127-C04 A-U Arthur M. Blank Center for Entrepreneurship 05/12/04 Babson Park, MA Phone: 781-239-4420 02457-0310 Fax: 781-239-4178 URL: http://www.babson.edu/entrep Nancy’s Coffee As the busy president of the $7 million Nancy’s Coffee Café chain, Beth WoodLeidt wasn’t able to visit each of their thirty suburban coffee shops as much as she would have liked. Whenever she did journey out as she was doing today, it was with a passion for building brand and enhancing profitability. Beth approached one of her more challenging locations—in a mall in central New York—and surveyed the space with a practiced eye. …that front table needs a wipe… the display shelves are dusty…the OneCard holder is hidden behind the tip jar…isn’t it too early in the day to be out of plain bagels?… She warmly greeted the staff she knew, introduced herself to new faces, and ordered a cappuccino from a slightly nervous young hire at the counter. As the teenager set about to whip up the best coffee drink of her brief career, Beth took the manager aside to offer a quick rundown on areas for improvement. Beth was just finishing up with her quality assessment when her cell phone buzzed with a call from a former corporate colleague in whom she had often confided about the challenges of running a retail business. Beth took a sip of her frothy brew, winked her approval to the relieved girl who had brewed it, and headed out into the mall to chat. When her friend noted that Beth sounded tired, the forty-year-old CEO closed her eyes and nodded into the phone: Gosh, I am tired! Remember about a year ago I started saying that I wanted to figure out where this business was going? Well, I’m still asking the same questions like, how can we attract the capital we would need to grow faster; what is the best exit strategy to shoot for; and what is the best way to enhance the value of what we are building? Sure, we’ll add another two more stores this year, but that’s just not doing it for me. It’s early winter, 2003—and that means I’ve been running this thing now for over ten years. And, as you know, the story hasn’t really changed; we’re still too small to be acquired, not valuable enough to be worth selling outright, and yet the business is large enough to need someone thinking about it almost all the time; yes, that would be me. We’ve hit a long plateau here; it’s past time to make some critical decisions. From Nuts to Beans In 1973, Nancy Wood—then a 36-year-old mother of three and married to Sandy Wood—founded a mall-kiosk business to sell dried fruit and nuts. When demand for that fare appeared to be softening, she began the search for a more viable product line. After connecting with master coffee roaster Irwin White at a fancy-food trade show in 1978, she decided to turn her lifelong passion for great coffee into a new business. Nancy’s eldest daughter, Beth, recalled that the concept was a bit ahead of its time: My mother took her kiosks and slowly began to convert them over to coffee bars she had named the Coffee Collection. She started introducing Kenyan and Columbian coffees, but people responded ‘no way; there is Folgers, and there's Maxwell House, and Dunkin’ Donuts.’ It was a very strange thing to many people who were being asked to pay a whole dollar for a single cup of coffee—or told they could grind their own fresh-roasted beans at home. They looked at my Mom like she was nuts. In those days it was very much about educating the consumer. By the late 1980s, Nancy’s son Carter and her daughter Roxanne had joined the venture full-time. While Beth had been contributing to the effort by periodically reviewing the aggregate financials for her mother, she had never taken much interest in the enterprise. So it was, with her mother’s blessing and encouragement, that Beth earned her BS at Babson College in Wellesley, Massachusetts, and soon began a rewarding management career in consumer product marketing. Newly married, Beth happily immersed herself in the busy corporate world of high-profile projects and after-hours brainstorming sessions—first with Pepsico, and later, with Johnson & Johnson: I loved the work. I had a good salary, a 401(k), stock options, bonus check, company car, great suits; I was loving life. Then suddenly, everything changed! Nancy died of cancer at the age of 56. Beth Enters the Family Business In 1993, Beth took a leave of absence from J&J to return home and help sort through the heartache and turmoil that followed her mother’s death. Sandy Wood had inherited his wife’s business, but made it clear that if his kids were not interested in 2 keeping the small chain going, then he would either try to sell the sites or liquidate the assets. Operating on the assumption that Beth would be returning to her corporate job once they had closed the doors on her mother’s enterprise, Beth carefully examined the financials and visited each of the seven locations to estimate what they might be worth. In the course of that investigation, Beth realized that her mother had developed a solid business model within a largely untapped niche—suburban shopping malls—and she was drawn to the possibilities. Beth’s husband Bill recalled that when Beth asked him to join her in the venture, it didn’t take much convincing: I was running a division of Bell Atlantic in Pennsylvania at the time. Beth and I had worked together much earlier in our lives; I had really enjoyed that. I have always figured that if two married people were meant to work together, it was Beth and I. We get along very well, and we both know our own place in the sandbox. One of the issues that we discussed was that one of our egos would have to get checked at the door. I was a leader where I was working before, but I understood that this was Beth’s family’s business, and that she was now going to be the face of The Coffee Collection, now named Nancy’s Coffee. With equal amounts of sadness, trepidation and excitement, Beth informed J&J that she would not be returning. Her father was pleased, and said that he would divest his interest in the business by annually gifting equal shares to his three children. It was understood by all that Beth would be the new CEO of Nancy’s Coffee. The Specialty Coffee Industry The Green Dragon, a Boston coffeehouse founded in 1697, became the clandestine headquarters of the American Revolution. It was there, in 1773, that the Boston Tea Party was planned as a protest against the tea taxes being levied by King George on his colonies. By the time the British and the colonists had settled accounts, coffee had become the hot beverage of choice in America. Throughout the 19th century in the United States, neighborhood coffeehouses proliferated, and home-roasting coffee became a common practice. The industrial revolution, however, fostered a demand for quicker, cheaper, and easier caffeine solutions. With the advent of vacuum packaging and modern transportation, it became possible for a roaster on one side of the country to sell to a retailer on the other side. As with many other food products, quality was compromised to accommodate mass production and efficient distribution. By the 1940s, the coffeehouses had disappeared, and Americans had been sold on the idea that fresh coffee went ‘woosh’ when the can was opened. In 1950, William Rosenberg founded Dunkin’ Donuts in Quincy, Massachusetts. While his donut shop took pride in serving what they called the “World’s Best Coffee”, it would be twenty more years before U.S. consumers could purchase a 3 truly high-end cup. In the early 1970s, a small cadre of coffee aficionados began to offer a unique brew made from hand-picked beans; fresh-roasted in small batches. Peets, founded on the West Coast by legendary coffee idealist Alfred Peet, quickly set the standard for superb coffee. In Seattle, Gordon Bowker, Jerry Baldwin, and Zev Siegl, named their coffee shop business Starbucks, after the coffee-loving first mate in Moby Dick. On the East Coast, George Howell was building his chain of Coffee Connection shops in the Boston area. New Yorker Irwin White began making a name for himself supplying fresh-roasted grounds to some of the finest restaurants in Manhattan. San Franciscan coffee broker Erna Knutsen coined the term Specialty Coffee, and in 1985, helped to found the SCAA (Specialty Coffee Association of America). SCAA membership grew steadily as these coffee pioneers—Nancy Wood included— developed dynamic, profitable business models by proactively educating American consumers about fine coffee. By the time Beth took the helm of her mother’s business in 1993—the same year that Starbucks had gone public—upscale consumers had developed a real taste for an excellent brew. Growth under the Radar Screen Beth and her management team undertook an aggressive search for retail space. To facilitate that process, they worked almost exclusively with the regional mall management companies that had been doing business with their mother for years. Beth explained they chose this path partly as a way of dodging a direct confrontation with the powerhouse sweeping in from the west: Starbucks had clearly stated that as they came east they were going to do cities like Philadelphia, Boston, DC and Manhattan in a big way. We really didn't know how to play in that kind of shark tank, so we figured that we’d let Starbucks have that, and play the suburban card. And at the time, that was low-hanging fruit. Even so, Beth was up against Starbucks almost immediately. One of her first meetings after coming on board concerned a regional mall lease that Starbucks had been considering for awhile. During that meeting Beth suddenly realized how happy she was to be free of the inefficient, multilayered bureaucracies that characterized much of corporate America: There were two leases on the table; a Starbucks lease, and one for Nancy’s Coffee. The mall representative said that the Starbucks lawyers had had the lease for six months—but she was willing to wait. I said, ‘Look, do you want Starbucks, or do you want a leased space?’ When she said, ‘A leased space’, I said, ‘Give me the pen.’ That lease is up next year, and I still haven’t gotten around to reading it. 4 Beth noted that Starbucks wasn’t the only coffee vendor shying away from space in enclosed malls: Establishing your brand in mall locations is not, quite frankly, a strategy for the faint of heart. Managing a mall shop is a difficult business, and it costs a lot of money. That worked for us in a way, since newcomers would get scared off by the idea of paying something like $100,000 a year in rent, when they could be paying $2,000 a month for a Main Street space in ‘Anytown, USA’. The team had learned through their mother’s experience, however, that these pricey mall locations offered an advantage that few suburban in-town settings could match; a captive base. The Captive Audience Throughout the 1990s, Nancy’s Coffee and its suburban-model competitors like Peets and Caribou had the luxury of being able to choose locations where no other specialty coffee shops were operating. Beth explained that this monopolistic positioning was especially advantageous in a setting with high overhead and two distinct customer groups: Our bread-and-butter customer is the mall employee—the three to five hundred people who come to the mall every day to work. If you can get them to try, you can get them to repeat. Then, obviously, we have our transient customers; the shoppers. We have squarely positioned ourselves to cater to stroller moms; mothers with time on their hands, and kids to entertain. They come to the mall for something to do; they may not always buy, but they always have to eat. So we have lots of cookies, apple juice, and bagels on hand for the little ones, which helps us get the mom for her cappuccino. In January 2002, in a move to foster a loyal base of customers, Nancy’s contracted with Paytronix—a nascent venture that had developed a swipe-card with both payment and loyalty program capabilities. Beth noted that the OneCard system (See Exhibit 1) went well beyond the paper cards used by a variety of food-retailers to encourage repeat business: This is like an electronic punch card that also functions as a debit card— either by putting in a cash balance or by prepaying for product. For example, we have this one guy—an eyeglass store manager at a mall in New Hampshire—who shells out $150 on the first of each month to buy the 85 cappuccinos he knows he’s going to drink over the next thirty days. We get his money up front, and he gets our $3 drink for less than $2. 5 If you can get mall employees to buy a OneCard membership for a dollar a year, they’re going to come to you every day, since for every nine drinks they get one free—they can even get a jumbo mocha in exchange for nine basic coffees. That’s a drink that we sell for four dollars; free to them, and my cost is about seventy-five cents. The OneCard is really a nice competitive advantage. We just had a Starbucks open in Buffalo, one floor below us. Our staff was nervous, but I didn’t understand why. I told them that with the OneCard, you already have all of your mall employees in your pocket. It worked; that Starbucks kiosk is struggling. By late 2003, Nancy’s Coffee shops could be found in over thirty locations from Boston, west to Niagara Falls, and from Nashua, New Hampshire, south to New Jersey (See Exhibit 2). Three of the stores had been acquired from the owner of a four-chain enterprise who had come to the stark realization that running coffee shops was not going to be the road to riches that he had once imagined it would be. Beth recalled that they were able to make significant improvements in the stores they took under management: When we acquired Café Coffee, their gross margins were running in the low thirties. They had been managing the business from Wellesley, Massachusetts, and no one was going out to visit the stores. From a financial standpoint, we controlled the employee hours and monitored the food costs. That helped to drive their gross margins closer to 50 percent. Operationally, we kept some of their people, but not all. We put some of our own people in who had much different operational standards than the Café Coffee people. At one store, we saw an increase in customer count, and in six months that store went from being in the red to being in the black. Just as Starbucks and Dunkin’ Donuts never said ‘never’ with regard to mall locations, Beth followed through on an opportunity to develop a street-front location. She was excited about the challenge and the possibilities: There are so many locations that are still looking for high-end coffee bars. The question is; are we as a high-end coffee bar looking for that location? We just opened a store on the street in Manchester, Vermont. My rent there is $1,800 a month. I think it will work, but it will take some time to attract a customer base. If we can find some more good towns like that, I suspect that we will probably do more like that versus more mall expansions. While Beth was happy with the performance of the majority of their stores, she sought to close the weakest locations in their portfolio as soon as possible. She commented that the timetable for divesting those shops was not entirely in her control: 6 You need to be making 15 to 20 percent operating income. If a store can’t make 15 percent in operating income after its fixed and variable costs are covered—then the store needs to be closed. But in our business, you can’t just close a store that isn’t performing—even one that is losing money— and that’s because of the leases we have to sign. These management companies finance their malls using not only the building as collateral, but the leases as proof of cash flow and their ability to repay the debt. If they were to give their tenants a kick-out clause, it makes their business model more risky and harder to leverage for borrowing. That’s why they insist on five, seven and ten year leases. I have a couple of locations I’d like to close tomorrow, but it would mean paying a termination fee—and leaving all my investment behind in terms of property, plant, and equipment. You can be sure that the day those leases expire—those stores will be gone. Managing the Organization Before his death in 1999, Sandy Wood completed the gifting of the business to his children—all as shares, except for the first distribution, when Roxanne and Carter had received a cash equivalent in lieu of stock. Beth now had a slightly larger stock position which left her to direct the company’s future: My brother said that after 15 years, it was time for him to go work for somebody else. So I suggested that Roxanne and I buy his stock and split it evenly. I own 51 percent of the business and my sister owns 49 percent. Our bylaws are very clear that control rests with the majority ownership, It is now my responsibility to set the business on a strategic path for growth. Beth had discovered that ‘living and dying by every single decision every single day’ fired her up in ways that her corporate job could not. Now a mother of an eight- and a five-year-old, she reflected that running the show had given her the freedom to craft a working environment that was far more responsive to the rhythm of life: I know that I never would have had children if I had stayed in corporate America. Now my time is much more my own than it ever was. I may work longer hours than I did in corporate, but if I want to leave at two o’clock to go watch my daughter in a French play, I can do that. This path has helped me to get more balance. I take the position that as long as you get your work done, it makes no difference to me how you configure those hours. When I had my first child, my book keeper’s baby was due three months later. So we set up a nursery in my office and hired someone to watch over the babies. 