Starbucks Corporation (NASDAQ:SBUX)
F3Q10 (Qtr End 06/30/10) Earnings Call
July 21, 2010 5:00 pm ET
JoAnn DeGrande – Investor Relations
Howard Schultz – Chairman of the Board, President & Chief Executive Officer
Troy Alstead – Chief Financial Officer, Executive Vice President & Chief Administrative Officer
John Culver – President Starbucks Coffee International
Jeff Hansberry – President of Consumer Products.
Clifford Burrows – President Starbucks Coffee US
John Glass – Morgan Stanley
David Palmer – UBS
Larry Miller – RBC
Sharon Zackfia – William Blair & Company, LLC
Keith Siegner – Credit Suisse
Michelle Gass - SBC
[Sarah Sinatory] – Sanford Bernstein
Joseph Buckley – Bank of America Merrill Lynch
John Ivankow – JP Morgan
Matthew Difrisco – Oppenheimer & Co.
Jeffery Bernstein – Barclays Capital
Good afternoon. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to Starbucks Coffee Company’s Third Quarter Fiscal Year 2010 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Mrs. DeGrande, you may begin your conference.
Thank you, Steve. Good afternoon Ladies and Gentlemen. This is JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company. Also on the call today from New York is Howard Schultz, Chairman, President and CEO. And with me here in Seattle is Troy Alstead, CFO.
Before we get started, I’d like to remind you that this conference call will contain forward-looking statements. Forward-looking statements are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements and should be considered in conjunction with cautionary statements in our Earnings Release and risk factor discussions in our files with the SEC, including our last Annual Report on Form 10K. Starbucks assumes no obligation to update any of these forward-looking statements or information. Please refer to the Investor Relations Section at Starbucks website at www.starbucks.com and in the Financial Statements of the Company and the Earnings Release were you’ll find disclosures and reconciliations of non-GAAP financial measures mentioned on the call today, along with our corresponding GAAP measures.
Now, before I turn the call over to Howard, I’d like to take this opportunity to make you aware of our Fiscal 2011 Biannual Analyst Conference, which will be held in December on the first, in New York. And more details will be coming soon, but we hope you’ll reserve that date on your calendar and join us there.
With that, Howard, I’m turning the call over to you.
Thank you, JoAnn. And welcome to all of you joining us today. I am very pleased with the strong Third Quarter Operating Performance and Financial Results that Starbucks announced today. Beyond simply reflecting a continuation of our past several quarter’s solid performance, the figures we released today are notable because they represent the highest Q3 operating margin and earnings per share in Starbucks history. And they demonstrate our ability to simultaneously drive and deliver solid growth, performance and profitability in our core business while investing in and bringing significant innovation to new and existing businesses.
The steady improvement in operating leverage inherent in our US and International Retail Busses are reflected in the record EPS and operating margins for the quarter. Our 9% increase in comp store sales driven by 6% growth in traffic in the US is our highest comp store growth since Q2 of 2006. And it represents the third consecutive quarter of positive comp sales growth in our US and International markets, reflective of both the health of our business and the relevancy and the importance to our customers.
Noteworthy is that the comp sales increase we saw in Q3 were accomplished in the face of continuing weakness and uncertainty in the global economy, and despite continuing very-soft consumer confidence metrics.
Our traffic growth takes on greater significance in the context of same-store-sales-trend data report by other domestic and multinational retailers.
In Q3, we invested heavily in new product innovation and in multiple significant brand in product launches. Troy will provide additional detail around these investments, but we designed and executed them in a way that we believe would enable us to simultaneously benefit and leverage both our retail and growing CPG business.
And while the investments did in fact provide tangible, quantifiable benefits to both businesses in Q3, a greater significance is that the Q3 investments will continue to pay dividends well into the future.
Consider however you want it, Customizable Frappuccino Campaign, for example. The campaign was an important contributor to our comp performance by driving retail traffic in the afternoon and evening day parts. And expanding the customer base by offering ingredient options such as soy milk and decaf coffee for customers wishing those options.
In fact, our Blended category contributed almost 2% to the overall 9% US comp this quarter. Beyond that, the campaign’s halo effect on the brand helped drive increased sales of Bottled Frappuccino across CPG channels for the first time in over two years. And beyond even that, it ignited significant consumer and retailer interest and excitement that continues to build around our $2 billion Frappunccino Brand platform overall; just as we had planned.
The success of our Customizable Frappuccino Campaign illustrates the power of Starbucks new business model. A unique model that will continue to enable us to innovate, cross promote, and leverage our global retail footprint on investment and prominence in social media and our growing global CPG business going forward.
Another major brand investment we made in Q3 was around the expansion of Starbucks VIA into grocery. In the Third Quarter, we launched VIA in grocery stores throughout the US to leverage the excitement and accelerating sales momentum from our retail launch. We also announced that VIA would be available in grocery in both the UK and Japan in Q4.
VIA is now projected to contribute over $100 million dollars to Starbucks’ top line in Fiscal 2010, a significant achievement by any measure.
To put VIA’s performance in perspective, consider that less than 3% of all new product generate over $50 million in the first year sales. VIA is performing like few consumer products ever have, and we are continuing to drive stead increases in VIA distribution, channel by channel, continent but continent, country by country.
On June 29th, we introduced our next VIA innovation, Ice VIA into all US and Canada stores and just last week into Japan. The early indications are that we have another fantastic product on our hands generating excitement and response from our partners and customers alike.
Once again, credit for our overall performance belongs to our partners around the world who continue to deliver and improve experience to our customers. Despite the demands of increased store traffic, every single customer metric showed improvement in Q3, continuing a trend that began in 2008.
To say that I’m incredibly proud of our partners and appreciative of their efforts is really a profound understatement. What I am is humbled by their unwaivering commitment to our customers, our values, our company and our business. And to all of our partners, I give them a huge thank you.
The continuing improvement in traffic and transaction metrics increasingly improved customer’s satisfaction feedback in operating efficiency. And transformative muscle we’ve build in front and back of store operations over the past 2 ½ years gives us confidence that we can accelerate our investments in innovation and new and existing business and generate disciplined-profitable growth around the world while at the time increasing our dividend and building long-term value for our shareholders.
Now, I’ll provide a recap of key initiatives for Starbucks Global Retail Business, CPG and Seattle’s Best Coffee. Then I’ll turn the call over to Troy who will go into Q3 financials in greater detail and provide an initial outlook for 2011.
Turning to the US business. The 9% US comp store increase we recorded in Q3 returned Starbucks store traffic to among the highest levels in our history. Strong top-line performance combined with efficient management of our supply chain, operational excellence and cost discipline throughout the organization enable us to deliver Q3 US operating margins of 15.6% and strong Q3 bottom-line profits.
The deep collection we’ve established with our customers continues to be reflected in the growing success of My Starbucks Rewards, a loyalty program that recognizes and rewards customers paying for their purchases with a registered Starbucks card. The program launched just over six months ago was created in response to our customer’s desire for value and recognition that built on their relationship with their store and their barista.
In Q3 our My Starbucks Rewards program drove significant incremental business for us, and in fact, was cited in a recent customer survey as a top reason for increased visitation versus six months earlier.
To give you some key performance metrics of the program, our customers are again on track to load over $1 billion dollars on Starbucks cards this year. Sales of cards are up 17% over last year, and the reload on existing cards was up over 59% compared to last year.
