星巴克 (SBUX) 2008 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Starbucks Coffee Company second quarter fiscal 2008 financial results conference call.

(OPERATOR INSTRUCTIONS).

Thank you.

Ms.

DeGrande, you may begin your conference.

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 22250367, through 9 PM Pacific Time on Friday May 2nd, 2008, and on the Investor Relations page at Starbucks.com through 5 PM Pacific time on Friday, May 30th, 2008.

In addition, today's remarks will be available on the Investor Relations portion of Starbucks.com by the end of the day, and will remain available through Friday May 30th, 2008.

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, net new store openings, free cash flow, the performance of the US 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 30th, 2007, and Starbucks' quarterly report on Form 10-Q for the fiscal quarter ended December 30th, 2007.

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

In addition, during this call we will discuss certain non-GAAP financial measures.

Information related to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in our press release on the Company's Web site, at Starbucks.com.

We also want to inform you that we have scheduled Starbucks' fiscal 2009 biannual analyst conference, which will be held in New York for the first time.

We suggest you save the date of Thursday, December 4th, and we'll provide additional details on the event in the coming months.

Now I would like to turn the call over to Howard Schultz.

Thank you, JoAnn.

Good afternoon, ladies and gentlemen.

I hope you've had a chance to read the release we've issued just a little while ago.

During today's call I will give you an update on the progress we've made since our January 30th conference call in laying the foundation for a renewed customer experience at Starbucks.

Pete will then take you through a review of our second-quarter results, provide an update on the full year, and then spend most of his time walking you through our three-year financial targets, including the key financial metrics for the Company looking out to 2011.

These will include our targets representing the significant slowing of store expansion in the US, while accelerating international unit growth, and our expectations for revenues, operating margins and EPS coming off a plan that requires less capital expenditures and delivers significant free cash flow into the future.

As you think through all of what we are sharing with you today, I want you to have an understanding of the main considerations we, meaning our Board of Directors and our management team, took into account in developing our plans for the rest of 2008 and for the 2009-2011 period.

And we will discuss all of these over the course of this call.

To put it simply, our approach has been one of balance, recognizing current economic conditions and their impact on the operating environment, while also remaining highly focused and committed to the long-term significant opportunities for our business.

We have a very realistic view of the current and growing pressures on consumers in the US, and increasingly in other key markets around the world where we operate.

And we are intent on best managing our plans to match the demand we see, scaling back our openings, and rigorously managing all of our expenditures in all areas where they are not critical to our mission.

At the same time, we want to continue to innovate and invest in those areas that preserve and reinvigorate the uniqueness of the Starbucks Experience through our transformation agenda so that we continue to grow our business and are well-positioned when economic conditions improve.

You will see all of this reflected in our targets for revenue, CapEx, margins, EPS and cash flow, which we are sharing with you today.

With that, I would like to first comment briefly on our announcement last week of Q2 preliminary results and our revised outlook for fiscal 2008.

Once our second-quarter results were in, and in light of the deteriorating retail operating environment in the US, we updated our view of the year, and felt it was the right thing to do to quickly communicate our revised outlook to you.

In our press release we identified the impact of Q2 EPS from investments we made as part of our transformational agenda, along with costs associated with the rationalization of our store portfolio.

And while they had a negative effect on our second-quarter bottom-line, we firmly believe that these investments are necessary and prudent as we work hard to transform the way we do business.

I should also mention that the benefits from these initiatives, such as the launch of Pike Place Roast, are not yet reflected in our results, but they will be over time.

While we are not going to use the economy as an excuse, it is important to keep in mind that our second-quarter results do reflect the sharp weakening US consumer environment.

Like most other retailers and restaurants, we are experiencing a downturn in customer traffic, demonstrated in reduced frequency of customer visits that we believe ties to a real reduction in consumers' discretionary spending habits.

With no immediate signs of recovery, this underscores why, as I will discuss, we have reviewed all aspects of our operations to make sure we are best utilizing our resources, and we are working hard to reduce expenses in non-critical areas.

At the same time, as I have said, it is incumbent upon us to maintain our focus on transforming our business for the future, so that we can deliver strong, sustainable performance over the long-term.

And we are making significant progress on the plan we announced to do this when I came back as CEO just 14 weeks ago, which centers on three things -- improving the current state of the US business, reigniting the emotional attachment with our people and our customers, and making fundamental changes for the long-term.

Today I'm going to review with you the new initiatives we have launched to date, as well as give you an early look at some exciting things that we have ahead of us in this year and beyond.

And I can assure you that we have the focus, commitment and excitement of our management team behind us in these efforts, as we believe that we can deliver on the strength of our business, enhance our relationship with our customers, by reminding them why the Starbucks experience is unique and only going to get better as we further build on our leadership position.

The first action we outlined in our transformation agenda was slowing the pace of US store openings by lowering our US net new store opening target by around 425 stores in this fiscal year.

Today, you saw in our press release that we have taken down our store opening target even further, including the reduction of an additional 30 Company-operated stores and over 125 licensed stores from our fiscal '08 opening target.

We now expect to open around 1020 net new stores in fiscal '08 in the US, down from the nearly 1800 stores we opened in the US in fiscal 2007.

That includes the previously announced closing of approximately 100 underperforming stores by year-end.

Importantly, we have also significantly reduced our previously announced US store opening target for fiscal '09, down to 250 net new Company-operated stores, and less than 400 in total US store openings, demonstrating our commitment to optimize our resources and reduce potential cannibalization of existing stores.

The second area of focus we identified was taking decisive actions to enhance the Starbucks Experience, and I am pleased to say we have made good progress to date in this area, with much more to come.

In February we took our first step with our Espresso Excellence training, which demonstrates our commitment to partner engagement and training, and to improve the customer experience.

While it's hard to measure the success of this program with financial metrics, it was crucial for us to infuse our store partners with energy, knowledge and renewed pride so that we can ensure that we were consistently and enthusiastically delivering the Starbucks Experience to our customers.

The feedback we have received from both customers and partners has been very positive, and the quality of our espresso beverages has clearly been enhanced.

On March 19, at our annual meeting, we announced several other important initiatives as part of the transformation agenda.

The first, which launched on April 8, was our new everyday brewed coffee Pike place Roast.

This smooth yet bold coffee, developed by our coffee and roasting teams, was designed to provide customers with a unique, consistent fresh brewed coffee experience.

At the same time, we also returned to our practice of grinding whole beans in our stores and brewing coffee every 30 minutes to provide our customers with the freshest coffee possible.

