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

Q4 2008 Earnings Call Transcript

February 12, 2009 at 5:00 pm ET

Executives

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

Thomas P. Cawley – Chief Financial Officer

Analysts

David Tarantino - Robert W. Baird

Analyst for Matthew Difrisco - Oppenheimer

Steve West - Stifel Nicolaus & Company, Inc.

Lawrence Petrone - WR Hambrecht Co

Colin Guheen - Cowen and Company

Operator

Good day everyone and welcome to the Peet’s Coffee & Tea fourth quarter and 2008 year end earnings results conference call. As a reminder, this call is being recorded and we will be conducting a question-and-answer session after the presentation. With us today from the Company is President and Chief Executive Officer, Mr. Pat O’Dea and Chief Financial Officer, Mr. Tom Cawley. For opening remarks, I will turn the call 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 will include forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those projected in these forward-looking statements and 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 could cause actual results to differ materially from those in our forward-looking statements, please refer to the section entitled, “Risk Factors” in the most recent annual report, on Form 10-K for the year ending December 30th, 2007 filed with the SEC on March 14 of this year or our third quarter Form 10-Q filed November 6, 2008. They are both available at Peet’s website. Now, let me turn it over to Pat.

Patrick J. O’Dea

Thanks Tom. In this call, we will cover our fourth quarter and full year performance and our outlook for fiscal 2009 within the broader context of our growth strategy. Before I do so, I want to highlight three important takeaways from our prepared comments today.

First, today we reported EPS of $0.80 per share, up 36% versus the $0.59 we reported last year and up 21% excluding the one time option review expense in last year’s number. Internally, I call it is finishing the year. We established this back in November of 2007 when we set our annual guidance and things look a lot different. Despite the challenging environment and the heavier waiting to fourth quarter as on our annual results our people responded to the challenge. We finished and I am proud of the way our people did it.

Second, we continue to expand our grocery business nationwide with the addition of about 800 stores in the fourth. This helped drive our grocery growth plus 23% for the quarter.

Third, we continue to target earnings in 2009 in the $0.94 to a $1 range or between 18% and 25% growth. At high level, we will accomplish this by leveraging the investments we have made over the last five years in our plan or retail store base or direct store delivery selling system in our people. When Tom discusses our financial performance later you will see how beginning to leverage these past investments drove our earnings performance in 2008 and at the end, I will comment on how I see it continuing to do so in 2009.

First, let me briefly comment on our top line results in the fourth quarter by channel.

Overall sales grew 12% and earnings per share were $0.29, up 26% from last year. Our retail stores grew 8.4%. This reflects fewer new stores as we only had a 13% increase in the number of stores opened in the quarter versus last year. We ended the quarter with 22 more stores in Q4 last year while in Q1, Q2 and Q3 we had increases of 31, 27, and 22 new stores respectively. Our retail business slowed just a bit in the quarter primarily driven by lower holiday gift item sales, this resulted in our growth rate and existing stores coming in about a point below our year-to-date trend.

Next, our food service and office business grew a combined 33% in the quarter, very much in line with our year-to-date growth of 35%. This was largely driven by the opening of 12 licensed stores in the quarter as well as an increase in the number of other customers in a variety of segments like colleges and universities, specialty grocery, offices, airports, etc that brew our coffee. For the full year, we added 38 new license locations and we ended the year with a total of 68. We also added about 30% more, we probably do locations to end the year with over 700 accounts that are serving our coffee.

Our home delivery business declined 7% in the quarter, about in line with our expectations given the more convenient availability of Peet’s in grocery stores in the highly seasonal gifting component of the business, which as expected, was more impacted by the economy over the holidays. Last, our grocery business grew 23% on the quarter, identical to the full year growth rate of 23%. In the quarter, we expanded into about 800 niche stores in the East and mid-West and we ended the year with distribution at about 8,200 stores, which represents about 43% of all commodity grocery volume but a significantly larger percentage of US specialty coffee volume as we are targeting our distribution gains to more well developed especially coffee markets.

We are pleased with these results since we were able to grow despite of the slowdown in the category growth rate overall. IRI data indicated that the specialty coffee category in grocery stores growth at a rate of about 7% in Q4, which is below to historical mid-teen’s growth rate and for the full year, the category was up about 12%

Now, I would like to turn over to Tom to discuss how we leveraged the investments we have made over the past five years to drive the strong earnings growth in 2008.

