Here’s the entire text of the prepared remarks from Starbucks’ (ticker: SBUX) Q4 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Howard Schultz, Chairman and Chief Global Strategist
James L. Donald, President and Chief Executive Officer
Michael Casey, Executive Vice President, Chief Financial Officer and Chief Administrative Officer
JoAnn DeGrande, Director of Investor Relations
Mary Ekman, Vice President, Corporate Development and Investor Relations
Ashley Woodruff, Bear Stearns
Mark Kalinowski, Buckingham Research
Jeffrey Bernstein, Lehman Brothers
Larry Miller, Prudential
Matthew Difrisco, Thomas Weisel Partners
Craig Bibb, WR Hambrecht
John Glass, CIBC
Sharon Zackfia, William Blair
David Palmer, UBS
Dan Geiman, McAdams Wright Ragen
Kristine Koerber, JMP Securities
Good afternoon. My name is Wes and I will be your conference facilitator. At this time, I would like to welcome everyone to the Starbucks Fourth Quarter and Fiscal Yearend 2005 conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session; if you would like to ask a question during this time, simply press “*”, then the number “1”, on your telephone keypad, if you would like to withdraw your question, press “*” then the number “2”. Thank you.
I would now like to turn the conference over to Ms. JoAnn DeGrande, Director, Investor Relations.
JoAnn DeGrande, Director, Investor Relations
Thanks Wes. Good afternoon ladies and gentlemen. I am JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company. With me today are Howard Schultz, Chairman, Jim Donald, President and CEO, Michael Casey, Executive Vice President and CFO, and Mary Ekman, Vice president, Corporate Development and Investor Relations.
During today’s call Jim will review key results and accomplishments, Howard will talk about our international development, and Michael will highlight the key drivers behind our fourth quarter and full year financial results as well as fiscal 2006 growth target. We will limit today’s call to one hour including Q&A. First I’d like to remind our listeners that this call is been broadcast live over the internet. The replay will be available via telephone at 800-642-1687, reservation number 4093403 through 5.30 pm pacific time on Thursday, November 24 and via the internet on the investor relations page at starbucks.com through 5.00 pm pacific time on Thursday December 15.
In addition today’s remark will be available on the investor relation portion of starbucks.com by the end of the day and will remain available through Thursday December 15. This conference call includes forward-looking statements such as “anticipated store openings”, “comparable store sales expectations”, trends beyond our expectations regarding the company’s revenue and expense growth estimated stock-based compensation expense, capital expenditures, effective tax rate, net earnings and earnings per share results. These statements are all based on currently available operating financial and competitive information and it’s subject to various risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company’s filings with the Securities Exchange Commission including the certain additional risks and uncertainties section of Starbucks Annual Report on Form 10-K/A, for the fiscal year ended October 3, 2004. The Company assumes no obligations to update any of these forward-looking statements. With that I will now turn the call over to Jim.
James L. Donald, President and Chief Executive Officer
Thank you, JoAnn, and good afternoon ladies and gentlemen. First, let me begin with a quick summary of our strong fiscal year financial results. And then I will share with you some of our key accomplishments for fourth quarter fiscal 2005.
Consolidated net revenues for the full year grew to a record 6.4 billion, up 20% from 5.3 billion last year, comprised of strong growth in both company-operated retail and licensing revenues. Comparable store sales growth was 8% for all company-operated stores, marking the 14th, consecutive year of comparable store sales growth of 5% or greater.
Net earnings for the full year were 494 million, an increase of 27%. EPS were $0.61, exceeding the high end of our original target of 56 to 57 1/2 cents introduced in July of 2004. And the average US company-operated retail store volumes increased by more than $50,000 to 1 million in fiscal 2005, demonstrating the continuing contribution from innovation, service with speed initiatives, and the strength of the Starbucks brand.
