10-Q 1 d10q.htm FORM 10-Q Form 10-Q

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the thirteen weeks ended March 26, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from              to             

Commission file number 1-12340

 

 

GREEN MOUNTAIN COFFEE ROASTERS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   03-0339228

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

33 Coffee Lane, Waterbury, Vermont 05676

(Address of principal executive offices) (zip code)

(802) 244-5621

(Registrants’ telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report.)

 

 

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in rule 12b-2 of the Exchange Act)    YES  ¨    NO  x

As of April 28, 2011, 142,036,711 shares of common stock of the registrant were outstanding.

 

 

 


Part I. Financial Information

Item 1. Financial Statements

GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Balance Sheets

(Dollars in thousands)

 

     March 26,
2011
     September 25,
2010
 

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 33,737       $ 4,401   

Restricted cash and cash equivalents

     30,765         355   

Receivables, less uncollectible accounts and return allowances of $20,565 and $14,056 at March 26, 2011 and September 25, 2010, respectively

     226,773         172,200   

Inventories

     300,760         262,478   

Income taxes receivable

     10,526         5,350   

Other current assets

     32,407         23,488   

Current deferred income taxes, net

     23,713         26,997   

Current assets held for sale

     27,229         —     
                 

Total current assets

     685,910         495,269   

Fixed assets, net

     429,595         258,923   

Intangibles, net

     569,016         220,005   

Goodwill

     808,881         386,416   

Other long-term assets

     58,914         9,961   

Long-term assets held for sale

     117,444         —     
                 

Total assets

   $ 2,669,760       $ 1,370,574   
                 

Liabilities and Stockholders’ Equity

     

Current liabilities:

     

Current portion of long-term debt

   $ 11,328       $ 19,009   

Accounts payable

     154,697         139,220   

Accrued compensation costs

     31,899         24,236   

Accrued expenses

     72,837         49,279   

Income tax payable

     3,088         1,934   

Other short-term liabilities

     36,876         4,377   

Current liabilities related to assets held for sale

     19,786         —     
                 

Total current liabilities

     330,511         238,055   
                 

Long-term debt

     1,048,399         335,504   

Long-term deferred income taxes, net

     195,952         92,579   

Other long-term liabilities

     27,651         5,191   

Long-term liabilities related to assets held for sale

     1,378         —     

Commitments and contingencies

     

Redeemable noncontrolling interests

     20,220         —     

Stockholders’ equity:

     

Preferred stock, $0.10 par value: Authorized - 1,000,000 shares;
No shares issued or outstanding

     —           —     

Common stock, $0.10 par value: Authorized - 200,000,000 shares;
Issued - 141,999,856 and 132,823,585 shares at March 26, 2011 and September 25, 2010, respectively

     14,200         13,282   

Additional paid-in capital

     737,616         473,749   

Retained earnings

     280,934         213,844   

Accumulated other comprehensive income (loss)

     12,899         (1,630
                 

Total stockholders’ equity

     1,045,649         699,245   
                 

Total liabilities and stockholders’ equity

   $ 2,669,760       $ 1,370,574   
                 

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-1-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Operations

(Dollars in thousands except per share data)

 

    

Thirteen

weeks ended
March 26,

2011

   

Thirteen

weeks ended
March 27,

2010

(As Restated)

 

Net sales

   $ 647,658      $ 321,953   

Cost of sales

     404,803        214,103   
                

Gross profit

     242,855        107,850   

Selling and operating expenses

     79,745        43,251   

General and administrative expenses

     43,499        24,464   
                

Operating income

     119,611        40,135   

Other income (expense)

     1,078        (133

Loss on financial instruments, net

     (5,959     —     

Gain on foreign currency, net

     4,045        —     

Interest expense

     (16,672     (833
                

Income before income taxes

     102,103        39,169   

Income tax expense

     (36,295     (15,114
                

Net Income

     65,808        24,055   

Less: Net income attributable to noncontrolling interests

     436        —     
                

Net income attributable to GMCR

   $ 65,372      $ 24,055   
                

Basic income per share:

    

Basic weighted average shares outstanding

     141,784,994        131,263,638   

Net income

   $ 0.46      $ 0.18   

Diluted income per share:

    

Diluted weighted average shares outstanding

     147,558,595        137,831,574   

Net income

   $ 0.44      $ 0.17   

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-2-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Operations

(Dollars in thousands except per share data)

 

    

Twenty-six
weeks ended
March 26,

2011

   

Twenty-six
weeks ended
March 27,

2010

(As Restated)

 

Net sales

   $ 1,221,806      $ 667,105   

Cost of sales

     835,351        463,678   
                

Gross profit

     386,455        203,427   

Selling and operating expenses

     158,034        96,626   

General and administrative expenses

     85,530        47,636   
                

Operating income

     142,891        59,165   

Other income (expense)

     1,166        110   

Loss on financial instruments, net

     (12,301     (354

Gain on foreign currency, net

     5,624        —     

Interest expense

     (22,730     (1,881
                

Income before income taxes

     114,650        57,040   

Income tax expense

     (46,393     (22,925
                

Net Income

     68,257        34,115   

Less: Net income attributable to noncontrolling interests

     473        —     
                

Net income attributable to GMCR

   $ 67,784      $ 34,115   
                

Basic income per share:

    

Basic weighted average shares outstanding

     141,579,543        131,116,251   

Net income

   $ 0.48      $ 0.26   

Diluted income per share:

    

Diluted weighted average shares outstanding

     147,310,364        137,628,396   

Net income

   $ 0.46      $ 0.25   

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-3-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Comprehensive Income

(Dollars in thousands)

 

     Thirteen weeks ended     Twenty-six weeks ended  
           3/27/2010           3/27/2010  
     3/26/2011     (As Restated)     3/26/2011     (As Restated)  

Net income

   $ 65,808      $ 24,055      $ 68,257      $ 34,115   

Other comprehensive income, net of tax:

        

Deferred (loss) gain on derivatives designated as cash flow hedges

     (1,424     190        (1,039     476   

Gain on derivatives designated as cash flow hedges reclassified to net income

     —          (122     —          (112

Foreign currency translation adjustment

     12,694        —          15,890        —     
                                

Other comprehensive gain

     11,270        68        14,851        364   
                                

Total comprehensive income

     77,078        24,123        83,108        34,479   

Total comprehensive income attributable to redeemable noncontrolling interests

     696        —          794        —     
                                

Total comprehensive income attributable to GMCR

     76,382        24,123        82,314        34,479   
                                

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-4-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statement Of Changes In Redeemable Noncontrolling Interests And Stockholders’ Equity

For the Period Ended March 26, 2011 (Dollars in thousands)

 

    Equity Attributable to                 Additional           Accumulated other     Total  
    Redeemable     Common stock     paid-in     Retained     comprehensive     Stockholders’  
    Noncontrolling Interests     Shares     Amount     capital     earnings     income (loss)     Equity  

Balance at September 25, 2010

  $ —          132,823,585      $ 13,282      $ 473,749      $ 213,844      $ (1,630   $ 699,245   

Sale of common stock

    —          8,566,649        857        248,667        —          —          249,524   

Options exercised

    —          515,730        52        1,728        —          —          1,780   

Issuance of common stock under employee stock purchase plan

    —          93,892        9        2,995        —          —          3,004   

Stock compensation expense

    —          —          —          4,517        —          —          4,517   

Tax benefit from exercise of options

    —          —          —          5,844        —          —          5,844   

Deferred compensation expense

    —          —          —          116        —          —          116   

Purchase noncontrolling interests

    19,118        —          —          —          —          —          —     

Adjustment of redeemable noncontrolling interests to redemption value

    694        —          —          —          (694     —          (694

Dividends paid

    (386     —          —          —          —          —          —     

Other comprehensive income, net of tax

    321        —          —          —          —          14,529        14,529   

Net income

    473        —          —          —          67,784        —          67,784   
                                                       

Balance at March 26, 2011

  $ 20,220        141,999,856      $ 14,200      $ 737,616      $ 280,934      $ 12,899      $ 1,045,649   
                                                       

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-5-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Cash Flows

(Dollars in thousands)

 

     Twenty-six
weeks ended
March 26,
2011
   

Twenty-six
weeks ended
March 27,
2010

(As Restated)

 

Cash flows from operating activities:

    

Net income

   $ 68,257      $ 34,115   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     30,991        12,667   

Amortization of intangibles

     17,793        5,204   

Amortization of deferred financing fees

     5,175        —     

Gain on foreign currency exchange transactions

     (5,624     —     

(Gain) loss on disposal of fixed assets

     (75     451   

Bad debts

     400        342   

Sales returns

     5,262        3,334   

Loss (gain) on financial instruments, net

     12,281        (112

Tax benefit from exercise of non-qualified options and disqualified dispositions of incentive stock options

     6        22   

Excess tax benefits from equity-based compensation plans

     (5,839     (4,492

Deferred income taxes

     2,862        (2,444

Deferred compensation and stock compensation

     4,633        3,926   

Changes in assets and liabilities, net of effects of acquisition:

    

Receivables

     (11,197     (31,583

Inventories

     (889     38,016   

Income tax receivable (payable), net

     2,562        (6,758

Other current assets

     (9,538     (7,935

Other long-term assets, net

     (11,300     102   

Accounts payable

     8,987        6,547   

Accrued compensation costs

     (8,487     (1,151

Accrued expenses

     8,129        15,043   

Other short-term liabilities

     (529     —     

Other long-term liabilities

     11,401        —     
                

Net cash provided by operating activities

     125,261        65,294   

Cash flows from investing activities:

    

Change in restricted cash

     150        210   

Proceeds from sale of short-term investments

     —          50,000   

Proceeds from notes receivable

     103        —     

Acquisition of Timothy’s Coffee of the World Inc.

     —          (154,208

Advance on acquisition of Diedrich Coffee, Inc., net of cash acquired

     —          (8,500

Acquisition of LJVH Holdings, Inc. (Van Houtte), net of cash acquired

     (907,835     —     

Capital expenditures for fixed assets

     (99,040     (53,175

Proceeds from disposal of fixed assets

     280        183   

Other investing activities

     (158     —     
                

Net cash used in investing activities

     (1,006,500     (165,490

Cash flows from financing activities:

    

Net change in revolving line of credit

     257,923        (3,000

Proceeds from issuance of common stock under compensation plans

     4,784        3,553   

Proceeds from issuance of common stock

     249,524        —     

Dividends paid to redeemable noncontrolling interests shareholders

     (386     —     

Excess tax benefits from equity-based compensation plans

     5,838        4,492   

Capital lease obligations

     (5     (25

Proceeds from borrowings of long-term debt

     794,500        —     

Deferred financing fees

     (41,628     —     

Repayment of long-term debt

     (354,773     (2,500
                

Net cash provided by financing activities

     915,777        2,520   

Change in cash balances included in short-term assets held for sale

     (6,510     —     

Effect of exchange rate changes on cash and cash equivalents

     1,308        —     

Net (decrease) increase in cash and cash equivalents

     29,336        (97,676

Cash and cash equivalents at beginning of period

     4,401        241,811   
                

Cash and cash equivalents at end of period

   $ 33,737      $ 144,135   
                

Supplemental disclosures of cash flow information:

    

Fixed asset purchases included in accounts payable and not disbursed at the end of each year

   $ 11,051      $ 8,870   

Noncash investing activity:

    

Liabilities assumed in conjunction with acquisitions

   $ —        $ 1,533   

The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.

 

-6-


Green Mountain Coffee Roasters, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements.

In the opinion of management, all adjustments considered necessary for a fair presentation of the interim financial data have been included. Results from operations for the thirteen and twenty-six week periods ended March 26, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending September 24, 2011.

The September 25, 2010 balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. For further information, refer to the consolidated financial statements and the footnotes included in the Annual Report on Form 10-K for Green Mountain Coffee Roasters, Inc. for the fiscal year ended September 25, 2010. Throughout this presentation, we refer to the consolidated company as the “Company” and, unless otherwise noted, the information provided is on a consolidated basis.

The Company has revised the classification of certain information presented in its fiscal 2010 audited consolidated financial statements to conform to its fiscal 2011 presentation.

 

2. Restatement of Previously Issued Financial Statements

As described in our Annual Report on Form 10-K for the year ended September 25, 2010, we have restated our financial statements and other information. For additional details on the effects of the restatements on certain line items within our previously reported Statement of Operations for the thirteen and twenty-six weeks ended March 27, 2010 please refer to the following sections in our Annual Report on Form 10-K: Overview of Restatement; Part II, Item 8, Financial Statements and Supplementary Data, Note 3, Restatement of Previously Issued Financial Statements and Note 24, Unaudited Quarterly Financial Data.

The restatements reflect adjustments to correct errors in the Company’s intercompany eliminations; the classification and timing of the recognition of certain royalty revenues from unrelated third party roasters; the over or under accrual of certain marketing and customer incentive programs as well as the correction of the classification of certain customer incentives from selling and operating expenses to a reduction in sales; and other miscellaneous adjustments. The nature and impact of these adjustments are described below and detailed in the tables below.