Thomas P. Cawley

Thanks Pat. Instead of repeating within our press release by line item for the quarter I want to step back and talk about the results for the year because I believe they are indicator what the future looks like.

All the numbers I quote will be comparing to 2007 full year, excluding the costs of the stock option review in 2007, in other words, it is all apples-to-apples.

For the full year we grew sales 14% while we grew operating income 31%. We were able to grow earnings at this rate by improving our operating margins from 5.2% of sales to 6%. Instead of looking at this by line item which you can all do in the press release, I want to relate this margin improvement back to the key thing for this year and next that we are leveraging past investments we made in the business to improve operating performance.

Number one, we have invested in people and systems that are improving the operating effectiveness to our retail organization. These investments helped us control waste in our stores, to manage labor effectively and to control the overall spending that it takes surround our stores, like maintenance and supplies. The net result that even in our older stores that those opened prior 2004, we experienced 130 basis point improvement store labor operating profit margins.

Number two, we have invested in infrastructure to grow our business for the last five years and we are now leveraging that. You can see this in our G&A and what for the year we improved 60 basis points, from 8.5% of sales to 7.9% of sales. Additionally, buried in our retail segment results, the overhead to support our retail stores dropped as a percent of retail sales by 50 basis points; and lastly, the costs operate and depreciate our roasting plant improved 40 basis points as a percent of the Company sales. This leverage has played and will continue to play a key role in improving our overall profitability.

Number three, we have invested in growing our high margin specialty business and we will continue to do so. In our segment reporting you can see that our specialty business is reported 29% operating margins for the year versus retail at 7%. Growing this high margin business is a priority, even in the Eastern US, where our margins are slightly lower than in the West. The overall impact to growing this segment is positive to the Company.

The net result of beginning to capitalize in the investment we have made showed up in our quarter as a 100 basis point improvement in operating profit margins, this included the 70 basis point improvement in gross margins and a 20 basis point investment in operating expenses related to the grocery expansion primarily.

There are two items in operating expenses this quarter that are mentioned in the earnings release that I think warrant calling out.

First, during the quarter, we incurred $620,000 impairment charge related to underperformance of two of our stores where location was an issue for us. This compares to $365,000 charge last year. And second, through active management of open claims, we are able to lower our workers’ compensation expense reserve by $1.1 million based on independent actuarial estimate of future liability.

Last year, we had a similar positive adjustment in Q4 of about $400,000. This has been a real area focus and resource investment for us over the last several years and we are realizing the benefits of it now, specifically lower expenses in a safe and healthy work environment for our people.

Let me talk a minute about our G&A spending in the quarter. We incurred lower G&A expense and even our own internal forecast. If we remember on our last conference call we expressed concern that the poor economy might negatively impact our holiday gifting business in home delivery and in our stores. Unfortunately, we were correct. In preparation for this, however, we circled that wagons internally and examined every dollar we spend as Company to do our best to manage down expenses. Our organization stepped up to the challenge and we were able to identify many opportunities both short term and long term. As a result, we are able to make up for some of the holiday gift-related sales issues and end the year beating our own internal annual profit budget which was created much better times some 17 months ago.

Last, I want to talk a little bit about our cash flow and our balance sheet. For the year, we generated $25.4 million from operations and this funded our CapEx to $25.9 million, give or take, a few hundred thousand. We had started this year with $31 million in cash and after net investment of $17 million in our own stock we now have $13 million in cash and no debt. I point this out because in this day and age we have a business that is self funding this growth and has a capital structure that insures that Peet’s can weather any storm and still be in a position to take advantage of opportunities that may arise.

In summary, you can start to see in our 2008 financials what we mean when we say we are beginning to leverage the past investments we have made to deliver improved earnings. In addition, I think we just did a very good job in managing our business in the fourth quarter which has Pat said earlier enabled us to finish the year.

Now, I would like to turn it back to Pat to talk about 2009.

Patrick J. O’Dea

Thanks Tom. In 2009, we continue to target earnings per share $0.94 to $1 range which translates to 18% to 25% growth. On top of our 21% EPS growth this year and I believe we can continue to grow earnings in this 20% plus range for the next several years.

