Starbucks' CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: Starbucks Corporation (SBUX)

Starbucks (NASDAQ:SBUX)

Q2 2012 Earnings Call

April 26, 2012 5:00 pm ET


JoAnn DeGrande -

Howard D. Schultz - Founder, Chairman, Chief Executive Officer and President

Troy Alstead - Chief Financial Officer, Principal Accounting Officer and Chief Administrative Officer

Jeffery J. Hansberry - President of Starbucks Channel Development, Seattle's Best Coffee

Clifford Burrows - President of Starbucks Coffee Americas and US


Keith Siegner - Crédit Suisse AG, Research Division

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Gregory R. Badishkanian - Citigroup Inc, Research Division

John S. Glass - Morgan Stanley, Research Division

Jason West - Deutsche Bank AG, Research Division

Michael Kelter - Goldman Sachs Group Inc., Research Division

Sara H. Senatore - Sanford C. Bernstein & Co., LLC., Research Division

David Palmer - UBS Investment Bank, Research Division

Sharon Zackfia - William Blair & Company L.L.C., Research Division

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division


Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Starbucks Coffee Company's Second Quarter Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] Ms. DeGrande, you may begin your conference.

JoAnn DeGrande

Thank you, Mike. Good afternoon. This is JoAnn DeGrande, Director of Investor Relations for Starbucks Coffee Company. Joining me on the call today is Howard Schultz, Chairman, President and CEO; and Troy Alstead, CFO.

Before we get started, I'd like to remind you that this conference call will include forward-looking statements, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factor discussions in our filings with the SEC, including our last annual report on Form 10-K.

Starbucks assumes no obligation to update any of the forward-looking statements or information. Please refer to the financial statements accompanying the earnings release to find disclosures and reconciliations of non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures.

This conference call is being webcast, and an archive of the webcast will be available on our website at under Investor Relations.

With that, let me turn the call over to Howard Schultz. Howard?

Howard D. Schultz

Thank you, JoAnn, and welcome to everyone on today's call. I'm very pleased to report the record second quarter fiscal 2012 results that Starbucks announced today. As we sit here today, Starbucks has 17,420 stores in 58 countries, serving nearly 60 million customers each week.

Our record Q2 revenues and earnings were driven by strong overall global comparable store sales growth, a significant increase in our CPG, what we refer to as Channel Development segment revenues and operational excellence. A strong top line combined with increased efficiencies and continued discipline around controlling costs enabled us to deliver second quarter EPS of $0.40 to our shareholders.

I'm particularly pleased that we were able to accomplish these results despite the challenges posed by high-legacy commodity costs and a particularly difficult consumer environment in Western Europe, further highlighted by the recessionary news out of England just this morning.

I would not ordinarily begin a call with discussion of one particular market, but we had such a memorable trip to China last week that I wanted to share a few of the details with you upfront. Starbucks' business in China is strong and poised for significant disciplined profitable growth. We have seen a tremendous increase in momentum in China since my last trip, as more and more Chinese consumers frequent our stores and connect with the Starbucks brand and store experience.

You almost have to see the customer engagement for yourself to fully appreciate the transformation. In the past, our typical core customer in China was an expat or tourist visiting a store in Shanghai or Beijing. Today, without question, we have made the significant transition to serving local Chinese customers who enjoy a wide variety of locally relevant products and a welcoming third place environment.

We are well on our way to achieving our plan of having 1,500 stores in Mainland China by 2015. In fact, we are so encouraged by the customer adoption we are experiencing and the momentum that has been growing that we announced today that we are increasing our China/Asia Pacific store opening targets for the fiscal year to 400 from 300, with China stores representing half of that growth.

Our comps in China continue to grow at a double-digit rate, reminiscent of our U.S. growth in the early 1990s, and store profit contribution is among the highest we have ever had in the company's history. Our progress and level of customer loyalty in Tier 1 cities like Beijing, Shanghai, Guangzhou and Shenzhen is now being mirrored in the 44 other cities that have embraced us as well. And our China leadership team, led by John Culver and Belinda Wong on the ground in China, are doing a terrific job building the foundational elements of our brand imprinting our partners with our values and delivering a fantastic customer experience in our store.

The team has also engaged in ongoing forums with multiple stakeholders so that we are building our business with great sensitivity and respect for the Chinese culture. While I was in Beijing last week, we brought together for the first time a group of the leading real estate executives from all over the country in order to share our values and long-term growth plans for the China market. The event was an overwhelming success that brought us closer to Chinese developers and landlords and will help us better compete for choice locations as we expand our operations.

Perhaps at no time during the trip was our enthusiasm and optimism greater than as the 2 first-of-their-kind partner family forums we held in Beijing and Shanghai. Following a theme of growing together, the forums provided us with an opportunity to connect with 1,200 of our partners, their parents and other family members. Through these events, we were able to demonstrate our recognition and appreciation of the importance of family in Chinese culture, to share our own tradition and values and to communicate our commitment to investing in and developing our partners so that they and we succeed together. We made it evident to Chinese parents that Starbucks can give their children career opportunities and important life skills that will prepare them for the future. Our Chinese partners are passionate to grow with us, and they are eager for opportunities to share more of the Starbucks Experience with their customers every day.

As a result of this trip and in response to the growing strength and relevancy of the Starbucks brand, our team has also made the decision to bring at home single-serve espresso and brewed coffee to the rapidly growing Chinese middle and upper middle classes. We'll do this by introducing Verismo by Starbucks a single-serve espresso beverage and brewed coffee machine, and Starbucks-sourced 100% arabica coffee and milk pods to the Chinese market sometime in calendar 2013, much earlier than initially contemplated.

We believe that we have a strong competitive advantage and that we can use our stores as the distribution system to build trial and awareness that will help create excitement and adoption of Verismo in China. Our success in China is built on the solid foundation and the dynamic efficient organization that evolved from the work we did in connection with our U.S. transformation. As John and his team are executing in China, we are also taking this fully integrated proven playbook into markets around the world.

