24/7 Wall St. : As you expand, when you are competing with companies like Starbucks and McDonald’s, do you think primarily in terms of product differentiation or getting good store locations?

Tattersfield: Even broader than that, it’s a combination of both.  As I look at brand differentiation I also look at customer experience.  Does it connect with what the Caribou brand really stands for and can we truly differentiate ourselves from a Starbucks and a McDonald’s?  Because we are truly all different and we have a different experience strategy.  We’re all going to be looking for the best real estate.  So that doesn’t take it out of the equation.  From a product strategy, we believe we have a superior product.  We’ll continue to apply that quality focus on everything else that we do.  So we’re in a test of looking at oven-baked items that we’re putting in stores now. We’ll be looking at seeing what the potential is to roll that out.   And it needs to match exactly what we’re doing with our coffee quality.  We do have differentiating strategies, but I also look at the brand experience.  Delivering that is one of the key components of us being successful.    

24/7 Wall St. :  Last quarter store sales were down slightly but commercial sales were up for you.  Is this something you envision continuing going forward, establishing more deals with supermarket chains and other commercial retailers?

Tattersfield:  One of the things that I came aboard — I have been here about 14 months – one of the things that the management team and I looked at evolving was the business from really a retail coffee house business to a branded coffee company.  And clearly a lot of our success that’s been happening this year is a big push to what we call our commercial business.  That entails the CPG category, the club category, which is Sam’s or Costco (NASDAQ: COST), as well as looking at other opportunities such as our relationship with Keurig and Green Mountain (NASDAQ: GMCR).  We’ve really grown this year in our commercial business from 2,000 doors to, at the end of the year, well over 6,000.  So if you look at the growth, from a revenue perspective even in the last quarter you saw basically our revenues were flat overall as a company.  We see a huge opportunity in the commercial businesses because you know 80% of the coffee is either consumed at or based out of home, not just in the retail coffee house base.  It doesn’t mean that we’re going to walk away from our retail coffee houses.  I love retail.  I’ve spent most of my career in retail and I think doing a fantastic job of differentiating the brand is probably going to happen most at the retail stores because then you can see how the brand translates to the consumer and what the brand stands for.  But we are also trying to figure out how to do that in the commercial business.  So to answer you question succinctly, we continue to see commercial growing and having a lot of opportunity.

24/7 Wall St. : Operating expenses on a quarter-to-quarter basis dropped from $25.8 million to $23.8 million, according to your most recent 10-Q.  To what extent do cost controls and store closings play a role in your plans going forward for expansion?

Tattersfield:  We are really not looking at continued store closures in our business.  One of the first things that we did as we came aboard was to rationalize the cost structure of our overall business.  So we did have a reduction in force and we did look at some closures of stores that clearly were not going to be able to perform because of poor real estate decisions.  We’re pretty much over that phase now.  Besides the normal “do you renew a lease?” as you look at if it’s in the best location versus moving it to a better location.  We don’t see significant reduction in our store-base anymore.  Opportunisticly, it might be something that we look at.  We are opening up 30 licenses this year.  So we continue to see that going forwards and are looking at doing that next year as well as pushing new prototype coffee houses because we also believe there’s a lot of space in how the category needs to evolve from where it traditionally is based today.

24/7 Wall St. :  This year coffee stocks in general have really been taking off.  Is this because margins in the coffee business have been improving dramatically or is it just that these stocks were just very oversold?

Tattersfield:  If you look at the category, I look at Caribou as a company that since its public offering has never been profitable in its history.  We have just delivered three consecutive quarters of profitable growth.  I think the Street gives you credit for that as long as you can continue to show the vision of where you want the brand to go and what direction you’re heading.  One of the things as we evolved this company from a retail coffee company to a branded coffee company is it’s a much larger category.  And if we continue to hold on to premium quality coffee products, that’s not something the consumer has been willing to give up.  The American consumer in particular, 54% of adults everyday get up and have coffee. It’s just one of those indulgent moments that’s part of the start of their day.  They might trade down on your menu or do something differently but most still are looking for a great quality product and experience. If that translates to people to buying more coffee stocks, there are plenty things that are going on with Green Mountain, which is another company that making tremendous inroads in the single cup serving option.  That’s a very viable business and we’re happy to be partnered with them in that growth.  But again in the multiple channel business that we’re looking, we see a tremendous opportunity in every one of our channels, including retail. So people are giving us credit for what we’ve done, I think it’s more important where we’re going.