How we expect our accomplishments is the recurring theme of this call. We will leverage the investments we have made over the last five years in our plant, our stores, our direct store delivery selling system and our people to improve the profitability of our existing business and to drive profitable growth. While we have a full plate of downstream new growth initiative that we will continue to develop and test, our focus this year will be squirreling and strengthening our core existing businesses, not on dramatic new geographic expansion of our grocery business or new store development.

We believe strongly this is the right strategic focus for us at this time and we will strengthen the Company long term as well. The result will be stronger earnings performance, but given the economic environment, our sales growth outlook is more measured and cautious. Here is how I see the strategy translating to our two largest business channels and the general outlook for each in 2009.

We will leverage the past investments we have made in our retail stores to improve the profitability of our existing store base, while adding just 10 new stores. In mid-2008, we rolled out a new inventory management system at store level that enabled us to significantly reduce waste in the second half of the year. We will get full year benefit in 2009 at the system. In addition, we will further improve on what we have been doing and expand the system beyond just coffee, milk, and baked goods which are covered now to include virtually everything we sell in the store.

We also have a number of initiatives aimed to continue to improve labor efficiency in our stores, while at the same time increasing the service levels during our morning rush. From the sales standpoint we believe we have several things going for us in our stores that will help us maintain the trend we have been on, including the following. Initiative we have to improve our morning service levels; the maturing of a young store base where 41% of our stores are less than three years old; the lower cannibalization on existing stores as result of lower new store development; and the loyal customer following we enjoy in relatively less economically sensitive locations. These factors combined with our ongoing new bean and beverage programs throughout the year will support the top line.

Overall, I am confident we will markedly improve our retail profitability in 2009 and it appears that our sales performance will remain stable with the above focus.

I would also add that our overall retail execution under the leadership of [21.46] is really starting to gel and it could not come at better time. In grocery, 2008 was about expanding our geographic footprint and building a direct store delivery selling system into key markets around the east. In 2009, we will focus on leveraging the investments we have made in building our sales organization to drive improve performance in this new and existing geographies and accounts as opposed to adding additional significant new expansion at this time. Due to less new expansion and a more competitive environment for probably at first six months of the year, our growth rate will come down quite a bit as some competitors respond to the slowdown in the economy by temporarily price promoting at very, very low levels.

I have seen this knee jerk response several times before in my career. As was the case then, I can see clearly from the data again now that this tactic does not result in sustained sales and share improvement. Conversely, it does serious damage to our brand deteriorating its value in the consumers’ mind and eroding the brand’s long term profitability. We will not play this game and do that kind of damage to our brand. That said, in the near term we will make changes to our sales and marketing approach to increase our effectiveness during the economic environment and this kind of competitive landscape.

Without going into detail on those changes here, which is not appropriate for competitive reasons, there are number of proven strategies that premium brands have used very successful over the time to enhance their value equation to consumers in a down economy. We will be applying some of these strategies to our business and uniquely leveraging our DSD sales force to execute them in a way others cannot.

So, in the short term, we will forego some sales growth and grocery to maintain long term profitability and in the process strengthen the integrity and value of our brand vis-à-vis of the others. We will also implement the above strategies as reference to enable stronger sustained profitable growth in the near term environment.

As Tom mentioned earlier in explaining our 2008 results, we are well positioned to continuing leveraging the infrastructure we have built, the plant, people and systems to enhance our margin performance in 2009. Not only do we not have to add significant new expense to what we have built but our systems and people are enabling us to identify and achieve sustainable cost and efficiency improvements at a level we could not have achieved just three years ago.

As a result, our net outlook for 2009 at this point is slightly more bullish and confident on the bottom line and more cautious on the top line.

Over the next several years, we should be able to produce 20% plus range earnings growth, leveraging the past investments we have made and strengthen the top line beyond this year as well.

Overall, I think we are very well positioned at this particular point in time, but not only wider the current economy but strengthened our profitability in the Company long term in the process.

Now, Tom will share some general financial guidance for 2009.

Thomas P. Cawley

Okay. Since Pat did a good job summarized in the strategies, I want to wrap up and give you some information to help you to model out the year.

