Starbucks Corporation (NASDAQ:SBUX)
Business Update Call
January 7, 2008 5:30 pm ET
JoAnn DeGrande - IR
Howard Schultz - CEO
Martin Coles – COO
Peter Bocian – CFO
Matthew DiFrisco - Thomas Weisel Partners
Sharon Zackfia - RBCCapital Markets
David Palmer - UBS
JoeBuckley - Bear Stearns
Andrew Barish – Banc of AmericaSecurities
John Ivankoe - JP Morgan
Howard Penney - FBRCapital Markets
Mitch Speiser - Telsey Advisory Group
Larry Miller - RBCCapital Markets
Jeffrey Bernstein - Lehman Brothers
Marc Greenberg - Deutsche Bank
I would like to welcome everyone to theStarbucks Coffee Company conference call and webcast. (Operator Instructions) Ms. DeGrande, you maybegin your conference.
Thank you. Goodafternoon and thank you for joining us today. This is JoAnn DeGrande, Director of Investor Relations atStarbucks Coffee Company. We havescheduled 45 minutes for today’s call, which will include forward-lookingstatements about recent trends inthe company’s businessand the company’sfuture business plans, initiatives and objectives.
These forward-looking statements arebased on currently available operating, financial and competitive informationand are subject tovarious risks and uncertainties. Actualfuture results and trends may differ materially depending on avariety of factors including, but not limited to: coffee, dairy and other rawmaterial prices and availability; thesuccessful execution of internal performance and expansion plans; fluctuations inU.S. and international economies and currencies; theimpact of initiatives by competitors; theaffect of legal proceedings and other risks detailed inthe company’s filingswith the Securitiesand ExchangeCommission, including therisk factor section of Starbucks annual report on Form10-K for the fiscalyear ended September 30, 2007. Thecompany assumes no obligation to update any of these forward-lookingstatements.
Before I turn thecall over to Howard Schultz, let meremind you that we will release Q1 fiscal 08 results on January 30; therefore,on this conference call we will not discuss financial results nor will wecomment on it inQ&A.
Thank you, JoAnn. Good afternoon and thank you for coming together soquickly. This is Howard Schultz, andwith me today isMartin Coles, our Chief Operating Officer and Peter Bocian, our Chief FinancialOfficer. We know for many of you it’slate in theday so we’ll keep thiscall relatively short. But because whatwe announced this afternoon is extremely important, we wanted to communicatedirectly to you about it.
As you can imagine, we arealso talking today to our partners and other groups who have astake in Starbucks’ successand its future. Please note that whiletoday’s call will bebrief, as JoAnn said, on January 30th we arescheduled to report our results for thefirst quarter of 2008. I intend to usethat opportunity to both review our performance for thequarter as well as to provide you with more specific details of our plans goingforward.
My goal today is to give you some insight into thereasons behind theactions we have taken and preview thedramatic and exciting changesthat are to come. As you saw inour press release, we’re going to implement aseries of strategic initiatives designed to increase shareholder value byrefocusing the companyon our customers and our relationship with our people.
So toput it simply, we aregoing back to what hasmade Starbucks and theStarbucks experience sounique; ethically sourcing and roasting thehighest quality coffee inthe world; therelentless focus on customers; thetrust we have built with our people; and theentrepreneurial risk-taking, innovation and creativity that arethe hallmarks of oursuccess.
For starters, let mestate unequivocally that Starbucks hasbeen, and continues to be, ahighly successful company. If I look atour company from apersonal perspective, when we went public inJune of 1992 we did sowith 119 stores and now Starbucks is one of themost recognized and respected brands inthe world, with over15,000 stores in 43countries serving 50 million customers aweek. We have annual sales of over $10billion and operating income well inexcess of $1 billion.
During these past several years, we did what many thoughtimpossible: we built one of themost recognized and respected brands inthe world. But despite allof that, and thestrength of our brand and our historic financial performance, we became insome ways victims of our own tremendous success.
We face challenges today, including theslowing economy and higher commodity, labor and health care costs, but themost serious challenge we face is of our own doing. We areemerging from a periodin which we invested ininfrastructure ahead of thegrowth curve; although necessary, itled to bureaucracy. We will now shift ouremphasis back onto customer-facing initiatives, better aligning our back endcosts with our business model.
I’m here to tell you that just as we created this problem,we will fix it. We arechanging ourorganization now and for thefuture. Itwill take a good dealof work and some time, but itwill happen, starting today. We willseize the enormousopportunity that lies ahead. We willhave the courage toexecute bold new ideas that will drive significant and needed changes.
