMCR on 8/31/10, it was explained that most of the inventory are brewers. I asked for a breakdown, and it was explained that is not supplied.

Revenue Recognition:

Revenue from wholesale and consumer direct sales is recognized upon product delivery, and in some cases upon product shipment. The Company has no contractual obligation to accept returns for damaged product nor does it guarantee product sales. Title, risk of loss, damage and insurance responsibility for the products pass from the Company to the buyer upon accepted delivery of the products from the Company’s contracted carrier. The Company will at times agree to accept returns or issue credits for products that are clearly damaged in transit.

Sales of single-cup coffee brewers are recognized net of an estimated allowance for returns. The Company estimates the allowance for returns using an average return rate based on historical experience. Royalty revenue is recognized upon shipment of K-Cups by roasters as set forth under the terms and conditions of various licensing agreements.

In addition, the Company’s customers can earn certain incentives, which are netted against sales or recorded in operating and selling expenses in the consolidated income statements. These incentives include, but are not limited to, cash discounts, funds for promotional and marketing activities, and performance based incentive programs.

Business Segments:

GMCR has two business segments, Specialty Coffee business unit (SCBU) formerly referred to as Green Mountain Coffee (GMC), and Keurig business unit (Keurig).

SCBU sells whole bean and ground coffee selections, as well as K-Cups in domestic wholesale and retail channels and directly to consumers. In addition, SCBU sells Keurig single-cup brewing systems and other accessories directly to consumers and more recently to supermarkets.

Keurig claims to be a pioneer and leading manufacturer of gourmet single-cup brewing systems and claims to target its premium patented single-cup brewing systems for consumers at home (AH) and away-from-home (AFH) mainly in North America. Keurig sells its AFH single-cup brewers to distributors for offices and its AH single-cup brewers to select retailers such as department stores and club stores for at-home use. Keurig sells coffee, tea and cocoa in K-Cups produced by a variety of roasters, including SCBU, and related accessories to select retailers such as department stores and club stores and also directly to consumers. Keurig earns royalty income from the sale of K-Cups shipped by its licensed roasters.

What we can not seem to figure out is how much of the product is sold to MBlock & Sons. They are a “fulfillment company”, and it does not appear that any of their financial information is available to the public. We would like to know how much inventory could be returned to GMCR. Are there any potential concessions? Any receivables? Etc.

The 10-K does indicate that most of Keurig’s AH orders are processed via MBlock & Sons.

The 10-K further states, “Keurig processes the majority of its orders sold through retailers for the at-home channel through a fulfillment company. Revenue processed by this fulfillment company amounted to $282.5 million and $88.6 million and receivables amounted to $46.3 million and $19.6 million at September 26, 2009 and September 27, 2008, respectively.”

“We rely on a single order fulfillment company, M.Block & Sons, Inc., to process the majority of orders for our At-Home (AH) single-cup business sold through retailers. We sell a significant number of brewers and K-Cups to this third party fulfillment company for re-sale to certain retailers. Receivables from this company were approximately 51% of our consolidated accounts receivable balance at September 26, 2009. Accordingly, we are subject to significant credit risk regarding the creditworthiness of this company. The inability of this company to perform its obligations to us, whether due to a deterioration in its financial condition or otherwise, could result in significant losses that could materially adversely affect us. If our relationship with this company is terminated, we can provide no assurance that we would be able to contract with another third party to provide these services to use in a timely manner or on favorable terms.”

The F2008 10-K mentioned the following about a fulfillment company, but did not mention M. Block by name. “Keurig relies on an order fulfillment company to process the majority of its orders for the home market sold through retailers, including collection of all accounts receivable. Receivables from this order fulfillment company were approximately 36% of our consolidated accounts receivable balance at year end.”

“Keurig processes the majority of its orders for the home market sold through retailers through a fulfillment company. Revenue processed by this fulfillment company amounted to $88.6 million at during fiscal year 2008 and receivables amounted to $19.6 million at fiscal 2008 year-end and $7.0 million at fiscal 2007 yearend.”

This is a key quote from F2008 10-K ( I would have to look if in most recent Q’s or K.) “Sales of single-cup coffee brewers are recognized net of an estimated allowance for returns.”

Keurig Brewers are sold near cost:

“With respect to the Keurig single-cup AH system, we are continuing to pursue a model designed to penetrate the marketplace, a component of which is to sell brewers and accessories essentially at cost, and are focused on driving new customers into single serve coffee.”