7 Right now I have four key people out on maternity leave! The other day one of my managers said to me that these are people who watched me have two children without skipping a beat—that I have allowed them to be moms and to be professionals at the same time. It's great to have that kind of impact. The Nancy’s Coffee business was supported by a six-person staff at the home office in Madison, Connecticut. Roxanne oversaw the purchase and delivery of goods like freshroasted coffee, display-shelf merchandise, and branded paper supplies—all drop-shipped to the individual stores by the various vendors. Perishables such as dairy, breads and confections were procured at the store level. In addition to the administrative team, the organization fielded a number of experienced supervisors to oversee training, quality, and recruitment. While the company had enjoyed years of loyal service from many of these senior managers (See Exhibit 3), Beth had discovered early-on that it wasn’t long-term staff that she had to worry about: The retail employee population is the reason that a lot of people franchise—they don't want to manage those headaches. And you will hear me say every week that, boy, if I didn't have employees, I'd have no problems! The Revolving Door In 1997, as Beth prepared to file over 1,500 W-2 forms for 250 positions at the company, she realized that the company needed to make a fundamental change: Our employee turnover that year was 700 percent. It was staggering. We did some analysis and saw that the under-eighteen kids were just a revolving door. I had this kid Chaz leave his keys on the register and walk out—he left the store wide open with nobody there. I held his final pay check because I wanted to find out why he did that. When he finally did call, he swore up and down at me for not mailing his check to him right away. At that point I’d had enough; we were done with those people. So we stopped hiring under-18 workers by taking advantage of a Department of Labor crackdown on minors working in food service operations. An espresso machine, for example, is considered highpressure steam equipment—and minors were not permitted to operate it— so we started saying that because of that and other restrictions, we could only hire people over the age of 18. Last year my turnover was 200 percent—all of it at the 18 to 24-year-old range. By lowering that churn, we were doing less training and hiring. That cut our labor cost a full point; it’s now running about 28 percent of sales (See Exhibit 4). 8 Although Beth acknowledged that employee challenges were inherent in the retailing business, she pointed out that the considerable challenge and expense of hiring, training, managing, and retaining viable workers was lessened when employees got involved: We have found some families who were interested in working for us, and we hired their kids, and their kids’ husbands and their friends and cousins, and that has sort of helped us create an employee population that has, in some locations, been relatively loyal. Beth added that the motivations of new-hires seemed to correlate with age: With young people, it's always, ‘what are you gonna pay me?’ They don't really care about the job security. But once people hit their 30s and early 40s, they want to know that they will have some job security, for example, ‘What role position can I play, and if I perform, will you give me job security? Nothing is for certain, of course, but I do think that we have created a culture where employees know I won’t walk in, demand their keys, and tell them to get out. That sort of thing happens a lot in retail. In order to compete with starting salaries in the range of $10 per hour being offered by upscale mall vendors like Old Navy and The Gap, in 2001 Nancy’s Coffee began to allow its workforce to accept tips. While this was a way of adding dollars per hour to the base pay—as well as providing an incentive for friendly and efficient service—Beth remained concerned that it was a very difficult practice to oversee: If a customer hands over a couple of dollars and says ‘keep the change,’ it's just too easy to drop everything in the tip cup and not ring up the sale. That happens a lot, and there are very few point-of-sale systems for cashbased businesses that can keep theft to a minimum. I wish everybody could pay with plastic, because even though I’d be paying 3 percent to the card companies, I would know the money is coming to me at the end of the day. Beth concluded that the primary advantage of the tip program was that it pushed up wages by as much as $10 per hour over the base salary during the frenzied winter shopping season. The prospect of that extra compensation was enough to virtually eliminate employee turnover during the fiscal quarter that had the largest impact on the bottom line. Financial Management In the early days, Beth used to review the company financials with the aim of providing her mother with a general assessment of aggregate performance. As CEO, Beth was shocked at the lax financial management that she uncovered when she attended to 9 the details. At the same time, she was thrilled about how fast she’d be able to make a real difference: When I first arrived at Nancy's, nobody in the organization could read a financial statement. Store managers were spending like crazy drunks— buying bagels for a dollar and selling them for 99 cents. I have brought about a complete shift from my Mom’s approach—from thinking that financials were something that accountants (and daughters) took care of— to running this thing like a real business. Store managers are now accountable for their bottom line, and they are very cost conscious because of it. I had to educate them on how to read a profit and loss statement, and I made that skill part of their review. They know that they need to negotiate the price on everything they buy, and they understand that their cost of goods can’t exceed 30 percent. That means that if they are planning to sell a napoleon for $1.99, then they know that can’t pay more than 60 cents for it. The company had attempted to design a program that would link these required skills to a performance reward, but Beth noted that it had not worked out: We tried to do a performance bonus that was based on our three key numbers for evaluation; sales, labor and net operating income. Almost nobody received the bonus because in order for the curve to work, we had to set the bar really high. Those people who did earn bonuses didn’t seem to value it very much; they still wanted their raise at the end of the year as part of their performance evaluation. The mindset wasn’t right the first time we tried it; we will regularly revisit that opportunity. With regard to justifying her passion for developing stringent systems and standards, Beth referred to the ominous weather forecast: It’s the beginning of the Christmas season, and if we get the twenty inches of snow throughout the Northeast like they’re predicting, our overall sales this weekend will be cut by at least a third; just because of one poorly timed snow storm! There are so many factors—like the weather—that I’ve discovered I just can’t control, so as a result you have to over-control the things you can have an influence over. Pointing out a significant decrease in accounts payable in her cash flow statement (See Exhibit 5), Beth explained that she had recently initiated a move designed to lower prices, generate more volume, and become more competitive: When we were smaller I was buying the very top-end of the six grades of coffee that our roaster offers. The people we attracted years ago were extremely discerning, but we had so few of them. As the market has 10 matured, and more players have come into the marketplace, people’s perception of coffee quality had been diluted. I decided that it would be okay to dial back a little on our quality a bit, and I think that is working out for us. Beth was now satisfied that she had created the financial and managerial groundwork that could support an aggressive expansion. The challenge was that despite the great strides the company had made towards sustainable profitability, Nancy’s current funding source was highly reluctant to fuel the aggressive expansion effort that Beth was anxious to undertake. Fueling Growth Cash flow from operations, plus long-term debt borrowings, generated an annual investment pool of between $400,000 and $500,000 (See Exhibit 5). Maintenance and upgrade expenses on existing stores were running about $200,000, leaving enough capital to open two new stores at an average build-out cost of $150,000 each. While this dynamic had enabled Nancy’s to grow to nearly thirty stores, Beth explained that from a financial standpoint, the business was not ready for sale: There's not enough money in it for me to give this up right now. At this point we’d be looking at a million and a half, maybe two million for the whole thing. I've got