Theunique nature of theStarbucks experience hasalways been evident inthe quality of ourcoffee and the qualityof our people, both of which aresuperior. But italso must be clear inthe way our storeslook and feel, in ourcommitment to our partners, inour involvement in thecommunities where we operate stores, as well as where our coffee comes from,and most importantly, inthe way we interactwith our customers.
To effect thechanges that areneeded, the boarddecided that I should take on theadditional role of Chief Executive Officer. I would like to payspecial tribute to Jim Donald, who is leaving thecompany. As you know, hehas been apassionate and tireless advocate for Starbucks and I amgrateful -- the entirecompany is -- for what hehas contributed andwish him nothing but thevery, very best in thefuture.
Inassuming the CEO roleagain, I will beresponsible for the overallstrategic direction and I will have thepredominant focus on every part of thebusiness, especially theUS businessthat touches thecustomer, people, products and places. Inunifying our entire organization to belaser-focused on thecustomer and the storeexperience, I will beworking closely with Martin Coles, who will handle theoversight of those parts of thebusiness that are moreoperational in nature.
Let meshare with you, inbroad strokes, about our strategic initiatives to drive thetransformation of Starbucks. We havethree fundamental pillars:
First, improving thecurrent state of the USbusiness. That includes how we engageour store partners and thetraining and tools we offer to them to beable to focus on thecustomers. Itwill include new innovations and new products; and most importantly, we intendto slow our pace of USstore openings. We also intend to close anumber of under-performing USstore locations. This will enable thecompany to renew our focus on our store level unit economics. We will also bebetter able to focus our efforts on improving thecustomer experience atcurrent stores, as well as to take acloser and more detailed look atour plans by market to ensure we arecapitalizing on theopportunities we have and not cannibalizing our existing stores.
Second, we need to reignite theemotional attachment with our customers, returning to our coreand restoring theconnections our customers have with Starbucks, our coffee, our brand, ourpeople and our stores.
Unlike many other places that sell coffee, Starbucks built theequity of our brand through theStarbucks experience. Itcomes to life every day inthe relationship ourpeople have with our customers. It’s notjust atransaction. By focusing again on theStarbucks experience, we will create arenewed level of meaningful differentiation and separation inthe market between usand others who areattempting to sell coffee.
Third, we will build for thelong term and this hastwo distinct pieces: we need to realign our organization and streamline themanagement of theorganization to better support customer-focused initiatives, ensuring ourplanning and support functions, from back end ITsystems to store operations, arefocused on what’s most important: thecustomer and theStarbucks experience.
Our international plans arecritically important and asignificant priority. We will redeploysome of the capitalthat we had originally earmarked for our USstore growth this year to further accelerate expansion and profitability of ourinternational business. We need to apply thesuccesses from keyinternational markets to theUS, learningfrom markets such as Canadaand the UKwhich have both enjoyed strong performance this past year.
As I have told you inthe past, therecontinues to be anenormous opportunity for us internationally and we arejust at thebeginning of capitalizing on it, with only 5,000 stores outside of theUS. I encourageyou to keep a close eyeon this part of thebusiness. It isgrowing significantly insize and importance to us. It’s very exciting that our brand hasreally become iconic interms of its status around theworld and is celebrated inevery market where we have opened.
Taken together, this agenda will transform Starbucks for thefuture by renewing our focus on coffee as our coreand connecting and concentrating our efforts allover the world ondelivering aconsistent and quality Starbucks experience that I can assure you will besecond to none.
I should tell you though that from aninnovation standpoint, some of this work hasbeen underway for many months. We have made agood deal of progress on new products and initiatives that will excitecustomers and we look forward to sharing these with you inthe months to come. I can tell you that you will seean acceleration inthe pace ofsignificant innovation around thecore coffeeexperience.
Looking ahead, thereality we face is both challenging and extremely exciting. It’s challengingbecause there are nosilver bullets and there areno overnight fixes. Itwill take time and it willmean some big changes.But losing sight of our mission of constantly focusing on thecustomer is something that we did on our own. As you know, we arenot alone in seeingthis kind of thing happen. Successful, fast-growing businesses can sometimesfind that their success hasunintended consequences. Growth and size can hide mistakes, but ata certain point itbecomes clear that changeshave to be made toreenergize the companyand move to thenext level of success.
