Starbucks Business Update Call Transcript

Starbucks Corporation (SBUX)

Business Update Call

January 7, 2008 5:30 pm ET

Executives

JoAnn DeGrande - IR

Howard Schultz - CEO

Martin Coles – COO

Peter Bocian – CFO

Analysts

Matthew DiFrisco - Thomas Weisel Partners

Sharon Zackfia - RBC Capital Markets

David Palmer - UBS

Joe Buckley - Bear Stearns

Andrew Barish – Banc of America Securities

John Ivankoe - JP Morgan

Howard Penney - FBR Capital Markets

Mitch Speiser - Telsey Advisory Group

Larry Miller - RBC Capital Markets

Jeffrey Bernstein - Lehman Brothers

Marc Greenberg - Deutsche Bank

Presentation

Operator

I would like to welcome everyone to the Starbucks Coffee Company conference call and webcast. (Operator Instructions) Ms. DeGrande, you may begin your conference.

JoAnn DeGrande

Thank you. Good afternoon and thank you for joining us today. This is JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company. We have scheduled 45 minutes for today’s call, which will include forward-looking statements about recent trends inthe company’s business and the company’s future business plans, initiatives and objectives.

These forward-looking statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors including, but not limited to: coffee, dairy and other raw material prices and availability; the successful execution of internal performance and expansion plans; fluctuations in U.S. and international economies and currencies; the impact of initiatives by competitors; the affect of legal proceedings and other risks detailed inthe company’s filings with the Securities and Exchange Commission, including the risk factor section of Starbucks annual report on Form 10-K for the fiscal year ended September 30, 2007. The company assumes no obligation to update any of these forward-looking statements.

Before I turn the call over to Howard Schultz, let me remind 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 we comment on it in Q&A.

Howard Schultz

Thank you, JoAnn. Good afternoon and thank you for coming together so quickly. This is Howard Schultz, and with me today is Martin Coles, our Chief Operating Officer and Peter Bocian, our Chief Financial Officer. We know for many of you it’s late in the day so we’ll keep this call relatively short. But because what we announced this afternoon is extremely important, we wanted to communicate directly to you about it.

As you can imagine, we are also talking today to our partners and other groups who have a stake in Starbucks’ success and its future. Please note that while today’s call will be brief, as JoAnn said, on January 30^th we are scheduled to report our results for the first quarter of 2008. I intend to use that opportunity to both review our performance for the quarter as well as to provide you with more specific details of our plans going forward.

My goal today is to give you some insight into the reasons behind the actions we have taken and preview the dramatic and exciting changes that are to come. As you saw in our press release, we’re going to implement a series of strategic initiatives designed to increase shareholder value by refocusing the company on our customers and our relationship with our people.

So to put it simply, we are going back to what has made Starbucks and the Starbucks experience so unique; ethically sourcing and roasting the highest quality coffee inthe world; the relentless focus on customers; the trust we have built with our people; and the entrepreneurial risk-taking, innovation and creativity that arethe hallmarks of our success.

For starters, let me state unequivocally that Starbucks has been, and continues to be, a highly successful company. If I look at our company from a personal perspective, when we went public in June of 1992 we did so with 119 stores and now Starbucks is one of the most recognized and respected brands inthe world, with over 15,000 stores in 43 countries serving 50 million customers a week. We have annual sales of over $10 billion and operating income well in excess of $1 billion.

During these past several years, we did what many thought impossible: we built one of the most recognized and respected brands inthe world. But despite all of that, and the strength of our brand and our historic financial performance, we became in some ways victims of our own tremendous success.

We face challenges today, including the slowing economy and higher commodity, labor and health care costs, but the most serious challenge we face is of our own doing. We are emerging from a period in which we invested in infrastructure ahead of the growth curve; although necessary, it led to bureaucracy. We will now shift our emphasis back onto customer-facing initiatives, better aligning our back end costs with our business model.

I’m here to tell you that just as we created this problem, we will fix it. We arechanging our organization now and for the future. It will take a good deal of work and some time, but it will happen, starting today. We will seize the enormous opportunity that lies ahead. We will have the courage to execute bold new ideas that will drive significant and needed changes.

