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Caribou Coffee Company Inc. (NASDAQ:CBOU)

Q4 2007 Earnings Call

February 14, 2008 4:30 pm ET

Executives

Kathleen Heaney - Integrated Corporate Relations

Roz Mallet - Chief Executive Officer and President

Kaye O'Leary - Chief Financial Officer

Analysts

Chris O'Cull - SunTrust Robinson Humphrey

Colin Guheen - Cowen & Co.

Operator

Welcome to the Caribou Coffee Company, Inc.'s Fourth Quarter 2007 Earnings Results Conference Call. (Operator Instructions).

I would now like to turn the conference over to Ms. Kathleen Heaney of Integrated Corporate Relations. Please go ahead, ma'am.

Kathleen Heaney

Thank you. Good afternoon, everyone. Caribou Coffee's fourth quarter 2007 earnings press release was distributed this afternoon, February 14, 2008 after the market closed. If you do not have a copy, one may be found on the website at cariboucoffee.com in the Investor Relations section accessed through the About Us tab.

Making presentations during the call today with be Roz Mallet, Chief Executive Officer and President and Kaye O'Leary, Chief Financial Officer.

Before we get into a discussion of the fourth quarter results, I need to read the Safe Harbor statement.

Part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be put upon them. The company undertakes no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this conference call.

We refer all of you to Caribou Coffee's most recent filings with the SEC for a more detailed discussion of the risks that could impact future operating results and financial conditions. During this call, management will discuss financial terms such as EBITDA, which is a non-GAAP measure. While this is a non-GAAP measure of financial performance, we believe it is a common and useful tool in evaluating the company's performance. A reconciliation to comparable GAAP measures can be found on the last page of today's press release, as well as on the website in the Investor Relations section.

With that, I would like to turn the call over to Roz Mallet.

Roz Mallet

Thank you, Kathleen. Good afternoon, everyone, and thank you for joining us today for the Caribou Coffee fourth quarter 2007 Earnings Call. It is my pleasure to be speaking with everyone today and I look forward to continuing the dialog as the year progresses.

2007 was a year of transition for Caribou. It was a year in which we took the necessary and sometimes difficult actions to position Caribou Coffee for profitable growth. We accelerated coffeehouse closings, which hurt our profitability, but ultimately leads to a healthier store base.

As previously discussed, we have slowed company-owned coffeehouse expansions, opening 9 in the fourth quarter for a total of 20 company-owned coffeehouse openings for the year. By contrast, we have accelerated franchised coffeehouse development. During the fourth quarter, we opened 11 franchised coffeehouses for a total of 28 franchised coffeehouse openings for the full year. We now have 52 franchised coffeehouses, up from 24 at the end of the fourth quarter 2006.

For 2008, we expect total new coffeehouse openings to be in the range of 35 to 50, of which the majority will be franchised. As we opened company-owned coffeehouses in the near term, we will focus on building out our existing market. Also for the past year, we have reexamined our site collection criteria. We have applied some of what we have learned about site model criteria to our existing site portfolio as well as to closing store decisions. For example, one of the key learnings from our study was how critically important easy access to the coffeehouse is for morning commuters.

During the fourth quarter, we closed nine coffeehouses for a total of 28 for the full year. As a review of the portfolio, we have made the tough decision to exit some smaller markets, where we were unable to dedicate the resources, both human and capital, necessary to get the stores to a level of performance that made economic sense. Along with aggressively managing the store portfolio, we are undertaking efforts to improve margins. To do this, we are implementing programs for food costs management and best practices on labor costs management.

We have also begun working with the consulting firm on operational engineering initiative. Additionally, we have many initiatives underway designed to boost average unit volumes. Also during the fourth quarter, we expanded the Caribou coffee brand through company-owned and franchised coffeehouses as well as commercial business and brand licensing channel.

As a result, total net sales in the quarter, were up about 5%. These included a significant increase in other sales, which rose 84% year-over-year. The hard work over the past year is beginning to show positive results and we are making progress. As previously announced, same-store sales were flat during the quarter and for the year as a whole, despite overall weakness in consumer spending patterns, I am particularly pleased with this performance based on the macroeconomic issues we were all facing.

As many of you know, our commercial business includes sales of prepackaged whole bean and ground coffee to trade channels such as conventional grocery, mass merchandisers and club stores. Not only are we adding new clients, we are also successfully broadening our geographic reach. During the fourth quarter, we added 115 store grocery chain in St. Louis, which will carry 10 SKUs of both whole bean and ground coffee.

On the brand licensing side, our agreement with Keurig is particularly noteworthy with a robust demand across many retail channels. Our franchise program has evolved in a different direction than we had originally planned, but a direction in which we are quite pleased.

