Starbucks, Inc. F1Q09 (Qtr End 12/30/08) Earnings Call Transcript

| About: Starbucks Corporation (SBUX)

Starbucks, Inc. (NASDAQ:SBUX)

F1Q09 Earnings Call

January 28, 2009 5:00 pm ET


JoAnn DeGrande – Director of Investor Relations

Howard Schultz - Chairman of the Board, President, CEO

Troy Alstead – CFO

Cliff Burrows – President of our U.S. Business


Joseph Buckley – Bank of America

John Ivankoe - J.P. Morgan

Steven Kron - Goldman Sachs

Matt Difrisco - Thomas Weisel Partners

Sharon Zackfia - William Blair

John Glass – Morgan Stanley

David Palmer - UBS

Jeffrey Bernstein - Lehman Brothers

David Tarantino - Robert W. Baird


Good afternoon. My name is Kara and I will be your conference operator today. At this time, I would like to welcome everyone to the Starbucks Coffee Company’s first quarter fiscal 2009 financial results conference call. (Operator Instructions) Ms. DeGrande, you may begin your conference.

JoAnn DeGrande

Thank you. Good afternoon, ladies and gentlemen. This is JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company. With me today are Howard Schultz, Chairman, President and CEO; Troy Pete, CFO, and Cliff Burrows, our President of our U.S. Business also is joining us today.

Q&A will follow today’s prepared remarks. Before we get started, I’d like to remind you that this conference call will contain forward-looking statements that should be considered in conjunction with precautionary statements contained in our earnings release and in the company’s most recent SEC filings.

Forward-looking statements are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Starbucks assumes no obligation to update any of these forward-looking statements or information.

Please see our filings with the SEC, including our last annual report on form 10-K for discussion of specific risks that may affect our performance and financial conditions. Also, please refer to the investor relation’s section of Starbuck’s website at to find disclosures and reconciliations of any non-GAAP financial measures mentioned on today’s call with the corresponding GAAP measures.

Now I’d like to turn the call over to Howard Schultz. Howard.

Howard Schultz

Thank you, JoAnn, and good afternoon, ladies and gentlemen.

Before launching into our overview of the quarter, I think it’s important for me to provide some context. When many of us met for the analyst conference in New York in early December, we announced that we were anticipating and preparing for a challenging holiday season and in fact a difficult fiscal 2009. Yet, while only seven weeks have passed since then, new data shows that by virtually all statistical measures, the pace of weakening in the business environment and global economy we were anticipating has been accelerated.

In the U.S., the unemployment rate has risen 7.2%, a 15-year high. So we’re now seeing unemployment in California approaching 10%. Jobless claims were at the highest level since 1982 and climbing. The rate of home foreclosures across the U.S. has more than doubled in the last two years.

These are just a few of the factors that have contributed to an all-time low in consumer confidence and the worst holiday shopping season in the U.S. since 1969. Similar conditions and circumstances are being felt around the world, especially in Western Europe and in the U.K. where retailers overall experienced their worst December in 14 years.

You know all this of course, but I remind you of the current environment at this moment not to distract from our results, but to make an important point. In today’s environment, companies with solid fundamentals, strong cash flows, appropriate levels of liquidity to support current operations and future growth opportunities, a loyal customer base and an enduring brand will have the strength to both ride out the storm and make sound strategic business decisions for the long-term.

On these criteria, I can assure you that Starbucks is a company with solid, sound fundamentals and most importantly a plan to win. So while I’m far from pleased with our performance this quarter and I anticipate that our results could remain under pressure until the economy begins to recover, I believe that we are navigating this storm effectively and that we will emerge from it leaner, stronger, and better positioned.

As we outlined in early December, we had identified approximately $400 million in targeted cost savings that would positively impact fiscal 2009 and we were continuing to scour the business for additional areas in which we could reduce cost, improve operating efficiencies or both.

Today, we will provide further detail on the previously announced savings and we’ll also share with you an additional $100 million dollars in new cost savings initiatives that we’ve identified that we expect will bring in the total fiscal 2009 savings to approximately $500 million dollars.

Today, we will also provide insight to new consumer facing actions and initiatives we are undertaking to ensure that we retain our core customers. Customers who account for a good portion of the 50 million transactions at our stores every week, while aggressively pursuing new customers through the Starbuck’s lines of quality and value.

You will hear more detail about some of these initiatives later, but our strategy includes continuing to offer the best coffee experience, aggressively pushing back on this perception about our affordability and introducing programs designed to bring consumers into our stores during all day parts.

Troy will then take you through the financials in detail and finally I’ll talk to some of the things that we have planned to ensure that we are on the path to building our business for the long-term.

Earlier today, we announced to our partners our plans for a global workforce reduction that will result in approximately 700 non-store partners being separated from the company, approximately half of those in the Starbuck’s support center in Seattle.

We also announced that we are planning to close approximately 300 additional under-performing company operated stores. Approximately 200 in the U.S. and the remainder in international markets to further strengthen our store portfolio.

We anticipate that the closures combined with the reduced store openings for fiscal 2009 and other labor efficiency initiatives could result in an additional reduction of as many as 6,000 store positions over the course of the fiscal year; however, as before, we hope to be able to place impacted store partners elsewhere in the store organization. Importantly, we’ve redeployed approximately 70% of displaced store partners from our original set of layoffs that we had this summer.

A list of the closures will be available once it has been finalized and once impacted partners have been notified.

