Starbucks F3Q08 (Qtr End 6/30/08) Earnings Call Transcript

| About: Starbucks Corporation (SBUX)
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Starbucks Corporation (NASDAQ:SBUX) F3Q08 Earnings Call July 30, 2008 5:00 PM ET


JoAnn DeGrande - Director, Investor Relations

Howard Schultz - Chairman of the Board, President, Chief Executive Officer

Peter J. Bocian - Chief Financial Officer, Executive Vice President, Chief Administrative Officer


Jeffrey Bernstein - Lehman Brothers

John Ivankoe - J.P. Morgan

John Glass - Morgan Stanley

Steven Kron - Goldman Sachs

Larry Miller - RBC Capital Markets

Joseph Buckley - Banc of America Securities

David Palmer - UBS

Sharon Zackfia - William Blair

Matt Difrisco - Oppenheimer

Howard Penny - Research Edge


Good afternoon. My name is Jamaria and I will be your conference operator today. At this time, I would like to welcome everyone to the Starbucks Coffee Company’s third quarter fiscal 2008 conference call. (Operator Instructions) Ms. DeGrande, you may begin your conference.

JoAnn DeGrande

Thank you. Good afternoon, ladies and gentlemen. This is JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company. With me today are Howard Schultz, Chairman, President and CEO; and Pete Bocian, Executive Vice President and CFO. Q&A will follow today’s prepared remarks.

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 22250961 through 9:00 p.m. Pacific Time on Friday, August 1, 2008, and on the investor relations page at through 5:00 p.m. Pacific Time on Friday, August 29, 2008.

In addition, today’s remarks will be available on the investor relations portion of by the end of the day today and will remain available through August 29th.

This conference call includes forward-looking statements about company plans and initiatives, including its transformation agenda and trends in or expectations regarding revenue and earnings per share growth, store openings and closings, the performance of the U.S. economy, same-store sales growth, operating margins, expense control, the company’s effective tax rate, shareholder value, capital expenditures, guidance and targets, and capital structure. These forward-looking 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 and Exchange Commission, including the risk factors section of Starbucks' annual report on Form 10-K for the fiscal year ended September 30, 2007, and Starbucks' quarterly report on Form 10-Q for the second quarter.

The company assumes no obligation to update any of these forward-looking statements.

Lastly, during this call we will discuss certain non-GAAP financial measures. Information related to these non-GAAP financial and the corresponding GAAP measures can be found in our press release on the company’s website at

With that, now I’d like to turn the call over to Howard Schultz. Howard.

Howard Schultz

Thank you, JoAnn and good afternoon, ladies and gentlemen. Today’s earnings call is perhaps one of the most important in our 16-plus years as a public company. We’ve taken significant steps to restructure the business for the long-term and I want to be sure you leave the call with a comprehensives understanding of these actions.

Equally, I want to share with you our unwavering confidence in the strength and resilience of the Starbucks brand and the leadership position we occupy within our industry.

During today’s call, I will give you an update on the progress we’ve made against our transformation initiatives, both in elevating the customer experience and the significant actions we’ve taken in fiscal ’08 to structure the business for the long-term profitable growth.

Pete will then take you through our third quarter results and provide an update for the full year. These targets will reflect a rationalized U.S. store portfolio and our international growth strategy, as well as the current macroeconomic environment. Finally, we’ll wrap up by looking at what’s ahead.

With that overview of what we will cover, let me start out by emphasizing that we are playing both offense and defense in our approach to the current business. We are making bold moves towards transforming our business for the long-term and at the same time, making the tough decisions to ride out this extremely challenging economic environment. We feel good about the balance we have struck and firmly believe that the decisions we have made in the last six months will deliver significant long-term opportunities for our business.

We’ve been relentlessly focused on strengthening our core business by listening to our customers and delivering innovation and change to elevate the Starbucks experience. We are also extremely encouraged by the customer reception to Pike Place Roast, Vivanno nourishing blends, and Sorbetto. As we continue to implement our transformation agenda, we also continue to battle the perfect storm of this economy. The economic climate and its impact on consumer spending is a reality we are acutely aware of. That being said, we have very clear visibility into the decisions we must make to ensure that we are well-positioned when the economy begins to improve.

I would like to first comment briefly on the actions we took earlier this week. Following our July 1st announcement regarding our store closure program in the U.S., we announced a realignment of our non-store organization that reflects what we believe to be an appropriately sized infrastructure to support the reduced number of stores. As a result of this most recent realignment, we reduced our support organization by almost 1,000 positions. This total includes eliminating open positions as well as reducing our current employee base. Most functions within our support organizations were streamlined, both at the Starbucks support center in Seattle and in the field across the U.S. and internationally.

The realignment, coupled with our recent decision to close approximately 600 underperforming U.S. company-operated stores also results in the geographic redrawing of our U.S. retail operations organization, enabling us to further streamline regional operations.

We also addressed our international non-store organization with a focus on reducing infrastructure and building an efficient foundation for the next phase of international growth.

We specifically announced that we are restructuring our business in Australia by refocusing on three key cities and surrounding areas -- Brisbane, Melbourne, and Sydney. This restructuring includes the closure of 61 underperforming locations throughout the country. We have tried for some time now to address the challenges that are unique to the Australian market. After evaluating several options to help strengthen the business in Australia, we made this decision to concentrate our attention and resources on profitable growth, operational efficiencies, and an enhanced experience for customers and employees.

The 23 remaining locations represent high-performing stores in these three key cities where we believe we can deliver financial performance and maintain a strong brand presence.