We have broadened our franchise development to include store within a store location, as well as college campuses. These locations expand on our airport kiosk growth with franchisees. The first stores in the store location, of which we have four was in markets where we had a presence. Importantly, this type of development has enabled us to expand into other markets where we did not have plans to open freestanding coffeehouses.

Some examples of our stores within a store agreements include locations in both SUPERVLU and Hy-Vee grocery store chain. We also have two licensed college locations and expect to open another three this year. This new franchising program is solidifying our business model and gaining market penetration.

Before I turn the call over to Kaye, I want to spend a moment addressing the competitive environment. Upon looking at the competitive market place, there are a lot of moving pieces for us to consider, especially given the aggressive entry into coffee by large companies like McDonald's. But we will stay focused on our core essence, delivering the smoothest best tasting gourmet coffee in an inviting unpretentious environment. That's what makes us special. These are facts that were confirmed by a comprehensive consumer study that we completed late last year.

Caribou Coffee has a strong highly engaged customer base, who literally love our brand. Our goal is to capitalize on these highly engaged loyal customers wherever we operate.

Finally, I believe in our product and the strength of our brand and with many initiatives already underway as well as others that will be introduced this year, I am confident about the future of Caribou Coffee.

With that, I will now turn the call over to Kaye to walk you through our financial results.

Kaye O'Leary

Thank you, Roz. Before I begin the financial review, please note that both the fourth quarter of 2007 and of 2006 consisted of 13 weeks. Company-owned coffeehouse operating weeks were 5,617 in the fourth quarter of fiscal 2007, as compared with 5,553 in 2006. I'll initially address our results and performance in the fourth quarter and then I'll briefly speak to the full year results.

During the fourth quarter, total net sales increased 5.2% from the comparable period in the prior year to $70.2 million. We reported a net loss of $15.1 million or $0.78 per share, as compared to a net loss of $2 million or $0.10 per share for the comparable quarter in 2006.

The net loss in the quarter include a $3.1 million in store closing expenses, $7.9 million of accelerated depreciation costs related to the impairment of 27 stores, as well as $3 million of general and administrative expenses related to our litigation settlement and the severance costs for our former CEO.

We reported an EBITDA loss of $1.4 million, compared to positive EBITDA of $4.9 million in the comparable period last year. It should be noted that EBITDA in the fourth quarter again included a $3.1 million of store closing expenses and $3 million of G&A expenses for litigation settlement and severance costs, which are expenses that we did not incur in 2006.

During the quarter, coffeehouse sales were up 1.4% to $64.6 million. The increase in coffeehouse sales was driven not only by the combination of opening new stores and closing existing stores, but also by the timing of the openings and closings, which resulted in 64 and more coffeehouse operating weeks in 2007 than we had in 2006.

We opened 9 new stores in the fourth quarter and 11 new stores in first three quarters of 2007 and we closed 28 company-owned coffeehouses over the last 12 months. Comp store sales for the fourth quarter were flat versus the 2% increase in comps in the same period of 2006. We did take a price increase of 2% on beverage items in our stores at the end of September. Our beverages represent about 80% of our in-store sales. So the 2% increase affects about 1.6% overall price impact on coffeehouse sales.

Other sales, which consist of our product sales to commercial franchise and Internet customers, as well as royalties from franchise and brand licenses and franchise development fees increased 84.4% in the quarter to $5.5 million. The increase was primarily driven by additional sales to existing and new commercial customers.

Also contributing the increase were product sales and royalties from the 28 new franchised coffeehouses that opened during the past 12 months, and franchise development fees from the 11 new franchised coffeehouses opened in the fourth quarter.

Cost of sales and related occupancy costs were $29.6 million in the fourth quarter. This was up 6% from $27.9 million in the same quarter the prior year. As a percentage of sales, cost of sales and related occupancy costs were 42.1% or about three-tenths of a percentage point increase from the 41.8% that we reported in the fourth quarter of 2006. The increase in cost of sales and related occupancy costs as a percentage of total sales was primarily due to the higher growth of our commercial business and the other sales category.

The commercial business has a higher cost of sales than our retail coffeehouse business, due to initial slotting fees associated with the addition of new distribution partners and due to higher freight and distribution expenses in this side of our business.

Operating expenses were $27.4 million in the fourth quarter of '07 or 39.1% of total net sales versus $27.2 million or 40.7% of net sales in the fourth quarter of '06. The decrease in operating expenses as a percentage of total net sales was due primarily to the timing of company-owned coffeehouse maintenance expenses and leverage from the additional other sales.

Depreciation and amortization expense increased to $13.0 million from $6.1 million in the fourth quarter of last year. This increase was related to $7.9 million of accelerated depreciation associated with coffeehouse asset impairments of 27 stores during the quarter and a full year's depreciation on coffeehouses that were opened in 2006. As a percentage of total net sales, depreciation and amortization increased to 18.5% in the fourth quarter from 9.2% in the comparable period last year.