The unique nature of the Starbucks experience has always been evident inthe quality of our coffee and the quality of our people, both of which are superior. But it also must be clear inthe way our stores look and feel, in our commitment to our partners, in our involvement in the communities where we operate stores, as well as where our coffee comes from, and most importantly, inthe way we interact with our customers.

To effect thechanges that are needed, the board decided that I should take on the additional role of Chief Executive Officer. I would like to pay special tribute to Jim Donald, who is leaving the company. As you know, hehas been a passionate and tireless advocate for Starbucks and I am grateful -- the entire company is -- for what hehas contributed and wish him nothing but the very, very best in the future.

In assuming the CEO role again, I will be responsible for the overall strategic direction and I will have the predominant focus on every part of the business, especially theUS business that touches the customer, people, products and places. In unifying our entire organization to be laser-focused on the customer and the store experience, I will be working closely with Martin Coles, who will handle the oversight of those parts of the business that are more operational in nature.

Let me share with you, in broad strokes, about our strategic initiatives to drive the transformation of Starbucks. We have three fundamental pillars:

First, improving the current state of the US business. That includes how we engage our store partners and the training and tools we offer to them to be able to focus on the customers. It will include new innovations and new products; and most importantly, we intend to slow our pace of US store openings. We also intend to close a number of under-performing US store locations. This will enable the company to renew our focus on our store level unit economics. We will also be better able to focus our efforts on improving the customer experience at current stores, as well as to take a closer and more detailed look at our plans by market to ensure we are capitalizing on the opportunities we have and not cannibalizing our existing stores.

Second, we need to reignite the emotional attachment with our customers, returning to our core and restoring the connections our customers have with Starbucks, our coffee, our brand, our people and our stores.

Unlike many other places that sell coffee, Starbucks built the equity of our brand through the Starbucks experience. It comes to life every day inthe relationship our people have with our customers. It’s not just a transaction. By focusing again on the Starbucks experience, we will create a renewed level of meaningful differentiation and separation inthe market between us and others who are attempting to sell coffee.

Third, we will build for thelong term and this has two distinct pieces: we need to realign our organization and streamline the management of the organization to better support customer-focused initiatives, ensuring our planning and support functions, from back end IT systems to store operations, are focused on what’s most important: the customer and the Starbucks experience.

Our international plans are critically important and a significant priority. We will redeploy some of the capital that we had originally earmarked for our US store growth this year to further accelerate expansion and profitability of our international business. We need to apply the successes from key international markets to theUS, learning from markets such as Canada and the UK which have both enjoyed strong performance this past year.

As I have told you inthe past, there continues to be an enormous opportunity for us internationally and we are just at the beginning of capitalizing on it, with only 5,000 stores outside of theUS. I encourage you to keep a close eye on this part of the business. It is growing significantly in size and importance to us. It’s very exciting that our brand has really become iconic in terms of its status around the world and is celebrated in every market where we have opened.

Taken together, this agenda will transform Starbucks for the future by renewing our focus on coffee as our core and connecting and concentrating our efforts all over the world on delivering a consistent and quality Starbucks experience that I can assure you will be second to none.

I should tell you though that from an innovation standpoint, some of this work has been underway for many months. We have made a good deal of progress on new products and initiatives that will excite customers and we look forward to sharing these with you inthe months to come. I can tell you that you will seean acceleration inthe pace of significant innovation around thecore coffee experience.

Looking ahead, the reality we face is both challenging and extremely exciting. It’s challenging because there are no silver bullets and there are no overnight fixes. It will take time and it will mean some big changes. But losing sight of our mission of constantly focusing on the customer is something that we did on our own. As you know, we are not alone in seeing this kind of thing happen. Successful, fast-growing businesses can sometimes find that their success has unintended consequences. Growth and size can hide mistakes, but ata certain point it becomes clear that changes have to be made to reenergize the company and move to the next level of success.

We areat that point and we know what we have to do to maintain our industry leadership inthe US and around the world. Put simply, we know that the position we hold in the marketplace today is not an entitlement of Starbucks. We must earn the trust of our customers every day by how we conduct our business, how we treat each other as people and how we act as a responsible corporate citizen.