To our existing company-owned stores, we are reaching out to all landlords globally to look for opportunities to renegotiate rents under our leases. This should allow our stores to become more profitable over time and we are eager to work with landlords to find solutions that are mutually beneficial.

We have also been forced to take a hard look at partner benefits. In doing so, we have focused on preserving those benefits that are core to our culture and values, while trimming back others that have simply become unsustainable on a go-forward basis. Making the decision to trim benefits was extremely difficult for us, as you might imagine, but it was for us just as it has been for many other companies an important step to take and we took it.

I am very pleased to report, however, that in the end we were able to leave intact health care coverage for all eligible full and part-time partners for fiscal 2009 and equity in the formal stock options for all our partners, the people who are so critical to the success of Starbucks today and into the future.

These extremely difficult decisions were made even more so by the fact that they will have a significant impact on many members of the Starbucks family who have directly contributed to our success over the years. For that reason, if these decisions were only about getting through a tough period, we would likely have come out differently, but they were not. These decisions were about the need and our management’s intent to transform Starbucks into a leaner, more nimble, and more aggressive company that is prepared to act and react quickly to fast-changing market conditions and consumer behavior in the U.S. and around the world.

You have heard us talk about redesigning our cost structure for the long term. The changes announced today are additional significant steps in that direction. Our retail stores remain and we believe will thrive in locations that are convenient to our core demographic base. We will discuss other demographics and geographies in new innovative ways, but more on that later.

There were 195 net new store openings for the quarter, significantly less than in the first quarter of fiscal 2008. We ended the quarter, it was more than 16,000 stores globally. Consolidated net revenues were $2.6 billion dollars in Q1, down 6% year-over-year.

Operating income was $118 million in Q1, which includes approximately $75 million dollars in restructuring charges. Most of these charges are associated with previously announced store closures in our U.S. business.

Earnings per share for Q1 were $0.09 and were $0.15 non-GAAP, including $0.06 relating to restructuring charges, and Troy will provide more detail in his remarks.

Now I’d like to touch on a few highlights from our three businesses beginning with our U.S. business. Despite the difficult economic environment and tough holiday season, Starbucks sold more than $26 million new Starbucks cards and cards overall were loaded with nearly $560 million dollars, an 8% increase over last year. This performance demonstrated for us the broad appeal of the Starbucks card as a gift, especially in contrast to the performance of the overall gift card business, which has been forecasted to be down as much as 10% heading into the final week of the holiday shopping season.

We are confident that the Starbucks card brings incremental business into our stores and are also confident we can get a higher incrementality for cards sold in third party channels such as the success we had with Costco, which activated more than five million cards during the holiday season.

We were also extremely encouraged by customer response to our new Starbucks gold card. Program members, now more than 500,000 strong, average 15 visits per month and spend about 10% more per visit than non-members. Even after the holiday season, we continue to see strong attachment, adding more than 10,000 new gold card members a week. All this we believe should be well for calendar 2009 and beyond and underscores the powerful asset we have in our card programs, which affords us the opportunity to deepen our customers’ connection with the brand and drive our business even in tough times.

Because we anticipated a difficult holiday season, our merchandise strategy enabled us to sell through a significant portion of our holiday inventory with limited markdowns. We focused on lower price gifts and added limited time sale. Our Thanksgiving blend seasonal coffee was very well received and we actually sold out of the coffee well before Thanksgiving.

Our partnership with product red enabled us to both leverage our immediate visibility in a cluttered consumer environment and reinforce the core values of our brand and our company. On balance, customer shopped late to get the benefit of additional discounts.

The U.S. business began to implement targeted cost savings initiatives in the first quarter through labor optimization, waste reduction, and supply chain efficiencies. Based on changing traffic trends, we evaluated and actively managed hours of operation and labor targets on a store-by-store basis.

From a planning perspective, this quarter we focused on implementing the fundamental changes we believe will set the U.S. business up for success in the future. These include a further simplified promotional calendar designed to both drive traffic and incrementality and obviously improve service.

Internationally, we are maintaining a steady course in executing our business strategies learned from the U.S., which has influenced us in taking a measured approach in our growth. We are partnering with those who have values similar to ours, understand their local markets, and are able to deliver successful results through either joint venture or licensed stores, which constitutes approximately two-thirds of all Starbucks international stores.

We also continue to look for opportunities to provide the Starbuck’s experience through international channels, such as our CPG and food service operations.

Looking at our first quarter, the international business continues to be different, based on which region we are discussing.

We had success with market entries in Portugal and Bulgaria and newer markets, including Russia and Argentina, are also performing well. Russia continues to have one of the highest average ticket rates, and Argentina is seeing some of the highest transaction volumes in our system.

In China, where we recently celebrated our 10-year anniversary, we are still seeing good growth in spite of the slowing economy, reflected in positive comp store sales. We currently have approximately 350 locations in 26 cities in mainland China and 700 locations in greater China, which includes Hong Kong and Taiwan.

The enthusiasm the Chinese people have for Starbucks reinforces our confidence in the long-term potential for this market. We are beginning to see margin improvement in China driven in part by initiatives to address labor optimization and waste.

We continue to see considerable weakness in certain international markets, especially the U.K. and Canada. We have and we’ll continue to put into place loyalty programs in these markets in response and within many markets we have implemented or will implement plans to drive additional traffic and gain efficiencies throughout the P&L, including but not limited to bringing additional value to our customers, labor optimization, reduce waste, supply chain optimization, and lease renegotiations, and reduced support cost.