First off, I want to make sure everyone is aware 2009 was 53 weeks for Peet’s. So, you think about growth that we are talking about. We will get about 2% benefits from the fact that we will have an extra week. I will be at; we are adding our lowest volume of the year with the post Christmas slowdown and New Year’s Day. Also we are not planning any price increases this year on retail or grocery, so we will have to earn any improvements the hard way.

So, for gross margin, based on what we have talked about, we now expect that we will be able to improve gross margin by about 50 basis points next year. As we said in the last call we have locked in our coffee with about 2% to 3% inflation and will cost us, but that will be almost totally offset by favorable milk commodity cost which we are forecasting to remain at the levels that they are at now which will be below last year’s levels.

Neutralizing commodities will allow us to flow the improvements we are making on a retail business and leverage in our roasting plant. Operating expenses will be about flatted in next year as the investment and growing sales and specialty will offset improvements in our stores. We will continue to leverage our G&A spending as a percent of sales but some of this will be offset by growth in depreciation from new stores and the implementation of our ERP system this year which for the $6 million capital investment that we will start to depreciate.

One quick note on timing, we are expecting most for our profit growth to come in the back half of the year, so do not expect the first two quarters to contribute too much to the annual growth. We had consistently shown that there are multiple leverages that we can and have pulled in our business as the year progresses and we will adapt as things change but we will believe that overall we are pretty well positioned for what is to come.

That is all our prepared comments Operator. You can now open up for questions.

Question-and-Answer Session

Operator

(Operators Instruction) Your first question comes from the line of David Tarantino - Robert W. Baird.

David Tarantino - Robert W. Baird

Question, first, about the grocery business. Could you elaborate on what you are seeing in terms of your grocery sales year-to-date and why you think that trend will only last for six months?

Patrick J. O’Dea

Let me step back for a second here. I think first, it is clear from the data, the most recent data that we have, that mainstream coffee and grocery stores is enjoyed a little bit of an uptick due to the economy and that the specialty category growth rate has come down a little bit to about 7% in the fourth quarter versus a 12% growth rate for the full year 2008. So, there has obviously been some dynamic and trade down that occurred there. However, despite that in the fourth quarter we are able to grow 23% equal to our annual growth rate and part of the way we had to do that was give back a little bit of the price increase that we took in August in the form of sort of some increased promotion.

I think what I am seeing happening now in the short term is there are groceries out there who would just assume one up kind of hold on to the higher pricing that they have now and instead of sort of getting the price right everyday and so the dynamic that occurs in the marketplace is sort of workers’ manufactures to get significantly more promotional spending and sort to try to bridge the gap if you will by going much deeper on promotion and then holding their everyday price and not only works for a very short period of time because you get a big spike in sales but it is not sustainable and what happens is the consumers just get trained not to buy unless it is on promotion.

So, based on my experience and what is occurred in the past, after a few months of seeing that that does not work, what will happen is the grocers working with people like us will get the everyday price right and then get back to a more sort of stable everyday price promotion strategy, which is sort of better for the branch, better for the category etc. I think in the short term you can see some pretty irrational things happen but when they do not work that the ultimate solution will be that prices will come a bit in grocery stores on an everyday basis and then a category starts growing again.

David Tarantino - Robert W. Baird

Okay. Could you maybe tell us directionally or at least give us a range of where your grocery sales are trending in terms of year-over-year change?

Patrick J. O’Dea

Change in the first quarter?

David Tarantino - Robert W. Baird

Yes.

Patrick J. O’Dea

Yes. Actually probably not a good idea for us to try to do that since we only have first six or seven weeks and based on promotion activity it could be either errantly high or low depending on timing.

David Tarantino - Robert W. Baird

Okay. Question on the retail business and you mentioned that sales trend slowed by about a point off of your run rate in Q4, was that strictly related to the holiday related spending and have you seen sort of a bounce back in the terms as you exited the holidays?

Thomas P. Cawley

Yes. I mean, as we said earlier David, this is Tom, that we had a big negative numbers on our hardware package food and our gifts and so forth. We continue to have growth in our traditional drinks and pastry business and those are doing very nicely, so as you kind of look and just say if it were not for that gifting we would have ended up on a very similar trend to where we had been. So, I think it is just a mix of the business that we had at that point in time. We did see slight falloff that we are talking fractions of percents type of stuff in some as a based business. So, as that is kind of bleed as way out because we do not sell much hardware package food the rest of the year. We do not have that negative drag on the business.