We remain committed to providing health care for all eligible full and part-time partners, executing our best in class corporate social responsibility efforts and encouraging our coffee suppliers to participate in our cafe practices program in our origin countries.

Our commitment to all of this is absolute. It is what differentiates us so clearly from others. It is why our customers are proud to support our brand and it will be the basis for our continued success.

Let me also acknowledge our other key differentiator: our people. I want to recognize the efforts and dedication of our great partners all around the world who contributed so much to the success of our company and are the driving force of our future success.

Now before we open it up for questions, let me try and address some topics that I suspect are on your mind.

First, am I taking this position for thelong term? The answer is unequivocally yes. I have been part of leading Starbucks for more than 25 years. It is a product of my vision and the board believes I am the best person to ensure that we restore the passion, entrepreneurial drive and commitment to innovation that are our lifeblood. We have challenges but enormous opportunity, and I am excited and enthusiastic about what we can accomplish together.

The second is, how does today’s announcement tie back to my well-publicized February 14th memo? And didn’t I play a role in some of the decisions that got us where we are today? The fact is as I said then that I did; but having been here from day one of this company and watching the brand grow and flourish the way it has, I was also the first to recognize that despite our terrific financial performance, the company’s heritage was being lost inthe shuffle. You have my commitment that those days of too much process and too much focus on the internal are gone and they will not return.

You’re also likely asking, what has happened since last February? Well the answer is a lot has happened, but at the same time not enough. Immediately when the memo hit people’s desks, we began planning and have developed a pipeline of exciting initiatives that we will be introducing in the coming months and we believe have the potential impact of a category builder like Frappuccino products or a new way for our customers to interact with us like the Starbucks card.

But overall, what this work made most clear to us is that the incremental changes we were making were simply not sufficient, particularly in light of rising commodity costs and the economic climate we are now operating in. We are committed to transformative events and you can be assured that I will be decisive.

Another question I would expect is on everyone’s mind is the holiday season and how recent sales performance was a driving force in today’s announcement; and if competition plays an important role. The answer is that the roots of this change precede the holidays and in fact, it is something the board has been discussing for some time.

In fact, the steps we’re taking are not designed to address current trends but rather and most importantly, to position us to stay ahead into the future and to do so by ensuring the Starbucks experience remains unique.

Our greatest challenge and opportunity is ensuring that we revitalize the romance, the theatre and warmth of experience that Starbucks haslong been known for and to ensure that we remain a brand that our customers are proud to be associated with because it is that, coupled with offering the highest quality coffee and products which has set us apart -- way apart.

Finally, I expect you are looking for some specifics of what our first quarter looks like. However as JoAnn has mentioned and I have reiterated, we will discuss that with you on the 30th of January.

So with that I hope that I have addressed many of your questions -- or at least those that we can address at this time -- and I’m happy to open up the lines for you.

Question-and-Answer Session

Operator

Your first question comes from Matthew DiFrisco - Thomas Weisel Partners.

Matthew DiFrisco - Thomas Weisel Partners

Howard, you mentioned a couple of things and actually the title of the release today is “Strategic Initiatives to Increase Shareholder Value”. Can you address some of those direct initiatives that you think haven’t been done by the company which might be going forward? Specifically uses of cash flow -- is there a share repurchase on deck here of larger magnitude than already out there?

How does that work in tandem with improving the customer experience? When I think the first thing there, or most people on their minds are thinking about the amount of price you’ve taken over the last couple of years. Is this going back to looking for traffic rather than just driving incremental sales and less aggressive on the price potentially, by improving the customer experience?

Howard Schultz

Let me try and answer that but with the caveat that the specificity of the strategic initiatives and how we are going to communicate that would bein more detail on the 30^th of January.

As we examine the company and some of the things that I’ve said inthe prepared remarks, I think it is one thing to look at the economy and look at the rising commodity costs and use that as a buffer, but the truth of that matter is that I strongly believe that much of the problem we have has been self-induced.

The strategic developments of the company are going to bea renewed level of focus -- laser focus -- on the experience that we have in our stores with our customers. To be specific about that is that we are sourcing, roasting and blending the highest quality coffee inthe world and we’re not in the transaction business; we’re not a QSR, we’re not in thefast food business.

