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Starbucks Corporation (NASDAQ:SBUX)

Q1 2006 Earnings Conference Call

February 1st 2006, 4:30 PM.

Executives:

JoAnn DeGrande, Director of Investor Relations

Jim Donald, president and Chief Executive Officer

Howard Schultz, Chairman and Chief Global Strategist

Michael Casey, Executive Vice President, Chief Financial Officer and Chief Administrative Officer

Mary Ekman, Vice President Corporate Development and Investor Relation

Analysts:

Jeffrey Bernstein, Lehman Brothers

Larry Miller, Prudential

John Glass, CIBC

Dan Geiman, McAdams Wright Ragen

Steve Kron, Goldman Sachs

Matthew Difrisco, Thomas Weisel Partners

Sharon Zackfia, William Blair

David Palmer, UBS

Ashley Woodruff, Bear Stearns

John Ivankoe, J.P. Morgan

Operator

Good afternoon my name is Mild (ph), I will be your conference facilitator. At this time, I would like to welcome everyone to the Starbucks First Quarter 2006 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remark, there will be a question and answer session. If you would like to ask a question during this time simply press “*” then the “1” on your telephone keypad. If you would like to withdraw your question, press “*” then the “2” on your telephone keypad. Thank you. Miss. DeGrande, you may proceed with the conference.

JoAnn DeGrande, Director of Investor Relations

Thank you, good afternoon ladies and gentlemen, this is JoAnn DeGrande, Director of Investor Relations to Starbucks Coffee Company. With me today are Howard Schultz, Chairman, Jim Donald, president and CEO, Michael Casey, Executive Vice President and CFO and Mary Ekman, Vice President Corporate Development and Investor Relations.

During today’s call, Jim will review key results and accomplishments, Howard will provide an update on the next stage of our entertainment strategy and Michael will highlight the key drivers behind our first quarter results as well as discuss our fiscal 2006 growth targets. We will windup today’s call to one hour including Q&A. I would like to point out today for the first time along with our fiscal first quarter results we also release our January revenues. As a reminder to all listeners, this call is being broadcast live over the Internet. A replay will be available via telephone at 800-642-1687, reservation number 372-8089 through 5.30 PM Pacific Time on Wednesday February 8 and at the internet on the Investor Relations page at starbucks.com through 5 PM Pacific Time on Tuesday March 7.

In addition, today’s remark will be available on the Investor Relations portions at starbucks.com by the end of the day and will remain available through Thursday March 2. This conference call includes forward-looking statements such as anticipated store openings, comparable store sales expectations, trends beyond our expectations regarding the company’s revenue and expense growth, capital expenditures, effective tax rate, net earnings and earnings per share results. These statements are all based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company’s filings with the Securities Exchange Commission including the risk factors sections of Starbucks Annual Report on Form 10-K for the fiscal year ended October 2, 2005. The company assumes no obligation to update any of these forward-looking statements. With that, let me turn the call over to Jim.

James L. Donald, President and Chief Executive Officer

Thank you, JoAnn, and good afternoon ladies and gentlemen. Starbucks robust performance in the first quarter of fiscal 2006 sets the stage for the year and provides momentum for achieving our ambitious 2006 growth targets. Our success for first quarter including new as well as returning seasonal and holiday favors. Product launches in both our international and domestic markets and a keen focus on execution at all levels of the business. This led to net revenues growth of 22%, net earnings growth of 20% and first quarter earnings per share of $0.22. Great team work and flawless execution resulted in 560 new store openings, a record number for our fiscal first quarter. Our stores also delivered solid comparable store sales growth to 7% at the high end of our 3% to 7% target range. We end the quarter with 10,801 Starbucks locations in 37 countries serving more than 40 million customers per week. The strong momentum from yearend continued in the January as revenues grew 23%, 555 million and comparable store sales for the month increased 10% and we added 67stores during the period.

Let us review some of the key drivers behind our first quarter results. First, I would like to highlight what is being happening in our retail stores, were our results are driven by superior operational execution at store level. Last year seasonal; and holiday favorites return this year beginning the fall of the Pumpkin Spice platform. The continued success of Pumpkin Spice provided an excellent play load during November return of our great anticipated holiday offering beverage trio, Peppermint, Gingerbread, and Eggnog. Based on the seasonal popularity of Eggnog this year, we added a Chai Eggnog Latte, which could be came a customer favorite.

We kicked off the 2005 holiday season; with an innovative and unique marketing approach through several carefully august-rated efforts, which included the redcup.com as well as our first simultaneous promotional launch in one of US and Canadian retail stores. Between store closings on November 9 and opening on November 10 our partners transform our stores to holiday red in 9 excitements among our partners and customers and building energy around Starbucks holiday offerings. We provide a variety of coffee relevant merchandise in holiday treats, specifically designed to meet the gifting needs of our customers. I am pleased to report that the combination of the strong merchandise selection and affective inventory management led to robust product sales during the holidays as well as fewer mark downs, foreign season when compared to last year. Prior to the holiday rush, we completed the deployment of our new point of sales scanners in US and Canadian stores with resulted in more efficient merchandise transaction processing and faster service counter during this busy buying season.

Once again, the Starbucks card was a very popular item, more than fours ago Starbucks was a market leader in introducing the store value card and many retails have since tried to replicate the idea for their own businesses based on our success. Yet despite the proliferation of the store value cards, we track you in the Starbucks brand along with convenience and the Starbucks expends that our partners deliver continues to differentiate the Starbucks card from others. The Starbucks card has created a loyal following among our existing customer base and continues to draw new customers. The strong growth of accounts the stickiness our card create with our customers and the frequency of usage, clearly separates us from other programs.

During the season of giving and is for our ongoing community out reach, we continued one of our traditions, the Starbucks Holiday Angels Joy Drive. Thousands of seriously ill children received gifts through this joint effort by Starbucks partners, customers and the Starlight, Starbright Children’s Foundation. I am pleased to say that this year’s Toy Joy delivered more than 865, 000 gifts to pediatric patients across US surpassing our goal and more than 100,000 gifts.

