Full Transcript of Starbucks’ 4Q05 Conference Call - Q&A (SBUX)

| About: Starbucks Corporation (SBUX)

Here’s the entire text of the Q&A from Starbucks’ (ticker: SBUX) Q4 2005 conference call. The prepared remarks are 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.

Question-and-Answer Session

Operator

Ladies and Gentlemen, at this time I’d like to remind everyone, in order to ask a question please press “*”, then the “1”, on your telephone keypad. Again as we asked please limit yourself to one question please.

Your first question comes from Ashley Woodruff of Bear Stearns.

Ashley Woodruff

Hi, thanks. First, would you talk about your experience developing some of your larger international markets such as Japan and the UK? And how what you have learned in these markets affects the way that you accelerate your development in China, particularly from an ownership structure and from a competitive standpoint? And then as a follow up to that, since your perspective for China is long term, can you discuss your willingness to take short-term losses in China as you develop the market and the necessary infrastructure building required over the next couple of years?

Howard Schultz

This is Howard. You have asked a number of questions. Let me try and the experience we had in the UK and Japan were quite different, so let me briefly describe that for everyone. We, if you remember, we acquired a small business in the UK that was up and running and that gave us a start and a foundation of about 50 stores. We had to convert those stores, and briefly we were also competing with lots of competitors at the time who were all vying for the same leadership position. I think if you accelerate the time from when we made the acquisition to today, we have demonstrated in very short order, five years or less, that we became the leader. We went after high profile locations. We established the brand. And we established the relevancy of the Starbucks experience and the third place experience. That third place experience in the UK is similar to Japan, but the way we got there was different. In Japan, we were competing with old line Japanese coffee stores that were very, very different than the kind of competition we had in the UK. And the differentiation in terms of the coffee quality, the experience, the non-smoking, all the things we did in Japan to distinguish Starbucks, were embraced very quickly. We have approximately, I think 600 or so stores in Japan today and a little bit less of that in the UK, but I'm proud to say that both, in both markets we have resulted in unquestionably the leader. In China, we're educating that market to what quality coffee is. That is similar to the experience we had in Japan and the UK, but there is a difference. One big difference is that we are noticing that the physical environments of Starbucks stores are very, very relevant and very strategically important to the Chinese way of life. And specifically what I mean by that is in the afternoon and evening we have been very surprised, almost stunned to see how the Chinese customer is using Starbucks stores as an extension of their home and office. In many ways it's because that the Starbucks stores are bigger than where people live. The commuting distances are very long. And because of this, the Chinese people are coming to Starbucks in waves that we did not anticipate or have that same experience in the UK and in Japan. The other thing that has surprised us is the level of awareness about Starbucks. The iconic nature of the western brands and how familiar young Chinese people are we're being swept into that in ways that have been very positive. The Chinese young consumer is very aspirational, and again, because of how Starbucks has been revered as a Western brand, we're benefiting from that. As I mentioned in the text, opening up outside of Beijing and Shanghai in places like Qingdao and Dalian, what that has demonstrated to us is that in areas, in places that are more rural than in metropolitan cities like Beijing and Shanghai, we're also seeing very positive results and this is giving us I think a lot of optimism. But this is a very complex, difficult market to both enter and succeed in, but we are off to a very, very good start. And I would say cautiously that the market is much, much larger than we previously anticipated.

James Donald

And with that, Howard, we will continue to make the proper investments there to build the infrastructure in there to achieve the size that we think is potentially available.

Howard Schultz

Right. Mike, do you want to add to that?

Michael Casey

Just to pick up on that I, to answer your question very directly, we are willing to sustain losses in order to pursue what we think is the biggest opportunity outside of North America. Fortunately, at the present time it has, the business has been profitable enough, that our current ownership structure that there have not been any significant losses. But we are willing to do that if we can make the prudent investments as Jim said to pursue the opportunities.

Operator

Your next question comes from Mark Kalinowski of Buckingham Research.

Mark Kalinowski

Hi. Just looking at the fiscal ‘06 earnings per share goal, looks like you exceeded consensus with the fiscal fourth quarter EPS but you kept your EPS target for fiscal ‘06 identical. I was just wondering if there's any thinking that went into that, that we should be aware of. Thanks.

Michael Casey

Thank you, Mark. The primary thinking is it's really too early in the year to make any adjustments. We've put a lot of time and effort into our operating plan for fiscal ‘06, and while we're off to a good start to the fiscal year, it's too early to make adjustments.

Mark Kalinowski

Thank you.

Operator

Your next question comes from Jeffrey Bernstein of Lehman Brothers.

