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Caribou Coffee Company Inc. (NASDAQ:CBOU)

Q2 2008 Earnings Call

August 5, 2008 4:30 pm ET

Executives

Kathleen Heaney - Integrated Corporate Relations

Roz Mallet - Past Chief Executive Officer

Kaye O'Leary - Chief Financial Officer

Mike Tattersfield - Newly appointed President and Chief Executive Officer

Analysts

Julie Welter - Piper Jaffray

Operator

Welcome to the Caribou Coffee Company, Inc. second quarter 2008 results conference call. (Operator Instructions) I would now like to turn the conference over to Kathleen Heaney.

Kathleen Heaney

Caribou Coffee's Second quarter 2008 earnings press release was distributed this afternoon, August 5, 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.

Joining me today are Mike Tattersfield, recently appointed President and Chief Executive Officer; Roz Mallet, past CEO; and Kaye O'Leary, Chief Financial Officer. Before we get into a discussion of the second 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 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. Following the presentation Roz and Kaye will be available to answer your questions.

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

Roz Mallet

Good afternoon, everyone, and thank you for joining us today for the Caribou Coffee second quarter 2008 earnings conference call. I will first discuss the business highlights for the quarter and Kaye will then review the financials.

Although, Kaye will discuss the financials in more detail I am pleased to report that our results as you read in the press release we issued earlier today, were better than market expectations. We’ve been expanding the Caribou Coffee brands to franchise coffeehouses, our commercial business and stronger unit level performance. As a confirmation of this strategy we reported an increase in revenue while continuing to manage the store portfolio with an additional six store closures in the quarter.

Nevertheless we are not satisfied with these generally positive results and are working diligently to improve the overall profitability of the company. As a reminder last year we began the process of aggressively managing our coffeehouse portfolio and closed 28 underperforming location; we are continuing to process this year. In conjunction with those product and operating initiatives at the coffeehouses to improve general economics, we are improving the overall health of our store base.

Despite the worsening consumer environment, we are making progress. We’ve done work on the store base as well as new product initiatives enabling us to report comps of negative 1.7% in the quarter, better than the overall industry. In contrast, our international units are experiencing very strong growth. We are particularly pleased to report that comps in these units were up 20% in the quarter.

Now about to our retail stores; through June we have closed 20 company-owned stores. We all well on our way to closing a similar amount of coffeehouses as 2007 level was previously disclosed. Our ongoing company-owned portfolio management process is the key part of our strategy to return to possibility. While we continue to focus on improving store economics we have slowed the pace of news store opening. As a result we did not open any company-owned units in the quarter.

However, given the demand we see for the Caribou Coffee brand we have accelerated franchise coffeehouse development. During the second quarter 12 franchise coffeehouses opened bringing the six months total to 23. We now have 75 franchise coffeehouses up from 39 at the end of the second quarter 2007.

As I mentioned last quarter, our franchising program continues to evolve to include store within a store locations and non traditional locations, which will help us introducing grow the brand in the market. At the end of second quarter we had 15 stores in our store locations and grocery stores in college campuses. We have an additional 20 individual store agreements signed, which have not yet opened. We are always looking for and will continue to evaluate opportunities to expand the brand and to expand the Caribou Coffee experience with customers in the new markets using these locations.

We spent a lot of time during the last conference call discussing the initiatives we are undertaking to improve unit level economic analyzing. Everything that we do in the coffeehouses has been under review including our products throughput, store prototype, labor deployment, growth capacity optimization and equipment utilization.

At the store level we’ve been focusing on ways to improve our controllable profit. As a result we are redesigning our labor deployment practices as well as our theoretical labor model measured against our recipe platform. We saw a slight improvement of labor in the second quarter and as we begin to implement other initiatives, we expect to see further improvement.

We also have initiatives underway which are designed to boost average unit volumes, which are anchored by the introduction of new beverage products and our award-wining coffee bean. During the quarter we introduced several new beverages including a brand new fruit and tea blended beverage line and expansion of our real smoothie offering and two special Candy Coolers that compliment our extensive Northern Light and regular cooler beverage offering.

The fruit and tea beverages come in three flavors; White Tea & Peach, Green Tea & Mango and Red Ted & Raspberry and we were getting good trial in repeating these new beverages. They are designed to capitalize on the health and wellness focus of many of our customers today. We brought back our popular Iced Tea smoothie and our real fruits smoothie and then also added a blueberry smoothie this year. This summer we are offering both the snickers candy cooler and the Andes Mint Candy’s Cooler, which are providing that desired treatment that customers have come to expect from Caribou Coffee.

On the Coffee front we continue develop and introduce unique and exclusive coffees that can only be found at Caribou Coffeehouses. Our popular Rare La Minita Peaberry Coffee is again being offered exclusively in our stores. Every year we purchase the entire year’s harvest of this high quality hand sorted bean from the growers in Costa Rica.