I would now like to speak to changes in the macro consumer behavior and consumer confidence issues facing most consumer brands and retailers around the world. There is no doubt that the seismic change in consumer behavior that has occurred over the last several years and coincided with the economic crisis that moved around the globe is in many ways here to stay. Now more than ever before, businesses and particularly consumer brands, must innovate and create differentiated value propositions for their customers in order to succeed.

Starbucks identified the shift very early, and we responded with My Starbucks Rewards loyalty program to both create value for our customers and build loyalty to our brand, and it has been widely successful. Today, there are more than 4.7 million active members in our loyalty program in the U.S. alone and over 2 million members in our loyalty program internationally loading more than $2.5 billion on cards annually. We have introduced the card in multiple markets around the world and have plans now to add even more in the months and quarters ahead as we build and share our value proposition around the world.

We are also at the forefront of mobile payment convenience and capability, where our mobile app has generated more than 45 million mobile payment transactions over the last 14 months, making Starbucks the largest and most widely embraced mobile payment program of any retailer in North America. The successful integration of our card and loyalty programs with our mobile apps has exponentially increased the relevancy and attachment of all 3 platforms, giving us an ongoing competitive advantage.

Starbucks is also an early mover in recognizing the disruptive opportunity for social and digital platforms. We are among the most liked brands on Facebook, most checked-in retailers on Foursquare, tweeted-about brand on Twitter and followed brand on the explosive Instagram platform. But those accolades mean less -- may mean little unless they drive a higher level of trust and a deeper emotional connection between the brand and the consumer in order to drive incremental revenue and create value for shareholders Starbucks' social and digital media capabilities do just that by enabling us to connect more deeply and more often with our customers and to compete more effectively by dramatically driving a higher return on our overall marketing investment all around the world.

Just yesterday, I was a featured keynote speaker at Facebook's Annual Global Leadership Meeting where I spoke to over 1,000 Facebook leaders and where Starbucks was highlighted as one of the leading innovators in the world on the Facebook platform.

Let me now shift my comments to a number of initiatives, developments and investments we have undertaken that have contributed to our achievement of our record financial performance and the highest level of customer relevancy as measured by any metric in our history. Then I will share a few exciting examples of how we are bringing our Blueprint for Profitable Growth to life and turn the call over to Troy.

In Q2, we announced several significant initiatives that further solidifies Starbucks' authority and leadership position in both packaged coffee and the exciting fast-growing at-home single cup and espresso specialty coffee categories. In January, to complement our full line of medium and dark roast coffees, we introduced Blonde, a lighter roast coffee available both packaged and in VIA and in K-Cup portion packs in response to strong demand from the 50 million-plus consumers who prefer a lighter coffee roast.

Early results suggest that our Blonde Roast coffees have been very well received, and that we are seeing incrementality in sales of brewed coffee, whole bean and VIA since launching in our stores. In March, we announced the Verismo system by Starbucks, a premium single-cup category innovation. Verismo enables consumers to craft both Starbucks' quality espresso beverages and brewed coffee consistently and conveniently one cup at a time from a single machine.

Through an exclusive strategic relationship with Germany-based Krueger, we will begin marketing and selling the Starbucks Verismo system and Starbucks-sourced 100% arabica coffee and milk pods this fall in our stores and in specialty retail stores as well. And also in March, we announced the expansion of our strategic relationship with Green Mountain Coffee Roasters to include the manufacturing, marketing, distribution and sales of Starbucks-branded Vue packs for use in Green Mountain's recently introduced Krueger -- I'm sorry, Keurig Vue Brewer.

At Starbucks, coffee remains at the center of everything we do. Starbucks Blonde Roast, together with Starbucks VIA, Starbucks K-Cup portion packs, Vue and now Starbucks Verismo demonstrates our commitment to absolutely lead the premium coffee category globally. From espresso to specialty roast and ground coffee to the rapidly emerging $8 billion premium single-serve market, our commitment is to deliver Starbucks quality coffee to our customers wherever, whenever and however they wish to enjoy them.

In March, we also announced plans for a global launch of a new beverage platform, Starbucks Refreshers, making Starbucks the first to bring natural energy from green coffee extract to consumers on a global scale. Refreshers will be viewed globally as the handcrafted beverage in our stores later this summer, and ready-to-drink Refreshers is currently available in 50,000 outlets and will grow to over 100,000 outlets in the U.S. alone, literally creating millions of additional impressions for the Starbucks brand, further enhancing our Blueprint for Growth.

Our commitment to innovation is impacting in a very meaningful way how we approach both our new store openings as well as store remodels. In Q2, we opened 50 net new company-operated stores around the world built to achieve LEED certification standards and with a commitment to local relevance in the local community. And we are on plan to open 1,000 net new stores globally and to remodel approximately 1,700 company-operated stores in the U.S. by the end of the year. Our shareholders are already realizing very favorable incremental returns on the investments in the remodels and new stores.

A few words on how the decisions we make are being informed by our Blueprint for Profitable Growth business strategy. Last year, we acquired Evolution Fresh, a fantastic company and brand with great people that is providing us with an exciting opportunity to revolutionize the $3.4 billion premium cold frappe to juice category. Last month, we introduced consumers to a unique premium juice and healthy food experience with the opening of our first Evolution Fresh retail store in Bellevue, Washington. Customer response to the store has been very positive, and we are incorporating the early learnings from the first store into plans for future retail expansion.

But there is much more to the Evolution health story. Drawing upon and leveraging Starbucks' unique merchandising and marketing expertise, we have transformed the look and feel of the Evolution Fresh packaging to more fully and effectively communicate the pure wholesome ingredients found in each nutritious and delicious Evolution Fresh juice. Consumers have embraced the new packaging, and consistent with the Blueprint, have already begun making Evolution Fresh bottle juices available in grocery stores in the West Coast and in our Seattle area of Starbucks retail stores. Customer response to the introduction of Evolution Fresh juices in each of these channels has been quite strong. In Starbucks retail stores alone, early results are pointing to a doubling of units sold as compared to the products Evolution Fresh juices are replacing.

