Peet's Coffee & Tea Inc. Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript

Oct.28.08 | About: Peet's Coffee (PEET)

Peet’s Coffee & Tea Inc. (NASDAQ:PEET)

Q3 2008 Earnings Call

October 28 2008 5:00 pm ET

Executives

Patrick J. O’Dea – President and Chief Executive Officer

Thomas P. Cawley – Chief Financial Officer

Analysts

Lawrence Petrone - WR Hambrecht Co

Nicole Miller - Piper Jaffray

David Tarantino - Robert W. Baird

Matthew DiFrisco - Oppenheimer & Co.

Operator

Good day everyone and welcome to the Peet’s Coffee & Tea third quarter 2008 earnings results conference call. (Operator Instructions) With us today from the company is the President and Chief Executive Officer, Mr. Pat O’Dea and Chief Financial Officer, Mr. Tom Cawley. For opening remarks, I will turn the conference over to Mr. Tom Cawley. Please, go ahead sir.

Thomas P. Cawley

Thank you Operator. As I begin, I need to inform you that the information being discussed in this conference call includes forward looking statements that involve risks and uncertainties. Our actual results may differ materially from those projected in these forward-looking statements so Peet’s can give no assurance to the effect of these statements and we assume no obligation to update them. For additional information concerning factors that can cause actual results to differ materially from those in our forward looking statements, please refer to the section entitled, “The Risk Factors” in the most recent annual report, on form 10-K for the year ending December 30, 2007 filed with the SEC on March 14 of this year and our second quarter 10-Q filed August 8, 2008. They are both available on Peet’s website. Now, let me turn it over to Pat.

Patrick J. O’Dea

Thanks Tom. In this call, we would like to cover three areas. Our third quarter performance, our outlook for this year, and guidance for fiscal 2009 within the broader context of our growth strategy. Before I do so, I want to highlight the three most important take aways I think you will see as we progress through our prepared comments and take your questions today.

First, despite lower sales growth in the quarter than we had experienced year to date, you will see that our business within each channel was about as healthy in the third quarter as it was in the second. The difference in top line performance was almost entirely driven by the timing of new distribution and promotion activities in our grocery business which shifted from September into October.

While our retail store performance was stable quarter to quarter, both this quarter and last one, we delivered much stronger earnings than most people expected are good examples of why we only provide annual guidance when the gun just doesn’t shoot that straight quarter-by-quarter.

Second, we are reaffirming our full year guidance of $0.77 to $0.82 per share. Whether we land more towards the middle of that range or the low end will be dependent upon what kind of consumer holiday season emerges in the broader retail and web-gifting environment as we expect groceries to continue to perform well.

Third, in 2009 we expect to grow earnings in the 20% to 25% range with sales growth in the low to mid teens and we expect to be able to achieve that level of earnings growth per year for the next several years. I will talk later about why we can achieve that kind of earnings growth despite what we know will be a difficult economic environment likely for the next couple of years. Let me start with the third quarter performance.

Overall sales grew 12.5% and our earnings per share were $0.15 versus $0.13 last year. By channel, our retail stores grew 11%. If we recorded comp sales growth, it would continue to be positive and very much in line with what we experienced in the first and second quarters.

The reduction in the retail growth rate versus our year to date rate of 13% is entirely driven by fewer year over year new store openings. We ended the quarter with 22 more stores than the third quarter last year, while in Q1 and Q2, we had increases of 31 and 27 new stores respectively. Next, in our retail stores, our business remains about the same as it was in the first two quarters.

Next, our food service and office business grew a combined 34% in the quarter. This was largely driven by the opening of nine licensed stores in the quarter as well as the sales to other customers in a variety of segments like colleges and universities, specialty grocery, offices, airports, and the like that brew our coffee. We expect to expand our licensed stores in these areas from 32 when we started this year to about 70 by year’s end.

Our home delivery business declined 2%in the quarter, about in line with our expectations given the more convenient availability of Peet’s in grocery stores. Last, our grocery business grew 15% on the quarter below the year to date trend of 23% and last quarter’s 27%.

The vast majority of the lower growth rate in the quarter was driven by a shift in new distribution and promotion activity from September to October. Now, in October, we are executing new distribution into about 1000 stores, many of which we would have expected in September.

In addition, the timing of some of our promotion activities fell into October this year versus September last year. To further illustrate the largely timing nature of the grocery growth rate in the quarter, here are two other data points.

