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

Q1 2008 Earnings Call Transcript

May 1, 2008 5:00 pm ET

Executives

Tom Cawley – CFO, VP and Secretary

Pat O'Dea – President and CEO

Analysts

David Tarantino - Robert Baird

Matthew DiFrisco - Oppenheimer & Co.

Steve West - Stifel Nicolaus

Larry Petrone - WR Hambrecht

Colin Guheen - Cowen & Co.

Nicole Miller - Piper Jaffray

Operator

Hello and welcome to today's Peet's Coffee & Tea first quarter conference call. As a reminder, today's call is being recorded and we'll be conducting a question-and-answer session after the presentation. (Operator instructions) Now for opening remarks and introductions, I'd like to turn the call over to Mr. Tom Cawley. Please go ahead, sir.

Tom Cawley

Thank you, operator. As we 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 ended December 31, 2008 filed with the SEC on March 14 of this year. It is also available on Peet's web site.

Now, let me turn it over to Pat O'Dea.

Pat O'Dea

Thanks, Tom. Overall, we're pretty pleased with the progress we made this quarter. I'm particularly pleased with the strong grocery growth, successful sell-in and performance in expansion markets and some improving operating efficiencies across the company, all of which have enabled us to overcome a softer retail market and some rising commodity-related costs this year.

Here are the highlights: First, our sales growth of 17% was at the low end of our 17% to 20% annual guidance, but we did expect to be on the lower end of this range in the first half of the year. Strong growth in both grocery and food service helped offset a softer retail quarter. Second, EPS was $0.15 per share, in line with our expectations. Third, our grocery expansion is on track. Through the end of Q1, we added 1,100 new grocery stores in the East and we are now serving almost 7,000 grocery stores, on track to achieving our goal of 8,000 by year-end. Lastly, the combination of procurement savings company-wide and improved operating efficiencies in our stores helped offset some of the rising commodity-related costs and increased investment in grocery expansion. This includes reduced waste in our stores from the inventory management system we are now rolling out and we expect these savings to continue and improve throughout the year.

By channel, our retail business grew a little over 14% in the quarter. This came from a combination of new stores opened during the past year and sales growth in our existing stores. While existing stores sales and traffic growth are positive, we've seen our trend drop a point from the fourth quarter of last year. Of course, the positive growth we are seeing is disproportionately driven by more positive beverage growth, offset by the mid-single digit bean declines associated with our multi-channel bean expansion.

In addition, we opened nine new stores in the quarter versus eight last year. Our specialty businesses grew a collective 22% in the first quarter. Our largest specialty business, grocery, was up 28%. This growth came equally from our established base in the western U.S. where we continue to improve market share through a superior DSD sales merchandising system, and our new markets in the eastern part of the country where new distribution is ramping up quickly. This quarter, we gained distribution in approximately 1,100 new grocery accounts, the largest chunk being the Publix chain in the southeastern U.S. We are also gaining more shelf space in both western and eastern U.S. grocery accounts based on our performance and the trade's desire to drive the more profitable specialty coffee category, where we are the clear premium brand.

The food service and office segment grew 29%. This was driven by the addition of five new licensed Peet's locations, bringing our total licensed locations to 37, as well as strong growth of our We Proudly Brew program. We strategically use our licensing and We Proudly Brew programs as part of our multi-channel strategy to develop the Peet's brand in key markets and as a means of accessing target markets in captive locations we could not serve any other way. This business includes customer types such as airports, large office complexes, restaurants, colleges and universities, and select higher-end grocery stores as part of an overall market development strategy.

The home delivery business was flat to last year. Home delivery is impacted by the expansion of our grocery business, since we are making our product available in geographies that historically were only serviced through home delivery.

Now, I'll turn it over to Tom to talk through the financials for the quarter.

Tom Cawley

Our EPS for the quarter was $0.15, which is up from $0.10 per share last year. Now, if you exclude the expenses related to our stock option review and subsequent lawsuit last year, EPS would have been flat to last year's $0.15. We had indicated on earlier calls that our year-over-year earnings growth would be the most difficult in Q1 for two reasons. First, we had significant investment in new grocery distribution that Pat just referred to. And second, we're lapping low milk costs from Q1 of last year with higher costs in Q1 of this year. Commodity milk was up 38% over last year in the quarter. As milk prices continue to drop, we start to lap the very high prices of July and August of last year and we'll see milk actually benefit us on a year-over-year basis later in the year.

Now let's go down the P&L by line item. Gross margin was 52.4%, down 30 basis points from last year's 52.7%. The decrease was driven by higher commodity costs, particularly milk and green coffee, but this was largely offset by, in order of importance, procurement savings, very good waste management in our retail stores, and the $0.05 per drink increase in pricing that we took on some of our drinks in January.