Operator

(Operators Instruction) Your next question comes from the line of Matthew Difrisco - Oppenheimer.

Analyst for Matthew Difrisco - Oppenheimer

Hello, this is Jake for Matt. I had a question on a margin outlook and just trying to [disaggregate]. It looks like you have a better margin outlook than you had before, just trying to figure out the pieces of that kind of new better outlook given the sales is not down a little bit. Is that from the slowdown of going into new grocery stores or anything else and by line item we can think about?

Patrick J. O’Dea

Sure. One big thing is we give guidance last time. We then have a good visibility towards milk and note actually is going to be very favorable for us on a year-over-year basis, in fact as I said earlier, totally offset the commodity impact at coffee providing following our forecast which is we are basically stay where it is right now.

So, that is one of the changes as we have got more conservative looking at our sales. That was one offset. The other is, as we went through probably in the past four months, we have dissected this business probably more than we had in the past four years and going through every single how we spend it, where the effectiveness of where we are doing things and I think you saw some of the results in the quarter but it also, as I said, some others are long term thing. So, our co-structure we have been able to get more efficient and we are implementing the ERP. That is going to be turning it on in May. We will start to get some benefits from there and what is doing is giving us a lot more visibility to things and we are much more comfortable that we can take cost at about our plant, takes cost at out stores and get more efficient as we build our business now in existing markets and grocery, get more efficiency in place just like shifting and getting the product there and start to leverage that.

So, those I think are just going through. When we gave guidance in November we had been through the full budgeting cycle yet and as we went through we just gotten a lot more clarity of what our cost right.

Analyst for Matthew Difrisco - Oppenheimer

Okay. And then in thinking about G&A, you talked about how you pulled back and given what you are looking at for the fourth quarter, wondering if there is any snapback on that or whether the efficiency’s gain or pull back is more permanent in nature?

Patrick J. O’Dea

It is permanent or earnings permanent. Yes. We did not defer things.

Analyst for Matthew Difrisco - Oppenheimer

Okay.

Thomas P. Cawley

First quarter anything like that. As we went, it was structural things that we are looking how we are doing business.

Analyst for Matthew Difrisco - Oppenheimer

Okay, great. And then in terms of the grocery, I believe you opened, I think you went at about 300 stores than was guidance and then so we expect no additional stores I think with a thousand for 2009 was the time prior….

Thomas P. Cawley

You know what? We are still our finally going to grocery store next year that will be later in the year where as a few markets will open up probably in the first two quarters you will see virtually none. There will be some selling to some existing markets but we are still expecting to do about a thousand next year.

Analyst for Matthew Difrisco - Oppenheimer

And then in terms of the grocery, can you give us anything you have seen on a regional basis? Is it your newer markets that you see more competition? You know were your competitors might be leaving you alone on the West Coast or anything regional that you can talk about?

Thomas P. Cawley

Not necessarily, actually the Eastern U.S. actually growing in a very rapid rate and the overall grocery trade margins in the Eastern U.S. tend to be lower so prices to the consumer now are more favorable. In the Western U.S. grocery margins tend to be higher and so prices on specialty coffee everyday tend to be higher so I think if anything and see a sort of some of the more aggressive short-term pricing things going on from a promotion standpoint that do not make a lot long term sense. If anything will probably occurring more in the West than in the East.

Analyst for Matthew Difrisco - Oppenheimer

Is it basically Starbucks is doing that or just every players is doing that including Dunkin Donuts and all the rest?

Thomas P. Cawley

It is probably, I think there is because Starbucks is 35% of the category that obviously their one of the people who where involved with it but we are seeing it in other brands also.

Operator

Your next question comes from the line of Steve West with Stifel Nicolaus & Company, Inc.

Steve West - Stifel Nicolaus & Company, Inc.

I want to get some clarity on or maybe a little more color on the revenue growth and you are looking at the account of 13% and you are talking about especially being way down in the first half or I guess you know the slower growth I should say. Can you give a little more color on what you are looking for, for specialty sale or at least a magnitude that you think will be down or up like 10% or something like that. So I am just trying to figure out how you are getting the 10% to 13 % because the retail is like it is really slowing down and in the fourth quarter its look like you got some inferred negative traffic there? Do you think that it will carry through for the year and so the net put your revenue number there at risk and therefore the kind of the overall number?