While Pike Place Roast has only been in our stores for three weeks, we have seen a notable increase in the number of cups brewed coffee sold per day, particularly in the Northeast region, which is our largest brewed coffee market.

This aligns with our goal to increase our share of the overall brewed coffee market, where we believe that we have been underrepresented, and bring our brewed coffee share closer to the great success we've achieved over the years in espresso beverages.

We are very pleased with the early success of this initiative, and it's still early.

At the annual meeting, we announced two exciting initiatives directly related to enhancing the preparation and quality of our coffee offerings.

The first was the next generation of espresso machines exclusive to Starbucks, the Mastrena, which is the result of five years of development in collaboration between Starbucks and one of the world's leading espresso machine manufacturers.

The technological advancement of Mastrena gives us a three to five-year lead ahead of others in terms of the quality and precision of every espresso shot made.

In addition to elevating the quality of our beverages, the Mastrena has a low physical profile, enabling our people to visually connect with our customers, something that we believe will significantly enhance both the barista and customer experience.

By the end of 2008, more than 30% of US Company-operated stores will have the new machine, and 75% will have it by the end of 2010.

Additionally, new international stores will receive the Mastrena starting this summer.

Another step toward elevating the coffee experience and further building on our brand leadership in the brewed coffee category was our acquisition of The Coffee Equipment Company and its revolutionary Clover brewing system.

The technology behind Clover, which has become the gold standard in innovation in brewed coffee, will allow us to deliver individual brewed cups of coffee of the rarest and most exotic Starbucks coffees to our most discerning customers.

The Clover's specialized brewing process blends the best of the vacuum pot and coffee press methods, and further develops and unlocks the unique flavor nuances of specialty copies.

Clover is being very well received in our two test markets, and we believe it provides another significant opportunity to differentiate the Starbucks Experience from all others.

Our current plans are to bring the Clover experience to customers in more than 80 of our US Company-operated stores in Seattle, Boston and San Francisco by the end of the calendar year.

We also launched several additional programs intended to encourage further engagement from our customers.

First, we recently introduced the first phase of our Starbucks Card Rewards program, in which we will continue to explore ways in which we enhance the Starbucks Experience using this platform of creating rewards and new ways to say thank you in appreciation to our customers.

Second, we introduced MyStarbucksIdea.com, a dynamic online community that allows us to deepen our relationship with our customers beyond the doors of our stores and cultivate ideas directly from a valuable group of people.

Thousands and thousands of customers have been on that site, and if you haven't seen it you should go on it and see the attachment and the relationship our customers have with our company.

We've accomplished a lot in just a few short months, yet there is so much more going on behind the scenes in the way of innovation, which I'm excited about.

I have participated in all the new product development reviews, and I'm impressed by the level of creativity, uniqueness and relevancy of the innovation, which we believe will capture our customers' attention, create demand, and drive traffic into our stores.

As part of the next phase of transformative initiatives, we are focusing specifically on our cold and blended categories.

This summer you will see a significant amount of product innovations through three new beverage platforms designed to invigorate our cold beverage offerings.

The first is Starbucks' entry through the Starbucks Double Shot platform into the energy beverage category.

This is a fast-growing segment with the $4.4 billion energy beverage market growing at a rate of 31% in 2007.

Entering this category offers us a significant opportunity for us to complement our customers' lifestyles and engage an important and relatively untapped demographic for Starbucks.

Other entries into this space have used caffeine as a supplement within their energy beverages, which makes Starbucks a natural, and we believe gives us a unique position in the marketplace with Starbucks coffee, as well as the equity and strength of our brand.

With this introduction, and for the first time in the Company's history, we are leveraging the assets of our JV partnership with Pepsi Cola to expand our successful Starbucks Double Shot platform across multiple channels to bring to the market Starbucks Double Shot and energy beverages in our retail stores and through the more traditional Consumer Products Group channel.

This new platform will include both customizable, handcrafted beverages in our stores, and ready-to-drink energy beverages, which will be available through Pepsi's nationwide distribution, complementing the system that created bottled Frappuccino.

The combination of Starbucks' strong brand awareness, our leadership in the ready-to-drink category, and the strength of our partnership with Pepsi, is a powerful and perhaps unparalleled combination.

Another advantage we have is the unique opportunity to also leverage the partnership's consumer advertising to raise awareness, which we believe will have a halo effect on our retail stores.

We are highly committed to the health and wellness category, and see this as an important long-term growth driver for the Company.

More importantly, our entry into this category is consumer-driven, and is in direct response to our research, in which our customers told us they're looking for healthy beverages and food offerings from Starbucks that will give them the energy and deliver real nutrition, while also tasting great, with moderate calories.

This summer we will make our first significant step forward into this category with the introduction of a health and wellness beverage platform.

Through our extensive research and development, we believe we have hit the mark with the protein and fruit blended beverage we have developed, which is made from simple ingredients that provide the benefit of sustained energy that our customers want.

This new beverage will be initially available in two flavors, and will include fresh brewed and a proprietary whey protein, with no artificial sweeteners, delivering 15 or more grams of protein with no more than 270 calories.

We have been testing these beverages in our stores and we have received very positive response from our customers and our partners, even exceeding our early expectations.

In our research, more than 60% of customers surveyed said they would come to Starbucks to buy healthy, nutritious beverages, and we are confident we have found the perfect answer to their needs.

Importantly, this is just the beginning.

We have a strong pipeline of many new relevant products that we plan to introduce through the rest of the year.

Lastly, as our Frappuccino category matures, and others have tried to repeat our success, it is critical for us to continue to pioneer new types of beverages to meet the cold beverage need.

We have been searching for some time for a cold beverage concept that would create the type of taste and proprietary nature and customer excitement that our Frappuccino blended beverages did over 10 years ago.

We searched the world over and over, and have found something, finally, that took us back to our heritage.

On our recent trip to Italy, we found a unique beverage platform that we believe to be a perfect complement to our overall beverage business.

This exclusive, proprietary opportunity was developed through a partnership with our Italian supplier, and represents a brand-new category of beverage, which is both refreshing, low-calorie, and indulgent at the same time.

It offers a unique frozen smooth texture, distinctive taste profiles, and options ranging from fruit-based, to dairy-based, to yogurt-based ingredients.

We are rapidly developing the lineup and have plans to first launch these beverages midsummer in parts of California.

We have segmented that specific market for this exciting product launch because it is a significant market for us, one which also is experiencing some of the most difficult challenges due to the current economic environment.

It's also a region that has a strong preference for a robust cold beverage lineup.