Now looking at the second quarter, I want a promotion provide this feeling of warmth and comfort during this cold winter days. We begin with our Cinnamon Dolce beverage platform highlighting sweet date notes that are lamination of our warm and buttery, Cinnamon pastry and in both feeling of the comfort and pleasure associated with walking in to your favorite bakery. Customers can choose between a variety of offers suite their needs, ranging from Cinnamon Dolce evocate the Cinnamon Dolce cream to a Cinnamon Dolce Frappuccino, or Frappuccino light blended coffee. This platform, this flavor platform highlights the handcrafted artistry performed by, by our breezes everyday in our stores and it’s something that truly sets us apart from our competitors. Nor that many of us begin the New Year with the result to make more healthy choices, we are also featuring Starbucks exclusive reduce that coffee cakes. This year our new flavor to reduce that model coffee cake joins two past flavors to reduce that Cinnamon to a coffee cake and reduce that Blueberry coffee cake. The new coffee cake presents a perfect compliment to assume both, cakes and chocolates as well as any of our other handcraft with special beverages.

As we mentioned during the last conference call, we are expanding our warming program to senior cities this year, which will provide more customers the option to enjoy a one favorite breakfast sandwich along with your favorite Starbucks beverage. Begin today our customers in quadrant that will report in Oregon can visit on of our 54 stores which launched the warming program just this morning. We’ve also add warming to 37 more location within our Seattle market today. Looking ahead, we planned to introduce this program to both San Francisco and Chicago during this spring. We will provide more details as we get closer to those market reductions.

Before I review international highlights I would briefly recap last week’s acquisition announcement. Starbucks acquired the remaining 95% ownership for the operations and Hawaii and Puerto Rico. This added, 67 stores to our company operated store portfolio and allows us greater influence over the brand and new attractive markets. This transaction also aligned with our long-term strategy to increase our equity position we’re appropriate. We’re energized about continued growth potential in both of these markets and see these acquisitions as an opportunity to more fully capture.

Now let’s take a look at our international markets and the progress we are making. We opened 201 new stores in the international markets during the first quarter and today we have retail presence in 36 countries outside the United States. Financial results for international segment continues to strengthen field have rapid retail expansion healthy comparable store sales growth and improving profit margin in markets throughout the world.

We see tremendous global opportunity for our brand ranging from ongoing presence in current markets to exploring, entering into new markets such as Brazil, Russia and eventually India. All this aligns with the work we are doing to build solid infrastructure that are to carry Starbucks global expansion to the future. Starbucks continues to offer a borderless community on a place for our customers to connect with one another and for our partners to build relationships within their communities. The success of this connection is evident in the robust results delivered by international segment this quarter.

Starting with Japan, you may have recently seen the news that Starbucks Japan has appointed eminent CEO, COO designate, Mercy has, present international management background having held numerous senior management positions at Levi Strauss Company in a number of markets over a 31 year career with the company. She joined Starbucks Japan as they posed their sixth consecutive month of positive comparable store sales growth and operational expertise and diagnosed as a retail industry will provide strong leadership as the company enters its second decade of operations later this year.

Continuing with the Asia-Pacific news, I’d like to update you on the success with discoveries, our new RTD products in Japan and Taiwan. The enthusiastic reception to Starbucks discoveries by consumers in those two markets far exceeded our expectations and gained live spread public awareness. The launch of this chilled cup coffee product featuring the high quality coffee customers expect from Starbucks clearly demonstrated powerful execution in collaboration between our US and Asia-Pacific consumer product teams.

Turning to China, I just recently returned from a 5-day city trip and was accompanied by Michael and 5 other senior Starbucks leaders. The trip provided a wonderful occasion for us to meet with partners and our company operators and license doors and observed first hand the opportunities that await us in this important market. Our retail presence continues to grow nicely as we opened over 50 stores in China market over the last 12 months including more than doubling our store count, in new company operator markets to 26 stores to-date.

In total, we entered the quarter with 221 stores in China and our business there is performing well. We’re seeing continued growth in market level comparable store sales and profitability in our older licensed markets such as Shanghai and Beijing and we are experiencing an enthusiastic reception in newer China markets without exception. Personally, this is my first trip to China and now I am even more confident in Starbucks future there strengthened by the gathering momentum of the lively coffee culture.

So our interaction with the local partners, it was apparent that the Starbucks culture and passion, it was powerful as what we experienced among our partners in our US and other established markets. My insight has reinforced by these first hand observations that the Starbucks experience clearly travel. Let me just share a quick story. We opened our store in Chongqing, a couple from a neighboring province was working on a development project nearby and heard about the Starbucks store opening, they postponed their return flight by a day to personally experience the opening Chongqing’s first Starbucks location. What is special about this story is that they told us that they were already planning a trip back the following week to visit our store again which demonstrates the relevancy of the Starbucks brand and the connection we are making in the communities worldwide.

Before wrap up my comments, I would like to share with you some special recognition that company received during the first quarter. First, Starbucks is recognized by the Financial Times as one of the world’s most respected companies. This is the first time, Starbucks made this prominent list determined by a survey performed by the Financial Times pulling more than 950 CEOs across 25 countries. The company was also recently recognized by brandchannel.com as one of the top 5 world’s most influential brands, a meaningful accomplishment ranking with such topper brands as Google and Apple. I’m also pleased to say that for the 8 years fortune magazine named Starbucks one of the 100 best companies to work for in 2005. And for a global retailer, with over 100,000 partners worldwide, this is a wonderful accomplishment and confirms that Starbucks can truly stage them all while we do think.

And finally, I’m pleased to announce that Starbucks has been recognized in China as one of the top 10 employers in 2005. We were awarded this recognition by CCTV, China’s National Television Network. These accolades are very meaningful as it takes the collective effort of each and every partner to ensure that Starbucks is a great place to work.