Thomas P. Cawley

Yes, so we started out is the retail for the year we are looking at high single digits and that does include an extra week so going from very high meaning we are now in mid-high if you were to take without the fifty third week. You know we have very little unit growth so we are not planning on our business, trying to be negative on a count basis or anything like that. So that is where we are thinking at the trend that we have had will continue and we are seeing a much better resilience from our customer given the demographics of where we are located and then our business is holding up much better and we do anticipate that.

Patrick J. O’Dea

And just to clarify what Thomas says, the trend we have been on all hold. You know that means for the first three quarters of 2008 the sale we are on was very stable and pretty much the same and dropping about a point in the four quarter and we expect the trend to continue like it was in the first three quarters of 2008 after getting short fall on the fourth quarter. So recent trend, we do not mean the trend is going down and unit trend is pretty flat

Steve West - Stifel Nicolaus & Company, Inc.

Correct. Okay, that is very helpful. Okay.

Thomas P. Cawley

Similar type performance as we had last year for the full year

Patrick J. O’Dea

Our term line will be horizontal.

Thomas P. Cawley

There is a mix change in the business. In the quarter you get different results but for the year we were growing the business modestly positive and we think that it will continue.

Steve West - Stifel Nicolaus & Company, Inc.

Okay and then with the kind of maturity of the stores and you get to talk about that before you really driving operating property as they get older. How much of the boost is that for your backup and your property growth? Is that the main part of it there?

Thomas P. Cawley

That is very good callout Steve because as you start looking at the percent of stores and how new they are, the later in the year we get next year. We have very few stores that are new so even as we go in the Q1 since we open seven stores in the fourth quarter, we have seven stores that are coming in very low but how do we get to the lower sales lows? And then you have the once we open from the 23 that we open in 2008 in the first quarter they were all still very young. But coming into the fourth quarter those were matured along and we will only have 10 more coming in so that does help from a retail profitability standpoint push back some of the earnings growth rate in the year just because we have very little start up and since our stores at least if the developers are on time we will be skewed a little bit earlier in the year this year.

Now that is open on the fact that we are finding developers push things back. But, so that is a good callout. That is part of what we will be driving later in the year growth. As well as obviously the fourth quarter is going to benefit because that is an extra week.

Steve West - Stifel Nicolaus & Company, Inc.

Right, exactly. One last question on the depreciation amortization, with the new ERP system coming in can you maybe guide us at least direct and accurate what we are looking for on the year as far as the percent of sales maybe?

Thomas P. Cawley

Yes. It is a pretty decent size numbers so $4 to $6 million and it is really up with the IT system, I think we are only putting it five year life on it.

Steve West - Stifel Nicolaus & Company, Inc.

Okay.

Thomas P. Cawley

And now we will be employed since of May so we do not get a full year benefit but if you the math on that it is a pretty big chunk. You know it will start to annualize it is over a million dollar depreciation a year so we will get a good portion of that this year so as you are building it you can get that.

Operator

Your next question comes from the line of Lawrence Petrone - WR Hambrecht Co

Lawrence Petrone - WR Hambrecht Co

I am just wondering looking at your guidance for your new license locations for 2009 it does not look like that you are facing any problem with regard to finding new partners to license Peet’s for the location, in other words you are not finding any problem in finding partners who perhaps might be a little bit hesitant given the economy. I am just wondering what your thoughts are there?

Patrick J. O’Dea

Yes, I think we said 30 to 40 new licenses.

Lawrence Petrone - WR Hambrecht Co

Yes you did.

Thomas P. Cawley

So they…I think there is opportunity here, it is more leasable and large traffic locations were we do not any have an existing competitor. So if an airport is opening up or a New Wing is being remodeled or something like that, we can get in there pretty swiftly and there is not any concerns about the economy on that type of situation and especially grocery stores whether they might be an existing player and groceries might be looking at totally cutting back on capital spending and saying, do I wan to make a big change? I think in places like that it will be a little bit more challenging but I think in terms of the goal we have which is 30 to 40 new type of locations we should be able to persevere despite those kind of situations.