Let me turn to our consumer products group. In the past, I haven’t typically gone into great detail of our CPG business, though it has achieved steady profitable growth in recent years. Increasingly though, we’re viewing the CPG business as central to our overall business strategy, enabling our packaged coffee, tea, and ready-to-drink businesses to leverage existing markets and brand awareness, providing us with channels and access to customers we have not otherwise been able to reach at retail and specifically focus on the whole market and allowing us to play on both sides of the value continuum.

Our CPG business operates very effectively with our joint venture in sales and distribution partners and has been able to benefit from the lessons we’ve learned on the retail side as it grows domestically and internationally.

In the first quarter, we expanded packaged coffee into Ireland and launched Starbucks coffee in Switzerland through our expanded relationship with Kraft in Europe. Switzerland is the first country in continental Europe to benefit from the expanded relationship and over the coming months, you’ll see us broaden our European presence. his compliments the packaged coffee business we have built in the U.S., Canada, and the U.K.

In the ready-to-drink coffee category where we have 90% share, which currently about a $1.3 billion dollar market in the U.S., Starbucks branded products accounted for approximately $7.00 in every $10 dollars spent in the ready-to-drink coffee category.

Through the North American coffee partnership, a joint venture between Starbucks and Pepsi, Starbucks double shot energy coffee drinks have become top performers in the ready-to-drink energy coffee sub-category since launched in June of 2008. Currently the line represents three of the segments five best-selling SKUs. In addition, we have joined Unilever and Pepsi in their PLP partnership and with them we are now expanding national distribution of Tazo Tea ready-to-drink beverages. These ready-to-drink businesses will play an important role in our stores and our customers abroad as well and today we hold leading positions in this category in Japan, Korea, and China.

As mentioned during the analyst conference, we recently began exploring new ways we could leverage our Seattle’s Best coffee brand to work for us. Starting with a food service test in more than 2,800 Subway restaurants in the U.S. beginning this month.

I’m pleased to share with you today that we also are expanding our franchising program with Seattle’s Best coffee. Our Seattle’s Best coffee brand is uniquely positioned to grow through franchising because of its national footprint, operational experience, and the innovative retail coffee concepts it offers.

We’ll be working with qualified franchisees to match them with site opportunities as part of our franchise development program.

Some of the real estate we will exit under the Starbucks brand as mentioned earlier may provide an attractive conversion opportunity to potential Seattle Best coffee franchisees as well as cost savings for Starbucks Corporation. We believe that the Seattle Best coffee brand can play a unique role in helping capture a larger share of especially coffee segment by providing options and a variety to a broader spectrum of customers.

Looking ahead, our task is clear. We must continue to work to retain and to strengthen our connection with our core customers while at the same time devising new and innovative ways to attract new customers to our stores and bring customers back and we’ll use all of the tools at our disposal. Cross channel promotion leveraging, CPG, all brands, all products, and new consumer loyalty programs. To do this, all while standing relevant in areas our customers care most about – coffee, customer experience, innovation, differentiation, and obviously in the environment that we’re in, real value.

Over the past year, we’ve been working diligently to make Starbucks a breakfast destination. We’ve improved the quality and nutrition of our offerings and we’re encouraged by the early success of oatmeal and other healthy options.

I’m pleased to share with you today that beginning in March, we will combine our breakfast strengths with a value proposition that challenges misperceptions about everyday affordability. Using uniform national pricing, we will offer several breakfast pairings in company-operated stores at attractive price points.

The question of value often gets tied to the competition. How are we competing with traditional QSRs who are offering cheap coffee in dollar menus? How can a premium brand like Starbucks be competitive when customers are trading down on everything from houses and travel to clothing and lunches out. I’d like to try and separate value from competition and talk about the differentiating factors that ultimately make Starbucks a competitive player in the leader in our category.

Starbucks has always been an experienced oriented brand and retailer and our approach has been to connect with our customers in ways our competitors simply cannot. This includes everything from Starbucks shared planet, the way we engage with our customers and communities to do business responsibly through our unique election day and inauguration day promotional initiatives, through our participation in the recent national call to service. What all of these efforts have in common is their relevancy to the values and lives of our customers and that is what we believe will help us remain resilient both during challenging times and long into the future.

We absolutely believe that now is a time to safeguard and lock in those elements of the Starbucks brand, which have been all about doing the right thing in both good and tough times.

Finally, we must and will continue to innovate deliberately, aggressively, with great consistency, and do it in a responsible fashion with customer satisfaction as our guide.

We have important pipeline of announcements that we will be making to highlight innovation, competition and value strategies that will enhance our business and lead us forward.

With today’s announcement, we believe that our organization will be aligned at all levels to achieve our objectives.

With that, I will now turn the call over to Troy who will review with you our Q1 results. Troy?

Troy Alstead

Thanks, Howard, and good afternoon, everyone.

Howard provided you with the high level recap of our fiscal first quarter. I’ll now provide additional details on our first quarter performance by each of our three business segments as well as review the impact to the balance of the fiscal year from the cost reduction initiatives we’re committed to achieving.

We entered fiscal 2009 in late September with initiatives underway to reduce our cost structure by $200 million dollars through portfolio rationalization and reduction in our non-retail support structure. Then, in early December, we announced an additional commitment to take out another $200 million in fiscal 2009 through efficiency enhancements in store and in our supply chain.