Now, almost 20% of all in-store transactions are now being paid for by using a Starbucks card. And in Q3, we surpassed $1 million gold-level members. The Starbucks Card and Reward Programs are powerful catalysts for customer loyalty and retention and will continue to enable us to leverage our scale, distinguish us with customers and further differentiate us from competitors going forward.
As you know, Starbucks has built the largest private wi-fi network in America. And on July 1st, we began offering customers free unlimited one-click wi-fi at company-operated stores in the US and Canada.
As we announced last month, this fall in partnership with Yahoo, we will leverage our wi-fi assets and launch our own proprietary Starbucks digital network; an online experience that will offer customers in our US company-operated stores unrestricted access to exclusive content and previews, a collection of select sites and services, free downloads and local community news. In addition to generating incremental revenue, the Starbucks Digital Network Provides us with the unique opportunity to drive traffic, further connect with our customers and distinguish Starbucks from competitors who simply offer commodity wi-fi access.
We are very excited about this new innovation and will provide you with additional details around the Starbucks Digital Network in future earnings calls.
Our research shows that both Starbucks and our customers are uniquely well suited to benefit from rapidly-advancing mobile payment and mobile gifting technologies.
In Q3, we took our initial step in offering these capabilities by launching a new mobile payment application, allowing customers at Starbucks stores in more than 1,000 target stores, and a small number of company-operated stores in Seattle and Silicon Valley to pay for their purchases with their Smartphones. We know believe that offering mobile payment and mobile gifting capabilities will result in a more efficient in-store experience, and provide us with significant competitive advantages, and further differentiate Starbucks from competitors. And based on early success and positive customer feedback, we are committed to expanding this program in the months ahead. So please stay tuned.
And we’re exploring new ways for customers to experience their neighborhood Starbucks as a late-afternoon and evening destination. In prior quarters, we’ve shared with you the efforts and insights gleamed from our innovative 15th Avenue Coffee and Tea Store and our Roy Street Store.
Last quarter we opened a fantastic new redesigned store on Spring St. in Soho, New York to really tremendous customer response. And in the fall we will be reopening our Olive Way Store in Seattle with an innovative new store environment and expanded menu of new premium food, and wine and beer. Changes we expect to drive more late-afternoon and evening customer traffic.
Turing to International. As I reported on our last calls, with our US business moving in the right direction, over the last several quarters the leadership team and I began increasing our focus on our International business. Our efforts have included working to increase our connection to international customers, incorporating greater local relevance into operations around the world, and perhaps most importantly applying the learning and operational rigor and discipline we developed for the US business to our international businesses.
I’m now pleased to report that the positive impact of these efforts is beginning to show up in a very good way. Our Q3 international business revenue was up 15% year over year. And our operating margins reached 10.3%, well ahead of the 2010 target we announced.
In addition, Q3 international comp store sales reached 6% driven by a 4% increase in traffic, representing the fourth consecutive quarter of positive traffic and all key markets showed improvement.
Our Third Quarter International Results are a testament to strong leadership that John Culver, our President of Starbucks International and his leadership team are providing our international markets, joint-venture partnerships and our store partners all over the world.
In the Third Quarter, we launched Starbucks VIA in Starbucks stores in Japan to an absolutely incredible reception that I witnessed firsthand. Let me put that in perspective for you, like sharing that two months into the retail launch of VIA in Japan we had far exceeded out internal sales targets for the entire year. VIA helped lift comps in Japan in positive territory and improved the trajectory of our retail business in Japan overall; providing further evidence of the success of our unique new business model that I described earlier.
With regard to China, we continue to deliver strong results in China as the team delivered double-digit comps for the quarter and are on track to maintain the momentum and deliver solid profitability this fiscal year. We continue to seek opportunities to deliver locally-relevant product offerings throughout our international markets and are seeing positive customer response for our localization efforts.
The creation of products like Black Sesame Green Tee Frappuccino and Black Bean Kiwi Tart are product innovations tailored for the Chinese pallet. And we introduce these in Q3 across all of our stores in China.
We have learned over the years that sensitivity and familiarity with the Chinese culture is critical in how we think about and execute all aspects of our business in China. And this learning has positioned us to grow our China business more aggressively, more successfully, and more profitably in the years to come.
Chinese consumers love Starbucks, and we see it every single day in our stores. And growing our presence and relevance in the Chinese market is a top priority for our organization and our leadership team.
Moving to Western Europe, we are seeing steady and sustained improvement in our company-owned UK, Germany and France markets. We are particularly excited about the positive comps in German and France, two countries where we are working to improve the business model. Each of these markets is confronting economic challenges and soft-consumer metrics, but our local teams are making great headway by developing new operating muscle.
John Culver is collaborating with Cliff Burrows, President of Starbucks US to make sure that the learning and the insights gleamed from the transformation in our US business is applied internationally.
For the end of Q3, we opened our first store in Hungary bring Starbucks to our 53 country around the world. As I previously mentioned, we continue to explore opportunities to enter India and Vietnam.
As we move forward on the International front, we will strike a smart balance between opening new markets and building depth, solid fundamentals and sustained profitability in our existing markets.
Turning to our Consumer Products Group. Starbucks CPG is a huge opportunity for our company. And in Q3 we continued to invest and bring innovation to the package and instant-coffee markets with multiple product, channel and market launches.
A year ago we announced our intent to reinvent and bring innovation to the $23 billion global instant coffee market. A market that had incredibly enough, not seen any innovation for over 50 years. A year later, early results in each of the four countries, and soon to be multiple channels in which we have launched has validated the correctives of that decision; the power of VIA and the opportunity that VIA represents.
By leveraging our unique global retail footprint to create awareness and encourage direct sampling and purchase, we have created a tailwind for the trade that has been validated and facilitated our entry into CPG channels. And once again, we are creating real growth and excitement around an important but stagnant global category.
But the early success of VIA says much more. It demonstrates that the power and the trust of the Starbucks brand coupled with our proprietary retail system enables us to influence consumer behavior and create use occasions without cannibalization; one cup at a time and around the world simultaneously.
We always expected VIA to be a big hit at the office and on the go, but what we have been surprised by and very excited is that recent research shows that VIA is gaining momentum in at-home use occasions as a more flavorful alternative to other single-serve options while requiring no equipment and with less waste.
VIA was designed and always intended to be a portfolio of instant coffee products. And innovating around VIA and expanding the product line beyond the original Columbia and Italian skews, and into new channels will remain priorities for us. Decaf VIA and VIA Ice represent the very beginning of the VIA innovation pipeline. Rapid innovation will provide opportunities to further increase awareness and trial of VIA and broaden our VIA customer base.
Incredibly enough, VIA is now available in over 37,000 points of distribution, as we told you on the last call it would be. And we plan to expand VIA into grocery in Japan and Canada as I’ve already stated.
We are confident that VIA’s already strong sales philosophy will accelerate as distribution moves more broadly into the channel and the VIA product line becomes even more assessable to customer over the coming months.
Q3 also saw us introduce Fusions Natural Flavored Coffee into our CPG package coffee business and the premium coffee category overall continuing the trend we highlighted last quarter.
In May, we appointed Jeff Hansberry to head up this business as President Starbucks Global Consumer Products Group and Food Service.
Jeff comes to use with more than 20 years of deep global-consumer products experience, first with Proctor and Gamble, and more recently with the Gala Winery where he lead the transformation of Gala’s Asia business and most recently led Gala’s flagship popular business unit to record share gaines. Jeff brings the expertise and leadership Starbucks needs to move our CPG business into high gear and introduce our brands and products into new and existing customer product markets around the world.
