Keurig Green Mountain, Inc.
KEURIG GREEN MOUNTAIN, INC. (Form: 10-Q, Received: 02/04/2015 16:16:30)

Table of Contents

 

 

 

FORM 10-Q

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(Mark One)

 

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

 

For the thirteen weeks ended December 27, 2014

 

OR

 

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

 

For the transition period from                      to             

 

Keurig Green Mountain, Inc.

 

 

Commission file number 1-12340

 

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  o

 

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  o

 

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 o

 

 

 

Non-accelerated filer o

 

Smaller Reporting Company o

 

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

 

As of January 29, 2015, 161,675,100 shares of common stock of the registrant were outstanding.

 

 

 



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Form 10-Q

For the Thirteen Weeks Ended December 27, 2014

 

Table of Contents

 

 

 

Page

PART I. FINANCIAL INFORMATION

1

Item 1.

Financial Statements

1

 

Unaudited Consolidated Balance Sheets

2

 

Unaudited Consolidated Statements of Operations

3

 

Unaudited Consolidated Statements of Comprehensive Income

4

 

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

5

 

Unaudited Consolidated Statements of Cash Flows

6

 

Notes to Unaudited Consolidated Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

27

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

43

Item 4.

Controls and Procedures

45

 

 

 

PART II. OTHER INFORMATION

46

Item 1.

Legal Proceedings

46

Item 1A.

Risk Factors

46

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

46

Item 6.

Exhibits

46

Signatures

 

47

 



Table of Contents

 

Part I.  Financial Information

Item 1.  Financial Statements

 

1



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Unaudited Consolidated Balance Sheets

(Dollars in thousands, except per share data)

 

 

 

December 27,
2014

 

September 27,
2014

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

506,359

 

$

761,214

 

Restricted cash and cash equivalents

 

30,177

 

378

 

Short-term investment

 

100,000

 

100,000

 

Receivables, less uncollectible accounts and return allowances of $76,265 and $66,120 at December 27, 2014 and September 27, 2014, respectively

 

643,029

 

621,451

 

Inventories

 

780,794

 

835,167

 

Income taxes receivable

 

42,780

 

 

Other current assets

 

75,290

 

69,272

 

Deferred income taxes, net

 

52,388

 

58,038

 

Total current assets

 

2,230,817

 

2,445,520

 

 

 

 

 

 

 

Fixed assets, net

 

1,222,569

 

1,171,425

 

Intangibles, net

 

344,856

 

365,444

 

Goodwill

 

957,771

 

755,895

 

Deferred income taxes, net

 

129

 

131

 

Other long-term assets

 

19,723

 

58,892

 

 

 

 

 

 

 

Total assets

 

$

4,775,865

 

$

4,797,307

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt

 

$

20,624

 

$

19,077

 

Current portion of capital lease and financing obligations

 

2,916

 

2,226

 

Accounts payable

 

396,667

 

411,107

 

Accrued expenses

 

326,337

 

305,677

 

Income tax payable

 

 

53,586

 

Dividend payable

 

46,594

 

40,580

 

Deferred income taxes, net

 

362

 

340

 

Other current liabilities

 

11,938

 

10,395

 

Total current liabilities

 

805,438

 

842,988

 

 

 

 

 

 

 

Long-term debt, less current portion

 

134,637

 

140,937

 

Capital lease and financing obligations, less current portion

 

116,440

 

116,240

 

Deferred income taxes, net

 

193,312

 

202,936

 

Other long-term liabilities

 

52,828

 

23,085

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

11,666

 

12,440

 

 

 

 

 

 

 

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 - 500,000,000 shares; Issued and outstanding - 162,066,179 and 162,318,246 shares at December 27, 2014 and September 27, 2014, respectively

 

16,207

 

16,232

 

Additional paid-in capital

 

1,753,913

 

1,808,881

 

Retained earnings

 

1,775,832

 

1,687,619

 

Accumulated other comprehensive loss

 

(84,408

)

(54,051

)

Total stockholders’ equity

 

3,461,544

 

3,458,681

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

4,775,865

 

$

4,797,307

 

 

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

 

2



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Unaudited Consolidated Statements of Operations

(Dollars in thousands, except per share data)

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Net sales

 

$

1,386,358

 

$

1,386,670

 

Cost of sales

 

922,236

 

922,623

 

Gross profit

 

464,122

 

464,047

 

 

 

 

 

 

 

Selling and operating expenses

 

176,522

 

168,215

 

General and administrative expenses

 

71,673

 

69,206

 

Operating income

 

215,927

 

226,626

 

 

 

 

 

 

 

Other income, net

 

181

 

429

 

Gain on financial instruments, net

 

3,345

 

4,561

 

Loss on foreign currency, net

 

(9,071

)

(10,550

)

Interest expense

 

(1,087

)

(2,620

)

Income before income taxes

 

209,295

 

218,446

 

 

 

 

 

 

 

Income tax expense

 

(74,616

)

(79,971

)

Net income

 

$

134,679

 

$

138,475

 

 

 

 

 

 

 

Net income attributable to noncontrolling interests

 

100

 

248

 

 

 

 

 

 

 

Net income attributable to Keurig

 

$

134,579

 

$

138,227

 

 

 

 

 

 

 

Net income attributable to Keurig per common share:

 

 

 

 

 

Basic

 

$

0.83

 

$

0.93

 

Diluted

 

$

0.82

 

$

0.91

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.2875

 

$

0.25

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

Basic

 

162,181,332

 

149,162,600

 

Diluted

 

164,075,038

 

151,581,897

 

 

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

 

3



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Unaudited Consolidated Statements of Comprehensive Income

(Dollars in thousands)

 

 

 

Thirteen weeks ended

 

Thirteen weeks ended

 

 

 

December 27, 2014

 

December 28, 2013

 

 

 

Pre-tax

 

Tax (expense)
benefit

 

After-tax

 

Pre-tax

 

Tax (expense)
benefit

 

After-tax

 

Net income

 

 

 

 

 

$

134,679

 

 

 

 

 

$

138,475

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized losses arising during the period

 

$

(406

)

$

174

 

$

(232

)

$

(631

)

$

280

 

$

(351

)

(Gains) losses reclassified to net income

 

(565

)

236

 

(329

)

275

 

(102

)

173

 

Foreign currency translation adjustments

 

(30,299

)

 

(30,299

)

(25,496

)

 

(25,496

)

Other comprehensive loss

 

$

(31,270

)

$

410

 

$

(30,860

)

$

(25,852

)

$

178

 

$

(25,674

)

Total comprehensive income

 

 

 

 

 

103,819

 

 

 

 

 

112,801

 

Total comprehensive loss attributable to noncontrolling interests

 

 

 

 

 

(404

)

 

 

 

 

(358

)

Total comprehensive income attributable to Keurig

 

 

 

 

 

$

104,223

 

 

 

 

 

$

113,159

 

 

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

 

4



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For the Thirteen Weeks Ended December 27, 2014

(Dollars in thousands)

 

 

 

Common stock

 

Additional paid-

 

Retained

 

Accumulated
other
comprehensive

 

Stockholders’

 

 

 

Shares

 

Amount

 

in capital

 

earnings

 

loss

 

equity

 

Balance at September 27, 2014

 

162,318,246

 

$

16,232

 

$

1,808,881

 

$

1,687,619

 

$

(54,051

)

$

3,458,681

 

Options exercised

 

179,269

 

18

 

3,152

 

 

 

3,170

 

Restricted stock awards and units

 

154,372

 

15

 

(15

)

 

 

 

Repurchase of common stock

 

(585,708

)

(58

)

(80,840

)

 

 

(80,898

)

Stock compensation expense

 

 

 

10,391

 

 

 

10,391

 

Tax benefit from equity-based compensation plans

 

 

 

12,328

 

 

 

12,328

 

Deferred compensation expense

 

 

 

16

 

 

 

16

 

Adjustment of redeemable noncontrolling interests to redemption value

 

 

 

 

228

 

 

228

 

Other comprehensive loss, net of tax

 

 

 

 

 

(30,357

)

(30,357

)

Net income attributable to Keurig

 

 

 

 

134,579

 

 

134,579

 

Cash dividends declared

 

 

 

 

(46,594

)

 

(46,594

)

Balance at December 27, 2014

 

162,066,179

 

$

16,207

 

$

1,753,913

 

$

1,775,832

 

$

(84,408

)

$

3,461,544

 

 

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

 

5



Table of Contents

 

KEURIG GREEN MOUNTAIN, INC.

Unaudited Consolidated Statements of Cash Flows

(Dollars in thousands)

 

 

 

Thirteen

 

Thirteen

 

 

 

weeks ended

 

weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

134,679

 

$

138,475

 

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

 

 

 

 

 

Depreciation and amortization of fixed assets

 

51,049

 

47,996

 

Amortization of intangibles

 

10,110

 

11,152

 

Amortization of deferred financing fees

 

1,413

 

1,413

 

Unrealized loss on foreign currency, net

 

8,981

 

11,932

 

Loss (gain) on disposal of fixed assets

 

217

 

(983

)

Provision for doubtful accounts

 

2,479

 

862

 

Provision for sales returns

 

42,856

 

38,237

 

Gain on derivatives, net

 

(3,462

)

(6,830

)

Excess tax benefits from equity-based compensation plans

 

(12,324

)

(4,509

)

Deferred income taxes

 

3

 

(33

)

Deferred compensation and stock compensation

 

10,407

 

7,087

 

Other

 

617

 

(225

)

Changes in assets and liabilities:

 

 

 

 

 

Receivables

 

(69,245

)

(99,310

)

Inventories

 

51,001

 

205,602

 

Income tax receivable/payable, net

 

(84,205

)

1,185

 

Other current assets

 

(3,654

)

(3,443

)

Other long-term assets, net

 

1,297

 

(86

)

Accounts payable and accrued expenses

 

(3,912

)

(71,430

)

Other current liabilities

 

(24,498

)

(5,094

)

Other long-term liabilities

 

28,599

 

678

 

Net cash provided by operating activities

 

142,408

 

272,676

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Change in restricted cash

 

(158

)

(537

)

Acquisition, net of cash acquired

 

(180,698

)

 

Capital expenditures for fixed assets

 

(100,303

)

(60,822

)

Other investing activities

 

(1,273

)

770

 

Net cash used in investing activities

 

(282,432

)

(60,589

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock under compensation plans

 

3,170

 

1,683

 

Repurchase of common stock

 

(80,898

)

(122,464

)

Excess tax benefits from equity-based compensation plans

 

12,324

 

4,509

 

Payments on capital lease and financing obligations

 

(853

)

(462

)

Repayment of long-term debt

 

(4,690

)

(3,154

)

Dividends paid

 

(40,580

)

 

Other financing activities

 

(140

)

26

 

Net cash used in financing activities

 

(111,667

)

(119,862

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(3,164

)

(3,652

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(254,855

)

88,573

 

Cash and cash equivalents at beginning of period

 

761,214

 

260,092

 

Cash and cash equivalents at end of period

 

$

506,359

 

$

348,665

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

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

 

$

68,292

 

$

21,112

 

Dividends declared not paid at the end of each period

 

$

46,594

 

$

37,188

 

Noncash investing and financing activities:

 

 

 

 

 

Fixed assets acquired under capital lease and financing obligations

 

$

375

 

$

12,148

 

 

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

 

6



Table of Contents

 

Keurig Green Mountain, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1.               Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) 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 GAAP for complete consolidated financial statements.