These actions in our U.S. and Australian store base demonstrate our willingness to make tough, timely decisions in areas that will improve our efficiency and cost structure. With that said, these decisions were incredibly hard because of the personal and professional impact they have on all of our people. We would not be the company we are today without the tremendous commitment and contributions our partners make every day and we are committed as ever to preserving the culture and values of the company and believe the decisions we have made will help to ensure the future success of Starbucks.

As we continue to implement our transformation strategy, a razor sharp focus on our operations is a non-negotiable requirement. As such, we’ve concluded that the CEO requires direct line of sight into our businesses and functions, with a concentration on the U.S. and international businesses and the consumer products group. With this in mind, I’ve asked Martin Coles, Chief Operating Officer, to once again assume the role of President of Starbucks Coffee International, a business that achieved great success under his previous leadership. We are excited about Martin’s return to our international business at a time of tremendous opportunity. Given this change, we’ve eliminated the COO position.

In order to effectively manage our in-store and out-of-store customer experience, category innovation and go-to-market strategy, we are consolidating marketing and category leadership, which includes food and beverage, under Michelle Gass, currently Senior Vice President Global Strategy, office of the CEO. Michelle brings unique experience in both marketing and strategy and will provide the organization with a clear voice and connection with our customers.

Dorothy Kim, currently Executive Vice President, Global Supply Chain Operations, has demonstrated an expert understanding of our supply chain operations process and strategic implementation, which will be utilized extensively in her new role as EVP Global Strategy Office of the CEO. Dorothy will be responsible for operationalizing our global business strategy to ensure that daily decisions and actions are consistent with long-term strategic success.

Peter Gibbons, Senior Vice President of Global Manufacturing Operations, who has led manufacturing, has been promoted to Executive Vice President Global Supply Chain Operations.

Vivek Varma, General Manager of Communications and Public Relations from Microsoft platform service division, will join us as Senior Vice President for Starbucks public affairs and he will assume this position in September.

Moving on now to our work to improve the state of the U.S. business while building for international growth, the U.S. store closures have already begun and will continue through mid-fiscal ’09. We expect these closures to increase customer traffic and sales at many stores, primarily because nearly 75% of all closures are within three miles of an existing company-operated store. The customer response that we have received regarding the closures has been overwhelming. We’ve seen everything from letter writing campaigns to phone calls to organized online petition movements. We appreciate the loyalty and passion our stores and partners engender in the community and we will do all that we can to channel this positive energy toward longer term opportunities for our entire store portfolio.

We reduced our fiscal 2009 company-operated gross store opening target in the U.S. to less than 200 stores. We have amplified the level of scrutiny we’ve placed on future store openings based on what we have learned during our recent period of high growth and have sharpened our focus on opening only those locations that will deliver a strong return on capital. And as I said previously, the realignment and reduction of our U.S. support organization reflects what we believe to be an appropriately sized infrastructure to support the reduced number of stores.

We will continue to pursue growth in our international markets where we believe very strongly in the long-term opportunity. During the quarter, we launched a promising new market in Argentina. This was one of the strongest openings in the history of our company and we are excited by the potential of this new market. We also recently signed a strategic partnership agreement with the U.K. based SSP, which will expand our presence by more than 150 stores over the next few years in airports and in train stations, a new channel for us in the U.K., France, and Germany. We believe that Starbucks can play the role of the neighborhood coffee shop wherever our customers happen to be.

Our six stores in Russia are ramping up more quickly than we had anticipated and in fact, these stores boast the highest average ticket in all of Starbucks. This, along with our successful launch in the Czech Republic, is a promising indicator for our expansion in what will ultimately be a significant market for us.

With the world spotlight on China this summer, our 600 greater China stores will serve as a unique platform and opportunity to introduce thousands of people around the world to the Starbucks experience.

As I promised in January, we have renewed our focus on strengthening our core of great coffee and proud partners, as well as elevating the experience one customer and one store at a time.

In a short time, the customer reception has been decidedly positive. Related to great coffee, we had three major initiatives in this area to strengthen our core. Pike Place Roast was one of the first initiatives launched in response to what we heard from our customers. We’ve experienced a lift in our brewed coffee business since its launch and it continues to do well.

We’ve also responded to customers’ feedback by reintroducing bold options in the afternoon in some key markets. This gives our customers a choice between Pike Place Roast and a bolder option throughout the day.

We began rolling out the state of the art Mastrena espresso machines and expect that nearly 30% of U.S. company-operated stores will have the Mastrena espresso machine by the end of the year, with 75% getting it no later than 2010.

We will continue to expand the clover program in the coming months and we believe our customers will be impressed, as we have been, with this unique, best of class cup of coffee. We have seen positive results from our stores in Seattle and Boston and building on what we have learned from our customers and partners over the past eight months, we will add the clover to more locations in Seattle at the end of August and in Boston in September. The clover brewer will debut in the San Francisco market shortly thereafter and we plan to have the clover in 500 stores by the end of 2009.

We will market the clover brand and brewer to differentiate and enhance the Starbucks experience, allowing us we believe to drive incremental traffic into our stores.

To help elevate the experience, we launched a new forum that allows us to tap into the enthusiasm of our customers. continues to provide valuable insight into our customers’ wants and needs, and we are monitoring and evaluating that feedback to inform our planning.

As of earlier this month, over 48,000 ideas have been submitted by Starbucks customers and more than 380,000 votes have been tallied on those ideas.

As I stated before, we believe our customers remain loyal to Starbucks. They are just visiting us less frequently as a result of the economic pressures. Recognizing these pressures on consumer spending and a continued desire by customers to enjoy the Starbucks experience, we have recently introduced a number of programs designed to provide value to our customers.