Intercompany Eliminations

During the fourth quarter of fiscal 2010, the Company identified an error as a result of applying an incorrect standard cost to intercompany K-Cup® portion pack inventory balances in consolidation. The Specialty Coffee business unit (“SCBU”) standard cost of K-Cup® portion packs included the royalty fee due to the Keurig business unit, and

 

-7-


management discovered that this royalty fee was not eliminated from K-Cup® portion pack inventory balances. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. During the close of the fiscal 2010 year, the Company also discovered an error in the application of an incorrect standard cost to intercompany Keurig Single-Cup Brewer inventory balances held by SCBU in consolidation, which also resulted in an overstatement of consolidated inventory and an understatement of cost of sales. In addition, certain intercompany sales transactions were not properly eliminated resulting in an understatement of both sales and cost of sales of an equal amount and did not affect net income. The cumulative effect of the errors as of the fiscal year ended September 26, 2009 resulted in a reduction to net income of approximately $1.8 million after income taxes.

Timing of Recognition and Classification of Certain Royalties from Third Party Licensed Roasters

The Company receives royalties on K-Cup® portion packs sold by third party roasters at the time of shipment in accordance with the terms and conditions of the licensing agreements with these roasters. The Company’s Keurig business segment purchases K-Cup® portion packs directly from the third party licensed roasters to sell to its customers. Because royalties on K-Cup® portion packs sold by third party roasters were earned at the time of shipment pursuant to the terms and conditions of the licensing agreements with these roasters, Keurig historically recorded these royalties at the time Keurig purchased the K-Cup® portion packs from the licensed roasters and included them in net sales. Management has determined that the royalty should be recognized as a reduction to the carrying value of the related inventory which will reduce cost of sales when the K-Cup® portion packs are sold to a third-party customer. As of the fiscal year ended September 26, 2009, the cumulative effect of the timing of the recognition of the royalty resulted in a reduction to net income of approximately $1.3 million after income taxes, with a cumulative reduction in sales and cost of sales as of September 26, 2009 of approximately $27.1 million and $24.9 million, respectively.

Timing of Recognition and Classification of Certain Marketing and Customer Incentive Programs

Management discovered errors in recording certain marketing and customer incentive programs, which were generally accounted for as a selling and operating expense in the Company’s consolidated statements of operations. These programs include, but are not limited to, brewer mark-down support and funds for promotional and marketing activities. Management determined that a lack of adequate communication between the accounting function to gather the appropriate information from the sales and marketing functions resulted in expenses for certain of these programs being recorded in the wrong fiscal periods. The cumulative effect as of fiscal year ended September 26, 2009 of the under-accrual of certain marketing and customer incentive program expenses resulted in a reduction to net income of approximately $47,000 after income taxes. In addition, the Company has corrected the classification of certain of these amounts as reductions to net sales instead of selling and operating expenses. Cumulatively, as of September 26, 2009, approximately $4.5 million has been classified as a reduction to net sales from selling and operating expenses.

The Company also identified an over-accrual of a liability related to certain customer incentive programs for SCBU that was due primarily to a failure to reverse an accrual related to certain customer incentive programs in the second fiscal quarter of 2010 resulting in a $0.5 million understatement of net income after income taxes, cumulative, as of September 26, 2009.

 

-8-


Other Adjustments

During fiscal years 2008 through the third quarter of fiscal 2010, the Company adjusted for the deferral of certain sales and costs related to a sales contract for which risk of loss had not yet transferred to the customer. The adjustment resulted in timing differences in when the sales and related cost of sales were recognized and resulted in a reduction to net income of approximately $0.2 million after income taxes, cumulative, as of September 26, 2009.

The restated Consolidated Statement of Operations for the thirteen and twenty-six weeks ended March 27, 2010 are presented below (dollars in thousands, except per share data):

Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Operations

Thirteen weeks ended March 27, 2010

(Dollars in thousands, except per share data)

 

    As Previously
Reported on
Form 10-Q
    Inter-Company
Elimination
Adjustments
    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive
Expense
Adjustments
    Other
Adjustments
    As Restated  

Net sales

  $ 324,915      $ 2,941      $ (4,300   $ 1,472      $ (3,075   $ 321,953   

Cost of sales

    216,263        5,230        (4,611     —          (2,779     214,103   
                                               

Gross profit

    108,652        (2,289     311        1,472        (296     107,850   

Selling and operating expenses

    42,979        —          —          272        —          43,251   

General and administrative expenses

    24,464        —          —          —          —          24,464   

Patent litigation (settlement) expense

    —          —          —          —          —          —     
                                               

Operating income

    41,209        (2,289     311        1,200        (296     40,135   

Other income (expense)

    (133     —          —          —          —          (133

Gain (loss) on financial instruments, net

    —          —          —          —          —          —     

Gain (loss) on foreign currency, net

    —          —          —          —          —          —     

Interest expense

    (833     —          —          —          —          (833
                                               

Income before income taxes

    40,243        (2,289     311        1,200        (296     39,169   

Income tax expense

    (15,541     911        (124     (478     118        (15,114
                                               

Net income

  $ 24,702      $ (1,378   $ 187      $ 722      $ (178   $ 24,055   
                                               

Basic income per share:

           

Weighted average shares outstanding

    131,263,638        131,263,638        131,263,638        131,263,638        131,263,638        131,263,638   

Net income

  $ 0.19      $ (0.01   $ 0.00      $ 0.01      $ (0.00   $ 0.18

Diluted income per share:

           

Weighted average shares outstanding

    137,831,574        137,831,574        137,831,574        137,831,574        137,831,574        137,831,574   

Net income

  $ 0.18      $ (0.01   $ 0.00      $ 0.01      $ (0.00   $ 0.17

 

* Does not add due to rounding.

 

-9-


Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Operations

Twenty-six weeks ended March 27, 2010

(Dollars in thousands, except per share data)

 

    As Previously
Reported on
Form 10-Q
   

Inter-Company

Elimination
Adjustments

    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive
Expense
Adjustments
    Other
Adjustments
    As Restated  

Net sales

  $ 674,278      $ 8,181      $ (9,876   $ (3,239   $ (2,239   $ 667,105   

Cost of sales

    463,801        12,114        (10,070     —          (2,167     463,678   
                                               

Gross profit

    210,477        (3,933     194        (3,239     (72     203,427   

Selling and operating expenses

    98,558        —          —          (1,932     —          96,626   

General and administrative expenses

    47,636        —          —          —          —          47,636   

Patent litigation (settlement) expense

    —          —          —          —          —          —     
                                               

Operating income

    64,283        (3,933     194        (1,307     (72     59,165   

Other income (expense)

    110        —          —          —          —          110   

Gain (loss) on financial instruments, net

    (354     —          —          —          —          (354

Gain (loss) on foreign currency, net

    —          —          —          —          —          —     

Interest expense

    (1,881     —          —          —          —          (1,881
                                               

Income before income taxes

    62,158        (3,933     194        (1,307     (72     57,040   

Income tax expense

    (24,962     1,565        (77     520        29        (22,925
                                               

Net income

  $ 37,196      $ (2,368   $ 117      $ (787   $ (43   $ 34,115   
                                               

Basic income per share:

           

Weighted average shares outstanding

    131,116,251        131,116,251        131,116,251        131,116,251        131,116,251        131,116,251   

Net income

  $ 0.28      $ (0.02   $ 0.00      $ (0.01   $ (0.00   $ 0.26

Diluted income per share:

           

Weighted average shares outstanding

    137,628,396        137,628,396        137,628,396        137,628,396        137,628,396        137,628,396   

Net income

  $ 0.27      $ (0.02   $ 0.00      $ (0.01   $ (0.00   $ 0.25

 

* Does not add due to rounding.

 

-10-


The restated Consolidated Statement of Cash Flows for the twenty-six weeks ended March 27, 2010 is presented below (dollars in thousands):

Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Cash Flows

Twenty-six weeks ended March 27, 2010

(Dollars in thousands)

 

    As Previously
Reported on
Form 10-Q
   

Inter-Company

Elimination
Adjustments

    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive Expense
Adjustments
    Other
Adjustments
    As Restated  

Cash flows from operating activities:

           

Net income

  $ 37,196      $ (2,368   $ 117      $ (787   $   (43)    $ 34,115   

Adjustments to reconcile net income to net cash provided by operating activities:

           

Depreciation

    12,667        —          —          —          —          12,667   

Amortization of intangibles

    5,204                5,204   

Loss on disposal of fixed assets

    451        —          —          —          —          451   

Bad Debts

    342        —          —          —          —          342   

Sales returns

    3,334                3,334   

(Gain) Loss on futures derivatives

    (112     —          —          —          —          (112

Tax benefit (expense) from exercise of non-qualified options and disqualified dispositions of incentive stock options

    22        —          —          —          —          22   

Excess tax benefits from equity-based compensation plans

    (4,492     —          —          —          —          (4,492

Tax expense from allocation of ESOP shares

    —          —          —          —          —          —     

Deferred income taxes

    (2,444     —          —          —          —          (2,444

Deferred compensation and stock compensation

    3,926        —          —          —          —          3,926   

Contributions to the ESOP

    —          —          —          —          —          —     

Changes in assets and liabilities, net of effects of acquisition:

           

Receivables

    (31,583     —          —          —            (31,583

Inventories

    34,276        3,933        (193     —          —          38,016   

Income tax payable, net

    (4,722     (1,565     76        (519     (28     (6,758

Other current assets

    (5,768     —          —          —          (2,167     (7,935

Other long-term assets, net

    102        —          —          —          —          102   

Accounts payable

    6,547        —          —          —          —          6,547   

Accrued compensation costs

    (1,151     —          —            —          (1,151

Accrued expenses

    11,499        —          —          1,306        2,238        15,043   

Other short-term liabilities

    —          —          —          —          —          —     

Other long-term liabilities

    —          —          —          —          —          —     
                                               

Net cash provided by
operating activities

    65,294        (0     (0     (0     (0     65,294   

Cash flows from investing activities:

           

Change in restricted cash

    210        —          —          —          —          210   

Proceeds from sale of short-term investments

    50,000        —          —          —          —          50,000   

Proceeds from receipt of note receivable

    —          —          —          —          —          —     

Acquisition of Timothy’s Coffee of the World Inc.

    (154,208     —          —          —          —          (154,208

Acquisition of Tully’s Coffee Corporation

    —          —          —          —          —          —     

Acquisition of Diedrich Coffee, Inc.

    (8,500     —          —          —          —          (8,500

Purchases of short-term investments

    —          —          —          —          —          —     

Capital expenditures for fixed assets

    (53,175     —          —          —          —          (53,175

Proceeds from disposal of fixed assets

    183        —          —          —          —          183   
                                               

Net cash used for investing
activities

    (165,490     —          —          —          —          (165,490

Cash flows from financing activities:

           

Net change in revolving line of credit

    (3,000     —          —          —          —          (3,000

Proceeds from issuance of common stock under compensation plans

    3,553        —          —          —          —          3,553   

Proceeds from issuance of common stock for public equity offering

    —          —          —          —          —          —     

Financing costs in connection with public equity offering

    —          —          —          —          —          —     

Excess tax benefits from equity-based compensation plans

    4,492        —          —          —          —          4,492   

Capital lease obligations

    (25     —          —          —          —          (25

Proceeds from borrowings of long-term debt

    —          —          —          —          —          —     

Deferred financing fees

    —          —          —          —          —          —     

Repayment of long-term debt

    (2,500     —          —          —          —          (2,500
                                               

Net cash provided by (used
for) financing activities

    2,520        —          —          —          —          2,520   

Net increase (decrease) in cash and cash equivalents

    (97,676     —          —          —          —          (97,676

Cash and cash equivalents at beginning of period

    241,811        —          —          —          —          241,811   
                                               

Cash and cash equivalents at end of period

  $ 144,135      $ —        $ —        $ —        $ —        $ 144,135   
                                               

Supplemental disclosures of cash flow information:

           

Fixed asset purchases included in accounts payable and not disbursed at the end of each year

  $ 8,870      $ —        $ —        $ —        $ —        $ 8,870   

Noncash investing activity:

           

Liabilities assumed in conjunction with acquisitions

  $ 1,533      $ —        $ —        $ —        $ —        $ 1,533   

 

-11-


3. Segment Reporting

The Company manages its operations through three operating segments, the Specialty Coffee business unit (“SCBU”), the Keurig business unit (“Keurig”) and the Canadian business unit (“CBU”) created primarily from the recently acquired Van Houtte business.

SCBU sources, produces and sells coffee, cocoa, teas and other beverages in K-Cup® portion packs and coffee in more traditional packaging including whole bean and ground coffee selections in bags and ground coffee in fractional packs. These varieties are sold primarily to wholesale channels, including supermarkets and convenience stores, restaurants and hospitality, office coffee distributors and directly to consumers in North America. In addition, SCBU sells Keurig® Single-Cup Brewing systems and other accessories to supermarkets and directly to consumers.

Keurig, a pioneer and leading manufacturer of gourmet single-cup brewing systems, targets its premium patented single-cup brewing systems for use both at-home (“AH”) and away-from-home (“AFH”), mainly in North America. Keurig sells AH single-cup brewers, accessories and coffee, tea, cocoa and other beverages in K-Cup® portion packs produced mainly by SCBU and CBU to retailers principally processing its sales orders through fulfillment entities for the AH channels. Keurig sells AFH single-cup brewers to distributors for use in offices. Keurig also sells AH brewers, a limited number of AFH brewers and K-Cup® portion packs directly to consumers. Keurig earns royalty income from K-Cup® portion packs when shipped by its licensed roasters, except for shipments of K-Cup® portion packs by third party roasters to Keurig, for which the royalty is recognized as a reduction to the carrying cost of the inventory and as a reduction to cost of sales when sold through to third parties by Keurig.