Jeffrey Bernstein

Great, thanks very much. Question on the food programs, both lunch and breakfast. It seems as if the lunch rollout has been fairly aggressive. I know it's currently in over I believe 3,200 stores, which is up over a thousand versus last year, and the please here I guess the breakfast rollout is going to be accelerated. I was just wondering if you can give us an update on the rollouts, just kind of the progress you're seeing in both the lunch and breakfast business and what type of boost you expect to give to sales going forward from each of these two initiatives? Thanks.

Howard Schultz

We said that the lunch and the breakfast are about $30,000 per store per year. And the acceptance that we've seen, and I'll address warming first, has given us the momentum to launch this into up to 600 stores as I just mentioned in three additional markets. We’re finding it more than just that incremental pick-up of revenue. We're finding that we’re offering our customer, whether it's lunch or breakfast, a value type of, a valued addition to their visit to the stores. And we're able to help them with their time-starved schedules by offering them this quality of sandwich both morning and lunch, at lunchtime to go with their quality beverage. So as we continue to see the momentum pick up in the markets that we're in, we continue to see opportunities outside of those markets to grow this business.

Operator

Your next question comes from Larry Miller of Prudential.

Lawrence Miller

Yeah, hi guys, great quarter. Just had a question on the composition of the comp store sales in the US, it sounded like when I was reading through the press release, 5% price, 5% check average, which would suggest 2% mix. Can you talk about the driver or the components of mix there and also the components of the traffic growth? Are you seeing increased frequency of the existing customer or new users or some combination of both? Thanks very much.

Michael Casey

To pick up on the first one, the mix increase is due to a number of things. One is the fact that we're increasing the amount of food that we're selling per transaction. We're increasing the amount of music that we're selling per transaction, so both of those add to the average check, as well as the fact that we are promoting and introducing some more indulgent beverages as we go through the year. So all three of those things contribute to a higher average revenue per transaction. It's a little hard to say, we believe that the increased transactions are due to both more frequent visits by existing customers as well as definitely new customers.

Operator

And our speed with service initiatives help to continue to drive that end of it.

Lawrence Miller

Thanks very much.

Michael Casey

Thank you.

Operator

Your next question comes from Matthew Difrisco of Thomas Weisel Partners.

Matthew Difrisco

Hi. I know it's early in the year but can you give us a little bit of detail what you're expecting as far as what's behind your EPS guidance for 2006 on the COGS side, specific to your two major guys which are dairy and coffee? Thanks directionally, better or worse than what you have seen in the contracts and prices that you bought in 2005.

Michael Casey

The primary driver of the increase in cost of goods that we referred to is green coffee. We have great visibility to the coffee that's coming into our system because we purchase it on long-term contracts, and we maintain a fairly significant inventory primarily of un-roasted coffee. And we're looking at about a 10% increase in the green coffee costs that pass through our P&L, maybe a little bit more this year. But that's all built into our targets. We're expecting approximately the same dairy costs that we had a year ago. And those are the two primary commodity costs that enter into our cost of goods sold.

Matthew Difrisco

But didn't we have a spike in dairy in Q1 this year that I guess are you anticipating a similar run up seasonally in first quarter of ‘06 calendar?

Michael Casey

No, our dairy prices were relatively steady this year. We had a, we had a spike in the summer of the previous year which we didn't have this year. So we got some favorable comparisons toward the end of fiscal 2005 in dairy. But a fairly, fairly steady price throughout the year in 2005, and we expect to have a fairly steady price through 2006. Very close, within a couple of pennies per gallon of the Starbucks composite dairy gallon year-over-year.

Matthew Difrisco

Okay. Thanks.

Operator

Your next question comes from Craig Bibb of WR Hambrecht.

Craig Bibb

Hi. The international is really spectacular. Can you talk about how much of that's being driven by Japan and the UK and how sustainable it is, particularly for Japan? And maybe give us an update on additional capacity for your ready-to-drink product in Taiwan as with Japan?

Howard Schultz

Craig, I'll start. I think what's really important to note here is that, the word that I would use to categorize what is happening internationally for Starbucks, and this is well beyond Japan and the UK, is the relevancy of the Starbucks experience. And the fact that we are as relevant in the UK and Japan as we are in the Middle East, in Malaysia, in China, in Spain, in Greece, in Paris, demonstrates that we are one of the few retailers that has the potential to create a global enterprise that probably does not have to be changed or refined or altered for local taste and local markets. The stores look and feel the same. It's the same exact quality of coffee. It's the same soft seating. It's the same music. And what we have learned over the years is that the international customers do not want it changed. They want the authenticity of the Starbucks experience. And that's what's so exciting. In terms of what's driving the profitability, there are a number of markets that are doing well. Clearly, the size of the market in Japan and the UK in terms of number of stores is significant, but we are making very strong strides across many different markets that are quite diverse. In terms of capacity on ready-to-drink, I don't know if you have talked to people in Japan, but we had the good fortune and the misfortune of being out of stock the first day in the ready-to-drink business in Japan, because the demand was too high. And we are now trying to play catch-up with our partner Suntory in finding the capacity and the supply to take advantage of the marketplace. But we have a good problem on our hand in both Japan and Taiwan, which demonstrates the power of the brand. And we have plans now to examine that as we have already announced in South Korea and other markets on a go-forward basis.