But there is renewed parity inthe marketplace that has, for whatever reason, created new levels of convenience, new levels of price and people around Starbucks are intercepting our traffic by creating awareness and trial and trying to hold those customers.

The new strategy of the company, which you will seein place, is to make sure that the level of differentiation that we will create in our stores, from the people who are trained behind the counter, the knowledge they have about the way beverages should be made and the total overall experience, will be heightened to the point where there will bea distinctive difference.

Unlike a technology company or a company that has to file for a new patent, what we’re dealing with here is something that we created, and it’s human nature. What we need to do is make sure that we are reducing the level of tasks that we’re asking our people to do and focus on what’s most important. What’s most important is passionately committing ourselves to the customer experience and driving significant differentiation in everything we do.

With regard to the stock buyback and things of that nature, I’ll give that to Pete and have him answer it.

Peter Bocian

Yes, I think the point when you read the release and with Howard’s comments, we believe that the biggest impact on shareholder value is going to bethe top line revenue growth, market share and then op margin expansion associated with that. After that, I think you know we’ve been active in share repurchase programs in returning the operating cash flow to the shareholders on a more immediate basis and we’ll continue to look at that.

But clearly, we believe that the opportunity is around top line growth, op margin expansion and we think we’ve got opportunities to both grow and opportunities in thecost area to fund the investments ourselves.

Howard Schultz

You asked one other point about the price value relationship and let me link that to customer loyalty programs and things that I think give us a competitive advantage inthe marketplace.

As you know, a significant component of Starbucks customers hold the Starbucks card; a growing and large percentage. Even during that last year we’ve seen the card outperform almost any other product we have in our stores in terms of growth over last year sothe attachment and relationship we have with Starbucks cardholders is very, very significant.

We strongly believe that there are unique strategic opportunities to mine that information and use that information to create surprise, delight and loyalty programs that we have not used in the past.

The other piece of this, which I think is important to note, is that unlike any other retailer or restaurant, we have other channels of distribution and we have leading share in those channels; a billion dollar business with Pepsi Cola with bottled Frappuccino and ready-to-drink coffee; we have the leading share of Starbucks ground and whole bean coffee inthe specialty coffee business in grocery.

In years past, we have never leveraged or threaded the relationship between where those products were sold and using those products as an opportunity to cross those customers’ buying patterns with the relationship that we can establish in our stores. So we think there’s a unique asset base that we can exploit for the benefit of our customers to create new ways that we tie those channels of distribution together with one voice, one brand position.

We know from our own research that tens of thousands of customers never come into a Starbucks store but are loyal users of bottled Frappuccino and whole bean coffee. We also know from research that many people who have become Starbucks retail customers, have had their first experience with Starbucks through bottled beverages or ground coffee ina grocery store. So that’s a piece of the puzzle that we’re going to really examine as we go forward.

In addition to that, we’ve expanded the ready-to-drink business inJapan, Korea, Taiwan and most recently in China. Those businesses are far outpacing the expectations we had of them.

Operator

Your next question comes from Sharon Zackfia - RBC Capital Markets.

Sharon Zackfia - RBC Capital Markets

Your traffic trends really started to slow around the same time as a lot of retailers. As you look atthe business, how do you try to disaggregate what’s economics versus self-inflicted? If you took the other side of the coin and said it was all economically based, what do you think you have in your arsenal to protect you against that going forward, from that kind of value perception?

Howard Schultz

Well let mebe clear. Certainly, there’s very few consumer brands that have been or will continue to be immune from the downturn in the economy and the cloud that’s hanging over the consumer, but we’re not using that as an excuse. I want to repeat, I strongly believe that we can strongly enhance our business despite the headwinds coming from the economy, commodity prices and we’re not going to use that as an excuse.

I strongly believe that we have the power inside our company to create new products, new innovation and new customer attachments that will insulate us significantly more than ithas inthe recent past. I’m not going to get into those details, but you will seein the near future that we are not going to sit still, we are not going to embrace the status quo. That we have products, that we have a level of innovation.