We will be employing all facets of the Blueprint to make Evolution Fresh the success we know it will be. Our U.S. retail store footprint, our social and digital media expertise, our Starbucks loyalty card program, our growing Channel Development muscle, and our more than 100,000 U.S. store partners to promote trial and awareness of Evolution Fresh juices in our stores. We plan to have Evolution Fresh beverages available across the Starbucks U.S. retail store system this summer and to leverage our new CPG distribution capabilities and roll out Evolution Fresh into multiple CPG channels over the next 18 months. We are extremely encouraged by the channel partner and customer response to the Evolution Fresh brand and platform and are more convinced than ever that Evolution Fresh will become another billion-dollar Starbucks brand.

Today, innovation and a laser focus on leveraging our social and digital media capabilities and delivering best-in-class products and a materially enhanced customer experience is part of Starbucks' DNA at every level of the organization and around the world. We are connecting more deeply and interacting more often with more customers than ever before in our history.

Starbucks business and the Starbucks brand have never been stronger, and we are both uniquely and ideally positioned to go after the enormous opportunity that lies ahead as we execute against our Blueprint for Profitable Growth in a disciplined and deliberate fashion all around the world.

On a personal level, I cannot be more excited, enthusiastic or optimistic about our future, and I thank the over 200,000 Starbucks partners who bring the Starbucks Experience to life every day.

I'll now turn the call over to Troy.

Troy Alstead

Thanks, Howard, and good afternoon, everyone. You can see based on Howard's remarks why we are so optimistic about what the future holds for Starbucks, and why we have communicated such aspirational growth targets for this year and beyond.

But before I move to that, I'd like to take you through our fiscal second quarter results. Today, we reported second quarter records for revenues, operating income and earnings per share. We continue to drive strong incremental traffic despite lapping significant comp growth from the past 2 years, and we continue to offset uncontrollable headwinds, particularly the struggling global economy and high coffee costs with operational efficiencies and innovation.

Our second quarter consolidated net revenues were $3.2 billion, up 15% from $2.8 billion a year ago. Revenue increase was primarily driven by a 7% increase in global comparable store sales, attributable to a 6% increase in traffic and a 1% increase in average ticket. Higher channel development revenues and solid gains in our licensed stores also contributed to the global revenue increase.

Operating income for the second quarter reached $430 million, a 14% increase over last year's second quarter. Consolidated operating margin was 13.5%, which was equal to the second quarter of last year. Higher commodity costs, primarily coffee, had a negative impact on operating income of $64 million and added 200 basis points of pressure on operating margin. Primarily offsetting this was increased sales leverage throughout much of the P&L, driven by our strong top line results.

Our consolidated G&A spend for the second quarter was 6.5% of net revenue, flat for the second quarter of last year. 3/4 of our total $207 million expense in G&A in Q2 are presented in our financial statements in other, and as a percentage of total net revenues, declined slightly over the second quarter of last year. This was largely made up of support expenses such as IT, marketing, finance, partner resources and other global functions.

This quarter also included investment to launch our Evolution Fresh brand. The remaining 1/4 of our G&A expenses lie within each business segment, and our expense is directly related to the support of those businesses. Our total business unit G&A as a percentage of total net revenue increased slightly over last Q2, due largely to growth in our Channel Development segment as we ramp up support of this high-growth business.

Earnings per share grew 18% to $0.40 for the second quarter, which included approximately $0.02 from the income benefit of a court ruling related to recognition of unredeemed stored value cards. You will see this reflected in the Interest Income and Other line. Finally, we continue to generate strong cash flow to fund capital expenditures and growth initiatives while returning capital to shareholders.

Let me now discuss our Americas business, which continued its excellent performance in the second quarter. Net revenues of $2.4 billion were 10% higher than the second quarter of last year, driven by strong comps of 8%. Comp transactions grew 7%, which despite still cautious consumer spending, was positively impacted by continued operational excellence in our stores, accelerating the benefit of the My Starbucks Rewards program, further success with our warming program and incremental visits due to the launch of Blonde Roast coffee.

Speaking of Blonde Roast, one of the highlights in the Americas in the second quarter was its launch on January 10 in the U.S. and on February 7 in Canada. Blonde Roast has been well received by both partners and customers. As we expected, we are seeing new customer occasions from our brewed coffee drinkers as they now have an offering to satisfy their desire for something lighter in addition to their usual visits. And whole bean sales in our stores have also increased, with 70% of Blonde Roast whole bean in-store purchases being incremental to previous purchasing patterns. It is still very early, but all these signs are encouraging for the future contribution of this great new offering.

Operating income also grew by 10% in the quarter, and we saw a slight improvement in operating margin despite the negative 150 basis point impact of higher commodity costs, mostly coffee. Store operating expenses as a percentage of company-operated store revenue were up slightly year-over-year. This is due to increased marketing expenses in support of the Blonde Roast launch and increased bank fees related to debit card transactions stemming from recent legislation.

We have talked a great deal about our success in driving efficiency in our stores and the resulting improvements to our margins. Our store operating expenses in the Americas has improved 380 basis points from 2009 to the first half of this year. We continue to relentlessly pursue opportunities for further efficiencies. We're also actively analyzing opportunities to invest in operating expenses such our labor and marketing spend to further drive the top and bottom lines.

Looking forward, the pipeline of new offerings in our stores remains robust. We've already begun adding Evolution Fresh bottled juices in our Seattle area stores, and we'll expand to additional cities throughout the year. In July, we will add Refreshers ready-to-drink and handcrafted beverages, and in the coming months, we will begin selling Starbucks K-Cups in our retail stores to meet our customer's in-home brewing needs.