We areat that point and weknow what we have to doto maintain our industry leadership inthe USand around the world. Putsimply, we know that theposition we hold in themarketplace today is not anentitlement of Starbucks. We must earn thetrust of our customers every day by how we conduct our business, how we treateach other as people and how we act as aresponsible corporate citizen.
We remain committed to providing health care for alleligible full and part-time partners, executing our best inclass corporate social responsibility efforts and encouraging our coffeesuppliers to participate inour cafe practices program inour origin countries.
Our commitment to allof this is absolute. Itis what differentiates us soclearly from others. Itis why our customers areproud to support our brand and itwill be thebasis for our continued success.
Let mealso acknowledge our other keydifferentiator: our people. I want to recognize theefforts and dedication of our great partners allaround the world whocontributed so much tothe success of ourcompany and are thedriving force of our future success.
Now before we open itup for questions, let metry and address some topics that I suspect areon your mind.
First, amI taking this position for thelong term? Theanswer is unequivocally yes. I have beenpart of leading Starbucks for more than 25 years. Itis a product of myvision and the boardbelieves I am thebest person to ensure that we restore thepassion, entrepreneurial drive and commitment to innovation that areour lifeblood. We have challenges butenormous opportunity, and I amexcited and enthusiastic about what we can accomplish together.
Thesecond is, how does today’s announcement tieback to my well-publicized February 14th memo? And didn’t I play arole in some of thedecisions that got us where we aretoday? Thefact is as I said then that I did; but having been here from day one of thiscompany and watching thebrand grow andflourish the way ithas, I was also thefirst to recognize that despite our terrific financial performance, thecompany’s heritage was being lost inthe shuffle. You have my commitment that those days of toomuch process and too much focus on theinternal are gone andthey will not return.
You’re also likely asking, what hashappened since last February? Well theanswer is a lot hashappened, but at thesame time not enough. Immediately when thememo hit people’s desks, we began planning and have developed apipeline of exciting initiatives that we will beintroducing in thecoming months and we believe have thepotential impact of acategory builder like Frappuccino products or anew way for our customers to interact with us like theStarbucks card.
But overall, what this work made most clear to us is that theincremental changeswe were making were simply not sufficient, particularly inlight of rising commodity costs and theeconomic climate we arenow operating in. We arecommitted to transformative events and you can beassured that I will bedecisive.
Another question I would expect is on everyone’s mindis the holiday seasonand how recent sales performance was adriving force intoday’s announcement; and if competition plays animportant role. Theanswer is that theroots of this changeprecede the holidaysand in fact, itis something the boardhas been discussingfor some time.
Infact, the steps we’retaking are notdesigned to address current trends but rather and most importantly, to positionus to stay ahead into thefuture and to do soby ensuring theStarbucks experience remains unique.
Our greatest challenge and opportunity is ensuring that werevitalize theromance, the theatreand warmth of experience that Starbucks haslong been known forand to ensure that we remain abrand that our customers areproud to be associatedwith because it isthat, coupled with offering thehighest quality coffee and products which hasset us apart -- way apart.
Finally, I expect you arelooking for some specifics of what our first quarter looks like. However asJoAnn has mentionedand I have reiterated, we will discuss that with you on the30th of January.
So withthat I hope that I have addressed many of your questions -- or atleast those that we can address atthis time -- and I’m happy to open up thelines for you.
Your first question comes from Matthew DiFrisco - ThomasWeisel Partners.
Matthew DiFrisco -Thomas Weisel Partners
Howard, you mentioned acouple of things and actually thetitle of the releasetoday is “Strategic Initiatives to Increase Shareholder Value”. Can you address some of those directinitiatives that you think haven’t been done by thecompany which might begoing forward? Specifically uses of cash flow-- is there ashare repurchase on deckhere of larger magnitude than already out there?
How does that work intandem with improving thecustomer experience? When I think thefirst thing there, or most people on their minds arethinking about theamount of price you’ve taken over thelast couple of years. Is this going backto looking for traffic rather than just driving incremental sales and lessaggressive on theprice potentially, by improving thecustomer experience?
Let metry and answer that but with thecaveat that thespecificity of thestrategic initiatives and how we aregoing to communicate that would bein more detail on the30th of January.
As we examine thecompany and some of thethings that I’ve said inthe prepared remarks,I think it is onething to look at theeconomy and look at therising commodity costs and use that as abuffer, but the truthof that matter is that I strongly believe that much of theproblem we have hasbeen self-induced.