We began to see the results of these cost reduction efforts in the first quarter and we believe the savings will accelerate throughout the year.

The additional steps announced today, further store closures and reductions in field leadership and non-retail support positions, along with the early successes we had on the previous actions against the initial $400 million, increased the savings opportunity in 2009 to $500 million dollars.

These actions further demonstrate our commitment to do what is necessary to withstand the near term challenging operating environment. These efforts are specifically focused on driving to a healthier business model to better position Starbucks to deliver when the economy rebounds.

Let’s first take a look at first quarter results and then I’ll provide additional details around the cost reduction initiatives.

Looking first at total company for the first quarter, we reported consolidated revenues of $2.6 billion dollars, a 6% decline from $2.8 billion dollars a year ago. The primary driver behind this decrease was a 9% decline in same store sales. The decline in consolidated same store sales was composed at a 5% decrease in traffic and a 4% decline in the average value per transaction.

I’ll provide more color on comps for both business segments in a few minutes, but of note, international same store sales went negative this quarter, reflecting further deterioration in the global economy, particularly our two largest company operated markets, the U.K. and Canada.

We reported consolidated pre-tax operating income of $118 million dollars in the first quarter, which included $75 million dollars of restructuring charges. This compared to $333 million dollars of reported operating income in the prior year with no restructuring charges.

Consolidated operating margin was 4.5% compared to 12.0% for the same period a year ago. Weaker sales had a de-leveraging effect and was the primary driver behind the contraction. In addition, 290 basis points of the margin decline were related to the $75 million dollars in restructuring charges I mentioned. When excluding those charges, the operating margin would have been 7.4%.

Earnings per share was $0.09 for the first quarter and non-GAAP EPS was $0.15 compared with EPS of $0.28 in the first quarter of FY08. First quarter EPS was negatively impacted by approximately $0.06 of restructuring charges with a large majority related to charges associated with lease exit costs and asset write-offs linked to the closure of under-performing stores in the U.S.

I’d also like to note two additional items impacting EPS for the quarter. The October leadership conference, which had approximately two and a half impact on EPS for the quarter and store impairment charges, which totaled approximately $0.02.

Results for operating segments, beginning with our U.S. business. Total U.S. net revenues for the quarter decreased by 6% to $2.0 billion from $2.1 billion a year ago. Company operated retail revenues decline 7% to $1.8 billion dollars for the quarter, primarily due to a 10% decline in comparable store sales.

Looking at the components of comp sales, both traffic and ticket weekend with a 6% year-on-year decline in traffic and a nearly 5% drop in the average value per transaction.

As a percentage of total of U.S. revenues, U.S. cost of sales, including occupancy cost, increased to 43.9% compared to 41.1% in the comparable period a year ago with higher cost of sales contributing nearly two-thirds of the increase.

The enhanced beverage quality standards we implemented in Q2 of last year and cost associated with new product introductions, such as Roast and Divano were the primary drivers behind the year-over-year increase in cost of sales.

Occupancy cost also contributed to the higher cost, primarily the result of de-leveraging to softer sales.

U.S. store operating expenses as a percentage of related U.S. retail revenues increased 300 basis points to 43.5%, the majority which can be attributed to loss sales leverage. Also impacting sale operating expenses was the October leadership conference, which I previously mentioned.

These two contributing factors mask the favorability we saw in reduced salaries and benefits expense associated with the reduction in headcount, which we announced in the second half of FY08, as well as early progress from our store labor efficiency initiatives.

U.S. operating income was $134 million for the quarter, down from $311 million dollars during the same period FY08. The operating margin decline to 6.7% of related revenues from 14.6% a year ago. Sales de-leverage was the leading contributor to the margin compression, which is reflected primarily in store operating and occupancy expenses.

The $54 million in restructuring charges directly related to the U.S. segment contributed approximately one-third or 270 basis points of the margin decline.

Moving now to results for our international segment. International total net revenues declined 8% to $496 million in the first quarter of FY09, reflecting the impact of further deterioration in global economy as well as the weakening of many currencies against the U.S. dollar year-over-year.

While we saw strength in a number of our smaller international markets, the weakening economic environment in our two largest markets, Canada and the U.K., clearly dominating our international performance.

Company operated retail revenues decreased 10% to $414 million, primarily a result of unfavorable foreign currency exchange due to the strengthening U.S. dollar against the British pound and the Canadian dollar.

Weak comparable store sales also contributed to the year-over-year decline. Comparable store sales were down 3%, primarily driven by further softness in sales in the U.K. and Canada, which represented 77% of our international same store sales in the first quarter.

Our U.K. business saw the steepest decline of the two markets, in line with the broader retail sector results in the U.K. Of note, the British retail consortium recently reported that December was the seventh consecutive month of same store sales decline in that county, as Britain slides into a recession.

This is consistent with the weakening traffic trends we began seeing in Q2 of FY08 in our U.K. stores. We’ve been closely monitoring the U.K. along with other markets and in the first quarter we found it necessary to record significance to our impairment charges, which was the primary driver behind the 590 basis point increase in store operating expenses as a percentage of international retail revenues.

The continued deterioration in the U.K. and with no near term improvement in sight, let us more recently to take decisive action in managing our U.K. store portfolio. We learned from our experience in the Australia market. They were moving underperforming stores from the mix can boost the health and profitability of the remaining portfolio and a decision to close stores in the U.K., along with a few other international markets, if the right step toward bolstering the performance of our international business.