As that reflect on our first quarter results, I’m proud of success we have achieved thanks to the hard work and commitment of our partners. I’m looking forward to the year ahead with continued focus on a core and accelerating pipeline of innovations and initiatives and a very strong management team in place. I’m confident that further extending our brand executing at all levels of the of the business and providing our customers with the products and innovation they have come to expect will continue to prove successful throughout the balance of the year.

I will now turn the call over to Howard.

Howard Schultz, Chairman and Chief Global Strategist

Thank you Jim, nice job, by the way and good afternoon everyone. Today, I’m going to focus my comments on a very exciting and evolving segment of our business, entertainment.

Before I talk about where we are today, I would like to take a step back and revisit the road Starbucks has taken in our evolving music and entertainment strategy. As many of you know, music has always been an essential part of the coffee house culture. For Starbucks our musical journey began in 1995 when we first introduced CD sales into our stores, as a result of a very popular in-house music program created by one of our store partners.

A natural extension from that was our 1999 acquisition of Hear Music, a San Francisco based music retailer known for the innovative way it helped consumers discover great music. This acquisition helped boost our in-store music selection and propelled us forward in creating the musical coffee house environment. Our role in music then moved beyond just the sale of CDs and extended to music programming at Starbucks stores worldwide.

Music compilations, a 24-hour music channel with XM satellite radio, an innovative collaboration with music labels to produce, market and distribute both exclusive and non-exclusive music followed. From there, Starbucks has evolved to become a significant presence in the music industry. For example, collaborations with record companies such as Concord Records for the release of Ray Charles’ Genius Loves Company, the final recording by the gifted artist, went on to an Eight Grammy and subsequently hit the number one position on the BillBoard sales chart. More recently, Herbie Hancock’s Possibility CD which we co-released with Hancock Music and Vector Recordings has received Two Grammy nominations. Not only has Possibility drawn the attention of the recording academy, it has also been the most successful debut in Mr. Hancock’s career, selling more than 42,000 copies in the US alone in its first week of sales. Possibilities also debuted at No. 22 in the BillBoard 200 Albums Chart.

In addition to offering music in our traditional stores, we also introduced Starbucks Hear Music Coffeehouse, a wonderful unique land of music store and coffeehouse which provides customers a venue to enjoy one of our hand crafted beverages while exploring a wide selection of CDs and digital music.

Our flagship Santa Monica store was recently joined by second Starbucks Hear Music Coffeehouse, which opened in San Antonio, Texas in December of ’05. A third Starbucks Hear Music Coffeehouse will open in Miami Florida later this month. Each store offers a vast selection of more than 1 million digital tracks to sample; listen, burn and print, truly transforming the way consumers discover and acquire music. A sale of CDs at Starbucks locations has provided record labels with a broad new channel of distribution and a powerful cost-effective in innovative way to connect with an expanded untapped customer basis at Starbucks.

Our approach today with music has been precisely executed changing how consumers discover great music while at the same time, generating a profitable revenue platform for the company. As we continue to seek and capitalize on emerging opportunities, we are taking our entertainment strategy to the next stage, films. As we have demonstrated over the last few years Starbucks has become a market maker in the music industry and now similar to music we are seeking to be an innovator in the marketing and distribution of film. Our strategy is to bring relevant and unique entertainment to the forefront utilizing our expansive retail footprint.

Over the past several years, the film industry has experienced a decline in box office receives while also realizing a significant increase in the cost to market new films. Starbucks has prepared to break that paradigm and changed the model of how new films reached the public. We are confident that the strength of the Starbucks brand coupled with our broad national footprints and be a catalyst for the industry by engaging our customer base the opportunity is there to generate higher box office proceeds and lower marketing costs associated with the premier of a film in a powerful and cost effective way.

What we intent to do is unlike any thing you have seen from other, Starbucks will not replicate the way in which fast food chains have co-opted their stores for the marketing of films, in order to sell more fast food. We are not entering into the venture with a sole purpose to sell more coffee, but instead to bring a inspirational uplifting story to our customers and to the public who may otherwise not have the opportunity to experience this particular film.

I’m speaking about the recent announcement of a truly transformational partnership in which Starbucks will participate in all aspects of the marketing and distribution of Landscape Entertainment’s new film Akeelah and the Bee. This next step is simply the natural evolution of our entertainment strategy and one we have been, been researching and exploring for quite some time. In our first quarter into this medium, it was critical to find the right film that would resonate with our customers and honor the trust they have place in us. Akeelah and the Bee is especially relevant with its inspirational story of a young girl who despite many social and economic obstacles advances from the inner city the scripts national splendid. This film which will be released in theatres on April 28th has the content depth and inspiration we were seeking and conveys the human touch that for fact, personifies the Starbucks brand.

I want to stop here for a moment and make it really clear that we are not investing in a movie and we are not getting into the movie business in a traditional way. What we are doing is leveraging our vast retail store footprint and the cultural relevancy of the Starbucks brand to bring film to the public in a new way during the time when the film industry has been challenged.

Starbucks will participate in all aspects of the marketing and distribution of this year film, and we will be an equity participant in the film’s success, not only at the box office but through the sale of the sound track and the DVD in all retail outlooks including our stores. The soundtrack will be available in early April and we will carry the DVD along with other traditional retails, when it becomes available later in the year.

Through this venture, we are creating an economic partnership with the film industry that mirrors the structure we created in music with the successful later trail CD. Through the power of the Starbucks brand, we will create awareness and drive new Movie Goers to the film, something movie producers could not do on their own. We will introduce the film through a truly innovative and interactive in store marketing campaigns, which will provide customers the opportunity to experience the fun and inspirational feeling of the movie. Many of our store partners will have a chance to view the film prior to its release and they along with strategic marketing materials with in the store will create enthusiasm in entries among our customers around the Akeelah and the Bee.