Selected Financial Data:

Items to watch would be Gross Margin changes. There is a decline from F2007 through F2009.

We also see the growth of Keurig versus SBCU. Not surprising, since this is their hopeful future revenue driver. F2009, was the first year that Keurig had higher revenues than SBCU.

Stock Issuance 2009

Company issued 5,750,000 shares for a gross amount of $386.7M ($67.25 per share). GMCR netted $369.8M. Difference is 4.4%.

Income Taxes 2009 10-K

Something to watch. Merely because Income tax expense per Income Statement has been consistently greater than Income tax paid per the Statement of Cash Flows. Something to note, and monitor for future.

Proceeds from Common Stock Issuance under compensation plans:

GMCR has collected $17M from employees in F2007 – F2009. Again, something to monitor.

Net Operating Loss fully utilized in F2008.

Stock Splits:

May 18, 2010 ………………3:1
May 19, 2009 ………………3:2
July 6, 2007 …………………3:1
January 12, 2001 ………….2:1

August 25, 2010 ($31.56)

Two Minute Drill:

A. The P/E ratio. Is it high or low for this particular company and for similar companies in the same industry? I think P/E is high, only in relation to future expected growth rate, and possible Quality of Earnings issues. Examples could be inventory growth, and potential lack of sell through.

B. What are total return expectations? Not disclosed.

C. Value of company and compare current price. Not disclosed.

D. Can the company still grow? Yes, of course. International expansion, etc.

Some quick ramblings….

Using all resources to sell through Fall season (back to school) and holiday season. GMCR counting on “tsunami” of sales of Keurig units. Buildup and investment of such has occurred. GMCR stock price reflects anticipation of sell through and continued growth. Lack of insider selling was a plus. Two insiders (Stacey & McCreary) have since exercised and sold shares during August 2010. Potential under-accrual of all direct and indirect warranty costs. Potential rising labor and other passed on costs from China. Coffee prices at 12 year highs. Consumer confidence could have affect on purchasing of both the unit and the coffee itself. Extended valuation if growth rate is less than expected. Potential bubble play.

CFRA claims GMCR Margin Worries

CFRA is a fairly cool and legitimate organization. Dr. Schilit has an impeccable reputation. He is the author of an excellent book titled, “Financial Shenanigans.”

Here is their website…

“ Green Mountain Coffee Roasters (GMCR) shares could have used a shot of espresso today. The stock has been sluggish throughout the session after forensic accounting research firm CFRA says GMCR could face some gross margin pressure in the upcoming period. Firm says inventory levels are too high given sales expectations, and company changed hedging policy so may be facing increasing cost pressure from rising coffee prices. Also, CFRA points out there have been a couple of relatively significant insider stock sales in the past few weeks after not having any for a couple of years. GMCR recently down 1.5% to $31.09 on heavy volume, after earlier falling as much as 7.2%. “

August 11, 2010 ($31.64)

GMCR announced that an Italian corporation, Luigi Lavazza, agreed to make a $250M investment in GMCR common stock. The purchase price will be the volume weighted-average price for the 60 days before the closing of the investment, less 7.5%.

If I assume today’s price as the wtd-avg price and deduct 7.5%, the price that Lavazza will pay is around $29 and the $250M will increase shares outstanding by 6.5%.

I am not at all familiar with Lavazza but investors seem to think it is a conduit for European expansion possibilities for GMCR. As I speculated a few weeks ago, the company needed to raise cash and stock issuance was likely. I think the company made the best of the situation by having a company in the industry make the investment.

August 4, 2010 30.92 Quick blurb

The following are some potential risks I see in GMCR.

  • Continued risk of consumer confidence staying low, and not enabling GMCR to sell through the holiday seasons. The press release for 3Q10; noted the large increase in the number of units shipped during the quarter. 846,000 vs. 440,000 last year. Where were the units shipped to? Was it M. Block & Sons? Or were the units actually sold? (According to IR, revenue is not recognized until end consumer or retailer receives the product.) Is there any risk to GMCR if the retail store or distributor can not sell the merchandise? Recently Kellogg’s and Proctor and Gamble have discussed consumer sentiment and retrenchment.