James Donald

To add to that, Howard, the maturity of our partner base as well as the leadership team that Martin Coles has put in place to head up some of these MBUs, the market business units, are seasoned in Starbucks and when you couple that with all of the experience and how well it travels plus the innovation, it is a very exciting opportunity that we see continuing to grow.

Michael Casey

And just to put a little more quantification on it, the international income from equity investees increase was primarily driven by Japan because of the size of the Japanese business compared to the others. And that's where you see most of the influence on our P&L from Japan is in that line. Although almost all of the other, I think can I almost all maybe all of the other businesses also contributed, but because of its size, Japan contributed the majority of the increase in that particular line. In the rest of the international business, as Jim mentioned, we're getting good leverage over the entire system so that the incremental stores are contributing each incremental store is contributing slightly more because of the fixed base being in place. And because of their size and good performance, the UK and Canada contributed a lot too, both showed solid improvement year-over-year, and they're both very large markets, so good progress in almost every aspect of our international business.

Craig Bibb

Great.

Operator

Your next question comes from John Glass of CIBC.

John Glass

Thanks. Jim you mentioned at the outset some speed of service opportunities still within the company. Could you just update us where that metric stands now? Maybe how much it's improved over the past year and what more specifically I guess you're doing in ‘06 to improve the speed of service?

James Donald

Well, first of all, on the initiatives it's a continuation of fine tuning what we're currently using in our stores and what we have used for the past two or three years, with the addition of scanners. Scanners have just been launched this past quarter, and we're starting to see some productivity improvements there. But whether it's drive-through or whether it's through our renovations, we are continuing to take the behind the bar scene, looking for more product, productive ways to get the customers through, at the same time enhancing their experience and applying that logic to the drive-through windows as well as the physical drive through drive, the driveways, if you will, as you enter that store. But the speed of service metrics, Michael, do you have…

Michael Casey

Well, it's a little, it's a little difficult to talk about. But the primary metric that we measure is how long the average person stays in the line.

James Donald

Right.

Michael Casey

And the good news is that when we speed the line up more people step into the line because it's more, it's more an issue of how long an individual is willing to stand in line as it is or how deep a line they're willing to join.

James Donald

And how quick it moves.

Michael Casey

Than it is to exactly know how quick it's moving.

Howard Schultz

And another one thing, that this is contrary to what we have been saying with regard to speed of service is we also want to make sure that we maintain our position of not being a fast food purveyor. We certainly want to increase the speed of service and be as efficient as possible, but we view ourselves, and have for 30 plus years, as a retailer and as a merchant. And we do not want to dilute the integrity of why people come in our stores for a level of speed of service that is going to put us in the transaction business. That's not our business.

Operator

Your next question comes from Sharon Zackfia of William Blair.

Sharon Zackfia

Hi, a question on the international business. Can you give us any more granularity on whether there are any specific initiatives that are yielding the improved gross margin and store operating expenses or is it simply just a matter of an increased sales base?

Michael Casey

It's primarily an increased sales base, but in each individual market the management teams are working on the things that they can do in their market to help. In Japan, for instance, there's been an effort as they get bigger to do more local sourcing. And when a market is small, sourcing from the US is the most economical thing to do because of our ability to buy in quantity is more important or more significant than the transportation expenses. As markets get larger they can source more and more things locally, get the high get the better prices, either off of our contracts or through their own contracts, and reduce the shipping expenses and in some cases the actually reduce the raw material costs. And so those are the kinds of things that are across all markets, but each market has its own list of things that it needs to do to get better.

James Donald

And also as Howard mentioned, as the experience and the customers experience with the stores as a third place, such as China continues to grow, it too drives the ticket and the transaction growth.

Sharon Zackfia

Thank you.

Operator

Your next question comes from David Palmer of UBS.

David Palmer

Hey, guys. Congratulations. You had a big increase in other operating expenses and in your comments you said it was due to higher payroll expense payroll-related expenditures to support the entertainment business and then you also mentioned the opening of Seattle's Best licensed coffee locations and ready-to-drink coffee launches. I assume you put that in the order of their ranking. Could you maybe give us some color on these cost increases? In particular, should we see higher ongoing expenses due to the entertainment business in particular? Thanks.

