Peet

123jump.com Staff
01 Dec, 2010
New York City

The specialty coffee roaster and retailer net quarterly revenue increased 9% to $80.2 million. Net income in the quarter surged 52% to $3.8 million. Earnings per share grew to 28 cents per share, compared to 19 cents per share in the corresponding period last year.

Peet''s Coffee & Tea, Inc. ((PEET))
Q3 2010 Earnings Call Transcript
November 2, 2010 5:00 p.m. ET

Executives

Paul Yee – Senior Director, Investor Relations and Finance
Patrick J. O''Dea – President and Chief Executive Officer
Thomas P. Cawley – Chief Financial Officer

Analysts

David Tarantino – Robert W. Baird & Company
Steve West – Stifel Nicolaus
Gregory McKinley – Dougherty & Company
Mitchell Pinheiro – Janney Montgomery Scott
Colin Guheen – Cowen and Company
Michael Wolleben – Sidoti & Company

Presentation

Operator

Good day, everyone and welcome to Peet''s Coffee & Tea Third Quarter 2010 Earnings Results Conference Call. As a reminder, this call is being recorded and we will be conducting a question-and-answer session after the presentation. I will now turn the call over to call Paul Yee, Peet''s Senior Director of Investor Relations and Finance. Please go ahead.

Paul Yee

Thank you, operator. Today, I''m joined by President and Chief Executive Officer, Pat O''Dea and Chief Financial Officer, Tom Cawley.

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 titled Risk Factors in the most recent Annual Report on Form 10-K for the year ended January 3, 2010 filed with the SEC on March 19 of this year. It''s also available on Peet''s website.

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

Patrick J. O’Dea

Thanks, Paul. In our call today, we will provide third quarter results and our full-year outlook, then come back to share some perspective on 2011.

First from an earnings standpoint, third-quarter EPS of $0.28 was up 47% versus year ago. Based on this strong performance and our outlook for the fourth quarter, we are raising our non-GAAP EPS for the full year from the previous guidance of $1.27 to $1.30, to $1.30 to $1.33. In addition, we are also establishing EPS guidance for 2011 of $1.53 to $1.60.

Second from a sales standpoint, we grew 9% in Q3, resulting in a year-to-date growth rate of 10%. Our growth continues to be led by our grocery business which was up 24% in the quarter and 30% year-to-date.

Third, we continue to improve the profitability of our business as operating margins expanded 210 basis points in the quarter despite higher year-over-year input court costs. Tom will provide some more insight here in a minute.

Finally, we took a price increase in our retail and home delivery businesses effective at the start of the fourth quarter and have announced a price increase to our food service and office customers, most of which will occur at the start of 2011. We have not taken any pricing in the grocery channel at this point.

Our third quarter results were not impacted by pricing and our outlook for the rest of this year and next firmly assumes the pricing that we have already announced. All in all, it was a strong quarter. We feel good about where we will finish this year and we are prepared as we enter 2011.

Now, for some color commentary on our performance. Our grocery business grew 24% in the third quarter. We do not have any notable new Peet''s distribution or promotional activity that fell within the quarter. So this group''s growth was predominantly organic in existing distribution.

This performance is a testament to the premium position of the Peet''s brand and the advantage of our unique selling and distribution system as IRI data aligned with the quarter indicated Peet''s average selling price in grocery was almost 10% higher than our closest competitor nationally and as much as 17% higher in the west.

According to our IRI which measures sell-through at some but not all grocery outlets, our growth in the west continued in the low to mid teens and in the east grew 51% with about 12 points of that east growth coming from Godiva. At the end of the quarter, we introduced two new Godiva seasonal flavors, pumpkin spice and peppermint, into some grocery mass and drug customers and early on they appear to be performing well.

As you all know, specialty coffee has grown rapidly over the last decade. It''s become mainstream as about 40% of all coffee purchased for at-home consumption through grocery stores is now specialty coffee.

Given this dynamic and Peet''s clear position as the premium quality premium priced brand in the segment, we received an inquiry several months ago from Walmart expressing interest in carrying Peet''s in markets where they now have a well-developed specialty coffee business. Starting just a couple weeks ago, we began shipments through our DSD network to about 600 Walmart stores.

We expect this new distribution to contribute modestly to our business this year and more meaningfully next year. In addition to this new distribution, we also expanded our DSD network and entered the Minneapolis market just a few weeks ago. And we began shipments to about 30 select Sam''s Club stores in the Western U.S. this month as well.

All of this is indicative of a broader point. Peet''s is firmly positioned at the high end of specialty coffee. As specialty becomes mainstream, there will continue to be new opportunities for us to grow geographically and through new channels and customers that would not have been possible a decade ago when specialty coffee was still in its infancy.