Starbucks has become recognized by entertainment authorities has a significant force in the music industry. Lending our trusted editorial voice and raising awareness of this film through our partnerships, through our powerful distribution systems to translate into Starbucks achieving a similar role in the film industry. While our core remains unchanged, we recognize that we have an opportunity to provide much more then the best cup of coffee. We offer our community gathering place where people come together to connect, explore and make new discoveries. We value the trust that our customers have placed in us and we are committed to providing high quality and relevant offerings as we take our entertainment strategy to the next stage.

Before I close I would like to share a quote with you, from a music reporter who seems to be as equally energized about Starbucks venture into entertainment as we are. According to Melinda Newman, the West Coast bureau chief for Billboard magazine, Starbucks and, Starbucks has become a power in the industry, they are forced to be recon with. If you are looking at Starbucks and saying, is this a project we will be best served by making a deal with Starbucks.

It’s exiting to share with these developments in our entertainment strategy. We are creating a truly transformational entertainment experience by providing our customers the venue to discover music and movies from a brand that they have come to trust. It all gets back to the basic, the foundation upon which we have build our company, it’s around a human connection and our passion to innovate and grew with new offerings, new sound and new experiences. While seeking unique opportunities to monetize our assets and in doing so increase shareholder value. We look forward to providing you with future updates as we build on this exciting venture. I will now turn the call over to Michael.

Michael Casey, Executive Vice President, Chief Financial Officer and Chief Administrative Officer

Thank you, Howard. During today’s call I will highlight our financial performance for the first quarter that was consolidated in by segments, from provide a brief review of the impact of, adopting the new stock based compensation accounting role. Comments on our strong balance sheets and cash flow, and provide updated targets for the remainder of the year. I am pleased to report that we once again produced strong top line and bottom-line growth, sales was solid in both our company operated and specialty businesses and in our US and international segments. More specifically consolidated net revenues for the quarter ended January 1st 2006 were record 1.9 billion up 22% from the first quarter of fiscal 2005. Company operated retail revenues increased 20% for the quarter, driven by the opening of 803 new stores in the last 12 months and 7% comparable store sales growth for the quarter. Comparable store sales growth consisted of a 6% in the number of customers transactions coupled with a 1% point increase in the average value per transaction. The comparable store sales growth of 7% particularly satisfying given that in October we lost the October 2004 leverage price increase in our US and Canadian markets.

Licensing revenues grew 39% for the quarter, driven by the opening of 1049 new licensed retail stores in the last 12 months and continued growth in the licensed grocery and warehouse club business. Food service and other revenues increased 18% for the quarter, primarily due to growth in new and existing US and International food services accounts. Operating income was up 23% to 280 million for the 13 weeks ended January 1, 2006, from 227 million in the prior year, as a percentage of total net revenues operating margin increased to a record 14.5% from 14.3% in the prior year, primarily due to lower cost of sales including occupancy cost. In-store operating expense has a percentage of total net revenues. Partially offset by higher corporate, general and administrative expenses. While store operating expenses has a percentage of related company operating retail revenues improved by only 10 basis points for the 13 weeks ended January 26th. As a percentage of total revenues, they improved by 50 basis points, this leverage was created by specialty revenues growing at a faster pace than retail revenues.

General and administrative expenses increased due to higher payroll related expenditures for stock based compensation and higher provisions for incentive compensation based on the company’s strong operating results for the first fiscal quarter of 2006. As well as increased charitable contributions during the quarter. As we previously discussed in which we adopted the financial accounting standard boards, final stock based compensation guidance formerly known as FAS123R. As we ride under FAS123R we are adopting the new expensing requirements for the fiscal 2006, with no restatement of prior period results.

The free cash stock based compensation expense recognized for the current quarter, was 23 million pre tax or 15 million net taxes for an EPS impact of $0.02 per share inline with our expectations. Please refer to page 8 of the pres release to view the numerous expense line items impacted by the adoptions of this accounting standard. Due to timing of our stock brands, which is generally concentrated in the middle of the first fiscal quarter, the current quarter’s pretax amount is slightly lower than what we would expect for subsequent quarters in 2006.

However we will continue to impact quarterly earnings per share by approximately $0.02 per share for the remainder of the fiscal year. As $0.02 per share per quarter, I’ll make sure, I heard about that, for the remainder of the fiscal year. The total stock-based compensation expense was allocated to our 3 reporting segments as follows, US Segment 51%, International segment 10% and corporate 39%. Current quarter expense was approximately 33% due to options granted in this fiscal year, approximately 10% due to our employee stock purchase plan and the remaining 57% was due to options granted in prior years.

I will now move on to first quarter results by operating segment, total net revenues for United States operating segment increased by 21% to 1.6 billion for the first quarter of 2006. Company operated retail revenues grew 19% to 1.4 billion primarily due to the opening of 634 new company operated retail stores in the last 12 months, and comparable store sales growth of 7%, US specialty revenues grew by 32% to 250 million for the first quarter. Within specialty revenues, licensing revenues increased by 40%, to 170 million. This is primarily due to higher product sales and royalty revenues from the opening of 650 new licensed retail stores in the last 12 months, which was 45% higher in store openings at this time a year ago. In additions we have strong operating level revenue performance. Both are contributing to the increasing and licensing revenues was the growth in the licensed Grocery and warehouse club business. Food service and other revenues increased 18% to 80 million, and there is a growth in both new and existing foodservice accounts.

US operating income increased 28%to 339 million in the first quarter from 266 million in the fiscal 2005. Operating margin increased to 20.9% of related revenues for the first quarter of fiscal 2006, from 19.8% for the first quarter of fiscal 2005, with a 110 basis point improvement. This improvement in operating margin was primarily due to leverage from strong revenue growth as discussed above, and controlled spending in most areas of the business. First quarter is historically a best quarter of the year from a margin point of view.