We have, we think, other assets that we can bring to bear, that renew the relationship that we have with our customers and create significant differentiations in the marketplace. I’m not going to use the economy with your or our people as an excuse.

Operator

Your next question comes from David Palmer - UBS.

David Palmer - UBS

I wanted to ask you about innovation. It seems like it’s been a while since your innovation has resonated -- well the beverage innovation , I guess there’s other dimensions to your innovation, particularly in the past. It seems like it’s been a while since that innovation has resonated significantly with customers. It feels like maybe the Cinnamon Dolce Latte was the last big hit and that was maybe two years ago.

When you’re looking atthe pipeline now and you talked about more transformative events, more incremental innovation. Can you talk about the innovation pipeline you have now and whether there are some triples or homeruns in that pipeline today? Or are we looking at a year where you’re going to have to get to work in building up that innovation pipeline before we start to see some of these things?

Howard Schultz

I think that’s a very good question. I think when I really examine the level of innovation that we have brought to our customers over let’s saythe last year or two, my conclusion and personal assessment is that the level of innovation has been subordinate to line extensions. They have been line extensions, they have not been innovation. They have not been transformative. They are not exciting. They are extensions of what we already do. And that’s fine, but that’s not what we’re here to do.

What we have to do is bring new opportunities to the marketplace that are consistent with the heritage of this company. I think for me when I’m asked a question about when is it coming and how good is it going to be? For those of you who have known me the longest I’ve always tried to, ina way, under promise and over deliver.

So on this kind of call what I can assure you is this: I am not satisfied, our team is not satisfied with where the business has been and the relationship that exists in our stores with our customers. We are going to fix it. Is it going to happen tomorrow? It’s not and there’s no short-term fix, there is no silver bullet.

But what I can promise you is there’s going to bea comprehensive focus that hasn’t existing around here ina long time. I remember what it was like to start the company. I remember when we were fighting for survival, fighting for respect. When you succeed at this level for so long, it produces not mediocrity, but you get a little soft and we have to get back to what made this company great and that is having the courage and the curiosity and the commitment to do things that have not been done before. The level of innovation that we have to bring to the market is a combination of extensions of what we do but transformative, big, bold ideas.

Operator

Your next question comes from Joe Buckley - Bear Stearns.

Joe Buckley - Bear Stearns

Are you prepared to share with us today some of the numbers on the store openings in theUS and the closings in theUS?

Secondly, this does go back to your February memo, are there things to undo like food, like some of the automated processes in terms of recapturing what you described on this call?

Howard Schultz

I appreciate the question. I think in both cases we will be more specific on the 30^th of January. I will say that in my view there are no sacred cows to restoring the company to what it once has been and we are committed to that. But we will have specificity for you on the 30^th.

Joe Buckley - Bear Stearns

You used the phrase too much process, to much internal focus; I think you used the words bureaucrat and bureaucracy being created. I’m not sure what you mean by all that relative to what’s needed to grow as you’ve grown.

Howard Schultz

Sure. Well I think that during the early stages of the growth and development of the company we were the quintessential entrepreneurial group of people. We did anything that had to be done to advance the cause of the company. In order to grow the company at the level that we have, which is going from remember we had 100 stores in 1987 and 100 employees; 20 years later -- 15,000 stores and 200,000 employees. In order to achieve that, we have made significant and necessary investments in almost every aspect of helping to build the foundation: process, foundation, infrastructure, roasting plant, distribution and lots and lots of people, well-intended people.

I think along the way in doing that we lost the focus that we once had on what was most important: the customer. What I’m going to do and I’m going to do it swiftly, I’m going to realign the organization, restructure the way we are configured to make sure that the layers of process and people that exist inthe company that take us away from the focus that we need -- the nimbleness and the entrepreneurialship -- is stripped away. That’s going to happen quickly.

Operator

Your next question comes from Andrew Barish – Banc of America Securities.

Andrew Barish – Banc of America Securities

On the international side of things, how are you looking at shifting some of the capital that quickly? Is it new markets or existing markets or are you looking at buying in JV markets at this point? Can you give us a little more color on that please?