These growth opportunities in combination with our continued strong organic growth rate in existing traditional grocery and along with any new package forms or product segments, we may choose to enter in the future are all positive underlying dynamics for our packaged coffee business moving forward.

Turning to retail, our stores are performing very well. Sales grew 4% in the quarter driven entirely by existing stores with stronger beverage growth offsetting a relatively flat bean business given the broader convenient availability of beans and grocery. In addition to our annual summer drink program, two major events occurred in our stores during the quarter to note.

First, we welcomed Roberto Mata from Coope Dota in Costa Rica to a tour of our stores to promote our special offering coffee, Alta de Dota. This helped drive our bean business late in the quarter and reinforced our commitment to quality, direct long-term relationships at origin and the sustainable practices behind this coffee that distinguish Coope Dota in Costa Rica.

Second, after three months of intense competition, Michi Adams from our Peet''s store in Petaluma, California won our third annual national barista competition in a final that was webcast live to Peet''s employees everywhere. Our barista competition demonstrates our commitment to handcrafting premium quality drinks and showcases the artisanship and dedication of our best baristas to all our people.

It is value reinforcing activities like these that our customers experience tangibly and intangibly every day when they visit a Peet''s store and this is what distinguishes us. While executing these programs, we also continue to drive store margin improvement as operating margins expanded plus 200 basis points in the quarter.

This quarter''s improvement was above our year-to-date improvement of 60 basis points as we are now reaping the benefits of training initiatives that we frontloaded earlier in the year. Rounding out our channel specific comments, our food service and office business grew plus 11% in the quarter, a bit less than previous quarters as we lost the pipeline volume of a major new customer a year ago.

Our home delivery business is flat to last year which exceeded our expectations that this business would continue to be negative as we expand our grocery business.

Now, I''ll turn it over to Tom to talk to quarter and the financial outlook for the remainder of this year.

Thomas P. Cawley

So for the quarter, we grew net income by 52% by combining 9% sales growth with the 210 basis point improvement in operating margins. We are generating profit growth in both our retail and specialty businesses as the $2 million improvement in operating profit was split pretty evenly between the two businesses.

Profit growth in the retail channel was primarily through improvements in margins as we grew sales 4% and improved margins 200 basis points from 6.9% to 8.9%. These results were driven by our operations team focusing on driving sales and margin productivity in our existing stores.

Half of the margin improvement was a direct result of improved labor productivity which was partially driven by the new labor deployment training that we did in Q1 that targeted better service and improved deployment. In specialty, we continue to drive double-digit growth in this high-margin business. While margins remain very high, they were down slightly on a year-over-year basis from 26.5% to 25.9% due primarily to higher coffee costs.

Now, looking at the overall business by line item, gross margin was 52.5%, down 110 basis points from last year. Half of this decline was due to higher commodity costs, specifically coffee and milk. The remaining was driven by increasing the specialty sales mix in our business which, as you know, has a lower gross margin than retail.

Our operating expense line improved 210 basis points versus last year. This was driven by retail operating costs which were down 170 basis points by improving labor productivity in our stores and leveraging our fixed overhead structure and favorable mix changes to the specialty channel which has a lower cost as a percent of sales than retail.

G&A improved by 60 basis points as total dollars were flat to last year. We had a very nominal increase in payroll, which was offset by a slight decline in marketing and outside services. Depreciation improved 40 basis points as a percentage of sales as total dollars were also flat to last year.

Our CapEx level is very low at about $11 million for the year. And we now have achieved a balance where older assets are becoming fully depreciated at the same rate we are adding new assets. As a result, our depreciation quarter-to-quarter is and will remain pretty flat but just under $4 million per quarter.

Net-net total operating margins were up 210 basis points or 80 basis points on a year-to-date basis. Now, I''d like to turn it back over to Pat for some perspective on 2011.

Patrick J. O’Dea

We''re in a good position strategically and financially heading into 2011. We built an infrastructure that is delivering increasingly profitable growth without requiring significant new capital investment. We have multiple near-term top and bottom-line growth opportunities and our 2011 plans were to deliver strong earnings growth while concurrently investing in research to support future growth.

Let me speak generally to our consumer packaged and retail businesses in 2011 before handing it over to Tom to provide some more specific guidance. In our consumer packaged coffee business, we see three main areas that will drive long-term growth for us. Our 2011 guidance is based on growth from two of these areas.

The common underlying dynamic between them is the Peet''s brands clear position as the premium quality, premium priced specialty coffee in a market that is rapidly becoming mainstream. The first is continuing the strong double-digit growth on Peet''s in our existing traditional grocery store distribution just as we have now for the past eight years.

This growth will be driven by the superior selling, merchandising and person-to-person marketing approach inherent in our DSD system. As specialty becomes mainstream, the Peet''s brand is ideally positioned at the high end for consumers to trade up to and we have the system to execute it.