International operating income decreased to $12.9 million in the first quarter of FY09, compared to $54.1 million a year ago. Operating margin was 2.6% compared to 10.0% a year ago, with the impairment charges I just mentioned, contributing 320 basis points of the decline.

While the global economic turbulence may continue to influence consumer spending and thus impact our international revenues, we are very actively taking steps to manage what we can control, the middle of the P&L, particularly in the U.K. market, which is experiencing the most noticeable change. The managing director appointed in October of last year is aggressively attacking costs and seeking efficiency improvements throughout the business.

Let me wrap up my business segment discussion with results from the global consumer products group, our CPG. CPG total net revenues rose 14% to $114.3 million in the first quarter of FY09, mainly due to increased sales in the U.S. to package coffee to Kraft. Operating income for CPG was $52 million in the first quarter compared to $51 million in the same period a year ago. The operating margin contracted 520 basis points to 45.1% of related revenues, primarily due to the impact of higher coffee commodity costs on higher sales volume of packaged coffee to Kraft.

Now, for a few comments on Starbucks balance sheet in liquidity. Starbucks financial position in liquidity remains strong. Despite the weakened economy, the company is still generating strong operating cash flow, which provides us with the flexibility to continue to pay down our short-term debt.

During the quarter, short-term borrowings under the combined credit facility and commercial paper program were reduced by $423 million dollars to $290 million dollars outstanding at the end of the quarter.

For the remainder of FY09, we expect our short-term debt to remain close to first quarter 2009 levels, including the expected restructuring costs related to additional store closures announced today.

As you know, Starbucks credit facility requires the company to comply with the minimum fixed charge coverage ratio covenant. The company is currently in compliance with this covenant and excluding the lease termination costs we expect to remain in compliance; however, the technical ratio calculation includes lease termination cost as if those costs were the same as rent. So as a result of our decision to improve our store portfolio by closing an additional 300 under-performing stores, we intend to pursue an amendment to our credit facility to address these lease termination costs.

By the way, it was for these same reasons that we successfully amended the covenant last year.

During the quarter, the business generated $694 million in cash from operations and $521 million in free cash flow.

Let me now move into a more detailed discussion on the half billion dollars in cost savings we aggressively are going after in FY09. In early December, I laid out cost reduction opportunities expected to impact the FY09 P&L by $400 million. Today, in response to the continued difficult operating environment, as well as an increased confidence and the pace at which we can drive inefficiencies out the business and improve the cost structure of the company, we increased that total to $500 million, which is expected to impact our P&L in FY09.

I’ll now provide more detail on the components and expected timing by quarter throughout 2009 of these actions. The first bucket of approximately $200 million relates to actions we took in FY08 comprised of store closures in U.S. and Australia and the reduction in support costs.

The expected P&L benefit in 2009 from these actions announced in July 2008 is currently estimated to be $65 million from closing approximately 600 U.S. stores, $15 million from closing 61 Australian stores, and $120 million from the reduction in force in related infrastructure cost announced in July 2008.

The next category totals $100 million and consists of initiatives underway within our supply chain, which we announced in early December. Specifically in 2009, we currently expect $75 million in procurement spending, related to rationalization of SKU counts in the vendor base, sourcing changes for core materials, and alignment of replenishment processes to better mass demand, and $25 million of improved manufacturing productivity in increased distribution efficiency.

The next category of cost reduction also announced in early December totals $100 million and consists of initiatives underway to increase efficiencies and reduce costs in our store operations. Our targeted improvement in FY09 includes $75 million benefit in store labor, as direct result of initiatives to apply lean principles to the operations of our stores, and $25 million reduction in store waste, particularly in the areas of food, brewed coffee, and dairy.

The additional $100 million of targeted cost takeout in 2009, which we announced today, consists of a wide range of focused initiatives across the business, including the impact of the additional reduction announced to our positions in the U.S. and international markets.

Of this aggregate $500 million, approximately $75 million was realized in the first fiscal quarter, primarily resulting from store closures and reduction in support costs. We were also encouraged in the first quarter by some early benefits of the store labor initiatives.

Over the balance of FY09, we currently expect the remaining approximately $425 million to ramp up throughout the year as follows. $100 million in the second quarter, $150 million in the third quarter, and $175 million in the fourth quarter.

As we move throughout the year, we will continue to provide updates on our progress against this $500 million targeted cost savings in our quarterly earnings calls.

Looking beyond FY09, not only do we expect these cost reductions to have a significant end year impact, but they also create a sustainable change to our underlying cost structure on a go-forward basis.

We fully expect these initiatives to drive additional savings as we annualize the benefits in FY10 and beyond.

Before I move on to details around the store closures, let me talk about executive compensation in this difficult time. First as we stated in our proxy statement, none of our named executive officers received bonuses for FY08 nor did they receive base salary increases for FY09. Additionally, last week Howard Schultz requested and the compensation committee of the board approved, a significant reduction to his annual salary from nearly $1.2 million to below $10,000 a year.

Finally, we’ve made the decision to retain only one corporate plane going forward and we will be doing all we can to sell our other aircraft, despite the current soft market for corporate planes.

Now, let me provide more specific detail around the additional planned closure of approximately 300 company operated stores with approximately 200 in the U.S. and the remainder in our international markets.