24/7 Wall St. :  Alright Mike, that’s all I have for you.  I really appreciate you taking the time to speak with us today.

Tattersfield: No problem.  

Garrett W. McIntyre

Dunkin’ Donuts appears to think it can join the ranks of all the other companies trying to take business from Starbucks (SBUX). McDonald’s (MCD) has been at the top of that list, and now they won’t be so lonely.

According to Reuters, Dunkin’ "gets around 65 percent of sales from beverages. Over the last few years, it has added espressos, lattes and cappuccinos that cost roughly $1 less than at Starbucks."

At some point the market for coffee will become so crowded that retail chains will have to give away the java and hope to sell breakfast food to bring in revenue.

Douglas A. McIntyre

Introducing 2008 targets: It sees same store sales of 3% to 7%, is targeting 18% revenue growth and targets 20% to 22% earnings growth.  Fiscal September-2008 looks like estimates are $1.06 EPS on revenues of $11.33 Billion.  That is in-line on earnings guidance but could be deemed a tad light on the revenue front depending on your mid-point of guidance and which estimate you use.  The good news is that this is not showing any newer fundamental flaws or major problems that would create real caution inside the company.  Shares are acting accordingly in initial reactions, and we’ll have to see how others interpretthose earnings and revenue growth ranges before declaring a formal vistory.

Starbucks opened a record 668 stores in the quarter as well and posted a comparable sales growth per store of 4%.  It still sees a total of 2,400 store openings this year and is now targeting 2,600 store openings in 2008.

Starbucks shares are up almost 4% in initial after-hours reactionary trading at $28.25.  If that level can hold, shares will be well above 10% off of the recent lows and may give investors a reason to think the worst has been seen or that most of the bad news has been priced in.  We’ll see if that holds, but that’s the initial reaction.

Jon C. Ogg
August 1, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.

We already discussed how the company has a long way to go before itcan fix its woes.  Upon some store revisits it seems the company is trying, and we have already been given notice of some price hikes that are going to be passed on to yours truly and you.  The larger food initiative that is being rolled out on top of last year’s rollout is still in the infancy, so perhaps we’ll get a glimpse of the company’s thoughts there.  The company has been under pressure from McDonalds (NYSE:MCD) and faces other pressure from Dunkin and others.  Here was our list of suggestions in May for the company to follow after we did a series of store evaluations in various locations.

What is interesting is if we take this into the consumer-meets-investor mindset.  Last night Whole Foods (NASDAQ:WFMI) posted stronger than expected or not as weak of results, and shares are up big today as a result.  Sure these comapnies are in different segments, but what they have in common is a loyal client base AND large earnings and valuation multiples compared to their competitors.  A 30+ P/E ratio used to be a 40+ P/E ratio for the longest time.  The question is what P/E multiple can victory be declared for a fair value.  We ran a piece wondering if shares had come close to a bottom at the end of June, and that is still an outstanding item. 

It’s quite possible that this multiple may need to compress further, but using the forward 2008 multiple it trades at an estimated 25.1 forward P/E.  Some will still deem this high if the market continues its weakness and volatility, but with earnings per share growth at more than 20% it becomes and argument over who will pay what for that growth.  If you wanted to use a ‘forward’  PEG ratio of 1.25 this becomes cheaper, with the flaw being that this is trying to fast-forward a year.  Based on that, this could still face more pressure as investors and traders fight over what the true value is.  But with the 52-week high of $40.00 and the curent $26.60 price it just looks and feels like the worst could be behind it.  One earnings warning or major hiccup will blow holes in that theory, and that always has to be kept in mind. 

Starbucks also saw its most recent short interest rise from 25.8 million shares in June to almost 27.4 million shares in July.  Options traders based on a static quote mid-day appear to be braced for a price move of just over 2.2% in either direction, although that is arguable with shares being stuck between strike prices.  The average analyst price target is still $35.00 or higher.

Jon C. Ogg
August 1, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.