Jeff will be reporting directly to me, and I’m delighted to welcome him onto our team.
Finally, the ability to combine the power of our brand, our global retail footprint and our connection to consumers all around the world, both in store and through social media, in order to build and accelerate sales through CPG channels is muscle that is unique to Starbucks and muscle that we will increasingly leverage going forward. We believe that this unique power and the benefits of the investments we made this quarter will become increasingly evident in the months and quarter ahead. As an example, we view Seattle’s Best Coffee as a billion-dollar growth opportunity.
Until recently, a customer could get a cup of freshly-brewed Seattle’s Best Coffee in only about 3,000 venues. But the end of this fiscal year, we will increase that tenfold and have Seattle’s best coffee available in 30,000 points of distribution. We’re just scratching the surface on the opportunity for SBC to grow distribution and reach new customers.
This quarter we made significant investments in Seattle’s Best brand. In May, Michelle Gass, President of Seattle’s Best unveiled a new brand direction and identity to the company. The new brand identity will play a key role in the strategy to make high-quality premium coffee far more assessable than ever before. The new brand transformation is being fueled by significant high-profile relationships, including Subway, which has completed its network-wide rollout, AMC Theaters, which is in the middle of launching across nearly 300 locations, and Burger King began rolling out our coffee earlier this month on the West Coast. Burger King will also distribute SBC in Canada. We’re excited to announce the extension of our partnership just this month.
And we are expanding our footprint into grocery with a more focused sell into the CPG channel. While it’s early days for our efforts to transform Seattle’s Best, our focus and intensity have never been greater and we look forward to strong continuing momentum.
In conclusion, Starbucks has been recognized by many as the number one brand in social media and as the first brand on Facebook to exceed 10 million fans. And in Q3, we invested further in building global awareness of our brand and our brand values, and in connecting with our customers around the world on issues that matter most to them. Let me share one example.
On April 15th, we initiated a global effort to encourage our customers to trade their paper cups in for an eco-friendly option by rewarding them with the complimentary cup of brewed coffee. The strong positive reaction from customers all around the world that this effort generated was reflected in both increased transactions and enhanced brand [inaudible] metrics.
The learning from and the success of our efforts to scale local efforts and make them relevant globally is a muscle that we will continue to develop and refine, and will become more apparent as we approach many of the initiatives around Starbucks 40th Anniversary Celebration next spring.
I want to close my remarks by stating once again how pleased I am with the strength of our overall business and the progress that we are making. The lessons and learning of the past several years continues to guide the entire Starbucks organization every single day. And I personally want to thank all of our partners, customers and shareholders for their belief in eh company and for the part each has played in bringing Starbucks were we are around the world today.
Now, I’ll turn the call over to Troy, who will go through Q3 results in more detail and share our targets for Fiscal 2011.
Thanks, Howard. And good afternoon everyone. As Howard indicated, this quarter’s performance was exceptional on many fronts, and particularly, we were about to generate strong traffic growth in both our US and International segments. Despite a still uncertain environment for many retailers, US traffic grow accelerated from last quarter further illustrating that the steps we’ve taken and continue to take to enhance the store experience are resonating with our customers.
Additionally, this quarter or international segment set a record for quarter operating income and reached double-digit operating margins, a threshold we did not expect to reach until Fiscal 2011. We also recorded the highest third quarter consolidated operating margin and the highest third quarter earnings in the company’s 39-year history.
We achieved this record performance even while making significant investments back into the business to support future growth.
Today I will provide additional details on our Fiscal Third Quarter Results including those investments. Then I will update you on our expectations for the fourth quarter as well as our initial outlook for Fiscal 2011.
Third Quarter Revenues were $2.6 billion dollars, up 9% from $2.5 billion a year ago. The revenue increase was primarily driven by a 6% increase in comparable store sales, attributable to a 6% increase in traffic and a 3% increase in the average value per transaction.
Both the overall comp and traffic growth were the strongest we’ve seen in more than four years. We reported consolidated operating income of $328 million in the third quarter, including $20 million of restructuring charges.
Most of the restructuring charges were related to stores that were previously closed in the US which Starbucks has been unable to terminate the lease or find subtenants for the unused space because of the continued softness in the commercial real estate market, which has made it more difficult than originally anticipated to sublease these spaces. Changes in assumptions underlying the lease accruals have impacted the expense that must be recognized. Lease exit and other costs associated with store closures in our International segment also contributed to the restructuring charges.
Excluding those charges, non-GAAP operating income was $348 million. This compares to Third Quarter Fiscal 2009 Operating Income of $204 million and non-GAAP operating income of $256 million.
Consolidated Operating Margin was 12.5% on a GAAP basis, and 13. 3 percent on a non-GAAP basis, which represented a 270 basis point improvement compared to last year.
In line with recent quarters, comparable store sales growth combined with operational improvements are creating powerful flow through to operating income.
As I noted earlier, the margin improvement this quarter was achieved while making significant investments back into the business to support future growth. In particular, and in line with our outlook last quarter, we invested roughly $0.04 per share in incremental marketing compared to last year to support the launch of VIA into the US CPG channel as well as the introduction of our new Customizable Frappuccino product in our North American Retail Stores.
Earnings per share was $0.27 for the third quarter compared to $.02 per share in last year’s Fiscal Third quarter. Non-GAAP EPS was $0.29 compared to non-GAAP EPS of $0.24 a year ago.
I will now review the non-GAAP results from our Operating Segments beginning with the US Business. Total US net revenues for the quarter were $1.9 billion, a 7% increase from a year ago. Company Operated US Retail Revenues increased 7% to $1.7 billion for the quarter, primarily due to a 9% increase in comp sales offset in part by a reduction in the number of stores.
The comp increase was driven by a 6% increase in traffic and a 3% increase in the average value per transaction. The 6% increase in transactions was the second straight quarter with positive year-over-year traffic accelerating from a 3% increase in the second quarter. It also marks the first time in almost three years that the US Business has had positive traffic growth over a two-year comp period.
In a still difficult environment for many retailers, this performance speaks to the resiliency of our business and the success we’ve had in upgrading the customer experience in our stores. Innovative products and store designs, additional marking support, and our loyalty program are among the factors contributing to the increase in customer visits.
We are very pleased with the successful mid-quarter launch of our customizable frappuccinos, which contributed roughly 2 points to the overall 9% comp growth for the quarter. Considering the decline we have seen in the blended beverage category in recent years, the reestablishment of growth this quarter is promising. We hope to continue this trend as we know offer something our competitors cannot; a high-quality blended beverage that is fully customizable.
My Starbucks Rewards, our new loyalty program launched six months ago has been extremely successful. Card loads, redemptions and percent of tender are all up significantly over last year, and customer feedback has been overwhelmingly positive. Perhaps most significant, we estimate that the new program drove between 1 and 2 points of the comp growth for the quarter net of discounts.
But with respect to the increase of average value per transaction, the pricing architecture work we started in the Fiscal Fourth Quarter of last year contributed roughly half of the 3% ticket growth. With most of the remaining increase coming from mix shift to the new customized frappuccinos, VIA and the continue rollout of our warming program.
US Cost of Sales, including occupancy was 38.1% of total revenues in the Third Quarter. It’s significant improve of 260 basis points compared to the year-ago period. Most of the improvement was the result of sales leverage, lower food costs from our redesigned food program, and other supply-chain efficiencies.