We are confident this unique breakthrough category will be received with great enthusiasm by our customers in California, which is just the precursor to a national launch in fiscal 2009.

And we believe customer acceptance to this new distinctive beverage category will create a new demand, driving incremental traffic to our stores, much like Frappuccino did 10 years ago.

While beverages are our core competency and our primary focus, we also remain committed to enhancing our complementary food offerings, which includes successfully replacing our warm breakfast sandwiches with a range of healthy, unique and great tasting breakfast alternatives.

We have made great progress in this area and with other products in our food lineup with a special tie-in to our beverage and health and wellness focus.

Our food transformation begins with the launch of new, nutritious breakfast foods in September, continues with the replacement of our current breakfast sandwiches in the early part of Q1, and will be followed by the rollout of a new, higher-quality proprietary bakery and chilled food program.

As evidence of the strong momentum that we have going, we can look ahead to holiday, and even to early 2009, with a great deal of excitement for the products and offerings in our pipeline.

For holiday, we will offer our traditional limited-time offering of Starbucks Christmas Blend [holding] coffee, which our customers will find even more flavorful than past seasons with an unparalleled taste and profile.

We've also streamlined and refocused our merchandise to offer our customers a selection of items unique to Starbucks, at attractive price points, given the tough operating environment.

In calendar 2009, we believe we will really push the innovation envelope with an entirely new multichannel product launch that will create a new category in the coffee arena.

This opportunity will allow us to leverage our assets to create a new platform based on new technology and the power of our brand and distribution network.

Stay tuned.

It should be clear that we are invigorated and Starbucks is coming back strong, delivering innovation and creativity.

With all the new and unique products currently under development and in tests, we are confident that we will deliver an elevated level of relevant innovation that will resonate with our customers and create new demand in our stores.

And at the same time, rest assured we will reaffirm our leadership position in all things coffee.

Along with our focus on innovation over the past few months we've also taken a close look at every aspect of our business.

And I said to our people, and I say it to you, there are no sacred cows.

This has and will continue to include scrutinizing and elevating everything we do against our core business and our long-term strategic intent to ensure that we are making the right decisions and running the business in a way that is right for our customers and adds value for our shareholders.

This led us to last week's difficult announcement, and that was the decision to refine our entertainment strategy and restructure our entertainment business to focus on digital strategy and core content with music and books.

Music and books will play an integral part of our coffeehouse heritage, and they will continue to play an important role.

But we've restructured and streamlined this area of our business in a way that will allow us to leverage key partnerships, focus on our initiatives that will add value to our customers in a much more cost-effective and balanced way.

Reshaping the entertainment business is just one example of the critical review of all aspects of our business model that is taking place throughout the organization as we work diligently on initiatives to strengthen the business for the future.

While many of these actions require investment, we also intend to realize opportunities to leverage back-end costs and drive efficiencies throughout the business.

Further, before we enter fiscal 2009 in October, we are committed to taking additional cost out of our non-customer-facing expense areas to better protect the profit commitment that we have made to you.

As we look over the next three years, there are a number of things firmly within our control.

Our cost and expense budgets, the capital we allocate to the business and the amount of investments we make in these initiatives.

Most importantly, we are focused on controlling and balancing all of that and maintaining a discipline on driving investments and initiatives that we believe will drive traffic and, therefore, drive revenue into our stores.

The transformation we are currently undertaking would not be possible without a strong organizational structure.

During the first quarter we further strengthened our management team with the alignment of key roles and the addition of new positions to form a leadership team with a laser focus on our customers and our partners.

And more recently have announced two additional appointments which further bolster our management structure in positions that are directly tied to the success of our transformational agenda.

At the business unit level, Cliff Burrows, previously President of our EMEA, was appointed to the position of President Starbucks Coffee US.

Cliff has led our business and brand to tremendous success in that part of the world and most recently was the head of our UK business.

He is now applying that same drive and business acumen to leading our US business, and the business could not be in better hands.

Also during the second quarter, we welcomed back Arthur Rubinfeld, a former Starbucks executive who returned to the Company in the new role of Global Development -- President of Global Development.

In this newly created position, Arthur is responsible for management of the global store portfolio, including site selection, design and creative concepts for Starbucks stores worldwide.

His first priority has been to conduct a thorough and comprehensive review and analysis of our current store portfolio to identify those areas where we are fully represented to make sure that we are in the best possible position to locate our stores for customer traffic and to carefully assess the appropriate growth opportunities ahead to support our long-term success.

With that, I will now turn the call over to Pete, who will review our Q2 results and provide some further information about our long-term financial plans and the metrics we believe are critical to assessing our progress in the transformation of Starbucks.

Thanks, Howard.

Good afternoon, everyone.

We recognize we've given you a lot of information in the last week, particularly today, with the communication of our long-range financial targets.

I plan to spend most of my time today on the long-range targets, but will also provide a recap of our fiscal 2008 second quarter and give you our latest full view on the year.

Then we will move into Q&A.

And recognizing there will be a greater number of questions today, we've allocated additional time for Q&A and plan to keep the call open until 3:30 PM Pacific Time.

Now looking at Q2.

As reflected in our preannouncement last week, Q2 proved to be a more challenging quarter then we anticipated going into the quarter.

Revenues for the quarter were up 12% to 2.5 billion from 2.3 billion a year ago, our lowest year-over-year increase to date.

As we disclosed last week, the softness was driven by a mid single-digit decline in US comparable store sales, driven by decreased traffic, which we believe is directly related to the challenging economic environment.

Operating income for the quarter [increased] to 178 million from 241 million in the prior year.

And operating margins contracted 360 basis points to 7.1% from 10.7% a year ago.

This contraction was primarily driven by the US business, although both the international and CPG businesses experienced margin pressure in the quarter as well.

I'll provide additional detail around the drivers behind the margin compression in each of the segment discussions.

But contributing to both the US and international margin erosion was the Q2 negative impact of the changes we're making with the implementation of the transformation agenda and charges related to the rationalization of our store portfolio.

Earnings per share was $0.15 in the second quarter of this fiscal year, compared to $0.19 per share in Q2 of last year.

The fiscal Q2 2008 second-quarter EPS was negatively impacted by approximately $0.03 of costs associated with transformation and charges related to the rationalization of our store portfolio.

Non-operating factors impacting net earnings for the quarter included higher interest expense, driven by an increased level of debt compared to the second quarter 2007, which was used for share repurchases.

We had a better effective tax rate year-over-year, primarily resulting from a larger contribution from international earnings in the quarter.