a $350,000 bank debt, and a bit more than that in outstanding payables. At the end of the day my sister and I might split about a million dollars. I just think that I've worked too hard for nearly eleven years for a half a million bucks. Beth figured that to reach a size worthy of harvest, they would need to add fifteen to twenty more stores to the chain—at a growth clip of five to seven stores per year. Beth referred to recent balance sheets (Exhibit 6) as she discussed the weaknesses of their existing leverage arrangements: My bank has been great to me. I have a million-dollar line-of-credit, but because I’m a cash flow customer—without some big building to give them as collateral—they keep me on short leash. We sign ten-year leases at our locations, but the bank is unwilling to go beyond 36 months on debt repayment. That doesn’t work for us. What we need to do is raise a million dollars, pay off our bank debt, and use the remaining capital either to open new stores or acquire some more independent shops that are in good locations but are struggling financially. If our bank will give us the terms we need, then we’d love to continue to pass our millions through them—if not, we’ll have to go elsewhere. Beth was working with an advisor to develop a proposal for a million-dollar loan with a ten-year term. They planned to give her current institution a one-month lead-time on the idea. If those bankers wouldn’t offer more liberal terms, then the plan was to find a 11 lender—or an individual—who would. While she preferred to raise the funds as longterm debt rather than give up equity, Beth was open to the idea of bringing on board a moneyed partner in exchange for a piece of the business—as long as she could maintain her majority position. Failing that course, Beth reflected on what seemed to her as a viable, but less attractive, option: I figure that I could always cut back to ten stores and three million dollars in sales. In that case we’d have no headquarters—bookkeeping, purchasing, tech support—all of that goes away and I’d run the thing from my home with some senior people to cover the stores. But I think if I did that, I would probably open another business and do something else in addition to that. That's why I want to explore the growth path first. If we can’t grow or get acquired, then the ten-store idea is a retrenching position that I could fall back to. Ever since her business management initiatives had begun to yield sustained profitability, Beth had been considering franchising as a way to leverage those systems, along with the Nancy’s brand name and the interesting story behind it: I have thought about the franchise route a lot, and I have considered bringing someone on board to help me explore that opportunity. You can certainly get growth faster and cheaper by franchising, but there are tradeoffs. Franchising for me is a struggle between control and lack of control; influence and lack of influence. One aspect that I’m not too excited about, for example, is that as a franchise organization, all of my personal and business finances would be out there for all to see. Right now, as a small business owner with everything privately held, I have a lot of flexibility. If I stepped into the role of managing franchisees, they would hold me financial accountable for every step that I made; I’m not so sure that is a stress that I need right now. I also like the culture that we have been able to create. From Niagara Falls to Boston, we have built a culture that feels like the same company. That is often not the case with franchises. In an effort to leave no stone unturned, Beth had arranged a meeting with senior managers at Starbucks. She explained that while her instincts had probably been correct, she probably should have guessed the outcome: Strategically my idea to have them acquire us made a lot of sense. They are not in enclosed shopping malls, they are really not having great success in New England because their coffee is too dark-roasted for most people, and they don't sell flavored coffee—which is 65 percent of what we sell. Their response was, ‘we like your business and we think it's 12 interesting, but we don't do malls’. As one of my business advisors said, you can't force an acquisition down somebody's throat; when they have a board meeting and they decide that they are going to go out and buy a small chain in our region, then we’ll probably be the one they call first. Moving Target Beth took another sip of her warm cappuccino, thinking that it was about time to wrap up her cell chat and get back to the tasks at hand. Thanking her friend for the call and encouraging words, Beth added: Don’t get me wrong—you know I love this business. I just think that I have to make some fundamental decisions about where we should go—either an exit strategy, or a more aggressive growth strategy. Should we cut back to ten of our best stores and run it as a side venture? Or maybe franchise, or locate some equity partner and open new stores until we become a more attractive acquisition target? I don’t have the answers, but I can tell you that the questions are sure keeping me up at night! Good thing I know where to get a great cup of coffee, huh? 13 Exhibit 1: The OneCard The OneCard Concept The OneCard is a true technological innovation never before utilized in a restaurant/retail environment. You can use the card to gather "loyalty points" toward free purchases, or, by storing money on the card, you can enjoy fast and easy payments—like having a Mobil SpeedPass® for the best coffee products anywhere! The OneCard, which is activated at the time of purchase, can be used for instant discounts on the web, or at our fine cafes. Two Membership Levels Standard • Nancy's Bonus Program (In Store): Beverages (Buy 9/1 Free), Lite Fare (Buy 5/1 Free), Bulk Coffee (Buy 9lbs/1lb Free) • Free beverage of your choice with OneCard Web Registration • OneCard Standard Annual Membership: $1.00 Premium • Nancy's Bonus Program (In Store): Beverages (Buy 9/1 Free), Lite Fare (Buy 5/1 Free), Bulk Coffee (Buy 9lbs/1lb Free) • Free beverage of your choice with OneCard Web Registration • Free beverage of your choice every month for 1 year ($60.00 Value) • Nancy's SpeedPay® (Stored Value) • Monthly Discounts & Promotions • OneCard Premium Annual Membership: $15.00 15 Exhibit 2: Locations New York Connecticut Albany 1 Crossgates Mall Poughkeepsie 10 Poughkeepsie Galleria Buffalo 2 Walden Galleria Queensbury 11 Aviation Mall Clay (to be closed 01/04) 3 Great Northern Mall DeWitt 4 Shoppingtown Mall Rochester (4) 12 Frontier Field (Seasonal) 13 Irondequoit Mall 14 Marketplace Mall 15 Eastview Mall Middletown 5 Galleria @ Crystal Run Saratoga Springs 16 Wilton Mall New Hartford 6 Sangertown Square Mall Syracuse (3) 17 Carousel Center Niagara Falls 7 Niagara Factory Outlet Madison 21 RJ Café; RJ Julia Bookstore Massachusetts Boston 22 Copley Place (to be closed 02/04) Dartmouth 23 Dartmouth Mall Holyoke (2) 24 Holyoke Mall @ Ingleside 25 1st & 2nd Level Lanesboro 26 Berkshire Mall 18 Carousel Center (Kiosk) 19 Center Armory New Hampshire Nashua 27 Pheasant Lane Mall Watertown West Nyack 8 Palisades Center Mall 20 Salmon Run Mall New Jersey Freehold 28 Freehold Raceway Mall Plattsburgh Vermont 9 Champlain Centré North Manchster 29 4943 Main Street 16 Exhibit 3: Management Structure; Years of Service *Multiple Unit Manager 17 Exhibit 5: Cash Flow Statements (Fiscal Year Ending 09/30) 2003 Cash Flows from Operating Activities Net Loss Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities Amortization and Depreciation Deferred Income Taxes Loss on Disposal of Property, Plant and Equipment Changes in Operating Assets and Liabilities Increase in Inventory Decrease in Prepaid Expenses Decrease in Accounts Payable, Accrued Expenses 2002 2001 (6,389) (106,546) (30,333) 204,589 (4,000) 253,828 258,294 (14,000) 272,286 245,366 (12,000) 133,541 (26,264) 15,347 (13,277) 5,621 (142,673) (33,316) 26,086 (100,290) 437,111 259,705 229,054 Cash Flows from Investing Activities Purchase of Property, Plant and Equipment Increase in Deposits Increase in Intangible Assets (274,539) (289) 783 (144,918) (1,322) (1,724) (196,796) (4,790) (2,950) Net Cash Used by Investing Activities (274,045) (147,964) (204,536) Cash Flows from Financing Activities Principal Payments on Long-Term Borrowings Proceeds from Long-Term Debt Principal Payments Under Capital Lease Obligations Proceeds from Loans Payable; Officers and Related Party Payment on Loans Payable; Officers and Related Party (291,023) 239,857 (59,567) (188,781) (314,760) 236,000 (48,503) 223,100 (162,002) (473,161) 292,996 (32,879) 476,780 (290,778) Net Cash Used by Financing Activities (299,514) (66,165) (27,042) (66,448) 45,576 (2,524) Cash; Beginning 91,053 45,477 48,001 Cash; Ending 24,605 91,053 45,477 Net Cash Provided by Operating Activities Net Increase (Decrease) in Cash 19 127-C04 A-U Arthur M. Blank Center for Entrepreneurship 05/12/04 Babson Park, MA Phone: 781-239-4420 02457-0310 Fax: 781-239-4178 URL: http://www.babson.edu/entrep Nancy’s Coffee As the busy president of the $7 million Nancy’s Coffee Café chain, Beth WoodLeidt wasn’t able to visit each of their thirty suburban coffee shops as much as she would have liked. Whenever she did journey out as she was doing today, it was with a passion for building brand and enhancing profitability. Beth approached one of her more challenging locations—in a mall in central New York—and surveyed the space with a practiced eye. …that front table needs a wipe… the display shelves are dusty…the OneCard holder is hidden behind the tip jar…isn’t it too early in the day to be out of plain bagels?