We approached this decision through a similar process as the one we undertook last year, employing several criteria to classify stores for closure, which included the identification of locations that were not profitable to store level and not projected to provide acceptable returns in the foreseeable future.

We also used site and markets to the criteria and consideration was given to the impact of the current and anticipated economic trends within each respective market. In the U.S., the approximately 200 stores targeted to close are spread across all major U.S. markets and account for only 3% of our current U.S. company operated store portfolio. The approximately 100 international company-operated stores slated for closure represent only 5% of our current international company-operated store base.

The majority of both U.S. and international store closures are expected to occur over the remainder of FY09. As a result of these closures and the further reduction of new store openings, along with other labor efficiency initiatives, which we previously discussed, there could be as many as 6,000 additional retail positions eliminated over the course of the fiscal year.

As is our practice, when possible, impacted partners may be placed in nearby Starbucks stores.

As part of our announcement today, we included our plan to eliminate approximately 700 non-store partners from our global workforce of which around half are in our Seattle support center. These are very difficult decisions, but are necessary to ensure we have the appropriate infrastructure and cost structure to improve the company’s financial performance going forward.

The earnings release and the 8-K we filed today provide additional details around the pre-tax charges associated with the store closures and the reduction in headcount.

As we indicated in the release, the current uncertainty of the global economy and the respective operating environments in which we do business preclude us from fighting targets for 2009. However, I would like to share with you our current view on a few key metrics and cost inputs for the remainder of this fiscal year.

In addition to the store closures announced today, we are also further reducing our store opening targets in FY09. We provided a table in the earnings release to help illustrate the expected composition of our global store portfolio at fiscal year end.

In summary, we only expect to add around 95 net new stores to our global store base this fiscal year with the majority of the openings coming through licensed stores.

In line with our decision to reduce store openings in FY09, we’ve accordingly further reduced our targeted capital expenditures from $700 million to around $600 million dollars.

The outlook on our two primary commodities, green coffee and dairy, is unchanged from our previous view, which we provided with our Q4 fiscal year end 2008 results. We expect unfavorable green coffee costs should be offset by favorable dairy. And also changed from our prior outlook, we expect a $0.02 unfavorable impact to EPS from foreign currency exchange due to the strengthening U.S. dollar against the dominant foreign currencies in which we do business.

To summarize our view of the remainder of this fiscal year, we are moving swiftly to adapt the business to the reality of the current operating environment and making fundamental changes in our operations and our cost structure. We’ve continued to work diligently to identify additional opportunities to further right size our cost structure. We continue to evaluate our global store portfolio and our driving enhanced discipline toward store performance. We will not allow under-performing stores to weaken our store base and if the analytics point to sustain under-performance in any given store, we’re moving aggressively to close that store and protect the overall health of the remaining portfolio.

Our focus is to further strengthen the store base and continue to seek opportunities to improve efficiencies and reduce costs while keeping a keen eye on maintaining the Starbucks experience to our customers and creating value long-term for our shareholders.

Now let me turn the call back over to Howard for his closing comments. Howard?

Howard Schultz

Thank you, Troy.

There are a few key points I’d like to make in closing before we go to the Q&A.

First, our cost containment efforts have been serious and our store portfolio is becoming healthier. We feel good about the progress we are making in improving the basics of our store operation and we are offering great value to our core customers through our card programs.

There are also encouraging signs of progress in various geographies around the globe. Second, we’ve taken a long look at areas of value and competition.

In short, we have heard those of you calling for more action and how we go to market in these two areas and we will be moving to correct misperceptions and drive stronger offers into the market. All this will play out over the coming months.

Finally, our brand tracking data, which is internal, strongly indicates that perceptions of the Starbucks brand have improved significantly with measures of value, operational improvements, corporate responsibilities, and loyalty initiatives back to the 2007 levels or even higher.

We’ve always relied on the research to predict future consumer behavior and we have no reason to believe that will change. We believe all this holds well for the company over the long term. We are focused on foundational improvements that are difficult to see from quarter-to-quarter, especially in this unpredictable economy.

We believe all of the work that we’re doing will pay off in the long run and I think as you can see from the remarks that I’ve made and Troy’s made and the announcements that we share with you today that there is an acute understanding of the situation and we’re making significant steps, courageous steps, to ensure the fact that Starbucks not only weathers the storm, but maintains our leadership position on a go-forward basis.

Thank you. We’ll open our line now for Q&A.

Question-and-Answer Session


(Operator Instructions) Our first question will come from line of Joe Buckley with Bank of America.

Joseph Buckley – Bank of America

A question on the U.S. same store sales performance through the quarter. You shared the October-November, the final results came in down ten. I’m wondering as you look at that December data, if that additional softness was related to the holiday merchandise or more the core beverage business?

Cliff Burrows

It really was just a general lack of acceleration in the final weeks of holiday and indeed certainly the consumer was shopping for bargains and was waiting for reductions to go through. So we came out of it very clean, but there was some margin impact.


Your next question is from the line of John Ivankoe of J.P. Morgan.

John Ivankoe - J.P. Morgan

Howard, when you were talking about national price points, I mean it really does allude to national advertising. I mean advertising a price point on television. So could you give us a little meat around, since March is only a month away, how you’re planning on communicating that value and whether it will be limited time only or permanent?