We ended the year surpassing our store opening targets of 1,500 new locations, opening a record 1,672 new stores ending the year with more than 10,000 stores and 100,000 partners. We are now serving approximately 35 million customers a week in 37 countries
Starbucks strong performance in fiscal 2005 reflects our global success in connecting with the communities in which we do business. This year we again leveraged cross-market learnings into innovative and successful new products that, combined with our popular core offering, stirred enthusiastic response from our customers. Looking forward, we have developed aggressive growth targets for the company in fiscal 2006. And it is with excitement that we launched Starbucks holiday promotion last week, which provides a solid foundation for achieving our goals as we enter the year ahead
Starbucks core retail business is the engine that drives our results. During Q4, we continued to generate customer and partner enthusiasm which is reflected in our strong comparable store sales growth and earnings performance. Through our new beverage and food offerings as well as a returning seasonal favorites and complimentary products such as music, we strive to provide the ultimate Starbucks store experience. In July we launched our Green Tea Frappuccino blended beverage made with Tazo Green Tea and our Tazo Green Tea Shaken beverages. It surpassed our expectations and was a great example of cross-market collaboration. We sourced the finest green tea available to bring this high quality beverage to our customers, which is an excellent option for those seeking a coffee alternative. As we approach fall, we reintroduced our highly anticipated Pumpkin Spice Latte, complimented this year by our pumpkin cream cheese muffin. Both our customers and partners eagerly await the changing seasonal offerings at Starbucks, whether they are revisiting past favorites or discovering something new.
The arrival of Ethos Water during August brought our newly acquired brand of water to Starbucks US company-operated stores. As we mentioned last quarter, Ethos Water is a premium-bottled water with a corporate social responsibility commitment to help bring clean water to global communities in need. This summer we told the Ethos story through a cross-country RV tour that resulted in visits to 33 states generating great enthusiasm about this brand. Through the fiscal yearend, Ethos Water has surpassed our previous bottled water sales by more than 30%. In fiscal 2005, we contributed 250,000 to water projects, and in 2006 we are estimating at least a million dollars from the donation of $0.05 for every bottle of Ethos Water sold.
Music continues to enhance the coffeehouse experience at Starbucks and music enthusiasts welcome our new CD offerings during the quarter, including our first ever global CD launch, Herbie Hancock's highly acclaimed new album, Possibilities. This collaboration with some of his favorite artists such as Sting, John Maher, Annie Lenox, Christina Aguilera, debuted at number 22 on the Billboard 200 albums chart. Demonstrating the strength and the draw of the Starbucks brand, more than 60% of the Possibilities CD sold in the United States were purchased in our stores. Through these highly popular beverage food and music offerings, we ended the quarter with strong momentum.
As we enter the new fiscal year, we continue to surprise and delight our customers through the return of holiday favorites and the introduction of new beverages, food, and gift ideas to strengthen customer loyalty and expand our customer base. A long-standing tradition among our customers is the eagerly awaited return of our trio of Starbucks holiday favorites: Eggnog Latte, Gingerbread Latte, and Peppermint Mocha. In addition, we have introduced two new holiday beverages, Chai Eggnog Latte, which is the blend of full flavored black teas and exotic spices steamed with rich eggnog for an innovative twist on a nostalgic holiday tradition, and Eggnog Frappuccino, an indulgent blend of Starbucks coffee, eggnog and ice.
To compliment our holiday beverages our popular Cranberry Bliss bar and Gingerbread loaf are also returning, offering a tasty indulgence and a great gifting option. Starbucks new Petite Cookies, in four different flavors, join our seasonal pastries and are a perfect treat on a cold day alongside a favorite warm Starbucks beverage. This year marks the 21st anniversary of Starbucks Christmas Blend, our traditional coffee of the season, and it’s one of our most popular coffees of the year. Starbucks coffee experts have created an extraordinary blend of Latin America and Asia Pacific coffees, punctuated by aged Indonesia coffee sourced specifically for this once a year offering. This coffee’s concentrated spice, its richness and full body pair well with traditional holiday flavors such as pumpkin, ginger, and cinnamon and is sure to make a hit with our customers again this year.