First, IRI which measures sales to consumers through grocery stores showed the Peet’s growth about 22% in the latest twelve weeks that most closely align with the quarter compared to about 24% in Q1 and Q2. Most of the difference can be explained by the shift in promotion timing into October.

Second, our grocery business over the first four weeks of the quarter in October is up 38% reflecting the promotion shift into October and the new accounts that we are selling in. So, we expect the grocery growth rate to return to the 25% range in Q4.

In summary, consumer take away and grocery remains pretty strong. The tightening shift from September to October affected the quarter and retail remains stable with Q1 and Q2. Now, I am going to turn it over to Tom who will discuss the financials for the quarter and also provide some color commentary on how we foresee ending the year within our original guidance range of $0.77 to $0.82.

Thomas P. Cawley

Thanks Pat. Our EPS for the quarter was $0.15, up from $0.17 per share last year. As we have said in the past, Q3 is our lowest sales quarter for us seasonally in all channels due to the warm weather. I would like to look at the results by line item.

Gross margin was 52.9%, up 80 basis points from last year’s 52.1. The increase was driven by procurement savings, leveraging of our [clamped] infrastructure, pricing in retail and grocery and good waste management in our retail stores.

These favorabilities helped us offset higher green coffee costs, which were up 6% over prior year, which by itself generated an 80 basis point degradation in margin that needed to be offset. Year to date our growth margin is 60 basis points higher than last year, which is about where we should be at the end of the year also.

Operating expenses were up 60 basis points versus last year to 36.1%. Operating expenses were higher than last year in our specialty business as expansion of the grocery business is more expensive than our existing west coast business. Retails had lower operating expenses as we were able to leverage the overhead structure that we have built to support our business.

As I said in last quarter’s call, in Q2 we had the perfect storm of low spending in a lot of different areas that resulted in low operating expenses, and this quarter they returned to more normal levels with even a little catch up spending.

General and administrative expenses were $5.2 million versus $4.9 million last year or 7.6% of sales versus 8.1%. That is a little below our forecast since we did defer some spending and grocery marketing that was related to the new accounts that pushed into October. We will continue to see favorable leverage in this line item as we grow this expense slower than our sales. For the year, we expect to spend just north of $23 million.

Depreciation in a quarter was up 30 basis points to 4.6% of sales. This line continues to grow slightly faster than sales due to the cost of the new stores and infrastructure investments. Net-net, our operating margins increased 30 basis points due to leveraging our existing cost structure.

For the year, we expect to see our operating profit margin about 50 basis points better than last year on a comparable basis. Below the operating end line, interest income was $130,000 for the quarter down from last year’s $284,000 due to a lower cash balance. We ended the quarter with $15 million in cash versus $23 million last year.

During the quarter, we spent $2 million to repurchase some of our stock. Our tax rate in the quarter was a bit higher than it has been running at 38.2%. We trued up our year to date rate as a result of lower tax-free interest on our investment that we had anticipated. Our full year tax rate should come in around 37%.

Year-to-date capital spending was $20 million. For the year we’re expecting to spend about $26 million, half of which is for new stores. Overall, from an EPS standpoint, we continue on our path of $0.77 to $0.82 per share target. This month the EPS was right in line with our expectations and we have not changed our expectations for the year. Admittedly, our expected outcome is now more likely in the $0.77 to $0.80 range since we do not see the low 80s as probable at this point. Now, I would like to turn it back to Pat to set the strategic priorities for 2009.

Patrick J. O’Dea

Thanks Tom. As I summarized at the start of the call in 2009 we expect earnings per share growth in the 20% to 25% range with sales growth up in the low to mid teens. In addition, we expect to continue to grow earnings in the 20% plus range for the next several years. 2009s 20% to 25% EPS growth will be on top of the 17% to 20% EPS growth we will have this year, and depending on where we end this year within our $0.77 to $0.80 range, it implies range for next year of about $0.94 to $1.00 per share.

There are a number of factors that will drive our strong earnings growth next year and in the years to come. First, our growth strategy change has never been overly dependent on building an ever-higher number of new retail stores every year. As I have said on many occasions, we are a specialty coffee and tea company that happens to have retail stores not a retailer dependent on accelerated unit growth.