CBU sources, produces and sells coffees in a variety of packaging formats, including K-Cup® portion packs, whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands. These varieties are sold primarily to wholesale channels, including supermarkets and retail, and through office coffee services to offices, convenience stores and restaurants mainly throughout Canada. CBU also manufactures brewing equipment and is responsible for all Company coffee brand sales in the grocery channel in Canada.

The Company evaluates performance based on several factors, including business segment income before taxes. The operating segments do not share any significant manufacturing or distribution facilities, except for brewer fulfillment at the Company’s Knoxville, Tennessee facility. Administrative functions such as accounting and information services are mainly decentralized, but continuing to move toward centralization through an enterprise shared services group. In the event any materials and/or services are provided to one segment by the other, the transaction is valued at estimated market price and eliminated in consolidation. The costs of the Company’s manufacturing operations are captured within the SCBU and CBU segments. The Keurig segment does not have manufacturing facilities and purchases its saleable products from third parties, including the SCBU and CBU. The Company’s inventory and accounts receivable are captured and reported discretely within each operating segment.

Expenses related to certain centralized administrative functions including Finance, Human Resources, Information System Technology and Legal are allocated to the SCBU and Keurig operating segments. Expenses not specifically related to the SCBU, Keurig or CBU operating segments are recorded in the “Corporate” segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior

 

-12-


executive officers and other selected employees who perform duties related to our entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors. Corporate assets include primarily cash, short-term investments, deferred tax assets, income tax receivable, notes receivable, deferred issuance costs and fixed assets. Corporate total assets as of March 27, 2010 have been revised to reflect the current presentation. In addition, beginning with the first quarter of fiscal 2011, the Company determined that because the Keurig segment includes all of the assets of Keurig, Incorporated, it would no longer include the Company’s net investment in Keurig, Incorporated in Corporate total assets. Accordingly, Corporate total assets and eliminations were each reduced by $10.7 million to remove the Company’s net investment in Keurig, Incorporated, which is now included only in the Keurig segment total assets. This allocation had no effect on consolidated total assets.

Goodwill and intangibles related to the Frontier, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU segment. Keurig related goodwill and intangibles are included in the Keurig segment. Van Houtte related goodwill and intangibles are included in the CBU segment.

The Company analyzes its business on a segment basis, records net sales on a segment basis and eliminates intersegment sales as part of its financial consolidation. Intersegment sales primarily consist of the SCBU and CBU selling K-Cup® portion packs to Keurig, and Keurig sells single-cup brewers and records royalty income from K-Cup® portion packs when shipped by the SCBU and CBU.

Selected financial data for segment disclosures for the thirteen weeks ended March 26, 2011 and March 27, 2010 are as follows:

Thirteen weeks ended March 26, 2011

(Dollars in thousands)

 

     SCBU      Keurig      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 253,244       $ 284,021       $ 110,393       $ —        $ —        $ 647,658   

Intersegment sales

   $ 151,473       $ 85,503       $ 16,402       $ —        $ (253,378   $ —     

Net sales

   $ 404,717       $ 369,524       $ 126,795       $ —        $ (253,378   $ 647,658   

Income before taxes

   $ 82,894       $ 53,877       $ 3,563       $ (21,609   $ (16,622   $ 102,103   

Total assets

   $ 1,054,920       $ 421,467       $ 1,128,367       $ 541,699      $ (476,693   $ 2,669,760   

Stock compensation

   $ 712       $ 515       $ 75       $ 1,014      $ —        $ 2,316   

Interest expense

   $ —         $ —         $ —         $ 16,672      $ —        $ 16,672   

Property additions

   $ 34,819       $ 5,230       $ 8,732       $ 2,398      $ —        $ 51,179   

Depreciation and amortization

   $ 12,919       $ 2,401       $ 11,828       $ 3,505      $ —        $ 30,653   

 

-13-


Thirteen weeks ended March 27, 2010

(Dollars in thousands)

(As Restated)

 

     SCBU      Keurig      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 155,162       $ 166,791       $ —         $ —        $ —        $ 321,953   

Intersegment sales

   $ 67,367       $ 38,625       $ —         $ —        $ (105,992   $ —     

Net sales

   $ 222,529       $ 205,416       $ —         $ —        $ (105,992   $ 321,953   

Income before taxes

   $ 31,503       $ 21,095       $ —         $ (10,894   $ (2,535   $ 39,169   

Total assets

   $ 468,876       $ 300,388       $ —         $ 202,457      $ (60,953   $ 910,768   

Stock compensation

   $ 637       $ 491       $ —         $ 792      $ —        $ 1,920   

Interest expense

   $ —         $ —         $ —         $ 833        $ 833   

Property additions

   $ 18,998       $ 5,567       $ —         $ 5,429      $ —        $ 29,994   

Depreciation and amortization

   $ 6,388       $ 1,814       $ —         $ 1,674      $ —        $ 9,876   

Selected financial data for segment disclosures for the twenty-six weeks ended March 26, 2011 and March 27, 2010 are as follows:

Twenty-six weeks ended March 26, 2011

(Dollars in thousands)

 

     SCBU      Keurig      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 472,645       $ 629,122       $ 120,039       $ —        $ —        $ 1,221,806   

Intersegment sales

   $ 289,201       $ 154,156       $ 17,004       $ —        $ (460,361   $ —     

Net sales

   $ 761,846       $ 783,278       $ 137,043       $ —        $ (460,361   $ 1,221,806   

Income before taxes

   $ 142,643       $ 51,922       $ 2,366       $ (57,629   $ (24,652   $ 114,650   

Total assets

   $ 1,054,920       $ 421,467       $ 1,128,367       $ 541,699      $ (476,693   $ 2,669,760   

Stock compensation

   $ 1,450       $ 1,016       $ 75       $ 1,976      $ —        $ 4,517   

Interest expense

   $ —         $ —         $ —         $ 22,730      $ —        $ 22,730   

Property additions

   $ 56,396       $ 10,313       $ 9,779       $ 12,340      $ —        $ 88,828   

Depreciation and amortization

   $ 24,904       $ 4,664       $ 13,077       $ 6,139      $ —        $ 48,784   

 

-14-


Twenty-six weeks ended March 27, 2010

(Dollars in thousands)

(As Restated)

 

     SCBU      Keurig      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 288,348       $ 378,757       $ —         $ —        $ —        $ 667,105   

Intersegment sales

   $ 125,986       $ 72,765       $ —         $ —        $ (198,751   $ —     

Net sales

   $ 414,334       $ 451,522       $ —         $ —        $ (198,751   $ 667,105   

Income before taxes

   $ 59,081       $ 27,049       $ —         $ (21,974   $ (7,116   $ 57,040   

Total assets

   $ 468,876       $ 300,388       $ —         $ 202,457      $ (60,953   $ 910,768   

Stock compensation

   $ 1,321       $ 998       $ —         $ 1,529      $ —        $ 3,848   

Interest expense

   $ —         $ —         $ —         $ 1,881      $ —        $ 1,881   

Property additions

   $ 33,303       $ 7,889       $ —         $ 8,344      $ —        $ 49,536   

Depreciation and amortization

   $ 11,389       $ 3,465       $ —         $ 3,017      $ —        $ 17,871   

 

-15-


4. Acquisitions

LJVH Holdings, Inc. (including subsidiaries - Van Houtte)

On December 17, 2010, the Company acquired Van Houtte through the purchase of all of the outstanding capital stock of LJVH Holdings, Inc., a specialty coffee roaster headquartered in Montreal, Quebec, for approximately USD $907.8 million, net of cash acquired. The acquisition was financed with cash on hand and a new $1.45 billion credit facility (see Note 10, Long-Term Debt). Van Houtte’s functional currency is the Canadian dollar.

Van Houtte specializes in sourcing, producing, and selling coffees in a variety of packaging formats, including K-Cup® portion packs whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands.

As previously announced, the Company is conducting a strategic review of the Van Houtte U.S. Coffee Service business (“Filterfresh”) in contemplation of a potential divestiture of Filterfresh. As a result, the Company has accounted for all the assets relating to the Filterfresh business as held-for-sale. See Note 8, Assets Held for Sale, for further information.

The Van Houtte acquisition was accounted for under the acquisition method of accounting. The total purchase price was USD $907.8 million, net of cash acquired. The total purchase price was allocated to Van Houtte’s net tangible assets and identifiable intangible assets based on their preliminary estimated fair values as of December 17, 2010. The preliminary fair value assigned to indefinable intangible assets acquired was determined primarily by using an income approach. The allocation of the purchase price is based upon management’s preliminary valuation and the Company’s estimates and assumptions and is subject to change within the measurement period as the valuation is finalized. Prior to the end of the measurement period for finalizing the purchase price allocation, any changes will be included in the purchase price allocation retrospectively. The Company does not anticipate material changes to the purchase price allocation. Changes in the purchase price allocation as of March 26, 2011 from the preliminary allocation at December 25, 2010 principally relate to an increase in the fair value of deferred tax liabilities of $36.5 million, an increase in the fair value of noncontrolling interests of $13.9 million and an increase in goodwill of $53.7 million. The table below represents the preliminary allocation of the purchase price to the acquired net assets of Van Houtte as of March 26, 2011 (in thousands):

 

     Total     Van Houtte
Canadian
Operations
    Filterfresh
Assets
Held For
Sale
 

Restricted cash

   $ 500      $ 500      $ —     

Accounts receivable

     61,130        47,554        13,576   

Inventories

     42,958        36,691        6,267   

Income taxes receivable

     2,260        2,190        70   

Deferred income taxes

     4,903        3,577        1,326   

Other current assets

     5,047        4,453        594   

Fixed assets

     143,928        110,622        33,306   

Intangible assets

     375,099        355,549        19,550   

Goodwill

     472,331        409,493        62,838   

Other long-term assets

     1,577        962        615   

Accounts payable and accrued expenses

     (54,502     (46,831     (7,671

Other short-term liabilities

     (4,330     (3,404     (926

Income taxes payable

     (1,496     (1,496     —     

Deferred income taxes

     (117,086     (104,866     (12,220

Notes payable

     (2,914     (1,770     (1,144

Other long-term liabilities

     (2,452     (1,683     (769

Non-controlling interests

     (19,118     (9,529     (9,589
                        
   $ 907,835      $ 802,012      $ 105,823   
                        

 

-16-


Acquisition costs were expensed as incurred and totaled approximately $1.9 million and $10.7 million for the thirteen and twenty–six weeks ended March 26, 2011, respectively and are included in general and administrative expenses for the Company.

The preliminary fair value estimates for definite lived amortizable intangible assets acquired include approximately $263.1 million for customer relationships, $10.9 million for trademarks and trade names, $1.4 million for franchises and $0.3 million for technology. The preliminary estimates for indefinite lived intangible assets acquired include approximately $99.4 million for the Van Houtte trademark which is not amortized. The estimates for definite lived intangible assets classified as held-for-sale are not amortized and approximated $19.5 million. Amortizable intangible assets are amortized on a straight-line basis over their respective useful live, and the preliminary weighted-average amortization period is 10.8 years.

An income approach, specifically the discounted cash flow method, was used to value the noncontrolling interests.

The preliminary estimate of the cost of the acquisition in excess of the fair market value of the tangible and intangible assets acquired less liabilities assumed represents acquired goodwill. The acquisition provides the Company with an expanded Canadian presence and manufacturing and distribution synergies, which provide the basis of the goodwill recognized with respect to the Van Houtte Canadian operations. As described in Note 8, Assets Held for Sale, the preliminary fair value of Filterfresh was estimated using a market-based multiple approach. In accordance with ASC 360-10-35, the preliminary purchase price allocated to Filterfresh was the fair value, less the estimated direct costs to sell Filterfresh established at the acquisition date. The excess of the purchase price (fair value) allocated to Filterfresh over the fair value of the net tangible and identifiable intangible assets represents goodwill. Goodwill and intangible assets are reported in the CBU segment. The goodwill and intangible assets recognized are not deductible for tax purposes.

 

-17-


At March 26, 2011, approximately $30.0 million of the purchase price is held in escrow and is included in restricted cash with corresponding amounts of $20.7 million and $9.3 million in other current liabilities and other long-term liabilities, respectively.

In conjunction with the acquisition, the Company recognized an indemnification receivable of $11.2 million for uncertain tax positions of the same amount. The indemnification receivable was measured at the acquisition-date fair value of the uncertain tax positions. The seller has an indemnification obligation for tax liabilities relating to periods prior to the acquisition date. Subject to limited exceptions, this obligation is capped at CAD$30.0 million (which must be satisfied first against a CAD$29.5 million escrow account) and may be reduced by payments of other indemnification claims under the purchase agreement. The fund expires on June 17, 2015. The Company currently believes the tax indemnification provided by the seller will be adequate for any identified income tax risk. The indemnification receivable will continue to be measured on the same basis as the related uncertain tax position liability.

The acquisition was completed on December 17, 2010 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. For the thirteen weeks ended March 26, 2011, the Van Houtte operations contributed an additional $100.5 million of consolidated revenue and reduced consolidated income before income taxes by $1.2 million. For the twenty-six weeks ended March 26, 2011, the Van Houtte operations contributed an additional $109.3 million of consolidated revenue and reduced consolidated income before income taxes by $2.7 million.

Diedrich Coffee, Inc.

On May 11, 2010, the Company acquired all of the outstanding common stock of Diedrich Coffee, Inc. (“Diedrich”) a specialty coffee roaster and wholesaler located in central California for approximately $305.3 million, net of cash acquired. The acquisition was financed with cash on hand and a term loan of $140.0 million. Diedrich is a wholly-owned subsidiary of the Company with operations integrated into the SCBU.