Turning to holiday merchandise, we have a tradition of positioning Starbucks as a gifting destination. From the smallest stocking stuffers, to holiday serve ware, to the best brewing equipment on sale, customers are sure to find something for everyone on their list. This year's assortment is a mix of traditional favorites and exciting innovations. Our lineup includes Starbucks exclusive gift packs and collectibles, two new seasonal Starbucks card designs, an expanded selection of Starbucks chocolates, the ever popular Barista Bear, and the new Hear Music holiday CDs, all at a variety of price points. We're very excited about our two new CD offerings for the holidays. They're both exclusive to Starbucks. ‘Elton John's Christmas Party’ consists of 21 classic holiday songs that were hand selected by Sir Elton himself. And ‘Baby It's Cold Outside’ is filled with holiday favorites performed by the likes of Dean Martin and Nora Jones. One of the highlights of the album is a never before released recording of Barbara Streisand singing ‘Ave Maria’ in English. With a breadth of merchandise offerings, we maintain our focus on the customer, and service with speed remains one of our top priorities. In anticipation of the upcoming holidays which bring an increase of merchandise sales at Starbucks, we have rolled out new point of sale scanners to all US company-operated stores, providing more efficient merchandise transactions to accommodate our customers' busy schedules
Our unique and innovative marketing approach to the holidays draws customers to our stores and creates excitement with the partners. To kick off the season last week, we generated enthusiasm around the delivery of Starbucks Christmas Blend to our stores by bringing the first snowfall to select markets around the country, including Seattle, New York, Los Angeles, Chicago and Miami. To further support the celebration, our Cheer Patrol will be sampling holiday beverages in 25 markets. And we'll be surprising and delighting our customers through non-traditional marketing, including an online component, theredcup.com, created specifically for the holidays. We encourage you to visit our website and share in the holiday fun. In the spirit of giving, we anticipate another successful season of collecting gifts for seriously ill children during the Holiday Angels Joy Drive with the Starlight Starbright Children's Foundation. Last year we collected more than 650,000 gifts, and we hope to surpass that number this year.
Beyond the holidays, we're looking forward to the expansion of our warming program which will provide more customers the opportunity to enjoy a warm breakfast sandwich from Starbucks. Our target is to increase the number of locations from the over 200 Starbucks stores in the Washington, D.C. area and Seattle that currently offer warm breakfast items today to approximately 600 total locations, including three additional markets by the end of fiscal 2006. We'll provide more details as we get closer to those market introductions.
Turning to our specialty business, we are leveraging our brands and our investments to generate growth outside of our company-operated retail footprint. Our success to date and the growth potential ahead are reflected in several key accomplishments. In September, we achieved a milestone with the opening of the 100th Seattle's Best Coffee licensed cafe in Borders Books & Music stores. This is a significant accomplishment less than one year after announcing the agreement, and we are well on our way to reaching our 400-store target. To further illustrate the potential of this brand, Seattle's Best Coffee will be the exclusive brewed coffee and espresso beverage for room service, banquets, catering and restaurants in more than 104 Points by Sheraton properties in the US by early 2006. And just in time for the holiday season, we have introduced Starbucks Cream Liqueur which is an artful blend of delicious cream, premium spirits and a hint of Starbucks coffee. This introduction follows the extremely successful launch of Starbucks Coffee Liqueur in February, which is the number one new spirits product in the United States in overall dollar sales.