Michael Casey

Well, you're correct. That we do put almost, we always try to put the items of explanation in the order of magnitude. The increases in the payroll associated with the entertainment business is to develop an expertise within the company that will allow us to continue to create the CDs and the recordings and the compilations that have been so successful in the last 12 months and to also bring us up the technology and learning curve with regard to things like the CD burning stations and the musical coffee houses that we expect in the next several months to open in Miami and in San Antonio, and to be ready and prepared for the sort of the next generation of entertainment delivery. So there, it takes a lot of people to develop that expertise, and we're pursuing it. And Seattle….

Howard Schultz

And like music, Seattle's Best with our licensing relationship with Borders was a startup. And we started from zero stores to over 120 now, and it too required an initial investment to put a team in place to drive that business separately from our Starbucks business.

James Donald

I think we have had a long history in which our shareholders have significantly benefited from of investing ahead of the growth curve, and we see an initiative that we feel is really going to stick. And we think that the music and other forms of entertainment and the SBC opportunity is well within those confines to invest ahead of the curve and are going to bring long-term value for our shareholders.

Michael Casey

And just to tie to next year, I think these three these three areas have probably reached an intermediate term plateau in terms of expenses. Next year the increases in other operating expenses are going to be due to our efforts to build our team in China and the infrastructure necessary to take advantage of that opportunity.

David Palmer

Okay. Thank you very much.

Operator

Your next question comes from Dan Geiman of McAdams Wright Ragen

Dan Geiman

Hi, good afternoon, going back to China just for a minute. Can you talk a little bit more about the unit economics that you're seeing in that market and also talk about your expansion plans in China, more in the near term and the mid-term, say the coming year and maybe the next couple, few years going out?

Michael Casey

Well, what I can say about the unit economics is that although we have different ownerships in different markets and so the way it's reflected in our P&L varies somewhat but it, but at the store level, unit economics in China are excellent. The average transaction, number of transactions is significantly below some of our high volume markets like the US or Japan. But the economics at the store level are actually superior. And that makes us encouraged in the short term, and it also makes us even more encouraged at the leverage we can obtain as those transactions grow.

James Donald

Having just returned from spending an extended period of time there, I think what's so encouraging about the opportunity we have is that the local officials, the local mayors and the local government officials in provinces that we're interested in, really view the Starbucks experience and the Starbucks brand as a sense of, almost a validation for their own community. And we are now being invited in and being discussed at levels that we didn't have a year or two ago because we were unproven. Also I think that people can see that there's a sense of pride that the Chinese young customer has in the Starbucks experience, and that is driving opportunities that we did not have when we first began. I do want to go back to something Michael said, is that we really have to build a world class Chinese-centric team of Starbucks people here. And this is one of the largest and most interesting and biggest opportunities we have, but it also is very complex and is going to require a very disciplined, highly methodical approach to getting it right. And as we have done in the past, we're going to have to invest ahead of the curve.

Dan Geiman

Thanks.

Operator

Your next question comes from Kristine Koerber of JMP Securities.

Kristine Koerber

Hi. Can you update us on the Starbucks Card redemptions, activations during the year? And are there further expansion opportunities internationally with the card?

Mary Ekman

I can give you a little bit of feel for the metrics. For fourth quarter, both activations and redemptions were up over fourth quarter last year in the range of 15 to 20%. We're continuing to see growth in the program generally and as a percentage of retail revenues. That activity has added about 10% of those sales. And that's equivalent to the level that it was last quarter or fourth quarter last year.

Michael Casey

We're continuing to use the Starbucks Card as an opportunity to find new customers through sampling and other marketing activities. We also have expanded our business to business activities pretty significantly. Over a number of years various companies have approached us about purchasing the Starbucks Card and using it as an incentive for their customers or their employees to somehow mode of a change behavior, and that's worked very successfully. We're currently in the process of working with a major financial institution that's in the process of purchasing in excess of $2mm worth of Starbucks Card activations. So that part of the business has become pretty significant.

Mary Ekman

We have the card in eight international markets today.

Operator

Ladies and gentlemen, that is the allotted time we have for Q&A today. I turn the conference back to management for any closing remarks.

JoAnn DeGrande, Director, Investor Relations

Great thank you. Thank you so much for joining us today. Our next call for first quarter fiscal 2006 will be on Wednesday, please note that February 1st. And at that time we will also include our January revenues. Thank you very much.

Howard Schultz

Thank you.

James Donald

Thank you.

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