Thestrategic developments of thecompany are going to bea renewed level offocus -- laser focus -- on theexperience that we have inour stores with our customers. To bespecific about that is that we aresourcing, roasting and blending thehighest quality coffee inthe world and we’renot in thetransaction business; we’re not aQSR, we’re not in thefast foodbusiness.
But there is renewed parity inthe marketplace thathas, for whatever reason, created new levels of convenience, new levels ofprice and people around Starbucks areintercepting our traffic by creating awareness and trial and trying to holdthose customers.
Thenew strategy of thecompany, which you will seein place, is to makesure that the level ofdifferentiation that we will create inour stores, from thepeople who are trainedbehind the counter, theknowledge they have about theway beverages should bemade and the totaloverall experience, will beheightened to thepoint where there will bea distinctive difference.
Unlike atechnology company or acompany that has tofile for a new patent,what we’re dealing with here is something that we created, and it’s humannature. What we need to dois make sure that we arereducing the level oftasks that we’re asking our people to doand focus on what’s most important. What’smost important is passionately committing ourselves to thecustomer experience and driving significant differentiation ineverything we do.
With regard to thestock buyback and things of that nature, I’ll give that to Pete and have himanswer it.
Yes, I think thepoint when you read therelease and with Howard’s comments, we believe that thebiggest impact on shareholder value is going to bethe top line revenuegrowth, market share and then op margin expansion associated with that. After that, I think you know we’ve beenactive in sharerepurchase programs inreturning theoperating cash flow tothe shareholders on amore immediate basis and we’ll continue to look atthat.
But clearly, we believe that theopportunity is around top line growth, op margin expansion and we think we’vegot opportunities to both growand opportunities in thecost area to fund theinvestments ourselves.
You asked one other point about theprice value relationship and let melink that to customer loyalty programs and things that I think give us acompetitive advantage inthe marketplace.
As you know, asignificant component of Starbucks customers hold theStarbucks card; a growingand large percentage. Even during thatlast year we’ve seen thecard outperform almost any other product we have inour stores in terms ofgrowth over last year sothe attachment andrelationship we have with Starbucks cardholders is very, very significant.
We strongly believe that there areunique strategic opportunities to mine that information and use thatinformation to create surprise, delight and loyalty programs that we have notused in thepast.
Theother piece of this, which I think is important to note, is that unlike anyother retailer or restaurant, we have other channels of distribution and wehave leading share inthose channels; a billiondollar business with Pepsi Cola with bottled Frappuccino and ready-to-drinkcoffee; we have theleading share of Starbucks ground and whole bean coffee inthe specialty coffeebusiness ingrocery.
Inyears past, we have never leveraged or threaded therelationship between where those products were sold and using those products asan opportunity tocross those customers’ buying patterns with therelationship that we can establish inour stores. Sowe think there’s aunique asset base that we can exploit for thebenefit of our customers to create new ways that we tiethose channels of distribution together with one voice, one brandposition.
We know from our own research that tens of thousands ofcustomers never come into aStarbucks store but areloyal users of bottled Frappuccino and whole bean coffee. We also know from research that many peoplewho have become Starbucks retail customers, have had their first experiencewith Starbucks through bottled beverages or ground coffee ina grocery store. Sothat’s a piece of thepuzzle that we’re going to really examine as we go forward.
Inaddition to that, we’ve expanded theready-to-drink business inJapan, Korea,Taiwan and mostrecently in China. Those businesses arefar outpacing theexpectations we had of them.
Your next question comes from Sharon Zackfia - RBCCapital Markets.
Sharon Zackfia - RBC Capital Markets
Your traffic trends really started to slow around thesame time as a lot ofretailers. As you look atthe business, how doyou try to disaggregate what’s economics versus self-inflicted? If you took theother side of the coinand said it was alleconomically based, what doyou think you have inyour arsenal to protect you against that going forward, from that kind of valueperception?
Well let mebe clear. Certainly, there’s very few consumer brandsthat have been or will continue to beimmune from thedownturn in theeconomy and the cloudthat’s hanging over theconsumer, but we’re not using that as anexcuse. I want to repeat, I strongly believe that wecan strongly enhance our business despite theheadwinds coming from theeconomy, commodity prices and we’re not going to use that as anexcuse.
I strongly believe that we have thepower inside our company to create new products, new innovation and newcustomer attachments that will insulate us significantly more than ithas inthe recent past. I’m not going to getinto those details, but you will seein thenear future that we arenot going to sit still, we arenot going to embrace thestatus quo. That we have products, thatwe have a level ofinnovation.