Before my final comments on the quarter, I would like to take a few moments to address the recent natural disasters that have impacted coffee farmers in Mexico and Central America. We extend our heartfelt condolences to the bereaved families and many others impacted by these tragedies. We estimate that there has been an approximate 5% production loss on all coffee, that's both Arabica and Robusta, combined that is grown and processed in the impacted regions. Since most of the devastation occurred at lower altitudes, we're confident there is no long-term impact on Starbucks’ coffee supply due to the high elevation at which it grows. To support the immediate relief efforts in the most affected areas, Starbucks has contributed to Mercy Corps to provide emergency assistance in Guatemala and to CARE Northwest for disaster relief in El Salvador. Additionally, teams of Starbucks agronomist and coffee buyers have been in Guatemala, El Salvador and Mexico disaster areas working with our business partners and local communities to further assess the impacts and determine the appropriate next steps. As a result of our ongoing visits, we have expedited distribution of $1 million, and it’s a portion of what we customarily provide over the course of the year to support social development projects to be immediately available for rebuilding local infrastructure.
Before I turn the call over to Howard for his comments on our international segment, I would like to again note that our truly remarkable financial results in fiscal 2005 were successfully achieved while pursuing aggressive growth. We have set the stage for future excellence and have again demonstrated our ability to translate our efforts into long-term shareholder value. Howard.
Howard Schultz, Chairman and Chief Global Strategist
Jim, thank you. And thank you for your leadership throughout the year. As we communicated to you at last year's analyst conference, we have been approaching our international development with an even more focused and strategic approach. Our goal is to achieve greater depth and awareness in existing markets while also introducing Starbucks locations in select new countries in order to leverage our investments in the infrastructure we are building. We also seek to capitalize on strategic emerging opportunities, including increasing our equity ownership where appropriate. In addition, we are beginning to leverage the power of the Starbucks brand by creating products for new channels of distribution that complement and support our retail stores, very much replicating the successful US strategy that resulted in products like Starbucks-bottled Frappuccino.
Let me begin by highlighting our progress this year in China, one of our most exciting international markets. Having successfully established a strong and increasing brand presence in China, with over 200 stores in Mainland China and in Hong Kong, and 150 stores in Taiwan, we are rapidly building on the foundation in this attractive market with a keen eye on growing both our license relationships and company-operated strategy.
To better capture this opportunity and realize greater long-term financial returns, we increased our equity ownership in southern China to 51% in Q4. We view China as one of our biggest growth opportunities and believe it could ultimately be our largest international market. As evidence of our confidence in the opportunities awaiting us, this year we opened our first company-operated location in China in the city of Qingdao. Following this expansion we were excited to open company operated stores in Dalian, one of the major cities in Northern China and in Chengdu in western China this fall.
While visiting there in September, I was invigorated by the ongoing acceptance of Starbucks from both customers as well as our partners. In a country that is primarily known for tea, customers have warmly embraced Starbucks coffee as well as the Starbucks experience. The acceptance that we have achieved since entering Beijing in 1999 has exceeded even my own high expectations, and I must say we have only just begun. We continually strive to build relationships in the communities in which we operate, and China is no exception. In recognition of the country's long and rich tradition of placing an importance on education, during my trip we announced the establishment of the Starbucks China Education Project, $5 million commitment to support educational programs in China. This is just another example of our long-term commitment to being a socially responsible company wherever we do business.
This week we were very pleased to announce that Jinlong Wang has rejoined Starbucks and has been appointed President of Starbucks Greater China. Due to his previous experience leading Starbucks’ international development as well as his firsthand knowledge of the business and consumer environment in China, Jinlong is uniquely qualified for leading our strategic efforts in this very important market. We warmly welcome him back to Starbucks. We continue to invest in our infrastructure and partner development in China and are laying the groundwork to capture the numerous opportunities this market has to offer us in years to come.
Also during my recent trip to Asia Pacific, I participated in the launch of our first ready-to-drink coffee beverages outside of North America. In Japan and Taiwan, we launched Starbucks Discoveries, a chilled cup coffee product featuring the high quality coffee customers expect from Starbucks. We took the time to develop just the right super-premium ready-to-drink coffee designed to appeal to the local taste preferences in Asia. The launch was extremely successful in both markets. We are now looking forward to introducing bottled Frappuccino coffee drinks in December to the southern Korean market through a licensing agreement with a local business partner. This is the same popular product that has been number one in the segment in the US and will be available in South Korea in three different flavors, coffee, mocha, and caramel.
