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Keurig Green Mountain's Q3 Earnings: New Business Additions To Boost Revenues

Keurig Green Mountain ( GMCR ) delivered better-than-expected results in its third fiscal quarter earnings released on August 6, 2014, as it beats its EPS guidance by $0.11. (( Keurig Green Mountain Q3 2014: Earnings call transcript )) The company generated net revenues of $1.02 billion in the third quarter, up 6% year-over-year (y-o-y). This significant growth was primarily due to 10% increase in portion pack net sales, partially offset by 4% decrease in brewer and accessory sales and 17% decrease in other product sales.

The company's gross profit increased 9%, which led to a 140 basis points improvement in gross margins, due to favorable commodity cost and improved productivity.

See our full analysis of GMCR here

Increased Portion Pack Volume Boosts Revenue Growth

Keurig Green Mountain's net revenues grew 6 % to around $1.2 billion, with portion packs segment contributing the most to the growth. Portion packs-related net sales rose 10% y-o-y driven by increased volume, partially offset by the net price realization of packs and decreased portion pack product mix. On the other hand, brewery and accessory net sales declined 9%, driven by a 13 percentage point increase in brewer sales volume offset by a 21 percentage point decrease due to brewer net price realizations. This decrease in average selling price of brewers was due to a strategic decision to drive the brewer volumes, so that the company is at a proper inventory position before the launch of Keurig 2.0.

The tremendous growth of portion packs had a cannibalizing effect on the net sales of other products such as traditional packaged coffee in retail stores, which decreased by 17% y-o-y. As a result, the company missed its revenue guidance by $30 million.

Positive Outlook On Revenue Growth

Keurig Green Mountain expects its revenue to accelerate in the fourth quarter with portion packs segment as the primary driver, primarily due to the below mentioned factors:

  • The company expects Keurig's installed base growth in Q4 to reach 25% to 30% y-o-y. Moreover, since the portion pack sell-through remained in-line with the growth of brewer installed base in the third quarter, it expects the Keurig installed base growth to drive portion pack sales to the same level in Q4.
  • Keurig expects to add few more impactful brands to its list of unlicensed brands to provide a boost to shipments in Q4. In the third quarter, the company gained agreements with some unlicensed brands that positively impacted the company's Q3 revenue growth. Last year, 21% of the total K-Cup sales in the U.S. were attributed to the company's unlicensed brands such as Kraft Foods' ( KRFT ) Maxwell House, Peet's Coffee & Tea and TreeHouse Foods ( THS ).
  • Significant revenue contribution from Keurig System's new partners. During the third quarter, the company entered several distribution deals with top brands such as Nestlé (SIX:NESN) and Subway.
  • Keurig has announced the launch of its new and improved hot brewer- Keurig 2.0 in the latter half of this year. In addition to that, the cold brewer-Keurig Cold, which will be designed to dispense single servings ranging from Carbonated Soft Drinks (CSD) to non-carbonated beverages like juice drinks and iced teas, is also scheduled to be launched in fiscal 2015.

We will discuss the impact of some of these factors in detail.

New Distribution Agreements To Boost Revenues

Over the last few years, the company has signed several distribution agreements with major brands such as Dunkin' Brands( DNKN ), Peet's Coffee and Starbucks Corporation ( SBUX ) to provide its consumers with high quality premium coffee at nominal rates, with a target to expand the customer base. Over the last 4 months, Keurig has entered into several distribution deals with top brands with the motive of giving a boost to its top-line growth. Some of these significant deals include:

  • Coca-Cola

Keurig's entered into a partnership with Coca-Cola (KO), where the two companies are together developing the Keurig Cold machine. The cold brewer provides a huge platform for Keurig to enter into cold beverage market which would expand its business to Carbonated Soft Drinks (CSD) and non-carbonated drinks. According to our estimates, CSDs constitute about 43% of the 30 billion gallon Liquid Refreshment Beverage (LRB) industry in the U.S., forming the largest segment. Keurig Cold provides an added platform for Coca-Cola to reach its large CSD consumer base, which might translate to increase in the consumption rates of avid customers. The company is currently working closely with the beverage giant in developing and perfecting some of the Coca-Cola's brands for the Keurig Cold system.We have discussed this in more details in our prior article. (See: Coca-Cola-Keurig Green Mountain Deal: A Win-Win Situation For Both)
  • Subway

In the month of June, Keurig Green Mountain announced its partnership with the restaurant chain-Subway to bring Keurig's single-serve brewers to almost all of the Subway chains in the U.S. and Canada. With Subway being the largest single-brand restaurant chain in terms of number of restaurants world-wide (42,000 stores in 107 countries), this deal might prove to be a blockbuster move for Keurig Green Mountain. According to our estimates, this deal might provide additional annual revenues of around $15 million from K-Cup sales alone.We have discussed its potential impact on the company's revenue in detail in our prior article. (See: Keurig Green Mountain's Partnership With Subway To Boost Volumes Of Brewers and K-Cups)The company is also pursuing its interest in number of other quick-serve restaurants where single served Keurig system can deliver significant results.
  • Nestle

Keurig Green Mountain announced a multi-year deal with the U.S. division of Nestlé, Nestlé USA on July 1, to bring Nestlé's branded coffee with creamer to its customers. Nestlé is the first brand to offer 2 in 1 K-Cup pack for hot coffee, combining high quality roast and ground coffee with branded creamer. The Nestlé Coffee-mate K-Cups will be available at Keurig's online stores in the fall of 2014 and in retail stores in the spring of 2015. The additional revenues due to the slightly higher priced creamer added K-Cups might account for 3%-4% of the total revenue growth. (See: Keurig-Nestlé Deal: Creamer Added K-Cups To Boost Net Sales)

Keurig is trying to attract new brands that can provide more innovative platforms and growth opportunities, both operational and financial.

New Product Launches To Affect Top-line Growth

  • Incremental Revenues

The company is about to release its next generation of brewers this fall- Keurig 2.0 and Keurig Cold. However, there is still a lot of uncertainty regarding the specifications and details of Keurig 2.0, but some of its advantages that may attract customers are:It offers all 50+ Keurig beverage brandsIt brews all Keurig K-Cups, Vue and K-carafe packsIt uses proprietary technology that can identify Keurig packs separatelyIt will be available at similar price rates as that of previous brewersVolumes of single pack servings could further accelerate after the company launches Keurig 2.0, as only those companies that have royalty agreements with Keurig Green Mountain will be able to release their single serve packs, restricting the entry of private labels and other third-party companies. This can boost volumes, as well as help the company realize better pricing. As a result, the company might witness a significant revenue growth in the initial months after the launch.Moreover, Keurig Cold provides an added huge platform for the company, as it enters cold beverage market, opening yet another area to enter. This means additional revenues, which might get boosted by the fact that Keurig is developing this brewer in partnership with the beverage giant- Coca-Cola- world's third most popular brand.
  • Short-term Pressure On Margins During The Initial Stages

Keurig Green Mountain continues to invest in research and development at double rate than the sales growth. The company's investment in Keurig 2.0 is higher than expected due to development expenses for new product cycle, as well as initiatives to include K-carafe and sample starter packs in every brewer box so that people may adapt to the new brewer functionality. Moreover, a huge part of the investment is going into setting up Keurig Cold's production centre in Vermont and in supporting Keurig Cold's dedicated facility in Lithia Springs Georgia.Keurig invested $103 million during third quarter, which might increase in the fourth quarter due to transition costs for the introduction of new system. As a result, the company is already expecting short-term inventory headwinds and added pressure on gross margins.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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