Here is a note of ours from January 2010: “M. Block & Sons processes a majority of the orders for the AH brewers sold to retailers. GMCR sells units to M Block & Sons and then M. Block sells to the retailers. M. Block & Sons represented 51% of the company’s receivables at last year end (9/26/09). This info is not available for the qtr ended 12/26/09. (I wonder how much inventory M. Block & Sons has.)”

  • Shares projected to be outstanding F2011, 4Q10 and 2011?
  • Really no mention of balance sheet. Funding requirements, debt service, etc. CapEx alone is projected at $122M to $140M. The guidance during 1Q10 was $95m to $115M. Granted, the initial guidance did not include Diedrich.
  • Coffee inflation. Coffee has hit 12 year highs. Hedging has costs. Here is a link to coffee prices on a monthly basis.

Really have to wait for the Q to come out before one could dig deeper.

July 30, 2010 (30.70)
Book value per share calculation:

Qtr end


Equity 662,133
Wtd avg diluted o/s 137,898
Book value/share 4.80
Goodwill 386,416
Intangibles 225,481
Tangible book/sh 0.36
Gross Margin comparison:
39 weeks ending
6/26/2010 6/27/2009 Change
Sales 985,792 580,841 69.72%
COGS 665,584 401,428 65.80%
Gross Profit 320,208 179,413 78.48%
As % of sales
Sales 100.00% 100.00%
COGS 67.52% 69.11%
Gross Profit 32.48% 30.89%
13 weeks ending
6/26/2010 6/27/2009 Change
Sales 311,514 190,509 63.52%
COGS 201,783 126,428 59.60%
Gross Profit 109,731 64,081 71.24%
As % of sales
Sales 100.00% 100.00%
COGS 64.77% 66.36%
Gross Profit 35.23% 33.64%
Free cash flow calculation:         
39 weeks ending
Free cash flow: 6/26/2010 6/27/2009 Change
Net income 55,750 41,507 34.31%
Add: Deprec 20,379 13,054 56.11%
Amort 9,497 3,861 145.97%
Less: Cap ex 84,386 29,027 190.72%
Free cash flow 1,240 29,395 -95.78%
Wtd avg shares 137,682 117,318 17.36%
FCF/share 0.009 0.251 -96.41%

Management also issued guidance for fiscal 2011. They project a sales increase of 44% to 50% vs. 2010, with eps in the range of $1.15 to $1.20 (Ron’s comment: I think this guidance is NON-GAAP.) Some quick analysis of the 2010 estimates indicates a net margin of ~7%. Using the sales projections, the projected eps and the current wtd. Avg shares, I calculate a net margin of ~8.2% – a 17% increase in the net margin in 2010. (Ron’s comment: Margin should expand with Diedrich purchase)

Perhaps too skeptical on my part but the press release noted the large increase in the number of units shipped during the quarter. 846,000 vs. 440,000 lst year, and I immediately wonder who they were shipped to. Was it M. Block & Sons? Or were the units actually sold? Ron’s comment: Based on discussions with Green Mountain IR, MBlock and Sons distributes to major retailers only. MBlock is not at all involved with groceries or office market. IR previously had relayed incorrect information on this. I think this is totally understandable, since it gets a bit complicated. All Major Retailer Inventory is shipped to MBlock. A sale is not recorded by GMCR when inventory is shipped to MBlock. All Major Retailer activity goes through MBlock. MBlock receives orders, pulls and ships inventory FOB. Hence, sale is recorded when inventory is shipped. At that point, GMCR records the sale, and charges MBlock. The Major Retailer owes money to MBlock. If retailer fails to pay MBlock for any reason, IR affirmed that MBlock is still responsible for the monies owed (accounts receivable) to GMCR. GMCR is not aware of any contractual deals which MBlock has with Major Retailer. Once sale is made, sale is final, and GMCR is not contractually obligated to take back any merchandise. This is identified in 10K under Revenue Recognition.

The acquisition of Diedrich used the cash and caused LT Debt to increase to $252,380 vs. last year end balance of $73,013.

Shares outstanding also increased 5.4% in the past year. Inventories increased 35.7% vs. year end.

Once again, I am looking at this from a valuation standpoint and it makes no sense. They have $9M cash as of 6/26 vs. $242M last year end and project another $35M-$55M in cap ex in the 4th qtr. Perhaps they will issue shares to fund the cap ex. Since it doesn’t pay a dividend, it really doesn’t cost much to keep the short position. I noted that Kellogg’s reported revs and earnings well short of estimates due to consumer weakness and I wonder how much longer consumers will overpay for coffee (K cups much more expensive).