 

The September 27, 2014 balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.  For further information, refer to the consolidated financial statements and the footnotes included in Keurig Green Mountain’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014.  Throughout this presentation, we refer to the consolidated company as the “Company” or “Keurig” and, unless otherwise noted, the information provided is on a consolidated basis.

 

In the opinion of management, all adjustments considered necessary for a fair statement of the interim financial data have been included.  Interim results may not be indicative of results for a full year.  Historically, in addition to variations resulting from the holiday season, sales may vary from quarter-to-quarter due to a variety of other factors including, but not limited to, the cost of green coffee, competitor initiatives, marketing programs and weather.

 

2.               Segment Reporting

 

Segment information is prepared on the same basis that our CEO, who is our chief operating decision maker, manages the business, evaluates financial results, and makes key operating decisions.  The structure includes a Domestic segment containing all U.S. Operations and immaterial operations related to international expansion, and a Canada segment containing all Canadian operations.

 

The Domestic segment sells brewers, accessories, and sources, produces and sells coffee, hot cocoa, teas and other beverages in K-Cup ® , Vue ® , Rivo ® , K-Carafe  and Bolt  packs (“portion packs”) and coffee in more traditional packaging including bags and fractional packs to retailers including supermarkets, department stores, mass merchandisers, club stores, and convenience stores; to restaurants, hospitality accounts, office coffee distributors, and partner brand owners; and to consumers through the Company’s website.  Substantially all of the Domestic segment’s distribution to major retailers is processed by fulfillment entities which receive and fulfill sales orders and invoice certain retailers primarily in the At Home (“AH”) channel.  The Domestic segment also earns royalty income from portion packs sold by a third-party licensed roaster.

 

The Canada segment sells brewers, accessories, and sources, produces and sells coffee and teas and other beverages in portion packs and coffee in more traditional packaging including bags, cans and fractional packs under a variety of brands to retailers including supermarkets, department stores, mass merchandisers, club stores, through office coffee services to offices, convenience stores, restaurants, hospitality accounts, and to consumers through its website.

 

Management evaluates the performance of the Company’s operating segments based on several factors, including net sales to external customers and operating income.  Net sales are recorded on a segment basis and intersegment sales are eliminated as part of the financial consolidation process.  Operating income represents gross profit less selling, operating, general and administrative expenses.  The Company’s manufacturing operations occur within both the Domestic and Canada segments, and the costs of manufacturing are recognized in cost of sales in the operating segment in which the sale occurs.  Information system technology services are mainly centralized while finance and accounting functions are primarily decentralized.  Expenses consisting primarily of compensation and depreciation related to certain centralized administrative functions, including information system technology, are allocated to the operating segments.

 

7



Table of Contents

 

Expenses not specifically related to an operating segment are presented under “Corporate Unallocated.”  Corporate Unallocated expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to the entire enterprise.  Corporate Unallocated expenses also include depreciation for corporate headquarters, corporate sustainability expenses, interest expense not directly attributable to an operating segment, the majority of foreign exchange gains or losses, legal expenses, and compensation of the Board of Directors.

 

The following tables summarize selected financial data for segment disclosures for the thirteen weeks ended December 27, 2014 and December 28, 2013:

 

 

 

Thirteen weeks ended December 27, 2014

 

 

 

(Dollars in thousands)

 

 

 

Domestic

 

Canada

 

Corporate-
Unallocated

 

Consolidated

 

Net sales

 

$

1,215,458

 

$

170,900

 

$

 

$

1,386,358

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

236,601

 

$

21,588

 

$

(42,262

)

$

215,927

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

$

44,586

 

$

13,859

 

$

2,714

 

$

61,159

 

 

 

 

 

 

 

 

 

 

 

Stock compensation

 

$

5,831

 

$

723

 

$

3,837

 

$

10,391

 

 

 

 

Thirteen weeks ended December 28, 2013

 

 

 

(Dollars in thousands)

 

 

 

Domestic

 

Canada

 

Corporate-
Unallocated

 

Consolidated

 

Net sales

 

$

1,191,866

 

$

194,804

 

$

 

$

1,386,670

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

$

232,800

 

$

31,973

 

$

(38,147

)

$

226,626

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

$

40,126

 

$

16,688

 

$

2,334

 

$

59,148

 

 

 

 

 

 

 

 

 

 

 

Stock compensation

 

$

3,706

 

$

1,030

 

$

2,346

 

$

7,082

 

 

The following table reconciles operating segments and corporate-unallocated operating income (loss) to consolidated income before income taxes, as presented in the Unaudited Consolidated Statements of Operations (in thousands):

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Operating income

 

$

215,927

 

$

226,626

 

Other income, net

 

181

 

429

 

Gain on financial instruments, net

 

3,345

 

4,561

 

Loss on foreign currency, net

 

(9,071

)

(10,550

)

Interest expense

 

(1,087

)

(2,620

)

Income before income taxes

 

$

209,295

 

$

218,446

 

 

8



Table of Contents

 

3.               Inventories

 

Inventories consisted of the following (in thousands) as of:

 

 

 

December 27,
2014

 

September 27,
2014

 

Raw materials and supplies

 

$

202,504

 

$

169,858

 

Finished goods

 

578,290

 

665,309

 

 

 

$

780,794

 

$

835,167

 

 

At December 27, 2014, the Company had approximately $375.1 million in green coffee purchase commitments, of which approximately 87% had a fixed price.  These commitments primarily extend through fiscal 2016.  The value of the variable portion of these commitments was calculated using an average “C” price of coffee of $1.75 per pound at December 27, 2014.  In addition to its green coffee commitments, the Company had approximately $103.8 million in fixed price brewer and related accessory purchase commitments and $1,129.0 million in production raw material commitments at December 27, 2014.  The Company believes, based on relationships established with its suppliers, that the risk of non-delivery on such purchase commitments is remote.

 

As of December 27, 2014, minimum future inventory purchase commitments were as follows (in thousands):

 

Fiscal Year

 

Inventory
Purchase
Obligations(1)

 

Remainder of 2015

 

$

612,262

 

2016

 

269,691

 

2017

 

262,952

 

2018

 

277,095

 

2019

 

120,123

 

Thereafter

 

65,762

 

 

 

$

1,607,885

 

 


(1)          Certain purchase obligations are determined based on a contractual percentage of forecasted volumes.

 

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4.               Acquisition

 

On December 18, 2014, the Company, through its wholly owned subsidiary Keurig International S.à.r.l., acquired all of the outstanding equity of MDS Global Holding p.l.c. (“Bevyz”), a manufacturer and distributor of an all-in-one drink system, for total cash consideration of $180.7 million, net of cash acquired.  The Company will utilize Bevyz’s complementary and unique technology and research and development capabilities in its own beverage platforms and products.

 

Prior to the acquisition, the Company owned approximately 15% of the outstanding equity of Bevyz.  As of December 27, 2014, the Company had not completed its valuation of fair value of the business acquired and the acquisition date fair value of the Company’s previously held equity interest in Bevyz.  As a result, for the fiscal quarter ended December 27, 2014, no gain or loss was recognized on the Company’s previously held equity interest.  No amounts were allocated to identifiable intangible assets or favorable or unfavorable contracts for purposes of the preliminary allocation.  The Company currently anticipates finalizing its valuation and the allocation of the purchase price, along with required retrospective adjustments, if any, in the second quarter of fiscal 2015.

 

The following summarizes the preliminary allocation as recorded as of December 27, 2014 (in thousands):

 

Accounts receivable

 

$

218

 

Inventories

 

743

 

Other current assets

 

504

 

Fixed assets

 

2,370

 

Other long-term assets

 

247

 

Goodwill

 

220,468

 

Accounts payable and accrued expenses

 

(5,911

)

Capital lease obligation

 

(763

)

Other long-term liabilities

 

(1,273

)

Total estimated fair value net assets acquired

 

216,603

 

Less previously held equity interest in Bevyz

 

(35,905

)

Total cash paid, net of cash acquired

 

$

180,698

 

 

Acquisition costs of $1.5 million were expensed as incurred and recognized in general and administrative expenses in the accompanying Unaudited Consolidated Statements of Operations.  Approximately $28.8 million of the purchase price was held in escrow at December 27, 2014 and is included in restricted cash and other long-term liabilities.  The revenue and earnings of Bevyz since acquisition and the proforma financial statements are immaterial.  For information on the assignment of goodwill to our operating segments, see Note 6, Goodwill and Intangible Assets .

 

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5.               Fixed Assets

 

Fixed assets consisted of the following (in thousands) as of:

 

 

 

Useful Life in Years

 

December 27,
2014

 

September 27,
2014

 

Production equipment

 

1-15

 

$

787,530

 

$

779,850

 

Coffee service equipment

 

3-7

 

59,508

 

61,029

 

Computer equipment and software

 

1-10

 

244,980

 

177,878

 

Land

 

Indefinite

 

12,576

 

12,767

 

Building and building improvements

 

4-30

 

248,908

 

238,945

 

Furniture and fixtures

 

1-15

 

37,863

 

36,899

 

Vehicles

 

4-5

 

12,467

 

13,032

 

Leasehold improvements

 

1-20 or remaining life of lease, whichever is less

 

96,752

 

95,373

 

Assets acquired under capital leases

 

5-15

 

42,073

 

41,200

 

Construction-in-progress

 

 

 

315,744

 

308,976

 

Total fixed assets

 

 

 

$

1,858,401

 

$

1,765,949

 

Accumulated depreciation and amortization

 

 

 

(635,832

)

(594,524

)

 

 

 

 

$

1,222,569

 

$

1,171,425

 

 

Assets acquired under capital leases, net of accumulated amortization, were $34.3 million and $34.1 million at December 27, 2014 and September 27, 2014, respectively.