For perspective, by the end of this year, our wholesale business will be approaching $100 million growing more than 20%, delivering profit margins in the mid to upper 20% range with an ROIC that is demonstrably higher than the current company average. We will continue to grow this business at a high rate in 2009 and the next several years. At the same time, in 2009 we will reduce the number of new company stores to just ten high performing units, but continue to add profitable licensed units between 30 and 40 in 2009 in captive locations like specialty groceries, airports, universities, and offices as part of our multi-channel plan to develop Peet’s in the market.

The second reason for our stronger EPS growth outlook is the financial leverage we will realize as a result of the infrastructure investments we have already made. During the past three years in particular, we have invested pretty heavily in people additions, a new plant, and the DFC system. As we add to our top line, we will achieve financial leverage in all three of these areas. Third, we have built unique capabilities that will enable us to drive our top line performance over the next several years. By the end of this year, we will have a DFC system serving about 8,500 grocery stores throughout the US, in markets which collectively account for about 65% of all specialty coffees sold through grocery stores.

We will continue to leverage this system to build Peet’s share in the western US, achieve strong year over year growth in newly achieved eastern and midwest distribution and it will also serve as a pipeline for new coffee and tea initiatives currently under development. Finally, we have significant cost reduction opportunities in just about every area with the exception of the high quality in coffee we buy, including procurement, distribution and overall expense management, all of which we are aggressively pursuing.

For these reasons, I am encouraged as we prepare to enter 2009 despite the head winds in the broader economy. Now, I will turn it over to Tom to provide direction on the components of our EPS guidance for 2009.

Thomas P. Cawley

The resulting financials for the year reflect these strategies. We expect to grow our EPS from the 20% to 25% range. Our specialty consumer sales will continue strong growth in the 20% range while retail growth overall will not grow as fast due to adding only ten stores. As a result we will fuel growth just under 10%.

One thing to note, our assumption in retail that we do not see improvement in the economic environment and we are planning our business as such. This combination of moving our mix to more specialty business and not incurring the losses of many new stores will result of about a half point of margin improvement next year. Let me give you some more color.

First, gross margin will be about flat to 2008. As we have said in the past, coffee is the single largest expense we have. Year to date, green coffee costs are now up to 14% of sales for Peet’s. Over the past four years we have seen raw commodity coffee almost double.

We have been able to manage this environment with effective hedging. For example, so far this year we have managed to limit our green coffee inflation to 6.5% versus the 19% average inflation one would have experienced had they purchased green coffee in the market with just the three-month lead-time. For next year we have also hedged our coffee and as of today we have purchased 85% of our total coffee for next year at a price 2% to 3% above our well-managed 2008 costs.

In addition, we are expecting other commodities to be flat for the year. We have plans to offset commodities and coffee inflation with savings initiatives and pricing we have taken this year and as a result expect improvement in our retail gross margin while holding our specialty gross margin flat. However, if the mix of our specialty business, which has a lower gross margin increases, it will offset the gains in each business and will result in the total company gross margin to be about flat to slightly up for the year.

Operating expenses will improve by about half a point next year due to improvements in retail as we lower our investment level in new stores. We have consistently communicated that new stores are a drag in our margin, so opening fewer of them will help. This improvement will be somewhat offset by an increase in operating expenses in our specialty business. Specialty has historically and will continue to run with very low operating expenses, about half of retail expense rate, but it will get higher next year as we continue to grow grocery in the east which runs higher operating expenses than in the highly profitable already leveraged western US.

Between depreciation and G&A, we expect a wash in percent of sales when comparing 2009 to 2008 as a slight leverage in G&A is offset by a slightly higher depreciation as percent of sales. The net result is that we will leverage a low to mid teen sales growth and 20% to 25% EPS growth. As you get below operating income, the P&L could look different depending on what happens in the stock market. As you might have seen today in our 8-K filing, our board yesterday authorized the company to repurchase up to an additional one million shares.

While this is not a commitment to repurchase shares, depending on our stock prices, you could see our interest income decrease or go away next year and our share count drop. At today’s prices, that would be a few cents accretive to us which has been contemplated in our guidance. Some of that benefit will be offset in your models though because our tax rate would be about 80 basis points higher than this year as we lose the tax benefit from our tax-free investment income.

We project that we will be able to maintain 20% to 25% earnings growth in our future as well by expanding our consumer business, leveraging our infrastructure, and operating a very profitable retail business. Our plan is to improve our operating margins by approximately 50 basis points per year over the next several years just as we did in 2008 and are projected in 2009. This will result in growing our EPS at a rate much faster than our sales.