Outside the U.S., we're seeing solid comps and margin improvement in Canada as we're leveraging the learnings from the U.S. in the past few years. And in Latin America, the markets continue to perform well with strong comp growth in a long runway for additional stores. In fact, our comp growth in Brazil is outpacing our expectations, which is evidence that our stores and brand continues to be well received.

In Europe, Middle East and Africa, the second quarter results reflect both the investments we've begun making in the transformation of the region, as well as the macroeconomic headwinds that we and others face there. While net revenues grow 14% year-over-year, the bulk of that was due to the consolidation of the Switzerland and Austrian markets. Same-store sales for our company-operated stores in the region were negative 1% for the quarter, first negative comp growth in this region since 2009.

And while we comped positively in the U.K. and France, it wasn't enough to offset softness in Germany and Ireland. We are not immune from the high unemployment and fragile consumer confidence across the region, but just as in the U.S. 3 years ago, we're actively working to overcome those challenges.

In March, our EMEA time launched what we are calling the Renaissance Plan, our blueprint for turning around performance in that important region, which is modeled after the success of our transformation agenda in the U.S. Already, our efforts are resonating with customers. In the second quarter, we saw the largest quarterly gain in our customer satisfaction scores in more than 2 years. We're sharpening our focus on in-store execution, including taking the steps to retrain all partners on preparing the perfect beverage each and every time. We're also adapting our approach to become more locally relevant, including adjusting the U.K. tall latte standard to include 2 shots of espresso, offering a second varietal of espresso to meet French customer needs and personalizing each experience by writing customers' names on cups.

Adjustments are being made to the long-term business model, including revamping our distribution model in the U.K. and increasing visibility to our strong digital marketing capabilities. These changes were largely the result of extensive customer research in the region and are a beginning step in the long road of correcting our course there.

EMEA saw an operating loss of $5.5 million in the second quarter, higher implementation costs as we work through the transition to what will be a much more efficient distribution model in the U.K. contributed to the loss. Additionally, we lost leverage in our store opening expenses in parts of Europe due to softer sales, and our G&A grew to support the new vision for the region.

The turnaround story in EMEA will be told over many chapters in the coming quarters and years. With our deep capabilities and sharpened disciplined honed over the past few years, we are confident the story will have an ending that is familiar to those who watch the U.S. turnaround unfold.

Howard spoke to the positive momentum we're experiencing in China and Asia Pacific, and we're seeing that momentum flow through to the P&L. Net revenues in this region increased 32% over the second quarter of last year, driven by a balanced equation of new stores and same-store sales growth. 18% comps in our company-operated markets were comprised of a 14% increase in transactions and 4% increase in average ticket. Combined with the 18% comp growth last Q2, this puts our 2-year comps at 36% and is evidence of how much the brand is gaining consistent traction with consumers across Asia. Including our joint venture and license markets, all 12 countries in the region comped positively, driven by growing brand awareness and acceptance throughout the region, coupled with beverage, food and merchandise offerings linked to cultural events like the Chinese New Year.

Speaking of China, we once again saw comps exceed 20% in the second quarter. The Starbucks brand is resonating with the Chinese consumer, and we are in the early stages of building a very loyal base. In fact, we celebrated our one-year anniversary of the My Starbucks Rewards program in China in Q2, and we already have more than 0.5 million members across a base of 330 company-operated stores.

Operating income in Cap [ph] was also strong, increasing 59% to $70 million in the second quarter. Operating margin grew 650 basis points to 39.8% despite higher commodity costs of approximately 140 basis points. This quarter's results also were impacted by the favorable timing of income for certain of our joint venture operations, which we do not expect to occur in the future.

Our team is continuing to do an excellent job of flowing our growing revenue through to the bottom line despite continued inflationary pressure in key Asian markets like China.

I'm going to move now to results from our Channel Development business. As a reminder, the name of the segment changed from Consumer Products Group or CPG but still represents the same business. The second fiscal quarter was an active one, as we marked the one-year anniversary of the transition of our packaged coffee business to a direct distribution model, rolled out several new products including Blonde Roast Coffee and Refreshers ready-to-drink beverages and announced even more innovative products that will be available later this year.

Our IRI-syndicated data revealed strong performance for many of our channels in the second quarter, and the most recent numbers show trends that are improving further. For the 4-week period ended April 15, Starbucks' dollar share of premium coffee continued to increase with packaged coffee sales and food, drug and mass channels, up more than 17% over the prior year. This was aided by Blonde Roast, whose distribution reached more than 50% ACV in less than 3 months and hit 90% ACV in our Tier 1 accounts.

The strong customer response we've seen in Blonde Roast Coffee, both in the grocery aisle and on retail stores, has given us another proof point that the product innovation and go-to-market strategies we put in place are working as intended.

In the premium single cup market, Starbucks has rapidly grown from no presence in the segment to a 21% share in just 2.5 years, driven by the continued growth of Starbucks VIA Ready Brew and the recent strong launch of Starbucks K-Cups. VIA sales were up 54% in the most recent 4-week period as we increased both SKU count and distribution. And K-Cups continued to see gains with the 15% share of the premium single cup market and more than 230 million cups shipped since their launch 5 months ago.

We also recently announced the introduction of our Verismo premium single-cup brewing system, which will be available this fall and will allow users to make both Starbucks quality of special beverages and brewed coffee at home. The addition of the Verismo system to our portfolio and product offerings once again demonstrates our commitment to provide our customers with premium coffee whenever, wherever and however they like it. We're also demonstrating product innovation in our ready-to-drink product line as we are now one month into the launch of Starbucks Refreshers in the CPG channels, a line of naturally flavored drinks made from real fruit juice and green coffee extract.

The results of our Channel Development business was strong once again, with total net revenues of $322 million in Q2, an increase of 57% over the same period last year. The addition of Starbucks K-Cups accounted for more than half of the increase, with the transition of the packaged coffee business in-house among other drivers of the revenue growth.