For the full year, we expect gross margin to actually be slightly better than last year as we lap higher milk prices later in the year and we continue to see the benefit of improving operating efficiencies in our stores, particularly coffee, milk, and baked goods waste reduction from the new inventory management system we are now rolling out.

Operating expenses were up 60 basis points versus last year at 35%. Operating expenses were higher in both retail and specialty as higher costs from 31 new stores that we've opened in the past 12 months drove up retail expenses and the expansion of grocery was the primary driver for specialty. For the year, we are expecting operating expenses to be about 0.5 point above last year due to the continuing costs from these two investments in growth.

General and administrative expenses decreased to $5.6 million from $5.9 million last year. Excluding the million dollars we spent on the stock option review last year, we actually increased G&A by about $600,000, with about half of that coming from higher marketing spending to support the grocery expansion and the rest from headcount-related costs. For the year, we do expect our apples-to-apples G&A spending to grow slower than sales and help to improve our margins.

Depreciation in the quarter was flat to last year at 4.6% of sales. This line continues to grow sales due to the cost of the new stores. Net-net, our operating margin would have been down about 40 basis points if you exclude the option review expense driven by higher commodities and investment in growth, offset by operating efficiencies and leverage. For the balance of the year, we should show improvement in margins as we've a more favorable commodity comparison, lower relative investment in growth, meaning fewer new stores per quarter, and we'll end the year with an operating margin that is above last year.

Below the operating line, interest income was $304,000 for the quarter, down from last year's $425,000 due primarily to a lower interest rate than last year. We ended the quarter with $33 million in cash, which was $2 million more than the end of the year.

The tax rate was 36.4% for the quarter, within our normal quarter-to-quarter variation expectations, around our full-year projection of about 37%. Year-to-date capital spending was $8.8 million. For the year, we are expecting to spend around $30 million, which includes $12 million to $13 million for new stores.

Now, I'd like to turn it back over to Pat to wrap it up.

Pat O'Dea

I think this quarter report is representative of what we'll be doing throughout the year and of what distinguishes our longer-term vision and strategy for Peet's. Throughout the year, the broader economic environment will challenge our retail business and impact commodity-related costs. We'll partially offset this with improved operating efficiencies in our stores and company-wide procurement savings, as we did here in the first quarter. At the same time, we'll continue rapidly growing our grocery business in both existing and eastern expansion markets, and our food service and office segment will grow quite nicely driven primarily by new license and We Proudly Brew locations. These areas will drive strong specialty segment growth, which is where most of our profit comes from.

I expect it to be a challenging operating year. There are many puts and calls that can affect us one way or the other, including what happens in the broader economic environment in the second half. As a result, it is too early in the game for us to change anything in our annual guidance other than to say, at this time, I think we'll be near the lower end of our 17% to 20% sales growth and our $0.77 to $0.82 EPS.

Longer-term, our vision has always been to firmly establish Peet's as the gold standard specialty coffee and tea brand by remaining true to the founding tenets of extraordinary bean selectivity, only artisan roasting by hand in small batches, and our unyielding commitment to true coffee freshness. This fanatical focus on quality and the investments we've made to scale it, including the only roast-to-order and direct delivery system of its kind in the industry, distinguishes us. And because we are first, foremost, and always a coffee and tea company, our business model is channel indifferent. We strategically leverage multiple channels in the most effective mix to deliver superior-quality Peet's Coffee and Tea to customers and long-term value to shareholders without becoming overly dependent on any one.

In summary, while 2008 will be a challenging operating year, we clearly occupy the premier quality position in a large and growing specialty coffee and tea market. We've already made the investments in infrastructure needed to capitalize on this opportunity and we'll begin to see the leverage of those investments starting this year and more meaningfully in 2009 and beyond.

That is all of our prepared comments today. Operator, we can now open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And first, we'll hear from David Tarantino from Robert Baird.

David Tarantino -- Robert Baird

Hi, good afternoon. Just a question on the EPS guidance for the year. I think, Pat, you mentioned towards the low end of the prior range. Are there any opportunities on the margin side that you think you would be able to get to the middle or the upper end of the range even if the revenue were to stay at the lower end of the range?

Tom Cawley

David, for us, if you remember $240,000 is $0.01 a share. There's always opportunities with milk, commodity prices moving or gas prices and any area like that; it's fairly easy for our number to move. So when there's still nine months left in the year, a lot of costs things, we don't rule out any type of numbers. We're dealing with pretty small numbers here, so I'd say the answer is yes.

Pat O'Dea

Yes. The only thing I'd add to that David is, because it's only about $240,000 that moves it $0.01, when you're this far out, it's obviously sort of hard to peg what will happen. The swing item will be how the retail business and the broader economic environment performs in the second half of the year because we already are getting some really good procurement savings and also really good operating efficiencies at our retail stores right now from waste reduction in coffee and milk and even better labor management, just from managing the business better. But, I'd think the swing item will be the retail top line in the second half.