At times like this the diversity of our income stream provides us the flexibility to adapt our strategy by emphasizing the more profitable less capital-intensive consumer wholesale businesses which is exactly what we are doing.

That is all I have prepared. I will now open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) We will go first to Larry Petrone of WR Hambrecht.

Lawrence Petrone - WR Hambrecht Co

Good afternoon gentlemen. Just a couple of questions. First, Pat, if I could take you back to your comments around the grocery channel. Earlier this year, you were looking at potentially being at about 8,000 stores by the end of the year. Just wondering where you see that figure at this point, and how many stores were you in and did you add any new stores in the third quarter.

Patrick J. O’Dea

So we are going to end the year with 8500 and... the number for the third quarter but all of the 8500 that we are going to be in came in, The third quarter was a couple of hundred. And then here in October we are adding another 1000, so that is part of the shift that I talked about earlier. We had expected to add that 1000 stores in September and one of the major customers just delayed the shelf set to October, so we are adding 1000 now to October and that will basically complete the 8500 for the year.

Lawrence Petrone - WR Hambrecht Co

So then your comments about the timing of distribution, that was mostly driven by customer decision in terms of a month-to-month situation?

Patrick J. O’Dea

Yes. These things move from timing of... it’s a major undertaking to reset the whole chain of stores and we can push it back three or four weeks, push it up, that’s all it is.

Lawrence Petrone - WR Hambrecht Co

Okay and just in terms of thinking for 2009, I know you obviously don’t want to give any guidance in term of number grosses you’ll be in next year, but I’m just curious what you’re thinking is in terms of deploying capital in that channel for next year. You mentioned earlier, I think Tom mentioned earlier, about the operating advantages of putting capital into that channel. Just wondering if you’ll look, and I presume also you’re still below 50% ACV in terms of that channel. There’s plenty of opportunities there. Just wondering whether or not you’re looking at being as aggressive next year as you have been this year with that channel.

Patrick J. O’Dea

So let me talk about that for a second and what’s going to happen next year, where we see the growth coming from. So next year the bulk of our grocery growth will come from building sale and share in the west and where we’ve added new distribution during this year in the east and midwest as opposed to adding a lot of new store or new market distribution, so to adhere to my comments earlier, that the end of this year we’ll be in 8500 stores and those 8500 stores are in markets which collectively account for 65% of all specialty coffee sales through grocery so we’re in markets that represent 65% of the category. It really makes more sense for us at this point to build our business in these well-developed markets and stores before running ahead to add a lot more new markets where the category is less well developed right now.

So in the western US, we expect to grow in the low teens next year where we’re already well established. For perspective our growth rate in the west over the past year has been in the mid-teens. In the west we’ll probably add 200 to 300 stores that are really just fill in some of the markets. In the east and in the midwest where we’ve added all this new distribution over the last year and a half to two years, we’re going to grow in the 60% to 70% range and that will largely be driven by the new distribution that we’ve achieved this year, much of it late in the year like right now in October.

So for perspective, outside of the west and the east and midwest, we’re growing more than 100% right now obviously from the new distribution and that’s without the benefit of the 1000 stores that we’re adding as we speak. At the end of 2009 we will add a few new markets and so all told between the fill in in the west and the geographies we’ve already entered, plus a few new markets late in 2009, we could add up to 1000 or so new stores next year, but the bulk of our growth is going to come from places we’ve just entered.

Lawrence Petrone - WR Hambrecht Co

I suppose that this deeper penetration in those markets you’re already in gets back to the comments that Tom made earlier about controlling marketing spend and your operating expenses allows you to leverage what you’ve already got in those markets in the east and west coasts.

Patrick J. O’Dea

I think yes, and I think the key to success and it’s been successful for us and I just [run the SD] business, I think this is the way to go. You sort of bite off a big chunk and then you build it and then you bite off another big chunk and you build it again. We did that in the western US. We went into about 4000 stores and we spent a couple or two or three years really building it and have turned it into a high performing, high profit, high growth business.

We just bit off another 4000 stores in the last year and a half in the east and midwest and now we’re going to build those along with what we have in the west as well and then we’ll go on from there, but it’s much more effective, it’s much more profitable, and ultimately more successful to build where we have it and frankly we’re in 65% of the category in the markets we’re in, so while it may only be about 40% of the US grocery ATV, we are where specialty coffee is sold right now.