 

Total depreciation and amortization expense relating to all fixed assets was $51.0 million and $48.0 million for the thirteen weeks ended December 27, 2014 and December 28, 2013, respectively.

 

6.               Goodwill and Intangible Assets

 

The following represented the change in the carrying amount of goodwill by segment for the thirteen weeks ended December 27, 2014 (in thousands):

 

 

 

Domestic

 

Canada

 

Total

 

Balance at September 27, 2014

 

$

369,353

 

$

386,542

 

$

755,895

 

Foreign currency effect

 

(2,894

)

(15,698

)

(18,592

)

Acquisition of Bevyz (see Note 4, Acquisition )

 

220,468

 

 

220,468

 

Balance at December 27, 2014

 

$

586,927

 

$

370,844

 

$

957,771

 

 

Indefinite-lived intangible assets included in the Canada segment consisted of the following (in thousands) as of:

 

 

 

December 27, 2014

 

September 27, 2014

 

Trade names

 

$

86,592

 

$

90,257

 

 

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Intangible Assets Subject to Amortization

 

Definite-lived intangible assets included in the Domestic segment and Canada segment consisted of the following (in thousands) as of:

 

 

 

 

 

December 27, 2014

 

September 27, 2014

 

 

 

Useful Life in
Years

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Acquired technology

 

4-10

 

$

16,490

 

$

(14,122

)

$

16,501

 

$

(13,713

)

Customer and roaster agreements

 

8-11

 

8,717

 

(5,410

)

8,939

 

(5,303

)

Customer relationships

 

2-16

 

378,502

 

(145,427

)

390,563

 

(141,163

)

Trade names

 

9-11

 

36,679

 

(17,165

)

35,911

 

(16,548

)

Total

 

 

 

$

440,388

 

$

(182,124

)

$

451,914

 

$

(176,727

)

 

Definite-lived intangible assets are amortized on a straight-line basis over the period of expected economic benefit.  Total amortization expense was $10.1 million and $11.2 million for the thirteen weeks ended December 27, 2014 and December 28, 2013, respectively.

 

The estimated aggregate amortization expense for the remainder of fiscal 2015, for each of the next five years and thereafter, is as follows (in thousands):

 

Fiscal Year

 

Amortization Expense

 

Remainder of 2015

 

$

29,716

 

2016

 

38,898

 

2017

 

37,502

 

2018

 

37,502

 

2019

 

37,402

 

2020

 

33,299

 

Thereafter

 

43,945

 

 

7.               Product Warranties

 

The Company offers a one-year warranty on all Keurig ®  hot beverage system brewers it sells.  The Company provides for the estimated cost of product warranties, primarily using historical information and repair or replacement costs, at the time product revenue is recognized.  Brewer failures may arise in the later part of the warranty period, and actual warranty costs may exceed the reserve.  As the Company has grown, it has added significantly to its product testing, quality control infrastructure and overall quality processes.  Nevertheless, as the Company continues to innovate, and its products become more complex, both in design and componentry, product performance may modulate, causing warranty rates to possibly fluctuate going forward.  As a result, future warranty claims rates may be higher or lower than the Company is currently experiencing and for which the Company is currently providing in its warranty reserve.

 

The changes in the carrying amount of product warranties for the thirteen weeks ended December 27, 2014 and December 28, 2013 are as follows (in thousands):

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Balance, beginning of period

 

$

12,850

 

$

7,804

 

Provision related to current period

 

14,166

 

10,230

 

Change in estimate

 

 

(58

)

Usage

 

(7,336

)

(5,185

)

Balance, end of period

 

$

19,680

 

$

12,791

 

 

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Table of Contents

 

For the thirteen weeks ended December 27, 2014 and December 28, 2013, the Company recorded recoveries of $0.2 million and $0.5 million, respectively.  The recoveries are under agreements with suppliers and are recorded as a reduction of warranty expense.  The recoveries are not reflected in the provision charged to income in the table above.

 

8.               Noncontrolling Interests

 

Noncontrolling interests (“NCI”) are evaluated by the Company and are shown as either a liability, temporary equity (shown between liabilities and equity) or as permanent equity depending on the nature of the redeemable features at amounts based on formulas specific to each entity.  Generally, mandatorily redeemable NCIs are classified as liabilities and non-mandatorily redeemable NCIs are classified as either temporary or permanent equity.  Redeemable NCIs that are not mandatorily redeemable are classified outside of stockholders’ equity in the Unaudited Consolidated Balance Sheets as temporary equity under the caption, Redeemable noncontrolling interests, and are measured at their redemption values 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 NCI at its redemption value.

 

Net income attributable to NCIs reflects the portion of the net income of consolidated entities applicable to the NCI shareholders in the accompanying Unaudited Consolidated Statements of Operations.  The net income attributable to NCIs is classified in the Unaudited Consolidated Statements of Operations as part of consolidated net income and deducted from total consolidated net income to arrive at the net income attributable to the Company.

 

If a change in ownership of a 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.

 

The changes in the temporary equity attributable to the redeemable NCI for the thirteen weeks ended December 27, 2014 are as follows (in thousands):

 

 

 

Equity attributable
to redeemable
noncontrolling interest

 

Balance at September 27, 2014

 

$

12,440

 

Net income

 

100

 

Adjustment to redemption value

 

(228

)

Cash distributions

 

(141

)

Other comprehensive loss

 

(505

)

Balance at December 27, 2014

 

$

11,666

 

 

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Table of Contents

 

9.               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, commodity price risk and foreign currency exchange rate risk.  The Company uses interest rate swaps to mitigate interest rate risk associated with the Company’s variable-rate borrowings, 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, and uses foreign currency forward contracts to hedge the purchase and payment of green coffee purchase commitments denominated in non-functional currencies.

 

The Company designates these contracts as cash flow hedges and measures the effectiveness of these derivative instruments at each balance sheet date.  The effective portion of the derivatives’ gains or losses, resulting from changes in the fair value of these instruments is classified in accumulated other comprehensive income (loss), net of related tax effects and is reclassified from other comprehensive income (“OCI”) into earnings in the same period or periods during which the hedged transaction affects earnings.  Any ineffective portion of the derivatives’ gains or losses is recognized in earnings in the period such ineffectiveness occurs.  If it is determined that a derivative is not highly effective, the gain or loss is reclassified into earnings.

 

Fair Value Hedges

 

The Company occasionally enters into foreign currency forward contracts to hedge certain recognized liabilities in currencies other than the Company’s functional currency.  The Company designates these contracts as fair value hedges and measures the effectiveness of these derivative instruments at each balance sheet date.  The changes in the fair value of these instruments along with the changes in the fair value of the hedged liabilities are recognized in net gains or losses on foreign currency on the Unaudited Consolidated Statements of Operations.

 

Other Derivatives

 

The Company is also exposed to certain foreign currency and interest rate risks on an intercompany note with a foreign subsidiary denominated in Canadian currency.  At December 27, 2014, the Company had approximately one year remaining on a CDN $90.0 million cross currency swap to exchange interest payments and principal on the intercompany note.  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 Unaudited Consolidated Statements of Operations.  Gains and losses resulting from the change in fair value are largely offset by the financial impact of the re-measurement of the intercompany note.  In accordance with the cross currency swap agreement, on a quarterly basis, the Company pays interest based on the three month Canadian Bankers Acceptance rate and receives interest based on the three month U.S. Libor rate.  Additional interest expense pursuant to the cross currency swap agreement for the thirteen weeks ended December 27, 2014 and for the thirteen weeks ended December 28, 2013 was $0.3 million and $0.4 million, respectively.

 

The Company occasionally enters into foreign currency forward contracts and coffee futures contracts that qualify as derivatives, and are not designated as hedging instruments for accounting purposes in addition to the foreign currency forward contracts and coffee futures contracts noted above.  Contracts that are not designated as hedging instruments are recorded at fair value with the changes in fair value recognized in the Unaudited 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.

 

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Table of Contents

 

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

 

 

 

December 27, 2014

 

September 27, 2014

 

Balance Sheet Classification

 

Derivatives designated as cash flow hedges:

 

 

 

 

 

 

 

Interest rate swaps

 

$

(2,682

)

$

(3,371

)

Other current liabilities

 

Coffee futures

 

 

3,437

 

Other current assets

 

Coffee futures

 

(701

)

 

Other current liabilities

 

Foreign currency forward contracts

 

130

 

108

 

Other current assets

 

 

 

$

(3,253

)

$

174

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedges:

 

 

 

 

 

 

 

Cross currency swap

 

$

9,296

 

$

5,951

 

Other current assets

 

 

 

$

9,296

 

$

5,951

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

6,043

 

$

6,125

 

 

 

 

Offsetting

 

Generally, all of the Company’s derivative instruments are subject to a master netting arrangement under which either party may offset amounts if the payment amounts are for the same transaction and in the same currency.  By election, the parties may agree to net other transactions.  In addition, the arrangements provide for the net settlement of all contracts through a single payment in a single currency in the event of default or termination of the contract.  The Company’s policy is to net all derivative assets and liabilities in the accompanying Unaudited Consolidated Balance Sheets when allowable by U.S. GAAP.

 

Additionally, the Company has elected to include all derivative assets and liabilities, including those not subject to a master netting arrangement, in the following offsetting tables.