Howard Schultz

Well the first that I’d say is for all of you that follow the company so closely, I really want to reiterate, please take a good look at what we are doing internationally. It wasn’t too long ago, August of ’96 that we opened our first store inTokyo and many people did not give us much credit for being able to expand the company we have internationally. Now with 5,000 stores in 43 countries we have built I think an incredible foundation of growth and development and a very strong iconic status among people from China, to Spain to Greece to Singapore, Mexico, you name it.

We believe that there is a lot more we can do internationally by refocusing our energy inthe organization on accelerating that growth. Our JV partners I think want to grow more. A great example of it in one our best performing markets inthe last couple of years has been Mexico. I think we originally thought that Mexicoat best might bea market of 150 stores. Well we have north of – is it 200 stores? – north of 200 stores inMexico and were not even half way there in terms of the growth and development. The original plan was not to growat that level.

So we believe that we can accelerate the growth of the company and also begin to demonstrate to you and other constituencies a much more significant level of profitability.

Candidly, when I look at where the market is valuing the stock, we are not getting the credit that we deserve for what is going on internationally and it’s probably because you don’t see the stores and you don’t see what’s going on.

But I have been in 11 countries in the last nine weeks and I can tell you that it reminds me of the early days of the growth of what’s going on inthe US in terms of attachment, the excitement and the fervor that’s going on when we open up stores in new and existing markets and we are going to take advantage of that.

Operator

Your next question comes from John Ivankoe - JP Morgan.

John Ivankoe - JP Morgan

Howard, I understand from an earlier question that you don’t want to talk about the specifics of the closure of the US stores, but I was hoping I could geta bit of a greater sense of why you think there’s a cause for the closure of US stores? Whether it was cannibalization that was more significant than the company previously understood or perhaps an entire market such as theMidwest for example? I don’t know if that is the case.

Howard Schultz

Clearly it is nothing even close to entire markets so we should move off of that. I think that in our ability to leverage and extend the brand, real estate choices were made that I think outstretched the relationship that we could have with customers and sothe closures that we are talking about are stores that have not performed inthe early stages and we have enough visibility because of the location and what has happened to recognize early that those stores are not going to perform.

The reason is I think in the past we have not made these kinds of swift acute decisions, we haven’t been as decisive as we can be and by closing those stores it will allow us to focus on what is most important, thecore stores that we have. It will enable us I believe to have a higher level of unit level of economics and the span of control that we have with our people will be much more efficient and we won’t be focusing on those stores.

But I think in large part it is we have stretched the real estate and the understanding that we have too far and we are just going to bring it back.

John Ivankoe - JP Morgan

Is there a fair characterization between drive-thru and non-drive-thru stores in terms of what might be closed?

Howard Schultz

No, this is not a drive-thru problem on any level.

Peter Bocian

I think there were two messages. One was around slowing the ramp of new stores which is the bigger number and one was around taking the harder look under performing stores in line with what Howard said, and that is the smaller number in the two pieces.

Operator

Your next question comes from Howard Penney - FBR Capital Markets.

Howard Penney - FBR Capital Markets

My question is sort of on the same lines as John about the store closings, but more specifically if you look atthe capital that was allocated to the US business and the stores that may not have hit your hurdles relative to the reallocation of the capital -- if that is the right characterization -- to the international markets, can you talk about the returns that you were getting on the shift in capital that’s going to go from not alow return business but maybe a high return business? Broadly speaking, can you just talk about the reallocation of your cash flows given the announcement today?

Peter Bocian

We are not going to give any new financial information as both JoAnne and Howard said upfront. We did talk about on the Q4 call the relative revenue to investment ratio and how we did in ‘06 and the trend in ’07, so we’ll look to keep updating that. They were lower than previous returns, and the recognition of that is part of it; we want to make better decisions around the stores we do open. We want to take swifter action if in fact we did make a bad decision; and again, that’s the smaller subset of this discussion. The goal is to optimize the return on capital with the best stores.

Operator

Our next question is from the line of Mitch Speiser - Telsey Advisory Group.

Mitch Speiser - Telsey Advisory Group

As we talk about the experience going forward, speed of service is always a focus of QSR, yet the convenience of speed is very important, I think, with any type of an establishment that fits broadly into this space.