The second major growth opportunity will be the geographic and channel distribution expansion opportunities which result directly from the mainstreaming of specialty coffee. Our expansion into 600 Walmart stores and select Sam''s Clubs this month is an excellent example as is our expansion into the Minneapolis market.

Our 2011 plans are based on growth coming from these two principal areas. A third major long-term growth opportunity for us is leveraging the brands, people and growth infrastructure we have built to accelerate our existing business growth and enter new segments where we don''t compete today.

We continue to work on a number of initiatives in these areas though our guidance today does not assume them in 2011. Net-net in our consumer packaged business, we believe we are well positioned with our brand at the high end and a proven growth infrastructure to continue to grow at a strong rate with upside potential from future new market initiatives.

Our retail business will continue to be a strong profit driver for us in 2011. The combination of the strong operating team we have now had in place for several years and the systems improvements we''ve made to run our business are paying dividends. Operationally, we''re pretty close to hitting on all cylinders.

We are measuring service level to our customers daily, reducing coffee, milk and baked goods waste, improving labor productivity through better training and deployment, reducing costs while becoming greener with plans for more energy-efficient lighting and greener cleaning supplies and the list goes on. There remains plenty of opportunity for us to make further improvements here and our 2011 plans contain a full plate of these type of operational initiatives.

Beyond these operational improvements, we expect retail sales in 2011 to be aided by the expansion of a new baked goods merchandising program qualified in 2010, improved service levels during our morning rush, new coffee and beverage offerings as well as the pricing increase we implemented a month ago.

In summary, I think we''re well positioned heading into next year. I''m excited about the progress we''re making, our plans for 2011 and the growth opportunities we have beyond what we have planned for next year.

Now, I would like to turn it over to Tom to provide some financial guidance for 2011.

Thomas P. Cawley

So two years ago on this call in October of 2008, we set the expectation that we had a multi-year path to deliver ongoing earnings growth in the 20% plus range by growing our specialty business, improving the profitability of our retail stores and leveraging our past investments. Our plans for 2011 continue to deliver on those expectations.

Our 2011 guidance of $1.53 to $1.60 represents effectively doubling our 2008 EPS with a three year EPS CAGR of 25%. The guidance we''re giving today includes the impact of the pricing actions we have announced to date, that is the recent retail and home delivery pricing actions and the food service and office pricing that is taking effect between now and January.

It does not assume pricing and grocery r additional pricing in other channels. The guidance also includes our expectations for coffee costs, aided by the knowledge that we''ve already locked in 40% of our needs for next year.

From a P&L standpoint, the growth story will look a lot like 2010 for Peet''s. Sales will grow in the 8% to 10% range with a higher growth rate in specialty and a mid single-digit growth rate in retail driven by our current store base.

Overall, company operating margins will improve about 50 to 100 basis points driven by our shift towards the specialty business, the continued optimization of the retail channel and the leverage of fixed costs. Looking at it by line item, gross margin is expected to decline by about 100 basis points due to higher coffee costs and an increase in the mix of specialty as a percent of total sales. Part of the natural increase will be offset by continued focus in retail that will reduce waste in coffee, milk and baked goods as our operational excellence continues to pay dividends.

The lower gross margins overall will be offset by lower operating expenses which will be down over 100 basis points. Since specialty has lower operating expenses versus retail, the mix shift is favorable here.

Secondly, as in cost of goods, retail will continue to focus on improved store efficiencies in all areas of the store including labor productivity, supplies and maintenance. As an example, we have even saved substantially by purchasing our dishwashers and buying our own soap versus leasing them with the cleaning program included.

We expect to leverage both G&A and depreciation next year since we are not adding much headcount or CapEx which should lead to an overall operating margin improvement of 50 to 100 basis points.

2011 will also be a continuation of the transformation that has taken place in the returns of the company. Since 2007, we have steadily improved our ROIC from 10% in 2007 to just over 16% this year.

Next year, we expect our ROIC to approach 20% as we continue to focus our growth on high margin, low capital businesses while leveraging the investments we have already made. That''s all our prepared comments, operator. You can now open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, if you would like to ask a question at this time, please press star then one on your touchtone telephone. If your question has been answered or wish to remove yourself from the queue, you may press the pound key. Again, to ask a question at this time, please press star then one on your touchtone telephone. Our first question on the queue David Tarantino with Robert W. Baird. Please go ahead.

David Tarantino – Robert W. Baird & Company

Hi. Good afternoon and congratulations on great results. Tom, just a couple of questions about guidance and perhaps I''ll start with 2010 and the outlook for Q4. In particular, it looks like you''re expecting less earnings growth in Q4 than what you saw in Q3. Yeah, you should have some pricing contribution in the retail business in there perhaps ahead of the cost increases you might see. So could you just reconcile maybe what''s weighing on the earnings growth in Q4 relative to Q3?