 

Offsetting of financial assets and derivative assets as of December 27, 2014 and September 27, 2014 is as follows (in thousands):

 

 

 

 

 

 

 

 

 

Gross amounts not offset in the

 

 

 

 

 

 

 

Gross amounts

 

Net amount of

 

Unaudited Consolidated Balance

 

 

 

 

 

Gross

 

offset in the

 

assets presented

 

Sheet

 

 

 

 

 

amounts of

 

Unaudited

 

in the Unaudited

 

 

 

Cash

 

 

 

 

 

recognized

 

Consolidated

 

Consolidated

 

Financial

 

collateral

 

 

 

 

 

assets

 

Balance Sheet

 

Balance Sheet

 

instruments

 

received

 

Net amount

 

Derivative assets, as of December 27, 2014

 

$

9,426

 

$

 

$

9,426

 

$

 

$

 

$

9,426

 

Derivative assets, as of September 27, 2014

 

9,830

 

(334

)

9,496

 

 

 

9,496

 

 

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Offsetting of financial liabilities and derivative liabilities as of December 27, 2014 and September 27, 2014 is as follows (in thousands):

 

 

 

 

 

 

 

Net amount of

 

Gross amounts not offset in the

 

 

 

 

 

 

 

Gross amounts

 

liabilities

 

Unaudited Consolidated

 

 

 

 

 

Gross

 

offset in the

 

presented in the

 

Balance Sheet

 

 

 

 

 

amounts of

 

Unaudited

 

Unaudited

 

 

 

Cash

 

 

 

 

 

recognized

 

Consolidated

 

Consolidated

 

Financial

 

collateral

 

 

 

 

 

liabilities

 

Balance Sheet

 

Balance Sheet

 

instruments

 

pledged

 

Net amount

 

Derivative liabilities, as of December 27, 2014

 

$

3,383

 

$

 

$

3,383

 

$

 

$

 

$

3,383

 

Derivative liabilities, as of September 27, 2014

 

3,705

 

(334

)

3,371

 

 

 

3,371

 

 

The following table summarizes the amount of unrealized gain (loss), gross of tax, arising during the period on financial instruments that qualify for hedge accounting included in OCI (in thousands):

 

 

 

Thirteen weeks ended

 

 

 

December 27, 2014

 

December 28, 2013

 

Cash Flow Hedges:

 

 

 

 

 

Interest rate swaps

 

$

689

 

$

574

 

Coffee futures

 

(1,172

)

(1,400

)

Foreign currency forward contracts

 

77

 

195

 

Total

 

$

(406

)

$

(631

)

 

The following table summarizes the amount of gains (losses), gross of tax, reclassified from OCI to income (in thousands):

 

 

 

Thirteen weeks ended

 

Location of Gains

 

 

 

December 27,
2014

 

December 28,
2013

 

(Losses) Reclassified
from OCI into Income

 

Coffee futures

 

$

624

 

$

(206

)

Cost of sales

 

Foreign currency forward contracts

 

(59

)

(44

)

Cost of sales

 

Foreign currency forward contracts

 

 

(25

)

Loss on foreign currency, net

 

Total

 

$

565

 

$

(275

)

 

 

 

The Company expects to reclassify $9.9 million of net gains, net of tax, from OCI to earnings for coffee derivatives within the next twelve months.

 

See Note 12, Stockholders’ Equity , for a reconciliation of derivatives in beginning accumulated other comprehensive income (loss) to derivatives in ending accumulated other comprehensive income (loss).

 

Net (losses) gains on financial instruments not designated as hedges for accounting purposes are as follows (in thousands):

 

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Table of Contents

 

 

 

Thirteen weeks ended

 

Location of net (loss) gain in

 

 

 

December 27,
 2014

 

December 28,
 2013

 

Unaudited Consolidated
Statements of Operations

 

Net gain on cross currency swap

 

$

3,345

 

$

4,561

 

Gain on financial instruments, net

 

Net gain on coffee futures

 

 

2,125

 

Cost of sales

 

Total

 

$

3,345

 

$

6,686

 

 

 

 

In addition, for the thirteen weeks ended December 27, 2014, the Company recognized $0.1 million in net losses as a cost of sale representing the ineffective portion on coffee futures designated as cash flow hedges.  No amounts were recognized for the thirteen weeks ended December 28, 2013 for ineffectiveness.

 

10.        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 (“FASB”) 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, which include quoted prices for similar assets or liabilities in active markets and quoted prices for identical assets or liabilities in markets that are not active.

 

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 summarizes the fair values and the levels used in fair value measurements as of December 27, 2014 for the Company’s financial assets (liabilities) (in thousands):

 

 

 

Fair Value Measurements Using

 

 

 

Level 1

 

Level 2

 

Level 3

 

Derivatives:

 

 

 

 

 

 

 

Interest rate swaps

 

$

 

$

(2,682

)

$

 

Cross currency swap

 

 

9,296

 

 

Coffee futures

 

 

(701

)

 

Foreign currency forward contracts

 

 

130

 

 

Total

 

$

 

$

6,043

 

$

 

 

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Table of Contents

 

The following table summarizes the fair values and the levels used in fair value measurements as of September 27, 2014 for the Company’s financial liabilities (in thousands):

 

 

 

Fair Value Measurements Using

 

 

 

Level 1

 

Level 2

 

Level 3

 

Derivatives:

 

 

 

 

 

 

 

Interest rate swaps

 

$

 

$

(3,371

)

$

 

Cross currency swap

 

 

5,951

 

 

Coffee futures

 

 

3,437

 

 

Forward currency forward contracts

 

 

108

 

 

Total

 

$

 

$

6,125

 

$

 

 

Derivatives

 

Level 2 derivative financial instruments use inputs that are based on market data of identical (or similar) instruments, including forward prices for commodities, interest rate 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 Unaudited Consolidated Statements of Operations for fair value hedges and derivatives that do not qualify for hedge accounting treatment.

 

Derivative financial instruments include coffee futures contracts, interest rate swap agreements, a cross currency swap agreement and foreign currency forward contracts.  The Company has identified significant concentrations of credit risk based on the economic characteristics of the instruments that include interest rates, commodity indexes and foreign currency rates and selectively enters into the derivative instruments with counterparties using credit ratings.

 

To determine fair value, the Company utilizes the market approach valuation technique for coffee futures and foreign currency forward contracts and the income approach for interest rate and cross currency swap agreements.  The Company’s fair value measurements include a credit valuation adjustment for the significant concentrations of credit risk.

 

As of December 27, 2014, the amount of loss estimated by the Company due to credit risk associated with the derivatives for all significant concentrations was not material based on the factors of an industry recovery rate and a calculated probability of default.

 

Long-Term Debt

 

The carrying value of long-term debt was $155.3 million and $160.0 million as of December 27, 2014 and September 27, 2014, respectively.  The inputs to the calculation of the fair value of long-term debt are considered to be Level 2 within the fair value hierarchy, as the measurement of fair value is based on the net present value of calculated interest and principal payments, using an interest rate derived from a fair market yield curve adjusted for the Company’s credit rating.  The carrying value of long-term debt approximates fair value as the interest rate on the debt is based on variable interest rates that reset every 30 days.

 

Long-Term Investment

 

The Company had a long-term investment of approximately $35.9 million included in other long-term assets in the accompanying Unaudited Consolidated Balance Sheet as of September 27, 2014, that was not publicly traded.  This investment was carried at cost and reviewed quarterly for indicators of other-than-temporary impairment.  During the first quarter of fiscal 2015, the Company acquired the remaining equity interests of this investment.  See Note 4, Acquisition.

 

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Table of Contents

 

11.        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 December 27, 2014, the Company had a $17.7 million state capital loss carryforward and a state net operating loss carryforward of $11.5 million available to be utilized against future taxable income for years through fiscal 2015 and 2029, respectively, subject to annual limitation pertaining to change in ownership rules under the Internal Revenue Code of 1986, as amended.  Based upon earnings history, the Company concluded that it is more likely than not that the net operating loss carryforward will be utilized prior to its expiration, but that 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.

 

As of each of the periods ending December 27, 2014 and September 27, 2014, the total amount of unrecognized tax benefits was $14.8 million.  The amount of unrecognized tax benefits at December 27, 2014 that would impact the effective tax rate if resolved in favor of the Company is $14.8 million.  As a result of prior acquisitions, the Company is indemnified for $7.2 million of the total reserve balance, and the indemnification is capped at $47.4 million.  If these unrecognized tax benefits are resolved in favor of the Company, the associated indemnification receivable, recorded in other long-term assets, would be reduced accordingly.  The indemnifications have expiration dates through June 2016.

 

As of December 27, 2014 and September 27, 2014, accrued interest and penalties of $2.3 million and $2.4 million, respectively, were included in the Unaudited Consolidated Balance Sheets.  The Company recognizes interest and penalties in income tax expense.  The Company released $1.0 million of unrecognized tax benefits in the current quarter of fiscal 2015 and expects to release an additional $7.8 million over the next twelve months due to the expiration of the statute of limitations.

 

In the normal course of business, the Company is subject to tax examinations by taxing authorities both inside and outside of the United States.  The Company is generally not subject to examination with respect to returns filed for fiscal years prior to 2010.

 

12.        Stockholders’ Equity

 

Stock Repurchase Program

 

At various times during fiscal 2012, 2013, and 2014, Keurig’s Board of Directors authorized the Company to repurchase a total of $2.5 billion of the Company’s common stock.

 

Under its existing repurchase programs, on February 28, 2014, the Company entered into an accelerated share repurchase (“ASR”) agreement with a major financial institution (“Bank”).  The ASR allows the Company to buy a large number of shares immediately at a purchase price determined by an average market price over a period of time.  Under the ASR, the Company agreed to purchase $700.0 million of its common stock, in total, with an initial delivery to the Company of 4,340,508 shares (“Initial Shares”) of the Company’s common stock by the Bank.  The Initial Shares represent the number of shares at the current market price equal to 70% of the total fixed purchase price of $700.0 million.  The repurchased shares were retired and returned to an unissued status.  The par value of the repurchased shares of $0.4 million was deducted from common stock and the excess repurchase price over the par value of $489.6 million was deducted from additional paid-in capital.  The remainder of the total purchase price of $210.0 million reflects the value of the stock held by the Bank pending final settlement and, accordingly, was recorded as a reduction to additional paid-in capital.  Final settlement of the ASR will occur no later than February 27, 2015 at the Bank’s discretion.  Upon settlement of the ASR, the total shares repurchased by the Company will be determined based on a share price equal to the daily volume weighted-average price (“VWAP”) of the Company’s common stock during the term of the ASR, less a fixed per share discount amount.  At settlement, the Bank will deliver additional shares to the Company in the event total shares are greater than the 4,340,508 shares initially delivered, and the Company will issue additional shares to the Bank in the event total shares are less than the shares initially delivered.  The receipt or issuance of additional shares will result in a reclassification between additional paid-in capital and common stock equal to the par value of the additional shares received or issued.  The number of shares that may be required to be issued by the Company to the Bank is limited to 10.0 million shares under the ASR.

 

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The Company reflected the unsettled portion of the ASR ($210.0 million) as a repurchase of common stock for purposes of calculating earnings per share and as a forward contract indexed to its own common stock.  The forward contract met all of the applicable criteria for equity classification, and, therefore, was not accounted for as a derivative instrument.

 

As of December 27, 2014, based on the VWAP of the Company’s common stock for the period February 28, 2014 through December 27, 2014, settlement of the ASR would have resulted in 1.5 million additional shares delivered by the Bank to the Company.

