Wednesday, June 9, 2010

Peet's Coffee Annual Shareholder Meeting (2010)

Peet's Coffee (PEET) held its 2010 annual shareholder meeting at an Emeryville, California hotel. Approximately 110 people attended. Shareholders were offered fruit, yogurt, juices, water, and, of course, Peet's coffee and tea. The company also gave shareholders a Peet's bag with a pound of coffee and a selection of tea bags.

After the formal portion of the meeting, CEO Patrick J. O'Dea handled the first presentation. Buttressed by Peet's excellent performance, Mr. O'Dea had more bounce in his step than in previous years. Mr. O’Dea mentioned that sales were up 7%, with the grocery business growing at 19% for the year. Grocery’s growth accelerated to 28% in the second half of 2009 and 39% in the first quarter of 2010. The retail business remained stable, and Peet's expanded profit margins +260 bps.

Food service and the office and home delivery businesses were increasing, but growth was slower when compared to other divisions. [Note: According to Peet's, these remain very important businesses, on their own and also as vehicles to introduce the brand to new audiences and build awareness to support grocery growth. This business was slow last year with the economy (8% sales growth), but rebounded to 27% in Q1 2010.]

Mr. O'Dea then turned the meeting over to Doug Welsh (VP of Coffee) and Laila Tarraf (VP of Human Resources). Mr. Welsh referred to Peet's being the "gold standard" of coffee. In an effort to maintain its "gold standard" after substantial growth, Peet's began re-evaluating its values. After much discussion, Peet's decided to focus on four core values: mastery, responsibility, curiosity, and prosperity.

For Peets, "mastery" means pursuing excellence in the craft with integrity. To promote high quality, Peet's holds barista competitions but does not compete in national or world competitions because it wants to focus on regular customers instead of judges. Peet's barista competition starts at the store level, then district managers nominate someone, after which the winners are sent to a central pool of judges, including Mr. Doug Welsh. After that round, baristas move on to a regional competition and then one last level of competition. Also, every single barista is re-qualified each year to ensure quality service.

Mr. Welsh showed several slides of espresso, explaining what a cup of espresso ought to look like. He said "blonding," or discoloration, was bad--"blonde is not more fun in espresso," he quipped. He also said that after sipping, the form and color should hold, not get mixed or discolored.

As for a good cappuccino (my favorite coffee drink), Mr. Welsh explained that it's not a good sign when the steamed milk process "sounds like a 747," because the temperature is probably too high, which creates a scalding taste. It's also not good for the foamed milk to look like "shaving cream"; instead, the foamed milk should be glossy, with the consistency of milk and ice cream.

He showed us several slides of cappuccinos, including a "white-out," where the top of the cup showed nothing but a huge mushroom cloud of foamed milk. Peet's grading assigns a white-out a zero score. An "acceptable" cappuccino looked good to me, but Mr. Welsh explained that it showed a dull sheen with already-burst milk bubbles. The ideal cup has a clear white/brown contrast between the milk and espresso, i.e., a brown ring on the outside that nurtures the foam in the middle. The best cappuccino would be "very bright white inside," contrasted with "a dark grain of espresso all around the cup." This configuration allows you to taste both steamed milk foam and espresso with every sip. In short, you want an "integrated" taste with each sip.

Ms. Taraff said that Peet's "curiosity" balances its "mastery." With 3,500 employees across the country, it's important to be consistent, and Peet's has a "Brew U" website where employees can take classes through development programs to maintain their edge and expertise.

Ms. Taraff turned the meeting back to Mr. Welsh, who talked about Peet's emphasis on "responsibility." Through various slides, he introduced Roberta Mata (a male), who is the leader of the "Dota Co-op" in Costa Rica. He said that Peet's feels an accountability to the co-op, not just to its end users, and the conditions at the co-op are some of the best in the coffee-growing world. The co-op has also won awards for its sustainable practices. More specifically, the co-op turns its pulp waste into methane. (Methane is a biogas fuel and functions as an energy source.)