Since we relaunched our Starbucks cards rewards program in April, over 1 million customers have signed up. These customers have reloaded $150 million on their cards, a rate 50% higher than a year ago, and we reached $1 billion in Starbucks card sales, or dollars loaded, in Q3 this fiscal year, more than two months earlier than fiscal year 2007.

Based on this response, we will take the Starbucks cards rewards program to a much higher level with significant enhancements to be introduced in time for the holiday season.

It’s interesting to note that at a time when there is so much pressure on consumers, the Starbucks card is enjoying its strongest level of attachment and loyalty since it was launched, with approximately one in seven customers now using the card to pay for their purchases.

I am also pleased to report that we have enhanced our strong relationship with Costco. They have purchased 1 million $20 value Starbucks gift cards and we expect these cards to be a powerful catalyst for driving their members into our stores for the fall and holiday periods.

Additionally, as we introduce new products such as Vivanno nourishing blend and Sorbetto, our pricing strategy includes addressing consumer spending concerns. Speaking of Vivanno, in all three markets where we launched, U.S., U.K., and Canada, we have seen customers embrace this new offering with a great deal of enthusiasm. The Vivanno launch is the first in a new category of nutritious offerings under our health and wellness platform and is in direct response to customer feedback asking for healthier options.

Also, on the innovation front, we recently did a limited launch of Sorbetto, an Italian inspired beverage, in 300 stores in Southern California, and this indulgent treat is getting rave reviews from customers and employees alike. We are evaluating the potential for broader market expansion in the future.

While Vivanno and Sorbetto are in the introductory phases, early indicators demonstrate that they have the ability to drive traffic into our stores, particularly in the challenging afternoon day part.

As we close fiscal 2008, we will continue to take further action of our goal of delivering long-term shareholder value and to position us to begin fiscal 2009 as a stronger, more efficient company.

We will be launching a new food platform this fall, based on healthier, unique breakfast alternatives that perfectly complement our beverages. Customers are looking for ways to add whole grains and more lean protein into their diets, and the portfolio of products launching in the fall will meet this need.

Now, you may have read in the media last week that we reversed our plans on breakfast sandwiches. In fact, we did commit earlier this year to replacing the current breakfast sandwiches, which while popular presented a number of issues, and we’re doing just that. We’ve been working to adjust the recipe and are now satisfied that these sandwiches do not interfere with the coffee aroma in our stores and that the new recipe will meet the highest quality standards.

We’ve revamped our entire 2009 product and promotional calendar and I believe, in my more than 25 years of being with Starbucks, it represents some of the best work we’ve done in years. Our fall and holiday offerings will have a particular focus on value, innovation, and on great coffee.

It’s too early to talk specifically about these offerings, but I’m confident that this will resonate with our customers.

As we move into fiscal 2009, we will continue to expand our health and wellness offering and of course, we’ll continue to innovate around the Starbucks experience. So while we’ve had to make some very tough decisions and continue to face challenges in the current operating environment, we are energized and we remain focused on our efforts to strengthen the business and build it for long-term shareholder value.

With that, I’d like to turn the call over to Pete.

Peter J. Bocian

Thanks, Howard and good afternoon, everyone. Howard reviewed with you a number of strategic initiatives we’ve implemented or announced over the past few months, all targeted to strengthen our business model for the long-term and to better structure our business to weather the near-term challenging economic environment. We committed to you that we would take action in fiscal ’08 in areas that we can control, and we have.

On July 1st, we announced the 600 U.S. store closures, and also recently restructured the entertainment business. Yesterday, we communicated actions in the headcount cost and expense areas, as well as the 61 store closures in Australia.

Combined, these actions are estimated to deliver a pretax benefit of approximately $200 million to $210 million in fiscal 2009, which translates to approximately $0.17 to $0.18 of EPS.

Also, we’ve continued to look at how we can more effectively use our capital and brought the dollars planned for ’08 and ’09 down, balancing our opportunities to invest with the currently tough economic environment.

Our goal is to enter fiscal ’09 on a clear path to improving our financial performance, as measured through operating income and earnings per share. In my time today, my goal is to provide financial context around the actions we’ve taken, review the quarter, and talk about where we stand for the balance of ’08 and moving into ’09. We’ll plan on a more detailed look into 2009 on the Q4 call scheduled for November.

Now let’s look at the third quarter. At a high level, the quarter had a significant financial impact from the actions we took, with $0.17 booked in the quarter around transformation activities, $0.14 from the U.S. store closures, and $0.03 from canceling future store sites and restructuring the entertainment business.

From a revenue and traffic standpoint, we did see a lift in brewed coffee from our Pike Place Roast launch but this was more than offset by our total same-store sales comps, which were slightly down sequentially from Q2. And you can see this reflected in only 9% revenue growth of the company in the quarter.

From an operational EPS perspective, when factoring in slightly lower comps, the cost of the Pike Place Roast launch and other transformation initiatives, namely our new espresso and brewed standards, we were down sequentially from Q2 and from your expectations.

Now let’s talk through the details of the quarter. Consolidated revenues for the quarter were up 9% to $2.6 billion, from $2.4 billion a year ago. As just mentioned, revenues came in below our expectations, driven mainly by continued slow traffic trends in the U.S. resulting in a mid-single-digit decline in total comps for the company.

Based on the actions we announced on July 1st around the closing of approximately 600 stores over the next three quarters in the U.S. company-operated store portfolio, we recognized a pretax restructuring charge of $167.7 million in Q3, which represents the asset impairment for these underperforming stores. This charge was below the estimated $200 million previously communicated due to our expected ability to redeploy some of the store assets.