 

An aggregate amount of $1,101.9 million remained authorized for common stock repurchase as of December 27, 2014.

 

Summary of share repurchase activity:

 

 

 

Thirteen weeks ended

 

 

 

 

 

December 27, 2014

 

Fiscal 2014(1)

 

Number of shares acquired

 

585,708

 

8,138,592

 

Average price per share of acquired shares

 

$

138.12

 

$

103.51

 

Total cost of acquired shares (in thousands)

 

$

80,898

 

$

1,052,430

 

 


(1)Number of shares acquired and average price per share reflect Initial Shares at then current market price, subject to change pending final settlement, and total cost of acquired shares includes total purchase price of $700.0 million under the ASR.

 

Accumulated Other Comprehensive Income (Loss)

 

The following table provides the changes in the components of accumulated other comprehensive income (loss), net of tax (in thousands) for the thirteen weeks ended December 27, 2014:

 

 

 

Cash Flow Hedges

 

Translation

 

Accumulated Other
Comprehensive Income
(Loss)

 

Balance at September 27, 2014

 

$

8,952

 

$

(63,003

)

$

(54,051

)

Other comprehensive loss, before reclassifications

 

(232

)

(29,794

)

(30,026

)

Amounts reclassified from accumulated other comprehensive income (loss)

 

(329

)

 

(329

)

Foreign currency exchange impact on cash flow hedges

 

(2

)

 

(2

)

Net current period other comprehensive loss

 

(563

)

(29,794

)

(30,357

)

Balance at December 27, 2014

 

$

8,389

 

$

(92,797

)

$

(84,408

)

 

The unfavorable translation adjustment change during the thirteen weeks ended December 27, 2014 was primarily due to the weakening of the Canadian dollar against the U.S. dollar.  See also Note 9, Derivative Financial Instruments .

 

Common Stock Dividends

 

During the first quarter of fiscal 2015, the Company declared a quarterly dividend of $0.2875 per common share, or $46.6 million in the aggregate, payable on February 12, 2015 to shareholders of record on January 13, 2015.  During the thirteen weeks ended December 27, 2014, the Company paid dividends of approximately $40.6 million.

 

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On January 30, 2015, the Company’s Board of Directors declared the Company’s next regular quarterly cash dividend of $0.2875 per common share, payable on April 30, 2015, to shareholders of record as of the close of business on March 31, 2015.

 

13.        Compensation Plans

 

Stock Options

 

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 during the thirteen weeks ended December 27, 2014 and December 28, 2013:

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Average expected life

 

5.5 years

 

5.5 years

 

Average volatility

 

57

%

75

%

Dividend yield

 

0.83

%

1.33

%

Risk-free interest rate

 

1.62

%

1.69

%

Weighted average fair value

 

$

67.11

 

$

40.98

 

 

Restricted Stock Units, Performance Stock Units and Other Awards

 

The Company awards restricted stock units (“RSUs”) and performance stock units (“PSUs”) to eligible employees (each, a “Grantee”) which entitle a Grantee to receive shares of the Company’s common stock.  RSUs and PSUs are awards denominated in units that are settled in shares of the Company’s common stock upon vesting.  In general, RSUs vest over a period of three or four years based on a Grantee’s continuing employment.  The vesting of PSUs follows a two or three year measurement period and is conditioned on the achievement of both a Grantee’s service and the Company’s performance requirements during the measurement period.  In the past the Company has also granted restricted stock awards (“RSAs”) which are awards of common stock that are restricted until the shares vest (generally over a period of three or four years).  The fair value of RSUs, RSAs and PSUs is based on the closing price of the Company’s common stock on the grant date.  Compensation expense for RSUs and RSAs is recognized ratably over a Grantee’s service period.  Compensation expense for PSUs is also recognized over a Grantee’s service period, but only if and when the Company concludes that it is probable (more than likely) the performance condition(s) will be achieved.  The assessment of the probability of achievement is performed each period based on the relevant facts and circumstances at that time, and if the estimated grant-date fair value changes as a result of that assessment, the cumulative effect of the change on current and prior periods is recognized in the period of change.  All awards are reserved for issuance under the Company’s Amended and Restated 2006 Incentive Plan (the “2006 Plan”) and the Company’s 2014 Omnibus Incentive Plan (which replaced the 2006 Plan).  In addition, the Company has awarded deferred cash awards (“DCAs”) to Grantees which entitle a Grantee to receive cash over time upon vesting.  The vesting of DCAs is conditioned on a Grantee’s continued employment.

 

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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 during the thirteen weeks ended December 27, 2014 and December 28, 2013:

 

 

 

Thirteen weeks ended

 

 

 

December 27,
 2014

 

December 28,
 2013

 

Average expected life

 

6 months

 

6 months

 

Average volatility

 

40

%

55

%

Dividend yield

 

0.88

%

1.34

%

Risk-free interest rate

 

0.05

%

0.04

%

Weighted average fair value

 

$

33.94

 

$

22.57

 

 

Income before income taxes in the Unaudited Consolidated Statements of Operations includes compensation expense related to the plans described above of $10.4 million and $7.1 million for the thirteen weeks ended December 27, 2014 and December 28, 2013, respectively.

 

14.        Commitments and Contingencies

 

Legal Proceedings

 

On May 9, 2011, an organization named Council for Education and Research on Toxics (“CERT”), purporting to act in the public interest, filed suit in Los Angeles Superior Court (Council for Education and Research on Toxics v. Brad Barry LLC, et al., Case No. BC461182) against several companies, including the Company, that roast, package, or sell coffee in California.  The Brad Barry complaint alleges that coffee contains the chemical acrylamide and that the Company and the other defendants are required to provide warnings under section 25249.6 of the California Safe Drinking Water and Toxics Enforcement Act, better known as Proposition 65.  Acrylamide is not added to coffee, but forms in trace amounts (parts per billion) as part of a chemical reaction that occurs in the coffee bean when it is roasted.  Therefore it is present in all roasted coffee.  To date, the Company is unaware of any reliable method for reducing acrylamide levels in coffee without adversely affecting the quality of the product.  The Brad Barry action has been consolidated for all purposes with another Proposition 65 case filed by CERT on April 13, 2010 over allegations of acrylamide in “ready to drink” coffee sold in restaurants, convenience stores, and donut shops.  (Council for Education and Research on Toxics v. Starbucks Corp., et al., Case No. BC 415759).  The Company was not named in the Starbucks complaint.  The Company has joined a joint defense group (“JDG”) organized to address CERT’s allegations, and the Company intends to vigorously defend against these allegations.  The Court ordered the case phased for discovery and trial.  Trial of the first phase of the case commenced on September 8, 2014 and was limited to three affirmative defenses shared by all defendants in both cases.  Other affirmative defenses, plaintiff’s prima facie case, and remedies are deferred for subsequent phases if defendants do not prevail on the three Phase 1 defenses.  Testimony in Phase 1 was completed on November 3, 2014, and final post-trial briefing of Phase 1 issues was completed on January 23, 2015.  The Court will entertain closing arguments on February 26, 2015, after which the matter will be submitted.

 

At this stage of the proceedings, the Company is unable to predict its outcome, the potential loss or range of loss, if any, associated with its resolution or any potential effect it may have on the Company or its operations.

 

On January 24, 2012, Teashot, LLC (“Teashot”) filed suit against the Company, Keurig and Starbucks Corp. (“Starbucks”) in the United States District Court for the District of Colorado (Civil Action No. 12-cv-00189-WJM-KMT) for infringement of Teashot’s U.S. Patent No. 5,895,672 (the ‘672 patent).  On February 6, 2014, the district court granted the Company’s motion for summary judgment of non-infringement.  Following an appeal by Teashot, on January 5, 2015 the United States Court of Appeals for the Federal Circuit unanimously affirmed the district court’s decision on summary judgment of non-infringement.

 

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Stockholder Litigation

 

One putative securities fraud class action is presently pending against the Company and certain of its officers and directors, along with two putative stockholder derivative actions.  The pending putative securities fraud class action was filed on November 29, 2011.  The first putative stockholder derivative action is a consolidated action pending in the United States District Court for the District of Vermont that consists of five separate putative stockholder derivative complaints, the first two were filed after the Company’s disclosure of the SEC inquiry on September 28, 2010, while the others were filed on February 10, 2012, March 2, 2012, and July 23, 2012, respectively.  The second putative stockholder derivative action is pending in the Superior Court of the State of Vermont for Washington County and was commenced following the Company’s disclosure of the SEC inquiry on September 28, 2010.

 

The putative securities fraud class action, captioned Louisiana Municipal Police Employees’ Retirement System (“LAMPERS”) v. Green Mountain Coffee Roasters, Inc., et al., Civ. No. 2:11-cv-00289, was filed in the United States District Court for the District of Vermont before the Honorable William K. Sessions, III.  Plaintiffs’ amended complaint alleged violations of the federal securities laws in connection with the Company’s disclosures relating to its revenues and its inventory accounting practices.  The amended complaint sought class certification, compensatory damages, attorneys’ fees, costs, and such other relief as the court should deem just and proper.  Plaintiffs sought to represent all purchasers of the Company’s securities between February 2, 2011 and November 9, 2011.  The initial complaint filed in the action on November 29, 2011 included counts for alleged violations of (1) Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 (the “Securities Act”) against the Company, certain of its officers and directors, and the Company’s underwriters in connection with a May 2011 secondary common stock offering; and (2) Section 10(b) of the Exchange Act and Rule 10b-5 against the Company and the officer defendants, and for violation of Section 20(a) of the Exchange Act against the officer defendants.  Pursuant to the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(a)(3), plaintiffs had until January 30, 2012 to move the court to serve as lead plaintiff of the putative class.  Competing applications were filed and the Court appointed Louisiana Municipal Police Employees’ Retirement System, Sjunde AP-Fonden, Board of Trustees of the City of Fort Lauderdale General Employees’ Retirement System, Employees’ Retirement System of the Government of the Virgin Islands, and Public Employees’ Retirement System of Mississippi as lead plaintiffs’ counsel on April 27, 2012.  Pursuant to a schedule approved by the court, plaintiffs filed their amended complaint on October 22, 2012, and plaintiffs filed a corrected amended complaint on November 5, 2012.  Plaintiffs’ amended complaint did not allege any claims under the Securities Act against the Company, its officers and directors, or the Company’s underwriters in connection with the May 2011 secondary common stock offering.  Defendants moved to dismiss the amended complaint on March 1, 2013 and on December 20, 2013, the court issued an order dismissing the amended complaint with prejudice.  On January 21, 2014, plaintiffs filed a notice of intent to appeal the court’s December 20, 2013 order to the United States Court of Appeals for the Second Circuit.  Pursuant to a schedule entered by the appeals court, briefing on the appeal was completed on June 23, 2014.  The Second Circuit heard oral argument on the appeal on December 1, 2014.  The underwriters previously named as defendants notified the Company of their intent to seek indemnification from the Company pursuant to their underwriting agreement dated May 5, 2011 in regard to the claims asserted in this action.