US Store Operating Expenses were 38.2% of total revenues, a 50-basis point improvement over last year. Sales Leverage and lower impairment in the current quarter compared to last year were the primary reasons for the improvement. These were particularly offset by additional marketing expenses to support the customizable frappuccino launch, which accounts for roughly half of the $0.04 of incremental marketing I noted earlier.
The continued application of lean principles and our store labor deployment has provided us with better leverage in our operating model. They are also contributing to record levels of customer satisfaction in our stores. Aspects of satisfaction, such as speed of service and taste of beverage has benefited significantly from the work routines we’ve developed and continue to refine for our store partners.
In addition, other current initiatives underway, such as a new point-of-sale system and a new inventory management system will impact the way our store partners operate and will allow them to focus more time on providing great service to our customers.
US Operating Income was $308 million to the quarter, a 36% increase compared to last year. The operating margin improved 350 basis points to 16.5 percent of related revenues from 13.0% a year ago. This operating margin improvement is mostly attributable to the additional sales leverage created as a result of the work we’ve done to become more efficient.
The US segment is a healthy high-profitable business with room for discipline growth. It also provides the foundation from which we will fund growth opportunities in other channels and other geographies, which brings me to the results or our International Segment.
International total net revenue has increased 15% to $551 million in the Third Quarter of Fiscal 2010, driven by comparable store sales growth of 6%, the acquisition of the France market at the beginning of the Fiscal Year, and favorable foreign currency translation. The comp growth was driven by a 4% increase in traffic and a 2% increase in the average value per transaction.
Broad-based strength across all of our company operated markets contributed to the comp growth, with Canada, the UK and China leading the way. In total, our Company-Operated Markets are profitable and the trends are improving.
Also, while it does not show up in the comp number, we saw strong top-line performance across most of the portfolio of license markets. The encouraging results across all regions are evidence of the relevancy of the Starbucks brand and reinforced the opportunity that exists outside of the US.
International Operating Income was $60 million in the Third Quarter of Fiscal 2010, a 55% increase compared to last year, and as I noted earlier, a quarterly record for International.
Operating Margin improved by 280 basis points to 10.9%, reaching double-digits two quarters ahead of our stated goal for Fiscal 2011; key drivers of the margin were improvement in sales leverage and supply-chain efficiencies.
We continue to make significant progress towards our vision and China will eventually be our largest market outside of the US. Comp trends are in the double digits and store profit contribution is among the highest in the system.
In terms of reasonable profitability, we are at a point where we expect Greater China to progressively become a significant contributor to the operating income of the International segment with the contribution in Fiscal 2010 projected to be roughly double the contribution in Fiscal 2009. All this is well for the future and reaffirms out belief in the China opportunity and the strength of the Starbucks brand in that region.
The International Segment is one of the key growth engines for Starbucks. Infinity for the Starbucks brand is high as evidenced by the continued top-line strength we see across most of our markets.
There is still a tremendous amount of work to do in order to fully capitalize on the global opportunity, and the complexities vary by region and by market.
However, with increased management attention, encouraging progress recently, and a multi-channel expansion strategy in key markets, we believe we’re on track to reach our longer-term goal of mid-to-high teens operating margins, while at the same time, significantly expanding the reach of the business.
I’ll now move on to the results from the Global Consumer Products Group.
CPG total net revenues increased 8% to $198 million in the Third Quarter of Fiscal 2010, primarily driven by the launch of VIA, increased sales into the packaged coffee channel, and Seattle’s Best Food Service Sales.
Operating income for the segment decreased 9% to $60 million for the quarter and operating margin decreased 550 basis points to 30.4%. The margin decrease was primarily due to increased marketing incentives for VIA and for packaged coffee, partially offset by strength in our Bottled Frappuccino Business.
The launch of VIA this quarter into the CPG channel follows a successful launch at the beginning of the fiscal year into our North American Retail Stores; much of the benefit from the additional marketing investment, roughly half of the $0.04 noted earlier should materialize in future periods as we are currently establishing the product in a channel by driving distribution, placement, awareness and trial.
Despite having limited distribution in the CPG channel for most of the fiscal year, we’re projecting to surpass $100 million in sales across all channels for this first year. The early success from this platform is encouraging and reinforces our belief that VIA will eventually be part of our portfolio of billion-dollar brands.
The increased marketing for packaged coffee seems to be paying dividends as Starbucks gained 180 basis points of market share in the third quarter compared to the year-ago period. This continues a trend we started to see in February and March, which were the first months that we experienced year-over-year market share gains in almost three years.
The Bottled Frappuccino Business benefited this quarter from increased marketing expenditures related to the customizable frappuccino launch in our store channel. This halo affect exhibits the power behind a consistent brand message across channels, something we’ve not done on a regular basis in the past, but that is now part of how we leverage our size and diverse reach.
The investments we made into the CPG segment this quarter and the resulting margin compression are in line with the outlook we provided on last quarter’s earnings call. These investments are necessary to support the future growth of the highly profitable business as we continue to build on our coffee leadership down the grocery aisle.
Starbucks continues to generate significant free cash flow as a result of the health of our business model. As a means of returning some of this cash back to shareholders, last quarter we paid the first dividend in the company’s 39-year history, initiated at a quarterly rate of $0.10 per share and with the targeted payout ratio of 35 to 40%.
Today we announced a 30% dividend increase to $0.13 a share, payable in August. In addition, we repurchased 6.7 million shares of Starbucks stock during the Third Quarter, leaving approximately 14 million shares still available for purchase under the current authorization.
The increase in the dividend after only one quarter is a strong signal that the Board has confidence in the financial performance of the company and the amount of cash that we generate beyond which is needed to fund the many opportunities that lie ahead.
We view both the dividend and the share repurchase program as part of a broad approach to generating strong shareholder returns.
We entered Fiscal 2010 cautiously optimistic based on the trends we were staring to see in our business, but acutely aware of the tenuous external environment. As the year has progressed, the momentum of the business surpassed our expectations driven by stronger traffic into our stores.
Now with a return to growth, and with 3/4s of the fiscal year behind us, I would like to provide you with an updated outlook on how we expect the year to close out.
Earnings per share is now expected to be in the range of $1.22 to $1.23, slightly above the range I provided last quarter. This estimate includes approximately $0.05 from the addition of a 53rd week, which will hit in the Fourth Quarter, and excludes roughly $0.04 cents for restructuring charges.
In addition to the earnings outlook, we expect mid single-digit revenue in comp growth for both the Fourth Quarter and the full year on a 52-week basis. For your non-GAAP operating margins for both the US and International Segments are now expected to finish near the high end of the ranges I provided last quarter, which are 15 to 17% for the US, and 8 to 10% for International.
Operating margins for the CPG Segment are still expected to finish near 35% for the year. The result is an expected non-GAAP consolidated operating margin near the high end of the 12 to 13% range previously communicated.
The operating margin outlook includes approximately $.02 of incremental marketing in the fourth quarter compared to Fiscal 2009. Most of this increase is to support the expansion of VIA in the CPG channel.
Also higher dairy costs are expected to impact Fourth Quarter Earnings by approximately $.01.
We now expect to add roughly 250 net new stores this year. And the capital expenditures are now expected to come in at roughly $450 million for the year.
I will now provide you with a high-level initial look at several Fiscal 2011 targets. As a reminder, we are still early in our fourth fiscal quarter of 2010. And we’re still working through our plans for 2011. That work will better inform us on many of the underlying details for the year, which may allow us to share more information on next quarter’s earnings call.