Additional charges for lease terminations and related severance costs will be recognized in the periods in which they occur, which we expect will take place over Q4 and into the first half of fiscal 2009.

Including the restructuring charges, we reported a pretax operating loss of $21.6 million, compared to operating income of $245 million a year ago. The restructuring charges were the largest driver behind this decline in operating income.

Consolidated operating margin was negative 0.8% for the quarter compared to 10.4% for the same period a year ago. This margin compression was primarily due to the $168 million restructuring charges taken in the third quarter, which accounted for 650 basis points of the decline.

Also contributing to the margin pressure was higher cost of sales, including occupancy in both the U.S. and international businesses and higher store operating costs in the U.S.

Earnings per share was a loss of $0.01 for the third quarter, compared to earnings of $0.21 per share in Q3 of last year. Included in the third quarter loss was roughly a $0.17 negative impact related to transformation related costs, of which approximately $0.14 can be attributed to restructuring charges and, similar to the second quarter, approximately $0.03 of costs were associated with the implementation of other transformation initiatives.

Let’s now move on to our operating segments for the third quarter. U.S. total net revenues increased by 6% to $1.9 billion in the third quarter of fiscal 2008. Company-operated retail revenues rose 5% to $1.7 billion for the quarter. In addition to the continued softness in existing store sales that I previously mentioned, the slower ramp of revenues from new stores was a contributor.

We believe that the combination of reducing new store openings and closing underperforming stores will provide our new and existing stores a better operating environment for revenue growth in the future.

Lower revenues driven by a mid-single-digit decline in U.S. comparable store sales negatively impacted nearly all of the P&L line items as a percentage of sales. U.S. cost of sales, including occupancy costs, as a percentage of total revenues increased 310 basis points to 43.4% compared to 40.3% in Q3 of last year. Aside from the traffic, higher distribution costs were also a factor, driven by the continued integration of stores into our centralized distribution model, which we expect to provide efficiencies and cost savings over time.

In the quarter, we also saw higher fuel costs. We did see a positive sign in the quarter as dairy prices started to stabilize year over year after five sequential quarters of significant pressure.

U.S. store operating expenses increased 430 basis points to 45.8% of related U.S. retail revenues, compared to 41.5% a year ago. The primary driver of the increase was softer revenues, as well as costs associated with the termination of future site commitments and other in-store expenses related to transformation initiatives, namely espresso quality and brewed coffee reinvention.

U.S. operating income declined to a loss of $27.8 million for the quarter, from income of $253.2 million in Q3 of fiscal ’07. The operating margin was a negative 1.4% of related revenues for the third quarter, compared to 13.8% in the prior year corresponding period. The margin decline was driven by the restructuring charges taken in the quarter, which had an 860 basis point impact.

Lost sales leverage drove the remainder of the year-over-year decline, along with higher store operating expenses and cost of sales, including occupancy, stemming from the U.S. store portfolio rationalization and transformation initiatives.

The net takeaway for our U.S. business is that we are in a difficult operating environment as a direct result of the current economic situation and its impact on our customers, which is influencing the frequency of their visits to our stores. That said, we are taking actions in areas we can control to deliver improved financial performance in the future, starting in fiscal 2009.

Let’s now move on to results for our international business. International total net revenues increased 24% to $536 million in the third quarter, from $432 million in the third quarter of fiscal 2007. Company-operated retail revenues increased 23% to $450 million, primarily due to the opening of 319 new company-operated retail stores in the last 12 months, and favorable foreign currency exchange, primarily from the Canadian dollar.

As with the second quarter, we saw softness in traffic in our U.K. stores in Q3, and slower sales momentum in Canada as well, as that market shows more signs of impact from the weak U.S. economy.

International operating income increased 9% to $36 million in the third quarter, compared to $33 million a year ago. Operating margin for Q3 was 6.6%, down 90 basis points from Q3 of 2007, with higher cost of sales and occupancy as the primary driver. Unfavorable dairy costs year over year were also a significant driver, primarily in the U.K.

In our three-year targets, we projected operating margin expansion in our international business of 400 basis points over four years, coming off of the 2007 base line. For fiscal 2009, the combination of the Australia closures and the cost expense take out just announced is expected to drive improvement of about 190 basis points as compared to 2007. This excludes any charges in FY09 related to the Australia closures.

Now moving on to results from our global consumer products group, total net revenues for CPG increased 4% to $91 million in the third quarter of fiscal ’08, primarily driven by higher sales of our ready-to-drink products in the Asia-Pacific market.

As we’ve seen in prior quarters, there are fluctuations in the timing of Starbucks packaged coffee and tea product sales to Kraft. In addition, we saw overall softer sales from Kraft to the trade in U.S. distribution channels.

Operating income for CPG rose 16% to $49 million in the third quarter, compared to $42 million in the same period a year ago. Operating margin expanded 560 basis points to 53.7% of related revenues, from 48.1% reported in Q3 of fiscal ’07, primarily due to the mix of revenue being less weighted toward the initial sale of coffee and tea products to Starbucks' distributor and more toward profit-sharing revenues earned on the distributor sales to retailers.

As a final note on Q3, with the continued challenging operating environment, we remain conservative in our use of cash and did not repurchase any shares during the quarter.

Now moving on to our latest view of full year fiscal 2008 -- to date, we’ve taken action on a number of fronts to position us to deliver on our three-year targets, starting with fiscal 2009. Howard has talked through some of the actions we’ve taken and the innovations we’ve introduced, including the introduction of Pike Place Roast, our new everyday brewed coffee offering, espresso excellence training and the initial rollout of Mastrena, the nationwide launch of Vivanno, and in Southern California, the launch of Sorbetto.