 

The first putative stockholder derivative action, a consolidated action captioned In re Green Mountain Coffee Roasters, Inc.  Derivative Litigation, Civ. No. 2:10-cv-00233, premised on the same allegations asserted in the now dismissed Horowitz v. Green Mountain Coffee Roasters, Inc., Civ. No. 2:10-cv-00227 securities class action complaint, the LAMPERS action described above, and the now dismissed action captioned Fifield v. Green Mountain Coffee Roasters, Inc., Civ. No. 2:12-cv-00091, is pending in the United States District Court for the District of Vermont before the Honorable William K. Sessions, III.  On November 29, 2010, the federal court entered an order consolidating two 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 Horowitz putative securities fraud class action.  On March 7, 2012, the federal court approved a further joint stipulation continuing the temporary stay until the court either denies a motion to dismiss the Horowitz putative securities fraud class action or the Horowitz putative securities fraud class action is dismissed with prejudice.  On April 27, 2012, the federal court entered an order consolidating the stockholder derivative action captioned Himmel v. Robert P. Stiller, et al., with two additional putative derivative actions, Musa Family Revocable Trust v. Robert P. Stiller, et al., Civ. No. 2:12-cv-00029, and Laborers Local 235 Benefit Funds v. Robert P.  Stiller, et al., Civ. No. 2:12-cv- 00042.  On November 14, 2012, the federal court entered an order consolidating an additional stockholder derivative action, captioned Henry Cargo v. Robert P. Stiller, et al., Civ. No. 2:12-cv-00161, and granting plaintiffs leave to lift the stay for the limited purpose of filing a consolidated complaint.  The consolidated complaint is asserted nominally on behalf of the Company against certain of its officers and directors.  The consolidated complaint asserts claims for breach of fiduciary duty, waste of corporate assets, unjust enrichment, contribution, and indemnification and seeks compensatory damages, injunctive relief, restitution, disgorgement, attorney’s fees, costs, and such other relief as the court should deem just and proper.  On May 14, 2013, the court approved a joint stipulation filed by the parties providing for a temporary stay of the proceedings until the conclusion of the appeal in the Horowitz putative securities fraud class action.  On August 1, 2013, the parties filed a further joint stipulation continuing the temporary stay until the court either denies a motion to dismiss the LAMPERS putative securities fraud class action or the LAMPERS putative securities fraud class action is dismissed with prejudice, which the court approved on August 2, 2013.  On February 24, 2014, the court approved a further joint stipulation filed by the parties continuing the temporary stay until the appeals court rules on the pending appeal in the LAMPERS putative securities fraud class action.

 

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The second putative stockholder derivative action, M. Elizabeth Dickinson v. Robert P. Stiller, et al., Civ. No. 818-11-10, is pending in the Superior Court of the State of Vermont for Washington County.  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 Horowitz putative securities fraud class action.  As a result of the federal court’s ruling in the Horowitz putative securities fraud class action, the temporary stay was lifted.  On June 25, 2013, plaintiff filed an amended complaint in the action, which is asserted nominally on behalf of the Company against certain current and former directors and officers.  The amended complaint is premised on the same allegations alleged in the Horowitz, LAMPERS, and Fifield putative securities fraud class actions.  The amended complaint asserts claims for breach of fiduciary duty, unjust enrichment, waste of corporate assets, and alleged insider selling by certain of the named defendants.  The amended complaint seeks compensatory damages, injunctive relief, restitution, disgorgement, attorneys’ fees, costs, and such other relief as the court should deem just and proper.  On August 7, 2013, the parties filed a further joint stipulation continuing the temporary stay until the court either denies a motion to dismiss the LAMPERS putative securities fraud class action or the LAMPERS putative securities fraud class action is dismissed with prejudice, which the court approved on August 21, 2013.  On April 21, 2014, the court approved a joint stipulation filed by the parties continuing the temporary stay until the appeals court rules on the pending appeal in the LAMPERS putative securities fraud class action.

 

The Company and the other defendants intend to vigorously defend all 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.

 

Antitrust Litigation

 

On February 11, 2014, TreeHouse Foods, Inc., Bay Valley Foods, LLC, and Sturm Foods, Inc. filed suit against Green Mountain Coffee Roasters, Inc. and Keurig, Inc. in the U.S. District Court for the Southern District of New York (TreeHouse Foods, Inc. et al. v. Green Mountain Coffee Roasters, Inc. et al., No. 1:14-cv-00905-VSB).  The TreeHouse complaint asserts claims under the federal antitrust laws and various state laws, contending that the Company has monopolized alleged markets for single serve coffee brewers and single serve coffee portion packs, including through its contracts with suppliers and distributors and in connection with the launch of its next generation coffee brewer.  The TreeHouse complaint seeks monetary damages, declaratory relief, injunctive relief, and attorneys’ fees.

 

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On March 13, 2014, JBR, Inc. (d/b/a Rogers Family Company) filed suit against Keurig Green Mountain, Inc. in the U.S. District Court for the Eastern District of California (JBR, Inc. v. Keurig Green Mountain, Inc., No. 2:14-cv-00677-KJM-CKD).  The claims asserted and relief sought in the JBR complaint are substantially similar to the claims asserted and relief sought in the TreeHouse complaint.

 

Additionally, beginning on March 10, 2014, twenty-seven putative class actions asserting similar claims and seeking similar relief have been filed on behalf of purported direct and indirect purchasers of the Company’s products in various federal district courts.  On June 3, 2014, the Judicial Panel on Multidistrict Litigation granted a motion to transfer these various actions, including the TreeHouse and JBR actions, to a single judicial district for coordinated or consolidated pre-trial proceedings.  The actions are now pending before Judge Vernon S. Broderick in the Southern District of New York (In re: Keurig Green Mountain Single-Serve Coffee Antitrust Litigation, No. 1:14-md-02542-VSB).

 

On June 23, 2014, TreeHouse and JBR filed a joint motion to expedite discovery, which the Court granted in part and denied in part on July 23, 2014.  On August 11, 2014, JBR filed a motion for a preliminary injunction, which the Company opposed.  The Court held a hearing on September 3-4, 2014, and by order dated September 19, 2014, denied JBR’s motion for a preliminary injunction.  On September 24, 2014, JBR filed a notice of appeal of the denial of the preliminary injunction.  On October 28, 2014, JBR moved to expedite its appeal, which the Company opposed, and on November 13, 2014, the Court of Appeals denied the motion for expedited treatment.  JBR filed its opening appeal brief on November 17, 2014.  The Company’s brief is due February 17, 2015, and JBR’s reply brief will be due March 3, 2015.

 

Consolidated putative class action complaints by direct purchaser and indirect purchaser plaintiffs were filed on July 24, 2014.  The Company filed motions to dismiss these complaints and the complaints in the TreeHouse and JBR actions on October 6, 2014.  On October 27, 2014, all plaintiffs informed the Company of their decision to amend their complaints rather than oppose the Company’s motions to dismiss.  Plaintiffs’ amended complaints were filed November 25, 2014.  The Company moved to dismiss the amended complaints on February 2, 2015.  Under the current briefing schedule, plaintiffs’ opposition briefs will be due April 10, 2015, and the Company’s reply briefs will be due May 11, 2015.

 

On September 30, 2014, a statement of claim was filed against the Company and Keurig Canada Inc. in Ontario, Canada by Club Coffee L.P. (“Club Coffee”), a Canadian manufacturer of single-serve beverage packs, claiming damages of $600 million and asserting a breach of competition law and false and misleading statements by the Company.  On October 21, 2014, Club Coffee filed an amended statement of claim against the Company and Keurig Canada Inc. claiming the same amount of damages as in the original statement of claim and asserting essentially the same breaches of competition law and false and misleading statements by the Company.  On January 12, 2015, the Company and Keurig Canada Inc. served Club Coffee with notice of motion for a motion to strike the claims made by Coffee Club for failure to state a reasonable cause of action.

 

The Company intends to vigorously defend all of the pending lawsuits.  At this time, the Company is unable to predict the outcome of these lawsuits, the potential 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.

 

Product Liability

 

In November 2014, the Company informed the U.S. Consumer Product Safety Commission and Health Canada that it identified a potential issue involving certain Keurig MINI Plus (non-reservoir) brewers (K10 and B31 models), where on very rare occasions, hot liquid could escape the brewer.  As a result, the Company recorded a net charge in fiscal 2014 of approximately $10.0 million in its statement of operations which represented the Company’s best estimate, based on a number of assumptions, of the cost to remediate this issue and related expenses.  Included in this charge is the recovery that the Company expects to receive from its insurance carriers where the Company has a legally enforceable contract that stipulates the terms of the insurance coverage and where the terms are not in or expected to be in dispute.  On December 23, 2014 the Company issued a recall for its Keurig MINI Plus brewers.  This action did not change our estimate for the reserve or the anticipated insurance recovery; however, as such charge is based on estimates, the Company’s ultimate liability and recovery may exceed or be less than the amounts recorded.  Based on current information known to the Company, the Company believes that this issue will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.

 

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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

 

 

 

December 27,
2014

 

December 28,
2013

 

Numerator for basic and diluted earnings per share:

 

 

 

 

 

Net income attributable to Keurig

 

$

134,579

 

$

138,227

 

Denominator:

 

 

 

 

 

Basic weighted-average shares outstanding

 

162,181,332

 

149,162,600

 

Effect of dilutive securities

 

1,893,706

 

2,419,297

 

Diluted weighted-average shares outstanding

 

164,075,038

 

151,581,897

 

 

 

 

 

 

 

Basic net income per common share

 

$

0.83

 

$

0.93

 

Diluted net income per common share

 

$

0.82

 

$

0.91

 

 

For the thirteen weeks ended December 27, 2014 and December 28, 2013, shares related to equity-based compensation of approximately 74,000 and 483,000 respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

 

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 Keurig Green Mountain, Inc. (together with its subsidiaries, the “Company”, “Keurig”, “we”, “our”, or “us”).  You should read the following discussion and analysis in conjunction with our unaudited consolidated financial statements and related notes included elsewhere in this report.