David Tarantino -- Robert Baird

And just to follow-up on the retail business, could you comment on where you're seeing that softness? Is it in beverages or in whole beans? Are there any markets in particular that are weak?

Pat O'Dea

Overall, as I said, our traffic in our existing stores -- our traffic and our sales performance is still positive but it's about a point down from where it was in the fourth quarter. It's obviously driven positive more by growth in our beverage business because, as we've been fairly consistent on our bean business, in our stores is in that single mid-digit decline. So if we were just a beverage business, it would be a bit more positive. Regionally, we're completely concentrated in California so there is a very slight difference between say northern and southern California, with northern California maybe being a little bit stronger. But --

Tom Cawley

It's not a significant difference outside of California versus California however. But, I think to clarify your question a little bit too, we've probably seen a proportional drop in the beans and the drink side of the business, meaning if we're down a point from last quarter, they were both about a point higher last quarter as far as the business overall.

David Tarantino -- Robert Baird

Got it. Tom, could you tell us where you stand on your green coffee contracting and whether you have any plans to raise prices in the specialty business?

Tom Cawley

That's two questions, so I'll answer the first one as far as where we stand today. So, as of yesterday -- coffee was down today so we may have actually bought more -- we had fixed-priced commitments on 93% of our coffee for this year and one-third of our 2009 requirements. Right now where we've locked in, we're right on where our expectations had been at the beginning of the year. So we did not buy any coffee during the run-up that happened when coffee got up to the crazy amounts. We thought that that was an irrational run-up and we waited until it came back down again. And then we were able to fix it kind of where we wanted to, to begin with.

Pat O'Dea

And you also asked about pricing in specialty. Specifically, we didn't take any pricing in specialty, and in particular grocery, for two reasons. One is because, as Tom just mentioned, we did not need to because we had forward-bought our coffee. Secondly, because we do treat coffee pricing, how we price, very strategically and not necessarily in reaction to a short-term commodity fluctuation. Coffee did hit about a 10-year high back in February and March, and there were quite a few coffee companies who took price increases. We assume presumably it was because their costs went up and they needed to cover it. Since we forward-bought our coffee, we waited it out, as Tom indicated, and the market has come down to more reasonable levels as a result of that. We're in a pretty good position now because we're able to finish off our purchases for the year more in line with what we had expected. We do assess our coffee pricing across channels strategically on an ongoing basis. By way of example, when I say strategically I mean making sure that our pricing is reflective of our premium premier quality brand position and also taking into account other factors such as the relative geographic development of the brand and other things.

David Tarantino -- Robert Baird

Great. Thank you.

Operator

Next, we'll hear from Matthew DiFrisco from Oppenheimer.

Matthew DiFrisco -- Oppenheimer & Co.

Thanks. Just have a couple of questions. Tom, I think I didn't hear this in the prepared remarks, but I apologize if I missed it. Can you give us an update on any effect that maybe was in the quarter from your natural gas exposure or how you stand as far as volatility to that remaining for '08, or is that contracted as well with your roasting capacity?

Tom Cawley

It's not contracted for us, so we price to market every month. It wasn't a significant number for us. It wasn't something -- I think we were pretty much close to what our forecast had been. So it's not something I called out nor do I even know the answer because it wasn't impactful enough to show up.

Matthew DiFrisco -- Oppenheimer & Co.

Okay. Then just looking at your trends and I think you said you don't report a same-store sales, but you were inferring that they're positive? If I'm incorrect please correct me, but it looks like your (inaudible) sales though are coming down. Should that imply then -- I'm just curious about the new store productivity, how that stands relative to your historical numbers and your metrics that you used to say of 750,000 to 800,000 or so year one and then building as beans gain traction and you cross over the one million mark per store and get into greater numbers. What's the experience the last couple of stores, or last couple of quarters' worth of openings? Is that progressing in this type of an environment?

Tom Cawley

Yes. We are on track for the numbers that you just said, so we're still -- the openings that we've had in the last 12 months are hitting those objectives in aggregate. What we're not seeing is it exceed the objective, which we did a couple of years ago. Where we had a couple of years where we were opening above that level, we're now opening at that level, more because we're getting the more balance of opening across geographies rather than just all northern California. So we're still happy with the way that that's progressing and we're still on those numbers. I think that the average store volume dropping obviously is as we bring in -- we've 31 new stores now and we still have 45% of our stores -- over 45% of our stores today are less than three years old. And it's just blending in stores that are doing 750, 850, 950 depending on the vintage into the total which has brought the average down. While admittedly, we've set the base which is positive, but it's not as positive as it used to be, which used to help keep the total average up higher. So when we were growing the existing base at a faster rate, it was able to keep our total average store volume flat. When we were blending in new stores at, say, $750,000 -- and we don't have as much strength in that, we've lost a couple of points off of that and that brings the average down.

Matthew DiFrisco -- Oppenheimer & Co.