From a business model perspective, we’ve also taken a number of actions to improve the economics of the store portfolio, get us better focused on our core, and better align our cost structure to be able to grow operating income as a company at much lower levels of same-store sales.

First, we announced the closure of approximately 600 unprofitable company-operated stores in the U.S., designed to both improve the direct profit contribution and also give neighboring stores a better opportunity to grow.

Second, we just announced the reduction of about 1,000 open and filled positions in the non-store part of the business. This is in addition to reductions taken in February and June of this year. As a reference point, our store headcount is about 95% of our entire employee or partner base. The combined actions taken represent a significant reduction in non-store positions.

Third, we took action on Australia, a market that I had talked about previously, though indirectly. With a smaller store base, we expect to significantly improve the financial results of that operation.

And there have been other actions, including slowing future new store development and restructuring our entertainment business.

In total, we expect the in-year fiscal ’09 benefit of these actions as compared to fiscal ’08 to be roughly $200 million to $210 million pretax, which excludes the related carryover of the lease termination and severance costs from store closures.

From an EPS perspective, we recognize that 2008 is a complicated story, with a number of restructuring costs, one-time investments, and partial year impacts. These include the $0.19 year-to-date impact from restructuring and other transformation costs identified to date, along with Q4 costs associated with the store closures in the U.S. and Australia, and the severance impact of the Q4 headcount action.

The timing of restructuring charges will impact our GAAP reported EPS in both the fourth quarter of fiscal 2008 and the first half of fiscal 2009.

If we look at full year fiscal 2008 non-GAAP EPS, we expect to be in the mid $0.70 range. This is down from our previous directional guidance of being somewhat below 2007 EPS of $0.87, driven primarily by reduced levels of traffic versus our previous expectations, and to some extent increased cost of brewed coffee and espresso quality.

With that starting point, as I stated earlier we’ve taken action that we expect will deliver $200 million to $210 million in pretax benefit, or add $0.17 to $0.18 of EPS next year.

As mentioned previously, the goal here is to deliver on the 2009 profitability targets, which are $0.90 to $1.00 in non-GAAP EPS. To reach that target range, we need to deliver low-single-digit same-store comp growth through increased traffic against a soft 2008 compare.

We also are driving for improved efficiencies in our U.S. store operations, as well as in our supply chain and procurement areas, all intended to deliver EPS expansion and cover the expected labor rate increases and commodity cost pressures.

Before I talk more about 2009, let me also talk through a couple of other changes for 2008. Year-to-date, we’ve reported revenue growth of about 13% versus the first nine months of 2007. Consistent with the EPS guidance, we now believe revenue growth for the full fiscal year will be around 11%, compared to our prior expectations of 13% to 14% growth.

Looking at our store opening targets, including the U.S. store closures estimated at approximately 200 for this year, we now expect net new sore openings in the U.S. of about 900, evenly balanced between company-operated and licensed stores. This compares to our original target of roughly 1700 net new stores in fiscal 2008 and represents about 50% reduction from actual FY07 U.S. store openings.

In our international markets we, along with our JV and license partners, are taking a more conservative approach in light of the current global economic factors. Including the just announced 61 stores closing in Australia, we’re now targeting net new store openings during fiscal 2008 of approximately 825 against our previous target of roughly 975. While we continue to believe in the long-term growth opportunity in our international business, we are taking the learnings from our U.S. market experience and approaching our international growth with cautious optimism, given the current economic environment.

We now expect capital expenditures to be about $1 billion; lower than our previous expectation of $1.1 billion.

Now let’s look ahead at some updates to 2009. Today I am going to give you a few comments in fiscal 2009, then plan to provide more detail on our fiscal year-end 2008 earnings call scheduled in November. Relative to the three-year targets looking out to 2011, we plan to come back and discuss these at our bi-annual analyst conference scheduled for December 4th in New York.

We are maintaining our EPS target range for 2009 of $0.90 to $1.00 on a non-GAAP basis. As mentioned above, building off the 2008 guidance, we’ve taken actions that put us on the path to achieving this goal. What still remains is to drive increased traffic in the stores and improve efficiencies in our U.S. store operations, as well as in our supply chain and procurement areas. You should look for updates on our progress as we move forward.

In looking at net new store growth, we continue to assess all our planned openings in light of this economic environment. For 2009, we have lowered the number of planned openings in both the U.S. and international markets. Let me now break it down for you.

Earlier this month, we indicated that we would reduce the gross number of new company-operated store openings in the U.S. to less than 200 stores in 2009. When netting out the approximate 400 remaining announced store closures against the openings we have planned for fiscal ’09, we expect a decline in total U.S. store openings of around 60 net new stores. This includes a reduction of approximately 225 company-operated stores and an expansion of around 165 net new license stores.

Our international expansion plans now target 900 net new stores in fiscal 2009, with joint venture and licensed stores still representing about two-thirds of that activity, as our business partners play an ever-increasing role in our growth strategy.

Our revised international store opening target factors in the current global economic climate with a cautious approach in the U.K. and Western Europe.

Turning to the use of capital, with the reduced store count targets for fiscal ’09, we are now lowering our capital expenditure target to about $750 million.

So in closing, we’ve taken a series of actions to improve the long-term health of the business -- closing of unprofitable stores, slowing the ramp of store build-out, right-sizing our cost and expense structure, and reducing the capital requirements of the business. At the same time, this is a traffic-driven business and we continue to invest in innovation and differentiating ourselves in the market.