July 29, 2010 (31.31) (+9%) CC Notes

1. Expects to add more new Keurig households in F2011 than they will in F2010. Gearing up now for that “opportunity.” This is being done with buildup of inventory and capital investment.

2. “New brewing system technology on its way.” Also ramping up to meet what they consider to be a strong demand driven opportunity.

3. 2010 Guidance:

A. 4Q10 Consolidated sales growth of 58% to 63%.

B. F2010 Consolidated sales growth of 66% to 68%.

C. “Robust 4Q10 K-Cup shipments.

D. K-Cup portion pack shipments increase of 73% to 76% for F2010 YoY.

E. 4Q10 NON-GAAP operating margin in range of 13% to 13.5%. (excluding acquisition related to transaction expenses)

F. F2010 NON-GAAP operating margin in range of 12.1% to 12.5%. (excluding acquisition related to transaction expenses)

G. F2010 interest expense of $5.5 million to $6.5 million

H. NON-GAAP tax rate of 39.2% for the fiscal year which excludes the tax impact of expenses related to the Timothy’s and Diedrich’s acquisition.

I. 4Q10 GAAP EPS (fully diluted) in range of $0.18 to $0.20 per share. (excluding acquisition related to transaction expenses)

J. Fully diluted NON-GAAP earnings-per-share estimate of $0.69 to $0.71 for the 2010 fiscal year includes $15 million pre-tax or $0.06 per diluted share non-cash immigration expenses related to the identifiable intangibles of the company’s acquisition.

K. CapEx for F2010 in the range of $122 million to $140 million compared to our prior estimate range of $105 million to $125 million.

L. F2010 depreciation and amortization expenses in the range of $44 million to $46 million.

4. 2011 Guidance

A. Total consolidated net sales growth of 44% to 50% over 2010.

B. Total K-Cup portion packs shipped system wide by all roasters will increase in the range of 64% to 68%.

C. Fully diluted NON-GAAP earnings-per-share in the range of $1.15 to $1.20 per share.

5. “Very strong brewer shipments in the quarter with 846,000 Keurig system brewers sold. Keurig brand brewers continue to represent vast majority of brewers sold. Would not give breakdown of brewer sales from Keurig versus their licensed partners.

6. Canada is said to be tracking USA history of brewer volume, etc.

7. Company claims in terms of the inter Company elimination for the Keurig business unit they eliminated from their gross sales $42.5 million of sales, and for the specialty coffee business, including Timothy and Deidrichs, that was $72.6 million in inner Company sales. And as regard to the impact on top line, the Timothy’s brand added approximately 8 percentage points of a 64% increase in consolidated sales and Diedrich’s, where we owned them about half the quarter, they added 4 percentage points of the 64% increase in sales.

8. Would not comment on future unit growth. This was in response to a question if investors should see the same units or more sold in 4Q10.

9. Expect normal run rates on warranty costs for 4Q10. Thinks defective issue is behind them. Net amount of warranty costs for defect, after $6m reimbursement is around $0.01 per share.

10. Capacity was hinted but not mentioned to be potential capacity production of $5B in units. Company claims they will have 42 high speed equivalent packaging lines installed, of which 37 are in production right now.

11. Items not discussed:

A. Shares projected to be outstanding F2011, 4Q10 and 2011.

B. Really no mention of balance sheet. Funding requirements, debt service, etc.

Quick review of some Analyst Reports:

1. Dougherty Company: They mentioned K-Cup and brew growth is strong. They praised the guidance for 2011.

They raised to buy.

They use the following estimates:

EPS: Q4 2010 EPS from $0.21 to $0.20.

Q4 2010 Revenues: from $335.3m to $358.8.

2011 Estimates:

EPS from $0.99 to $1.18.

Revenues from $1,707.3m to $1,972.1m.

Price target from $27 to $36.

2. Merrill Lynch – On 4/15/10 Merrill downgraded to underperform. The recent report was issued on 7/29/10. The report is titled, “3Q review – gearing up for the holidays.”

A. Optimistic outlook. They mention, “a below the line beat.” I don’t know what that means. Maybe it means, they missed on earnings, and beat on guidance?

B. Net sales beat their forecast. System wide K-Cups missed. Brewer shipments strong. Cited inventory build of 75K as part of that.