Let me talk a little bit more about the financial impact of the closed stores for full year of 2007. As Roz mentioned, during the year we closed 28 underperforming coffeehouses and recorded closing expenses of $6.8 million. This included $3.1 million during the fourth quarter.

The 28 stores that we closed only encountered for $900,000 of the $10.4 million of the accelerated depreciation or asset impairment charges that we took for the full year. The stores that we closed in 2007 had largely been previously impaired or were already fully depreciated. We continue to monitor the performance of all of our stores and at this point, we expect to close a similar number of coffeehouses in the current year with store closing expenses at a similar level.

It is important to understand that there are no typical store closing expense. Expenses associated with the closings are variable from coffeehouse to coffeehouse. They are dependent upon the amount of time left on the leases and the remaining book value associated with each coffeehouse as well as the real estate market conditions in the trade area that we are seeking to exit.

General and administrative expenses increased 71.5% in the fourth quarter to $11.7 million, from $6.8 million in the year ago period. As a percentage of sales, G&A expenses increased to 16.71% during the fourth quarter, as compared to 10.2% during the comparable period in fiscal '06. The increase in G&A expenses as a percentage of sales was due to the severance costs associated with company's former CEO and litigation and settlement costs as well as increased consulting fees associated with market research and store profitability research and planning.

From a balance sheet perspective, we ended the quarter with $9.9 million in cash and marketable securities and no outstanding borrowings under our revolving credit facility. We are currently in the process of amending our credit facility from $60 million to $20 million, which more closely fits our capital requirement.

Capital expenditures were $1.4 million in the fourth quarter, which were related to new coffeehouse openings, remodels and investments in our production and information system infrastructure.

During the fiscal year ended 12/30/07, total net sales increased to 8.7% from the comparable period in the year to $256.8 million. We reported a net loss of $30.7 million or a $1.59 per share as compared to a net loss of $9.1 million or $0.47 per share for the comparable period in '06. The net loss for the year included $6.8 million in store closing expenses, driven by the closing of 28 stores and $10.4 million of accelerated depreciation costs related to the impairment of 35 stores.

For the year, we reported a positive EBITDA of $3.8 million compared to a positive EBITDA of $15 million if '06. I would like to remind you again that 2007 EBITDA did include $6.8 million of store closing expenses and $3 million of G&A expenses for litigation settlement expense and CEO severance that we did not incur in 2006. Our CapEx for the year was $17.2 million and included $7.5 million for the opening of the 20 new company-owned stores.

And with that we will be happy to turn things over to the operator and answer any questions you might have. Operator, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Chris O'Cull with SunTrust Robinson Humphrey.

Chris O'Cull - SunTrust Robinson Humphrey

Good morning everyone. How are you?

Roz Mallet

Hello.

Chris O'Cull - SunTrust Robinson Humphrey

Roz, my question relates just to the current strategy and the effect you think you will have on the business, how long do you think it is going to take the company under the strategy to get closer to profitability? And a follow-on to that would be as the Board evaluated alternative strategy such as re-franchising or licensing the brand to restaurant chain to determine whether they would offer better long-term profitability?

Roz Mallet

We are in the midst of completing our strategies for the next three years, creating a long range plan. We expect to have a much better idea where we will end up in profitability over the next few months. I won't predict that no matter what happens, but I will tell you that we are going to look at all alternatives to continue to broaden the brand distribution. We have four channels right now that we are utilizing and we will, in terms of strategy change, be projecting those very detailed in our existing markets and across United States and then globally.

Chris O'Cull - SunTrust Robinson Humphrey

And then let me ask you when you think about franchising and another company has plans to open new units via franchising, help me understand how does re-franchising or selling company markets play into that? I mean is there any opportunity maybe to improve profitability of the company by selling company stores to franchisees, maybe seeding markets, is that part of the consideration?

Roz Mallet

We are going to consider lots of alternatives to accelerate our points of distribution in all of our markets. So I am not going to say no to anything at this stage. We haven't made a definitive decision on any one strategy of growth. Again, we are going to use all four channels.

Chris O'Cull - SunTrust Robinson Humphrey

Okay. And then you talked a lot about the invention, I think you hired a consultant to help look at the operational opportunities and the company stores, (inaudible) economic, does that relate to top-line opportunities or is that mainly focused on just improving efficiencies in terms of cost control?

Roz Mallet

We have several initiatives, the one around operational efficiencies really is about our throughput, our capacity, and making sure that we can effectively build our sales as well as build our profits and so we will get perspective on both sides of the P&L.

Chris O'Cull - SunTrust Robinson Humphrey

Okay. And then you also mentioned and I think, do you guys have done some deep site modeling work and part of that analysis I guess that came out of that was that I think you said that location of breakfast or at least ease of use for breakfast daypart is a big part of the success of the restaurants. I mean when you think about positioning the restaurants on certain sides of the road, so that you get the breakfast traffic, how does that look now when you look at the system and you have evaluated the stores? I mean, are there a lot of issues in terms of being on the wrong side of the road for that breakfast daypart?