We have, we think, other assets that we can bring to bear,that renew therelationship that we have with our customers and create significant differentiationsin themarketplace. I’m not going to use theeconomy with your or our people as anexcuse.
Your next question comes from David Palmer - UBS.
David Palmer - UBS
I wanted to ask you about innovation. Itseems like it’s been awhile since your innovation hasresonated -- well thebeverage innovation , I guess there’s other dimensions to your innovation,particularly in thepast. Itseems like it’s been awhile since that innovation hasresonated significantly with customers. Itfeels like maybe theCinnamon Dolce Latte was thelast big hit and thatwas maybe two years ago.
When you’re looking atthe pipeline now and youtalked about more transformative events, more incremental innovation. Can you talk about theinnovation pipeline you have now and whether there aresome triples or homeruns inthat pipeline today? Or arewe looking at ayear where you’re going to have to getto work in building upthat innovation pipeline before we start to seesome of these things?
I think that’s avery good question. I think when Ireally examine thelevel of innovation that we have brought to our customers over let’s saythe last year or two,my conclusion and personal assessment is that thelevel of innovation hasbeen subordinate to line extensions. They have been line extensions, they havenot been innovation. They have not beentransformative. They arenot exciting. They areextensions of what we already do. And that’s fine, but that’s not what we’rehere to do.
What we have to dois bring new opportunities to themarketplace that areconsistent with the heritageof this company. I think for mewhen I’m asked aquestion about when is itcoming and how good is itgoing to be? For those of you who have knownme thelongest I’ve always tried to, ina way, under promiseand over deliver.
Soon this kind of call what I can assure you is this: I amnot satisfied, our team is not satisfied with where thebusiness has been and therelationship that exists inour stores with our customers. We aregoing to fix it. Is itgoing to happen tomorrow? It’s not andthere’s no short-term fix, there is no silver bullet.
But what I can promise you is there’s going to bea comprehensive focusthat hasn’t existing around here ina longtime. I remember what itwas like to start thecompany. I remember when we werefighting for survival, fighting for respect. When you succeed atthis level for solong, it produces not mediocrity,but you get alittle soft and we have to getback to what made this company great and that is having thecourage and thecuriosity and thecommitment to dothings that have not been done before. Thelevel of innovation that we have to bring to themarket is acombination of extensions of what we dobut transformative, big, bold ideas.
Your next question comes from JoeBuckley - Bear Stearns.
Joe Buckley - Bear Stearns
Areyou prepared to share with us today some of thenumbers on the storeopenings in theUS and theclosings in theUS?
Secondly, this does go back to your February memo, arethere things to undo like food, like some of theautomated processes interms of recapturing what you described on this call?
I appreciate thequestion. I think inboth cases we will bemore specific on the30th of January. I will saythat in my view there areno sacred cows to restoring thecompany to what itonce has been and we arecommitted to that. But we will havespecificity for you on the30th.
Joe Buckley - Bear Stearns
You used thephrase too much process, to much internal focus; I think you used thewords bureaucrat and bureaucracy being created. I’m not sure what you mean by allthat relative to what’s needed to growas you’ve grown.
Sure. Well I thinkthat during the earlystages of the growthand development of thecompany we were thequintessential entrepreneurial group of people. We did anything that had to bedone to advance thecause of the company. Inorder to grow thecompany at thelevel that we have, which is going from remember we had 100 stores in1987 and 100 employees; 20 years later -- 15,000 stores and 200,000employees. Inorder to achieve that, we have made significant and necessary investments inalmost every aspect of helping to build thefoundation: process, foundation, infrastructure, roasting plant, distributionand lots and lots of people, well-intended people.
I think along theway in doing that welost the focus that weonce had on what was most important: thecustomer. What I’m going to doand I’m going to do itswiftly, I’m going to realign theorganization, restructure theway we are configuredto make sure that thelayers of process and people that exist inthe company that takeus away from the focusthat we need -- thenimbleness and theentrepreneurialship -- is stripped away. That’s going to happen quickly.
Your next question comes from Andrew Barish – Banc ofAmerica Securities.
Andrew Barish – Bancof America Securities
On theinternational side of things, how areyou looking at shiftingsome of the capitalthat quickly? Is itnew markets or existing markets or areyou looking at buying inJV markets at thispoint? Can you give us alittle more color on that please?