Lawrence Petrone - WR Hambrecht Co

The other question so to relate down at least on the retail side, with all the investment that you have made over the past 12 months as you said earlier, in infrastructure, in driving the efficiency gains that you driven. I am just wondering what kind of impact that it had on the three ramps in new stores. I mean have you found that the types of thing you are doing and plan to do would, in fact shortened the period for that new store to reach maturity?

Thomas P. Cawley

Not specifically. A lot of the stuff we have done is realty more on the cost side than it has been on sales building side of things. One of the things that is making it harder in the environment of our ramp and so forth is just we are going into headwinds when we tend to open in there and so it will be less important for us because we are going forward just as our last ramping that we need to do with fewer stores. But I would say that if you were to breakdown… if we put $100 of investment into the stores from system and process and so fort, you know $80 of it has gone after the cost structure as were in and then $20 is gone after probably things vary in service and things like that. It is not marketing and so forth as far as investment.

Lawrence Petrone - WR Hambrecht Co

Just last question on the CapEx for this year, I do not know if you mentioned it in your prepared comments but it sounds like it is going to be meaningful itself of the $26 million that you invested in 2008?

Thomas P. Cawley

Thank you for asking that question I forgot to call that out and so that is why I can do it. It will probably more like $16 million. So we will open up about $10 million of CapEx so just to give you a breakout of where it is. The new stores will consume sort of $5 million. We are going to do some remodels including our flagship first store that we will be remodeling that is going to be closing in a week. To start remodeling that our Bind streets Store in Berkley and we will spend about $1.5 million on remodels for the year. We spent close to $2 million on just regular stores and just things that we are doing all the time. IT is a lot of spending this year. We will spend about $4 million on IT and our especially businesses is in total there is maybe a million dollars total in capitals. So there is not a lot for grocery food service. And then we will spend a couple of million in the plant and it should total about $16 million.

Operator

Your next question comes from the line of Colin Guheen with Cowen And Company

Colin Guheen - Cowen and Company

The trade down in the mainstream is it really trade down or do you think it is new consumers coming in to the category that might start brewing at home? Can you just flush out your comments or what do you think about where that trade down from mainstream? What dynamic is happening there?

Thomas P. Cawley

I can not say, I do not have the precise answer but I do have the data, what the data implies. So if you think about sort of for the first three quarters in 2008 especially is growing on the low to mid-teens and then in the fourth quarter it goes through about 7% conversely mainstream throughout the year in the first three quarters and sort of flat just slightly declining and then in the fourth quarter it is growing about 5%. So that will imply that there might be a little bit of trade down going on there and I think sort of geographically if you were to break it out, you might find more of it in areas that you would expect to find it and less of it in areas where you are down.

So probably more pronounced than less well-developed especially the coffee markets where the economy has more than in fact and not as much elsewhere.

Colin Guheen - Cowen and Company

And so that overlay is not exactly matched up to where if it is joining the stores

Thomas P. Cawley

No not necessarily.

Colin Guheen - Cowen and Company

The second question is, you are talking about more promotion in the specialty category, and we have heard too that people are taking inventories. Is that the trend that happens so people go on promotions? They might drive increased volumes at a time when opts undertaking that inventories at the same time can you just quash out kind of squeeze that occurs…

Patrick J. O’Dea

For warehouse brands I think that is…from a bonafide point and for other people listening especially at the end of the calendar year, Colin right? So if you need to flush out the inventories at the end of the fiscal year, you want to start out clean. You know do a lot of promoting to sort of clean out the system and that is what happens from warehouse brands. Obviously we are direct store delivery so we do not have any inventory in our plan. So we do not have any inventory in stores. It is just what sales doing.

I think in short term period just sees some people doing some crazy short term hot promotions that will spike up then will go away and that will result in sustainable business improvement. I think ultimately what you will see is the category will settle out. Groceries will get their prices right on; specialty coffee brands all go back to the more sustainable growth environment and that is kind of where we are.

Colin Guheen - Cowen and Company

So we should be modeling a little bit of a dip in the first half I guess, is that you still seem to get your revenue growth guidance. You are going to need about roughly maybe on grocery stores 20% growth for the year is that might be higher there?