We expect mid-to-high level single-digit revenue growth for the year driven by low-to-mid single-digit comp growth. Our comp trends have improved dramatically throughout this fiscal year driven in part by the actions we’ve taken to improve the customer experience, and also by perhaps a slightly better economic environment.
As we move into Fiscal 2011, we expect these trends to moderate as the comparisons become more difficult. Also while the external environment may be slightly better than a year ago, we still recognize the challengers that exist in the current economy with high unemployment, a questionable housing market, and unstable consumer confidence.
We plan to add approximately 500 net new stores globally with roughly 100 in the U.S. and 400 in the International. The majority of the new additions in both segments are expected to be licensed stores.
We expect capital expenditures to be approximately $500 million to $550 million for Fiscal 2011. Full year non-GAAP operating margin improvement is expected to be 100 to 150 basis points in the U.S. Segment, and 100 to 200 basis points in the International Segment.
CPG operating margins are expected to be in the range of 30 to 35%, slightly lower than this year, primarily different by increased investment to support the ongoing VIA rollout.
Consolidated operating margin is expected to improve by 50 to 100 basis points over 2010. We expect Fiscal 2011 earnings per share to be $1.36 to $1.41, or 15 to 20% growth on Fiscal 2010 non-GAAP earnings per share excluding the benefit in 2010 from the 53rd week.
We do not anticipate any restructuring charges in Fiscal 2011 as the previously-announced store closure program will largely be completed by the end of Fiscal 2010. Any remaining costs beyond 2010 associated with this program will fall into continuing operations.
I’d like to highlight a few items that are embedded in our earnings targets. First, VIA is expected to contribute modestly to Fiscal 2011 earnings as we continue to build this important growth opportunity. We will continue to innovate on this platform and add points of distribution while investing in marketing in the infrastructure to support the business.
Next, we expect to absorb approximately $0.04 in additional commodity costs for Fiscal 2011, primarily related to higher coffee prices. Recent supply issues in the Latin American growing region have caused C market prices for Arabica coffees to increase. While the prices we pay for coffee do not move in tandem with the C market due to many variables including the timing of our purchases, significant long-term movements in the market do influence our cost over time.
According to various industry sources, including the International Coffee Organization, global coffee output is expect to rise next year led by gains in Brazil. It is believed that these increases in output should mostly offset current shortages putting downward pressure on prices longer term. However, the current price inflation does pressure a portion of our supply for Fiscal 2011, which is reflected in the estimated $0.04 per share impact.
Lastly, in terms of marketing, we expect to spend at roughly the same rate as Fiscal 2010, which approximately 2.5% of total net revenues. It is worth noting that the level of marketing spent in past years has been much lower, including 1.7% in Fiscal 2009. These run rates include marketing expenses that we record directly, such as those that are in our store channel, plus marketing expenses that are recorded indirectly through shared profit models such as our package coffee business.
We believe the increased level of marketing this year has helped drive incremental business. And we will continue to invest in this area.
Our one-voice approach to communicating at consistent message across multiple channels allows us to leverage our size and diverse business model to drive grand awareness.
In closing, the third quarter continued to build on the momentum we have had in the business for well over a year. This quarter is a powerful demonstration of our ability to produce record earnings and record operating margins while also making record levels of investment in the future growth opportunities.
In the US, customer satisfaction is at all-time high. Traffic growth is robust, and the store portfolio is healthy. We have elevated store experience to a place the other large competitors cannot duplicate.
Internationally, the business has progressed to what we expect will be sustainable double-digit operating margins earlier than expected as we roll out key learnings from the US and start to gain traction from their success. We are expanding that business in a focused-disciplined manner as we see the enormous long-term opportunity and understand that we must execute well in order to fully capitalize on its potential.
Outside the store channel, we are aggressively diversifying our business and pursuing a greater share of coffee consumption by taking our great products to consumers in more places than ever before.
We are backed by a solid balance sheet and strong cash flow, an experienced management team, and a powerful highly-relevant brand. We believe that we now play from a position of strength. And we have a unique opportunity to build the kind of company that has not existed before, one that coalesces the powerful combination of a large retail footprint, a significant consumer products presence, and a highly engaged customer base.
With that, now let me turn the call back over the operator who will be begin Q and A. Steve.
(Operator Instructions) First question comes from John Glass with Morgan Stanley. Your line is now open.
John Glass – Morgan Stanley
All right, thank you. My question relates to both your international margin goals over the next couple years and unit growth. Can you, Troy, or can you get to those mid-to-high-teen operating margins that you expect internationally simply by doing some of the things you’re doing now, which is to say improving the operations of international, or does it require – how much of it is required in scaling those markets. That’s number one.
And when do you think you will start developing company store units again internationally? Is there a margin threshold you’d like to see first before doing that, or is there some other gaiting factor to international company development?
Let me speak first to the operating margin internationally. And over time, we expect to grow toward that long term targets we talked about, mid-to-high-teens internationally by virtue of a few things.
One is what we spoke about this quarter. And we really began to see the benefit of this quarter, which is applying many of the same lessons within the four walls that we brought to bear in the US in the past year or two, and bringing those to bear outside of the US; lean initiatives, innovation within the store, improving customer satisfaction, the loyalty program. A number of things that have been so successful for us here are extremely relevant in many markets outside of the US We’re seeing the benefit of that now, and we’ll continue to apply those in the years ahead to be part of that march toward the mid-to-upper teens.
We also expect to add stores and add revenues. And scale will help us both develop a consumer proposition and strengthen the brand exposure that we have in these markets around the world. And it will also provide scale and leverage on our GNA structure that we have outside of the US, which is clearly built now and invested ahead of the curve for the larger business that we see in our future.
So it’s really those same number of things along with, you know, innovation in the business and expansion outside of our store internationally in the CPG channels just as we’ve done in the US. It’s all those things together that will help us really drive our scale, our reach, and our operating margin targets outside of the U.S.
And your second question?
John Glass – Morgan Stanley
It was about company owned stores, Troy, your plans for company owned store internationally.
We have always had a shared ownership model outside of the US. As you know, we’re roughly – 70% percent of our stores are licensed. The rest approximately are company operated. And over time, I would expect that same ratio to apply.
We will invest and build in deep markets were we can bring to bear the capabilities that we have. Places like Canada and the UK, as an example, and then we will license other markets where we are able to significantly take advantage of very strong local operating partners who bring their capabilities to the table to help us grow the business locally.
So I would expect us to grow in a similar ratio over time. Not particularly in any one quarter, but over the longer run, I would think that we will operate in a mixed-model outside of the US.
In China, a market that you’ve heard us talk a great deal about and we’re very excited about, we have a mixed structure in China as well where we operate an owned model that we are very pleased with and we’re seeing great unit economics from. And we have licensed and JV markets for part of that country, which really allows us the best of both, leveraging each others capabilities and also making sure that we can drive the brand, drive the business, and enjoy the profitability that we see in the future.
And I might add before the next question just one correction perhaps from my comments earlier. The revenue increase for the company was driven by a 9% increase in comparable store sales in the quarter, which is driven by a 6% increase in traffic. I perhaps misspoke by saying 6% comp growth, but it was a 9% comp growth in the quarter.
Your next question comes from the line of David Palmer with the UBS. Your line is now open.