With that, I’ll turn the call back over to Howard.

Howard Schultz

Thank you, Pete. I hope that you now have a comprehensive understanding of the current state go our business and of the decisive actions we are taking to position the company for future growth. It should be clear that we are doing everything within our control to ensure that the business is operating at peak efficiency, making prudent decisions and staying focused on the innovation that has always been a hallmark of our company.

As you know, there are no quick fixes but I can state with conviction that we are doing all the right things to exit this challenging period even stronger than before.

With that, I’m happy to open up the call to your questions. Thank you.

Question-and-Answer Session


(Operator Instructions) Your first question will come from the line of Jeffrey Bernstein with Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

Thank you. I think you mentioned something about assuming low single-digit positive comps for fiscal ’09. Just wondering within there if you could talk a little bit about the pricing assumptions. I believe you are now lapping last year’s increase in the next couple of days. Just wondering how much pricing power you believe you have and/or are you willing to absorb for the margin pressure to potentially avoid further traffic loss?

And kind of as a follow-up to that, if you could just talk a little bit about your commodity cost assumptions. I know you made a quick comment on dairy but if you could just talk about as you are looking out to fiscal ’09, what you are thinking about in terms of coffee and dairy products for the next year. Thanks.

Peter J. Bocian

We’ve been consistent in driving for 2009 through 2011 to be able to improve operating income and make our EPS targets at let’s call it relatively low same-store comps. Investing in innovation to drive more traffic and comps but having a financial model that is healthy at call it 2% to 3%. So we’ve been consistent on that when we established the targets three months ago and that’s our current plan. And in that, really no assumption around taking pricing in ’09.

On the commodities, let me just deal with ’08 in that we still have about a $0.03 dairy assumption for the year for 2008. We’ve done pretty well on the coffee side and relatively immaterial year-on-year for coffee for 2008. And then what I’ll plan on doing on the Q4 call in November is really going through in more detail as we look ahead into 2009 how the commodity costs look at that point in time. But as I said, our goal is to drive the comps, needing about 2% to 3% to make our objective, and then as we work U.S. store, operation efficiencies, and supply chain and procurement efficiencies, they are intended to mitigate any labor rate pressure or commodity cost pressure in 2009.


Your next question is from John Ivankoe with J.P. Morgan.

John Ivankoe - J.P. Morgan

Thanks very much. Actually, just a very quick housekeeping question, if I may, and then a little bit of a broader question; you know, Pete, in the guidance for fiscal ’08 for mid-70s, what EPS are you assuming for the second quarter, 15 or 18? In other words, should we exclude that $0.03 in the second quarter?

Peter J. Bocian

What we’ve done in the non-GAAP EPS of mid-70s, we’ve excluded the $0.19 year-to-date, which would include the Q2 $0.03, so from the math you were doing, it would put it from the 15 to the 18, and then excluded the $0.17 in Q3. And then there will be Q4 GAAP EPS impact from the store closures, whether it’s Australia or the [Tucom] lease terminations and severance around the U.S., so that’s why you should look at the mid-70s as not including any of the year-to-date $0.19, nor what we expect to happen in Q4 around the closures.

John Ivankoe - J.P. Morgan

Okay, fair enough. And secondly, and a little bit of a follow-up on Jeff’s question; he asked a question on pricing for 2009 and what I would like Howard to address, if possible, is the comments on value promotions in the fiscal first quarter, a focus on value and exactly what that may entail. I mean, whether it would be actually advertising price points or discounting or combos -- if you could just give us a sense of where the brand may be heading over the next couple of months.

Howard Schultz

We have no intention of doing things that would dilute the integrity of the premium position that Starbucks occupies, and what I mean by that specifically is we are not going to go down the fast food lane and do things that are what I believe not in the interest of, long-term interest of the value of the brand and the experience. We’ve been testing a number of initiatives in many markets over the last I’d say two months or so, and some of those initiatives are proving to be interesting. We’re gaining as much insight as possible but you are not going to see us bundle product in a way that would be consistent with fast food.

I do believe that given the attachment and the asset of the Starbucks card and the plans that we have for the card in the fall, that there’s a big opportunity there and that is a hidden asset that I don’t think we have exploited in the past. And given the traction we’ve gotten in the last couple of months and how many people have signed up, it looks like something that’s quite interesting and given the environment, something that we really can use to our advantage. So that’s the place where we’re going to go.


Your next question is from John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks very much. Pete, can you break out the $0.17 to $0.18 of benefits next year into the three major categories that you talked about, relative contributions? And can you -- how do -- do we think about this as actually dollars that you have saved or is some of this calculation avoided future costs?

And I know I’m not supposed to do this, but can you talk about the tax rate you are assuming for ’08 as well? Thanks.

Peter J. Bocian

I’ll just give you an order of magnitude around the three areas that contribute to the $0.17, $0.18, and you should look at that as an in-year ’08 versus ’09, so for example, there will be some partial impact benefit this year from the actions. We’ve netted that out to look at a year-on-year comparison. Australia is relatively small, relative to the other two, and then I’d say more than half is around the headcount action, with the rest being the U.S. store closures.


Your next question is from Steven Kron with Goldman Sachs.

Steven Kron - Goldman Sachs

Great, thanks. If I can just ask a quick follow-up to that, if you are thinking about the $0.17 to $0.18, does that also include a benefit in the, as you guys described, the same-store sales that may ensue from the existing store base, or is that separate?