Diedrich specializes in sourcing, roasting, and selling specialty coffee in a variety of packaging formats, including K-Cup® portion packs whose brands include Diedrich Coffee®, Coffee People® and its licensed Gloria Jean’s® brand.

The allocation of the purchase price based on the fair value of the acquired assets and liabilities assumed was as follows (in thousands):

 

Restricted cash

   $ 623   

Accounts receivable

     10,361   

Inventories

     6,732   

Deferred income taxes

     1,733   

Other current assets

     2,543   

Fixed assets

     11,741   

Intangibles

     100,200   

Goodwill

     217,519   

Other long-term asset

     156   

Accounts payable

     (3,836

Accrued compensation costs

     (8,670

Accrued expenses

     (3,480

Deferred income taxes, long-term

     (30,361
        

Total

   $ 305,261   
        

 

-18-


Acquisition costs were expensed as incurred and totaled approximately $4.8 million and $8.0 million for the thirteen and twenty-six weeks ended March 27, 2010, and are included in general and administrative expenses of the Company.

Amortizable intangible assets acquired include approximately $83.3 million for customer relationships and $16.9 million for product names. The weighted-average amortization period for these assets is 10 years and will be amortized on a straight-line basis over their respective useful lives.

The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $217.5 million. The acquisition provides the Company with an expanded West Coast presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment of the Company. The goodwill and intangible assets recognized are not deductible for tax purposes.

The acquisition was completed on May 11, 2010 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. Effective September 26, 2010, the beginning of the Company’s fiscal year 2011, Diedrich was migrated onto the Company’s common information technology platform. As a result, it is impracticable to disclose separately Diedrich’s contributions to revenue and income before taxes for the thirteen and twenty-six weeks ended March 26, 2011.

Timothy’s Coffee of the World Inc.

On November 13, 2009, the Company acquired all of the outstanding capital stock of Timothy’s Coffee of the World Inc. (“Timothy’s”), which included its brand and wholesale coffee business. Timothy’s is as a wholly-owned Canadian subsidiary, with operations integrated into the SCBU segment. Timothy’s functional currency is the U.S. dollar.

Timothy’s wholesale business produces specialty coffee, tea and other beverages in a variety of packaged forms, including K-Cup® portion packs whose brands are Timothy’s® and its licensed brand Emeril’s®. The acquisition provided the Company with a Canadian presence, the Timothy’s brand name and a coffee roasting and packaging facility in Toronto.

Total consideration under the terms of the share purchase agreement amounted to approximately USD $155.7 million. The share purchase agreement contained customary representations, warranties and covenants given by the parties. The total cash disbursement was $154.2 million and the Company assumed liabilities of $1.5 million which were recorded as a noncash transaction.

The allocation of the purchase price based on fair value of the acquired assets less liabilities assumed is as follows (in thousands):

 

Accounts receivable

   $ 8,732   

Inventory

     6,911   

Other current assets

     83   

Fixed assets

     7,827   

Intangibles

     98,300   

Goodwill

     69,297   

Accounts payable

     (6,852

Accrued compensation costs

     (132

Accrued expenses

     (966

Capital lease

     (186

Deferred income taxes

     (27,274
        

Total

   $ 155,740   
        

 

-19-


Acquisition costs were expensed as incurred and totaled approximately $1.9 million for the twenty-six weeks ended March 27, 2010 and are included in general and administrative expenses of the Company.

Amortizable intangible assets acquired include approximately $83.2 million for customer relationships with an estimated life of 16 years, approximately $8.9 million for the Timothy’s trade name with an estimated life of 11 years and approximately $6.2 million for supply agreements with an estimated life of 11 years. The weighted-average amortization period for these assets is 15.2 years and will be amortized on a straight-line basis over their respective useful lives.

The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $69.3 million. The acquisition provided the Company with a Canadian presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment of the Company. The goodwill recognized is not deductible for tax purposes.

In conjunction with the acquisition, the Company recognized an indemnification receivable for uncertain tax positions. As of March 26, 2011, the amount of this indemnification receivable is $5.0 million. The seller has an indemnification obligation for tax liabilities relating to periods prior to the acquisition date. This obligation is capped at CAD$7.9 million. The indemnification obligation expires on September 13, 2014. The Company currently believes the tax indemnification provided by the seller will be adequate for any identified income tax risk. The indemnification receivable will continue to be measured on the same basis as the related uncertain tax position liability.

The acquisition was completed on November 13, 2009 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. For the thirteen weeks ended March 26, 2011, the Timothy’s operations contributed an additional $14.9 million of revenue and $8.4 million of income before taxes. For the twenty-six weeks ended March 26, 2011, the Timothy’s operations contributed an additional $27.2 million of revenue and $15.2 million of income before income taxes. For the thirteen weeks ended March 27, 2010, the Timothy’s operations contributed an additional $13.0 million of revenue and $3.8 million of income before taxes. For the twenty-six weeks ended March 27, 2010, the Timothy’s operations contributed in an additional $17.2 million of revenue and $2.8 million of income before income taxes.

Supplemental Pro Forma Information

The following information reflects the Van Houtte, Diedrich and Timothy’s acquisitions as if the transactions had occurred as of the beginning of the Company’s fiscal 2010. The unaudited pro forma information does not necessarily reflect the actual results that would have occurred had the Company, Van Houtte, Diedrich and Timothy’s been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies.

The following table represents select unaudited consolidated pro forma data (in thousands):

 

     Thirteen
weeks ended
March 26,
2011
     Thirteen
weeks ended
March 27,
2010
     Twenty-six
weeks ended
March 26,
2011
     Twenty-six
weeks ended
March 27,
2010
 

Unaudited Consolidated proforma revenue

   $ 647,658       $ 424,154       $ 1,320,636       $ 862,462   

Unaudited Consolidated proforma net income

   $ 69,947       $ 23,032       $ 92,137       $ 34,432   

Unaudited Consolidated proforma diluted earnings per share

   $ 0.47       $ 0.17       $ 0.63       $ 0.25   

 

-20-


5. Inventories

Inventories consisted of the following (in thousands):

 

     March 26,
2011
     September 25,
2010
 

Raw materials and supplies

   $ 84,719       $ 46,328  

Finished goods

     216,041         216,150   
                 
   $ 300,760       $ 262,478   
                 

Inventory values above are presented net of $2.3 million and $3.0 million of obsolescence adjustments at March 26, 2011 and September 25, 2010, respectively.

At March 26, 2011, the Company had approximately $294.3 million in green coffee purchase commitments, of which approximately 77.5% had a fixed price. These commitments extend into fiscal 2012. The value of the variable portion of these commitments was calculated using an average “C” price of coffee of $2.74 per pound at March 26, 2011. In addition to its green coffee commitments, the Company had approximately $145.2 million in fixed price brewer inventory purchase commitments and $118.4 million in production raw materials commitments at March 26, 2011. The Company believes based on relationships established with its suppliers that the risk of non-delivery on such purchase commitments is remote.

 

6. Fixed Assets

Fixed assets consist of the following (in thousands):

 

     Useful Life in Years    March 26,
2011
    September 25,
2010
 

Production equipment

  

1-15

   $ 248,758      $ 160,080   

Coffee service equipment

  

3-7

     56,017        11,013   

Computer equipment and software

  

1-10

     71,104        41,923   

Land

  

Indefinite

     7,650        1,743   

Building and building improvements

  

4-30

     37,562        23,954   

Furniture and fixtures

  

1-15

     19,770        11,413   

Vehicles

  

4-5

     7,894        1,020   

Leasehold improvements

       
  

1-20 or remaining life of

lease, whichever is less

     25,968        17,224   

Construction-in-progress

        65,549        72,161   
                   

Total fixed assets

        540,272        340,531   

Accumulated depreciation

        (110,677     (81,608
                   
      $ 429,595      $ 258,923   
                   

Total depreciation expense relating to all fixed assets was $19.0 million and $6.8 million for the thirteen weeks ended March 26, 2011 and March 27, 2010, respectively. Total depreciation expense relating to all fixed assets was $31.0 million and $12.7 million for the twenty-six weeks ended March 26, 2011 and March 27, 2010, respectively.

Assets classified as construction-in-progress are not depreciated, as they are not ready for production use. All assets classified as construction-in-progress on March 26, 2011 are expected to be in productive use within the next twelve months.

 

-21-


In the thirteen and twenty-six weeks ended March 26, 2011, the Company capitalized $0.5 million and $0.9 million of interest expense, respectively.

In the thirteen and twenty-six weeks ended March 27, 2010, the Company capitalized $0.4 million and $0.7 million of interest expense, respectively.

 

7. Goodwill and Intangible Assets

The following represents the change in the carrying amount of goodwill by segment for the twenty-six weeks ended March 26, 2011 (in thousands):

 

     SCBU      Keurig      CBU      Total  

Balance at September 25, 2010

   $ 314,042       $ 72,374       $ —         $ 386,416   

Acquisition of Van Houtte

     —           —           409,493         409,493   

Foreign currency effect

     —           —           12,972         12,972   
                                   

Balance at March 26, 2011

   $ 314,042       $ 72,374       $ 422,465       $ 808,881   
                                   

The Company has not recognized any impairment loss associated with goodwill.

Definite-lived intangible assets consist of the following (in thousands):

 

     March 26, 2011     September 25, 2010  
     Gross Carrying
Amount
     Accumulated
Amortization
    Gross Carrying
Amount
     Accumulated
Amortization
 

Intangible assets subject to amortization

          

Acquired technology

   $ 21,623       $ (12,487   $ 21,317       $ (11,464

Customer and roaster agreements

     27,325         (12,194     25,900         (10,688

Customer relationships

     430,661         (22,530     176,867         (8,915

Trade names

     38,017         (4,037     29,256         (2,338

Non-compete agreements

     374         (314     374         (304
                                  

Total

   $ 518,000       $ (51,562   $ 253,714       $ (33,709
                                  

Definite-lived intangible assets are amortized on a straight-line basis over the period of expected economic benefit. Total amortization expense was $11.7 million and $3.1 million for the thirteen weeks ended March 26, 2011 and March 27, 2010, respectively. Total amortization expense was $17.8 million and $5.2 million for the twenty-six weeks ended March 26, 2011 and March 27, 2010, respectively.

Indefinite-lived intangible assets were $102.6 million at March 26, 2011 and consisted of trademarks.

The estimated useful lives of the intangible assets subject to amortization are 4 to10 years for acquired technology, 8 to 11 years for customer and roaster agreements, 7 to 16 years for customer relationships, 9 to 11 years for trade names and 2 to 5 years for non-compete agreements.

The estimated aggregate amortization expense for the remainder of fiscal 2011, for each of the next five years and thereafter, is as follows (in thousands):

 

2011

   $ 23,400   

2012

   $ 46,625   

2013

   $ 46,416   

2014

   $ 45,807   

2015

   $ 44,254   

2016

   $ 43,543   

Thereafter

   $ 216,393   

 

-22-


8. Assets Held for Sale

In conjunction with the acquisition of Van Houtte (see Note 4, Acquisitions), the Company is conducting a strategic review of the Van Houtte U.S. Coffee Service business (“Filterfresh”) in contemplation of a potential divestiture of Filterfresh. Management expects to complete the sale within a year of the acquisition date of December 17, 2010. As a result, as of March 26, 2011, all the assets and liabilities relating to the Filterfresh business have been reported in the Consolidated Balance Sheets as assets and liabilities held-for-sale. The preliminary fair value of Filterfresh was estimated using a market-based multiple approach.

The following is a summary of the major classes of assets and liabilities of Filterfresh included as assets and liabilities held-for-sale as of March 26, 2011 (in thousands):

 

Cash

   $ 6,510   

Accounts receivable, net of allowance for uncollectible accounts of $0.3 million

     13,555   

Inventories

     6,705   

Other current assets

     459   
        

Total current assets

   $ 27,229   

Fixed Assets

   $ 34,505   

Intangibles

     19,550   

Goodwill

     62,838   

Other long-term assets

     551   
        

Total long-term assets

   $ 117,444   

Current portion of long-term debt

   $ 452   

Accounts payable

     2,162   

Accrued compensation

     3,233   

Accrued expenses

     3,023   

Income taxes payable

     22   

Deferred income taxes, net

     10,894   
        

Total current liabilities

   $ 19,786   

Long-term debt

   $ 609   

Other long-term liabilities

     769   
        

Total long-term liabilities

   $ 1,378   

 

9. Stockholder’s Equity

On September 28, 2010, the Company sold 8,566,649 shares of its common stock, par value $0.10 per share, to Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), for an aggregate purchase price of $250.0 million. The sale was recorded to stockholders’ equity net of transaction related expenses of approximately $0.5 million. The shares were sold pursuant to a Common Stock Purchase Agreement which contains a five-and-one-half-year standstill period, subject to certain exceptions, during which Lavazza is prohibited from increasing its ownership of Common Stock or making any proposals or announcements relating to extraordinary Company transactions. The standstill is subject to additional exceptions after a one-year period, including Lavazza’s right to purchase additional shares up to 15% of the Company’s outstanding shares.