David Palmer – UBS
Thank you guys. One question on VIA. Fiscal 3Q, you can correct me if I’m wrong, was the inventory load in quarter for VIA, or substantially all of the retail channel. So we would expected to see more of a spike in CPG revenue growth and then perhaps a dip down in revenue in the coming quarters after, of course, you had that load in quarter. But perhaps there’s something we’re not seeing, such as slotting fees, other promotion payments that are effectively more one time in nature that were an offset to net revenue in that quarter. So how should we think about that VIA in the coming quarters in the contribution to profit and revenue? Thanks.
Yes, I’ll take that. In the quarter, VIA distribution was building as we went throughout the quarter and will continue to build as we move through Q4 and for some time. So it’s definitely not a case where we launch and we’re immediately at the levels of distribution that we will be at maturity, or that we even will be in three months from now, or six months from now.
So as we move throughout the quarter, we built distribution. And that’s why the load end of the pipeline, and the revenues you see, and the impact on the CPG business was not perhaps as big in the third quarter as you might have expected, but rest assured, the roll out continues. Distribution will build as we move into the fourth quarter. We very pleased by the velocity gains that we’re seeing in our key customers. So as we build distribution, as we drive velocity, all those things lead us to be as optimistic about VIA as you’ve heard us speak to.
Troy, maybe either Annie or Jeff can just talk about the issue of recess and how that affected the rollout of VIA nationally.
Yes, let’s have Jeff Hansberry, as Howard introduced him, our new president of consumer products is here to respond to them.
Thank you. So relative to the CPG business in the U.S. food, drug, mass, we introduced the VIA brand off timing versus a lot of recess with our major retailers. So our distribution build continues week after week, month after month, and you’ll continue to see it build throughout the fourth quarter of this year.
Your next question comes from the line of Larry Miller with RBC. Your line is now open.
Larry Miller – RBC
Yeah, thanks. I was wondering if you could update us your healthier product initiatives. As you guys know, in March of next year, there’s going to be a national menu labeling event. And I was just wondering if you could give us the sense of what you have on tap there if you could.
Okay, Cliff, you want to take that please?
Yeah, hi. We’ve continued to focus on the quality of our food program and introducing healthier options be it beverage or be it food. We have had a great reaction from certainly our most loyal customers have responded well because with our digital channels now, we’re able to get immediate reaction. We’ve used things like free pastry days to introduce those products to a wider audience, and so we’ve seen it grow. And there’s definitely a trend towards healthier products.
To do a calorie introduction both again on the menu boards, we have seen a great dialogue, which ultimately has led to a much more informed choice. We haven’t seen it materially change the overall numbers of the store, but we have seen people welcoming the choice we’re giving them, and the informed choice they’re making.
And I think one of the exciting developments is the customized frappuccino. For a very long time, we have been restricted in the options and we have been unable to offer the customization that people have enjoyed in the hot beverages.
And in recent, really in the last quarter, we have seen this introduction where we’ve been able to introduce no-fat options on the milk, and also soy options, which has extended the reach of our products to new audiences, or to people with specific dietary requirements.
So we see this as very relevant for our customers and we will continue to support it going forward.
Your next question comes from the line of Sharon Zackfia with William Blair. Your line is now open.
Sharon Zackfia – William Blair & Company, LLC
Hi, good afternoon. I was hoping perhaps you could touch the remodeling program. I think you had talked about that a little bit in the US last quarter, and what the plans are for that.
And then separately, I guess follow in on John’s question. Could you specifically address China? It would seem like a very attractive market for you, and how quickly you can that, and the opportunity for company owned stores in that market.
Okay, Cliff, let me just frame the issue about remodels, and I’ll give it back to you. Is that okay?
Sharon, I think the headline that I’d like to just start out with is that over the course of the past year, as you know, we’ve opened a number of stores domestically and around the world that are consistent with the array of new pallets that we’ve established. Some of whom you might have seen in Seoul, is a great example of that.
But from Japan, to Hong Kong, to Paris Disney, and the US, and now in the UK, we’ve opened up these new stores. And every single one of them have been met with great enthusiasm from customers.
We then took the elements of those new stores and Arthur Rubenfeld and his team along with Cliff and his operations team are incorporating the elements of that new design into all remodels. And we will remodel more stores obviously than we open next year.
But Cliff, if you can talk about it in specificity with the numbers, and also the results that we’re seeing from some of the things that have gone on already.
Thanks, Howard, and thanks Sharon.
Howard is absolutely right in terms of learning from some of the work we’ve done here in Seattle. I think one of the most significant changes was the one highlighted earlier, which is Spring Street in Soho where we really have transformed the environment in that store. And we’ve invested for the long term. It is now a location to be incredibly proud of. It is very relevant for its environment in downtown Soho.
And also, we are seeing improved sales from both our ability to sell customers more quickly and extend the range of products, be they food, in that case with an access to self serve, and terms of the range products with the introduction of Clover into that store. And all of those elements have helped to, I think, reestablish our relevance in the New York market, and we have seen growth well above 9% in the quarter.
We are touching some stores in a major way, and those are generally on ten- year renovations. And we are being strategic in the market that we are going after more aggressively. And in some cases, we’re accelerating those renovations.
The strategic cities are quite obvious. They are the larger metropolitan areas of the US and I would include New York, San Francisco, L.A. in that. And as we go forward into 2011, we’ll continue that.
And we are talking – we have touched approximately 100 stores in 2010, and roughly half of those in some significant way and half of those in a minor way. And we are using the pallets that have been developed. We are also using relevant local materials, and we’re focused on our lead certified for all the stores in major renovations, or indeed with new openings, to make those stores applicable for all our ambitions around the environment.
So very pleased with investments we made. We continue to learn and evolve, and we will see ourselves doing about the same number of renovations as we go forward in 2011.
Sharon, I just want to add one thing. And that is, we’ve established very strict financial disciplines in terms of the ROI on new stores. We’ve had a very good year this fiscal year. And we’re applying that same discipline to the remodels that Cliff alluded to.
Just if I need to correct, it is 1,000 stores that we will touch in the US in 2011.
And then Sharon, to the last part of your question about China, China has among our highest unit economics of anywhere in the world; great growing brand in the market, excellent return on investment at the store level. So we have a tremendous appetite to grow in that market both in terms of growing our company-owned markets, and we have company owned businesses throughout much of China. And also working with our joint venture partners to accelerate the pace of their growth in the markets. So you’ll see us growing both company owned and likely JV markets as we continue here in China.
The next question comes from Matt Difrisco with Oppenheimer. Your line is now open.
Matthew Difrisco – Oppenheimer & Co.
Thank you. I just have one clarification, then a question. Just as far as I want to understand your commodity cost outlook primarily to coffee, should we assume you’re looking at today’s prices holding steady and not as though you lock those in, but if there’s any sort of easement, there would be a change. Or that’s sort of a moving number, and you’re just taking today’s levels.
And then my question also is more with respect to follow on to David’s with regards to the rollout of VIA into the non-Starbucks retail stores, but in the grocery. Can you provide some milestones where you think full penetration sort of mirroring the number of outlets that you have whole bean available? And when will we see sort of approaching numbers close to a lot of overlap with your whole bean point of distribution and hitting mass grocery?
If I look at that 37,000 number, I’m still assuming that’s obviously more than half of those. Well, maybe at least more than a third of those are Starbucks stores on a global basis. So I just was curious where wiping out your store base of company owned, where you stand as far as the grocery distribution now at the end of the year, and maybe at the end of ’11.
Troy, why don’t you take the commodity costs and we’ll give Jeff the VIA question.