Can you give us a sense of where you prioritize speed of service through this transformation? Has that been an issue, do you think, among other issues? Is getting faster serving the customer a part of this realignment? Thank you.

Howard Schultz

Thanks for the question. In fact, that speed of service does not show up as a concern of our customers. I think we really have achieved the right balance between the expected wait time and people feeling that the expectation of that wait time has been met. There’s no indication that that is in any way acore issue for us.

I think over time what we have done is perhaps we have used focus on efficiency to maybe too much of a driver and maybe that has hurt the experience; we will examine that. But speed of service has not been an issue and won’t be on a go-forward basis.

Operator

Your next question comes from Larry Miller - RBC Capital Markets.

Larry Miller - RBC Capital Markets

Does this announcement change your thoughts on the long-term North American unit potential or are we just talking about a shift in the pacing?

On the cannibalization, you talked about having less. How quickly can you guys slow the development plan or change the development plan? 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 more cash, are you giving thoughts to maybe paying dividends and returning cash in different ways than you might have inthe past? Thanks.

Howard Schultz

I’ll take the first two. The announcement today about slowing US growth and examining those stores that need to be closed should in no way drive you to the point where you think the overall store target for Starbucks worldwide or inthe USare changing. I think that’s a very important point, I’m glad you asked the question.

Our level of enthusiasm and the bullishness of what we feel we can dohas not changed. This is a moment in time where we’re going to reset the growth of the US business but over the long term you can be assured that we’re going to achieve our objectives.

Larry Miller - RBC Capital Markets

On the cannibalization side, it sounds like you want to open stores that have less cannibalization but I would have thought that most of your fiscal ‘09 program is done at this point. Is that not the case?

Howard Schultz

First of all we have historically had some of the best -- if not the best -- real estate portfolio of any retailer or restaurant inthe US and as a result of that have very strong and unique relationships with landlords and developers. I think when we go to them as we have been doing and talk about the things we want to do, there will bea great deal of cooperation. The ‘09 number that you are referring to is not in play. I think we have a strong level of flexibility and nimbleness inthe process.

Larry Miller - RBC Capital Markets

Did that happen in ‘08 as well?

Howard Schultz

Well the fact that we’re going to slow theUS growth demonstrates that. I think you had a question about dividends.

Peter Bocian

As we look at it, clearly the slower growth in theUS is going to free up capital, increase free cash flow. The international won’t be as large as the USso when we communicate the change you’ll be able to seethe differential and what it’ll increase free cash flow.

As I said before, we’ve been very active in share repurchase. We’ll continue to look at the different avenues to use the free cash flow to deliver shareholder value.

Operator

Our next question is from the line of Jeffrey Bernstein - Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

In terms of the US opening potential, can you talk about the impact from the expanded customer base? You are targeting a broader audience, perhaps reaching out to a lower income consumer. You guys talked about the average income going down, especially ina tougher macro environment. Did that have any impact on an ultimate 20,000 unit target or perhaps whether you think that has any near term impact from a macro standpoint?

On the international shift, just to get comfort, I know you talk about how international is not getting as much credit as perhaps you’d like; I tend to agree with that. Can you give us comfort that the international growth is the best alternative use of cash? You mentioned the UK and Canada, but some specific metrics to demonstrate that international growth is a better opportunity than returning this cash. Maybe going forward you can give more details on those international markets. Thank you.

Howard Schultz

I’ll have Pete answer the latter, and let me take the first question. It’s kind of perverse that we were given so much credit over the years for broadening the base of our customer profile and now we’re going to be penalized because perhaps some of those customers are being affected by the economic pressures.

Let’s first frame the size of the prize. I think you’ve heard mein the past say that if we examine total US coffee consumption, we believe at this time that we are capturing less than 10% of the overall coffee consumption opportunity inthe US. So there’s a very large market that we have yet to go after.

We know the past history that we have broadened the base of our customers, and one of the most interesting and again, one that we really have not focused on is we have a very large and growing Hispanic customer base that we did not have to the degree we have it now, even five years ago.

We don’t have hard data to suggest whether or not the current attrition is in any way related specifically to the economic issues that are facing people who are earning less money, but I think you have to reach that conclusion at some level. That though, and I think I want to say it again, does not slow down the enthusiasm or the planning that we have for the growth target of the company which we feel very strongly about and very bullish about.