We also have a new line of the exclusive limited availability Coffees called Origin Select. Our first offering Timana Colombia Reserve became available in our stores in June and is a Rainforest Alliance Certified premium coffee available for a lot of time at a selective number of our stores. We are also pleased that our Ethiopia Organic Yirgacheffe coffee earned a Gold Award at the Specialty Coffee Association's Roaster's Choice tasting competition.

During the second quarter our commercial business was a stand out and is driving in the current economic environment as we are seeing changes in consumer purchasing behavior particularly at the big box store. This increase in demand coupled with new business drove a 67% increase in our commercial sales over the prior year with monthly revenue records being achieved.

We believe the demand that we are seeing speaks to strength of the brand. Our commercial business include sales of pre-packaged whole bean and ground coffee to trade channels such as conventional grocery, mass merchandisers and club stores. Along with growing this and our existing customer based we continue to add new customer account, which have also given us nationwide coverage.

Some key accounts wins in the second quarter were King’s Super Market, Foodtown and Big Wide Markets serving New York, New Jersey and Massachusetts for a total of 139 stores. We also continue to add grocery stores in existing market and have expanded our Super value relationships. Subsequently at quarters end we added Kroger and will be in five markets beginning this quarter.

On the brand licensing side, our agreement with Keurig remained a particularly bright spark during the second quarter with robust demand continuing for Caribou K-Cups across many of the retail channel. Today over 1 million pound of Caribou Coffee have been packaged in K-cup.

To review 2008 as a transition year; now we are making progress and turning around the business in a difficult consumer environment. It is a slow and steady process and the actions that we are taking today will position the company to resume growth and improved profitability.

The Caribou Coffee brand remain strong which is reflected in our growth of our commercial and franchise businesses. We are positioning the company to capitalize on a very loyal customer base and we look forward to updating you on our progress in the upcoming quarters. With that I will now the turn the call over to Kaye to take you through our financial results.

Kaye O'Leary

Before I begin the financial review, please note that both the second quarter 2008 and 2007 consisted of 13-weeks. Largely driven by our store closure, our company-owned coffeehouse operating weeks were 5,444 in the second quarter of fiscal ‘08, as compared to 5,762 in 2007, a 318 fewer operating weeks in ’08 than in ‘07.

We continue to emphasize our efforts in driving our top line growth and improving our unit economics and the company’s economics model. Our second quarter financials are beginning to reflect the results of those efforts. Despite closing 22 stores year-to-date and experiencing a negative 1.7% comp store sales in the quarter, our total net sales grew five tenths of a percent to roughly $300,000 driven by 67% growth in our commercial business and 71% growth in our franchise business.

We reported a net loss of $2.4 million or $0.13 per share as compared to a net loss of $2.9 million or $0.20 per share for the same period last year and I would like to emphasize that the $2.4 million loss in this quarter included $1.3 million in store closing expenses and $200,000 in impairment charges, so a total of $1.5 million expense impact on the quarter. So, of our $0.13 per share loss $0.08 per share was due to store closure or impairment charges in the quarter, which compares to roughly $634,000 of store closure or impairment charges or $0.03 per share of the $0.20 per share in the second quarter of 2007.

We reported EBITDA of $2.9 million in the quarter compared to EBITDA of $2.4 million in the comparable period last year. It should be noted that the second quarter of 2008 included store closure expense of $1.3 million versus the $134,000 in the second quarter of 2007, a $1.2 million year-over-year increase in the second quarter of ’08.

Now, I would like to format our financial discussion a little bit differently today. Beginning with our 2007 10-K filing we began to report our financial results based on three difference business segments. The first being retail, the second being commercial and the third being franchisee.

Each of these business segments shared commonality and that they all stay true to our core essence of offering only the highest quality, best taste in coffee. However, the three segments have different economic model. So, I am going to talk about the financial results for the three businesses today and you will access to our segment reporting in our second quarter 10-Q that should be filed tomorrow.

First I will talk about top line sales. In our retail business segment, which is our company owned stores we reported second quarter of ’08 coffeehouse sales for $57.3 million or a decrease of 3.5% from the second quarter of ’07. This was due to negative comps in the quarter of 1.7% and 318 fewer store operating weeks in Q2 ’08 due to store closures.

We closed six company owned stores in the quarter and we closed 22 company owned stores year-to-date in 2008. For those you keeping track beginning with August of 2007 we closed 40 company owned stores. The last retail price increase we took was a 2% increase on beverages, which represented about 80% of our retail sales and we took that at the end of the September of 2007.

Commercial sale through the second quarter of ’08 was $4.5 million up 67% from $2.7 million in 2007. Commercial sales were roughly 7.1% of our net sales in the quarter versus 4.3% of our net sales in the same quarter last year. The growth is being driven by the addition of new grocery store partners and new food brokers as well as growing sales to our existing grocery store partners and to Keurig.

Our franchise sales, our third business segment for the second quarter of ’08 were $1.4 million versus $836,000 in ’07 roughly a $600,000 increase. Franchise sale were 2.3% of total net sales in this quarter versus 1.3% of total net sales last year. 12 new franchise stores opened in the quarter bringing us to 36 new franchise coffeehouses that have opened during the past 12 month.