C. Increasing estimates in line with company 2011 guidance.

D. “Maintain underperform rating, and $30 P.O”

I find the need to read and interpret the SEC filing (forthcoming Q), before one can really interpret the financial reporting.

April 28, 2010 (86.91) Quarterly earnings released, quick notes, Q not yet released.

Of course need to wait for CC and 10Q. Here are some quick notes. Trading down 10+ in AH, at $76.50

1. Weighted average shares increased 114M to 45,943,858. That equates to almost $1B at today’s closing price. I have not seen actual shares outstanding yet, perhaps even more. Value Line projects 44M weighted Shares outstanding at end of 2010. Lots of dilution.

2. capex guidance is $105M – $125M. Previous guidance was $95m to $115M.

3. Non GAAP earnings ( a joke to even discuss Non Gaap) expected to be $0.50 – $0.54 in 3Q10. Value Line expected $0.55 for same quarter.

4. Sales for quarter decreased $24,448 from December. Not unexpected, since holiday quarter. Receivables decreased $12,701. Seems reasonable. Inventories decreased $14,154. Also reasonable. Accounts Payable increased $16,536. Something to watch. Could this be partial cause of cash rising.

5. Quick Free Cash Flow work ups

6 Months Ended 3/27/10 6 Months Ended 3/28/09
Net Income 37,196 27,367
Depreciation 12,667 8,477
Amortization 5,204 2,406
Total 55,067 38,250
Capex (53,175) (14,516)
Free Cash Flow 1,892 23,734

Statement of Cash Flows has some non cash capex as well. Not sure yet how that would affect FCF. I would think that Capex would increase?

April 15, 2010 (95.20) Review of BAC Merrill Downgrade 4/15/10

1. Does not expect any negative events, just thinks earnings got ahead of itself. Price objective is still $90.

2. Recent events have been a positive. This includes events that could show that Keurig is more than a niche. One being purchase of Tully’s and process of Diedrich. These purchases enable GMCR to directly control 90% of K-cups. Also cites strong market share trends (18% in 4Q09), which have caused retailers to more aggressively market Keurig. Also reiterated Smuckers alliance, and how that will help grocery distribution. BAC feels the Smuckers alliance shows that a mainstream company is acknowledging share is being taken from drip makers.

3. They raised their F2015 eps estimates to $6.35 from $6.00.

4. Risks to their downgrade include , continued brewer and K-cup growth at current rates, faster penetration into new channels, and enhanced relationships.

5. Expects long-term household brewer penetration of 18%, compared to current 4%. “Significant penetration is critical to support current valuation.” Their target price “includes a significant increase in penetration.”

6. Projects Net Revenues at $1,343.6 for 2010, $1776.6 for 2011, and $2,113.11 for 2012.

7. Their long-term eps assumption includes a decline of usage rates. They expect the daily usage to decline to 1.0X from 1.40. They call this a “more natural decline,” as more casual users are using Keurig. They also discuss growth in hotel and second home brewers. Their F2015 K-cup unit sales imply that K-Cups will represent about 12% of total U.S. Coffee volume.

8. Expects K-cup sales price per unit to decline to $0.30 over next 5 years. The reasons being, deflationary supermarket effect, consumer price comparisons and lower online sales (which are more profitable), because of supermarket channel. Thinks there will be lower unit costs along with lower unit revenues.

9. Total brewer installed base to peak at ~20mm (~19mm home brewers.)

10. Expects royalty rate to stay at $0.06 per cup. Expects Smuckers to be most significant licensee.

11. All projections and estimates include Diedrich purchase to go through.

12. Mentioned branding and manufacturing partnerships with Jarden and Cuisinart.

13. Claims short interest is below averages of 1 – 3 year time frames, and thinks that short covering will only offer moderate support. Short interest still higher than other packaged food stocks. Short interest peaked in 1Q09. ( add – 3/31/10 short interest was 7.3M shares or about 7.5 days to cover and at 12/31/09 short interest was 8.8M shares or 4.8 days to cover; the increase in days to cover is related to drop in average daily volume from 1.8M daily to .975M daily.)