Howard Schultz

John, I appreciate the question. I think as noted in my comments, we are making significant strategic shift. We’ve never had really national pricing and so the markets have been very different from market-to-market. So this is a change. The pairings that we’re talking about, you alluded to bundling, this is an attempt that we think is a very strong sign of the things that we need to do around value and the research that we’ve done strong indicates that he appetite from our customers to respond positively is there.

For competitive purposes, I’m not going to respond to what we may do or when, but we are making a commitment and we think it’s the right thing to do at this time and is very, very important to demonstrate a deep level of understanding and sensitivity about what our customers are feeling and our research strongly suggests that.


Your next question is from the line of Jeffrey Bernstein of Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

Talk a little about the potential impact of the 800 U.S. closures on the rest of the system, specifically with the comps. I think you said 400 already closed, just wondering if you’ve done a study to look at the neighboring stores. What the impact is to those stores and if you have made a comment regarding January and the flow through from December consumer weakness and whether that continued into January.

Howard Schultz

We haven’t made any comments about January and won’t be doing that today at all. With respect to closed stores and impact on nearby stores, part of the benefit we expected going into store closures the first time around, last year, the 600 plus stores, was related to transfer of some of those sales as we closed those stores to nearby stores. I can tell you that we have seen that and we’ve been very pleased that as we needed to close under-performing stores, a good percentage of those sales we’ve been able to pick up at nearby stores.

Now we’re only part way through that program so we keep evaluating the results and I wouldn’t be prepared to talk about the percentages that we’ve seen, but it has met our expectations and as we go into this new round of store closures, we’re approaching it with better insight to capture sales.

Cliff Burrows

I think the other thing is there’s an opportunity to do as we’ve closed neighboring stores, we’ve been able to transfer some of the partners to match those increased sales and overall lessened the impact on the partners out there in stores and strengthened our knowledge base and capability in ongoing stores.


Your next question is from the line of David Palmer with UBS.

David Palmer - UBS

Cost question. Could you touch on cost items, energy related costs including packaging in all the distribution costs and maybe even store lease costs. Any color or quantification on how the commodities that are coming down might provide some earning relief and also could leases perhaps be reset lower or renegotiated lower?

Troy Alstead

Many of the cost elements you’ve talked about are part of this half a billion dollars of cost savings that we’re going after this year in terms of specific efficiencies in our distribution system. Commodities, things like fuel, which we talked less about, but coffee and dairy were not part of that half a billion and what I said about that and what I expect is that all those commodity impacts together. Fuel is moving in certain directions, dairy we expect favorable this year, coffee somewhat unfavorable. On balance, we think those are reasonably offsetting each other and are flat to the prior year.

Now, I will go on further to say that as I think Howard mentioned, we are approaching leases with existing stores to attempt to work with the landlords in a win-win way to get some appropriate reflection of the current environment on those go-forward rental rates. We do think it will benefit the business and it’s something that’s a part of our estimated projections going forward.

Howard Schultz

If we are reaching out to our top suppliers in a way that we’ve never done before and some of these relationships go back 10 to 20 years. People who have really been in business with us, people whose business has really grown as a result of our success and we believe that we will be able to engage in discussions and that will have a positive impact on the business in a go-forward way.


Your next question is from the line of Sharon Zackfia of William Blair.

Sharon Zackfia - William Blair

Troy, I was wondering if you could give us a new break even comp, given the new cost savings for you to grow earnings this year.

Troy Alstead

Sharon, no, we’re not planning to do that at this point in time. It’s been very difficult for us to have visibility into consumer trends and comp growth on one hand, and as we’re aggressively going after all these cost initiatives and determining the timing of those as they play out throughout the year. We’re just not in a position to provide that kind of break even at this point in time.


Your next question comes from the line of Steven Kron of Goldman Sachs.

Steven Kron - Goldman Sachs

Question on the retail store footprint in the U.S. As you look at your store closures that you’ve announced, I guess maybe you could share a little bit, like beyond the financials. So non-financial commonalities of a lot of these store closures and what are you learning about the brand and density in certain geographies and how does this change your thinking to where this brand can extend to?

Howard Schultz

So much of the issues surrounding the closures relate to the significant fracturing of the impact of the financial system by geography and so if you take the state of California and Florida, which for us has been the two most affected markets. Those markets in previous years have been fantastic not only growth markets, but very profitable for the company.

I wouldn’t draw a conclusion as a result of those two geographies, the equity of the Starbucks brand or the store opening schedule in the future is dismal, because we’re dealing with things that we’ve never dealt with before. When you take a zip code and you look at the foreclosures in that market, there was no opportunity that we ever could have forecasted when we open up stores there, that the market would be so dramatically impacted by the fact that people aren’t living there anymore.

So I know the kind of answer you want, but the truth is that there is such a direct correlation between the stores we open in anticipation of a normalized economic environment and the fact that that economic environment no longer exists. So I think the steps we’re taking are for this moment in time and we’re focused on that and to be able to forecast future as it relates to new growth and new geography, we got to get through this time and really understand what the situation will be.

The flip side of that though is that in many, many areas of both California and Florida where the economy is relatively strong or the impact of foreclosures has not been as significant, our stores are thriving. So there’s such a common thread to the problem and I might add to the retailers and higher end restaurants that I talk to, you can almost mirror their situation with ours in both those two states.

Cliff Burrows

We’ve seen time and time again and it’s become more prevalent in the current climate, which is the relevance of Starbucks as a place of community, a place for community, and where people go to to engage with others and I think that is a good measure for success and indeed a good indicator of the future. We have to grow with community and where we play a part.