Channel Development operating income for the quarter was $82 million, a 22% increase over the same quarter last year. Operating margin of 25.4% was as expected, 740 basis points lower than the same quarter last year. Higher commodity costs once again had a significant impact in the second quarter, accounting for 620 basis points of margin deterioration. As we enter the second half of fiscal 2012, we remain solidly on track with our plans for the Channel Development business and are focused on executing against the diverse opportunities for growth we have in our portfolio.

Now that we're halfway through fiscal 2012, I'd like to provide an updated outlook for the year. Given the strength of the first half of the year, revenue percentage growth over last year is now expected to be in the low teens. Due to the fact that we have now lapped the transition to a direct distribution model for our packaged coffee business, our balance of year trends will be modestly lower than the first half.

We expect company-operated comparable store sales to grow at a mid-single-digit pace. We continue to expect operating margin to grow by 50 to 100 basis points over our FY '11 non-GAAP results, driven by a second half uptick in margins due to easing commodity cost pressure. We continue to expect the Americas segment to improve slightly over last year's 20%. We now expect EMEA, while remaining profitable for the full year, to decline compared to last year due to the current economic climate in many of our markets there and due to our continued investment to support our turnaround efforts. We're now targeting CAP to end the year with operating margin of approximately 30% to 35%, recognizing the consistently strong results this region continues to deliver. And finally, we're targeting Channel Development operating margin in approximately 25%, down from prior years due largely to higher commodity costs.

As we have generated considerable momentum in our business, we're raising our expectations for earnings per share growth for the second half of fiscal 2012 to a range of 25% to 29% over last year's second half, excluding non-routine gains. For the third quarter, we're targeting EPS in the range of $0.45 to $0.46; and for the fourth quarter, we're targeting EPS in the range of $0.46 to $0.48. Our full year EPS target range is now $1.81 to $1.84, representing 19% to 21% growth over the $1.52 EPS in FY '11 excluding last year's non-routine gains.

The expected impact of higher commodity costs in FY '12 remains unchanged from what I previously guided, approximately $230 million. We anticipate an approximately $0.06 unfavorable impact to EPS for the second half of the year. While I will give targets for the next fiscal year, 2013, during our third quarter earnings call, I do want to give you a look at what we're expecting for next year as a result of declining coffee prices. We're now approximately 11 months price-protected for fiscal 2013 at prices favorable to 2012. This should equate to an operating income tailwind somewhat higher than $100 million. It's important to note that we expect to reinvest at least half and perhaps more of this commodity upside back into the business. We're looking to further build infrastructure to accelerate growth in China, we'll continue investment into the transformation of Europe and as we did in New Orleans in October of 2008, we're holding a global leadership conference this October in Houston that is expected to cost between $35 million and $40 million.

Moving on to store counts. Given the strength of our business and new store performance, we are increasing our new store target to approximately 1,000 net new stores globally. We're accelerating new store growth in the Americas, now expected to add approximately 500 net new stores and also accelerating in CAP, which allowed approximately 400 net new stores. We had no change to our EMEA estimate of 100 net new stores as we're largely focused on the improvement in our existing assets in that region.

The new store growth and a record number of renovations will drive capital expenditures of approximately $900 million in FY '12. We continue to expect the tax rate of approximately 33% for the year, and marketing is still expected at 3.5% of revenues, with increases in each quarter versus the prior year.

The second quarter just ended reflects the fundamental health and relevance of the Starbucks brand, the continued strong trends of the Starbucks business and our ability to drive growth in the top and the bottom lines. The quarter underscores our financial discipline, deep capabilities and unwavering commitment to overcome the challenges we face in the business from the economic crisis in the U.S. beginning in 2008 to the unprecedented commodity costs of the past 2 years and now to the macroeconomic turmoil in Europe.

The quarter demonstrates our deep commitment to the core coffee category, including introduction of Blonde Roast to provide existing and new customers a new way to experience Starbucks coffee and to provide the company access to a greater share of the overall coffee category. The quarter deepens our leadership in the premium single-cup segment, with a continued strong growth of VIA, the rapid acceleration of Starbucks K-Cups, the expanded partnership with Keurig on the Vue platform and the announcement of Starbucks Verismo.

The quarter reflects our ability and commitment to drive growth in the current quarter and year, while also investing in the business and in focused innovation to plant the seeds of growth in China, in single-serve, in Blonde, in Evolution Fresh and in Refreshers, that will produce growth in revenues and profitability for years to come. And the quarter just ended once again demonstrates the passion and talent and dedication of our Starbucks partners all around the world.

With that, I'd like to turn the call back over to the operator for Q&A. Mike?

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Keith Siegner from Credit Suisse.

Keith Siegner - Crédit Suisse AG, Research Division

Just one quick question on one of the opportunities that we've talked about a little bit in the past. And Howard, you said coffee is at the center of everything you do. But to some extent, so is tea, and it continues to feel like a little bit of an untapped opportunity. And I know there's a new individual kind of in charge of tea. And I was just wondering if you have any thoughts about maybe what is the opportunity in tea, how should we think about that, and how are you approaching that opportunity either the rest of this year or into next year?

Howard D. Schultz

Thank you for the question, Keith. Let's level set [ph]. First off, Tazo, within the Starbucks family currently represents on its own $1 billion business in terms of its brand position, in terms of revenue from our store base and in CPG. The acquisition of Evolution is not only to expand and explore the opportunities within juice. But when I talked about this publicly, we spoke about the significant interest and the study we've done around health and wellness. Obviously, we think that the medicinal qualities and the efficacy of tea will play a very large role in the overall category of health and wellness at Starbucks. Today is not the day to talk specifically about Tazo and our future plans, but I can tell you that we recognize the unique opportunities we have with Tazo in multiple channels of distribution as part of our health and wellness initiative, and there'll be more about that in the months and quarters ahead.