 

-23-


10. Long-Term Debt

Debt outstanding consists of the following (in thousands):

 

     March 26,
2011
     September 25,
2010
 

Revolving credit facility, USD

   $ 80,000       $ —     

Revolving credit facility, multicurrency

     183,355         —     

Term loan A

     250,000         —     

Term loan B

     550,000         —     

Other

     1,643         13   

Revolving credit facility

     —           173,000   

Term loan A facility

     —           45,000   

Term loan A1 facility

     —           136,500   
                 

Total long-term debt

     1,064,998         354,513   

Less original issue discount

     5,271      

Less current portion

     11,328         19,009   
                 

Long-term portion

   $ 1,048,399       $ 335,504   
                 

On December 17, 2010, in conjunction with the Van Houtte acquisition, the Company entered into a new $1.45 billion senior secured Credit Agreement (the “Credit Agreement”) with Bank of America, N.A. and other lenders consisting of (i) a $450.0 million U.S. revolving credit facility, (ii) a $200.0 million alternative currency revolving credit facility, (iii) a $250.0 million term loan A facility, and (iv) a $550.0 million term loan B facility.

The term loans A and B require quarterly principal repayments and have maturities of December 2015 and December 2016, respectively. The revolving credit facilities mature in December 2015. The term loans and revolving credit facilities bear interest at a rate equal to an applicable margin plus, at the Company’s option, either (a) a eurodollar rate determined by reference to the cost of funds for deposits for the interest period 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 with respect to the term loan A and revolving credit facilities is a percentage per annum varying from 1.0% to 2.5% for base rate loans and 2.0% to 3.5% for eurodollar rate loans, based upon the Company’s leverage ratio. The applicable margin with respect to the term loan B is a percentage per annum equal to 3.0% for base rate loans and 4.0% for eurodollar rate loans. With respect to the term loan B, the eurodollar rate is deemed not to be less than 1.50% per annum. The average effective interest rate at March 26, 2011 and September 25, 2010 was 5.6% and 2.7%, respectively, excluding amortization of deferred financing charges. The Company also pays a commitment fee on the average daily unused portion of the revolving credit facilities. The term loan B is net of a 1% original issue discount that is recorded as a contra-debt liability and will be amortized to interest expense over the contractual life of the loan using the effective interest rate method.

The Credit Agreement is secured by substantially all assets of the Company and its domestic wholly-owned material subsidiaries. The Credit Agreement contains customary negative covenants, subject to certain exceptions, including limitations on: liens; investments; indebtedness; merger and consolidations; asset sales; dividends and distributions or repurchases of the Company’s capital stock; transactions with affiliates; certain burdensome agreements; and changes in the Company’s lines of business.

The Credit Agreement requires the Company to comply on a quarterly basis with a consolidated leverage ratio, a consolidated interest coverage ratio and a capital expenditures covenant. At March 26, 2011, the Company was in compliance with these covenants. In addition, the Credit Agreement contains certain mandatory prepayment requirements, including a percentage of annual excess cash flow and customary events of default.

 

-24-


At March 26, 2011 and September 25, 2010, respectively, the Company had $4.4 million and $0.7 million in outstanding letters of credit under the Credit Agreement and former credit facility, respectively.

In connection with the new Credit Agreement, the Company incurred debt financing costs of $41.4 million. These costs are included in Other Long-Term Assets on the Consolidated Balance Sheet and are amortized as interest expense over the life of the respective loan using the effective interest rate method. Interest expense for the twenty-six weeks ended March 26, 2011 also includes $2.6 million related to debt financing costs that were written-off due to the extinguishment of the former credit facility.

The Company enters into interest rate swap agreements to limit a portion of its exposure of variable interest rates by entering into interest rate swap agreements which effectively fix the rates. In accordance with the swap agreements and on a monthly basis, interest expense is calculated based on the floating 30-day Libor rate and the fixed rate. If interest expense calculated is greater based on the 30-day Libor rate, the swap counterparty pays the difference to the Company; if interest expense as calculated is greater based on the fixed rate, the Company pays the difference to the swap counterparty. In addition, the Company has entered into an interest rate cap to limit the interest rate exposure of $167.0 million in variable-rate borrowings.

Below is a summary of the Company’s derivative instruments mitigating interest rate exposure of variable-rate borrowings (in thousands):

 

                                      Fair Value of Interest Rate
Derivatives
 

Derivative

Instrument

  

Hedged

Transaction

     Notional Amount
of Underlying
Debt
     Fixed Rate
Received
    Interest Cap     Maturity     

March 26,

2011

    September 25,
2010
 

Swap

     30-day Libor       $ 14,567         5.44     —          2011       $ (180   $ (647

Swap

     30-day Libor         40,000         1.38     —          2012         (483     (670

Swap

     30-day Libor         20,000         3.87     —          2013         (1,087     (1,416

Swap

     30-day Libor         28,433         1.20     —          2013         (313     —     

Swap

     30-day Libor         20,000         2.54     —          2016         (325     —     

Swap

     30-day Libor         30,000         2.54     —          2016         (494     —     

Swap

     30-day Libor         50,000         2.54     —          2016         (794     —     

Swap

     30-day Libor         30,000         2.54     —          2016         (490     —     

Cap

     30-day Libor         167,000         —          1.5% - 2.0%        2013         257        —     
                                   
      $ 400,000              $ (3,909   $ (2,733
                                   

For the thirteen weeks ended March 26, 2011 and March 27, 2010, the Company paid approximately $0.8 million and $0.6 million, respectively, in additional interest expense pursuant to swap agreements. For the twenty-six weeks ended March 26, 2011 and March 27, 2010, the Company paid approximately $1.3 million in additional interest expense pursuant to swap agreements.

Maturities

Scheduled maturities of long-term debt are as follows (in thousands):

 

Fiscal Year       

Remainder 2011

   $ 7,744   

2012

     11,913   

2013

     15,051   

2014

     21,298   

2015

     27,514   

Thereafter

     981,478   
        
   $ 1,064,998   
        

 

-25-


11. Redeemable Noncontrolling Interests

In the CBU segment, the Company operates under certain joint venture arrangements for coffee services in the United States and Canada. The financial statements consolidate entities in which the Company has a controlling financial interest. Net income attributable to redeemable non-controlling interest reflects the portion of the net income (loss) of consolidated entities applicable to the redeemable noncontrolling interest partners in the consolidated statement of operations. The net income attributable to noncontrolling interests are classified in the consolidated statements of operations as part of consolidated net income with the net income attributable to the noncontrolling interests deducted from total consolidated net income. The Company’s redeemable noncontrolling interests are redeemable at amounts based on formulas specific to each entity. The Company classifies redeemable noncontrolling interests outside of shareholders’ equity in the consolidated balance sheet under the caption, “Redeemable noncontrolling interests”, and measures it at the redemption value at the end of each period. If the redemption value is greater than the carrying value, an adjustment is recorded in retained earnings to record the noncontrolling interest at its redemption value.

If a change in ownership of consolidated subsidiary results in a loss of control or deconsolidation, any retained ownership interests are remeasured with the gain or loss reported to net earnings.

 

12. Derivative Financial Instruments

Cash Flow Hedges

The Company is exposed to certain risks relating to ongoing business operations. The primary risks that are mitigated by financial instruments are interest rate risk and commodity price risk. The Company uses interest rate swaps and caps to mitigate interest rate risk associated with the Company’s variable-rate borrowings and enters into coffee futures contracts to hedge future coffee purchase commitments of green coffee with the objective of minimizing cost risk due to market fluctuations.

The Company designates the interest rate swap and cap agreements and certain coffee futures contracts as cash flow hedges and measures the effectiveness of these derivative instruments at each balance sheet date. The changes in the fair value of these instruments are classified in accumulated other comprehensive income (“OCI”). Gains and losses on these instruments are reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. If it is determined that a derivative is not highly effective, the gains and losses will be reclassified into earnings upon determination.

The Company is using interest rate swaps to hedge its exposure to interest rate risk associated with variable-rate borrowing through December 2015 and using coffee futures contracts to hedge market fluctuations through December 2011.

Other Derivatives

The Company is also exposed to certain foreign currency risks and enters into derivatives to mitigate this exposure. The Company has entered into a five year, $150.0 million

 

-26-


Canadian cross currency swap to mitigate the remeasurement risk of foreign exchange rate fluctuations on an intercompany note. Gains and losses from this instrument are largely offset by the financial impact of remeasuring the intercompany note that is denominated in Canadian currency. This cross currency swap is not designated as a hedging instrument for accounting purposes and is recorded at fair value, with the changes in fair value recognized in the Consolidated Statements of Operations.

In conjunction with the acquisition of Van Houtte (see Note 3, Acquisitions), the Company assumed certain derivative financial instruments entered into by Van Houtte prior to the acquisition. These derivatives include foreign currency forward contracts and coffee futures contracts and were established to mitigate certain foreign currency and commodity risks. These derivatives were not designated as hedging instruments for accounting purposes and are recorded at fair value, with the changes in fair value recognized in the Consolidated Statements of Operations.

The Company does not hold or use derivative financial instruments for trading or speculative purposes.

The Company is exposed to credit loss in the event of nonperformance by the counterparties to these financial instruments, however nonperformance is not anticipated.

The following table summarizes the fair value of the Company’s derivatives included in the Consolidated Balance Sheets (in thousands).

 

     March 26,
2011
    September 25,
2010
    Balance Sheet Classification  

Derivatives designated as hedges:

      

Interest rate swaps

   $ (4,166   $ (2,733     Other short-term liabilities   

Interest rate cap

     257        —          Other current assets   

Coffee futures

     83        —          Other current assets   
                  
     (3,826     (2,733  

Derivatives not designated as hedges:

      

Cross currency swap

     (8,831     —          Other short-term liabilities   

Foreign currency forwards

     (165     73       

 

Other current assets

(Other short-term liabilities)

  

  

                  
     (8,996     73     
                  

Total

   $ (12,822   $ (2,660  
                  

The following table summarizes the amount of gain (loss), gross of tax, on financial instruments that qualify for hedge accounting included in other comprehensive income (in thousands).

 

    

Thirteen
weeks ended

March 26, 2011

   

Thirteen
weeks ended

March 27, 2010

    

Twenty-six
weeks ended

March 26, 2011

   

Twenty-six
weeks ended

March 27, 2010

 

Interest rate swaps

   $ (2,078   $ 319       $ (1,433   $ 732   

Interest rate cap

     (392     —           (392     —     

Coffee futures

     83        —           83        66   
                                 

Total

   $ (2,387   $ 319       $ (1,742   $ 798   
                                 

 

-27-


The following table summarizes the amount of gain (loss), gross of tax, reclassified from other comprehensive income to income (in thousands).

 

     Thirteen
weeks ended
March 26, 2011
     Thirteen
weeks ended
March 27, 2010
     Twenty-six
weeks ended
March 26, 2011
     Twenty-six
weeks ended
March 27, 2010
     Location of Gain or (Loss)
Reclassified from OCI into
Income

Interest rate swaps

   $ —         $ —         $ —         $ —         Interest Expense

Interest rate cap

     —           —           —           —         Interest Expense

Coffee futures

     —           124         —           188       Cost of Sales
                                      

Total

   $ —         $ 124       $ —         $ 188      
                                      

The following table is a reconciliation of beginning accumulated other comprehensive income to ending accumulated other comprehensive income, net of tax (in thousands).

 

     Thirteen
weeks ended
March 26, 2011
    Thirteen
weeks ended
March 27, 2010
    Twenty-six
weeks ended
March 26, 2011
    Twenty-six
weeks ended
March 27, 2010
 

Beginning accumulated OCI

   $ (1,245   $ (1,574   $ (1,630   $ (1,870

Additions to OCI:

        

Interest Rate Swaps

     (1,240     190        (855     437   

Interest Rate Cap

     (234     —          (234     —     

Coffee Futures

     50        —          50        39   
                                
     (1,424     190        (1,039     476   

Reclassifications to income:

        

Interest Rate Swaps

     —          —          —          —     

Interest Rate Cap

     —          —          —          —     

Coffee Futures

     —          (122     —          (112
                                
     —          (122     —          (112
                                

Ending accumulated OCI

   $ (2,669   $ (1,506   $ (2,669   $ (1,506
                                

The Company expects to reclassify $83,000 from coffee derivatives and $123,000 from the interest rate cap, gross of tax, to earnings within the next twelve months.

The Company incurred net losses on financial instruments not designated as hedges for accounting purposes as follows (in thousands).

 

     Thirteen
weeks ended
March 26, 2011
    Thirteen
weeks ended
March 27, 2010
     Twenty-six
weeks ended
March 26, 2011
    Twenty-six
weeks ended
March 27, 2010
 

Net Loss on Cross Currency Swap

   $ (5,179   $ —         $ (8,831   $ —     

Net Losses on Coffee Futures

     (780     —           (250     —     

Net Losses on Foreign Currency Option and

         

Forward Contracts

     —          —           (3,220     (354
                                 

Total

   $ (5,959   $ —         $ (12,301   $ (354
                                 

The foreign currency contracts were entered into to mitigate the risk associated with the Canadian denominated purchase price of Van Houtte.

 

-28-


13. Fair Value Measurements

The Company measures fair value as the selling price that would be received for an asset, or paid to transfer a liability, in the principal or most advantageous market on the measurement date. The hierarchy established by the Financial Accounting Standards Board prioritizes fair value measurements based on the types of inputs used in the valuation technique. The inputs are categorized into the following levels:

Level 1 – Observable inputs such as quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than quoted prices that are observable, either directly or indirectly, for identical or similar assets and liabilities in active or non-active markets.

Level 3 – Unobservable inputs not corroborated by market data, therefore requiring the entity to use the best available information, including management assumptions.