 

Overview

 

We believe that we are a leader in specialty coffee, coffeemakers, teas and other beverages in the United States and Canada.  We consider ourselves an innovative, technology-driven, values-based personal beverage system company.  Our multi-brand beverage and brewer portfolio is aimed at changing the way consumers prepare and enjoy coffee and other beverages both at home and away from home.  We develop and sell a variety of Keurig ®  brewers and produce and sell specialty coffee and other specialty beverages in portion packs including hot apple cider, hot and iced teas, iced coffees, iced fruit brews, hot cocoa and other beverages for use with our Keurig ®  hot brewing systems.  We also offer traditional whole bean and ground coffee in other package types including bags, fractional packages and cans.

 

Products

 

Portion Packs

 

We offer portion packs of varying sizes including single-serve K-Cup ® , Vue ®  and Rivo ®  packs as well as multi-serve K-Carafe  packs capable of producing a three to four cup carafe and Bolt packs capable of producing a 64 ounce carafe.  We offer high-quality Arabica bean coffee including single-origin, Fair Trade Certified , Rain Forest Alliance Certified , organic, flavored, limited edition and proprietary blends.  We also procure Robusta bean coffee for use in certain blends.  We carefully select our coffee beans and appropriately roast the coffees to optimize their taste and flavor differences.  We manufacture and sell portion packs of our own brands and participating brands through licensing and manufacturing agreements.  We offer brand choice such as Caribou Coffee ® , Dunkin’ Donuts , Eight O’Clock ® , Emeril’s ® , Folgers ® , Folgers Gourmet Selections ® , Gloria Jean’s ® , Kirkland Signature , Krispy Kreme ® , Lavazza ® , Millstone ® , Newman’s Own ®  Organics Peet’s Coffee & Tea, and Starbucks ® .

 

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The Company has licensing agreements for tea with Unilever North America (Lipton ® ), Celestial Seasonings, Inc. (Celestial Seasonings ®  branded teas and Perfect Iced Tea ® ), Good Earth ®  Corporation and Tetley ®  USA, Inc. (Good Earth ®  and Tetley ®  branded teas), R. C. Bigelow, Inc. (Bigelow ®  branded teas), Snapple Beverage Corp. (Snapple ®  branded teas), Starbucks Corporation (Tazo ®  and Teavana ® ) and Associated British Foods plc (Twinings of London ® ) for manufacturing, distribution, and sale of portion packs.  In addition to coffee and tea, we also produce and sell portion packs for lemonade and hot apple cider under our Green Mountain Naturals  brand, iced fruit brews under our Vitamin Burst  brand, cocoa and other dairy-based beverages under our Café Escapes  brand, and cocoa under the Swiss Miss ®  brand.

 

Brewers and Accessories

 

We are a leader in sales of coffeemakers in the U.S. and Canada.  As of the end of our 2014 fiscal year, we had the top four best-selling at-home coffeemakers by dollar volume in the United States according to the NPD Group for consumer market research data in the United States.  Under the Keurig ®  K-Cup ® , Keurig ®  Vue ® , Keurig Bolt , Keurig ®  2.0 and co-branded Keurig ®  Rivo ®  brand names, we offer a variety of commercial and home use brewers for the away from home (“AFH”) and at home (“AH”) channels differentiated by features and size.

 

In addition, we have license agreements under which licensees manufacture, market and sell coffeemakers co-branded with “Keurig ®  Brewed”.  Licensees include Breville PTY Limited selling a “Breville ® ” branded brewer; Jarden Consumer Solutions selling a “Mr. Coffee ® ” branded brewer, Conair Corporation selling a “Cuisinart ® ” branded brewer and GE Appliances selling a “GE Café ” series refrigerator with Keurig ®  K-Cup ®  brewing system branded brewer.

 

We offer a variety of accessories for the Keurig ®  Brewing platforms including K-Cup ® , Vue ® , Rivo ® , K-Carafe , and Bolt  pack storage racks, baskets, and brewer carrying cases.  We also sell other coffee-related equipment and accessories, gift assortments, hand-crafted items from coffee-source countries and gourmet food items covering a wide range of price points.

 

Other Products and Royalties

 

We sell coffee in other package types in addition to portion packs such as bagged coffee and cans (for the grocery and mass channels) and fractional packages and ancillary products (for the office coffee and food service channels).  We also earn royalties from licensees under various licensing agreements.

 

In recent years, growth in the coffee industry has come from the specialty coffee category fueled by the emergence of specialty coffee shops throughout the U.S. and Canada.  Single-serve has been the fastest growing segment of the specialty coffee category. Concurrently, consumers are more frequently seeking to enjoy premium experiences within the comfort and convenience of their own homes, including the consumption of specialty coffee.  We have benefited from these broad consumer trends and believe we will continue to be a leader in the hot beverage marketplace because of our carefully developed and distinctive advantages over our competitors, including quality, convenience and choice.

 

Our growth strategy involves using our consumer insights to develop innovative new brewing systems and beverages; continually improving and refining our current systems and beverages; and, developing and managing marketing programs to drive Keurig ®  Brewing system adoption in order to generate ongoing demand for portion packs.  We currently target opportunities primarily in American and Canadian households, foodservice, educational and office locations.  Over the longer term, we also will work to expand our addressable opportunity globally.  As part of our strategy, we work to sell our at-home hot system brewers at attractive price points which are approximately at cost, or at a loss when factoring in the incremental costs related to sales, in order to drive the sales of profitable portion packs.  As we introduce new innovative beverage systems such as the Keurig ®  2.0 Beverage System or Keurig cold beverage system, we expect to experience higher appliance costs as we scale the related manufacturing processes followed by lower appliance cost structures as the supply chain creates more efficient manufacturing processes.  During the early years of the launch of these innovative new beverage systems, we will continue to sell the at-home appliances at attractive price points which we expect will result in selling these new innovative at-home appliances at a loss prior to factoring in the incremental costs related to these sales.

 

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In addition, we have license agreements with Breville PTY Limited (producer of Breville ®  brand coffeemakers), Jarden Consumer Solutions (producer of Mr. Coffee ®  brand coffeemakers) and Conair Corporation (producer of Cuisinart ®  brand coffeemakers), under which each produce, market and sell coffeemakers co-branded with Keurig ® .

 

In recent years, our growth has been driven predominantly by an increase in adoption of Keurig ®  hot brewing systems, which include both the brewer and the related portion packs.  In fiscal 2014, approximately 94% of our consolidated net sales were attributed to the combination of portion packs and Keurig ®  brewers and related accessories.

 

We believe the primary consumer benefits delivered by our Keurig ®  hot beverage brewing system are as follows:

 

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

 

2                 Convenience—the Keurig ®  system prepares beverages generally in less than a minute at the touch of a button with no mess, no fuss.

 

3                 Choice—with many single serve beverage brands across multiple beverage categories, Keurig offers more than 290 individual varieties, allowing consumers to enjoy and explore a wide range of beverages.  In addition to a variety of brands of coffee and tea, we also produce and sell iced teas, iced coffees, hot and iced fruit brews, hot cocoa and other dairy-based beverages, in portion packs.

 

We see these benefits as being our competitive advantage and believe it’s the combination of these attributes that make the Keurig ®  hot beverage brewing system appealing to consumers.

 

We are focused on building our brands, diversifying our product lines and profitably growing our business.  We believe we can continue to grow sales by increasing consumer awareness of the Keurig ®  brand in the United States and Canada; expanding into new geographic regions; expanding consumer choice of coffee, tea and other beverages in our existing brewing systems; developing and introducing new brewing platforms; expanding sales in adjacent beverage industry segments; and/or selectively pursuing other synergistic opportunities.

 

The key elements of our business strategy are as follows:

 

·                   Increasing adoption of the Keurig ®  hot brewing systems in the United States and Canada;

·                   Expanding beverage choice through both our owned and partner brand offerings;

·                   Expanding in current channels;

·                   Launching new, innovative beverage system technologies and platforms; and

·                   Continuing international expansion.

 

Increasing adoption of the Keurig ®  hot brewing systems in the United States and Canada.  While we are positioned as a leader in the hot beverage marketplace, we have opportunities in the United States and Canada to increase brand awareness and household penetration.  In our fiscal year 2014 we launched our Keurig ®  2.0 Beverage System - the first Keurig ®  brewer to brew both a single cup and a carafe.  Extending the Keurig ®  value proposition to include a carafe option for at-home users allows us to target an incremental need of consumers for brewing larger volumes quickly and simply.  We are also implementing measures to improve the shopping experience at retail to further distinguish the Keurig ®  brand and enhance brand recognition.  Additionally, we are launching targeted marketing campaigns to increase regional household penetration in certain geographic areas through increased awareness, trial and conversion.  As we continue to introduce the new Keurig ®  2.0 Beverage System in fiscal 2015, we anticipate that we will continue to incur transition costs through the first year of launch including higher brewer costs for the new 2.0 appliances as compared to the earlier reservoir model appliances leading to lower gross margins.

 

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Expanding beverage choice through both our owned and partner brand offerings.   We have continued expanding consumer choice in the Keurig ®  Brewing system by entering into or extending a number of business relationships across multiple channels and geographies for use with Keurig ®  brewers.  Expanded or new brand offerings and partnerships in fiscal 2015 include a partnership with Community Coffee Company to bring Community ®  coffee to Keurig ®  portion pack formats for consumer and commercial Keurig ®  hot brewing systems, an acquisition of the Laughing Man Coffee and Tea brand from Laughing Man Worldwide, LLC to bring a selection of gourmet coffees and teas to Keurig ®  brand packs for use in the Keurig ®  hot brewing system beginning in spring 2015, and an expanded ten year partnership with Caribou Coffee for the manufacturing, marketing, distribution, and sale of Caribou Coffee in Keurig ®  portion pack formats for use in Keurig ®  consumer and commercial hot brewing systems.  We believe these new brand and product offerings fuel excitement for current Keurig ®  brewer owners and users; raise system awareness; attract new consumers to the system; and promote expanded use of the Keurig ®  Brewing system.  These relationships are established with careful consideration of potential economics.  We expect to continue to enter into these mutually beneficial relationships in our efforts to expand choice and diversify our portfolio of brands with the expectation that they will lead to increased Keurig ®  Brewing system awareness and household adoption, in part through the participating brands’ advertising and merchandising activities .

 

Expanding in current channels .  We have identified and are targeting specific opportunities within our existing channels, specifically the AFH channel, including food service, workplace, higher education and hospitality locations.  These are areas where we have substantial room to grow, considering we are currently in less than one percent of food service outlets.