We also had a lower share count year-over-year based on prior share repurchase activity.

I'll talk more about share buybacks later in my remarks, both for the quarter, the balance of the year, and in the context of the long-range plan.

Let me now cover our operating segments' second-quarter results.

US total net revenues increased by 8% to 1.9 billion in the second quarter of fiscal '08.

Company-operated retail revenues, which represent 89% of total US revenues, also rose 8% to 1.7 billion for the quarter.

As we disclosed last week, contributing to the slower growth in US retail revenues was the softness in existing store sales, down mid single-digits in year-on-year comps, as well as a slower ramp of revenues from new stores.

We believe the major driver to be the current economic environment, which is resulting in lower frequency of customer visits to the stores.

It's also important to note that Q2 had very little impact from the benefit of innovation that Howard talked about in has remarks, with most of the significant announcements from our annual meeting going live in April at the start of our Q3.

US cost of sales including occupancy costs as a percentage of total revenues increased 180 basis points to 41.4% compared to 39.6% in Q2 of last year.

This was chiefly driven by lower-than-expected sales, coupled with occupancy costs from higher rent expense driven by the new stores.

We also had higher dairy costs, and in the quarter dairy cost the Company about $0.01 of EPS year-on-year.

US store operating expenses increased 320 basis points to 44.2% of related US retail revenues, compared with 41% a year ago.

Approximately half of the increase was related to soft revenues, and the other half to transformation initiatives and the rationalization of our US store portfolio.

In the quarter we wrote off costs associated with terminating future site commitments, along with the associated inventory and store assets.

We have yet to recognize much of the impact from the planned closures of 100 stores, which we still expect to complete in the balance of the year.

US operating income declined to 194 million for the quarter from 268 million in Q2 of fiscal '07.

Operating margins experienced significant compression to 10% of total revenues for the second quarter of fiscal 2008 compared to 15% of revenue a year ago, due to lower levels of traffic in our stores, along with higher store operating expenses and higher cost of sales and occupancy costs.

Moving now to results for our international business.

International total net revenues increased 27% to 493 million in the second quarter from 387 million in the second quarter of fiscal '07.

Company-operated retail revenues increased 27% to 417 million, primarily due to the opening of 314 new Company-operated total retail stores in the last 12 months and favorable foreign exchange, primarily from the Canadian dollar.

International operating income decreased 16% to 18 million in the second quarter compared to 21 million a year ago.

Operating margins for Q2 were about 4%, down 180 basis points from Q2 of 2007.

The most significant contributor to the decline in operating margins was related to the store portfolio rationalization activities and the transformation costs incurred in the quarter.

Also, we did see some early signs of softness in traffic in our UK stores.

On a year-to-date basis, operating margins are roughly 100 basis points ahead of prior year, excluding the Q2 costs mentioned earlier.

We'll talk more about our expectations for international operating margin expansion when we talk about the long-range plan.

Now let me turn to results from our global Consumer Products Group.

Total net revenues for CPG increased 22% to 96 million in the second quarter of fiscal 2008, primarily driven by higher sales volumes of packaged coffee and tea in the US.

Operating income for CPG rose 13% to 43 million in the second quarter compared to 38 million in the same period a year ago.

The operating margin compressed 350 basis points to 44.3% of related revenues from the 47.8% reported in Q2 of fiscal '07, primarily driven by lower income from equity investees as a result of product write-offs within the NACP partnership.

We still expect total-year operating margins for this business at around 50% in 2008.

During the quarter the Company did not purchase any shares -- repurchase any shares, after purchases of a total of 12.6 million shares at a cost of 342 million in Q4 of 2007, and another 12.2 million shares in Q1 2008 at a cost of 295 million.

Our plan for the balance of the year is to be relatively conservative in our use of cash, given the current operating environment.

Now turning to updates to our total year 2008 outlook.

Over the past several months we continued to reduce the number of net new store openings we have slated for the year in the US.

As Howard mentioned, we have lowered the US store opening target to 1020 net new stores, down from 1788 stores in 2007, and from the target of 1175 we communicated in January.

The breakout of the stores is expected to be about 620 Company-operated and 400 licensed.

We are keeping the international store opening target at the 975 store update we provided on the Q1 call.

We still expect capital expenditures to be about 1.1 billion for the year, with the reduction in new store investment being offset by investments in innovation.

We expect consolidated revenue growth of 13 to 14% for the year, with year-to-date revenue growth at 15%.

Last week we communicated directional guidance for 2008, based on the reduced traffic and related lower revenue and profit in our US business.

We provided an estimate that EPS for FY '08 would be somewhat lower than the $0.87 reported in fiscal 2007.

This directional guidance reflects the uncertainty we have around consumer spending in the near term.

We saw significant deterioration in traffic in our stores sequentially from Q1 to Q2.

As a reference, each point of traffic in the US in the quarter is worth about $0.01 of EPS.

We are in a volatile economic environment with our innovation just launching.

We have cost takeout plans under way, but can get limited in-year benefit.

We believe we can hit a specific target range for '09 as we will get the full-year benefit of our cost takeout plans.

We also expect to realize the international margin opportunity, and innovation will have a full-year of impact on the US business.

With that, let me move to our three-year view.

On last quarter's call, we committed to providing you with quantifiable longer-term financial metrics so you could better measure our progress as we continue to take advantage of growth opportunities globally, but with a renewed focus on use of capital and creating long-term shareholder value.

To accomplish this, we moved up our long-range planning process and fast-tracked the development of the business cases around our key initiatives.

And while one could argue the timing is not the best in terms of the current economic environment, we believe it's absolutely the right time to set the stake in the ground, align the organization with a clear focus and direction, and move quickly into execution.

Before I review the key components of the long-range plan, I'd like to go through some of our thought process in working through the targets for the Company.

First, we had a strong focus on controllables -- costs and expenses, stores, and overall capital expenditures.

Second, we made a commitment on international to deliver the growth and margin potential of the heavily licensed model.

Third, we needed to stabilize the US business to grow earnings with a more conservative assumption around same-store sales growth.

And lastly, we made sure we had significant investment in the customer experience to drive traffic.

Now let me go through the details which are included in the release.

As relates to our investment in stores, first we plan to reduce the number of net new store openings in the US over the three-year period to less than 400 stores per year, with approximately 250 Company-operated stores opening in each period.

Over the three-year period, we will open a total of 1200 stores, with the goal to make these our best of the best opportunities.

As a reference point, we opened 1788 stores in 2007 alone, and we're on a trajectory to grow that number in 2008.