Yes, I’ll do that. Matt, on coffee prices, no, you should not assume that we’re just looking at today’s commodity price and extending it forward. We are basing our projections in the $0.04 per share impact in ’11 that I mentioned is based on what we understand of our coffee needs, our buying, the holes in the inventory that we need to fill as we progress throughout the year, and what we see coming in prices. So it’s based on that. It’s not as simple as taking today’s price and extending it forward. So there is some room for that to change and go as we go through the year.
And I think one point I’d make is that we have always maintained a fairly flexible buying pattern with coffee that allows us to be in the market when we need to and with price to the fix contracts, fix them at various times. And so we’ll also use how far out we go, and when we fix prices to afford us as much flexibility was we can as we approach the year.
Jeff, do you want to address the VIA question about distribution?
Yes. Well, specifically on VIA, if you break apart the 37,000 points of distribution today, 25,000 of those points to distribution are food drug mass in the US. And as we approach the end of our fiscal year, we should approach 30,000 points of distribution. And I would expect that we will get to going at the end of Fiscal ’11 approaching 35,000 outlets.
If you take a look at our roast and ground business, today on an ACV basis, we’re at about 92% of the ACV of US food drug mass. I would expect by the end of ‘011, we would be at that same kind of level at about 35,000 outlets across food drug mass and also club.
Your next question comes from the line of Keith Siegner with Credit Suisse. Your line is now open.
Keith Siegner – Credit Suisse
Thank you. Just a quick question on SBC. So we’ve reached 30,000 points of distribution. We’re going to gain Taco Bell units next year. Beyond that, how much more opportunity do you see? Is there a C store opportunity? Is there a greater package, good opportunity through a single-serve option there? If you could give us a sense of the incremental opportunity beyond what we’ve already reached for SBC that would be great.
I think Michelle Gass, the president of SBC is in the room, so Michelle
Yes, hi, Keith. Thanks for the question.
We absolutely see tremendous potential with the SBC brand in all the channels that you just cited.
Just to clarify, we are in fact in a test with Taco Bell. That has not been committed as of yet, but we’re highly encouraged by the results we’re seeing. With that said, you know, the key strategy for Seattle’s Best is about making premium coffees far more accessible than it ever has been. And so we look forward to expanding in multiple points of distribution in C stores as you mentioned, in family casual dining, QSR that we’ve been talking about, and certainly a reinvention down the aisle.
Michelle, can you frame how many points of distribution there are out there that potentially is applicable? I’m not saying we would get those accounts, but the total number accessible to SBC.
Yes. If you frame the entire market across channels, just taking dining and C store for example, there are hundreds of thousands of points of distribution where coffee is being served today in a range of premium states, I’ll say, from commodities to premium. And we see many of those points accessible for the future of Seattle’s Best.
So I want to make a clarification, or just make it clear, that we are going to extend SBC to ubiquitous points of distribution that the Starbucks brand has never lived in, and obviously is not compatible with. And there lies the opportunity to place SBC in places that we previously could not with the Starbucks brand.
And Howard, I’ll add just one final build. If you take the brewed coffee category in the US alone, Starbucks today commands just 4% of that market. So there’s clearly a lot of room for both of these brands to be highly complementary in the coffee category.
Your next question comes from the line of Sarah Sinatory from Sanford Bernstein. Your line is now open.
Sarah Sinatory – Sanford Bernstein
Okay, thank you. I wanted to ask also about the CPG business because I think, and maybe this has changed, at one point I thought that there was a view that maybe that I could grow, you know, at an analyzed pace closer to the mid teens. So I want to say first of all, is that the case, like a longer term view? And if so, what kind of drivers are there? What does that imply about the returns on the advertising you spend – you’re making now? Because I know across the business, you’ve put some very impressive top line, but we’re seeing a lot of reinvestments. So I guess I’m just trying to try to gauge what kind of growth, where it would come from, and what the ramp would look like.
And as a related question, VIA I think contributed a little bit less to comps this quarter than it has in the past couple quarters, so is that, is there sort of a natural fade to adaption? Or is there, is that just because now you have it in a lot more places of distribution?
Sarah, I’ll respond to that. First on the VIA question on comps, no, it was actually pretty close to a similar contribution to the total comp number this quarter as it had been in previous quarters. So very comparable, very similar kind of impact. What we’re seeing with VIA is just a very sustained result in our stores even as we’ve expanded distribution and as we’ve built that business out.
So we would expect that to continue. And that’s not going to be different this quarter from previous quarters.
And then in terms of CPG long term, we’ve not put out there long-term growth targets. But what we have said very clearly and still are very optimistic and confident in is that over the long run, we would expect CPG to grow more rapidly than our businesses in the store. That’s not necessarily what would happen in Q3 or Q4 of this year. But over the long run as we build out our capabilities in this space, as we expand things like VIA, as we continue to innovate down the aisle, as we go back and support our long-standing package coffee business down the aisle by investing against it, and innovating against it, we would expect over time CPG to become a more significant contributor to the revenue mix and the operating income mix in the company.
So we do expect that to build, but I would just suggest that that’s a build that happens over a period of them, not quickly overnight as we build out these capabilities, and the infrastructure, the product portfolio, and the innovation to go after, what we see is just a tremendous growth opportunity in the long run.
Annie, do you want to take a shot at talking about the advertising and leveraging the CPG opportunity across the retail business?
Unidentified Analyst [Annie]
Absolutely, thanks Howard. One of the things that we had talked about is the strong business law that we have, and leveraging, this one voice. When we advertise VIA, we get the benefit not only in our CPG channel, but also in our retail channels. We have an extraordinarily pleased at the household penetration and the awareness that we’re building. But more importantly, the repeat has been just astronomical, 2X of industry average on repeat for VIA.
And I think Troy alluded to this earlier, we’re building this brand to be a single cup solution for our consumers. In the US, 50% of the consumption is happening in the home; 25% at work. And when you look outside the US in countries like Japan that we recently launched, over 60% is actually in-home consumption. It’s extraordinarily complementary to our holding business and to our retail business in our store.
Your next question comes from the line John Ivankow with JP Morgan. Your line is now open.
John Ivankow – JP Morgan
Great, hi, thanks. You know, a question on, you know, the cash that you have on hand on the balance sheet, cash investments if you could remind us that number. And also the free cash that you’re going to generate next year. You know, I just wanted to have a sense of a couple things. I mean, why, you know, I guess, I think we talked about this why China couldn’t even be faster. But even coming back to the US business, you know, it seems like your new store returns are as good as they’ve been in years. I mean, why we don’t, you know, push the throttle a little bit in terms of new store development given your comps, and you know, the talent that’s coming out of your overall store structure, especially given record guest satisfaction scores.
That’s the first point, and then secondly, you know, again given that cash on hand in the free cash generation, I was curious, you know, how much stock buyback if any, you know, you had in your guidance for Fiscal ’11.
Okay, John. Troy, why don’t you start with the response on cash and then maybe Cliff and I can talk about store growth.
Yes, will do. In terms of cash, you’re right. Our business produces a tremendous amount of cash. I want to be clear, there’s no constraint whatsoever to our growth, whether it be in stores or otherwise, based on the cash we have on hand, much less availability should we need it. So we have a very, very strong cash producing business, strong cash on hand, free cash flow this year, 2010, that will reach probably in the range of $1.2 billion based on operating cash flow of about $1.7 billion.
As I look at 2011 based on the significantly growing earnings model that we’ve put in our initial outlook, I would expect those numbers to be at least that level or higher as we move forward. So very, very strong cash generation that we’re prepared to invest in all the high-returning opportunities we have for our business, both in China, as we build those capabilities to your question and we build out the consumer proposition. And into our US store business as that opportunity presents itself.