The following table discloses the level used by fair value measurements at March 26, 2011:

 

Financial Instrument

   Fair Value Measurements Using      Balance  Sheet
Classification
 
      Level 1      Level 2     Level 3     

Derivatives

Derivatives

   $

 

—  

—  

  

  

   $

 

340

(13,162

  

  $

 

—  

—  

  

  

    

 

Other current assets

Other short-term liabilities

  

  

                            

Total

   $ —         $ (12,822   $ —        
                            

The following table discloses the level used by fair value measurements at September 25, 2010:

 

Financial Instrument

   Fair Value Measurements Using      Balance  Sheet
Classification
 
      Level 1      Level 2     Level 3     

Derivatives

Derivatives

   $

$

—  

—  

  

  

   $

$

1,717

(4,377

  

  $

$

—  

—  

  

  

    

 

Other current assets

Other short-term liabilities

  

  

                            

Total

   $ —         $ (2,660   $ —        
                            

Derivative financial instruments include coffee futures contracts, interest rate swap agreements, an interest rate cap and foreign currency option contracts. To determine fair value, the Company utilizes the market approach valuation technique for coffee futures and foreign currency options and the income approach for the interest rate swap and interest rate cap agreements.

Level 2 derivative financial instruments use inputs that are based on market data of identical (or similar) instruments, including forward prices for commodities, interest rates curves and spot prices, that are in observable markets. Derivatives recorded on the balance sheet are at fair value with changes in fair value recorded in other comprehensive income for cash flow hedges and in the Consolidated Statements of Operations for other derivatives.

 

14. Product Warranties

The Company offers a one-year warranty on all Keurig® Single-Cup brewers it sells. Keurig provides for the estimated cost of product warranties, primarily using historical information and repair or replacement costs, at the time product revenue is recognized. The Company continues to experience higher-than-historical rate warranty claims associated with its reservoir brewer models. Management’s analysis of these claims remains consistent with its previous diagnosis of a later-stage performance issue caused by a component failing at higher-than-anticipated rates. While not a safety concern, when manifested, brewers with this issue operate inconsistently or cease operation at a later stage of the warranty life. This issue is not presenting itself consistently across all units, and whether or not it occurs depends on a number of variables including brewer usage rate and water quality. Management believes that they identified the root cause of the component failure in 2010 and units produced since January 2011 incorporate an improved component that is expected to substantially eliminate the issue. While the Company maintains a reserve for product warranty costs based on

 

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certain estimates that include the findings relating to this component failure, because this is a later-stage issue, actual warranty costs may exceed the reserve, and there can be no assurance that the Company will not need to increase the reserve or experience additional warranty expense related to this quality issue in future periods.

The changes in the carrying amount of product warranties for the twenty-six weeks ended March 26, 2011 and March 27, 2010 are as follows (in thousands):

 

     Twenty-six
weeks ended
March 26, 2011
    Twenty-six
weeks ended
March 27, 2010
 

Balance, beginning of period

   $ 6,694      $ 724   

Provision charged to income

     21,611        8,715   

Usage, net of recoveries

     (12,590     (6,161
                

Balance, end of period

   $ 15,715      $ 3,278   
                

 

15. Earnings Per Share

The following table illustrates the reconciliation of the numerator and denominator of basic and diluted earnings per share computations (dollars in thousands, except per share data):

 

     Thirteen
weeks ended
March 26, 2011
     Thirteen
weeks ended
March 27, 2010
(As Restated)
     Twenty-six
weeks ended
March 26, 2011
     Twenty-six
weeks ended
March 27, 2010
(As Restated)
 

Numerator for basic and diluted earnings per share:

           

Net income

   $ 65,372       $ 24,055       $ 67,784       $ 34,115   
                                   

Denominator:

           

Basic weighted average shares outstanding

     141,784,994         131,263,638         141,579,543         131,116,251   

Effect of dilutive securities - stock options

     5,773,601         6,567,936         5,730,821         6,512,145   
                                   

Diluted weighted average shares outstanding

     147,558,595         137,831,574         147,310,364         137,628,396   
                                   

Basic net income per share

   $ 0.46       $ 0.18       $ 0.48       $ 0.26   

Diluted net income per share

   $ 0.44       $ 0.17       $ 0.46       $ 0.25   

For the thirteen and twenty-six weeks ended March 26, 2011 options to purchase 514,000 and 507,000 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

For the thirteen and twenty-six weeks ended March 27, 2010 options to purchase 153,000 and 81,000 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

 

16. Compensation Plans

Stock Option Plans

The grant-date fair value of employee stock options and similar instruments is estimated using the Black-Scholes option-pricing model with the following assumptions for grants issued in the twenty-six weeks ended March 26, 2011: an expected life averaging 6 years; an average volatility of 52%; no dividend yield; and a risk-free interest rate averaging 2.4%. The weighted-average fair value of options granted during the twenty-six weeks ended March 26, 2011 was $28.81 per share.

 

-30-


The grant-date fair value of employee stock options and similar instruments is estimated using the Black-Scholes option-pricing model with the following assumptions for grants issued in the twenty-six weeks ended March 27, 2010: an expected life averaging 6 years; an average volatility of 53%; no dividend yield; and a risk-free interest rate averaging 2.8%. The weighted-average fair value of options granted during the twenty-six weeks ended March 27, 2010 was $15.88 per share.

Employee Stock Purchase Plan

The grant-date fair value of employees’ purchase rights under the Company’s Employee Stock Purchase Plan is estimated using the Black-Scholes option-pricing model with the following assumptions for the purchase rights granted in the twenty-six weeks ended March 26, 2011: an expected life averaging 6 months; an average volatility of 43%; no dividend yield; and a risk-free interest rate averaging 0.2%. The weighted-average fair values of purchase rights granted during the twenty-six weeks ended March 26, 2011 was $10.21 per share.

For the purchase rights granted in the twenty-six weeks ended March 27, 2010, the following assumptions were used: an expected life averaging 6 months; an average volatility of 57%; no dividend yield; and a risk-free interest rate averaging 0.2%. The weighted-average fair values of purchase rights granted during the twenty-six weeks ended March 27, 2010 was $7.58 per share.

For the thirteen and twenty-six weeks ended March 26, 2011, income before income taxes was reduced by a stock compensation expense of $2.3 million and $4.5 million, respectively.

For the thirteen and twenty-six weeks ended March 27, 2010, income before income taxes was reduced by a stock compensation expense of $1.9 million and $3.8 million, respectively.

Employee Stock Ownership Plan

The Company maintained an Employee Stock Ownership Plan (the “ESOP”), which terminated at the end of the 2010 calendar year. The ESOP is qualified under sections 401(a) and 4975(e)(7) of the Internal Revenue Code. In the twenty-six weeks ended March 27, 2010, the Company recorded compensation costs of $0.6 million to accrue for anticipated stock distributions under the ESOP. The Company recorded no compensation costs for the twenty-six weeks ended March 26, 2011 and there were no unearned shares remaining in the ESOP at March 26, 2011.

Deferred Compensation Plan

The Company also maintains a Deferred Compensation Plan, which is not subject to the qualification requirements of Section 401(a) of the Internal Revenue Code and which allows participants to defer compensation until a future date. Only non-employee directors and certain highly compensated employees of the Company selected by the Company’s board of directors are eligible to participate in the Plan. In the twenty-six week periods ended March 26, 2011 and March 27, 2010, $116,000 and $78,000 of compensation expense was recorded under this Plan, respectively.

 

17. Income Taxes

The Company recognizes deferred tax assets and liabilities for the expected future tax benefits or consequences of temporary differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.

As of March 26, 2011, the Company had net operating loss carryforwards of $10.6 million and $21 million respectively for federal and state, as well as a $26 million combined federal and state capital loss carryforward available to be utilized against future taxable income for

 

-31-


years through fiscal year 2029, subject to annual limitation pertaining to change in ownership rules under the Internal Revenue Code. Based upon earnings history, the Company has concluded that it is more likely than not that the net operating loss carryforwards will be utilized prior to their expiration, but the capital loss carryforward will not. The Company has recorded a valuation allowance against the entire deferred tax asset balance for the capital loss carryforward.

The total amount of unrecognized tax benefits at March 26, 2011 and September 25, 2010 was $16.6 million and $5.5 million, respectively. The amount of unrecognized tax benefits at March 26, 2010 that would impact the effective tax rate if resolved in favor of the Company is $16.6 million. The Company is indemnified for up to $16.2 million of the total reserve balance. If resolved in favor of the Company, the associated indemnification receivable, recorded in other long-term assets, would be reduced accordingly. The Company recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes.

The Company has made an election to recognize interest and penalties accrued on uncertain tax liabilities as interest expense. The Company does not expect a significant change to the amount of unrecognized tax benefits within the next twelve months.

In April 2011, the Internal Revenue Service issued guidance providing a safe harbor election with respect to success-based fees paid in business combinations. The Company recognized approximately $2.2 million as an income tax benefit for the thirteen weeks ended March 26, 2011 related to the $5.7 million success-based fee paid in connection with its acquisition of Van Houtte.

 

18. Legal Proceedings

On October 1, 2010, Keurig filed suit against Sturm Foods, Inc. (“Sturm”) in the United States District Court for the District of Delaware (Civil Action No. 1:10-CV-00841-SLR) for patent and trademark infringement, false advertising, and other claims, related to Sturm’s sale of “Grove Square” beverage cartridges that claim to be compatible with Keurig Single-Cup brewers. The suit alleges that the “Grove Square” cartridges contain instant rather than fresh-brewed coffee, improperly use the “Keurig” mark, and do not work safely or effectively, in addition to violating Keurig patents (U.S. Patent Nos. 7,165,488 and 6,606,938). Keurig seeks an injunction prohibiting Sturm from selling these cartridges, as well as money damages. On October 18, 2010, Keurig requested that the court issue a preliminarily injunction on the use of the “Keurig” mark and false advertising claims pending final resolution of the case. The court denied that request so those issues will be resolved in due course during the litigation.

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

The Company and certain of its officers and directors are currently subject to a consolidated putative securities fraud class action and a consolidated putative stockholder derivative action, each pending in the United States Court for the District of Vermont, and a putative stockholder derivative action pending in the Superior Court of the State of Vermont for Washington County.

The consolidated putative securities fraud class action, organized under the caption Horowitz v. Green Mountain Coffee Roasters, Inc., Civ. No. 2:10-cv-00227, is pending in the United

 

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States District Court for the District of Vermont before the Honorable William K. Sessions, III. The underlying complaints in the consolidated action allege violations of the federal securities laws in connection with the Company’s disclosures relating to its revenues and its forward guidance. The complaints include counts for violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 against all defendants, and for violation of Section 20(a) of the Exchange Act against the officer defendants. The plaintiffs seek to represent all purchasers of the Company’s securities between July 28, 2010 and September 28, 2010 or September 29, 2010. The complaints seek class certification, compensatory damages, equitable and/or injunctive relief, attorneys’ fees, costs, and such other relief as the court should deem just and proper. Pursuant to the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(a)(3), plaintiffs had until November 29, 2010 to move the court to serve as lead plaintiff of the putative class. On December 20, 2010, the court appointed Jerzy Warchol, Robert M. Nichols, Jennifer M. Nichols, Marc Schmerler and Mike Shanley lead plaintiffs and approved their selection of Glancy Binkow & Goldberg LLP and Robbins Geller Rudman & Dowd LLP as co-lead counsel and the Law Office of Brian Hehir and Woodward & Kelley, PLLC as liaison counsel. On December 29, 2010 and January 3, 2011, two of the plaintiffs in the underlying actions in the consolidated proceedings, Russell Blank and Dan M. Horowitz, voluntarily dismissed their cases without prejudice. Pursuant to a stipulated motion granted by the court on November 29, 2010, the lead plaintiffs filed a consolidated complaint on February 23, 2011, and defendants moved to dismiss that complaint on April 25, 2011. Briefing on the motions to dismiss has not yet been completed.

The stockholder derivative actions consist of the following: a consolidated action captioned Himmel v. Robert P. Stiller, et al., Civ. No. 2:10-cv-00233, pending in the United States District Court for the District of Vermont before the Honorable William K. Sessions, III; and M. Elizabeth Dickenson v. Robert P. Stiller, et al., Civ. No. 818-11-10, pending in the Superior Court of the State of Vermont for Washington County. The derivative complaints are asserted nominally on behalf of the Company against certain of its directors and officers and are premised on the same allegations asserted in the putative securities class action complaints described above. The derivative complaints assert claims for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets. The complaints seek compensatory damages, injunctive relief, restitution, disgorgement, attorneys’ fees, costs, and such other relief as the court should deem just and proper. On November 29, 2010, the federal court entered an order consolidating the two federal actions and appointing the firms of Robbins Umeda LLP and Shuman Law Firm as co-lead plaintiffs’ counsel. On February 23, 2011, the federal court approved a stipulation filed by the parties providing for a temporary stay of that action until the court rules on defendants’ motions to dismiss the consolidated complaint in the putative securities fraud class action. In the state action, on February 28, 2011, the court approved a stipulation filed by the parties similarly providing for a temporary stay of that action until the federal court rules on defendants’ motions to dismiss the consolidated complaint in the putative securities fraud class action.

The Company and the other defendants intend to vigorously defend the pending lawsuits. Additional lawsuits may be filed and, at this time, the Company is unable to predict the outcome of these lawsuits, the possible loss or range of loss, if any, associated with the resolution of these lawsuits or any potential effect they may have on the Company or its operations.

 

19. Related Party Transactions

The Company uses travel services provided by Heritage Flight, a charter air services company owned by Mr. Robert P. Stiller, the Company’s Chairman of the Board.