Thomas P. Cawley

David, I think it''s more of a math question just on the size of our earnings. In Q3, last year, we only made $0.19 whereas in Q4 we made $0.35. So you''re correct in that percentagewise, our growth will be lower. But the dollar contribution improvement will be higher. So I think it''s more just that we''re working off of a low base with the higher earnings growth in Q3.

David Tarantino – Robert W. Baird & Company

Okay. And then maybe a related question about 2010, you didn''t point to the middle of your revenue growth range, maybe you did and I missed it. But is that still the plan or might you be able to exceed that given that you''ve taken some pricing in retail? And it looks like the momentum in a lot of the businesses has continued.

Thomas P. Cawley

Yeah. We weren''t changing that. We didn''t take that up. I think in retail -- just as we''re -- whether it''s the pricing or anything, I think retail will look similar next quarter maybe. We actually start having kind of a negative impact on retail from non-comp where we basically -- our comp will be higher than our sales growth in Q4 because we do that upside down because all of our stores from 2008, seven out of the eight -- or 2009 -- will be comped in Q4 and we''ve only opened two stores this year but we closed four stores. So actually holding, if our sales growth were the same, we''d actually have higher comp to get there. So retail isn''t going to contribute a whole lot with the pricing. So yeah, we didn''t change anything from our sales expectation because of the pricing.

David Tarantino – Robert W. Baird & Company

Okay. Great. And then perhaps on 2011, the EPS growth at least at the midpoint of both of the ranges is below your 20% to 25% target that you laid out. I understand the CAGR is at the high end of that. But is there anything about next year that would prevent you from getting into that 20% to 25% range? Is it maybe a mismatch on the pricing and the costs or what is going on there, I guess, is the question?

Patrick J. O’Dea

Yeah. I think what we we''re just looking at -- I think we''re -- it''s more like 20 or something versus our CAGR of 25% which we will have run. As we overdeliver within this year and so forth, it''s just because we''re carrying forward and we see things that kind of are helping us this year that we probably won''t have the same tailwind on some things that may have a few more headwinds for us next year.

But I think it''s kind of -- it''s a long-term target that we''re working against and continuing to move in that direction and we feel comfortable that fundamentally things haven''t changed. We''re still on that exact same path.

David Tarantino – Robert W. Baird & Company

Great and then one last one. Pat, just could you talk a little bit about the Walmart opportunity and I''m assuming that includes the Peet''s brand. And if so, why does the Peet''s brand fit with the Walmart customers? It doesn''t seem on the surface to be an exact match but maybe you can help us understand that a little better?

Patrick J. O’Dea

Yeah, of course. So, as I mentioned, we got a call a few months back and if you think about it, the approximately 600 Walmart stores that we began shipping to are in existing geographies where we''re selling to grocery and these are the well-developed as specialty coffee markets. So Walmart -- and these are overwhelmingly in supercenters obviously and they are the largest grocer in America.

So, if there is a Walmart supercenter in the middle of a major well-developed specialty coffee market and they''re selling a lot of specialty coffee, it makes sense for them and for us to be there. It would be sort of like coming to Northern California and saying you don''t want to be in Safeway, the largest grocer in a very well-developed specialty coffee market.

So I think the driver here is really is where the stores are and whether or not they have well-developed specialty coffee categories, not what the banner is on the store. And it is early and we''ve only been in these stores for a few weeks, but I can tell you in a number of these stores in the kind of markets you would expect, we are moving a lot of Peet''s.

David Tarantino – Robert W. Baird & Company

Great. Thank you.

Operator

Thank you, sir. Our next question on the queue is Steve West with Stifel Nicolaus. Please go ahead.

Steve West – Stifel Nicolaus

Hey, Pat, a couple questions. Could you talk about maybe your thoughts on single serve? I guess it''s been what, a year, since you guys made the bid on Diedrich''s. I know in the past you said you don''t need single serve but you were still interested and there''s been a lot of kind of motion in that industry. Kind of what are your thoughts there on that segment still?

Patrick J. O’Dea

The same. I think there is a limit to what I can say for obvious reasons but we''ve been expressed an interest in the single-serve market dating back over a year. We continue to be interested in it and we expect that we will be in it. But I really can''t sort of comment on it any more than that for obvious reasons.

Steve West – Stifel Nicolaus

Okay. And then with the price in -- our I guess the lack of price in the specialty channel grocery, why not follow competition? It seems like you have a great opportunity here with coffee being up and all the competition doing it.