Okay. Can you prioritize in the other operating expense line with respect to your retail division, your company-owned stores, what there might be as far as pressure points or concerns as far as inflationary, whether its labor, utilities, or anything else that we should see, or is there just a little bit of softness from the environment that we're dealing with right now as far why there might be a little deleverage there? Is it just deleverage or is there -- ?

Tom Cawley

Yes. It actually is just deleverage right now. It's just not having as much growth from the base. We think we're having fairly traditional wage inflation, which is our biggest line item. And then everything else through there -- we do have higher shipping costs but that's going to hit gross margins. If you go through the other lines, I'd say it's average to just slightly above average. We don't have any extraordinary 10% plus inflation items that would be in operating expenses for new stores. So what we are seeing is the bulk of our operating expense growth, or 100% of our operating expense growth, is coming from the new stores that we're adding in just what a large proportion of our base that is right now.

Matthew DiFrisco -- Oppenheimer & Co.

Okay. And then last question and then I'll let you go. Is the G&A side of the business, and relative G&A, is there anything there that as you expand into more of a national footprint in the grocery store that might need investing there or is it correct to assume that you should be able to use that as a source of leverage over several years to come and drop below 8% potentially going into '09?

Tom Cawley

Yes. It should be a source of leverage going forward. Most of the expansion, for example, district managers for our route sales people and so forth, falls into operating expense, and that's why you see some of the operating expense growth in grocery. The only area where we are putting a little bit more that hits the G&A line is the marketing expending as we go into new markets does go up a little bit, which is what I explained was half of the G&A growth this quarter and that was mostly in new markets. So there is a little bit of that but it won't be growing at the rate of sales.

Matthew DiFrisco -- Oppenheimer & Co.

Okay, great. Thank you very much.

Operator

Next, we'll hear from Steve West from Stifel Nicolaus.

Steve West -- Stifel Nicolaus

Hey guys. I just had a couple of quick questions about the specs of the expansion as you're going forward and across to the East Coast. If you could maybe, Pat, talk about some of the stores that you've been in for maybe just a couple of months. I assume that the pipeline load has done its sell-through piece of it. Are you seeing the replenishment rates in those stores equal to what you saw in some of your newer western coast stores? Does that make sense, what I'm trying to ask there? Are you seeing the orders drop as fast as you did for some of your older grocery stores there?

Pat O'Dea

Yes. Obviously, some of this 1,100 store distribution is stores that we've been in for four weeks or five weeks kind of thing, so it's tough to get a fully accurate read because you've got a fair amount of pipeline in there. But, let me try to answer the question as best I can. So just to set a baseline, in the western U.S. where we've been for five-plus years now, in the most recent IRI reporting that we have, our dollar sales growth for the first quarter -- and this is out of grocery stores in the western United States -- is up 14% to 15% and we've been there for five years. So we're still growing very strong there.

Then there's sort of a tranche of eastern United States stores that we're just lapping the anniversary of. So when we went into New England for example, we were fully into New England last year in the first quarter this time. And by way of example, in Boston, according to IRI, our share there has now more than doubled versus last year, so we continue to see very strong growth there. Relatively speaking, obviously in the western United States where we've been for five years compared to the eastern -- and our brand was born here -- compared to the eastern United States where we've only been for a year, the average movement in any particular store is obviously significantly less in the eastern United States than it would be in the western United States, and by a factor of two or a little bit more. But, we're very pleased with the share growth. Our customers are very pleased with the growth and in fact, several eastern United States customers where we've been in for a year or less are already increasing our shelf space based on the growth that we've experienced.

I think in terms of where we just entered, literally four or five, six weeks ago, we do get an early read because our route sales reps all have handheld computers, so we're able to see how much is going into the store. We're at or above our early objective in those accounts, so I'm feeling pretty good about where we are right now.

Steve West -- Stifel Nicolaus

Okay that's awesome. Can I just ask a quick a follow-up to that? So your velocity on the East Coast is slower than the West Coast which makes perfect sense. Have you seen in those Boston stores, has the velocity kind of gradually picked up as you've gone through time? Is there a plan that you guys have in place to try to continue to increase that velocity, even in these newer Publix stores that you've got going on longer term?

Tom Cawley

Yes. The velocity has obviously picked up. As I said, in Boston we're more than double the share we were a year ago. In Baltimore-Washington, where we just filled out the market, over the last several months with another customer or two, we're more than double than we were a year ago. So the velocity has definitely picked up. The way our DSD route system works, obviously we've sort of an inflection point where we reach a certain volume on a route and then we convert it to a fixed-cost route and we start to really leverage it. So we're feeling very good about the growth across all three tranches: The western U.S., where we entered New England a year ago and where we are just entering now.