We plan to continue accelerating unit growth in our international business with net new store opening targets of 1050 in 2009, 1150 in 2010, and 1300 in 2011.

We expect the mix of licensed stores to increase in international, with about 65% licensed over the three-year period.

Factoring in the lower 2008 store target for the US, total store count at the end of 2011 will be about 21,500 stores, with stores in our international markets growing from about 30% of the total store portfolio today to over 40% in 2011.

International represents a good growth opportunity for us, and also helps us balance the use of capital.

Looking at the use of capital, we expect capital expenditures of roughly 800 million per year starting in fiscal 2009.

This compares with about 1.1 billion of capital expenditures in both 2007 and 2008.

We estimate that about 70% of the capital will be for investments in the stores.

Now shifting to revenue growth, we are targeting international revenue to grow at a compound annual growth rate of 20% for the three-year period, driven by new store openings and continued growth in existing stores that we anticipate a moderation in the pace of same-store sales growth near term.

Our Consumer Products Group is expected to grow at least 15% per year through product and channel expansion.

The US segment is expected to continue to grow, but at a significantly slower pace, in line with the slowing of new store openings, and more conservative expectations of same-store sales growth.

For the US, we have assumed a continued difficult consumer economic environment near term.

As a result, we expect US revenues to grow about 5% in 2011, and have a three-year compound annual growth rate of just over 6%.

In 2011, total company revenues are expected to be just over 14 billion, which is a 10% three-year compound annual growth rate, with growth in 2009 expected higher than the 10%, and then moderating slightly over the three-year period.

We have provided EPS target ranges for each year from '09 through '11.

It is important to note that we intentionally broadened the ranges to reflect both the greater uncertainty associated with the outer years as well as the near term uncertainty of the economic environment.

For fiscal '11, EPS is expected to be in the range of $1.35 to $1.50.

For fiscal 2010, we anticipate EPS in the range of $1.10 to $1.20.

In 2009, we are targeting an EPS range of $0.90 to $1.00 as we continue to invest in our transformation agenda with the benefits still in the early stages and an assumption of a still difficult economic environment.

In looking at operating margin, we expect international operating margin improvements of approximately 100 basis points per year, reaching an operating margin of about 12% in 2011.

CPG operating margin is expected to remain flat with fiscal '07 results at about 50 points of operating margin each year.

We expect operating margin for the US segment to stabilize after 2008 at an average of approximately 11.5% from fiscal 2009 to fiscal 2011.

We also expect to gain leverage of almost 1 point of revenue from unallocated corporate general and administrative expenses by 2011 from the reported 2007 levels, with the improvements spread proportionately over the four-year period.

With these segment operating margin targets, and the improvement in the G&A spend outside the segments, we expect total company operating margin to improve over the three-year period from 2008 levels.

However, it will remain below the 2007 operating margin of 11.2%, influenced by the US business.

And lastly, we expect our tax rate to improve to about 34% in '09, driven by a larger mix of international operating income, and to further improve to 33% in 2010 and 2011.

Moving now to free cash flow.

Based on the guidance we provided today, we expect our performance to result in the generation of over 4.4 billion in cash from operating activities, and have 2.4 billion in capital expenditures, leading to over 2 billion cumulative free cash flow from 2009 to 2011.

This compares to aggregate expected free cash flow of about 800 million from fiscal '06 to fiscal '08, with an expected 3.8 billion of cash from operating activities and 3 billion in capital expenditures.

We define free cash flow as cash from operations, less total capital expenditures.

We intend to use this excess cash to return value to shareholders through share repurchases, or drive increased value through investment in new opportunities with attractive expected returns on capital.

Before I turn the call back over to Howard, I want to summarize what we communicated to you today.

We defined how many new stores we will open.

We view this as within our control.

We defined the capital we will use over the next three years, again, within our control.

We defined cost takeout actions, which show up in unallocated G&A and in the businesses -- again, within our control.

We defined our plan for international growth and margin expansion, shifting to a higher licensed partner contribution.

Our view is this is a solid, balanced plan.

Consumer products continues at current operating margin levels, and grows through new channels and products.

We view this similar to the international plan.

We are left with a discussion of the US business -- what will be the near and midterm economic environment, and will our innovation have a material impact.

We are a traffic-driven business, with beverages being the core.

Howard talked today about the entire beverage line and the coming innovations.

In summary, we hope you leave today's call with a sense of our focus around the key elements in the plan with the knowledge of working hard on what will create value long-term, the value proposition we offer our customers.

With that, I'll turn the call back over to Howard for a few closing remarks, and then we'll open it up for Q&A.

Thank you, Pete.

Let me once again emphasize that 2008 is a year of transition for Starbucks, a year for us to reenergize and sharpen the focus on our brand and our business.

Since I returned as CEO in January, we have taken decisive steps towards transforming Starbucks for the future.

We are aggressively pursuing initiatives that will position us to capture the long-term opportunity.

This is balanced with what we believe to be a realistic expectation about the impact of the current economic environment.

The next few years will be a period of sensible strategic and exciting growth for Starbucks, centered on strengthening our business model, enabling us to maintain our position as one of the world's most recognized and respected brands, and to increase shareholder value in a way that is sustainable and in line with what you expect from us.

With that, I'm happy to open up for Q&A.

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John Glass, Morgan Stanley.

Pete, I wanted to go back to your long-term earnings outlook, and it seems as if you're calling for over 20, even 25% earnings growth in the out years.

Can you help us break down operating profit growth and what the buyback contribution is?

It would seem it's going to be heavily reliant on buybacks.

Can you also talk about maybe your decision to use buybacks versus dividend policy to communicate the maturation of the business to investors?

I think the first is, there is share repurchase in the long-range plan.

But I would characterize it as 10% growth, coupled with operating margin expansion off of an '08 baseline.

So your 20% is off '08.

If you move back to '07, not as dramatic.

My view is we've got to improve, stabilize the US operating margins, improve the US, get the lift out of Consumer Products Group, contribute the G&A, and operating margin will improve over the horizon.

In addition, then, we get some lift out of share repurchases and out of the tax rate over time.

Relative to your second question, historically we have used share repurchases.

We'll continue to dialogue with the Board.

The good news is with the 800 million per year of capital that we expect to spend, there should be a lot more free cash flow.

So I will leave it as there will be, we expect, significant value to return to the shareholders.

Historically, we'd use share repurchases.

Not in a position today to really talk in detail around dividend, but we'll have the dialogue with the Board over time.

