Keurig in transition

by Keith Nunes
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While a recall of Keurig's Mini Plus Brewers (left) had an effect on earnings, the company was challenged as it attempted to transition consumers from the original Keurig to the Keurig 2.0 platform (right).

WATERBRY, VT. — Keurig Green Mountain, Inc. is in the midst of changing, transitioning from an upstart innovator to a category leader in the market for single-serve beverages in the United States and Canada. With the category leadership designation come many benefits, but also a few negatives, most notably expectations.

After several years of rapid growth, where the company sold approximately 20 million brewers to U.S. consumers, management must now address the expectations of the market for a similar level of performance while also fending off competitors that have built entire businesses around Keurig-compatible knockoff brewers and pods. The challenge of those expectations was on display Feb. 4, when the company announced its earnings results for the first quarter of fiscal 2015, ended Dec. 27.

“Keurig is pleased to deliver earnings per share in line with our outlook,” said Brian Kelley, president and chief executive officer. “Revenue came in below our expectations primarily due to a weaker-than-expected holiday season for brewers, including the effect of the voluntary recall on certain Mini Plus brewers, and greater-than-expected retailer portion pack inventory reductions. We believe these factors are transitory and, while the impact to the holiday season for our hot platform was disappointing, we remain very enthusiastic about our opportunity to grow and premiumize at-home beverages across both our hot and cold platforms.”

Net income for the quarter fell 3% compared with the first quarter of fiscal 2014 to $134,679,000, equal to 83c per share on the common stock. Sales for the quarter were basically flat, coming in at $1,386,358,000 compared with $1,386,670,000 during the same period of the previous year.

While the recall of the Mini Plus Brewers had an effect on earnings, it was also clear the company was challenged as it attempted to transition consumers from the original Keurig to the Keurig 2.0 platform.

“Quite simply, our 2.0 launch got off to a slower start than we planned, due to a few important factors,” Mr. Kelley said Feb. 4 in a conference call with financial analysts. “First, our efforts to get new packs transitioned onto retail shelves and into homes did not move quickly enough. There was also confusion among consumers as to whether the 2.0 would still brew all of their favorite brands.

“These issues impacted consumer perception of the 2.0 and led to lower-than-expected brewer ratings early on. While consumer confusion has begun to subside and ratings have improved, the effect weighed on brewer sales during the key holiday season.”

Keurig Green Mountain shipped 4.3 million brewers during the quarter, a decline of approximately 600,000 when compared with sales during the same period of the previous year. Mr. Kelley said 400,000 of the decline were due to the Mini Plus brewer recall.

Portion packs also contributed to the revenue shortfall, as the mix impact across brand and channels was greater than expected. Volumes also were impacted by softer-than-expected brewer sales, because consumers typically stock their pantry when they first buy a brewer, according to the company.

“As we look at the quarter, the issues impacting our results are transitory and part of a complex product transition that we knew would be challenging,” Mr. Kelley said. “We are confident in our strategy and are proceeding resolutely, as we continue to see strong growth prospects for the Keurig hot system. Specifically, we expect our U.S. at-home installed base to grow in the mid-teens this year, and we believe we have a long runway for growth in the hot system, as we continue to target the 70 million households that use a coffee maker daily.

“Single-serve household penetration in the U.S. is still well-below the 40%-plus levels seen in other developed countries, such as Portugal, France, The Netherlands, Spain and Belgium. Combined with our forthcoming cold system, we feel even more confident in the ability of the Keurig brand to be a leading player in the growing trend to offer premium beverage systems at home.”

Despite Mr. Kelley’s reassurances, financial analysts on the call were not satisfied, and several attempted to get Mr. Kelley to clarify the issues surrounding the challenging quarter. Akshay Jagdale, an analyst with KeyBanc Capital Markets, noted that a non-licensed brewing system “gained a ton of share” during the quarter and asked if brewer price point was an issue.

Mr. Kelley responded that Keurig Green Mountain did not lose a lot of share to the newer, cheaper brewers on the market.

“Remember, we are number 1,2,3,4,5,6,7 and 9 of all brewers sold in terms of dollars, and I believe we are 6 or 7 of the top 10 in terms of units sold,” he said. “The difference between us at No. 1 and the others is, I think, vast.”

 

Betting on added innovation

While the market for the Keurig hot system may be cooling, the company has high expectations for its Keurig Cold system, which is slated to hit the market later this year.

“Our plans are progressing well, and we’re on track to launch this fall,” Mr. Kelley said. “Our partners, the Coca-Cola Co. and the Dr Pepper Snapple Group, are working closely with us in virtually all aspects of the Keurig Cold system in preparation for launch.”

The Cold system is scheduled to launch with 30 beverage varieties across 16 brands, including carbonated soft drinks, craft sodas, iced teas, sports drinks, seltzers and flavored waters. By the spring of 2016, the company anticipates the system will feature more than 60 varieties of beverage and more than 28 brands.

“As we’ve said before, Keurig Cold will be a multi-branded system, and we expect to add new partners in the future,” Mr. Kelley said.

While the Cold system may get most of the attention, Keurig Green Mountain has several other innovation initiatives under way. This spring, the company plans to introduce its K-Mug line of coffees, which will brew between 12 ozs and 18 ozs of coffee per serving.

Mr. Kelley added that the company also is researching new ways to sell its brewers and pods to consumers.

“As you know, the way consumers shop today is undergoing major transformation,” he said. “To align with the changes we are seeing in the marketplace, particularly with the younger demographic, we are testing a number of unique Keurig system shopping and pricing models. They’re designed to make it even more appealing for a broader segment of consumers to join the Keurig system.

“Today these models are being tested on-line in our Keurig Choice program that allows consumers to join Keurig for a monthly fee over a defined time period — a subscription-like model. We are also exploring these types of models with retailers, as they explore omni-channel opportunities to improve customer engagement.”

Continued growth was a key theme of Keurig Green Mountain’s first-quarter earnings discussion. The company estimates the size of the brewer market is approximately 70 million households. To continue growing, the company will have to focus its efforts on being more targeted, Mr. Kelley said.

“We know we can do much more finite targeting to continue to grow the installed base,” he said. “And then over the longer term, we know that exciting innovation, exciting brewers, beautiful brewers, new colors — it excites the category. And we know we can create that excitement. We can drive the category, and it’s about innovation. Those are some of the things that give us the confidence that we can continue to grow.”
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