Now moving to the international segment, as Jim mentioned we recently spend a week together in China and following that trip I am more convinced than ever of a great opportunity that awaits us there. Either exciting times in our international business, our investments for the future, were also roofing the benefits of strong financial results due to a sharp focus consolidated execution in our current markets. International total revenues increased 25% to 314 million in the first quarter. International company operated retail revenue increased 23%, 267 million in fiscal 2006. Primarily due to the opening of 169 new company-operated retail stores in the last 12 months, and comparable store sales growth of 8% for the quarter. The increase in comparable store sales results from a 5% in customer transactions; couple with a 3% increase in average value per transaction.

International specialty revenues for the quarter increased 35% to 56 million, primarily due to higher product sales in royalty revenues from opening 398 licensed stores in the last 12 months, which is a 45% higher, which is 45% higher than store openings a year ago. And to a lesser extent the recent launch of our new ready-to-drink coffee beverages in Japan and Taiwan, in the fourth quarter of fiscal 2005, and in Korea in the first quarter of 2006. Operating income from international operations increased an impressive 79% to 35 million in the first quarter from 20 million in fiscal 2005, international operating margin expanding to a 11.3% of related revenues from 7.9% fiscal 2005. This significant improvement was primarily due to lower cost of sales including occupancy cost and store operating expenses has a percentage of net revenues, also contributing to the margin expansion was an increase in income for nearly every equity investors, particular Japan and Korea. Due to an increase in that store base improved comparable store sales growth and strengthening store profitability. Partially offset in these improvements was an increase in other operating expense from marketing and advertising related to the recent launch of ready-to-drink coffee beverages in Japan, Taiwan and Korea.

Our international store base continues to increase rapidly, and we are achieving a growing contribution from established areas of the business, our investing and emerging markets and channels. The balance between these 2 resulted significant margin improvement in the first quarter, but it is expected to shift back towards investment and therefore less margin improvement for the remainder of fiscal 2006. Moving briefly to the consolidated balance sheet, total cash, cash equivalents and other liquid investments increased 594 million at the end of the first quarter of 2006, from 368 million at the end of fiscal 2005, primarily due to strong operating cash flows.

During the first quarter of fiscal 2006, Starbucks repurchased 4.3 million shares of common stock for total cost of 121 million and reduce the outstanding balance on our credit revolver by 172 million. Our solid balance sheet, continuing strong cash flows and our borrowing capacity allows to continue to fund our operations, opportunistic repurchase shares and selectively invest in new growth opportunities, such as our recently announced acquisitions of full ownership of Hawaii, Puerto Rico operations.

Before we, moving on to our 2006 fiscal targets, let me add a little color on the Starbucks card activity. This was a contributor to the January revenues we reported today. During the first quarter customers activated a record 221 million on Starbucks products. Including a 165 million in December alone and an increase of 35% compared to the first quarter of fiscal 2005. At the end of the quarter, more than 293 million was loaded on to the Starbucks part waiting to do with in. A significant increase compared to 192 million at the end of the first quarter last year. During the month of January Starbucks redemptions reached an all time record of 93 million or 22% of company operated retail revenues in United States and Canada.

I will now turn to an overview of a updated fiscal 2006 growth targets. Based on our very strong first quarter performance in our latest forecast for the balance of the year, we planned to open at least 800 new stores on a global basis in fiscal 2006. In United States we planned to open approximately 700 company operated locations and 600 licensed locations, in international markets we planned to open 150 company operating stores and 350 licensed stores. We anticipate robust revenue growth will continue and we are targeting a total net revenue growth of approximately 20% on a quarterly basis and for the full year. As we reported today, January comparable store sales growth exceeded our target range of 3% to 7%. We do not view that level of growth as sustainable, however and we continue to expect comparable store sales growth in the range of 3% to 7% it must be anomalous for the remainder of fiscal 2006.

Starbucks annual leadership conference for all US, store managers, which was held during the fiscal second quarter last year, will be held during the third quarter this fiscal year. I mentioned this important store operating activity, for 2 reasons. First the cost of this event is significant enough that timing shifts do impact earnings growth rates for the affected quarters, and second it is worth noting very early on that we are planning our fiscal 2007 leadership conference, shift back to the 7th to the 2nd quarter, and to be held at an international location for the first time. In updating our plans for the remainder of the fiscal year, we bare in mind the important balance from strong comp performance and making investments from the future growth initiatives. This strategy has consistently generated long-term value for our shareholders. In the second half of fiscal 2006, a key area of increased investment for us will be infrastructure to support the significant opportunity we foresee in China.

We have recently filled several leadership positions in China and we are close to filling several additional key positions and making other infrastructure investments for the market, which we expect to big impact in international segment expenses, and operating margin through out the remainder of fiscal 2006. Based on our excellent first quarter results and our continued positive outlook for the balance of the year, we have raised our earnings per share target range to $0.68 to $0.70 per share for fiscal 2006, an increase of $0.05 per share over our original target set last July.

Based on January revenue with result and the revenue and expense outlook I just described, we now a somewhat stronger expectation for our second quarter results, by the time we set our original, targets. Well our goals for the last half of the year are generally unchanged. More specifically on a quarterly basis, we’re targeting earnings per share of $0.14 per share for Q2 and a range of $0.16 to $0.17 per share for each of Q3 and Q4. I want to remind listeners again that our fiscal 2006 earnings targets include stock option compensation expense estimated at approximately $0.02 per share per quarter and $0.09 per share for the full year. And as a result, EPS growth rates compared to fiscal 2005 have decreased due to this accounting change.

The effective tax rate is expected to remain at approximately 38% in fiscal 2006 with quarterly variations and capital expenditures are expected to be in the range of 700 million to 725 million.

With that, I would like to ask the operator to queue the first question. Please ask one question at a time and re-queue for additional questions, thank you.

Question-and-Answer Session

Operator

And at this time, I would like to remind everyone, if you would like to ask a question, please press “*” then the number “1” on your telephone keypad, “*” “1” to ask a question. We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Jeffrey Bernstein with Lehman Brothers.