Well thefirst that I’d say is forall of you that followthe company soclosely, I really want to reiterate, please take agood look at what we aredoing internationally. Itwasn’t too long ago,August of ’96 that we opened our first store inTokyo and many people did not giveus much credit for being able to expand thecompany we have internationally. Nowwith 5,000 stores in43 countries we have built I think anincredible foundation of growth and development and avery strong iconic status among people from China,to Spain to Greeceto Singapore, Mexico,you name it.
We believe that there is alot more we can dointernationally by refocusing our energy inthe organization onaccelerating that growth. Our JVpartners I think want to growmore. Agreat example of it inone our best performing markets inthe last couple ofyears has been Mexico. I think we originally thought that Mexicoat best might bea market of 150stores. Well we have north of – is it200 stores? – north of 200 stores inMexico and werenot even half way there interms of the growthand development. Theoriginal plan was not to growat that level.
Sowe believe that we can accelerate thegrowth of the companyand also begin to demonstrate to you and other constituencies amuch more significant level of profitability.
Candidly, when I look atwhere the market isvaluing the stock, we arenot getting the creditthat we deserve for what is going on internationally and it’s probably becauseyou don’t see thestores and you don’t seewhat’s going on.
But I have been in11 countries in thelast nine weeks and Ican tell you that itreminds me of theearly days of thegrowth of what’s going on inthe US interms of attachment, theexcitement and thefervor that’s going on when we open up stores innew and existing markets and we aregoing to take advantage of that.
Your next question comes from John Ivankoe - JP Morgan.
John Ivankoe - JPMorgan
Howard, I understand from anearlier question that you don’t want to talk about thespecifics of theclosure of the USstores, but I was hoping I could geta bit of agreater sense of why you think there’s acause for the closureof US stores? Whether itwas cannibalization that was more significant than thecompany previously understood or perhaps anentire market such as theMidwest for example? I don’t know if that is thecase.
Clearly itis nothing even close to entire markets sowe should move off ofthat. I think that inour ability to leverage and extend thebrand, real estate choices were made that I think outstretched therelationship that we could have with customers and sothe closures that we aretalking about arestores that have not performed inthe early stages andwe have enough visibility because of thelocation and what hashappened to recognize early that those stores arenot going to perform.
Thereason is I think in thepast we have not made these kinds of swift acute decisions, we haven’t been asdecisive as we can beand by closing those stores itwill allow us to focus on what is most important, thecore stores that wehave. It will enableus I believe to have ahigher level of unit level of economics and thespan of control that we have with our people will bemuch more efficient and we won’t befocusing on those stores.
But I think inlarge part it is wehave stretched thereal estate and theunderstanding that we have too far and we arejust going to bring itback.
John Ivankoe - JPMorgan
Is there afair characterization between drive-thru and non-drive-thru stores interms of what might beclosed?
No, this is not adrive-thru problem on any level.
I think there were two messages. One was around slowing theramp of new stores which is thebigger number and one was around taking theharder look under performing stores inline with what Howard said, and that is thesmaller number in thetwo pieces.
Your next question comes from Howard Penney - FBRCapital Markets.
Howard Penney - FBR Capital Markets
My question is sort of on thesame lines as John about thestore closings, but more specifically if you look atthe capital that wasallocated to the USbusiness and thestores that may not have hit your hurdles relative to thereallocation of thecapital -- if that is theright characterization -- to theinternational markets, can you talk about thereturns that you were getting on theshift in capitalthat’s going to go from not alow return businessbut maybe a highreturn business? Broadly speaking, can you just talk about thereallocation of your cash flows given theannouncement today?
We arenot going to give any new financial information as both JoAnne and Howard saidupfront. We did talk about on theQ4 call the relativerevenue to investment ratio and how we did in‘06 and the trend in’07, so we’ll look tokeep updating that. They were lower thanprevious returns, and therecognition of that is part of it; we want to make better decisions around thestores we doopen. We want to take swifter action if infact we did make a baddecision; and again, that’s thesmaller subset of this discussion. Thegoal is to optimize thereturn on capital with thebest stores.
Our next question is from theline of Mitch Speiser - Telsey Advisory Group.
Mitch Speiser -Telsey Advisory Group
As we talk about theexperience going forward, speed of service is always afocus of QSR, yet theconvenience of speed is very important, I think, with any type of anestablishment that fits broadly into this space.
Can you give us asense of where you prioritize speed of service through thistransformation? Hasthat been an issue, doyou think, among other issues? Is getting faster serving thecustomer a part ofthis realignment? Thank you.