Peet's long-term outlook can create excellent results. For example, during 2004 and 2008, there was a coffee crisis, and market prices for coffee went below production costs. In other words, it cost more to produce coffee beans than to sell it, meaning co-ops were not making money. Peet's recognized the problem and agreed on a three-year fixed rate for coffee that allowed Peet's to hedge its costs. When the market turned, the fixed-rate arrangement helped Peet's bottom line. Also, Peet's willingness to work with the co-op during the coffee crisis generated goodwill that helped Peet's in future negotiations.

Mr. Welsh also talked about "prosperity," another one of Peet's values. He said that farmers working for TNS (TechnoServe: that sold to Peet's earned a 60% higher price than semi-washed (home-washed) coffee. Mr. Welsh proved that growers were better off upgrading from low level production (home-washed coffee) to Peet's higher standards.

CEO O'Dea punctuated the end of the meeting by saying, "That's your company," and we moved to the Q&A session. Unfortunately, there was no one walking around with a microphone, so many people, including myself, couldn't hear most of the questions. I've done the best I can to provide an accurate review of the questions and answers.

A shareholder asked if Peet's uses "E-Verify." No one seemed familiar with the system, which is used to check a potential employee's eligibility for work. (It's basically something designed to catch undocumented workers.) The system is relatively new and has major flaws, so most states don't use it. (Arizona employers are required to use it; California employers are not.)

Someone else said that his local store didn't carry Guatemala San Sebastian. The CEO said all stores offered all of Peet's coffee selections, and he would check up on the particular retail store.

In response to another question, the CEO indicated that most major grocery stores carry Peet's coffee beans, but Wal-mart (WMT) does not carry Peet's coffee beans. He also said that the "quality of service is the most important thing in retail [i.e., Peet's stores]," so he would not want Peet's retail store employees to have the same aggressive sales personality as its grocery store sellers. (One of the reasons I like going to Peet's is because of its outstanding employees.)

Another person asked whether baristas receive profit-sharing incentives. Peet's pointed out that all employees who are managers and above receive RSUs and all employees may participate in its ESPP, which allows employees to buy shares at a discount. Also, Peet's wages are significantly above minimum wage, which reduce turnover. Moreover, Peet's has the "best health insurance program by far"--after working 500 total hours, a Peet's employee need only work 21 hours a week or more to be eligible for Peet's health care program.

Someone asked whether Peet's would be expanding internationally. "Not in the next twelve months," because growth opportunities exist domestically.

Another shareholder asked, "What happened to Diedrich Coffee?" Peet's had made an offer to buy the company, but the acquisition did not pan out. The CEO said that Diedrich had a "license to produce K-cups," but the licensor was also interested and willing to pay more for the company. (K-cups allow users to easily make single cup servings of coffee.) Peet's CEO said he believes the single cup market will grow, especially in homes. (By the way, Peet's received an 8 1/2 million dollars break-up fee--not bad for a failed deal, huh?)

Peet's has closed stores about six or seven times because the location didn't work out. For example, in some sites, anticipated housing or commercial construction never occurred.

Someone asked about quality assurance, and Peet's CEO responded, "We're not perfect," so they rely on customer feedback. Peet's has customer feedback cards at various stores and also uses mystery shopper programs to check on its customer service.

I asked why Peet's didn't offer more Colombian coffees. The best coffee I've ever had has been from Colombia, and then from Costa Rica. Mr. Welsh said that Colombia was having serious coffee production problems and was four million bags short of production. (Four million bags is significant--a single "bag" is sixty kilograms, or 132 pounds.) Colombia had suffered from bad weather and a tree renovation program that caused the country to use much of its land for trees, limiting the land that could be used for coffee production. Although Colombia is the world's third largest producer of coffee, the supply of Colombian coffee had shrunk considerably, causing prices to skyrocket. Mr. Welsh indicated that "now is not the time" to buy Colombian coffee beans.

Someone asked whether Peet's had a poison pill provision. Peet's does not have such a provision, making takeovers/buyouts easier.

Another shareholder asked when Peet's would issue a dividend. The CEO said that Peet's can still find ways to grow the company and use cash to enhance value; therefore, it currently preferred stock buybacks to dividends.

As I've said before, Peet's consistently delivers a great annual meeting, so if you get a chance to go, you should take it. I am pleased to be a Peet's customer and shareholder.

Disclosure: I own an insignificant number of Peet's shares.

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