Steve West -- Stifel Nicolaus

Okay. And then one last question. If you guys, half-way to your target on the 2,300 stores, would you look at going through 2,300 or is that too far to look out? I'm not trying to peg you down here, just trying to see are you able to go through that if you can get them filled in and then negotiate those contracts? Would that be a possibility?

Pat O'Dea

No, I think 8,000 for 2008 is a good number. I think that's a good number. It's just it's a capacity thing, it's a timing thing, in terms of just being able to get to all the accounts and they have certain timing on which they bring in new products and stuff. I think 8,000 is good.

Steve West -- Stifel Nicolaus

Okay, great. Thank you very much.

Operator

Next, we'll hear from Larry Petrone from WR Hambrecht.

Larry Petrone -- WR Hambrecht

Yes. Thanks a lot. Just two follow-up questions. On the retail store profitability, I think last quarter either Pat or Tom you had mentioned that about 55% of your stores are producing virtually all the profits in the retail channel. It sounds from your earlier comments that that number is up a little bit, but that profitability is not as significant as it was before. In other words, profits from those individual stores on average are not as high as they were before. Does that make sense or am I reading this wrong?

Tom Cawley

Let me clarify what you are saying because I know what you're referring to and I want to be sure everybody understands what you're saying. What he's referring to is that 45% of the Peet's stores at the end of the year were less than three years old. And since we've a ramp up where stores actually lose money in the first year, make very little in their second year, their first calendar year, in the second year and the third year start to make some decent money. If you add up the first three years, stores kind of break even because they lose up to $100,000 in the first year, aren't making much in the second year and by the third year might be making a $100,000. So it nets to zero. So the 45% of the stores that are less than three years old contribute nothing to our profit and in 2007, for the full year, they actually contributed zero when you netted that three groups. So it means that 45% of the stores where we've already made an investment in the capital, we've already hired the people, we've trained the employees and done everything give you a zero profit. So all of your earnings are coming from stores that were older than three years or 55% of the stores. So that's the premise he's talking about. It's not that only 45% of the stores don't make money or are losing money or anything. What I referred to is that I think if I were to take the end of the quarter, just the fact that we opened nine versus eight last year, we might be a little bit above 45% right now just from the opening timing so that that impact would be a little greater. It's still pretty close. I didn't mean to say it was a dramatic shift in our overall weighting.

Larry Petrone -- WR Hambrecht

Okay. Thanks for the background clarification. I suppose I should have provided that background. The other question is how do you think we should think about the rollout. On the 2,300 grocery expansion stores, you're almost halfway there in the first quarter. You're about a third the way on the retail stores if you take the upper end of your guidance of 30 new retail stores this year. Do you expect a lot of those store rollouts to continue to happen in the first half and sort of to slow down as we go through the balance of the year? What do you think in terms of how we should lay this out from a modeling perspective?

Tom Cawley

First, from a retail viewpoint, it will be fairly evenly distributed over the next three quarters. We just got off to a pretty strong start and I think from here on out it will be fairly even. From a grocery viewpoint, I would --

Pat O'Dea

From a grocery standpoint, I think the second quarter will be pretty good and therefore, the first half we'll probably be 60%, 70% of the way to our goal and then we'll fill in the rest in the third and fourth quarter.

Larry Petrone -- WR Hambrecht

Okay. And just one last question if that's okay. With your penetration into the Publix grocery stores, just wondering where you are in the Southeast with regard to ACV penetration. I know typically you like to get around 60% to 70%. I'd presume that with that partnership with Publix you have a pretty significant jump start on that.

Pat O'Dea

Yes. In the South, in fact [ph] in the State of Florida if you've got Publix, you are at 60% to 70% because they're so dominant there. But, we obviously when we enter a market we enter the whole market and all the other major chains in the southeastern United States, down there in sort of the Florida-Georgia area, we'll be in, if we're not in them already.

Larry Petrone -- WR Hambrecht

Okay, great. Thank you.

Operator

Next, we'll move to Colin Guheen, Cowen and Company.

Colin Guheen -- Cowen & Co.

Most of my questions have been answered, but I guess one question. With the grocery expansion, is there opportunity to add licensed stores with some of these agreements later on down the line? If it's not explicit now, is it a possibility?

Pat O'Dea

Later on down the line, it certainly could be. It's not part of our plan right now, but sure.

Colin Guheen -- Cowen & Co.

Okay. And can you just elaborate a little bit more on the shelf space expansion on the West Coast and any kind of numbers you can put around that?