Thanks for thequestion. Infact, that speed of service does not show up as aconcern of our customers. I think wereally have achieved theright balance between theexpected wait time and people feeling that theexpectation of that wait time hasbeen met. There’s no indication thatthat is in any way acore issue forus.
I think over time what we have done is perhaps we have usedfocus on efficiency to maybe too much of adriver and maybe that hashurt the experience; wewill examine that. But speed of service hasnot been an issue andwon’t be on ago-forward basis.
Your next question comes from Larry Miller - RBCCapital Markets.
Larry Miller - RBC Capital Markets
Does this announcement changeyour thoughts on thelong-term North American unit potential or arewe just talking about ashift in thepacing?
On thecannibalization, you talked about having less. How quickly can you guys slow thedevelopment plan or changethe developmentplan? I would have thought that most of‘08 is certainly done and fiscal ‘09 is probably done as well.
If unit growth is expected to slow and you guys accrete morecash, are you givingthoughts to maybe paying dividends and returning cash indifferent ways than you might have inthe past? Thanks.
I’ll take thefirst two. Theannouncement today about slowing USgrowth and examining those stores that need to beclosed should in noway drive you to thepoint where you think theoverall store target for Starbucks worldwide or inthe USare changing. I think that’s avery important point, I’m gladyou asked thequestion.
Our level of enthusiasm and thebullishness of what we feel we can dohas not changed. This is amoment in time wherewe’re going to reset thegrowth of the USbusiness but over the longterm you can beassured that we’re going to achieve our objectives.
Larry Miller - RBC Capital Markets
On thecannibalization side, itsounds like you want to open stores that have less cannibalization but I wouldhave thought that most of your fiscal ‘09 program is done atthis point. Is that not thecase?
First of allwe have historically had some of thebest -- if not thebest -- real estate portfolio of any retailer or restaurant inthe USand as a result ofthat have very strong and unique relationships with landlords anddevelopers. I think when we go to them as we have beendoing and talk about thethings we want to do, there will bea great deal ofcooperation. The ‘09number that you arereferring to is not inplay. I think we have astrong level of flexibility and nimbleness inthe process.
Larry Miller - RBC Capital Markets
Did that happen in‘08 as well?
Well thefact that we’re going to slow theUS growthdemonstrates that. I think you had aquestion about dividends.
As we look atit, clearly the slowergrowth in theUS is going to freeup capital, increase free cash flow. Theinternational won’t beas large as the USso when we communicatethe changeyou’ll be able to seethe differential andwhat it’ll increase free cash flow.
As I said before, we’ve been very active inshare repurchase. We’ll continue to lookat thedifferent avenues to use thefree cash flow todeliver shareholder value.
Our next question is from theline of Jeffrey Bernstein - Lehman Brothers.
Jeffrey Bernstein -Lehman Brothers
Interms of the USopening potential, can you talk about theimpact from theexpanded customer base? You aretargeting a broaderaudience, perhaps reaching out to alower income consumer. You guys talkedabout the averageincome going down, especially ina tougher macroenvironment. Did that have any impact on anultimate 20,000 unit target or perhaps whether you think that hasany near term impact from amacro standpoint?
On theinternational shift, just to getcomfort, I know you talk about how international is not getting as much creditas perhaps you’d like; I tend to agree with that. Can you give us comfort that theinternational growth is thebest alternative use of cash? Youmentioned the UKand Canada, butsome specific metrics to demonstrate that international growth is abetter opportunity than returning this cash. Maybe going forward you can givemore details on those international markets. Thank you.
I’ll have Pete answer thelatter, and let metake the firstquestion. It’s kind of perverse that wewere given so muchcredit over the yearsfor broadening thebase of our customer profile and now we’re going to bepenalized because perhaps some of those customers arebeing affected by theeconomic pressures.
Let’s first frame thesize of theprize. I think you’ve heard mein thepast say that if weexamine total US coffee consumption, we believe atthis time that we arecapturing less than 10% of theoverall coffee consumption opportunity inthe US. Sothere’s a very largemarket that we have yet to go after.
We know thepast history that we have broadened thebase of our customers, and one of themost interesting and again, one that we really have not focused on is we have avery large and growing Hispanic customer base that we did not have to thedegree we have it now,even five years ago.
We don’t have hard data to suggest whether or not thecurrent attrition is inany way related specifically to theeconomic issues that arefacing people who areearning less money, but I think you have to reach that conclusion atsome level. That though, and I think Iwant to say itagain, does not slow down theenthusiasm or theplanning that we have for thegrowth target of thecompany which we feel very strongly about and very bullish about.