This is a moment in time where we’re going to take the right action, reset our objectives, reset our focus and get back to what we have done best.

Peter Bocian

When I look at international, we delivered slightly above 8% op margins in 2007 and when you really break down the mix of licensed versus company-owned, I mean, there should bea lot more potential because on the licensed side we’re getting the royalty, getting paid for the coffee and the product sold. We should have a much stronger business model.

Behind that then, we’ve looked atthe progress we’ve made in Canada and/or the UK and operationally we’ve gotten a lot better. So when we look at Canada returns, for example, we have the opportunity as we get to scale in those markets to deliver the margins that we had in theUS.

So it really is probably two stories within the international story, but we believe that the large markets like a Canada, like a UK, like a China where we can operationally perform, we can deliver the kind of margins we saw inthe US.

So we have two things going on internationally and we believe ramping the investment in company-owned stores, now that we know we can deliver strong operational performances, is the right answer.

Operator

Your next question comes from Marc Greenberg - Deutsche Bank.

Marc Greenberg - Deutsche Bank

Howard, your success has been remarkable so my concern relates to how much actual change you’re really talking about. To be honest, the script is pretty constant -- it’s the brand it’s the people, coffee focus, long-term store count unchanged, growth abroad. It is very strange to hear about so much change and not have it financially dimensionalized at all.

What can investors, after hearing this call, really sink their teeth into before January? What about margins, profits, costs, improved returns? I guess your point on investing capital ahead of the curve doesn’t really square, in my mind, with the view that the capital is better served investing more aggressively abroad, We’re numbers guys, and you are not giving us any numbers.

Howard Schultz

Let me remind you that we arein the quiet period of the quarter so in view of that, there are limitations to what we can say and we will try to be more specific and respond to your concerns and your questions on the 30th.

Let me try, in my own way, to say this: I’ve been here 25 plus years. I’ve seen every aspect of the growth and development of the company and I am dissatisfied -- perhaps more than anyone else on this call -- with where we sit today. I have as much stake personally as well as my own reputation and my passion and commitment to making sure that we restore the company back at every level: the customer experience, the relationship we have with our people.

In terms of this call, I’ve always felt strongly that we have to have the kind of relationship with The Street and our shareholders that is a mirror image of the trust we have with our people and our customers. What I’m here to say is that I am making a commitment and a promise that we are going to do everything we can to make sure that relationship we have with you from a financial standpoint is one in which you will be a proud shareholder of the company and recognize that we’re making the right strategic decisions over thelong term. We’re going to take decisive action to put in place those things that have not been done before.

In terms of international, I can’t let you -- ina way -- discount the fact that we’re going to reallocate capital from theUS business to international. Let’s face it -- our core business is building and operating our retail stores. From 1996 to today, we’ve taken a business that did not exist and we’re now in 43 countries serving millions of people with lots of stores. Most importantly, we have built a reputation in every one of those countries.

I strongly believe that there’s a unique opportunity to create the kind of business internationally that we have inthe US and the thing that we know best is operating stores. We are going to redeploy the capital and the relationship we have in those markets in a way that we did in the early stages of our US business. Unlike theUS, we have a tailwind in international that will give us unique opportunities.

So from an investor standpoint -- and I’m one of them with you -- is that the opportunity to invest capital and get return on capital is the best use of funds for us to redeploy from theUS to international.

I think we’ll end it there and I just want to saythe following. In closing, we have a lot to do, but this is not anything but a successful company and we’re going to build on that success. We have a relationship with our customers that is the envy of so many other companies and other consumer brands; we’re going to leverage that. We have new channels of distribution that we have not taken advantage of to benefit our retail business; we’re going to do that. We’re going to realign our organization to be focused on the most important aspect of our business, the customer. We’re going to get out of the line extension business and create real innovation that will transform the experience.

None of this is going to happen overnight, you have my promise and my commitment though that I’m going to seeit through thelong term and we’re going to be the kind of company that every constituent that we touch -- our people, our customers, our shareholders -- will be proud to be associated with.

Thank you very much.

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