Operator

Your next question comes from Nicole Miller from Piper Jaffray.

Nicole Miller - Piper Jaffray

I just wanted a couple things. How much are the coffee blocks for next year, Tom?

Thomas P. Cawley

We purchased 85% of our coffee through it for next year.

Nicole Miller - Piper Jaffray

The guidance you gave, what kind of coffee prices like inflation in general does that contemplate, and then what kind of price increases if any add [retown] grocery does that include?

Thomas P. Cawley

It includes 2% to 3% inflation in coffee costs on a year-over-year basis and there’s no pricing beyond what we’ve done in 2008.

Nicole Miller - Piper Jaffray

I certainly appreciate the growth in grocery but just a quick question on the store count of 10. I realize it’s not a main driver, but just more curiosity. Is that pull back due to just the environment, is it due to your balance sheet, or we’re hearing a lot of retailers and restaurants talk about some of the sites not getting built out as landlords can’t get access to cut it, so I’m just wondering what is kind of your main driver and how you decided how many stores to open next year?

Thomas P. Cawley

It’s all the above, Nicole, a little bit. In fact one of the things I did last year, there’s other thing going out which is some people are pulling out of some centers with people like Whole Foods pulling back and things like that. It also is disrupting some deals, for example, we have a deal in Seattle that Whole Foods has backed out of that we’re delaying opening until they get another tenant, so we’ll actually only have 23 stores this year which I didn’t mention in the speech, but it’s a combination of a lot of things. There is developments that are not being built that were being built in the past, but also it really is more driven by our internal, putting our resources against the business that we see has much higher returns.

Our objective as we go forward, we’re running the business out of an ROIP kind of in the 11.5% range. Just next year we start looking at it, we can probably improve that to about 14%. We’re targeting with the specialty business is growing more that we can have a 20% return on our invested capital because of the effectiveness of our specialty businesses we grow, so that’s the biggest drivers external environment right now. Obviously it’s about the best time to be building your retail stores as there are more closing than opening across the country but I think it’s more the opportunity that we have is just so attractive on the other side of our business.

Patrick J. O’Dea

Yes, and I just wanted to add real quick to that, Nicole, I think the last point that Tom made is true because as you know, when it comes to store development, the pipeline is [rough in] advances but when you actually build the store so [inaudible] would only be building ten stores next year. We made the decision to do this awhile back before some of the things that you’ve seen in the marketplace started to occur in the last couple of months, so we had sort of made the decision in our mind to throttle up on the consumer business heading into 2009 and throttle back a little bit on the company-owned store business because of the size of the consumer growth opportunity, because frankly in part we’re going to be adding 30 to 40 new licensed stores which we think will be an effective tool and weapon for us as we develop Peet’s in a particular market, so we made the throttle back/throttle forward decision awhile back.

Nicole Miller - Piper Jaffray

I may have missed this, so if I did I’ll just read it in the transcript, but did you say where the 10 stores are going to open?

Patrick J. O’Dea

It will be in existing markets.

Operator

Your next question comes from David Tarantino from Robert W. Baird.

David Tarantino - Robert W. Baird

Tom, on the 2008 guidance, it seems now you’re pointing towards the lower to middle part of the range whereas last time it seemed more like the middle of the range. I’m just wondering what’s changed since 90 days ago to make you be a little bit more cautious.

Thomas P. Cawley

A lot has happened in 90 days. One of the things that we do find is the holiday season, our retail business, is very much driven by just feet on the street from people shopping and things like that, as well as our gifting business and our home delivery. So I think it’s very good just looking at the grocery business but that’s not going to be an issue, but it really is a kind of an uncertainty that what’s going to happen in November and December, when I see the mall traffic numbers, not that we’re in malls, but just people out and about. We do get a pretty big bump in our business from those folks and if they’re not out we are a little bit worried they might not be coming to our stores, so I think it’s just kind of the whole consumer confidence at an all time low and all those sort of things.

David Tarantino - Robert W. Baird

So just to be clear, it’s more conservative than in your outlook over the next few months than what’s happened in the last three or four months?

Thomas P. Cawley

Yes, I think it’s more taking a guess as to what can happen in November, December with retail and gifting. That’s really what it’s all about. Our business in our stores as I said

in the prepared comments here, quarter 1, quarter 2, quarter 3, if we were reporting comps, it being nearly identical, so the consumer, the Peet’s customer anyway in our stores is coming in the third quarter just like they were in the second and first but in the fourth quarter there’s a lot of incremental volume associated with other people shopping in other retailers who incidentally stop at Peet’s and people who are gifting, so and then that dynamic isn’t in our first, second, or third quarter so if there’s any caution toward the 77, 80 as opposed to the 80, 82, that’s where it would be.