To what extent have you considered expanding the role of licensing in the US as a business that's maturing, the returns have gone down?

You talk about no sacred cows.

Would you consider relicensing or re-franchising a portion of the US business?

When we look at licensing as a part of the portfolio, I think one thing we can look back on is that perhaps the number of licenses and some of the license partners was too much.

And we want to dial that back.

I think we have to make sure that the level of execution and the experience is compatible with what we believe to be the most important component.

And when we've had issues and tension, more often than not it's been on those licensed stores.

So we want to be very prudent, and not chasing an economic model that in any way would dilute the integrity of the experience.

Thank you.

Joe Buckley, Bear Stearns.

The CapEx number in '08 not changing you attribute to capital spending related to the transformation agenda.

What exactly is that?

What is the CapEx on the transformation side?

You're correct.

The CapEx would have gone down based on lower Company-operated store openings.

The CapEx we're talking about when you think about the Clover -- so putting the Clover machine in the stores.

Mastrena has a capital component.

The beverages that Howard described leverage some of the infrastructure, but could have their own unique capital components as well.

So that's really where call it the backfill is happening.

And we plan to incorporate all of those within the 800 million each year looking forward.

A question on (inaudible) for the quarter.

You mentioned the margins being hit by some of the rationalization, store rationalization.

You made reference to softness in some of the key international markets, I guess the UK specifically.

Talk about what you did in the quarter.

Did you have store closings in the UK or Canada?

What's kind of the game plan there going forward?

Without naming the market, we are looking at the stores -- it was not Canada or the UK -- and rationalizing, and not dissimilar to the 100 stores that we've talked about for the US.

So there is some element of that, and it was fairly material when you look at the size of the impact for international in the quarter.

So what I tried to do was bridge you, relatively speaking, that on a full-year basis, if you normalize, roughly speaking, for the store rationalization, and some element transformation -- for example, we did have the Espresso Excellence training in Canada, as an example, which had an impact in the quarter.

If you normalize for those, we had a great first quarter relative to 180 basis points.

We're back kind of in the 100 basis point range after Q2 excluding the items I talked about.

Howard, you want to talk about the UK traffic a little bit?

What we've shared with you today is that there is some sign -- and I wouldn't get too excited about it today because we don't have enough information -- but there is some sign that there is a softening in the UK business due to the economic issues facing that consumer.

And as we speak to other retailers, both US and broad, that are doing business there, we're not alone.

It's really yet to be seen whether or not that is going to be a mirror image of what we have experienced here, or whether or not that's going to be a short-term situation.

We don't know.

One more question on the store rationalization.

Did you close stores in some international markets during the quarter?

We took charges against the P&L relative to eventually being in a position to do that.

Thank you.

Nicole Miller, Piper Jaffray.

I just wanted to ask about the executive succession planning at the end of this three-year turnaround phase.

What is really the milestone that you're looking to achieve to measure a successful turnaround?

You're talking about successful turnaround, or succession planning?

I guess two questions then, however you'd like to address it.

Both.

In terms of succession planning, I've made a commitment to the Board and to our people that I am here for the long-term.

And I have -- there's no -- I'm not looking behind me to say once we do X or Y, it's time for me to find a successor.

I'm here for the long-term to lead the Company back to the position it's been, and deeply committed to that process.

The management team is strong.

There's lots of people within our organization that are heavily tenured, and the organization, I think, is organized the right way.

But we're all looking at the same thing, and that is a deep, comprehensive and individual commitment to the long-term.

In terms of milestones, prior to this past period, call it 18 months, we had the kind of relationship with our customers and our people and with our shareholders that basically exceeded expectations.

And we want to get back to a point where the level of confidence that you have in us is tied to where it once was.

We realize we have some work to do.

But I don't want to get into the specifics.

We know that we've got negative traffic.

We're not accustomed to that.

We're not happy with it.

This is a management team and a company that's used to winning, and we're built for that, and we want to do that again.

Thank you.

I appreciate that color.

Just a quick question on the numbers side.

When you talked about the free cash flow, you didn't mention paying down debt.

So I guess we're to assume that you're implying you'll be at a net interest expense situation in the P&L.

Is that right?

We have some long-term debt, about 550 million, and then we have some short-term.

Keeping that kind of leverage across the horizon is probably a good assumption.

My last question on the numbers.

What are the conditions under which the US operating margin could expand?

Or asked another way, what are the constraints?

First, we do believe '08 is a recalibration versus '07.

Then we're cautious on how fast the economy turns, and what the new kind of increase in traffic per year will be going forward.

That said, we're very optimistic about all the innovation; we just haven't baked it all into the financial targets.

So, what I would describe as the upside would be the innovation and/or the environment being better than we have baked in.

So I view it as we've tried to be relatively conservative.

You can discuss that against different measures of how bad the economy one person expects it to be, but we've tried to bake in relatively conservative, which says we maintain the US operating margins that we expect in '08 -- and you can pretty much figure those out based on our directional guidance -- and then maintain those through the horizon.

There's a lot of opportunity, I believe, with the innovation to hit a home run.

We haven't baked it in.

How do commodities play a factor?

We have some element of coffee and dairy increases baked in.

We also, on the other hand, have supply chain efficiencies and other procurement savings baked in.

So I think not a material hit across the horizon.

But we do expect to get efficiencies to offset what could happen.

So we're not expecting dramatic changes, and we've done a pretty good job in coffee, for example.

If you look at this year, we may take a $0.01 hit in coffee, which is pretty good given the size of the commodity.

Dairy is going to be about $0.03 for the year.

So overall I think the team has done a great job in the coffee space and managing it.

We can afford it to increase some over the horizon, and then we're working on a number of things in procurement, supply chain, and cost and expense to mitigate it if it was bigger than our plan.

Thank you very much.

Jeffrey Bernstein, Lehman Brothers.

Just on international, as it becomes a larger portion of your business, can you talk about maybe some of the markets where you're actually seeing the greatest success, perhaps a couple of key sales and margin levels?

I think you mentioned international represents -- or will represent 40% of your global portfolio, up from the current 30.

Just wondering as an add-on, what about the percentage of profit from international?

I had a follow-up.

I'll start and Pete can jump in.

When you look back on the fact that we opened our first international store in August of '96 in Japan, and now in 44 countries, I think the headline reads that Starbucks has proven that the experience we've created in our stores is highly relevant, and with great acceptance across very different markets, cultures, and whether we're pioneering in China or going to Western Europe, where coffee has been there for hundreds of years, have demonstrated great success.

We have had unique experiences in many places, with the upside probably the greatest in China in terms of number of stores and the real big prize there.