Roz Mallet

Actually what I said was morning commuter and sometimes that commuter is having coffee for breakfast and sometimes the commuter is having baked goods breakfast and we have been evaluating each site, and if you will, how we have been measuring the importance of being on the right hand side of the road. And so, I cant' give you a percentage of problem areas. We will continue to look at improving every site that we approve in the future.

Chris O'Cull - SunTrust Robinson Humphrey

Was it a big factor when you considered in the past for you when you looked at site locations? Or what were some of the primary drivers for determining a site location in the past?

Roz Mallet

What's interesting is that our site model has approximately 100 measures. And so as we have been reviewing that model, we have really just been trying to make sure that we completely understood from our consumers' perspective what are the most important measurements. And so we have really probably changed the emphasis to some degree and reduced some of the priorities but we haven't had a sweeping changes and what is in that site model.

Chris O'Cull - SunTrust Robinson Humphrey

When you looked at reducing certain priorities, give me an example, if you would, of maybe one of the more important priorities you found that maybe not as important as it used to be or needs to be?

Roz Mallet

Access in and out of the site or what I already discussed. I really prefer not to give you a lot of detail on that.

Chris O'Cull - SunTrust Robinson Humphrey

Okay.

Roz Mallet

We might consider that proprietary information.

Chris O'Cull - SunTrust Robinson Humphrey

Thanks guys.

Roz Mallet

Thank you.

Operator

(Operator Instructions). We will go next to Paul Westra with Cowen & Co.

Colin Guheen - Cowen & Co.

Hi. Good afternoon. It is Colin Guheen for Paul. Just, a first question on the 35 franchise openings next year. Can you just detail what types of units those are going to be? How many of those are kind of traditional stores versus supermarkets or other type of location?

Roz Mallet

We actually said 30 to 50 overall openings.

Colin Guheen - Cowen & Co.

30 to 50, okay.

Roz Mallet

Overall openings. And we said the majority will be franchised.

Colin Guheen - Cowen & Co.

Okay.

Roz Mallet

And then what I commented on was around our grocery licensing program and that really has picked up over the last six to nine months. And so there will be quite a few of those. There will continue to be global openings as well as some airport and college campus openings. And we have a New Jersey franchise that will be opening this year as well. This is a multi-unit development.

Colin Guheen - Cowen & Co.

So just a small number of them are actually traditional stores, the others are these different kind of asset plays in airports or co-branded with the supermarket channels and international. Is that --

Roz Mallet

There are traditional stores as well as the kiosk, the store within a store.

Colin Guheen - Cowen & Co.

Okay. How many of them are traditional stores more or less?

Roz Mallet

I really don’t have a number because we have got several franchise groups that are committing to growth for the year. And as you know, some of this will depend on the economies and the way their schedules work. And so I can’t give you a definitive number on each one.

Colin Guheen - Cowen & Co.

Okay. And then the new company units, are those mostly in Minnesota or any of those outside Minnesota?

Roz Mallet

The majority of them are in Minnesota.

Colin Guheen - Cowen & Co.

Okay. And of your 430 company stores now, how many of the closures, I guess, over the last couple of years have been in Minnesota with most of the closures been outside Minnesota?

Roz Mallet

Actually, they have been pretty widespread geographically, and there is very few in Minnesota so far.

Colin Guheen - Cowen & Co.

Okay. Great. And I guess just the commodity coffee market just kind of where you stand there and any impacts that are coming up in ’08?

Roz Mallet

Actually, the cost of coffee beans has not been as big an issue as dairy cost has been. I think you have probably heard that from several of our competitors as well.

Kaye O’Leary

Coffee is becoming more competitive. We are seeing pricing increasing on coffee, and it’s becoming a hot commodity in the commodities market. So it is something that we are actively on top of right now in terms of figuring out how to minimize the impact of it over the year.

Colin Guheen - Cowen & Co.

Okay. And are you locked in for a certain period of the year? Or, where do you stand with that?

Kaye O’Leary

Again, we are buying forwards for different points in time during the year as we feel it benefits the company.

Colin Guheen - Cowen & Co.

Okay. Great. Thank you very much.

Operator

(Operator Instructions). Ms. Mallet, there appears to be no further questions on the phone at this time. I will turn the call back over to you for any closing comments.

Roz Mallet

Thank you. Before we sign off, we want to let you know that going forward we will be combining our comp sales and earnings releases. Thank you for joining us today. And we look forward to speaking with you again at the end of the next quarter.

Operator

This does conclude today’s conference call. We appreciate your participation. You may disconnect at this time.

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