David Tarantino - Robert W. Baird

Got it, and a question on the current quarter or the Q3 EPS. Was the shift in the grocery distribution or promotion, did that impact earnings in the quarter negatively or positively?

Thomas P. Cawley

Negatively, yes. I mean our sales, obviously there was quite a bit of sales attributed to that we don’t have a flow through so it’s part of the reason why our operating expenses look higher, we didn’t get the leverage from the additional sales in the business, so we do think that a good portion will be pushed into the fourth quarter, so net net it’s not a impact that we’re concerned about, but it did impact the quarter.

Patrick J. O’Dea

Yes, it was timing. Just to be clear, it was two separate things. One is new distribution into about 1000 new stores throughout the east and the midwest and that’s just filling the pipeline, and that part didn’t cost us anything. If anything, that was a slight net positive. Then the second piece was promotion timing meaning the timing on which the major customers decided to execute their Peet’s promotions this year versus last year and they went into October.

David Tarantino - Robert W. Baird

So Tom on a net basis, could you help quantify the earnings drag that impacted Q3, roughly speaking?

Thomas P. Cawley

It would probably be north of a penny, it may be as much as two.

Operator

Your next question comes from Matthew DiFrisco of Oppenheimer and Company.

Matthew DiFrisco - Oppenheimer & Co.

Congratulations on being able to have a good growth year in ’08 and a good growth year in ’09. I don’t think any of us expected high 80s so what you’re doing I think is pretty strong in this market. You didn’t talk about the gas or natural gas that has been in the past somewhat of a drain and I know natural gas and utilities were relatively high for normal retailers, you guys with the roasting facility, I wondered if there was any pressure in the margins in 3Q that we might see upbound a little bit in ’09 and provide some margin relief as well.

Patrick J. O’Dea

I wish I had good things to say on that on the natural gas front. About three months ago we hedged for the following year on our natural gas. We actually locked in our prices, so we’re not going to get the benefit of natural gas prices coming down until fourth quarter of next year basically. Is that what you’re referring to, the drop in cost?

Matthew DiFrisco - Oppenheimer & Co.

Exactly, and I know you guys use natural gas to do the roasting process and it’s come up in different talks before.

Patrick J. O’Dea

We won’t have a benefit nor a cost from it which in this market would have been a benefit but we’re locked in with our prices.

Matthew DiFrisco - Oppenheimer & Co.

Can you talk about what you expect as far as what are these licensed stores? What are the volumes you expect to get from them? Are they kiosks or are they going to be selling the full menu that you sell at a company owned store? Then I also had a question on what are the particular regions first that you’re going to be looking at first to build out?

Patrick J. O’Dea

The stores do have the full menu with the exception of they don’t scoop beans but some of them will sell pre-packaged beans and they tend to be anywhere in size from a kiosk within a grocery store which would be rather small to an airport location that could be or even a mall location that could be 1500 square feet. Generally though they’re hundreds of square feet, they’re fairly small.

The sales volume varies fairly dramatically too. When you’re at grocery stores they tend to do less than $0.5 million of sales, and when you’re in a good airport location you could be doing multi million dollars so on average you’re probably pulling $0.5 million because there’s more often they’ll be in grocery stores. [inaudible] other people are in, we don’t have a lot all over but that’s the type of, because we look at the industry and what we might expect in some of these.

Thomas P. Cawley

And the way we use them is we target, when we think about developing Peet’s in the marketplace, we have our own stores, we have partners who would brew coffee with us which would be the licensed partner in this case, or in some cases, it’s just a brewing partner. Then we have home delivery and other food service institutions like restaurants and stuff, so when you look at the market and when we go in and we decide where is our target market and where do we want to develop brewing partners and there’s, out of that we match that up with the demographic and [psychographic] profile for Peet’s and then we develop a list of target potential partners and as far as licensed brewing is concerned, that includes specialty grocers, airports, colleges, and universities and from select particular large office complexes.

In terms of where it’s going to fall, what markets, that’s much harder to tag that just because you’re out there selling it and you can’t always be as selective about who’s going to buy it and on what timing because sometimes there are people who have existing contracts and sometimes it’s wide open playing field but obviously we would want to develop this business in any market where we’re currently in the consumer business.