And with that, Cliff might speak to the store in the US in particular.
Yeah, just to talk, John, about the US, we are very, very conscious and holding ourselves in a very disciplined way as to how we approach growth. We have been focused on leveraging the opportunity within the four walls of existing portfolio. And we have started to add a selected number of new stores in markets where the economy allows us to do.
Going forward, we are looking at and starting to develop plans around how do we grow in the U.S.; complimenting our existing stores, leveraging the learnings that we’ve had from the renovations in new pallets. And also, looking at building the capability in a different way so that we do not get distracted from our core business. And I could talk about that from both a store-development perspective, acquiring, designing, and opening new stores, or indeed a resale side to make sure my field team are not focused just on growth.
So I think it’s disciplined growth. We see opportunity in the licensed environment as well as the company operating environment here in the US. And I think the focus has been on existing, on cleaning the portfolio, and going forward, you will see us talk more about growth in the coming quarters.
Your next question comes from the line of Jeffrey Bernstein with Barclays Capital. Your line is now open.
Jeffrey Bernstein – Barclays Capital
Great, thank you. Just a couple of follow up questions broadly to size up CPG. I guess a fair amount of attention has been paid to VIA and Seattle’s Best. I know you said on VIA that, I think you said 100 million top line of Fiscal ’10. I’m just wondering whether we can kind of discuss the ramp up you expect, one, from sales from VIA and Seattle’s Best in ’11 and beyond. And not just sales, but looking at any kind of insight in terms of margins, either for either product lines, or channel, or relative traditional CPG, just trying to size up those two in terms in both sales and profitability contribution over the next couple of years. I’m just wondering how you measure the canalization. I think you said there’s been absolutely none from VIA. How you measure canalization to Starbucks retail from either VIA or Seattle’s Best just to kind of assess what kind of impact this has onto your core business. Thanks.
Let me take the later and then Troy, I’ll give it back to you on the issue of CPG growth and profit margins.
I think before we even sold one box of VIA, we had assumed that there would be modest canalization to our existing whole bean and ground business in our stores. Once we rolled that out at retail, the encouraging news was that there was no canalization. It was just deminimous at best that this was a new use occasion and new behavior, and that has certainly continued. So we don’t believe that we’re going to see any significant attrition from our core customers as it relates to VIA. And the innovation and the pipeline of innovation with regard to VIA will be highly complementary to what I’ve just described.
With regard to SBC, as Michelle said, with such a small single-digit percentage of total brewed coffee in America despite the success of the Starbucks brand, we’re going to reach thousands of new customers as a result of SBC’s distribution that never would have had access to Starbucks in the channels that it’s going to be in. So we’re going to aggressively grow and build both VIA and SBC in ways that we do not believe at this point will have any negative effect on Starbucks core retail business or cannibalize Starbucks in grocery.
With regard to CPG overall, I think you can sense that we believe that we have a very unique opportunity to build a very significant business outside of our retail stores that’s complimentary, that gives us another leg to the stool, and we’re just getting started. It’s very hard at this point to predict the size of these brands and the margins of these brands. But suffice it to say that going in, we believe that SBC and VIA are billion-dollar opportunities that we’re committed to.
With regard to VIA, we’ve said publicly already that those, the operating, the cost of goods and the margin of VIA is analogous to our core coffee business. And we believe that these are just the early stages of our ability and capability to build a complimentary business and do it in a way that no single retailer, or no single CPG company has been able to do before, especially when you link it to the competency and the discipline that we’ve created and destined in around social media to be able to engage our customers in a way to lower our cost of advertising. And I think we’re just getting started and we’re very, very excited about the initial results.
Troy, do you want to add to that?
Yes, I will. I think I might just add to one piece you said, Howard, which is also the mention that the innovation that we’re doing around VIA most recently VIA Ice has also similarly very incremental. And something that adds to our business rather than cannibalize us. So even the existing current product lines and new innovation we have coming, we think, simply gives us a change to grab more coffee consumption and more coffee occasions over time.
And then with respect to targets, we don’t have revenue targets for either SBC or VIA to provide to you at this stage of the game. Perhaps as we get deeper as we get into 2011 and a bit deeper into the build of both of those businesses that we’ll have a little bit more to speak about. But just remember, those are new focus areas that are growing tremendously that we are investing behind and we would expect to build and grow as we move through 2011.
And with respect to profitability, SBC we believe is a complimentary margin structure to our overall business. We will build capabilities and invest and grow that over time. And would expect it to be a good contributor to revenues, to profits, and again, complimentary to the margin structure of the company.
And then VIA also, as Howard mentioned, very complimentary to our product margins in our stores when we sell it to the store channel. And a very good healthy margin channel as well down the CPG aisle as well. Recognizing, just as we did in the third quarter that given the long term opportunity of VIA, we will spend against it. We’ll spend against it with infrastructure, and we’ll spend against it with advertising and marketing to build that consumer awareness to drive trial and to drive repeat. And so we’ll continue building profitability, and growing and business, and growing trial, and spending against it to drive that over certainly the fourth quarter, and through 2011.
Operator, if we can take one question, I think that would be fine.
Okay, your next question comes from the line of Joe Buckley with Bank of America Merrill Lynch. Your line is now open.
Joseph Buckley – Bank of America Merrill Lynch
Thank you for staying with me. I question again, going back to the very initial question on the international profit margin improvement and potential, how much of that can you realize by applying the full world lessons of the US and how much of it is related to the infrastructure t hat you put in place for license businesses around the world?
Yeah, Joe, what I would say is both of those things are important pieces of the margin improvement. I won’t be satisfying to you probably as giving you a specific breakout of each. But there’s no question that the profit improvement that we’ve driven through our US stores in the past 12 months, and you’ve seen it very clearly show up in our financial results, we believe there is tremendous numbers of points of percentage-point margin and improvement that can come over time as we apply the pricing architectural work, as we apply the liens to our principles in store around the world outside of the US So certainly an important contributor to that margin improvement both in 2011 and the targets that we’ve put out for next year and beyond, I will expect will come from those kind of efficiencies. As well as supply chain efficiencies, and procurement efficiencies, and all the things that we have perfected much more significantly in the US and are rapidly applying those thing where they’re appropriate outside of the US.
And then to your second question, leveraging the infrastructure we have in place is also no question a part of that equation. We have a significant very important investment in our infrastructure capability outside of the US. And it’s bigger and more capable today than our business is today. And the message there is that we have our sights set on growing a very significant large international business. We have not hesitated to build the structure outside of the US that we need to capture that and to grow that. That structure is largely in place, and I would expect going forward that as we add stores, as we grow revenues, as we had new channels of distribution outside of the store, that you will see us fairly consistently now over time leverage that structure as just one piece of the margin improvement outside of the US.
Troy, thank you. For all of you on the phone, thank you for staying with us. Obviously, we’re incredibly pleased with record third quarter earnings. And in an environment like this with the consumer confidence waning to put up 9% comps and 6% global traffic, and at the same time, making the investments we have in VIA and the beginning of a major significant CPG channel, we are extremely pleased with the results and the outlook we’ve given you for Fiscal ’11.
Look forward to talking to you soon in the next quarter, and thank you very much for your support.
This concludes today’s Starbucks Coffee Company’s Third Quarter Fiscal Year 2010 Earnings Conference Call. You may now disconnect.
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