Throughout 2005, we continued to pursue focused and strategic international development through the opening of our stores in new countries and increasing our equity ownership in some of our established markets. We were delighted to bring the Starbucks experience to the Republic of Ireland, the Bahamas and Jordan. We also increased our ownership to 100% in both Germany and Chile. The combination of these activities throughout the year resulted in nearly 3,000 international locations open at the end of fiscal 2005, which includes opening 2,400 stores outside of North America in less than ten years. To put that in perspective, that number is even more remarkable when you consider that it took us nearly three decades to achieve similar growth in the United States. As I have said before, we feel extremely fortunate to be in a position that allows us to share Starbucks with people around the world, including 36 countries outside the United States, and to establish the Starbucks experience as part of the daily lives of customers in existing new and highly competitive global markets.
We continue to see our international operations as a key growth driver for the company well into the future. Looking forward, we will continue to pursue opportunities toward our long-term goal of at least 15,000 international locations.
Before I turn the call over to Michael, I would like to take a few minutes to share with you a few leadership updates. I would like to welcome Javier Teruel, who is joining Starbucks Board of Directors. Javier has extensive experience in the consumer goods industry serving as Vice Chairman of Colgate Palmolive Company since July 2004. With his strong background both domestically and internationally, Javier will be a valuable contributor to the company as we grow and become increasingly relevant to local customers in every market we enter. I would also like to congratulate Dorothy Kim, our Executive Vice President of Supply Chain and Coffee Operations who was recently named as one of the five women to watch by Fortune in their recent ‘Most Powerful Women’ magazine business issue 2005. Dorothy has been with the company since 1995 and has been instrumental in this critical but often looked behind the scenes function of our business.
In closing, let me reflect briefly on the leadership changes discussed earlier this year. While it was bittersweet to see the retirement of Orin Smith, a long-time member of the senior management team, and former President and CEO, our disciplined approach to succession planning and Jim Donald's transition into the role has occurred seamlessly. Jim has brought his own level of energy, intensity and focus, and he has already made a significant impact on our company and our people. Now I’d like to turn the call over to Michael to discuss our financial results.
Michael Casey, Chief Financial Officer and Chief Administrative Officer
Thank you, Howard. Consolidated net revenues for the quarter ended October 2, 2005 were a record 1.7 billion, up 14% from fourth quarter of fiscal 2004. Please keep in mind that fourth quarter of fiscal 2005 included 13 weeks, while fourth quarter of last year included 14 weeks. Since all the components of our revenue growth are detailed in today's press release, I'm going to simply highlight the consistent broad-based strength of our revenue growth. On a 13-week versus 13-week and 52-week versus 52-week basis, consolidated net revenues grew 23% for the quarter and 23% for the year. Company-operated retail revenues increased 20% for the quarter and 23% for the year, driven by the opening of 735 new stores in the last 12 months and 8% comparable store sales growth for both the quarter and the full year.
Licensing revenues grew 20% for the quarter and 21% for the year, driven by the opening of 937 new licensed retail stores in the last 12 months. Foodservice and other revenues increased 27% for the quarter and 15% for the year, primarily due to growth in new and existing US and international foodservice accounts, and to a lesser extent, growth in our emerging entertainment business.
Our business model is based on strong revenue growth accompanied by moderate margin improvement over the long term, but not necessarily every quarter or in every line item.