Peter J. Bocian

It assumes some element of that but the majority is the direct impact of the profit from the under-performing stores. And then let me, I remembered, the tax rate for next year, we’re expecting about a point improvement, consistent with our long range targets, which we talked about in April, so -- yes, so I would just go back to the targets. We have some things moving around in Q3 that gave us benefit for the year but if you look back at the long range targets, we said about a point a year starting from the ’08 at that point in time.

Howard Schultz

One thing about the comps -- I think we are taking modest assumptions with regard to the incrementality from the closed stores in ’09. I do think it’s early in a small store base but the 50 stores that we closed are showing incrementality in the stores that are in its proximity, which is encouraging.


Your next question is from Larry Miller with RBC.

Larry Miller - RBC Capital Markets

I wonder if I can follow-up sort of on that $0.17 to $0.18 and ask the question a different way -- can you give us an idea what kind of U.S. margin benefit you are thinking about in fiscal 2009 relative to a clean fiscal 2007?

Peter J. Bocian

What I’d like to do is come back on the Q4 call in November and talk in more detail. I did talk about international today around the 190 basis points from the ’07 baseline. We think we’re on track relative to CPG in terms of the long-term targets, which were around the 15% growth and 50 points of op margin. We also believe we are on track, maybe slightly ahead in terms of the unallocated G&A, so I think by looking at those three components, you can somewhat back into the U.S. op margin that’s required to deliver the $0.90 to $1.00. So I’ll give you more detail in November but that’s the way I would frame it in terms of we believe we’re on track relative to unallocated G&A, CPG. We’ve taken two significant actions relative to international, and then there is an op income with the tax rate that feeds the $0.90 to $1.00, and we’ll talk more about that in November.


Your next question is from the line of Joe Buckley with Banc of America.

Joseph Buckley - Banc of America Securities

Thank you. One follow-up and then a real question -- I think what John Glass was asking was the tax rate for ’08, because it looks like -- you know, if $0.16 is the real number, it looks like a very low tax rate in the third quarter. Am I correct in that?

Peter J. Bocian

Yeah, the tax rate is heavily skewed in the third quarter by the restructuring. We also did get a benefit around some audits, so it would be slightly better. I would just put slightly better in full year ’08, excluding the restructuring than you had there before.

Joseph Buckley - Banc of America Securities

Okay. And then on the international side, you took quite a few units out of the expansion plans and you mentioned Western Europe and the U.K. Are you cutting pretty broadly across those markets?

Howard Schultz

Well, I think as we said in the prepared text, I think we want to be very cautious. I think there are signs in the U.K. that are difficult to predict, but there are signs that remind us of what happened here in the beginning of ’08 and those signs kind of bode downward in terms of consumer spending. We want to be very careful, and in markets like Spain and Greece, specifically in Spain, they are experiencing a very, very tough economy and in view of that, we want to be as cautious as possible and not over-expand at a time when the consumer may be under significant pressure.

But offsetting that, the openings in the last six months or so in Brazil and Argentina, the ongoing success we’re enjoying in Mexico, and although it’s only six stores in Russia, there’s a lot of places where we can make that up. We’ll just see how the year goes.


Your next question is from David Palmer with UBS.

David Palmer - UBS

Thanks. Howard, I wanted to ask you about innovation; you’ve discussed in the past how innovation has not been all that incremental. In the last couple of years, you had the Pike Place Roast and that seemed to have a big cost and it gave a boost but maybe not that big of a boost, and you mentioned Vivanno has gotten positive reviews but your guidance for the fiscal fourth quarter has mid-single-digit declines continuing. So I’m wondering, I want to get a sense of your confidence going into this fall innovation wave, when do you think that this will start to take root and really drive more incrementality in terms of improvement in the overall comp?

Howard Schultz

I don’t want to be sarcastic in any way, but can you tell me when the economy is going to improve?

David Palmer - UBS

So you feel like --

Howard Schultz

I think what we are seeing is two stories here. Pike Place Roast, Vivanno, both national footprint launches, and Sorbetto in California -- all three introductions, we have seen incremental take rate on all three products. In a normalized environment, we would have seen an up-tick in traffic and in comp store sales as a result of that, in terms of past history. But because of the ongoing pressure in our business, and for that matter almost every other premium retailer and brand that we talk to, we’ve been unable to move the needle upward because we still have a significant amount of headwind. And so in some cases, we’re moving the customer from one beverage to another.

I think the encouraging factor though in both Sorbetto and Vivanno for the first time, we do see an up-tick in the afternoon traffic and that has been the burden for the past six months or so, or even more than that.

But clearly we are facing a headwind in terms of the economy that’s very, very difficult to kind of crack through. It is very encouraging though that we launched a national platform with Pike Place Roast and Vivanno that are incremental, and the Sorbetto product has been even better in Southern California, but not enough to move the needle yet. And we’re going to continue with innovation in the fall and holiday and as I said in my remarks, we’ve got a great calendar for calendar ’09. But until the economy significantly improves, we’re just trying to do what we can to get through this storm and be much stronger when it improves.


Your next question is from Sharon Zackfia with William Blair.

Sharon Zackfia - William Blair

Good afternoon. Pete, a question for you on the comp guidance for next year; you’ve got the $0.17 to $0.18 in benefit now that I don’t think was fully anticipated when you talked to us last, so why isn’t the bar for comps a little bit lower for the same guidance reiteration for next year?

Peter J. Bocian

What’s happening is that the ’08 has gotten a little softer, so the starting point has moved away from us a little. We have continued to take actions and sized them for you in the $0.17, $0.18 but that’s really the difference in communication, is some movement in ’08 lower than we expected, which is in sync with the mid $0.70 EPS guidance is almost exclusively driven by lower same-store comps, and then therefore we’ve got a little bit higher hurdle for next year relative to comps.