… She warmly greeted the staff she knew, introduced herself to new faces, and ordered a cappuccino from a slightly nervous young hire at the counter. As the teenager set about to whip up the best coffee drink of her brief career, Beth took the manager aside to offer a quick rundown on areas for improvement. Beth was just finishing up with her quality assessment when her cell phone buzzed with a call from a former corporate colleague in whom she had often confided about the challenges of running a retail business. Beth took a sip of her frothy brew, winked her approval to the relieved girl who had brewed it, and headed out into the mall to chat. When her friend noted that Beth sounded tired, the forty-year-old CEO closed her eyes and nodded into the phone: Gosh, I am tired! Remember about a year ago I started saying that I wanted to figure out where this business was going? Well, I’m still asking the same questions like, how can we attract the capital we would need to grow faster; what is the best exit strategy to shoot for; and what is the best way to enhance the value of what we are building? Sure, we’ll add another two more stores this year, but that’s just not doing it for me. It’s early winter, 2003—and that means I’ve been running this thing now for over ten years. And, as you know, the story hasn’t really changed; we’re still too small to be acquired, not valuable enough to be worth selling outright, and yet the business is large enough to need someone thinking about it almost all the time; yes, that would be me. We’ve hit a long plateau here; it’s past time to make some critical decisions. From Nuts to Beans In 1973, Nancy Wood—then a 36-year-old mother of three and married to Sandy Wood—founded a mall-kiosk business to sell dried fruit and nuts. When demand for that fare appeared to be softening, she began the search for a more viable product line. After connecting with master coffee roaster Irwin White at a fancy-food trade show in 1978, she decided to turn her lifelong passion for great coffee into a new business. Nancy’s eldest daughter, Beth, recalled that the concept was a bit ahead of its time: My mother took her kiosks and slowly began to convert them over to coffee bars she had named the Coffee Collection. She started introducing Kenyan and Columbian coffees, but people responded ‘no way; there is Folgers, and there's Maxwell House, and Dunkin’ Donuts.’ It was a very strange thing to many people who were being asked to pay a whole dollar for a single cup of coffee—or told they could grind their own fresh-roasted beans at home. They looked at my Mom like she was nuts. In those days it was very much about educating the consumer. By the late 1980s, Nancy’s son Carter and her daughter Roxanne had joined the venture full-time. While Beth had been contributing to the effort by periodically reviewing the aggregate financials for her mother, she had never taken much interest in the enterprise. So it was, with her mother’s blessing and encouragement, that Beth earned her BS at Babson College in Wellesley, Massachusetts, and soon began a rewarding management career in consumer product marketing. Newly married, Beth happily immersed herself in the busy corporate world of high-profile projects and after-hours brainstorming sessions—first with Pepsico, and later, with Johnson & Johnson: I loved the work. I had a good salary, a 401(k), stock options, bonus check, company car, great suits; I was loving life. Then suddenly, everything changed! Nancy died of cancer at the age of 56. Beth Enters the Family Business In 1993, Beth took a leave of absence from J&J to return home and help sort through the heartache and turmoil that followed her mother’s death. Sandy Wood had inherited his wife’s business, but made it clear that if his kids were not interested in 2 keeping the small chain going, then he would either try to sell the sites or liquidate the assets. Operating on the assumption that Beth would be returning to her corporate job once they had closed the doors on her mother’s enterprise, Beth carefully examined the financials and visited each of the seven locations to estimate what they might be worth. In the course of that investigation, Beth realized that her mother had developed a solid business model within a largely untapped niche—suburban shopping malls—and she was drawn to the possibilities. Beth’s husband Bill recalled that when Beth asked him to join her in the venture, it didn’t take much convincing: I was running a division of Bell Atlantic in Pennsylvania at the time. Beth and I had worked together much earlier in our lives; I had really enjoyed that. I have always figured that if two married people were meant to work together, it was Beth and I. We get along very well, and we both know our own place in the sandbox. One of the issues that we discussed was that one of our egos would have to get checked at the door. I was a leader where I was working before, but I understood that this was Beth’s family’s business, and that she was now going to be the face of The Coffee Collection, now named Nancy’s Coffee. With equal amounts of sadness, trepidation and excitement, Beth informed J&J that she would not be returning. Her father was pleased, and said that he would divest his interest in the business by annually gifting equal shares to his three children. It was understood by all that Beth would be the new CEO of Nancy’s Coffee. The Specialty Coffee Industry The Green Dragon, a Boston coffeehouse founded in 1697, became the clandestine headquarters of the American Revolution. It was there, in 1773, that the Boston Tea Party was planned as a protest against the tea taxes being levied by King George on his colonies. By the time the British and the colonists had settled accounts, coffee had become the hot beverage of choice in America. Throughout the 19th century in the United States, neighborhood coffeehouses proliferated, and home-roasting coffee became a common practice. The industrial revolution, however, fostered a demand for quicker, cheaper, and easier caffeine solutions. With the advent of vacuum packaging and modern transportation, it became possible for a roaster on one side of the country to sell to a retailer on the other side. As with many other food products, quality was compromised to accommodate mass production and efficient distribution. By the 1940s, the coffeehouses had disappeared, and Americans had been sold on the idea that fresh coffee went ‘woosh’ when the can was opened. In 1950, William Rosenberg founded Dunkin’ Donuts in Quincy, Massachusetts. While his donut shop took pride in serving what they called the “World’s Best Coffee”, it would be twenty more years before U.S. consumers could purchase a 3 truly high-end cup. In the early 1970s, a small cadre of coffee aficionados began to offer a unique brew made from hand-picked beans; fresh-roasted in small batches. Peets, founded on the West Coast by legendary coffee idealist Alfred Peet, quickly set the standard for superb coffee. In Seattle, Gordon Bowker, Jerry Baldwin, and Zev Siegl, named their coffee shop business Starbucks, after the coffee-loving first mate in Moby Dick. On the East Coast, George Howell was building his chain of Coffee Connection shops in the Boston area. New Yorker Irwin White began making a name for himself supplying fresh-roasted grounds to some of the finest restaurants in Manhattan. San Franciscan coffee broker Erna Knutsen coined the term Specialty Coffee, and in 1985, helped to found the SCAA (Specialty Coffee Association of America). SCAA membership grew steadily as these coffee pioneers—Nancy Wood included— developed dynamic, profitable business models by proactively educating American consumers about fine coffee. By the time Beth took the helm of her mother’s business in 1993—the same year that Starbucks had gone public—upscale consumers had developed a real taste for an excellent brew. Growth under the Radar Screen Beth and her management team undertook an aggressive search for retail space. To facilitate that process, they worked almost exclusively with the regional mall management companies that had been doing business with their mother for years. Beth explained they chose this path partly as a way of dodging a direct confrontation with the powerhouse sweeping in from the west: Starbucks had clearly stated that as they came east they were going to do cities like Philadelphia, Boston, DC and Manhattan in a big way. We really didn't know how to play in that kind of shark tank, so we figured that we’d let Starbucks have that, and play the suburban card. And at the time, that was low-hanging fruit. Even so, Beth was up against Starbucks almost immediately. One of her first meetings after coming on board concerned a regional mall lease that Starbucks had been considering for awhile. During that meeting Beth suddenly realized how happy she was to be free of the inefficient, multilayered bureaucracies that characterized much of corporate America: There were two leases on the table; a Starbucks lease, and one for Nancy’s Coffee. The mall representative said that the Starbucks lawyers had had the lease for six months—but she was willing to wait. I said, ‘Look, do you want Starbucks, or do you want a leased space?’ When she said, ‘A leased space’, I said, ‘Give me the pen.’ That lease is up next year, and I still haven’t gotten around to reading it. 4 Beth noted that Starbucks wasn’t the only coffee vendor shying away from space in enclosed malls: Establishing your brand in mall locations is not, quite frankly, a strategy for the faint of heart. Managing a mall shop is a difficult business, and it costs a lot of money. That worked for us in a way, since newcomers would get scared off by the idea of paying something like $100,000 a year in rent, when they could be paying $2,000 a month for a Main Street space in ‘Anytown, USA’. The team had learned through their mother’s experience, however, that these pricey mall locations offered an advantage that few suburban in-town settings could match; a captive base. The Captive Audience Throughout the 1990s, Nancy’s Coffee and its suburban-model competitors like Peets and Caribou had the luxury of being able to choose locations where no other specialty coffee shops were operating. Beth explained that this monopolistic positioning was especially advantageous in a setting with high overhead and two distinct customer groups: Our bread-and-butter customer is the mall employee—the three to five hundred people who come to the mall every day to work. If you can get them to try, you can get them to repeat. Then, obviously, we have our transient customers; the shoppers. We have squarely positioned ourselves to cater to stroller moms; mothers with time on their hands, and kids to entertain. They come to the mall for something to do; they may not always buy, but they always have to eat. So we have lots of cookies, apple juice, and bagels on hand for the little ones, which helps us get the mom for her cappuccino. In January 2002, in a move to foster a loyal base of customers, Nancy’s contracted with Paytronix—a nascent venture that had developed a swipe-card with both payment and loyalty program capabilities. Beth noted that the OneCard system (See Exhibit 1) went well beyond the paper cards used by a variety of food-retailers to encourage repeat business: This is like an electronic punch card that also functions as a debit card— either by putting in a cash balance or by prepaying for product. For example, we have this one guy—an eyeglass store manager at a mall in New Hampshire—who shells out $150 on the first of each month to buy the 85 cappuccinos he knows he’s going to drink over the next thirty days. We get his money up front, and he gets our $3 drink for less than $2. 5 If you can get mall employees to buy a OneCard membership for a dollar a year, they’re going to come to you every day, since for every nine drinks they get one free—they can even get a jumbo mocha in exchange for nine basic coffees. That’s a drink that we sell for four dollars; free to them, and my cost is about seventy-five cents. The OneCard is really a nice competitive advantage. We just had a Starbucks open in Buffalo, one floor below us. Our staff was nervous, but I didn’t understand why. I told them that with the OneCard, you already have all of your mall employees in your pocket. It worked; that Starbucks kiosk is struggling. By late 2003, Nancy’s Coffee shops could be found in over thirty locations from Boston, west to Niagara Falls, and from Nashua, New Hampshire, south to New Jersey (See Exhibit 2). Three of the stores had been acquired from the owner of a four-chain enterprise who had come to the stark realization that running coffee shops was not going to be the road to riches that he had once imagined it would be. Beth recalled that they were able to make significant improvements in the stores they took under management: When we acquired Café Coffee, their gross margins were running in the low thirties. They had been managing the business from Wellesley, Massachusetts, and no one was going out to visit the stores. From a financial standpoint, we controlled the employee hours and monitored the food costs. That helped to drive their gross margins closer to 50 percent. Operationally, we kept some of their people, but not all. We put some of our own people in who had much different operational standards than the Café Coffee people. At one store, we saw an increase in customer count, and in six months that store went from being in the red to being in the black. Just as Starbucks and Dunkin’ Donuts never said ‘never’ with regard to mall locations, Beth followed through on an opportunity to develop a street-front location. She was excited about the challenge and the possibilities: There are so many locations that are still looking for high-end coffee bars. The question is; are we as a high-end coffee bar looking for that location? We just opened a store on the street in Manchester, Vermont. My rent there is $1,800 a month. I think it will work, but it will take some time to attract a customer base. If we can find some more good towns like that, I suspect that we will probably do more like that versus more mall expansions. While Beth was happy with the performance of the majority of their stores, she sought to close the weakest locations in their portfolio as soon as possible. She commented that the timetable for divesting those shops was not entirely in her control: 6 You need to be making 15 to 20 percent operating income. If a store can’t make 15 percent in operating income after its fixed and variable costs are covered—then the store needs to be closed. But in our business, you can’t just close a store that isn’t performing—even one that is losing money— and that’s because of the leases we have to sign. These management companies finance their malls using not only the building as collateral, but the leases as proof of cash flow and their ability to repay the debt. If they were to give their tenants a kick-out clause, it makes their business model more risky and harder to leverage for borrowing. That’s why they insist on five, seven and ten year leases. I have a couple of locations I’d like to close tomorrow, but it would mean paying a termination fee—and leaving all my investment behind in terms of property, plant, and equipment. You can be sure that the day those leases expire—those stores will be gone. Managing the Organization Before his death in 1999, Sandy Wood completed the gifting of the business to his children—all as shares, except for the first distribution, when Roxanne and Carter had received a cash equivalent in lieu of stock. Beth now had a slightly larger stock position which left her to direct the company’s future: My brother said that after 15 years, it was time for him to go work for somebody else. So I suggested that Roxanne and I buy his stock and split it evenly. I own 51 percent of the business and my sister owns 49 percent. Our bylaws are very clear that control rests with the majority ownership, It is now my responsibility to set the business on a strategic path for growth. Beth had discovered that ‘living and dying by every single decision every single day’ fired her up in ways that her corporate job could not. Now a mother of an eight- and a five-year-old, she reflected that running the show had given her the freedom to craft a working environment that was far more responsive to the rhythm of life: I know that I never would have had children if I had stayed in corporate America. Now my time is much more my own than it ever was. I may work longer hours than I did in corporate, but if I want to leave at two o’clock to go watch my daughter in a French play, I can do that. This path has helped me to get more balance. I take the position that as long as you get your work done, it makes no difference to me how you configure those hours. When I had my first child, my book keeper’s baby was due three months later. So we set up a nursery in my office and hired someone to watch over the babies. 