Thomas P. Cawley

You know, we have as I mentioned in the script here, I think we''re priced about right relative to competition. We''re ranging anywhere from sort of on average 10% premium nationally and in some markets, it''s the size of 17% premium. So I think we''re priced about right and we''re growing our share and we''re building the business. So it feels about right, right now. I will say that depending on how events develop as we head into next year, we reserve the right to increase pricing in grocery if we think that''s the right thing to do.

Steve West – Stifel Nicolaus

Okay. And then can you talk or maybe, Tom, somebody, talk about your specialty growth outlook in 2011? You''re adding 600 Walmart stores, that''s roughly 6% of your store base, you''re adding -- I guess would you expect -- are we expecting smaller shelf sets? It just seems like kind of a light guidance there with that plus your near double-digit growth, organic growth and things like that. It just seems kind of light and then talk about maybe the target test and possibility for an expansion into that next year.

Patrick J. O’Dea

So a broad starting point in the answer to your question is that I do believe that we will see additional sort of channel customer and geographic opportunities given how quickly specialty coffee has grown and become mainstream. The Walmart is a great example of these 600 or so stores in a well-developed specialty coffee geography where we have our DSD system in place and it''s very easy to service these stores.

And we are seeing some early good movement in the kind of markets that you would expect that we would see that. Having said that, I do also think that if you took a comparable perhaps some other banner store, we might see that there''s a higher percentage of people who will shop at Walmart stores who might not be Peet''s customers. So while they''ll be productive relatively speaking, I wouldn''t expect them to be as productive as some of our larger more premium positioned grocery chains.

I think right now if we had to peg it, we are probably somewhere in the low 9000s in terms of the number of grocery stores that we''re permanently available in, I would say that by the end of 2011, we would safely be in 10,000 permanent points of distribution from a grocery standpoint and that would include sort of the Walmart supercenters that I spoke of.

I do think there''s additional new customer opportunities both permanently and certainly on an in and out temporary basis, as we mentioned earlier, we do, do a lot of Godiva seasonal shipments to the drug trade. I think there will be in and out opportunities Peet''s in places like club stores like we''re doing with Sam''s this month and I think there will be expanded permanent distribution opportunities in what we consider mass but is really also grocery because both Target and Walmart are in the grocery business.

Steve West – Stifel Nicolaus

Okay. Great. Thank you, Pat.

Operator

Thank you. Our next question in queue is Greg McKinley with Dougherty & Company. Please go ahead.

Gregory McKinley – Dougherty & Company

Yes. Thank you. I wonder if we could focus just a little bit on your retail business. It looks like that continues to generate some positive comp momentum. Back of the envelope looks like maybe 4% or so. You talked about improved beverage sales and flat bean sales. Can you go into a little more depth there? What is driving improved beverage performance? To what degree have you seen some of the refresh presentation of the baked goods having an impact? Maybe to what degree you can, talk about how your, I think quicker service turn times, you were believing had an improvement on retention of customers in the store et cetera?

Patrick J. O’Dea

Let me take a shot and, Tom, jump in here but -- I think one of the major -- first our beverage business in our stores has always been growing at a significantly faster rate than our overall retail business because the bean business has historically been slightly negative due to the grocery piece. So you can start to get sort of a sense for that here when we have a flat bean business, a 4% retail growth and our beverage business is up higher than that.

I think one of the main drivers of the growth this year has been the training that was put in place early in the year on deployment and the measurement of service levels during our morning rush and we do have a target. We try to get all of our stores exceeding 75% to 80% of beverage transactions they have during the rush hour within a three-minute period of time or so. So it''s not by any means a quick service, but it is quick enough and when we get improvements there, we can see good results.

I also think we''ve been fairly successful with the summer drink program despite the fact that the weather was not as corporative in terms of it being a mild summer here in the Western U.S. -- and some new drinks like pumpkin spice that we have out right now. So it''s a combination of drink news and service levels. It is not the -- a revised merchandising program on baked goods, it''s just not in enough stores to have impacted it yet. And there is a little bit of a contribution I would say, probably half a comp point, if I''m not mistaken, from our coolers. But that''s kind of where it''s kind of come from.

Gregory McKinley – Dougherty & Company

Okay. Thank you. And then you talked about a meaningful portion of your retail operating expense leverage coming from your labor initiatives. Is that putting the manager more in terms of a customer interface as opposed to just managing the store and so you''re able to get away with lower labor hours from other staff or what''s driving that improvement?

Thomas P. Cawley

Yeah. No, not that at all. In fact, some of the key changes we''ve made is just as far as the time of day when people are staffed. They''re putting them more in the morning as we go after our speed of service during the morning where the majority of our business takes place. And you''re taking some people off the back end of the day. In addition, the deployment from a speed of service is kind of roles within the store where the manager is not so much customer facing but coaching more and actively managing the people on the floor, not running the register and not making drinks and things like that.

