Brewer Sales Drive Keurig Green Mountain’s Q2 Earnings

Keurig Green Mountain (NASDAQ:GMCR) released a strong second fiscal quarter report on May 7, driven by a combination of top-line growth and operating leverage. The specialty coffee company reported significant net sales of $ 1.1 billion, with a growth of 10% year-over-year, attributed to a 29% increase due to brewer sales volume. The net sales growth includes the unfavorable impact of foreign currency exchange rates, which reduced the sales figure by approximately 1%. ^[1]

Keurig Green Mountain beat its quarterly EPS guidance; Non-GAAP diluted earnings per share was reported $1.08, a year-over year growth of 16%, much more than the company’s anticipation. Other than reporting record figures for second quarter revenue and net income, the company reported increased free cash flow, all while returning nearly $800 million of cash to shareholders in the quarter in the form of dividends and share repurchases, including the accelerated share repurchase(ASR).(( Keurig Green Mountain (GMCR) CEO Brian Kelley on Q2 2014 Results- Earnings Call Transcript))  During the second quarter, GMCR repurchased a total of 4.9 million common shares. Free cash flow was up 30% with contribution from higher net income, working capital and disciplined capital spending. During the quarter, working capital was a source of $109 million in cash with receivables and inventories both adding to its free cash flow growth. The company expects both inventories and rate of capital investment to accelerate in the coming quarters, due to new product introduction.

During the second quarter, the company took three major measures to ensure future growth including its transition to new Keurig 2.0 brewers, the transition to new version of portion packs and K-Cups that are compatible with the 2.0 brewers and the introduction of additional brands to the Keurig system.The company announced their continued partnership with brands like Smuckers (NYSE: SJM) and Starbucks (NASDAQ: SBUX), as well as added Peet’s Coffee & Tea and Krispy Kreme (NYSE: KKD) as new partners. Lavazza, Green Mountain’s long term partner, entered the Keurig system to bring Italy’s favorite coffee brand to Keurig consumers.

GMCR’s stock price has soared up by 13% since the release of second quarter report. We have a $80 price estimate for Green Mountain Coffee Roasters, about 20% lower than the current market price. The company has been consistently reporting significant revenue growth, tremendous growth in earnings per share (EPS) quarter-over-quarter, expanding profit margins and moreover, it is at its strongest financial position ever. The company’s losing share of coffee-brewer market, due to increasing competitors, and weak operating cash flows can somewhat outweigh the above mentioned factors.

See our full analysis of GMCR here

Unimpressive Gross Margin Growth

The hike in coffee prices in the second quarter was large enough to make a small yet visible difference in the bottom-line performance of the company. Even though the coffee companies usually keep their supply hedged through futures contracts, the impact of any rise in commodity prices is likely to be felt later. The second quarter witnessed an increase in gross profits by 10% and the gross margins rose by a mere 20 basis points to 41.5% from 41.3% in the prior year period. Some components from the portion pack manufacturing lines that were disassembled, are being used for new product platform manufacturing development. This adversely affected gross profit by 80 basis points.

Non-GAAP operating profits rose to $272 million, up 21% from same period last year with non-GAAP operating margin expanding 230 basis points to 24.6%.  The company’s expenses were down 3% from the prior year period, most of which was related to lower General and administrative expenses and marketing expenditures as the resources were shifted to promotional spending. During the quarter, net foreign currency losses were about $0.03 per share, compared with the $0.05 forecasted, due to a slightly more favorable Canadian dollar exchange rate. Effectively, disciplined cost control and better productivity led to double digits operating profit and margins growth, which effectively paved a way for solid earnings and a significant increase of 30% in free cash flow year-over-year.

Keurig 1.0 Brewers: Once Again To The Rescue

The company’s persistent effort to grow its installed base in both at-home and away-from-home channels, gave a vital push to Keurig 1.0 brewers’ sales. Looking regionally, its domestic business delivered 12% revenue growth, while the Canadian business declined 5%. On a local currency basis, revenue in Canada was up 4%. A strong brewer shipment growth in Q2 led to continued growth in the company’s installed base. Of the 1.8 million Keurig brewers sold in the quarter, 1.7 million were sold by Keurig Green Mountain, while the licensed partners reported selling the rest 100,000 brewers. This drove 9% brewer and accessory net sales growth in the quarter. However, the Keurig 1.0 brewer sales were lower than the first quarter but more than what company anticipated in this quarter, as there was a continuous threat by competing products from companies such as SodaStream and PepsiCo’s Bevyz. The increased brewer sales volume was offset by an 18% decrease due to net price realization and a 2% decrease due to brewer product mix.

In Q2, the growth in portion pack net sales was attributable to the fact that the company sold more portion packs to retailers and consumers with a higher wholesale average selling price relative to the prior year period.

Volumes of single pack servings could once again accelerate after the company launches Keurig 2.0 later this year. Only those companies that have royalty agreements with  Keurig Green Mountain will be able to release their single serve packs, restricting the entry of private labels and other third-party companies. This can boost volumes, as well as help the company realize better pricing.

Yearly Guidance Revised

Keurig Green Mountain modified their yearly guidance for the fiscal 2014, after its strong top line performance in the second quarter. However, some of the targets were lowered down on account of increasing competition. GMCR raised its free cash flow expectations by $50 million, but has lowered down its guidance range for Non GAAP earnings per diluted share by about $0.12. For the fiscal 2014, the company expects capital investment in the range of $350 million to $400 million, with acceleration in the later half of the year,due to the introduction of new Keurig Cold platform and the business system transition to SAP. The net sales growth guidance is kept unchanged. For the third quarter, diluted EPS is projected to be in the range $0.83-$0.88 and the earnings growth is projected to increase 13% to 20% over the prior year period.

Keurig Green Mountain has a comprehensive launch plan in the fourth quarter for Keurig 2.0 system with in-store, point-of-purchase materials and significant marketing investment to drive awareness and traffic. Moreover, a new Keurig Cold production center in Vermont will be set up, dealing with the the first cold production lines. The coffee brewer company is 100% contracted on coffee for fiscal year 2014 and roughly 50% locked in for fiscal year 2015 at higher rates year-over-year. Green Mountain remains optimistic for the present fiscal year with main focus on cost management.

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1. GMCR 10-Q, Second fiscal quarter, May 7, 2014 [↩]