7 Right now I have four key people out on maternity leave! The other day one of my managers said to me that these are people who watched me have two children without skipping a beat—that I have allowed them to be moms and to be professionals at the same time. It's great to have that kind of impact. The Nancy’s Coffee business was supported by a six-person staff at the home office in Madison, Connecticut. Roxanne oversaw the purchase and delivery of goods like freshroasted coffee, display-shelf merchandise, and branded paper supplies—all drop-shipped to the individual stores by the various vendors. Perishables such as dairy, breads and confections were procured at the store level. In addition to the administrative team, the organization fielded a number of experienced supervisors to oversee training, quality, and recruitment. While the company had enjoyed years of loyal service from many of these senior managers (See Exhibit 3), Beth had discovered early-on that it wasn’t long-term staff that she had to worry about: The retail employee population is the reason that a lot of people franchise—they don't want to manage those headaches. And you will hear me say every week that, boy, if I didn't have employees, I'd have no problems! The Revolving Door In 1997, as Beth prepared to file over 1,500 W-2 forms for 250 positions at the company, she realized that the company needed to make a fundamental change: Our employee turnover that year was 700 percent. It was staggering. We did some analysis and saw that the under-eighteen kids were just a revolving door. I had this kid Chaz leave his keys on the register and walk out—he left the store wide open with nobody there. I held his final pay check because I wanted to find out why he did that. When he finally did call, he swore up and down at me for not mailing his check to him right away. At that point I’d had enough; we were done with those people. So we stopped hiring under-18 workers by taking advantage of a Department of Labor crackdown on minors working in food service operations. An espresso machine, for example, is considered highpressure steam equipment—and minors were not permitted to operate it— so we started saying that because of that and other restrictions, we could only hire people over the age of 18. Last year my turnover was 200 percent—all of it at the 18 to 24-year-old range. By lowering that churn, we were doing less training and hiring. That cut our labor cost a full point; it’s now running about 28 percent of sales (See Exhibit 4). 8 Although Beth acknowledged that employee challenges were inherent in the retailing business, she pointed out that the considerable challenge and expense of hiring, training, managing, and retaining viable workers was lessened when employees got involved: We have found some families who were interested in working for us, and we hired their kids, and their kids’ husbands and their friends and cousins, and that has sort of helped us create an employee population that has, in some locations, been relatively loyal. Beth added that the motivations of new-hires seemed to correlate with age: With young people, it's always, ‘what are you gonna pay me?’ They don't really care about the job security. But once people hit their 30s and early 40s, they want to know that they will have some job security, for example, ‘What role position can I play, and if I perform, will you give me job security? Nothing is for certain, of course, but I do think that we have created a culture where employees know I won’t walk in, demand their keys, and tell them to get out. That sort of thing happens a lot in retail. In order to compete with starting salaries in the range of $10 per hour being offered by upscale mall vendors like Old Navy and The Gap, in 2001 Nancy’s Coffee began to allow its workforce to accept tips. While this was a way of adding dollars per hour to the base pay—as well as providing an incentive for friendly and efficient service—Beth remained concerned that it was a very difficult practice to oversee: If a customer hands over a couple of dollars and says ‘keep the change,’ it's just too easy to drop everything in the tip cup and not ring up the sale. That happens a lot, and there are very few point-of-sale systems for cashbased businesses that can keep theft to a minimum. I wish everybody could pay with plastic, because even though I’d be paying 3 percent to the card companies, I would know the money is coming to me at the end of the day. Beth concluded that the primary advantage of the tip program was that it pushed up wages by as much as $10 per hour over the base salary during the frenzied winter shopping season. The prospect of that extra compensation was enough to virtually eliminate employee turnover during the fiscal quarter that had the largest impact on the bottom line. Financial Management In the early days, Beth used to review the company financials with the aim of providing her mother with a general assessment of aggregate performance. As CEO, Beth was shocked at the lax financial management that she uncovered when she attended to 9 the details. At the same time, she was thrilled about how fast she’d be able to make a real difference: When I first arrived at Nancy's, nobody in the organization could read a financial statement. Store managers were spending like crazy drunks— buying bagels for a dollar and selling them for 99 cents. I have brought about a complete shift from my Mom’s approach—from thinking that financials were something that accountants (and daughters) took care of— to running this thing like a real business. Store managers are now accountable for their bottom line, and they are very cost conscious because of it. I had to educate them on how to read a profit and loss statement, and I made that skill part of their review. They know that they need to negotiate the price on everything they buy, and they understand that their cost of goods can’t exceed 30 percent. That means that if they are planning to sell a napoleon for $1.99, then they know that can’t pay more than 60 cents for it. The company had attempted to design a program that would link these required skills to a performance reward, but Beth noted that it had not worked out: We tried to do a performance bonus that was based on our three key numbers for evaluation; sales, labor and net operating income. Almost nobody received the bonus because in order for the curve to work, we had to set the bar really high. Those people who did earn bonuses didn’t seem to value it very much; they still wanted their raise at the end of the year as part of their performance evaluation. The mindset wasn’t right the first time we tried it; we will regularly revisit that opportunity. With regard to justifying her passion for developing stringent systems and standards, Beth referred to the ominous weather forecast: It’s the beginning of the Christmas season, and if we get the twenty inches of snow throughout the Northeast like they’re predicting, our overall sales this weekend will be cut by at least a third; just because of one poorly timed snow storm! There are so many factors—like the weather—that I’ve discovered I just can’t control, so as a result you have to over-control the things you can have an influence over. Pointing out a significant decrease in accounts payable in her cash flow statement (See Exhibit 5), Beth explained that she had recently initiated a move designed to lower prices, generate more volume, and become more competitive: When we were smaller I was buying the very top-end of the six grades of coffee that our roaster offers. The people we attracted years ago were extremely discerning, but we had so few of them. As the market has 10 matured, and more players have come into the marketplace, people’s perception of coffee quality had been diluted. I decided that it would be okay to dial back a little on our quality a bit, and I think that is working out for us. Beth was now satisfied that she had created the financial and managerial groundwork that could support an aggressive expansion. The challenge was that despite the great strides the company had made towards sustainable profitability, Nancy’s current funding source was highly reluctant to fuel the aggressive expansion effort that Beth was anxious to undertake. Fueling Growth Cash flow from operations, plus long-term debt borrowings, generated an annual investment pool of between $400,000 and $500,000 (See Exhibit 5). Maintenance and upgrade expenses on existing stores were running about $200,000, leaving enough capital to open two new stores at an average build-out cost of $150,000 each. While this dynamic had enabled Nancy’s to grow to nearly thirty stores, Beth explained that from a financial standpoint, the business was not ready for sale: There's not enough money in it for me to give this up right now. At this point we’d be looking at a million and a half, maybe two million for the whole thing. I've got a $350,000 bank debt, and