Q - Jeffrey Bernstein

Thank you very much. Actually just a question on the overall costing segment and there’s been a lot of chatter lately down to focus on improving their offerings to more in the service and growth in US is ramping up, just wondering if you could provide us with this year take on the competitive landscape, specifically I guess who would you categorize as your main competitor if any, and do you view the competitive landscape and healthy for the category? Thanks.

A - Howard Schultz

I think that’s an important question. First, we’ve always said that as a percentage of total coffee consumed in North America, we probably have less than 10% of the total coffee market. And in view of that, we’ve always had a very strong competitive list of people that were trying to capture the morning segment away from Starbucks, we viewed the recent activity by the companies you’ve mentioned as a positive influence on the category, the more education, the more advertising that people place on the category, on a macro level will have a greater effect I think on our ability to demonstrate the differentiation between not only Starbucks coffee but most importantly the experience that we create day-in and day-out. And as we’ve said in the past, although jumping on since on a wonderful job in the New England area, we sold our own against them consistently the spike the amount of money that they continued to spend in that market and on some levels we’ve seen the business spike up when they have placed for this proportion amount of money in advertising. So, we are mindful of the competitors but we think when all have said and done it’s a positive effect on the category we’ll benefit from it.

A - James L. Donald

Howard, I might add to this, this is Jim Donald that as we prepare for this, we’re also preparing for our partners to become experts in coffee and the taste of our coffee masters those of partners that have going through a train if you will on coffee countries of origin, and use coffee at home as actually outpace the comp that we’ve grown 50% in the last year going from 10,000 coffee masters to 15,000 coffee masters that’s both well for us.

Operator

Your next question comes from the line of Larry Miller with Prudential.

Q - Larry Miller

Yeah, hi, thanks very much. Just wanted to ask you that the margins that was impressive almost 21% and I think you’ve typically guided to, relatively flat margins and I was just trying to think it out how extending about the business going forward as you’re rolling out more food but doesn’t launch and if you could develop on how the entertainment strategy might look in that line as it starts to extend I would move reason an expanded use of thing?

A - Michael Casey

We had our best, this Michael, we had our best margin quarter in the history of the company in this first quarter so, we are very pleased about that, the first quarter is traditionally our best quarter for margins because it benefits from the gifting in the holiday sales, merchandize sales in addition to our everyday beverage business. So, we would expect this to be the strongest margin quarter of the year as it has been historically. Looking at our individual segments, we think that full year margins in our US retail business in a range around 19% is the right place for that business, it’s the right next between delivering value to the customers and delivering value to the shareholders. And so, we are very pleased to be managing our business on a full year basis in that range and when its, its in the high, when its at the high end of that around 19 range, obviously we’re pleased with that. We do expect if we continue to grow our US business with very steady margins that we will get leverage in other parts of the P&L particularly with the corporate G&A. In the international business, the margins are lower than in the US and over the long term we think the will move in the direction of the US margins but they’re not going to move in that direction quickly because as I tried to emphasize in my earlier remarks, while we are showing significant improvements in almost every market, almost every quarter we’re also identifying new growth opportunities whether it would be China or ultimately Brazil or Russia or some place else. So that the next role continues to change as older stores, older markets become more profitable and new markets that have command its opportunity come into the picture. So we do expect year-over-year improving margins in the international segment but not as fast as you might expect, if we weren’t pursuing the huge opportunities in the international. Now we do expect to get margin improvement consistently as a total company namely from G&A level.

Operator

Your next question comes from the line of John Glass with CIBC.

Q - John Glass

Thanks, good afternoon. My question is on the rate of international unit growth, as though sets if you hit your goals and obviously we need to say you will, it will actually be the first year in which the percentage growth rate of international units is lower than the US. And I am just wondering why given your success in improving profitability, why has that decelerated the growth rate and should we expect an inflation point in the pickup in unit growth, anytime soon, maybe not just in China but in other areas of the world where you’ve obviously been successful?

A - James L. Donald

John, we don’t look so much at percentages as we do it at the number of stores and we’re confident that we’re going to hit this year’s targets for stores and hopefully you feed them and then each subsequent year, open more stores in almost all of our markets could certainly in total, then we did the year before and continue to ramp that up, particularly in our concentrated markets like the UK, Japan, China as it comes on and then Europe as well.

A - Howard Schultz

But I would just say John, I wouldn’t look at it so much on the quarterly basis, it’s a timing issue on a lot of issues that relate to permitting a municipality, the long range plan as its said before, is at least 15,000 stores outside North America and we’ve been more infused or confident about the way in which we haven’t received and the ongoing profitability of the international business, so, I would be more mindful of it long term in quarter-to-quarter.

Q - John Glass

Thank you.

Operator

Your next question comes from Dan Geiman with McAdams Wright Ragen

Q - Dan Geiman

Hi good afternoon. Regarding roll out of the breakfast warming program how stores will it have expanded by the end of the fiscal year, do you anticipate and also do you anticipate the rate of expansion to accelerate in future years. Also any expectation and results on per-store basis are going to be comparable to what you’ve seen Seattle and Washington?

A - James L. Donald

Yeah, Jim Donald, we look for the results to be comparable to what we sold out and that’s between $25,000 and $30,000 a year annualized sales. We mentioned we’re rolling out Portland, Oregon today and they will have Chicago and San Francisco, so it rolls up to about 600 stores.

A - Howard Schultz

At fiscal yearend an additional 400 down…

A - James L. Donald

About 200 currently in Seattle and Washington.

Q - Dan Geiman

Okay great.

Operator

Your next question comes from Steve Kron with Goldman Sachs.

Q - Steven Kron

Thanks I had a question on speeder service initiatives, you mentioned Jim in your prepared remarks the point of sales scanner is introduced throughout the retail stores and improvement there, I was wondering if there was any way to kind of, quantify what effect that’s had on speeder service and on that topic, the expansion of breakfast and the role out that you discussed, we too assume that, in the current markets where you are testing breakfast, that it hasn’t been diluted to your service speeds. Thanks.