Pat O'Dea

It's fairly account specific, so you can get pretty micro pretty quick. But, as we shared earlier, in Safeway, we more than tripled our space versus a year ago in the last six months. We've had several other large western United States grocery customers increase our space meaningfully in the 25% to 50% range, all based on our share growth and performance. And the fact that we're the premium and higher-priced brand in the category, so if they can sale a bag of Peet's, it's the best bag of coffee they can sell. So that's been all very positive. I think what has really been encouraging though is we've got some customers in the eastern United States where we've only been for a year who sort of, without us making the sale, are coming to us and saying we're resetting our coffee category and we're going to increase your space by 50%. So that's all very positive. I think it's also consistent with what I've shared in the past, which is my view that the specialty coffee category in grocery is at a tipping point. While it's only 28% of the total U.S. category right now, I think within the next three years it will be more like 50%, more like it is here in the western United States where it's about 45% in the west and as high as 62% here in the Bay Area. So this is all going to sort of happen pretty quickly here over the course of the next three to five years and I think we'll be helping to drive it and will be beneficiaries of it as well.

Colin Guheen -- Cowen & Co.

Great. And just a modeling question. What's a good number for the tax rate in '08?

Tom Cawley

I think if you use around 37%, you'll be in a good place.

Colin Guheen -- Cowen & Co.

37%. And you said 50% year-over-year -- I'm sorry 50 basis points year-over-year operating expenses will be up. Is that the guidance?

Tom Cawley

I'm sorry, operating --

Colin Guheen -- Cowen & Co.

Operating expenses were up 50, you said should be up 50 basis points year-over-year?

Tom Cawley

Yes. Up to 50 basis points.

Colin Guheen -- Cowen & Co.

Okay. Thank you very much.

Operator

(Operator instructions) Next, we'll move to Nicole Miller with Piper Jaffray.

Nicole Miller -- Piper Jaffray

Good afternoon.

Pat O'Dea

Hi.

Tom Cawley

Hi, Nicole.

Nicole Miller -- Piper Jaffray

On the CapEx number, is it still $25 million? And what are the buckets?

Tom Cawley

No. It's $30 million.

Nicole Miller -- Piper Jaffray

$30 million. Okay.

Tom Cawley

Yes. So the buckets we have, they'll be about, depending on how many stores we end up with, somewhere around $13 million in new stores. We have probably about $4 million in remodels in existing stores. We have some plant spending and specialty spending on some of the grocery stuff of a couple million and then we have about $7 million for IT. We are embarking upon the ERP this year, so we're moving forward with that and that spending will happen mostly in this year. It won't go into service until next year, so it won't be depreciated, but it will be cash flow. And then we're just moving in -- in May we'll be moving all of our headquarters employees into our old plant. We've just finished building it out; that was about $3.5 million to do that.

Nicole Miller -- Piper Jaffray

Okay. And on the grocery, 8,000 -- I just want to confirm the 8,000 target. That's obviously the entire country, both West and East Coast. And then what's the ultimate -- so just confirming that -- now, what's the ultimate door penetration? I know a lot of numbers could be used and I don't know how you guys define it. But for example, we'll hear that there's over 60,000 retail doors when you look at retail in grocery. So, just curious on how you define it and what you think the absolute potential is over time.

Tom Cawley

First, the 8,000 is a total. And in terms of potential, I think in the 15,000 to 20,000 range ultimately. I think it follows specialty coffee development. So if you ask me today, point in time, if you could be in every grocer where specialty coffee is well developed enough today to be there, the number might be more like 10,000 to 12,000. And three years from now, it would be more like 15,000 to 20,000 based on the development of the category.

Nicole Miller -- Piper Jaffray

Okay. And on the SKUs, is there SKU potential? Like let's say we are down, we're in the future at point X and it is 15,000 to 20,000 doors, how do your SKUs compare like West Coast to East Coast, and is there an ability for you to just sell more product in those doors?

Pat O'Dea

I'm glad you asked the question. So it really for us, it's not a SKU-driven thing. So for example, the number of SKUs that we've in our largest, fastest moving grocery customer in the western United States is the same or about the same as we do in the eastern United States. It might be somewhere in the neighborhood of 8 to 10 SKUs. What it is, is we've really powered our SKUs and the way that we build our business is through obviously the stall [ph] targeted marketing activity we do. But, the direct store delivery selling and merchandising system really drives the business with incremental displays of those 8 to 10 power SKUs. So I think sometimes people get the impression and actually there are a lot of people who do this in their marketing programs, where they think just putting more SKUs in the store is the way to build the business. It's really not the way we build our business. The way we build it is through incremental display merchandising activity and marketing programs that target the right customer. So, I think in our 12-ounce bag business in grocery, that will always be sort of that 9 to 10 SKU business. And then we've the direct store delivery platform that we can go in with and add new forms of coffee or tea or other things down the road.

Nicole Miller -- Piper Jaffray

That's very helpful. Thank you. And I just have one last question kind of related to that. Can we also get an update on what you see your retail store potential being? And I'm curious if the grocery expansion supports more stores over the long term or if it has an impact like that?