Patrick J. O’Dea

We talked about and Tom said high single digit reach out and then now it implied at a 15% growth rate in specialty overall and I think you also share that we thought most of our earnings at least with shift on the second half of the year. I think sales for the especially segment in the first half of the year is you should model as being lower and then sort of coming back a little bit more. I do not know how it will be tonic. I do not think I can tell you and I can not shoot that straight in the situation like this where we are sort of like a first quarter dynamic. The first and second quarter dynamic it could be a couple of months, it could be three months and it could be one month. It just depends.

The other thing, I wanted just to underscore to, when somebody ask earlier about you know how is your grocery business doing year to date? The way our promotion style impacts our gross rate with any given month pretty significantly so that does not shoot that straight either. In January the Light Promotion months lost February and the second half in March are stronger so I have a much better view at the end of the first quarter but I think it will be lighter in the first half and stronger in the second.

Colin Guheen - Cowen and Company

And then I guess for Tom in tax rate next year share count, what is behind the guidance or any range of it?

Thomas P. Cawley

Well I took in the last one; share count is going to depend somewhat on stock price performance. We are purchasing some shares as you saw in the cash flow statement. We spent $20 million to re-purchase shares in the fourth quarter so share count came down. Depending on overall business and what is going on we may purchase some more share. Interest would then change and share count would go it depends on the mixture of what you are assuming there. We are going to have quite a bit lower share counts just based upon on the re-purchase that we did because even if we did not buy another share just because that will lap in the first quarters so we will be in the mid-thirteen’s probably going in to the first quarter and all else will be equal and stay there for the rest of the year.

I think we have not change our guidance on tax rate. I think I said that it would be pumped up in 2009. We will be probably approaching 38 partially because we are expecting we have a lot of tax free interests and we are not going to have that next year. So that will pump up our tax rate next year. So probably it would be 37.5 to 38.

Colin Guheen - Cowen and Company

Okay is there is a goal a range or a goal on share re-purchase?

Thomas P. Cawley

It is totally opportunistic.

Colin Guheen - Cowen and Company

Is there a cash balance… is there any target cash balance that you like to be had or is there?

Patrick J. O’Dea

No not necessarily I mean we are not definitely not looking to re capitalized the whole Company and level up we will do anything like that in this environment. We want to get the line in credit earlier it really was just to handle the potential working capitals strengths in the business as we built coffee inventory as it becomes available because you will see our coffee inventories particularly after Central America harvest their coffee, we build our inventories by about $10 million so going into the spring. So, we just did not want to get that over $13 million of cash. We could use that in inventory and we just needed something to have for our rainy day fund, which is what the line of credit was for, but we do not want to be sitting on a ton of cash but we also do not want to be sitting on a bunch of debt either.

Colin Guheen - Cowen and Company

Okay. One last thing, could you use the contract in a situation but I remember you signed in natural gas contract and also a coffee contract that is both coming up in the fourth quarter and the prices stay where they are and assumed that was be pretty favorable?

Patrick J. O’Dea

Coffee, we purchased 95% of our coffee now with six price commitments for the year. So, that is not one contract. That is growing contracts that we are always 12 months ahead and we are buying now, we are buying for 2010. Coffee we did, I mean natural gas, we did hedge and we are hedge through August that they are on favorable rate and that would come off starting in September where it could stay where it is we will get some benefit there. Just we have never really, we have called out in the past and that is just our roasting plant by the way, the roasted coffee.

When natural gas gathered it is worse, I think I call that a couple years ago that might process $400,000 annually. So, when it is coming down, we are talking $100,000 just like that. It is not a million of dollars of the impact like coffee would be.

Colin Guheen - Cowen and Company

Is it on an annual basis or quarterly basis?

Thomas P. Cawley

Annual.

Patrick J. O’Dea

On the annual basis, I called it up before; inflation was costing us $400,000 annually.

Operator

At this time there are no further questions. Mr. Cawley, I would like to turn the conference back over to you for closing comments.

Thomas P. Cawley

Okay. Well, thank you all for joining us for our call and we look forward to talking to you in two and a half months for our first quarter results. Thank you.

Operator

Ladies and gentlemen, this will concludes the Peet’s Coffee & Tea fourth quarter and 2008 year end earnings results conference call. We thank you for your participation and you may disconnect at this time.

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Source: Peet's Coffee & Tea Inc. Q4 2008 Earnings Call Transcript
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