 

Launching new, innovative beverage system technologies and platforms .  We are also focused on continued innovation in both hot and cold beverage systems.  Some of our recent initiatives and planned product introductions include:

 

·                   The introduction of Keurig ®  2.0, our next generation at-home hot beverage system.  Keurig ®  2.0 is the first Keurig ®  brewer to brew both a single cup and up to a four-cup carafe from a Keurig ®  brand pack providing Keurig ®  consumers with even greater beverage choice with the same Keurig simplicity and convenience they expect from Keurig.  Keurig ®  2.0 is also the first Keurig ®  brewer to feature Keurig ®  2.0 Brewing Technology , which enables the brewer to recognize the inserted Keurig ®  pack and optimize to the recommended, customized setting for that particular beverage.  The Keurig ®  2.0 Brewing Technology  ensures that the Keurig ®  2.0 system delivers on the promise of excellent quality beverages, produced simply and consistently, every single time;

·                   An estimated launch of the Keurig cold beverage system in fiscal 2015.  Keurig cold will deliver freshly prepared cold carbonated, sparkling and still beverages.  During the first quarter of fiscal 2015, we announced an agreement with Dr Pepper Snapple Group to develop and manufacture a selection of Dr Pepper Snapple Group’s iconic brands for use in the Keurig cold beverage system in the United States and Canada.

·                   During fiscal 2014, we announced the first significant partnership related to the Keurig cold beverage system: a ten-year agreement to collaborate on the development and introduction of The Coca-Cola Company’s ®  global brand portfolio for use in the Keurig cold at-home beverage system.  Under the global strategic agreement, Keurig and The Coca-Cola Company will cooperate to bring the Keurig cold beverage system to consumers around the world.

 

Continuing international expansion.  Continuing into fiscal 2015, we are planning to launch our Keurig ®  hot system global platform in targeted countries outside of North America.  In fiscal 2014, we launched a Keurig ®  brewer in the AFH channel in the United Kingdom.

 

Our business relationships with participating brands are generally established through licensing or manufacturing arrangements.

 

Under licensing arrangements , we license the right to manufacture, distribute and sell the finished products through our distribution channels using the brand owners’ marks.  For the right to use a brand owner’s mark, we pay a royalty to the brand owner based on our sales of finished products that contain the brand owner’s mark.

 

Under manufacturing arrangements , we manufacture finished beverage products using raw materials sourced by us or provided by the brand owner.  In both instances, once the manufacturing process is complete, we sell the finished product either to the brand owner or to our customers. 

 

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Under certain manufacturing arrangements, our sole customer is the brand owner and we are prohibited from selling the beverage products to other types of customers through our distribution channels.  Under other manufacturing arrangements, in addition to manufacturing the beverage for sale to the brand owner, we have the right to sell the beverages using the brand owner’s marks in certain of our channels through a licensing arrangement, as described above.

 

No individual licensing or manufacturing arrangement (including arrangements covering multiple brands) has accounted for more than 10% of our consolidated net sales in any period.  We analyze the impact of each arrangement on consolidated net sales on an individual basis.  We have determined that it is unlikely that we would lose our licensing or manufacturing rights to multiple brands at the same time.  Each of our licensing and manufacturing arrangements are separately negotiated with unrelated parties, and each has distinct terms and conditions, including the duration of agreement and termination rights.  Further, based upon the number of business relationships as well as the depth of our owned-brands, it is our belief that no individual business relationship is critical to the execution of our growth strategy.

 

Management is focused on executing our growth strategy to drive Keurig ®  hot beverage brewer adoption in households and offices in the U.S. and Canada in order to generate ongoing demand for portion packs.

 

We compete not only with other widely advertised branded products, but also with private label or generic products that generally are sold at lower prices.

 

For the first quarter of fiscal 2015, our net sales of $1,386.4 million as compared to net sales of $1,386.7 million in the first quarter of fiscal 2014 (“the prior year period”) were roughly even.  Gross profit for the first quarter of fiscal 2015 was $464.1 million, or 33.5% of net sales, as compared to $464.0 million, or 33.5% of net sales for the prior year period.  For the first quarter of fiscal 2015, selling, operating, and general and administrative expenses (“SG&A”) increased 4.5% to $248.2 million from $237.4 million for the prior year period.  As a percentage of sales, SG&A expenses increased to 17.9% in the first quarter of fiscal 2015 from 17.1% in the prior year period.  Our operating margin declined to 15.6% in the first quarter of fiscal 2015 from 16.3% in the prior year period.

 

We continually monitor all costs, including coffee, as we review our pricing structure, as cyclical swings in commodity markets are common.  The recent years have seen significant volatility in the “C” price of coffee (i.e. the price per pound quoted by the Intercontinental Exchange).  We expect coffee prices to remain volatile in the coming years.

 

We offer a one-year warranty on all Keurig ®  hot beverage brewers we sell and provide for the estimated cost of product warranties, primarily using historical information and current repair or replacement costs, at the time product revenue is recognized.  In addition, sales of Keurig ®  hot beverage brewers are recognized net of an allowance for returns using an average return rate based on historical experience and an evaluation of contractual rights or obligations.  We focus some of our research and development efforts on improving brewer reliability, strengthening its quality controls and product testing procedures.  As we have grown, we have added significantly to our product testing, quality control infrastructure and overall quality processes.  As we continue to innovate, and our products become more complex, both in design and componentry, product performance may modulate, causing warranty or sales returns rates to possibly fluctuate going forward.  As a result, future warranty claims rates may be higher or lower than we are currently experiencing and for which we are currently providing for in our warranty or sales return reserves.

 

We generated $142.4 million in cash from operating activities during the thirteen weeks ended December 27, 2014 as compared to $272.7 million during the thirteen weeks ended December 28, 2013.  We used cash during the thirteen weeks ended December 27, 2014 primarily to acquire Bevyz for $180.7 million, net of cash acquired, fund capital expenditures of $100.3 million, repurchase shares of our common stock for $80.9 million, and pay dividends of $40.6 million.

 

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 cash dividends, share repurchases, capital expenditures and the working capital required for our growth over the next few years.

 

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Business Segments

 

We manage our operations through two operating segments, a Domestic segment including all U.S. Operations and immaterial operations related to international expansion, and a Canada segment including all Canadian operations.  See Note 2, Segment Reporting , of the Notes to Unaudited Consolidated Financial Statements included in this Quarterly Report.

 

We evaluate the performance of our operating segments based on several factors, including net sales to external customers and operating income.  Net sales are recorded on a segment basis and intersegment sales are eliminated as part of the financial consolidation process.  Operating income represents gross profit less selling, operating, general and administrative expenses.  Our manufacturing operations occur within both the Domestic and Canada segments, and the costs of manufacturing are recognized in cost of sales in the operating segment in which the sale occurs.  Information system technology services are mainly centralized while finance and accounting functions are primarily decentralized.  Expenses consisting primarily of compensation and depreciation related to certain centralized administrative functions including information system technology are allocated to the operating segments.  Expenses not specifically related to an operating segment are presented under “Corporate - Unallocated.”  Corporate - Unallocated expenses are comprised mainly of the compensation and other related expenses of certain of our senior executive officers and other selected employees who perform duties related to the entire enterprise.  Corporate Unallocated expenses also include depreciation for corporate headquarters, corporate sustainability expenses, interest expense not directly attributable to an operating segment, the majority of foreign exchange gains or losses, certain corporate legal expenses and compensation of the Board of Directors.

 

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 accounting principles generally accepted in the United States of America (“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 net income and non-GAAP net income per share.  These non-GAAP measures exclude legal and accounting expenses related to antitrust litigation, the SEC inquiry and associated pending securities and stockholder derivative class action litigation; and non-cash related item related to the amortization of identifiable intangibles, each of which include adjustments to show the tax impact of excluding these items.  Each of these adjustments was selected because management uses these non-GAAP measures in discussing and analyzing its results of operations and because we believe the non-GAAP measures provide investors with greater transparency by helping to illustrate the underlying financial and business trends relating to our results of operations and financial condition and comparability between current and prior periods.  For example, we excluded antitrust litigation expenses because these expenses can vary from period to period and transaction to transaction and expenses associated with these activities are not considered a key measure of our operating performance.

 

We use the non-GAAP measures to establish and monitor budgets and operational goals and to evaluate 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.  We compensate for these limitations by presenting both the GAAP and non-GAAP measures of its results.

 

Acquisition

 

On December 18, 2014, we completed the acquisition of 100% of the outstanding equity of MDS Global Holding p.l.c. (“Bevyz”), a manufacturer and distributor of an all-in-one drink system, for total cash consideration of $180.7 million, net of cash acquired.  Prior to the acquisition we owned approximately 15% of the outstanding equity of Bevyz.  We plan to utilize Bevyz’s complementary and unique technology and research and development capabilities in our beverage platforms and products.

 

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Results of Operations

 

Summary financial data of the Company

 

The following table presents certain financial data of the Company expressed as a percentage of net sales for the periods denoted below:

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Net sales

 

100.0

%

100.0

%

Cost of sales

 

66.5

%

66.5

%

Gross profit

 

33.5

%

33.5

%

 

 

 

 

 

 

Selling and operating expenses

 

12.7

%

12.1

%

General and administrative expenses

 

5.2

%

5.0

%

Operating income

 

15.6

%

16.3

%*

 

 

 

 

 

 

Other income, net

 

0.0

%

0.0

%

Gain on financial instruments, net

 

0.2

%

0.3

%

Loss on foreign currency, net

 

(0.7

)%

(0.8

)%

Interest expense

 

(0.1

)%

(0.2

)%

Income before income taxes

 

15.1

%*

15.8

%*

 

 

 

 

 

 

Income tax expense

 

(5.4

)%

(5.8

)%

Net income

 

9.7

%

10.0

%

 

 

 

 

 

 

Net income attributable to noncontrolling interests

 

0.0

%

0.0

%

 

 

 

 

 

 

Net income attributable to Keurig

 

9.7

%

10.0

%

 


* Does not sum due to rounding.

 

Segment Summary

 

Net sales and operating income (loss) for each of our operating segments and corporate-unallocated are summarized in the tables below:

 

 

 

Net sales (in millions)

 

 

 

Thirteen weeks ended

 

 

 

December 27,
2014

 

December 28,
2013

 

Domestic

 

$

1,215.5

 

$

1,191.9

 

Canada

 

170.9

 

194.8

 

Total net sales

 

$

1,386.4

 

$

1,386.7

 

 

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