In fiscal 2005, we achieved margin improvement in both Q4 and the full year. In the full year of fiscal 2005, our operating income increased by $174 million or 28.7%. Of that amount, 123 million or 71% was due to higher revenue and 51 million or 29% was due to operating margin improvement. Our operating income as a percent of revenue increased to a record 12.3% from 11.5% in fiscal 2004 and 10.3% in fiscal 2003. This year's improvement came in cost of goods sold, including occupancy costs, other operating expenses, depreciation and amortization and general and administrative expenses as well as in our income from equity investees.
I will now move on to Q4 results by operating segment. For a detailed breakdown of the revenue growth, please refer to the press release. US operating income increased 27.7% to 239 million in fourth quarter from 187 million in fiscal 2004. Operating margin increased to 17.3% of related revenues for fourth quarter of fiscal 2005 from 15.3% for fourth quarter of fiscal 2004. The improvement in operating margin was primarily due to higher average revenue per retail transaction, which favorably impacted cost of sales including occupancy costs and store operating expense. This improvement was partially offset by higher expenditures in our emerging specialty businesses as we continue to invest in our infrastructure to support our entertainment business and Seattle's Best Coffee licensed cafes.
Now moving to the international segment. Operating income from international operations increased 54% to 30 million in fourth quarter from 20million in fiscal 2004. International operating margin expanded to 10.9% of related revenues from 8.6% in fiscal 2004. This improvement was primarily due to a lower cost of sales, including occupancy costs, and store operating expenses as a percent of related revenues, fueled by leverage on fixed costs from strong growth in revenues, combined with operating efficiencies in our international markets. Our store base is increasing rapidly, and we are achieving a growing contribution from established areas of the business, while integrating and investing in recently acquired emerging markets and channels. Partially offsetting these improvements was an increase in other operating expenses related to the launch of the new ready-to-drink coffee beverages in Japan and Taiwan. As these strong results demonstrate, progress in our international operations continues
Moving to the consolidated balance sheet, total cash, cash equivalents and other liquid investments decreased to 368 million at the end of fiscal 2005. From 780 million, 788 million at the end of fiscal 2004, primarily due to the sale of securities to fund common stock repurchases. During fiscal 2005, Starbucks repurchased 45 million shares for a total cost of $1.1 billion. I would also like to point out that our return on equity increased to 21.7% in fiscal 2005 from 17.1% in fiscal 14.0% in fiscal 2003.
In August 2005, the company entered into $500 million five-year revolving line of credit, under which we had borrowings of 277 million at the end of the fiscal year. Our strong balance sheet, continuing strong cash flows, and the borrowing capacity provided by the revolver allow us to continue to fund our operations and selectively invest in new growth opportunities as well as to repurchase shares.
Let me now share with you Starbucks fiscal 2006, financial targets, which were previously announced in July but have now been updated for stock option expensing and for our recent two-for-one stock split. We plan to open approximately 1,800 new stores on a global basis in fiscal 2006. In the United States, we plan to open approximately 700 company-operated locations and 600 licensed locations. In international markets, we plan to open approximately 150 company-operated stores and 350 licensed stores. We are targeting total net revenue growth of approximately 20% and continue to expect comparable store sales growth in the range of 3 to 7% in fiscal 2006 with monthly anomalies. We are expecting moderately higher commodity costs and higher operating expenses in support of our international growth and our US licensing businesses, to be offset by continued leverage of general and administrative expense. We also expect lower interest income and fewer average shares outstanding in fiscal 2006 as compared to fiscal 2005 due to the recent stock repurchase activity. Additional share repurchase activities in fiscal 2006 will depend on market conditions.
We are targeting EPS of $0.63 to $0.65 for fiscal 2006, including stock option compensation expense estimated at $0.09 per share. On a comparable basis and including stock compensation expense, we expect full year and quarterly earnings per share growth for fiscal 2006 to be consistent with the company's longer term 20% to 25% targeted range. The effective tax rate is expected to be approximately 38% in fiscal 2006 with quarterly variations. And capital expenditures are expected to be in the range of 700 million to 725 million in fiscal 2006.
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