 

-33-


During the thirteen and twenty-six weeks ended March 26, 2011, Heritage Flight billed the Company the amounts of $0.2 million and $0.3 million, respectively, for travel services to various employees of the Company.

During the thirteen and twenty-six weeks ended March 27, 2010, Heritage Flight billed the Company the amounts of $0.1 million and $0.2 million, respectively, for travel services to various employees of the Company.

 

20. Revision to Fiscal 2010 Year-End Consolidated Statement of Cash Flows

In preparing the consolidated financial statements for the thirteen weeks ended December 25, 2010, management identified that certain amounts previously disclosed within the Consolidated Statement of Cash Flows for the fiscal year ended September 25, 2010 required reclassification. These misstatements had no effect on the Company’s cash and cash equivalents. Specifically, the supplemental disclosure of fixed asset purchases included in accounts payable and not disbursed was overstated by approximately $8.2 million. This resulted in an $8.2 million understatement on the capital expenditures for fixed assets line and net cash used for investing activities category for fiscal 2010 and a corresponding understatement of the change in accounts payable line and an overstatement of net cash used in operating activities. The Company will make this immaterial correction when the fiscal 2010 financial statements are next issued.

 

21. Pending Accounting Pronouncements

In December 2010, the Financial Accounting Standards Board issued an update to accounting guidance for business combinations related to the disclosure of supplementary pro forma information. Accounting guidance for business combinations requires a public entity to disclose pro forma revenue and earnings for the combined entity as though the combination occurred at the beginning of the reporting period. This update clarifies that if a public entity presents comparative financial statements, the pro forma information for all business combinations occurring during the current year should be reported as though the combination occurred at the beginning of the prior annual reporting period. This update also expands the disclosure requirement to include the nature and amount of pro forma adjustments made to arrive at the disclosed pro forma revenue and earnings. This update is effective for business combinations for which the acquisition date is on or after annual reporting periods beginning after December 15, 2010, which is fiscal 2012 for the Company. The effect of adoption will depend primarily on the Company’s acquisitions occurring after such date, if any.

 

22. Subsequent Event

On April 8, 2011, the Internal Revenue Service issued guidance providing a safe harbor election with respect to success-based fees paid in business combinations. This guidance allows the Company to deduct 70% of success-based fees incurred in taxable years ending on or after April 8, 2011, which is fiscal 2011 for the Company. On December 17, 2010, the Company completed the acquisition of LJVH Holdings, Inc. (“LJVH” and together with its subsidiaries, “Van Houtte”) and incurred approximately $5.7 million of success-based fees upon the completion of the business combination. This subsequent event provides additional evidence about conditions that existed at March 26, 2011, and as a result, the Company recognized approximately $2.2 million as an income tax benefit and discrete item for the thirteen weeks ended March 26, 2011.

The Company has performed an evaluation of subsequent events through May 3, 2011, which is the date the financial statements were issued.

 

-34-


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

We are a leader in the specialty coffee and coffee maker businesses. We roast high-quality Arabica bean coffees including single-origin, Fair Trade Certified TM, certified organic, flavored, limited edition and proprietary blends offered in K-Cup® portion packs, whole bean and ground coffee selections, as well as other specialty beverages including tea and cocoa also offered in K-Cup® portion packs. In addition, we manufacture and sell the Keurig® Single-Cup Brewing system for use with K-Cup® portion packs. K-Cup® portion pack brands that are packaged and sold by us include:

 

   

Barista PrimaTM

 

   

Bigelow®

 

   

Café Escapes®

 

   

Caribou Coffee®

 

   

Celestial Seasonings®

 

   

Coffee People®

 

   

Diedrich Coffee®

 

   

Donut House®

 

   

Emeril’s®

 

   

Gloria Jean’s®

 

   

Green Mountain Coffee®

 

   

Green Mountain NaturalsTM

 

   

Kahlua®

 

   

Newman’s Own® Organics

 

   

Timothy’s®

 

   

Tully’s®

 

   

revv®

 

   

Van Houtte®

 

   

Wolfgang Puck®

The Newman’s Own® Organics, Caribou Coffee®, Celestial Seasonings®, Kahlua®, Emeril’s®, Gloria Jean’s®, Bigelow® and Wolfgang Puck® brands are licensed to us for exclusive use in the Keurig® Single-Cup Brewing system. During the second quarter of fiscal 2011, we entered into agreements with Dunkin’Donuts and Starbucks Corporation to make each brand’s coffee and Starbucks’ Tazo® tea available in single-serve K-Cup® portion packs. In April 2011, we entered into an agreement with ConAgra Foods, Inc. to make Swiss Miss® Hot Cocoa available in K-Cup® portion packs.

Over the last several years the primary growth in the coffee industry has come from the specialty coffee category, including demand for single-cup specialty coffee. This growth has been driven by the wider availability of high-quality coffee, the emergence of upscale coffee shops throughout the country, and the general level of consumer knowledge of, and appreciation for, coffee quality and variety. 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.

 

-35-


Our growth strategy involves developing and managing marketing programs to drive Keurig Single-Cup brewer adoption in North American households and offices in order to generate ongoing demand for K-Cup® portion packs. As part of this strategy, we work to sell our At Home (“AH”) brewers at attractive price points in order to drive the sales of profitable K-Cup® portion packs. The fundamental nature of our business model, we believe, is that, over time, brewers will begin to contribute a smaller percentage of total revenue relative to K-Cup® portion packs leading to higher overall operating margins.

In recent years, the Company’s growth has been driven predominantly by the growth and adoption of the Keurig Single-Cup Brewing system which includes sales of K-Cup® portion packs and Keurig Single-Cup Brewers.

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

 

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

 

  2. Convenience – The Keurig system prepares beverages in about 30 seconds at the touch of a button with no mess, no fuss.

 

  3. Choice – With more than 250 varieties of K-Cup® portion packs available for the system many consumers enjoy exploring and trying new brands. In addition to a variety of brands of coffee and tea, we also produce and sell hot apple cider, iced teas and coffees, cocoa and other dairy-based beverages, in K-Cup® portion packs, including chai latte and mocha varieties.

We believe it’s the combination of these attributes that make the Keurig Single-Cup system so appealing to so many consumers.

The Company’s sales and earnings growth continues to be driven by consumer adoption of the Keurig Single-Cup Brewing system. We’re taking several steps to capitalize on that growth opportunity by focusing on continued adoption of our Keurig Single-Cup brewing systems and increasing consumer awareness of and interest in the convenience, quality and choice represented by the Keurig Single-Cup system. Along with growing recognition of the Keurig brand, we believe our partner brewer brands – Breville, Cuisinart and Mr. Coffee – offering Keurig-brewed technology will help drive incremental system awareness and adoption. Looking forward, we believe we have significant opportunity to increase the number of Keurig consumers.

We believe we can continue to grow sales by increasing customer awareness in existing regions, expanding into new geographic regions, expanding sales in high-growth industry segments such as single-cup coffee, tea, and other beverages and selectively pursuing other opportunities.

For the second quarter of fiscal 2011, the Company’s net sales of $647.7 million represented growth of 101% over the second quarter of fiscal 2010 with 82% of our consolidated net sales attributed to the combination of K-Cup® portion pack, Keurig Single-Cup Brewer, related accessory and third party licensed royalty sales. Included in these results are the net sales from the Van Houtte acquisition, which contributed approximately $100.5 million to net sales, after eliminating the effect on consolidated net sales of K-Cup® portion pack sales to Keurig by Van Houtte and royalties recorded by Keurig from Van Houtte. The primary drivers of the increase in net sales were the 94% increase in total K-Cup® portion pack net sales which totaled $199.1 million, which includes Van Houtte, and the 86% increase in total Keurig Single-Cup Brewer and accessory net sales which totaled $53.8 million.

 

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Management is focused on executing on the above stated growth strategy to drive Keurig Single-Cup Brewer adoption in North American households and offices in order to generate ongoing demand for K-Cup® portion packs. We believe the financial model should result in increasing overall income before tax margins as we leverage selling, general and administrative expense (“S,G&A”) resources on a higher sales base and in later years improve gross margins as K-Cup® portion packs increase as a percentage of the overall sales mix. For example, in the second quarter of fiscal 2011, S,G&A increased 82% to $123.2 million from $67.7 million in the second quarter of fiscal 2010 and, as a percentage of sales, S,G&A improved to 19% in the second quarter of fiscal 2011 from 21% in the second quarter of fiscal 2010.

Gross margin for the second quarter of fiscal 2011 was 37.5% of net sales as compared to 33.5% of net sales in the second quarter of fiscal 2010. The improvement in gross margin is attributed to the net effect of the price increase implemented during the first quarter of fiscal 2011 on all K-Cup® portion packs, which was partially offset by continually rising green coffee costs occurring during fiscal 2011. In addition, warranty expense and sales returns as a percentage of net sales for the second quarter of fiscal 2011, was lower than the prior year period as the prior year period incurred higher levels of warranty expense and sales returns related to a quality issue associated with certain brewer models produced primarily in late calendar 2009.

We continually monitor all costs including coffee as we review our pricing structure. Coffee continues to be important input cost but as our sales mix has shifted in recent years to heavier weighting of K-Cup® portion packs (where there is less coffee per package compared to traditional pounds of bagged or fractional packaged coffee), the significance of green coffee costs continues to decline. Cyclical swings in commodity markets are common and the most recent years have been especially volatile for the “C” price of coffee (the price per pound quoted by the Intercontinental Exchange). The “C” price of coffee has been increasing consistently during fiscal 2011, and coffee prices are expected to remain volatile in the coming years. To help mitigate this volatility, we generally fix the price of our coffee contracts for approximately two fiscal quarters, and at times three fiscal quarters, prior to delivery so that we have the ability to adjust our sales prices to marketplace conditions if required. In September, 2010, the Company announced a price increase on K-Cup® portion packs beginning October 11, 2010. We anticipate potential lower unit volume in the future as a result of this price increase than we would have otherwise experienced keeping prices constant. We are currently in the process of implementing a further price increase for all package types in an attempt to offset the continuing rise in coffee costs as well as other commodity costs. We expect that the full benefit of this price increase will be realized during our fiscal fourth quarter of 2011.

The Company used its cash from operations to fund increases in working capital and capital expenditures to fund the growth of the business, and, in part, the recent acquisitions of Van Houtte, Diedrich and Timothy’s. In the second quarter of fiscal 2011, cash was used to fund capital expenditures of $51.6 million compared to $29.5 million in the second quarter of fiscal 2010. The increase in capital expenditures was primarily related to manufacturing infrastructure and packaging equipment for K-Cup® portion packs. We currently expect to invest approximately $275.0 million to $305.0 million in capital expenditures during fiscal 2011. We consistently analyze our short-term and long-term cash requirements to continue to grow the business. We expect that most of our cash generated from operations will continue to be used to fund capital expenditures and the working capital required for our growth over the next few years.

2010 Restatement

As discussed in Note 2, Restatement of Previously Issued Financial Statements, of the Notes to Consolidated Financial Statements, we have restated our financial statements and other information.

In this Quarterly Report on Form 10-Q, we are reporting net income of $24.1 million and $34.1 million for the thirteen and twenty-six weeks ended March 27, 2010, respectively, compared to $24.7 million and $37.2 million, respectively, that we reported in our Form 10-Q dated May 6, 2010. This decrease results from the restatement and errors of the same type that gave rise to the restatement as previously disclosed in our Annual Report on Form 10-K for the year ended September 25, 2010.

 

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In light of the restatement, readers should no longer rely on our previously filed financial statements and other financial information for the years and for each of the quarters in the fiscal years 2009, 2008, 2007 and 2006 and for the first three quarters of fiscal 2010.

Business Segments

The Company manages its operations through three operating segments, the Specialty Coffee business unit (“SCBU”), the Keurig business unit (“Keurig”) and the Canadian business unit (“CBU”). We evaluate performance primarily based on segment income before taxes. Expenses not specifically related to the SCBU, Keurig or CBU operating segments are recorded in the “Corporate” segment.

SCBU sources, produces and sells more than 200 varieties of coffee, cocoa, teas and other beverages in K-Cup® portion packs and coffee in more traditional packaging, including whole bean and ground coffee selections in bags and ground coffee in fractional packs, for use both at-home (“AH”) and away-from-home (“AFH”). These varieties are sold primarily in North American wholesale channels, including supermarkets and convenience stores, in restaurants and hospitality, to office coffee distributors and directly to consumers via its website www.greenmountaincoffee.com. In addition, SCBU sells Keurig Single-Cup Brewers and other accessories directly to consumers and supermarkets.

Keurig is a pioneer and leading manufacturer of gourmet single-cup brewing systems, and also targets its premium patented single-cup brewing systems for use both AH and AFH, mainly in North America. Keurig sells AH single-cup brewers, accessories and coffee, tea, cocoa and other beverages in K-Cup® portion packs produced mainly by SCBU and CBU to retailers by principally processing its orders through fulfillment entities for the AH channels. Keurig sells AFH single-cup brewers to distributors for use in offices. Keurig also sells AH brewers, a limited number of AFH brewers and K-Cup® portion packs directly to consumers via its website, www.keurig.com.

CBU sources, produces and sells coffees in a variety of packaging formats, including K-Cup® portion packs, whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands. These varieties are sold primarily to wholesale channels, including supermarkets and retail, and through office coffee services to offices, convenience stores and restaurants mainly throughout Canada. CBU also manufactures brewing equipment and is responsible for all Company coffee brand sales in the grocery channel in Canada.