Your next question comes from the line of John Ivankoe from JPMorgan.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

I just wanted to get a sense of timing of what's happening in EMEA. The transformational agenda in the U.S. obviously bore fruit very, very quickly, and it included some of your very substantial reorganization of the way that the overall division was managed. So I guess the question is how far along are you in the process, kind of deciding what you want to do in Europe, with being a smaller business but a more profitable business? I mean, I guess to some extent, that was the case in the U.S., be a possibility at least in the short term, and I think in the press release, you talked about new regional strategic initiatives. Is that the type of thing that's already at its peak in the P&L right now, or we could expect margins to increase or might they even get worse in the near term as you continue to invest and figure out what you want to do there?

Howard D. Schultz

John, this is Howard. First off, let's split off EMEA into 2 parts, the Western Europe and the Middle East. The Middle East market for Starbucks, in which we have hundreds of stores in the Gulf, is quite healthy, and we continue to feel very bullish about that part of the equation. With regard to Western Europe, let me walk you through what we've done in anticipation of the transformation of that business. First off, one of our most senior and most experienced executives and operators, who is at our side co-authoring the U.S. transformation is Michelle Gass. She has moved to become the President of that region, and she's living in the U.K. In addition to that, the largest company-owned market within that region is the U.K., and we've also moved one of our strongest retail operators from the U.S., Kris Engskov [ph], who is managing the U.K. business reporting to Michelle. I think we -- in a sense, we've seen this movie before, and I'm proud to say it had a very good and positive ending in terms of what we were able to do in the U.S. I think there are many similarities in terms of the downturn in the economy and consumer confidence. And I think that we all feel quite optimistic over the long term that we're going to be able to not only turn this business around, but it's going to be a profitable market for Starbucks. Having said that, the situation is very, very tough and it's not one Europe. The situation in Greece, the situation in Portugal, the situation in Spain, I can go on and on, and then just this morning, we wake up to the news of an announcement of a double-dip recession in Great Britain. So what we've said early on within the U.S. transformation is that we were not going to use the economy as an excuse for our inability to transform and succeed in that market, and we're not using it internally as well. But we can't ignore the headwinds. But I think the short version is that we have put in place a strategic plan that we feel is going to address the issues at hand, in many ways takes a lot of the proven successes we had in the U.S. with Michelle in the lead, and she is getting all the support and resources from the corporation. We also think that we should invest into the market in terms of innovation and be very strategic in how we're going to grow the market. But the short version here is that it's going to take a while. We are cautiously optimistic and we think over the long term, we will succeed in this market, but it's -- this is not going to happen overnight.


Your next question comes from the line of Greg Badishkanian from Citigroup.

Gregory R. Badishkanian - Citigroup Inc, Research Division

Just wondering maybe if you could talk a little bit about potential weather impact in the quarter in the U.S. and maybe how same-store sales trended or throughout the quarter or by geographic region or some other color based on that.

Howard D. Schultz

In all due respect, we do not allow weather to enter the equation of Starbucks comp store sales internally, and we're certainly not going to allow it to enter the conversation publicly. We are going to succeed in good and bad weather. I don't think the weather had any significant impact on comps. I think that 8% comps in the U.S. business on the backdrop of the economic issues is a stunning number. And to be honest with you, I was a little bit surprised to see some of your reactions in terms of disappointment.


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

John S. Glass - Morgan Stanley, Research Division

The Channel Development category has a number of moving pieces. I think you've actually added several even this past quarter and so it's very difficult, I think, to track it. So 2 questions, one is general and one is more specific. Generally, Troy or whoever would like to take this, could you sketch out maybe the next few quarters if there are major milestones in which pieces of these businesses should drop in? Or if you want to maybe just more generally talk about what you think the revenue from the Channel Development category ought to grow over, say, the next 4 quarters? That's the general one. And specific to that in the K-Cup business, it looks like the 230 million that you shipped in 5 months is a slight deceleration from the previous comments like on a monthly basis. I'm not sure if there's channel loading or that -- not. Can you talk about what the revenue associated with that was specifically? And I think before you said $0.03 to $0.05 accretion, this year, is that still the right way to look at that?

Troy Alstead

John, let me start with part of the answer, and then I'm going to turn it over Jeff Hansberry to take more of it. First of all, we have all along said we anticipate a $0.03 to $0.05 of incremental profit impact this year from Starbucks K-Cups, and then a quarter ago I said we expected, given the rapid acceleration and great customer response to that product launch, that we expected the top end of that range and that's still what we expect at this point in time for this year, given the launch as it's progressing throughout the year, right near the top end of that incremental impact is what we would expect. Now certainly, as we move into 2013 and with greater distribution, continued growth and velocity and at that point in time presence in the Starbucks stores we'd certainly expect an additional increment in 2013, and that's something will talk about a bit later. Channel Development continues to be our fastest revenue growing business, and I would expect that to continue to be true as we face the quarters and years ahead for quite some time. There's one mechanical element that everyone should remember, which is we have just as of one month ago lapped the point in time a year ago where we've brought into our P&L and onto our revenue line the packaged coffee revenues as we brought that business back in-house. And so that the consolidation impact will go away from this point forward, so there's a little bit of a trend difference that simply happens as a result of that accounting. But beyond that, Channel Development is progressing rapidly as a bright spot for us, and I'll ask Jeff to address more specifically some elements of his business.

Jeffery J. Hansberry

Thanks, Troy. Hi, John. So with regard to K-Cup, we actually shipped more K-Cups in the second quarter than we did in the first. We're very pleased with the progress that we're making on K-Cup and in fact, in the last 4 weeks versus the 4 weeks prior to that, we actually grew share by 210 basis points. So we're continuing to see a very solid ramp in our share growth. We're now getting to the point where we've got distribution built out -- actually continuing to build some additional distribution. We are now turning on our marketing and merchandising efforts. So we expect our K-Cup business to continue to grow going forward.