14. Expects shares outstanding of 46.129 in 2010, 46.929 in 2011, and 47.729 in 2012.

April 14, 2010 (95.14) Review of Value Line 1/29/10

1. Various Metrics

2008 2009 2010
Sales Per Share 13.58 18.42 28.60
Cash Flow per share 1.10 1.57 2.75
Capex Per share 1.32 1.11 2.15
Earnings Per Share 0.58 1.13 1.85
TBV per share 3.79 13.54 15.80
Shares O/S 36.85 43.6 44.00
ROTC 9.6% 6.8% 10.0%
ROE 16.0% 7.7% 11.0%

2. Insiders own 23% of company. FMR owns 14.6%.
3. Projected growth rates 2012 – 2014, Sales 33%, Cash Flow 34%, earnings 45% and book value 45%.
4. 1.6B K-cup portion packs sold, 2.3M Keurig Brewing systems sold.
5. Company financial Strength B+
6. Projected price 2012 – 2014 is $100 – ~$155.

Review of BAC report 2/24/10

1. Various estimates and metrics

2008 2009 2010E 2011E 2012E
EPS 0.63 1.14 2.00 2.59 3.17
EPS YoY 80% 81% 75.4% 29.5% 22.4%
P/E 145.4 60.3 42.2 32.6 26.6
Operating Margin 9.1% 9.8% 12.5% 12.9% 13.1%
ROE 20.4% 12.5% 14.4% 16.1% 16.8%

2. Merrill likes the potential of the Smuckers (Folgers) agreement. Potential for future.
3. Price objective $90.

January 28, 2010 (88.00)

We instituted a short position yesterday before they reported earnings. After earnings, the shares are up almost 10% today. The headlines of the press release are certainly impressive. For the 13 weeks ending 12/26/09 (GMCR’s first qtr 2010), revenues were up 77% vs. the prior year. GMCR made some acquisitions during the year that influenced this increase. (In March 2009, the company acquired Tully’s coffee and in November 2009, it acquired Timothy’s World Coffee.

The company has also submitted a proposal to acquire Diedrich Coffee.

Wtd avg shares 12/26/09 (000)             45,829
Price                                                      88
Mkt cap (000)                                        4,032,952

The company has two business segments: Specialty Coffee business unit (SBCU) formerly referred to as Green Mountain, and the Keurig business unit. SBCU sells whole bean and ground bean coffee, as well as K-cups. SBCU also sells Keurig single cup brewing systems directly to consumers and supermarkets.

Keurig sells single cup brewing systems for consumers at home (AH) and away from home (AFH). It sells AFH brewers to distributors for offices and AH brewers to retailers and warehouse clubs for at-home use. Keurig sells coffee, tea and cocoa in K-cups produced by a variety of roasters, including SBCU. Keurig earns royalty income from the sale of k-cups shipped by its licensed roasters. (Need to check this: Keurig buys coffee from SBCU and then SBCU pays a royalty to Keurig?) Ron’s comment on September 1, 2010, is that I believe this is eliminated in consolidation (if it even occurs).

M. Block & Sons processes a majority of the orders for the AH brewers sold to retailers. GMCR sells units to M Block & Sons and then M. Block sells to the retailers. M. Block & Sons represented 51% of the company’s receivables at last year end (9/26/09). This info is not available for the qtr ended 12/26/09. (I wonder how much inventory M. Block & Sons has.)

The company sells its brewers at cost in order to drive people into the single serve market.

Sales for the year ended 9/26/09 were $803M. EPS (diluted) for the year was $1.39. During the 1Q09 conference call, mgt said eps projected to be $2.10/share this fiscal year. Reuter’s estimates have $2.04/share. Both estimates exclude impact of potential Diedrich Coffee deal. Assuming the $2.10/share eps, the current year PE is around 40. Reuters has estimate of 2.70 eps for fiscal 2011, an increase of 28.5%, which would mean a PE of around 32 based on fiscal 2011 earnings. Not cheap in either case but they have done a good job of surprising with earnings.

Sales projection for this year from Reuters is $1,308M giving Price/Sales of over 3, but is 2.4 based on 2011 revenue projections. (Reuters is projecting sales increase of 28%.