This is amoment in time wherewe’re going to take theright action, reset our objectives, reset our focus and getback to what we have done best.
When I look atinternational, we delivered slightly above 8% op margins in2007 and when you really break down themix of licensed versus company-owned, I mean, there should bea lot more potentialbecause on thelicensed side we’re getting theroyalty, getting paid for thecoffee and the productsold. We should have amuch stronger business model.
Behind that then, we’ve looked atthe progress we’vemade in Canadaand/or the UKand operationally we’ve gotten alot better. So when welook at Canadareturns, for example, we have theopportunity as we getto scale in those marketsto deliver the marginsthat we had in theUS.
So itreally is probably two stories within theinternational story, but we believe that thelarge markets like a Canada,like a UK,like a Chinawhere we can operationally perform, we can deliver thekind of margins we saw inthe US.
Sowe have two things going on internationally and we believe ramping theinvestment in company-ownedstores, now that we know we can deliver strong operational performances, is theright answer.
Your next question comes from Marc Greenberg - DeutscheBank.
Marc Greenberg -Deutsche Bank
Howard, your success hasbeen remarkable so myconcern relates to how much actual changeyou’re really talking about. To behonest, the script ispretty constant -- it’s thebrand it’s the people,coffee focus, long-term store count unchanged,growth abroad. It is very strange to hear about somuch change and nothave it financiallydimensionalized atall.
What can investors, after hearing this call, really sinktheir teeth into before January? What about margins, profits, costs, improvedreturns? I guess your point on investing capital ahead of thecurve doesn’t really square, inmy mind, with the viewthat the capital isbetter served investing more aggressively abroad, We’re numbers guys, and you arenot giving us any numbers.
Let meremind you that we arein thequiet period of thequarter so inview of that, there arelimitations to what we can sayand we will try to bemore specific and respond to your concerns and your questions on the30th.
Let metry, in my own way, tosay this: I’ve beenhere 25 plus years. I’ve seen every aspect of thegrowth and development of thecompany and I amdissatisfied -- perhaps more than anyone else on this call -- with where we sittoday. I have as much stake personally as well as my own reputation and mypassion and commitment to making sure that we restore thecompany back at everylevel: the customerexperience, therelationship we have with our people.
Interms of this call, I’ve always felt strongly that we have to have thekind of relationship with TheStreet and our shareholders that is amirror image of thetrust we have with our people and our customers. What I’m here to sayis that I am making acommitment and apromise that we aregoing to do everythingwe can to make sure that relationship we have with you from afinancial standpoint is one inwhich you will be aproud shareholder of thecompany and recognize that we’re making theright strategic decisions over thelong term. We’re going to take decisive action to put inplace those things that have not been done before.
Interms of international, I can’t let you -- ina way -- discount thefact that we’re going to reallocate capital from theUS business to international. Let’s face it-- our core businessis building and operating our retail stores. From 1996 to today, we’ve taken abusiness that did not exist and we’re now in43 countries serving millions of people with lots of stores. Most importantly,we have built areputation in every oneof those countries.
I strongly believe that there’s aunique opportunity to create thekind of business internationally that we have inthe USand the thing that weknow best is operating stores. We aregoing to redeploy thecapital and therelationship we have inthose markets in away that we did in theearly stages of our USbusiness. Unlike theUS, we have atailwind in internationalthat will give us unique opportunities.
Sofrom an investorstandpoint -- and I’m one of them with you -- is that theopportunity to invest capital and getreturn on capital is thebest use of funds for us to redeploy from theUS tointernational.
I think we’ll end itthere and I just want to saythe following. Inclosing, we have a lotto do, but this is not anything but asuccessful company and we’re going to build on that success. We have arelationship with our customers that is theenvy of so many othercompanies and other consumer brands; we’re going to leverage that. We have new channels of distribution that wehave not taken advantage of to benefit our retail business; we’re going to dothat. We’re going to realign ourorganization to befocused on the mostimportant aspect of our business, thecustomer. We’re going to getout of the lineextension business and create real innovation that will transform theexperience.
None of this is going to happen overnight, you have mypromise and my commitment though that I’m going to seeit through thelong term and we’regoing to be thekind of company that every constituent that we touch -- our people, ourcustomers, our shareholders -- will beproud to be associatedwith.
Thank you very much.
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