And your next question comes from the line of Jason West from Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just a -- I have question on the coffee side. You gave a number, Troy, of about $100 million incremental benefit on the commodity. That's a little bit lower than we might have thought, given how far coffee prices have come down. So can you talk a little bit about if -- I'm assuming the average for fiscal '13 is quite a bit above where the current price is on coffee. And could you talk about the outlook for pricing in the retail stores in light of lower prices on coffee.

Troy Alstead

Thanks, Jason. Yes, what we expect now is that, firstly [ph] we're past the peak of the year-over-year impact, negative impact on our P&L. The peak of that was really the first quarter. The second quarter also included quite an increment of extra expense due to commodities. And that will ease as we go through the balance of this year. There's still some incremental costs, but it will get a bit easier for us. We are now price protected about 11 months of our needs of fiscal 2013, while there's still some open position that it could impact cost for that year. That has given us fairly good visibility now into what that increment looks like. And that's what led to that estimate of at least $100 million benefit to our P&L next year. Now to your point, yes, our average cost in 2013 is higher than where the cost is traded on the open market today. And that's because, as we have said all along, we've been buying throughout this market and buying on the way down. And part of that is about giving us access to and ensuring the supply of the best coffee in the world. That's always our top priority when we're buying coffee. And the second priority is we're moving risk from the P&L and managing that long-term coffee exposure that has led us to that strategy of buying throughout and buying long. That also suggest to me that if coffee prices remain where they are today, I would expect tailwinds in 2013 as I mentioned earlier. And again, it remain where they are today. And that's not a prediction. I don't have that kind of crystal ball. But if they did, that would also suggest better coffee prices for us coming in 2014. So we see the light at the end of the tunnel on commodities, and we're looking forward to that turning around for us on the P&L.


And your next question comes from the line of Michael Kelter from Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc., Research Division

I wanted to ask about the unit development. You raised your guidance to 1,000 units, which was up a lot from last year's 100 or 200. Where do we go from here? For the Americas, for example, is that a stable number, 500, or is that the start of a ramp back up? And when you look beyond that to Asia and emerging markets more broadly, it looks like that's wide open to you. How quickly do you plan to ramp that up over the next several years, and what's the limiter?

Howard D. Schultz

Michael, it's Howard. I can't give you a specific number, but let me just share with you what kind of goes into our thinking in terms of the future. A few things. One is that we're quite encouraged that in the U.S., the stores that we've opened over the last 12 months and then in the last 24 are performing extraordinarily well in terms of a class of stores. And in many ways, as good as any new class we've seen in a decade. So any thought of saturation or inability to find quality real estate and continue to expand in the U.S. or for that matter, North America should be taken off the table. I think we're quite encouraged with what's going on in the Americas on a macro level in markets like Brazil. And we touched on that earlier in our prepared comments, we have less than 100 stores in Brazil, and we're seeing very, very strong sales results, and we're going to accelerate under Cliff's leadership the number of stores we can open in Brazil, and in addition to that, places like Argentina and others. We just had a meeting with our Mexican partner, and he feels very strongly that he too can accelerate his growth. And then you get to Asia and China, and we didn't speak specifically about India. But the prospect of having thousands of stores in China alone is no longer a statement that we don't -- it's not a dream. This is a reality. We are -- we've turned the corner in terms of the iconic nature of the brand, the position, the leadership team. And we feel very strongly that we're going to be able to do that effectively. And then John and his team are getting ready to open up India with really the #1 partner in that nation, which is Tata, and we should have great results there. So net-net, I can't envision in the coming years that we would open up less stores than we've just announced and feel very good about the teams that are in place and the trends that are in place. And having just returned from China last week, which was just an extraordinary trip, eye-opener for all of us, I think we are on the cutting edge of becoming really one of the most admired Western brands to enter China in a very long time.


Your next question comes from the line of Sara Senatore from Sanford Bernstein.

Sara H. Senatore - Sanford C. Bernstein & Co., LLC., Research Division

I want to go back to Europe, understanding that Middle East and I think that Eastern Europe probably are, as well, are pretty strong for you. Is there anything -- the one thing -- the one distinction between Western Europe and the U.S. a couple of years ago is that you're such a dominant brand and retailer in the U.S., whereas in Europe, it feels like maybe it's a little bit more competitive. So can you just talk broadly about that market and whether or not structurally, there are differences there that might make it harder for you to get margins up? And likewise, whether or not it says anything about how competitive maybe the consumer products market is, given that my sense was that the Krueger partnership would be particularly well-suited to Europe.

Howard D. Schultz

I mean, thank you for the question. That's Cliff who was the resident U.K. person with that around the table and used to run that region for us. So Cliff, you want to take that?

Clifford Burrows

Yes, I'd like to take it. Thank you, Sara, for the opportunity. I think all the things you said about the dominant position we've had here and the competition in Europe is very, very true, and the economy across each of the markets we're all too well aware of. In each of the markets now, we have very strong leaders. And we, through Michelle, have a very strong president. And we know what we need to do there, and I believe that the team are equipped to do that. And making local -- ourselves locally relevant, whether that's the strength of the coffee in the U.K., or the varietals in France, the fruit assortments in each of those markets, is really the key to this because as you say, very competitive. We focused totally and very intensely on the U.S., Michelle was my business partner at that time as we focused market-by-market here in the U.S. And now that segment tends to come to vary [ph] in Europe, and it is going to have to be country-by-country to beat local competition. And sometimes, that is national chains and sometimes that is very local players. But I think they are very well equipped to do it. And I would just make a comment, having been in the U.K. recently, that places like London are still thriving because of global money and just the strength of those economies. When you get outside of the main cities, it is quite depressing at the moment with streets upon streets of shops with for sale and closure signs, which I think just goes to show how deep that recession is in the U.K. And they are going to do hard work but they're well equipped to do it. I'm absolutely confident that the relevance of the Starbucks proposition from the quality of the coffee to the third place to the people bringing it to the customer, they'll have a great experience, and we will win in each of those markets over time.


Your next question comes from the line of David Palmer from UBS.