Patrick J. O’Dea

Yeah. Just to summarize, the best way to -- the best word use is deployment. It''s who''s deployed, where they''re deployed, when they''re deployed. Taking deployment from lower volume times in the afternoon and having it up in the morning as opposed to hours reduction, it''s really not about hours reduction. It''s about productivity and deployment.

Gregory McKinley – Dougherty & Company

And then could you talk to us a little bit about your -- what we should expect to see from Godiva here? I mean, my understanding is that flavored coffee product tends to be seasonally strong here during the holidays. Any new marketing or distribution plans to coincide with that?

Patrick J. O’Dea

We are seeing that flavored coffee and Godiva in particular, is tending to be more seasonal than even we expected, although I would say that we did expect it to be somewhat seasonal. I think a good example of that is these two new flavors that we have introduced seem to be doing fairly well, pumpkin spice and peppermint. It''s also I would say -- we see the mix of our business on Godiva coming significantly -- the higher percentage of the mix coming from non-traditional grocery in places like mass and even the drug channel.

So, Godiva is certainly not a home run after a year in the marketplace but we are continuing to build it. And we are -- it''s a key part of our plans next year but it''s not going to be a $25 million business next year or anything like that.

Gregory McKinley – Dougherty & Company

Thank you.

Operator

Thank you, sir. Our next question on the queue is Matt DiFrisco with Oppenheimer. Please go ahead.

Unidentified Analyst

This is Parmeet [ph] for Matt DiFrisco. Most of my questions have been answered. I just wanted to quickly ask you if you could maybe touch upon your capital allocation priorities (inaudible) with your cash.

Patrick J. O’Dea

Yes. So as I said in the call, we don''t have a lot of capital next year. We''re not increasing our capital spend rate much next year. We will probably be in the $12 million $13 million. I would say that the only area which will be -- where we have been spending our money just in general is this year, we will spend about $12 million, half of it is on the retail business, particularly in remodels. We only are doing two new stores in 2010.

Next year, we will do maybe four. So there will a little bit more capital there. There''s also -- the rest of it has been spent -- of $12 million in 2010 -- on the plant and IT are the two biggest spending areas and that will continue. We have kind of follow-on things to our enterprise system that we will be spending on next year. The bulk of the increase will be a little bit more in IT and then a little bit more in a few new stores. Did you have a follow-up? We will do it …

Unidentified Analyst

No, no, no -- well I just -- I guess what I also wanted to ask you is sort of, in terms, of cash on the balance sheet ….

Thomas P. Cawley

God, I''m sorry.

Unidentified Participant

Yeah. Okay.

Thomas P. Cawley

So we had announced that our -- three months ago or something that we -- this year we bought our -- or this quarter we did buy back some shares. We bought back about 350,000 shares of stock during the quarter. We have that use of all of our previous million share authorization that we had but we did authorize another million share repurchase program at the end of October which at least through the end of the quarter we had not executed upon any of that. We had said that we were looking to offset any dilution from options when we announced that share.

So that would be one use of cash that we would be having. We do have some capital needs. But our primary as we said in the past if there was an opportunity for a growth vehicle that we could invest in, we''d like to put our cash against growth. Secondarily, we would look at repurchasing shares for other uses.

Unidentified Participant

Okay. Thank you, Pat.

Operator

Thank you. Our next question in the queue is Mitch Pinheiro with Janney Montgomery. Please go ahead with your question.

Mitchell Pinheiro – Janney Montgomery Scott

Good afternoon. A couple things. One, just staying on Godiva for a second, so, year-over-year, on a comp basis, how should we look at Godiva in the fourth quarter? Will you have more holiday display, more marketing, promotional activity around Godiva this quarter versus last year?

Patrick J. O’Dea

Yeah, because last year at this time, we were pipelining in the initial shipments of Godiva. When we''re going up against that this year -- so whenever you sell something in, you have to fill the shelves and fill the pipeline and it''s a pretty good pipeline shipment. This year, we will obviously have significantly more sell-through because we''re in distribution and we''ve got two new flavors, pumpkin spice and peppermint and we''re in several drug and mass and grocery customers with those and the displays. So there will be more activity. In terms of shipments, however, we will be going up against last year''s pipeline.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. In terms of assumptions, I think you may have talked about this in your prepared remarks but what are your assumptions for green coffee costs for 2011?

Thomas P. Cawley

Okay. So as we said in our remarks, we have 40% of our 2011 usage locked as of today at substantially lower cost than we would pay if we were -- placed an order for new coffee tomorrow. So we''re not long buyers right now. This hedging will allow us to be opportunistic over the next six to eight months but we are assuming we will be buying significantly higher cost coffee with that timeframe.