A - James L. Donald

Second, I will answer the second one first, and that is correct it is not diluted to, we are talking about the speeder service, we have worked into the model, how the deployment works in those particular areas. So we are looking at, that overall in the first quarter we probably in terms of speeder service, we are 6% faster, however when I look at the scanner, it’s just one piece of what we call speeder service, other area is behind the bar that we are reengineering to including driver to continue to increase that speeder service. And when we look at our transactions growth, we are finding that, as we said this in the past that as lines moves faster they tend to kind of keep same amount of people and because they know they can get through, in that timeframe that is life for us and life for them. So we continue to tweak it along with scanners, with other operations as well.

A - Howard Schultz

I would like to just add one thing from that previous question that, I didn’t get to the second half of, I think Larry Miller’s question about margins, as we add other things into out retail stores. The music the entertainment, the food products, don’t have this good gross margin, as it beverages the handcrafted beverages, but at the PC level at the store, they contribute strongly and they don’t have a negative impact on overall store markets. So it changes the composition a little bit, but overall it adds to the average check and increases the store product contribution proportion.

Operator

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

Q - Matthew Difrisco

Hi I also have a food question that relates right to the coffee company, but also wanted to have a food something that catching halt here. As far as incremental, looking at our incremental basis, what you’ve learned from the 200 or so stores that you are in now. If you can give subscription of how the bell curve looks percent of the sales that food presents on from those various markets that you’ve seen.

A - James L. Donald

The food is the percentage of our business, continuous to increase with our new products offerings and looking at what we are doing with special platforms like better for you. So we are seeing an overall increase in food as it is today. We are seeing an incremental increase when you add on the breakfast involving sandwiches to this food category. So it’s a combination of both, and I thought you are going to go to where, how is the one with sandwich has been accepted which has been very well. But it’s not necessarily driving the food increase by itself.

Q - Matthew Difrisco

Well I tried to get into is breakfast becoming incremental on top of food, or is kind of lies of in other foods so.

A - James L. Donald

No, no it is incremental to that.

Q - Matthew Difrisco

And what’s the high watermark that you’ve seen so far, best case scenario, best market that is gone to be as a percent of sale?

A - James L. Donald

Well I think, it bettered to take in terms of averages, and both the lunch program and the wine program, the benchmark is about $30,000 per store, per year.

Q - Matthew Difrisco

And that’s probably right that’s not only…

A - James L. Donald

With out any material weakness in terms of speeder services, or the qualitative aspect of the customer experience.

A - James L. Donald

And we look at that from a USD prospective to earnings per stores per day, and we find it, as we roll out if, from market to market that the executions gets better, the understanding of it gets better, we are sure to see that, just Michael said stay in that $30,000 year range.

Q - Matthew Difrisco

Each individually 30,000 incrementally?

A - James L. Donald

Yes each store, correct.

A - Howard Schultz

That’s lunch and wine.

Q - Matthew Difrisco

Got it absolutely thank you.

Operator

So your next question from Sharon Zackfia with William Blair.

Q - Sharon Zackfia

Hi good afternoon. A question on the holiday, focus here that you made this year, can you maybe give us some perspective on what you saw most effective that was less effective than, what you might see you replicate going forward?

A - James L. Donald

Well obviously we have, irons that just blow out, and we have irons that do, what we considered to beyond our performance, but if I had to breakdown, I would tell you that, the chances of our entire holiday program starting with the execution that we delivered on store by store basis across North America, and we can figure and say on November 10 that all stores were set for holidays, meaning that all that playing well and had a time and make sure that our product was there, point of sale material in store sides, that I think led to an excitement from our store partners that clearly carry today and carry the momentum are going through. By don’t you look at what that, that merchandise mix was made up from beverages to food to job merchandise that‘s breeze to bears is some of our gifting that flowing to Starbucks gift card was there. And I got to tell you Christmas blend coffee, set record levels as well. It was just we hit out the part when it comes to the execution of a holiday and it is well tiny parts of blends we can probably do better than that we are currently working on.

Q - Sharon Zackfia

Okay thank you.

Operator

Your next question comes from David Palmer with UBS.

Q - David Palmer

Hi guys, congratulations on that quarter.

A - James L. Donald

Thanks.

Q - David Palmer

Specialty revenue growth was, was pretty strong this quarter I thought and I would mistimed maybe tempted is the reasons why no craft noted in that very strong sales, at Seattle’s Best, Starbucks coffees and that its coffee sales for boosted, competitors having supply disruptions, I am just wondering if you think that this was unusually strong quarter for grocery roll out sales maybe because of some clear things like that and also I am wondering maybe even if your new discoveries ready to bring beverage in Japan was at any part of driver of that specially revenue line as well. Thanks.

A - James L. Donald

The primary driver in specialty revenues for us was our licensing a retail store licensing which is the, build out of both Starbucks and Seattle Best license stores that was the primary factor. We also had a strong contribution from our food service business which is been a, 10% to 15% growth in last few quarter that grew between 15% and 20% this quarter and I hope, the grocery was strong and it, undoubtedly it sets craft attributed some of the two I’m sure this is contributes to that, but that was a relatively small part of growth in all specialty revenue.

Q - David Palmer

Okay thank you.

A - James L. Donald

I saw that as one of the thing, I think underlying the success of the holiday Christmas retail season and what you just noted in the specialty business. Its something that we kind of goes unset but I think its work repeating and that is the, the equity of the Starbucks brand, the power of the Starbucks brand in the marketplace coupled with the relevancy of the third place the sensuous community and how people are using our stores. The attachment that people have to, the Starbucks experience travels well beyond their experience in the stores and I think we are seeing the connectivity of the Starbucks brand in other channels of distribution and how people are trusting the experience beyond their stores. And I think it’s very different in traditional consumer brand that are, that have been dealt to advertising and promotion where Starbucks has build the brand in a very enjoying way almost quick essentially by the experience. And that is, and we are seeing the, the ongoing relationship of the brand and other products and other channels, that are parallel in success of our retail business.