David Palmer - UBS Investment Bank, Research Division

I too have a question on Europe. I know you have a long-term goal of reaching mid-teens margins in that division, and you're talking about certain investments that you're making in this year. Is the thought that some of these bigger margin improvements towards these ultimate goals can really begin in earnest in fiscal '13? And separately, as we think about your business, oftentimes, McDonald's will talk about things that it can do almost a Plan B from its own marketing when things get tough to stabilize sales, maybe give up a little bit on the margin but also create a little bit of a floor on sales. Is there a Plan B for Starbucks when things get tough? Are there things that you can do to help your business in Europe?

Troy Alstead

Let me at least take the first part of that question. And I would just say that the investments we're making in Europe are very much about addressing the critical issue we face in the consumer environment at this point in time. And what we're seeing is a very quick response to that. Our consumer -- customer satisfaction scores improved more meaningfully in the second quarter in the U.K. than they had in years. So we know that reaction is already happening. I would expect that the payback would produce and come over time. And I would also react a little bit to your words of the goal of mid-teen margins in Europe. We don't have a goal. We actually have a plan to get to mid-teen margins. We have a vision toward the elements and how that margin march will happen over a period of time, including improvement in top line through our engagement with customers, a disciplined focus on the middle of the P&L as a part of that effort, improvement in the overall infrastructure, supply chain, G&A and otherwise over time. So we have a very well-thought through plan that we are as confident as ever. What we can't control and predict it so much is the macro environment but needless to say, our plan A is approaching investments in Europe both from customer side, the P&L side and the infrastructure side remains the same and I think you'll see us approach that consistently from here forward.

Howard D. Schultz

Let me add one thing. I think many of you were around 3 years ago, 4 years ago on conference calls just like this when the headlines around Starbucks and the inability of us potentially to navigate through the financial crisis and, to be honest, some self-induced mistakes. I don't know how many of you would honestly say today that you thought that we would be able to not only transform the business but in fact, produce record revenue and record profits. I will tell you unequivocally, and you can hold us to this, that we will turn the European business around in the same way that we turned the U.S. business around. I can't tell you when and I can't tell you with specificity what the margins are going to be but we will emerge as the leader in Europe the same way we emerged as the constant leader in the U.S. The advantage that we have going forward in Europe versus the U.S. is that we have fantastic JV partners in many of these markets, who will understand consumer behavior based on living in those markets, have the leverage and the understanding of how to navigate through the storm, they've seen it before. We also have less of a store base so the problem is not as big. And then lastly, we are looking for ways to leverage licensed partners in very unique types of real estate. For example, we just opened in train stations in France with a license partner, and we are opportunistically looking at ways to offset the burden on the P&L that we have today with many of the company-owned stores based on license opportunities that we have not yet taken advantage of. The one thing we learned in the U.S. that if we would've known, we would've invested heavily ahead of the problem, which we did not do. And so we're confident we will turn this around, and we're going to be opportunistic about our abilities and when we come out of this, we're in a stronger position. But please, I don't want anyone to leave this phone call with any feeling whatsoever about the lack of confidence that we have as a management team, with Michelle and Kris [ph] in that region, that we will absolutely turn the situation in Europe around despite the significant headwinds that we are facing.


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

Sharon Zackfia - William Blair & Company L.L.C., Research Division

I'm going to shift back to the Americas, and the comp obviously was very strong and has been very strong for quite a while. And Troy, when we saw you recently, the day part still seemed like it was relatively skewed to the morning as it has been forever. So I'm just curious on throughput in the morning, what you're seeing there? Obviously, there's continued improvement getting those lines to move faster. How much faster we can go, kind of where the ceiling is on the morning?

Clifford Burrows

Sharon, this is Cliff. Let me just set up the day for you because you're absolutely right, morning remains our strongest period, and we continue to see increased transactions in the morning. But I'm delighted to say we are seeing growth in all day parts, and that is very encouraging because we are focused on building capacity in the morning to deal with the increasing customers coming through. At the same time, as you know, we've worked with our food programs to stretch some of those other day parts whether it's bistro boxes in a lunch program or Cake Pops in the more afternoon treat. And as you know we're trying a few things to lengthen the day and for the evening. And I have to say very encouraged by all of those. Since time, the work we started 3 years ago, 4 years ago now with lean and improving our efficiencies so that we can get people through more quickly while paying much more personal attention to them, we have -- still have considerable runway. And although we're achieving really record transactions every day on our New York stores, we are confident we can continue to do that. So we'll grow our transactions, I'm confident, and we'll continue to focus on food attach for all day parts. So we have a lot of runway ahead of us.


Your next question comes from the line of Bonnie Herzog from Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

I wanted to ask a question about your packaged coffee business. And just in terms of what you're seeing, I guess what appears to be moderating pricing yet faster volume growth. What are the drivers of this? And then do you think you're achieving the right balance here between pricing and then volume growth for this business?

Howard D. Schultz


Jeffery J. Hansberry

Bonnie, it's Jeff Hansberry. We think that we are, and we have seen recent continued share growth in the Starbucks packaged coffee brand. And that coming through Q2, it's very significant and important for us at this milestone quarter as we cycle through our first full year of a direct model, and at the same time moved into Starbucks Blonde Roast, which represents an opportunity for us to better serve a broader segment of coffee customers outside of our retail stores, where we're seeing growth driven by not only the introduction of Blonde Roast but also we have grown share by over 100 basis points during the quarter -- during a period when we faced a significant competitive launch by the Gevalia brand. So we feel like we're striking the right balance, maintaining loyalty with our current customers and bringing new customers to the Starbucks franchise while maintaining and defending our premium position.

JoAnn DeGrande

So that concludes our call today. We're out of time, but we thank you all for joining us, and we'll speak to you again in late July for our Q3 earnings call. Have a great evening.


This concludes today's Starbucks Coffee Company's Second Quarter Fiscal Year 2012 Earnings Conference Call. You may now disconnect.

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