Tom Cawley

I would hope it would. I think our strategy three years ago was that we would have grocery follow retail and retail would build the brand awareness. And I think that as grocery has been more successful for us, it has gotten to be such a big part of our business we are starting to see that we may be able to brand awareness through grocery. So from a nation-wide standpoint, it may be we're seeding markets with the brand that we can go into later. We've never really said what our potential is for total stores and it's because when you're sitting under 200, 500 seems like a lot and 1,000 seems like a lot. I think those are the numbers we've throw out in the past as far as the type of numbers that we're thinking of. But, we really have cautioned ourselves of setting any grand goals of saying this is where we're going to be because it's not about how many we open. It's the quality of each one that we're working on.

Pat O'Dea

Let me just add to that just to paint a picture and pick a market. Tom, how many stores do we've in Sacramento now?

Tom Cawley

About 10.

Pat O'Dea

Okay. So we've about 10 stores in Sacramento today. I'd say three or four years ago, we only had a few; and four or five years ago, we didn't have any grocery business in Sacramento either. Today, Sacramento's kind of a nice little metaphor for how we would develop the brand in a market. So we've 10 company stores in Sacramento. We entered the grocery category before many of those stores were built. And in grocery, in Sacramento, we now have a 12% share of the total coffee market which is the number two position overall. That translates to about a 27, 28 share of the specialty coffee market in Sacramento.

In addition to the 10 stores, we'll probably have by the end of this year, in Sacramento, I don't know, another maybe between 15 and 20 strategically placed licensed locations. And through the mix of the licensed locations, our company stores, the direct store delivery grocery business and then complementing that with strategic food service and office institutions, whether they be colleges and universities or white tablecloth restaurants, and we're going to have a very well developed market in Sacramento.

I think when we think about expanding in markets, we can use any and all of that mix of tools to develop our coffee business in the most effective way that we believe we should as opposed to thinking about it like, we're retail and we've to do this, or we're just doing grocery and we've to do that. It's putting the pieces together in the smartest, most effective way and being really indifferent to the channel per se and just driven by developing the coffee business.

Nicole Miller -- Piper Jaffray

That's all I had this afternoon. Thanks guys.

Operator

We'll have a follow-up question from Matthew DiFrisco from Oppenheimer.

Matthew DiFrisco -- Oppenheimer & Co.

Thanks. I guess it has never been really a question on the conference calls in the past because you've always been going so strong in the other direction as far as adding doors. But it has been several years now since you've had some major grocery stores and we've never really gone back and asked about the original guy like Safeway and your larger accounts that came on earlier, as far as holding them and retaining them. What do you see as far as net stores? If you weren't to add any stores, do you normally have as far as attrition, whether it's just them making their decision to leave Peet's or it doesn't fit the exact market if it's a lower end market or anything being -- behind my question I'm wondering if there's any change now that for instance, Starbucks is referring to their CPG group stand-alone and seems to be focusing on it a little bit; then you've got Dunkin getting into the grocery channel. I'm just curious if you've noticed a pickup of attrition from a couple of your grocery store chains at all?

Pat O'Dea

Yes, we lost stores [ph]. Is that what you mean by attrition?

Matthew DiFrisco -- Oppenheimer & Co.

Yes. I assume that you do have a couple of grocery stores, out of the thousand that you might sign up with one chain, that you might have a couple that elect to jump out and not put it on their shelves for regional preferences perhaps.

Pat O'Dea

Let me clarify. So, in terms of account attrition, we've never entered a grocery account, not performed, and then been kicked out, so just to be clear about that. We've always performed well and remained in. In terms of within a particular account, have we ever gone in, started to service all of their stores and then discovered that some of the stores in less well-developed geography or less-friendly specialty coffee geography, were not worth servicing. The answer to that is yes both ways. So, in Safeway, for example, when we first entered, we were only in about 1,200 of their 1,800 stores because we mutually selected the ones that we thought were the best. Today, it's more like 1,400 because the category is better developed, Peet's is better developed. So we've added stores that we wouldn't have been in before.

When we enter into a new customer, we'll sit down with them together and we'll say, looking at their stores, where does it collectively make sense to have the kind of very super premium, premier quality, higher-end priced specialty coffee like Peet's? We'll make that decision. And then we'll go in, we'll service the stores and based on how things are going over the first three to six months, we'll proactively go back to the account and say, I think we should add these stores or I think we should subtract these other stores. That's really sort of really all kind of around the edges type of stuff, nothing major. It's in our best interest to do that.

Matthew DiFrisco -- Oppenheimer & Co.

Okay. And then just another little follow-on here on the license that you touched on there. Again, sorry to refer to other companies. I'm not asking you to make comments on their comments, but I think Howard Schultz commented the other day that Starbucks is a little bit, the question of franchising stores and he actually came back and said he regrets how many license he might be doing domestically because it did sort of crimp the potential of the company-owned stores. How do you measure that or how well tested do you feel about those 100 Raley stores coming out and potentially cannibalizing some of your existing company-owned stores and future company-owned growth?