Q - David Palmer

Thank you.

Operator

Your next question comes from Ashley Woodruff with Bear Stearns.

Q - Ashley Woodruff

Hi thanks. Just significantly expanded the entertainment initiative over the past several years and as you said soon you will be testing movies and probably more. And then could you talk a bit about how you balance from a time allocation standpoint managing the course Starbucks coffee brand operations versus analyzing the new initiative like entrainment?

A - Michael Casey

Well every thing that we do though is core to, what we are calling our Starbucks Coffee house experience our store retail store experience. And we are not trying own house in there, they are not necessary; they don’t necessarily compliment the customers experience. And so we work when we work with our operating team, we work with our implementation team; roll it down to store level. We are making sure that the execution is all in one and it’s all wrapped around, that customer’s experience. So they are able to tie that experience, with understanding about coffee knowledge, understanding how to juggle new beverages that might come out in spring versus fall versus winter and we tie all into one package. So they are able to, to juggle these and they should be bring out to provision. Howard, do you have any thing to add to that with the entertainment?

A - Howard Schultz

I would only say that the, the ongoing success we had with music and the initiative of the movie all of the positions that we are making on the content side is made with the launch of making sure that the music and the movie is accretive to the experience our customers have come to expect from Starbucks. We don’t want to do anything that would dilute the trust that our customers have in our company. And I think the first wave of all of that is with our partners. We want our partners to be proud of the music that we are choosing, and the movie that we are going to share with the American audience. And I think it’s linked to making sure that everything we do matters and it supports the foundation of the company and that is, we are not an entertainment company, we are not a music company, we are coffee company, we are creating opportunities that will complement the coffee experience.

A - James L. Donald

And I want add to that, because of the excitement that was generated for the holiday said, by the execution that I’ve ever seen in retail, when we get our partners excited about it, they get tremendous buy and it keeps executed.

A - JoAnn DeGrande

Operator we have time for one more question please.

Operator

Thank you Ma’am and we now go to the line of John Ivankoe with J.P. Morgan.

Q - John Ivankoe

Hi thanks very much. You know Howard I was, just thinking about the entertainment initiatives and specifically movies and I will then follow up on a couple of questions, and presumably you have to pick and choose the movies, coming Lions Gate as both of them dictating the movies that you are going to promote, could you discuss, I guess that’s selection process and whether its, in the script stage or if its actually in the finished product stage, kind of you an elaborate a little bit on the financials behind it, I know you mentioned in your prepared remarks that you will be responsible for the marketing cost, but is there any capital commitment at all, for the movie, and if I may, I think this is one question, is that, so we just assume at least for the time being in the current year music is, and I guess sales, CD format that we currently see in the stores is being relatively static, I mean have you done with that, we should expect a significant continued involvement of that piece of the entertainment strategy thanks.

A - Howard Schultz

Okay, John it’s a lot of question.

Q - John Ivankoe

Well, its kind of, its actually short if you think about, for just you, walk thorough how you go through this movies, thanks.

A - Howard Schultz

Okay, let’s begin with, I think we believe that given the unique relationship we built with our customers around music, that we had built a level of trust that gave us the license to extend music to other forms of environments. So over the past 12 months, and maybe slightly longer, we have had ongoing conversations with multiple movie studios about trying to find a movie that would set with the aspirational story and the uplifting and a story that we felt needed to be told, and story that we thought we could get behind in a very natural seamless way. This particular movie was pretty much done when we saw it, we had screened many movies, we had read many scripts, this particular movie was almost completed.

Lions Gate to their credit, although they are public company, it’s a more of an independent movie company, then say Warner Brothers they’ve great success this year past year with Crash, they understood the challenge of the movie industry in terms of box office problems, high marketing costs and saw right away, that Starbucks got involved in the movie that we could advance the rate at which people would go see it and potentially lower their marketing cost, what we wanted for that was something that mirrored what we did was Ray Charles, which was the template of our music initiatives. We wanted equity in the movie business, in the movie without investing any dollars in the movie itself. We agree that we would create a marketing campaign in store that was significantly less in dollars then we are going to get paid and we wanted to be able to participate not only in the front-end, but in the backend of the box-office received in all ancillary products if in fact the movie success is what we believe it to be. And this is a very important first step because, it sets the stage and the template by which other movie deals, assuming this will be successful will be judged. Since that time, we’ve many movie studios contact us wanting to be the next one, we are going to wait and see how we do with this, and as if fact, all the things that we hope to happen occurs. With regard to music this should not in anyway be a signal that we are done with music quite a contrary. Our music business continuous to be strong and healthy we have a new album coming out relatively soon with Surgio Mendes , we’ve got Tony Bennett coming out and we just had great success Dean Martin, believe or not during Valentine’s Day and we are full throttle on our ability to create a profitable stream of revenue for the company and a new channel distribution, what’s interesting about what we’ve done this year, as we also gave you are a market maker and discovering a group called Antigone Rising, they never had a record deal, they sold over a 100,000 units for Starbucks and we just picked to be the opening act of the balance of the Rolling Stones, that was attributable directly to the validation of Starbucks involvement. So we are a market maker, we’ve recognized the power of that, and also the responsibility we are going to look for ways in entertainment that are profitable, that are unique and add texture to the brand.

Q - John Ivankoe

Thanks very much Howard.

A - Howard Schultz

Thank you.

A - Howard Schultz

I guess that does.

JoAnn DeGrande, Director of Investor Relations

Thank you for listening into our earnings call today, we hope that you will join us for our webcast of our second quarter fiscal 2006 financial results, which will be on May 3rd, and note that at that time, that will be also include revenues figures along with Q2 results. Thanks again.

Operator

Ladies and gentlemen we appreciate your joining us today, this does conclude our Starbucks first quarter 2006 earnings conference call. You may now disconnect.

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Source: Starbucks F1Q06 (Qtr Ending Jan 1, 2006) Earnings Conference Call Transcript (SBUX)
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