Q1 2010 Q4 2009 Q3 2009 Q2 2009 Q1 2009
Sales (000) 349,363 222,205 190,509 193,351 196,980
Q increase 57.23% 16.64% -1.47% -1.84%
Receivables 150,639 96,351 72,746 76,251 75,685
Allowance 9,740 4,792 4,288 5,116 5,357
Net Receivables 140,899 91,559 68,458 71,135 70,328
Q increase 53.89% 33.74% -3.76% 1.15%
Net as % Sales 40.33% 41.20% 35.93% 36.79% 35.70%


12/26/2009 9/26/2009
Equity 606,454 590,174
Intangibles 132,636 36,478
Goodwill 169,429 99,600
Avg Diluted shs o/s 45,829 38,628
Book/share 13.23 15.28
Tangible book/sh 6.64 11.76

Book value decrease is due to the purchase of Timothy’s Coffees in Nov. 2009. The deal was a cash deal paid for from cash equivalents. As of 12/26/09, the company had $123M in cash and st invest. As noted above, the company has extended a cash purchase offer for Diedrich Coffee shares valued at $285M. The company plans on paying for the acquisition with cash on hand and drawing down on their credit facility. During 1Q call, mgt noted that they see good cash flow from receivables in late Jan and Feb.

GMCR does have availability under a revolving credit facility. The facility is $225M (from 9/26/09 10-K). From 1Q 2010 8-K, it appears they have approx. $150M available at 12/26/09. Their final $35/share offer for Diedrich is above their original offer of $30/sh. due to a counter offer from Peet’s Coffee for Diedrich and then an offer of $32.50.

Not out of the question that the company may need to offer more shares (as they did last year).

SCBU Keurig Total
Sales FYE 9/26/09 382,495 420,550 803,045
% total 47.63% 52.37%
Sales FYE 9/27/08 285,894 214,383 500,277
% total 57.15% 42.85%
2009 increase 96,601 206,167

The Keurig increase bodes well for the company as the K-cup portion packs increased 63% during FYE 9/26/09 to 1.6B packs. Even if brewer sales flatten or fall, the portion pack sales will continue. Assuming the company is correct in saying they sell the brewers at cost, the gross margins will be positively impacted by a higher percentage of K-cup sales. Stiffel Nicholas notes that the K-cup patent expires in Sept 2012. It could be renewed until 2023 but if that patent renewal is not permitted, it could have a significant impact on the future earnings as the company receives 6.4 cents as a royalty fee on each k-cup sold.

This is a momentum stock that everyone loves right now. It is overvalued on both a PE and PB valuation. I think there are some lofty expectations built in and I don’t think they are realistic. Even at 25 times earnings and 4 times book, one arrives at a price of $50-$55 per share and I would probably look to cover there.
I ran the valuation analysis and assumed some very aggressive growth rates. Using 15% growth for 10 years and 3 times book, the roi is 10%, so it is not impossible for the company to grow into its valuation.

It’s not material but the company uses a charter air company owned by the current Chairman of the Board. The amounts billed to GMCR by the charter air company ranged from $230,000 – $305,000 per year for the last 3 fiscal years.

Barron’s wrote an article in June 2009 relating to the royalty income the company receives from Diedrich Coffee for the coffee that Diedrich sells to Green Mountain. An interesting scenario and Barron’s indicated the royalty income may have accounted for about 9% of the company’s earnings. Interesting to watch developments with the GMCR acquisition of Diedrich. The Federal Trade Commission has asked for additional information from the companies before approving the transaction.

There are 4 companies that have licenses to manufacture k-cups: Timothy’s, Tully’s (both now owned by Green Mountain), Diedrich (soon to be owned by Green Mountain). I think the fourth is Frontier Coffee Products which has been owned since 2001, but I am not certain of that. From a business standpoint, it makes sense for the company to buy the licensees, especially if the agreements are not favorable to Green Mountain.

They are paying a substantial price for Diedrich (DDRX), the only publicly traded licensee. 2010 projected eps of $1 and a current book value of about $2.50. The stock went from .21/share in March to a buyout of $35/share less than a year later. Interesting price appreciation and I’m not sure what’s behind it.

I can say they are just a coffee company but they do have product that they compare to razor blades – once you have the razor you need the blades – and that is true of their k-cups. They have begun to distribute brewers and portion packs through Wal-Mart and Costco. It is possible that they could grow into the valuation over time. The cost per cup is not cheap but once you have the brewer, there isn’t much you can do except buy the k-cup portion packs.

Still, the short is based on the current valuation so we will need to watch the valuation and the company’s growth. We should know the outcome of the FTC review of the Diedrich deal in February unless the review is extended. Maybe it’s just a fad, you know, like the I-pod. 😉


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