a bit more than that in outstanding payables. At the end of the day my sister and I might split about a million dollars. I just think that I've worked too hard for nearly eleven years for a half a million bucks. Beth figured that to reach a size worthy of harvest, they would need to add fifteen to twenty more stores to the chain—at a growth clip of five to seven stores per year. Beth referred to recent balance sheets (Exhibit 6) as she discussed the weaknesses of their existing leverage arrangements: My bank has been great to me. I have a million-dollar line-of-credit, but because I’m a cash flow customer—without some big building to give them as collateral—they keep me on short leash. We sign ten-year leases at our locations, but the bank is unwilling to go beyond 36 months on debt repayment. That doesn’t work for us. What we need to do is raise a million dollars, pay off our bank debt, and use the remaining capital either to open new stores or acquire some more independent shops that are in good locations but are struggling financially. If our bank will give us the terms we need, then we’d love to continue to pass our millions through them—if not, we’ll have to go elsewhere. Beth was working with an advisor to develop a proposal for a million-dollar loan with a ten-year term. They planned to give her current institution a one-month lead-time on the idea. If those bankers wouldn’t offer more liberal terms, then the plan was to find a 11 lender—or an individual—who would. While she preferred to raise the funds as longterm debt rather than give up equity, Beth was open to the idea of bringing on board a moneyed partner in exchange for a piece of the business—as long as she could maintain her majority position. Failing that course, Beth reflected on what seemed to her as a viable, but less attractive, option: I figure that I could always cut back to ten stores and three million dollars in sales. In that case we’d have no headquarters—bookkeeping, purchasing, tech support—all of that goes away and I’d run the thing from my home with some senior people to cover the stores. But I think if I did that, I would probably open another business and do something else in addition to that. That's why I want to explore the growth path first. If we can’t grow or get acquired, then the ten-store idea is a retrenching position that I could fall back to. Ever since her business management initiatives had begun to yield sustained profitability, Beth had been considering franchising as a way to leverage those systems, along with the Nancy’s brand name and the interesting story behind it: I have thought about the franchise route a lot, and I have considered bringing someone on board to help me explore that opportunity. You can certainly get growth faster and cheaper by franchising, but there are tradeoffs. Franchising for me is a struggle between control and lack of control; influence and lack of influence. One aspect that I’m not too excited about, for example, is that as a franchise organization, all of my personal and business finances would be out there for all to see. Right now, as a small business owner with everything privately held, I have a lot of flexibility. If I stepped into the role of managing franchisees, they would hold me financial accountable for every step that I made; I’m not so sure that is a stress that I need right now. I also like the culture that we have been able to create. From Niagara Falls to Boston, we have built a culture that feels like the same company. That is often not the case with franchises. In an effort to leave no stone unturned, Beth had arranged a meeting with senior managers at Starbucks. She explained that while her instincts had probably been correct, she probably should have guessed the outcome: Strategically my idea to have them acquire us made a lot of sense. They are not in enclosed shopping malls, they are really not having great success in New England because their coffee is too dark-roasted for most people, and they don't sell flavored coffee—which is 65 percent of what we sell. Their response was, ‘we like your business and we think it's 12 interesting, but we don't do malls’. As one of my business advisors said, you can't force an acquisition down somebody's throat; when they have a board meeting and they decide that they are going to go out and buy a small chain in our region, then we’ll probably be the one they call first. Moving Target Beth took another sip of her warm cappuccino, thinking that it was about time to wrap up her cell chat and get back to the tasks at hand. Thanking her friend for the call and encouraging words, Beth added: Don’t get me wrong—you know I love this business. I just think that I have to make some fundamental decisions about where we should go—either an exit strategy, or a more aggressive growth strategy. Should we cut back to ten of our best stores and run it as a side venture? Or maybe franchise, or locate some equity partner and open new stores until we become a more attractive acquisition target? I don’t have the answers, but I can tell you that the questions are sure keeping me up at night! Good thing I know where to get a great cup of coffee, huh? 13 Exhibit 1: The OneCard The OneCard Concept The OneCard is a true technological innovation never before utilized in a restaurant/retail environment. You can use the card to gather "loyalty points" toward free purchases, or, by storing money on the card, you can enjoy fast and easy payments—like having a Mobil SpeedPass® for the best coffee products anywhere! The OneCard, which is activated at the time of purchase, can be used for instant discounts on the web, or at our fine cafes. Two Membership Levels Standard • Nancy's Bonus Program (In Store): Beverages (Buy 9/1 Free), Lite Fare (Buy 5/1 Free), Bulk Coffee (Buy 9lbs/1lb Free) • Free beverage of your choice with OneCard Web Registration • OneCard Standard Annual Membership: $1.00 Premium • Nancy's Bonus Program (In Store): Beverages (Buy 9/1 Free), Lite Fare (Buy 5/1 Free), Bulk Coffee (Buy 9lbs/1lb Free) • Free beverage of your choice with OneCard Web Registration • Free beverage of your choice every month for 1 year ($60.00 Value) • Nancy's SpeedPay® (Stored Value) • Monthly Discounts & Promotions • OneCard Premium Annual Membership: $15.00 15 Exhibit 2: Locations New York Connecticut Albany 1 Crossgates Mall Poughkeepsie 10 Poughkeepsie Galleria Buffalo 2 Walden Galleria Queensbury 11 Aviation Mall Clay (to be closed 01/04) 3 Great Northern Mall DeWitt 4 Shoppingtown Mall Rochester (4) 12 Frontier Field (Seasonal) 13 Irondequoit Mall 14 Marketplace Mall 15 Eastview Mall Middletown 5 Galleria @ Crystal Run Saratoga Springs 16 Wilton Mall New Hartford 6 Sangertown Square Mall Syracuse (3) 17 Carousel Center Niagara Falls 7 Niagara Factory Outlet Madison 21 RJ Café; RJ Julia Bookstore Massachusetts Boston 22 Copley Place (to be closed 02/04) Dartmouth 23 Dartmouth Mall Holyoke (2) 24 Holyoke Mall @ Ingleside 25 1st & 2nd Level Lanesboro 26 Berkshire Mall 18 Carousel Center (Kiosk) 19 Center Armory New Hampshire Nashua 27 Pheasant Lane Mall Watertown West Nyack 8 Palisades Center Mall 20 Salmon Run Mall New Jersey Freehold 28 Freehold Raceway Mall Plattsburgh Vermont 9 Champlain Centré North Manchster 29 4943 Main Street 16 Exhibit 3: Management Structure; Years of Service *Multiple Unit Manager 17 Exhibit 5: Cash Flow Statements (Fiscal Year Ending 09/30) 2003 Cash Flows from Operating Activities Net Loss Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities Amortization and Depreciation Deferred Income Taxes Loss on Disposal of Property, Plant and Equipment Changes in Operating Assets and Liabilities Increase in Inventory Decrease in Prepaid Expenses Decrease in Accounts Payable, Accrued Expenses 2002 2001 (6,389) (106,546) (30,333) 204,589 (4,000) 253,828 258,294 (14,000) 272,286 245,366 (12,000) 133,541 (26,264) 15,347 (13,277) 5,621 (142,673) (33,316) 26,086 (100,290) 437,111 259,705 229,054 Cash Flows from Investing Activities Purchase of Property, Plant and Equipment Increase in Deposits Increase in Intangible Assets (274,539) (289) 783 (144,918) (1,322) (1,724) (196,796) (4,790) (2,950) Net Cash Used by Investing Activities (274,045) (147,964) (204,536) Cash Flows from Financing Activities Principal Payments on Long-Term Borrowings Proceeds from Long-Term Debt Principal Payments Under Capital Lease Obligations Proceeds from Loans Payable; Officers and Related Party Payment on Loans Payable; Officers and Related Party (291,023) 239,857 (59,567) (188,781) (314,760) 236,000 (48,503) 223,100 (162,002) (473,161) 292,996 (32,879) 476,780 (290,778) Net Cash Used by Financing Activities (299,514) (66,165) (27,042) (66,448) 45,576 (2,524) Cash; Beginning 91,053 45,477 48,001 Cash; Ending 24,605 91,053 45,477 Net Cash Provided by Operating Activities Net Increase (Decrease) in Cash 19
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