Matthew DiFrisco - Oppenheimer & Co.

And then just looking... in the past with the relationship whether it was Omni or some of your We Proudly Brew that you had in some of the chains in the Pacific Northwest, those sales were... some of those contracts expired and you didn’t get the sales back. I’m just wondering about the stickiness of these type of agreements for say a traditional franchise relationship where you might have a businessman develop a market over a five to ten year period and be an owner operator of the stores that’s predictable and sustainable. Are these stores going to be several operators or are we looking at the end of the day having a couple of hundred licensed stores with three or four relationships or are they going to be 10 to 20 relationships and three to four stores per licensee?

Thomas P. Cawley

You know the stickiness point varies depending on what you’re looking at. What we’re mostly focused at is two places. One is sort of what I call large strategic multi customers where we see a licensed stores as an opportunity to build awareness for Peet’s in a market where we want to do it. A great example of that would be Sacramento and what we’ve done with the chain up there where they have about 100 stores that either have a licensed Peet’s in them or will have a licensed Peet’s in them and that will be 20% to 30% of that 100, and then the other 70 will have another smaller scale brewing solution for Peet’s that short of a licensed store.

That’s the strategic relationship that helped us build market share and internal awareness for Peet’s in the market and in fact in the last couple years we’ve been able to raise our market shares as a result of brewing partnerships like that in Sacramento and being basically tied for share leadership there now in the grocery business. Then there are, there’s a second category of brewing relationships either through licensed brewing or We Proudly Brew program, where it’s not at the point of sale for coffee at home like the grocery store, but it’s to a specific target audience and that would be places like airports, colleges, and universities and some special large office complexes.

In places like airports those agreements might last for five years and they are through a partner. Those things might get bit out every five years or so, so you’ll have some turnover in places like that. You tend to have less turnover in places like colleges and universities and some of the businesses. I don’t see it as sort of a high churn in and out business. People are making a fairly significant commitment. I think you’ve seen other people do a large number of licensed stores and you don’t see them fluctuating down up or down dramatically year-to-year.

Matthew DiFrisco - Oppenheimer & Co.

The first experience I had was at JFK so hopefully you expand this way also, give us New Yorkers some good coffee.

Thomas P. Cawley

Hang on there, we’ll get a licensed store coming into JFK shortly.

Matthew DiFrisco - Oppenheimer & Co.

That would be great. Last question, Tom, are there any stores, I know you’ve talked in the past about the drain from the last three years worth of growth and the slower development for those stores to get to full volumes and profitability in contribution. Are there any stores or have you done the analysis of some of those stores that might be at a tipping point if we take another leg down in the say the Inland Empire in Southern California where you’ve opened some of those stores, takes another step down where we might close those stores and have a beneficial impact closing them?

Thomas P. Cawley

Yes, we have one store in the Inland Empire that we opened. We tend to... if we were in a market that was hit by sub-prime right now, right then or something like that and the store was doing less than our expectations, our predisposition would be to wait it out and try to build the business there, so we’re not very quick to pull triggers going to bail out of something because of the environment around it in the short term, so there’s not really, that’s not in the plans to do something like that.

Matthew DiFrisco - Oppenheimer & Co.

So if the store was losing cash greater than the lease payments you’d keep it going?

Patrick J. O’Dea

We just don’t have a lot of stores that fit that profile. We have a lot of stores that are new in the last three years that are progressing along their maturity curve but if we sit down and look at our stores, we’re not looking at it and saying “That one needs to be impaired, that one needs to be impaired.” Our stores are pretty well targeted to more insulated areas as Tom said and someplace like the Inland Empire in Southern California where we only have one store, I think it builds pretty well, actually. I mean, I guess to your question of saying would we just hang on to dogs that are draining money, no. We closed a store earlier in the year in Denver that was a bad real estate decision for that exact reason, so if we had them, we wouldn’t e afraid to do it. It’s not like there’s a long list that we’re going to improve our P&L by closing 40 stores or something like that.

Operator

It appears we have no further questions at this time. I’ll turn the conference back over to our speakers for any additional or closing remarks.

Patrick J. O’Dea

That’s it for us. Thank you all for coming and we look forward to talking to you on our year-end call in February.

Operator

That concludes today’s conference. You may disconnect at this time. We do appreciate your participation.

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