Howard Schultz

Interesting thing, I’ve been holding town hall meetings with customers and the concern that people have. It’s so emotional when they express it is please don’t close my store and it’s hard to capture the relevancy of Starbucks as a third place and the meaning that we have in people’s lives across America.


Your next question is from the line of John Glass of Morgan Stanley.

John Glass – Morgan Stanley

I had a question about international margins and they were weaker this quarter. Comp deceleration in international markets hasn’t been as pronounced as in the U.S. although the margin decline has been greater there. Why is that the case and how much of a savings that you’re applying, how much of that will go to help the international margins in particularly the closures there. Do you expect those to improve margins or do you not get the transfer of sales? Could you comment on how much decline of profitability has to do with foreign exchanges?

Howard Schultz

We had a disproportionate amount from our previous history of impairment charges hit that international segment. That had a more significant impact in the first quarter and so deflates those margins. Many of the stores that needed to be impaired are concurrently the stores that we are evaluating and looking at for closures.

The fixed structure in many international markets, particularly Europe, the cost structure is somewhat more fixed. As we lose sales, that de-leverage impact is even more significant. We did have some foreign exchange impact in the first quarter. It was not a significant number. For the full year, we think it’s a little more than $0.02 impact, but there was some modest amount of negative impact on our international segment in Q1.

Store closures, yes, we do expect that by virtue of closing these approximately 100 stores in the international segment. That’s similar to our experience when we closed many stores in Australia last year and as we are closing these U.S. under-performing stores, that will remove losses from the international segment on one hand and then also we expect that will bolster the performance in the rest of the portfolio and as a result improve performance.


Your next question is from the line of Matt Difrisco of Thomas Weisel Partners.

Matt Difrisco - Thomas Weisel Partners

Troy, I’m looking at the incremental $100 million that you’re labeling for 09, associated with the 300 incremental store closures. Can you give us a sense of more of an annual number, because that does seem a little bit low for 300, considering 600 is generating a much larger number it appears. Curious how much that will look on an annual basis and also as far as innovation, I know initially when you guys started to talk about the cost savings and the closures, we were looking for a little bit more of savings and there was always an inference that there was going to be a reinvestment into innovation and a lot of the December conference was focused on new products coming out. In this deteriorating environment, is there less of action towards innovation and maybe restraining some of that investment. Is there greater savings in there or is there still a sense of reinvesting?

Troy Alstead

I’ll take the discussion about the $100 million and then perhaps Cliff and Howard can address the innovation question. The additional $100 million of savings we announced today, which takes the total we expect in 2009 to $500 million. I’ll point out that the store closure component of that is really a smaller piece of that $100 million dollars and that’s because we expect over the balance of this year it will take time to close those stores. That $100 million is partially store closures, but it is also reduction of force that we have announced today and as we notice in the release a broad range of other initiatives across the business. On an annualized basis, I’m not ready to say what I think annualized in 2010 these benefits will be, but I will point out that of all the actions we’re taking, they carry into 2010 and we’ll annualize more significantly than what we’re benefiting from in 2009. That’s an important element of what we’re doing and so those store closures will absolutely carry into and have the most significant impact in 2010. \

Howard Schultz

With regard to innovation, and I think that’s a very appropriate question. In view of the environment we’re in and the issues that almost every business is facing, especially those in the retail business. I think it’s very prudent to maintain a healthy outlook towards the needs for innovation and balancing that out with the cost of it and when will we get returns. We’ve had a number of very important innovative initiatives that have been in the pipeline for quite some time and we’ve gone back and looked at those. We’ve taken those out that we believe are no relevant now and kind of doubled down on things we think are highly relevant for the environment and our ability to reignite the experience and reinvent what we do that is complimentary with core of coffee. I think in the coming days and weeks you’ll hear more about that, but I think we want to balance out the lens that we’re operating on right now is an acute understanding of the environment of cost containment. At the same time, the need for consumer facing initiatives that customers are going to respond to in this environment and things that we can own that really relate to the core of coffee.


Your final question is from the line of David Tarantino from Robert W. Baird.

David Tarantino - Robert W. Baird

Question on the store level of cost savings. Can you comment on how you and employees at the store level are feeling about achieving those savings, while also elevating the Starbucks experience at the same time. It seems like those objectives may be at odds. So anything you can offer there would be helpful.

Cliff Burrows

Just to say that we are very conscious of that balance between our financial objectives and indeed maintaining and improving the experience for both our people in the stores and indeed our customers. Some of what you’ve heard about the slowing of the introduction of innovation and simplifying of our promotional calendar all goes to help our store partners in terms of focus on the day-to-day activities in the store.

We are through lean practices developing ways to be more efficient in our stores and indeed reduce waste in the stores and we started the action in the final month of the year and we saw a good impact in terms of labor efficiencies and we continue to see that and we will see that accelerate through quarter two and into the balance of the year.

What we have also seen is a new bonus scheme for our partners where it’s focused on sales and we saw an increase proportion of partners benefit from that, because the bonus scheme focused purely on sales kicked in for many of our partners in a way it was not done before and that really has helped to increase the focus on both sales and improved experience for our customers. So we feel pretty good about it, but we are very conscious that it is a very fine balance.

JoAnn DeGrande

Thank you very much. That concludes the call for today. Thanks for joining us and we will speak with you again next quarter. Have a good afternoon.


This concludes today’s Starbucks Coffee Company conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!