Our 2011 guidance assumes this coffee we buy blends in with what we already have and we will incur about 15% higher costs of coffee that we use next year. We are also going to manage our menu, our brewed coffees, promotional calendars et cetera to mitigate any origin-specific cost issues. So between this and being hedged, we think the forecast we have now is manageable within the pricing action we''ve already taken. Of course, if three to six months from now we find out we are wrong, we would take pricing to recover and most likely starting in grocery where we haven''t taken any yet.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. So year-over-year right now assuming you can buy opportunistically and do some things, maybe green coffee is up 15% next year? Did I get that right?

Thomas P. Cawley

Yeah.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. Thank you. Walmart, looking at Walmart, how many SKUs? What kind of shelf presence do you have there?

Thomas P. Cawley

I think we have about -- it varies depending on the store but it''s in the sort of eight to 10 SKU range and sometimes the number of facings we have on the shelf exceed that. But generally speaking, we''ve got about a full shelf.

Mitchell Pinheiro – Janney Montgomery Scott

And it will all be in the normal like what? I guess 12 ounce.

Patrick J. O’Dea

12 ounce bags, yes.

Mitchell Pinheiro – Janney Montgomery Scott

(inaudible) not super sized or any…

Patrick J. O’Dea

No, no and again, I mean, the way you should think about this is Walmart is the largest grocer in America and the stores that we are in are grocery stores. They''re supercenters and they''re in markets where we are in other grocery stores. So it''s really pretty much very, very similar to what you would find if you walked into any of our other grocery stores.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. Last question just, Pat, relates to sort of your -- the third growth driver you were talking about that you would like to leverage your brand and people and infrastructure into new segments. Is that -- so are we just talking to talk coffee or does that also imply non-coffee?

Patrick J. O’Dea

No. It''s pretty much coffee and tea.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Patrick J. O’Dea

Okay. Thank you very much.

Operator

Thank you, sir. Our next question on the queue is Colin Guheen with Cowen. Please go ahead.

Colin Guheen – Cowen and Company

Great. Just a couple of questions. First on the Walmart deal, did the DSD -- did the current state of the DSD system determine the 600 store number or was it vice versa? Was the 600 store number the number that was more or less determined regardless of the current state of the DSD?

Patrick J. O’Dea

We worked collaboratively with them to identify the stores in the markets where we believed their business was well developed and our coverage was good and it was sort of a meet in the middle.

Colin Guheen – Cowen and Company

Okay. So would some expansion in the DSD allow that number to be bigger or …?

Patrick J. O’Dea

Sure. Yeah. We''re not -- it wasn''t constrained by the DSD system if that''s what you mean. It was really more pegging the stores in the markets where we thought it would be best but it could be expanded and the only question is sort of the timeframe.

Colin Guheen – Cowen and Company

Okay. And, I don''t know, just looking through your slide presentation, we always talk about the U.S. grocery specialty coffee market at $1 billion and growing 8% to 10%. How do we look at adding these new channels now that it seems that we''re sort of at an inflection point for specialty coffee in those new channels?

Thomas P. Cawley

Yeah. You know, the data we have always quoted in the investor presentation has been just IRI data which would exclude Walmart and Target and so forth from the data. So the $1 billion is traditional grocery. I don''t know, I don''t have a good estimate for you on how large specialty coffee is if we were to include mass, drug and clubs. Probably something I should pull together from some sources for you.

Patrick J. O’Dea

Yeah. I think we have a sense for it that I -- I think it''s a good question and we should come back to you and share that.

Colin Guheen – Cowen and Company

Okay. And then just the date, when are you going to be rolled out to all 600 stores?

Patrick J. O’Dea

We are in them now.

Colin Guheen – Cowen and Company

You are already in them?

Patrick J. O’Dea

Yes. The DSD system is pretty sensitive.

Colin Guheen – Cowen and Company

And then just on the -- Tom, can you just update me on the store count? How many -- what was the net you said you''d closed to? Was that in the quarter or what''s the …

Thomas P. Cawley

No, no, I was talking about the ones we closed at the beginning of the year. So we''ve only two this year. So we closed four at the end of -- last day of last year. So we have 193 stores right now compared to 195 last year.

Colin Guheen – Cowen and Company

Great and then are you going to -- is there one slated for the fourth quarter and then how many for 2011?

Thomas P. Cawley

There''s zero in the fourth quarter and next year will probably be four, three or four.

Colin Guheen – Cowen and Company

It sounds like the retail stores are humming better than they ever have. Any plans to maybe accelerate some unit growth beyond 2011?

Patrick J. O’Dea

You know, one of the -- that''s kind of part of the third vector that we talked about. We have -- we''re going to be investing in some significant investment in some research next year that will be targeted toward much longer-term five year plus sort of growth plans and it transcends channels. But certainly part of it will be addressing next generation what we want to do with our existing stores and taking them to the next level. So I would call that sort of a research project over the next 12 months and we''ll see how that pans out but that''s probably a good question for a call in about 12 months from now.