Our consolidated cost of sales and related occupancy costs were $27 million in the second quarter, up 1.8% from $26.5 million in the same quarter of last year. On a consolidated basis our cost of sales and related occupancy costs was 42.7% of sales, about a 500 basis points increase from the 42.2% of sales reported in the second quarter of ’07. Again it’s important to understand how this is impacted by our different business segments.

First in retail, our retail coffee sales and related occupancy costs came in at 40.9% as a percent of sales from the second quarter and I’d like to highlight that this was flat to prior year. Despite increasing commodities cost we are beginning to see the benefits of our inventory management program and we are beginning to see the leveraging impact of closing our underperforming stores on our cost of sales and on our occupancy cost.

The cost at sales and related occupancy in our commercial segment was 64.3% of sales, a 440 basis point decrease from 68.7% of sales in ’07 as we begin to benefit from the sales growth that allow us the leveraging of expenses like starting fees in this segment. The franchise segment cost of sales and related occupancy costs increased to 49.1% of sales from 48.8% last year driven by shifts in product mix and increasing distribution expenses.

Operating expenses were $25.8 million in the second quarter of ’08, a $40.8 million of total net sales versus $27 million or 43% of total net sales in the second quarter of 2007. the 220 basis point improvement as a percentage of total net sales was driven by improvements in margin and all business segments driven by the leverage on sales growth specifically our commercial and franchise segments and better labor management and our closing of underperforming stores in the retail business segment.

Depreciation and amortization expense decreased roughly 22.4% to $4.6 million from $6 million in the second quarter of last year. This decrease was a result of the effect of the impairment of 38 company owned of company owned and operated coffee during the last 12 month as well as fewer coffeehouses opened in the period. This is partially offset by $200,000 of accelerated depreciation related to the impairment of one store in the second quarter of 2008.

G&A expenses decreased 7.5% in the second quarter to $6.6 million from $7.2 million in the same period last year largely driven by reduced head count. From a balance sheet perspective we ended the quarter with $6.7 million in cash and marketable securities. We have $3 million drawn under our revolving credit facility largely to fund the legal settlement and executive transition expenses. Our capital expenditures are roughly $4 million on a year-to-date basis.

For the first half of 2008, our total net sales were $124.9 million versus $124.7 million in the first half of ’07. Our comp store sales for the first half were negative 2%. Our net loss for the first half was $8.8 million or $0.46 per share, this compares to a net loss of $7.1 million or $0.37 per share in the first half of ’07.

2008 year-to-date net loss includes $3.9 million of store closing costs and $1.7 million in impairment charges, totaling $5.6 million or $0.29 per share of expenses from closings and impairments. In comparison 2007 year-to-date net loss included $900,000 of store closing costs and $900,000 of impairment charges totaling $1.8 million or $0.09 per share.

With that Roz and I will be happy to answer any questions you might have at this time.

Question and answer session

Operator

(Operator Instructions) Your first question comes from Julie Welter - Piper Jaffray.

Julie Welter - Piper Jaffray

Just to follow up on the K-Cup sales, I know you said it was $1 million pounds to-date, now is that sold or packaged so far for coffee?

Roz Mallet

That’s been processed to Keurig and we've been in business with Keurig and K-Cups for little over a year.

Julie Welter - Piper Jaffray

So its one year, but some of those could be an inventory technically?

Roz Mallet

Yes, it could be still an inventory.

Julie Welter - Piper Jaffray

And then can you give any color on how many pounds were processed to Keurig this quarter and has that kind of increased or decreased?

Roz Mallet

Julie we don’t have that information with us.

Julie Welter - Piper Jaffray

And then just in terms of, the grocery category in general I know your specialty sales are growing and part of that from the sale of ice cream, but just in terms of pure coffee pounds kind of the core of the business, can you talk about general terms for you guys or the industry in general and is that going with just trends in the economy right now?

Roz Mallet

Well, the coffee that’s being roasted for the commercial business is growing. We are seeing an increase from business like Costco as the economy has changed. I don’t have a specific number for you there Julie.

Julie Welter - Piper Jaffray

Congratulations on the new CEO, Michael and I think he is on the call today, just wondering maybe I don’t know if Michael can answer this, but what attracted him to the brand and why that change is made now?

Roz Mallet

We really prefer to stick to the second quarter results if you don’t mind and Mike in our next quarter will be glad to spend sometime talking about what he is here for.

Julie Welter - Piper Jaffray

So, you can’t give us any indications of some of the first things he’d like to address or areas of focus, even with branding operations or other changes?

Roz Mallet

No, Julie Mike’s been here for one day.

Julie Welter - Piper Jaffray

Well, yes obviously he has done research on the company before he accepted the position, so just wanted some initial thoughts there.

Operator

We have no further questions in the queue.

Roz Mallet

We’d like to thank everyone for joining us today and we will see you again next quarter. Thank you.

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