Pat O'Dea

So let me put this in perspective. First, just start off by saying we've 37 licensed locations today, so I don't think we're saturated by any means, of course. Matt, we are very strategic when it comes to licensed Peet's stores. We use licensed stores as part of an overall strategic plan to develop a market and as a means of exposing the brand to the right target audience in captive locations where we couldn't be any other way. But, in either situation, we only enter into licensed store agreements with partners whose interest in Peet's is clearly driven by a desire to make a distinguishing statement about the quality of their coffee program and they both have the desire and the capability to meet our demanding, more demanding freshness and brewing standards. And as a result, there are a lot more customers interested in a Peet's license store than we end up partnering with.

So this year will be a better, more licensed store locations added to the 37 we've today for two major reasons. One is there are some Raley stores that are part of our overall market development plan to develop Sacramento where we'll put in some licensed locations. It's not 100 by the way. I think out of the 100 stores, I want to say and don't hold me to the exact number, but I think out of 100 stores, it's like 70 who will get a We Proudly Brew program, which is not a license. I think there's 30, which over the course of the next three years, will get a license. So it's not 100. And then, in addition to those, we do have the remainder of the locations are classic captive locations like airports, large office complexes, colleges and universities. But, when it's all said and done, we might have 65 to 70 licensed stores across the United States, strategically placed, with customers who are really interested in making a statement and willing to go to the extra efforts they have to do that with our brewing and freshness standards.

Tom Cawley

One of the other things that a chain like Raley's does give us that we don't, we are not currently going into the smaller towns in the Central Valley of California which is where they are based out of Sacramento. So, there's a lot of towns where we just would not ever put a store and this gives us a presence. As we look at it as part of market planning going in, we are making decisions on some of these, just saying them the town is not big enough. They have to have a grocery store, and they have a grocery store and it's the best grocery store maybe in town for them, but we wouldn't put a store there anyway. So it is all part of the same market planning and works in conjunction with the real estate team.

Matthew DiFrisco -- Oppenheimer & Co.

You're talking to a customer who services two of your licensed stores or licensed Proudly Brewed place is the only place I can get a cup of coffee in this area in New York, so I agree you are not saturated. But, I was curious, with the sort of the hitting the brakes by your number one competitor, if something like you see great amount of acceptance from the ING Cafe in mid-town Manhattan, is there an ability now maybe where you could get pocket locations where you have no company-owned retail presence with a few iconic type locations? For instance, New York people know you as through the JFK store where it was a licensed store at one time and then you have the ING brand, your present in Whole Foods. Is it an opportunity, with the number one player hitting the brakes on growth, for you to go to landlords that are left holding the bag on leases that aren't going to be fulfilled now and say, well, this is a great iconic location. I could easily open up here and do a million in the middle of this and sort of be a beachhead for at least a test, rather than some other more riskier ventures or, I don't know, looking down the line as far as building out or putting capital in another direction?

Pat O'Dea

Yes. Do you mean as a licensed location?

Matthew DiFrisco -- Oppenheimer & Co.

No. I meant as a company-owned store.

Pat O'Dea

Oh, as a company-owned store.

Matthew DiFrisco -- Oppenheimer & Co.

In an iconic location in the middle of Manhattan, or if you put one in and just see how it goes and sort of help out the experience of, as you've said in the past, you've said an existing store, company-owned, is a great place to try it the first time and you have a better sell-through once I see it in the grocery channel knowing what Peet's is and knowing it's a premium positioning. So that same mentality, I mean don't totally abandon the approach of let the first experience be done within your control at your own store. So, are their iconic type locations where you could be next to a very high volume area that Starbucks might be passing on or waiting a year or two down the line to go into where you could seize on the opportunity?

Pat O'Dea

Yes. I guess the headline response would be I think we've got a real clear strategic path here in what we're doing and I don't know that I'd veer off it. I know I wouldn't veer off of that path to take advantage of some opportunistic situation that was caused by somebody else's misfortune or whatever. So I think we'll continue to use licensing strategically as we talked about, but we're not going to take a 90-degree turn of the ship here in the direction we're going in just because there might be a one-off or one or two opportunities because of the situation you talked about.

Matthew DiFrisco -- Oppenheimer & Co.

No. I understand. I meant to say though, due to your faster growth in grocery, more so than just reacting to them. I didn't mean to position it that way. Just that you have the opportunity to extend your brand nationally through grocery, could you sort of accompany that with pockets. But, thank you for answering.

Operator

We'll take a follow-up from Colin Guheen, Cowen and Company.

Colin Guheen -- Cowen & Co.

My question was already asked and answered. Thanks.

Operator

Thank you. For closing remarks then, I'll turn it back over to Mr. Cawley.

Tom Cawley

Okay. We have no closing remarks. Thank you all for joining us. Bye-bye.

Operator

Thank you for participating in today's conference. You may now disconnect.

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Source: Peet's Coffee & Tea, Inc. Q1 2008 Earnings Call Transcript

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