Colin Guheen – Cowen and Company

Okay. Great. Tom, is there any way you could just -- what is kind of the net effect of pricing year over year in 2011? I know you''re -- do you have that number or …?

Thomas P. Cawley

Yeah. I don''t have it. It''s within the retail -- the channels we''ve taken, it''s about equal to
what our coffee cost inflation was. But I don''t have the number offhand.

Colin Guheen – Cowen and Company

Great. Okay. Thank you very much.

Operator

Thank you, sir. Our next question on the queue is Michael Wolleben with Sidoti & Compay. Your question please.

Michael Wolleben – Sidoti & Company

Thank you. I''m sorry if I missed this here, but did you guys break out the segment operating margins that you guys are looking for to get to that 50 to 100 basis point consolidated margin for 2011? Are we going to see the same trends here with retail sales with the retail segment improving and still a slight dip down in the specialty sales margin?

Thomas P. Cawley

Yes, particularly since we''re -- our plan right now is not to take any pricing in grocery. So grocery actually will be absorbing the higher commodity costs while retail will continue to have more -- it has pricing to offset it, the inflation and has more initiatives against it. So yes, I think it will be a similar type of trend.

Michael Wolleben – Sidoti & Company

Okay. And if you guys did decide to change that and take price at the grocery segment. How quick can you push that in through your DSD?

Patrick J. O’Dea

Pretty immediate. The only -- we like to give customers about 30 days, but we can do that immediately.

Michael Wolleben – Sidoti & Company

Okay. Great. Then just on the balance sheet here, with those inventory levels that you guys have had up here over the last two quarters, is that just a timing thing or is that kind of the levels that you guys expect to be carrying moving forward to kind of a new normal with those sales increases?

Patrick J. O’Dea

Actually, it''s all green coffee. So we have a -- if you look at the total increase, green coffee is driving 85% of it. And we actually probably last year at this time had too little coffee on hand for just normal hedging activity. Last year, I think our inventory Q3 to Q3 was only up about 3%. Now it''s up 30%. So we''re kind of doing a catch-up. I think we probably ran a little too thin on days of inventory just as far as giving us flexibility across the 30 origins that we buy and all the things we do with our coffee. So I would say this is a more normal rate. And it''s partially up because the coffee is more expensive also. So that''s -- you get the combination of the two.

But I would say we''re -- this is more typical and from a quarter-to-quarter if you went to like first quarter to now though, it is driven by seasonality. We have to take in coffee when it grows. I mean, it is a crop but this is a more normal level.

Michael Wolleben – Sidoti & Company

Okay. Great. Thanks guys.

Operator

Thank you, sir. Our next question on queue is Greg McKinley with Dougherty & Company. Please go ahead.

Gregory McKinley – Dougherty & Company

Yeah. Thanks. Just a quick follow-up. In terms of the food service channel, you talked about some moderation in growth there due to prior year, big customer rolling into the system. How should we think about growth in that channel going forward?

And then also, I wonder -- maybe you can''t do it for competitive reasons but expand a little bit if you could on new markets that you said are not included in your guidance. Obviously, I guess single serve would be one but what other type of opportunities might you be looking at? Thank you.

Patrick J. O’Dea

On the food service piece, sort of as we head into 2011, I think the growth rate will increase from where it is this quarter. And we see good continued growth in that business from our brewing programs and from our license stores. So we feel pretty good about that heading into 2011. So I would consider this a blip that will bleed into the fourth quarter a little bit and then we''ll come out of it.

Gregory McKinley – Dougherty & Company

How many licensed locations are there currently?

Patrick J. O’Dea

103. And next year, we would expect to add circa 15 to 20 kind of a thing to that. Your second question, as I said, I think the guidance that we have assumes the current pricing in grocery and it assumes that we add a net about 1000 points of new permanent distribution of which the 600 Walmart stores would be part of it. We will also have some in and out type activity in places like club stores and things like that. So that''s all included.

It does not include entering new geographic markets other than what we have just entered here in Minneapolis in the third quarter. It doesn''t include new geographic markets. It doesn''t include any major new packaged forms or entering into any new segments.

Michael Wolleben – Sidoti & Company

Okay. Thank you.

Operator

Ladies and gentlemen, that concludes our time for questions and answers. I would now like to turn the program back over to Mr. Paul Yee for any closing remarks.

Paul Yee

Thank you for joining us today. We''ll report Q4 and full year 2010 results in mid-February. Until then, we hope you all enjoy the pleasure of a couple of Peet''s 2010 Holiday Blend this season either in your homes or in our stores.

Operator

Thank you, sir. And ladies and gentlemen, this does conclude today''s program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect at this time.