Cost of sales for the Company consists of the cost of raw materials including coffee beans, cocoa, flavorings and packaging materials; a portion of our rental expense; production, warehousing and distribution costs which include salaries; distribution and merchandising personnel; leases and depreciation on facilities and equipment used in production; the cost of brewers manufactured by suppliers; fulfillment charges (including those paid to third-parties or to fulfillment entities); and freight, duties and delivery expenses. Selling and operating expenses consist of expenses that directly support sales, including media and advertising expenses; a portion of the rental expense; and the salaries and related expenses of employees directly supporting sales and marketing as well as research and development. General and administrative expenses consist of expenses incurred for corporate support and administration, including a portion of the rental expense and the salaries and related expenses of personnel not elsewhere categorized, as well as certain acquisition-related expenses.

Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to our entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign exchange gains or losses, certain corporate legal expenses and compensation of the board of

 

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directors. In addition, corporate expenses include acquisition-related costs. Corporate assets include primarily cash, short-term investments, deferred tax assets, income tax receivable, notes receivable, deferred issuance costs and fixed assets.

Goodwill and intangibles related to the Frontier, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU segment. Keurig related goodwill and intangibles are included in the Keurig segment. Goodwill and intangibles related to the Van Houtte acquisition are included in the CBU segment.

The Company analyzes its business on a segment basis, records net sales on a segment basis and eliminates intersegment sales as part of its financial consolidation. Intersegment sales primarily consist of the SCBU and CBU selling K-Cup® portion packs to Keurig, and Keurig sells single-cup brewers and records royalty income from K-Cup® portion packs when shipped by the SCBU and CBU.

Basis of Presentation

Included in this presentation are discussions and reconciliations of income before taxes, net income and diluted earnings per share in accordance with generally accepted accounting principles (“GAAP”) to income before taxes, net income and diluted earnings per share excluding certain expenses and losses. We refer to these performance measures as non-GAAP income before taxes, non-GAAP net income and non-GAAP diluted earnings per share. These non-GAAP measures exclude transaction expenses related to the Company’s acquisitions, legal and accounting expenses related to the SEC inquiry, the Company’s internal investigation and pending litigation, foreign exchange impact of hedging the risk associated with the Canadian dollar purchase price of the Van Houtte acquisition, and non-cash 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 the Company’s management uses these non-GAAP measures in discussing and analyzing its results of operations and because it believes the non-GAAP measures provide investors with greater transparency by helping to illustrate the underlying financial and business trends relating to the Company’s results of operations and financial condition and comparability between current and prior periods. For example, the Company excluded acquisition-related transaction expenses because these expense can vary from period to period and transaction to transaction and expenses associated with these activities are not considered a key measure of the Company’s operating performance.

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

Acquisitions

On December 17, 2010, the Company acquired its Van Houtte business through the purchase of all of the outstanding capital stock of LJVH Holdings, Inc., a specialty coffee roaster headquartered in Montreal, Quebec, for approximately USD $907.8 million, net of cash acquired. The acquisition was financed with cash on hand and a new $1.45 billion credit facility. The CBU consists of the operations of Van Houtte.

 

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

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

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     Twenty-six weeks ended  
     March 26,
2011
    March 27,
2010
    March 26,
2011
    March 27,
2010
 
           (As Restated)           (As Restated)  

Net sales

     100.0     100.0     100.0     100.0

Cost of sales

     62.5     66.5     68.4     69.5
                                

Gross profit

     37.5     33.5     31.6     30.5

Selling and operating expenses

     12.3     13.4     12.9     14.5

General and administrative expenses

     6.7     7.6     7.0     7.1
                                

Operating income

     18.5     12.5     11.7     8.9

Other income (expense)

     0.2     0.0     0.1     0.0

Loss on financial instruments, net

     (0.9 )%      0.0     (1.0 )%      (0.1 )% 

Gain on foreign currency, net

     0.6     0.0     0.5     0.0

Interest expense

     (2.6 )%      (0.3 )%      (1.9 )%      (0.3 )% 
                                

Income before income taxes

     15.8     12.2     9.4     8.5

Income tax expense

     (5.6 )%      (4.7 )%      (3.8 )%      (3.4 )% 
                                

Net Income

     10.2     7.5     5.6     5.1

Less: Net income attributable to noncontrolling interests

     (0.1 )%      0.0     0.0     0.0
                                

Net income attributable to GMCR

     10.1     7.5     5.6     5.1
                                

 

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Segment Summary

Net sales and income before taxes for each of our operating segments are summarized in the tables below (in millions):

 

     Net sales (in millions)     Net sales (in millions)  
     Thirteen
weeks ended
March 26,
2011
    Thirteen
weeks ended
March 27,
2010
    Twenty-six
weeks ended
March 26,
2011
    Twenty-six
weeks ended
March 27,
2010
 
           (As Restated)           (As Restated)  

SCBU

   $ 253.3      $ 155.2      $ 472.7      $ 288.3   

Keurig

     284.0        166.8        629.1        378.8   

CBU

     110.4        —          120.0        —     

Corporate

     —          —          —          —     
                                

Total Company

   $ 647.7      $ 322.0      $ 1,221.8      $ 667.1   
                                
     Income before taxes (in millions)     Income before taxes (in millions)  
     Thirteen
weeks ended
March 26,
2011
    Thirteen
weeks ended
March 27,
2010
    Twenty-six
weeks ended
March 26,
2011
    Twenty-six
weeks ended
March 27,
2010
 
           (As Restated)           (As Restated)  

SCBU

   $ 82.9      $ 31.5      $ 142.6      $ 59.1   

Keurig

     53.9        21.1        51.9        27.0   

CBU

     3.5        —          2.4        —     

Corporate

     (21.6     (10.9     (57.6     (22.0

Inter-company eliminations

     (16.6     (2.5     (24.6     (7.1
                                

Total Company

   $ 102.1      $ 39.2      $ 114.7      $ 57.0   
                                

Thirteen weeks ended March 26, 2011 versus thirteen weeks ended March 27, 2010

Revenue

Company Summary

Net sales for the second quarter of fiscal 2011 increased 101% to $647.7 million, up from $322.0 million reported in the second quarter of fiscal 2010 (“the prior year period”). Included in these results are the net sales from the Van Houtte acquisition, which contributed approximately $100.5 million to net sales, after eliminating the effect on consolidated net sales of K-Cup® portion pack sales to Keurig by Van Houtte and royalties recorded by Keurig from Van Houtte. The primary drivers of the increase in the Company’s net sales were the 94%, or $199.1 million, increase in total K-Cup® portion pack net sales, which includes Van Houtte, and the 86%, or $53.8 million, increase in Keurig® Single-Cup Brewer and accessories sales. Approximately 82% of net sales this past quarter were from the Keurig Single-Cup Brewing system and its recurring K-Cup® portion pack revenue with total K-Cup® portion pack net sales of $411.8 million and total Keurig brewer and accessory net sales of $116.2 million.

In September 2010, the Company announced a price increase on all K-Cup® portion packs effective October 11, 2010. In the second quarter of fiscal 2011, the price increase improved net sales by approximately 10.3% over what net sales would have been if calculated based on the pricing for K-Cup® portion packs in effect during the prior year period.

SCBU

SCBU segment net sales increased by $98.1 million or 63%, to $253.3 million in the second quarter of fiscal 2011 as compared to $155.2 million in the prior year period with the primary driver being the continued growth in K-Cup® net sales.

Keurig

Keurig segment net sales increased by $117.2 million, or 70%, to $284.0 million in the second quarter of fiscal 2011 as compared to $166.8 million reported in the prior year period. The

 

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increase in Keurig segment net sales was due to a 87%, or $51.1 million, increase in single-cup brewer and accessories sales and a 70%, or $71.0 million, increase in K-Cup® sales to retailers and consumers.

CBU

The Van Houtte acquisition was completed on December 17, 2010 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. For the thirteen weeks ended March 26, 2011, CBU segment net sales were $110.4 million.

Gross Profit

Company gross profit for the second quarter of fiscal 2011 totaled $242.9 million, or 37.5% of net sales, as compared to $107.9 million, or 33.5% of net sales, in the prior year period. The improvement in gross margin is attributed to the net effect of the price increase implemented during the first quarter of fiscal 2011 on all K-Cup portion packs, which was partially offset by continually rising green coffee costs occurring during fiscal 2011. In addition, warranty expense and sales returns as a percentage of consolidated net sales for the second quarter of fiscal 2011, was lower than the prior year period as the prior year period incurred higher levels of warranty expense and sales returns related to a quality issue associated with certain brewer models produced primarily in late calendar 2009.

Selling, General and Administrative Expenses

Company selling, general and administrative expenses (“S,G&A”) increased 82% to $123.2 million in the second quarter of fiscal 2011 from $67.7 million in the prior-year period. The increase was primarily attributed to SG&A incurred in the CBU segment, as a result of the Van Houtte acquisition. As a percentage of sales, S,G&A improved to 19% in the second quarter of fiscal 2011 from 21.0% in the prior year period. Second quarter 2011 general and administrative expenses included approximately $1.9 million of transaction-related expenses for the Van Houtte acquisition, $0.4 million of legal and accounting expenses associated with the SEC inquiry and pending litigation, as well as $11.7 million in amortization of identifiable intangibles related to the Company’s acquisitions, as compared to $4.8 million of transaction-related expenses for the Diedrich acquisition and $3.1 million of amortization of identifiable intangibles in the prior year period.

Gain (Loss) on Financial Instruments

The Company incurred $6.0 million in net losses on financial instruments not designated as hedges for accounting purposes during the second quarter of fiscal 2011. The net loss was primarily due to a $5.2 million fair value adjustment of our cross currency swap, which hedges the risk in currency movements on an intercompany note receivable denominated in Canadian currency.

Foreign Currency Exchange Gain (Loss), Net

The Company has certain assets and liabilities that are denominated in Canadian currency. During the second quarter of fiscal 2011 we incurred a net foreign currency gain of approximately $4.0 million primarily related to re-measurement of these assets and liabilities.

Interest Expense

Company interest expense was $16.7 million in the second quarter of fiscal 2011, as compared to $0.8 million in the prior year period due primarily to an increase in outstanding borrowings incurred in connection with the Van Houtte acquisition.

 

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Income Taxes

The effective income tax rate for the Company was 35.5% for the second quarter of fiscal 2011, as compared to the Company’s annual estimated tax rate of 38.4%. The difference was primarily due to earnings from our Canadian operations being taxed at a lower rate than earnings from our U.S. operations and the safe harbor deduction for 70% of success-based acquisition fees we paid in the Van Houtte acquisition, which resulted in approximately $2.2 million of income tax benefit.

Net Income, Non-GAAP Net Income and Diluted Earnings Per Share (“EPS”)

Company net income in the second quarter of fiscal 2011 increased 172% to $65.4 million, as compared to $24.1 million in the prior year period. Non-GAAP net income for the thirteen weeks ended March 26, 2011, when excluding transaction-related expenses, amortization of identifiable intangibles related to the Company’s acquisitions and legal and accounting expenses related to the SEC inquiry and pending litigation in the quarter, increased 147% to $71.5 million from $29.0 million non-GAAP net income in the prior year period which excludes transaction-related expenses for the Diedrich acquisition and amortization of identifiable intangibles related to the Company’s acquisitions.

Company diluted EPS was $0.44 in the second quarter of fiscal 2011, as compared to $0.17 per share in the prior year period. Non-GAAP diluted EPS was $0.48 in the second quarter of fiscal 2011, as compared to $0.21 per share in the prior year period.

 

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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 March 26, 2011 and March 27, 2010 (in thousands):

 

     Thirteen weeks
ended
March 26, 2011
    Thirteen weeks
ended
March 27, 2010
 

Net income

   $ 65,372      $ 24,055   

After tax:

    

Acquisition-related expenses (1)

     (1,858     2,886   

SEC inquiry (2)

     249        —     

Amortization of identifiable intangibles (3)

     7,763        1,998   
                

Non-GAAP net income

   $ 71,526      $ 28,939   
                

Diluted income per share

   $ 0.44      $ 0.17   

After tax:

    

Acquisition-related expenses (1)

   $ (0.01   $ 0.02   

SEC inquiry (2)

   $ 0.00      $ —     

Amortization of identifiable intangibles (3)

   $ 0.05      $ 0.01   
                

Non-GAAP net income per share

   $ 0.48      $ 0.21
                

 

* Does not add due to rounding.
(1) Represents direct acquisition-related expenses of $1.9 million ($1.2 million after-tax) and $4.8 million ($2.9 million after-tax) for the second quarter of fiscal 2011 and fiscal 2010, respectively. In the second quarter of fiscal 2011, the Company recognized a tax benefit of $3.0 million related to the reversal of certain nondeductible acquisition-related expenses incurred during the Company’s fourth quarter of fiscal 2010 and the first quarter of fiscal 2011 that are now deemed deductible in accordance with recently enacted tax regulations. This tax benefit was reversed for purposes of this non-GAAP table.
(2) Represents legal and accounting expenses, net of tax, related to the SEC inquiry and pending litigation classified as general and administrative.
(3) Represents the amortization of intangibles, net of tax, related to the Company’s acquisitions classified as general and administrative expense.

 

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Twenty-six weeks ended March 26, 2011 versus twenty-six weeks ended March 27, 2010

Revenue

Company Summary

Net sales for the twenty-six weeks ended March 26, 2011 increased 83% to $1.2 billion, up from $667.1 million reported for the twenty-six weeks ended March 27, 2010 (“the prior YTD period”). Included in these results are the net sales from the Van Houtte acquisiti