But then you look at a country like Mexico, where we probably -- in the initial business plan at most probably had 100 to 150 stores.

We've been there five years.

We're close to 250 stores.

Just named best company to work for in Mexico.

Fantastic business there, and that business will grow north of 500 stores.

And there's many markets like that.

So I look at the UK and Japan, which have about 800 and 700 stores, respectfully, still not showing any signs of hitting the wall in terms of saturation, except the near-term issue about the economy in the UK -- we are very bullish on the international opportunity, and the fact that we think we really haven't gotten the economic leverage that Pete talked about in his formal remarks, which I think he'll talk about now.

I think to date, certainly the fact that it's heavily licensed means we don't count the system sales, so the revenue is not as big as the revenue of the US.

But as you look out, when you run the numbers, a 20% growth rate with 100 basis points of op margin getting to 12% in 2011, that pot of operating income is big for the Company.

So you've got a compound annual growth rate of over 30% on the OI.

So it won't be as big on the revenue side as the store portfolio by the nature of how we count the revenue.

But it will move to a more material part of the Company.

And then I think the message is also that, given the amount of licensed, I would argue at 12% we still have room to go.

Because we don't count all the revenue; therefore, we should have a much higher percent of revenue, reported in op income.

So my view is this is a stake in the ground for the next three years.

We've been treading water, kind of, OI as a percent of revenue in international for a couple years, and we need to do both -- grow at a healthy rate, and then get the op margin expansion.

And it helps broaden the portfolio, so we're not so US-dependent relative to where the profit comes from.

In terms of those most successful international markets (multiple speakers) seeing operating margins above the US?

What I talked about before is that -- and this will be against an '07 US -- is that Canada is approaching the US kind of margins.

There is still more challenges around the spread.

From a Company-owned market, the UK is improving, but behind Canada.

And then, the other big market that will be Company-operated will be China, and I would describe that as in the early stages.

Don't need as much revenue to get store probability, but a lot of infrastructure to make sure we do it right.

So you look at it, those are the three big ones.

Then you move into the license space, and some of the countries that Howard was talking about, whether it's Japan or Mexico, we're getting the royalty and the components of the license relationship.

One thing I would also add is that we're beginning to leverage the relationships we have with our partners.

So as an example, perhaps our best -- one of our best performing partners is our partner in Mexico and the Middle East.

In both those cases, our Mexico partner is our partner in Brazil, and will be our partner as we open up Argentina.

The Middle East business, which has been a great business for us, with the (inaudible) group, is also our new partner in Russia.

So our partners want more geography and I think that bodes well for the fact that this is a business that they believe in, and I think these are still the embryonic stages of the growth and development of our international business.

Just wondering if you can give any greater detail kind of U.S.-based, but the consumer research you guys have been talking about recently showing that US traffic declines are due more to economic pressures rather than the substitution (multiple speakers)

I'm glad you asked me that question because I had heard that there's some cynicism from the research.

It's just black and white; it speaks for itself.

We went out -- we've done more research in the last three months than we've done in a number of years, given the uncertainty of the economy and where the business is, and the fact we want to make some very big bets on the innovation pipeline.

But the first thing we wanted to really understand is that given the compression in traffic, we wanted to specifically understand what is driving customers to either come less frequently or not come at all.

And the unequivocal data -- and we've shared this with our Board and, obviously, our management team -- is the fact that the economy is the top box why people are not coming as often or not coming for that treat.

And specifically, when we asked are you going to other establishments in view of the fact you're not coming to Starbucks, there is no indication whatsoever that we're losing business specifically to any one competitor or a new category of competitors.

And there's no silver lining in the fact that we have less customers coming to our stores now, but the fact that it is the economy does demonstrate to us that we have a strong headwind that we need to understand that we're dealing with, and it's different than any other time in our history.

And as a result of that, we're trying to operate differently.

Does that change your thought process in terms of offering greater value, if they're not trading down per se?

I think that what we saw with the launch of Pike Place Roast is that we're getting some [deeper] mentality as a result of that brewed coffee and its unique taste, and also potentially we're getting people who have not come before because they have been an espresso-based drinker, or perhaps they're trading down.

But we haven't seen that in terms of the average ticket.

When we launch the Italian beverage in California this summer, we will price that beverage to be what we would view as an affordable luxury, and something that will be, I think, very interesting for our customers in view of the fact that it will be less expensive than Frappuccino.

Thank you.

Steven Kron, Goldman Sachs.

Just looking at your targets a few years out of 11.5% in the US, and looking at that compared to even just last year at 14.5, 300 basis point degradation there, I guess just looking -- or assuming the sales improvements by that point will have kicked in, and the expense rationalization you talk about, I guess -- can you talk about some of the offsets here?

Are you expecting a mix change like the new products you're introducing might be a lower-margin product?

What's going to prevent those margins from getting back?

I know you talked about maybe that's upside, but it just struck me as a number that seemed pretty low given where the business was just in fiscal '07.

I think, clearly, the recalibration in '08 is the negative traffic on the store base, as there are other pressures, whether it's dairy, whether it's natural wage pressures that happen every year.

So I view '08 as a starting point, and then taking conservative growth rates from there.

Clearly, if we can beat the growth rates, or they return to the comps of old -- and we're not putting that in the plan -- that would be upside.

But I think it's important that we're recalibrated on improving op income in the US without significant comps from the new '08 baseline.

I recognize it doesn't look favorable against '07, but I'm trying to recalibrate our expectations going forward, and then looking for some element of upside if the economy/innovation is better.

So there's nothing else from the expense side we should be expecting, whether it's a mix shift in cost of sales, absent commodity inflation will continue to be a headwind or other types of store operating expenses?

It's really just the moderating of the growth rate is not -- doesn't cover as much of the cost and expense that could and will increase somewhat over the horizon.

I also want to add that this is a time when I think our management team and our board wants to create expectations that at a minimum we meet, and we want to be conservative in our approach, especially in view of the fact that no one, at least around this table, can predict when the economy is going to change.

Fair enough.

Howard, obviously, you mentioned this is a business; it's built on transactions, and you're focused back on your beverage -- further emphasis on the beverage side of the business.

It seems as though a lot of new products coming through over the course of the next 12 to 18 months, perhaps maybe fast-tracking some of the products, bringing them to market a little bit quicker.

In light of that, can you maybe discuss how -- your comfort level with the amount of testing you're doing on a lot of these products before bringing them into the stores, given that it is maybe on a faster (multiple speakers)

Let's start with health and wellness first.