Howard Schultz

I would add one other thing, and that is we’ve talked to many people who are trying to calibrate the economy and consumer spending in calendar ’09 and their advice to us is in many cases to assume at best that the consumer is going to be at parity with where they are now, so I don’t think this is any time to give guidance on comps that is more aggressive than we’ve already done.


Your next question is from Matt Difrisco with Oppenheimer.

Matt Difrisco - Oppenheimer

Thanks. Howard, I guess I want to -- you always get this question asked, but I might as well ask it again; franchising. Has something -- are we going to look at this maybe as a potential opportunity in some of the markets when we look at -- not the 75% where you have a store within three miles but if you look at towns like Baton Rouge, for instance, it seems like you’ve exited large areas of the middle of the country and left sort of just maybe some iconic type locations there for stores. Could you ever entertain or do we think that we’re at the point maybe where it might be a strategy to do regional franchise development agreements within the United States?

Howard Schultz

I know you’ve asked that question before and what I want to try and answer for you is just the way that we are looking at this. You know, if we thought that, and perhaps there are people on the call who do feel that way, that the best days of Starbucks were behind us and that the long-term opportunity that we have as a company and the long-term opportunity of the unit economics of Starbucks are not going to be as strong as they have been in the past, then perhaps we would be looking at a different financial structure.

But when we look at the opportunities that we have coupled with some of the mistakes that have been made and the headwind of the economy, we believe strong unequivocally in the model, in the brand, and have great confidence that we can return a much higher long-term value for the shareholders given the current structure of how we are organized.

And the other piece of that is that so much of what we do and what we’ve been able to do around the experience in the brand is based on the people side of Starbucks, which has been the brand.

So at this time, the answer is the same as it was when you asked it previously, and that is that we are maintaining the current strategy we have and we think that’s the right one for the company, our customers, and for this audience, most importantly, our shareholders.

Peter J. Bocian

And I recognize that was a U.S. question, but just to re-emphasize that as we move and grow internationally, we are continuing to do two-thirds, more or less, with joint ventures and licenses where we don’t have the scale and where they have an infrastructure and presence that can add value. So we are expanding internationally with a heavy license content.

JoAnn DeGrande

Operator, we have time for one more question today, please.


Yes, and your final question will come from the line of Howard Penny with Research Edge.

Howard Penny - Research Edge

Thanks very much. I guess you’ve been at the process of restructuring and right-sizing the organization from seven, eight months now, and as we’ve moved over those seven, eight months, the issues have gotten to where we’ve got more store closings, more people have been let go and now international is starting to see a little bit of a slow down. To the degree that you can, can you sort of take me inside the thought process of Starbucks as we’ve developed over these eight or nine months and how the incremental process is working and where we are from a timing standpoint?

Howard Schultz

I think I understand the question. I’ll try and answer it as best I can. The -- I returned January 7th and in that -- the management team and I have been very, very focused on trying to answer and ask the toughest questions possible about the core business and the domestic issues. And at the same time, I think we also tried to be very open-minded about the mistakes that were made, not point fingers, not blame anybody but solve for the problems. And I think we’ve demonstrated with this audience and with our people the ability to not only ask the tough questions but make the tough decisions, as evidenced by what we did this past week.

When you look at the power of the Starbucks brand, I think it is being overshadowed and in many ways overdone by the cloud that is hanging over the company because of the performance over the past year or year-and-a-half.

We have studied lots of companies that have been through this. Some have not made it through, many have. I think the companies that have made it through have embraced their core purpose, have had confidence in the equity of the brand and what they stand for, and have been able to answer the question about what is it that we really do well and what can we be proud of? And aside from the performance and the stock price, what has not changed is the fact that ethically, if you look at Starbucks, we are sourcing ethically the highest quality coffee in the world. We are known for I think the culture and values and guiding principles of our company and there’s an unbelievable reservoir of trust that exists between our partners and our people. The brand was built that way.

I think in times like this, it’s very easy, and I think you have a tendency to kind of grab for things for a quick fix or a silver bullet. I know that this audience does not have as much patience perhaps as we need to at times but the fact is that we have made the right choices, we see the light at the end of the tunnel, we’ll demonstrate that during fiscal ’09. We have completely revamped the calendar of products and promotions and what we are going to do in ’09 with I think a couple of surprises built in in the calendar year, and I think that’s going to be positive.

We can’t predict the economy and I think the thing that is sometimes missed here is that the economy has gotten worse in terms of consumer spending, consumer confidence since January. Who could have predicted we’d be paying close to $5 a gallon for gas? No excuse, but that’s the reality.

So we’ve got to manage through that. We’ve got to I think make sure that we demonstrate to you that the management team is up for this and the proof is not in the talking and not in this conference call but in the doing.

I’ve had a long history here, you know, it may not stand for anything other than the fact that I’ve been here but I can tell you that we are in here every single day, passionately committed to not only the process but winning. And ladies and gentlemen, Starbucks is going to win.


Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. Ms. DeGrande, are there any closing remarks?

JoAnn DeGrande

Yes, thank you. That does bring our third quarter earnings call to a close today. We invite you to join the webcast of our 2008 fourth quarter and fiscal year-end earnings results in November. And as Pete noted, the bi-annual analyst conference is scheduled for December 4th. We will be sending details out shortly. Thanks again for joining us today.


Ladies and gentlemen, this concludes today’s Starbucks Coffee Company’s conference call. You may now disconnect.

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