We did a very good job testing that under the radar in a number of stores over the past few months, coupled with the very strong response we got from research.

And as I said in my remarks, that category really speaks volumes to our customers' need states, and we believe strongly that we provide our customers with a reason to come to Starbucks that is incremental to their coffee need.

The product tested well and exceeded the expectations we had in terms of units per day.

We think we've done a great job in terms of flavor.

And I think it's important to note that we're not introducing a product; we're creating a new platform in the Company around beverages and food.

And the food program is done.

It's all ready to go.

We will launch that in September, followed by the second tranche of food, which will come in the fall that will replace the breakfast sandwich.

But health and wellness beverages, we think we've hit the mark, and it's spot-on in terms of the trend.

The energy beverage, this is almost a $5 billion category, again, leveraging Pepsi's distribution system, as well as their manufacturing capability, and leveraging the fact that we have license to play in that space, and perhaps we should have been in it sooner.

But we also will be the first retail establishment to create that product customized for our customer.

And then the halo of that we'll get off Pepsi's system like we did with bottled Frappuccino should drive traffic into our stores.

It's also a younger customer, should be incremental.

Third, the Italian beverage is something we discovered.

We couldn't be more excited about it.

The proof of everything is how it tastes.

And this is a product that is very unique in flavor, in profile and texture, and we think we got it right.

Not everything is equal here in terms of its -- what we think it's going to do, but we haven't had a lot of innovation at Starbucks for quite some time.

We've been in the business of building flavors and line extensions.

And we're getting back off our heels and back on the offense, and we're going to innovate like hell and bring new product and new excitement, both to our customers and our people, and we're going to get it right.

Thanks very much.

Carol Lintz, Pioneer Investments.

First in your capital spending budget, how much of that is going to be for maintenance capital spending on existing units?

Second, in the food program, will this require additional equipment to be brought into the store, or will the food be brought in pre-prepared?

And finally, in the new Italian beverage that is cappuccino-like, you mentioned I believe that the pricing is at a lower level than the current Frappuccino line.

What impact would that have on margins?

Let me take the back-end.

The new beverage -- it's not Frappuccino-like or cappuccino-like.

It is a summer beverage that is both indulgent but low-calorie and refreshing, and will be priced at an attractive price point.

I'm not going to speak to margins on that, for a whole host of reasons, but it meets the requirements that we've always had for our beverage business.

In terms of food, there's no new equipment that is required for the food program.

We're going to -- the food program will be enabled by the existing equipment and warming that we have in existing stores.

Adding on that, we did slow down or stop the rollout of warming until we had a clear view of the breakfast sandwich replacement.

So we'll pick that up.

But there's, I think, 3300 stores today that are already warming-enabled, and that's all we need to have for the new food rollout.

On your capital question, I defined, of the 800 million per year, about 70% is store.

And I just, rule of thumb, half and half between new store and renovation, roughly speaking.

Larry Miller, RBC Capital Markets.

I had a couple of questions on the international margins.

First of all, I was under the impression that they were structurally lower than the US.

It sounds like that's going to reverse over the next couple of years when you get to 12% and the US business (inaudible) 11%.

Maybe you can help me understand why that might be.

I didn't want to get here by the US going down and international going up, so that's the first data point.

And we'll work on the US.

But structurally it's actually the opposite.

We count less of the system -- less of the revenue for international.

The profit dollars per revenue we count is higher in a licensed model.

So structurally, the question I've often got is why isn't international better than US, because of the nature of the structure.

So I think this plan shows good progress towards what should be a higher operating margin-type model, driven by the percent of licensed.

As I mentioned earlier, we've been running about 40/60 -- 40% Company-operated, 60% licensed -- historically, and then over this horizon moving to 65 plus% licensed.

So even getting more leverage out of the structural relationship.

Matthew DiFrisco, Oppenheimer.

I think Howard made a comment earlier in the call here about Pikes, and you made a note that it didn't start until April and this is one of the key initiatives.

I'm just curious -- the comment said it was being well received.

Is that incremental, or do you think that's somewhat substituting?

I have a little bit of a follow-on there.

It's a little bit more than three weeks in, and we are getting some incrementality from the beverage.

So the encouraging news is that we're seeing -- first off, we think we are, as I said in my remarks, under-represented in the brewed coffee space, which we think is a huge opportunity for us which we haven't focused on probably for 20 years.

All of the emphasis and all the excitement has always been on espresso and espresso beverages, and that's where innovation has come.

This is the first time we've really, I think, created a new coffee that we think really speaks distinctively to doing something that really differentiates itself from everyone else.

The response has been very positive.

We have gotten incrementality.

The strongest has been in the Northeast.

And we're early in, but we're enthused.

John Ivankoe, JPMorgan.

First a clarification, if I may.

Pete, I want to make sure I heard you right.

Regarding the international margins, did you say that (inaudible) excluding store closure and transformation charges, that margins would have been up 100 basis points in the second quarter, or would that be for the first half of 2008?

For the first half.

We had a very strong Q1.

Some of it's related to timing, but we're up -- so I said year-to-date, trying to give you a sense of the size of the store rationalization and the transformation that all happened in Q2.

Sharon Zackfia, William Blair.

Howard, I'm curious -- as you've been implementing a lot of these initiatives in the US, have you seen any negative ramifications in terms of customer confusion, or lower lines, reduced throughput?

No.

I think -- we have a tool that we use, which we call customer voice.

And that tool is for us to gauge the experience our customers are having in the stores, and whether or not -- and we, obviously, monitor this very, very often, both in terms of comparing it both in the near-term and over the long-term.

And since Espresso Excellence training has come about, there is clearly, I think, a noticeable difference in the level of engagement.

I think sometimes the lines have been a little bit longer because we're asking people to customize milk, to make shots in espresso -- shot glasses as opposed to in a paper cup.

But we've encouraged our people to just say to the customer, I'm sorry you might be waiting a little bit longer, but we want to make the drink perfect for you.

And if anything, I think, people have seen the fact that Starbucks is making a concerted effort to elevate the experience and the quality.

So the short answer is we haven't seen anything that would give us pause that the transformation and the things we're doing and bringing to the stores is causing anything but a net positive for us.

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Gary Magnuson, Smith Barney.

Howard, with hiring back Arthur, have you explored -- I was sort of surprised with the slowdown in the store count in the US, and was wondering what you think about the possibility of locations in smaller towns?

Can you give us some color just on the slowdown, and maybe speeding up later on in the future?

First off, we think it is absolutely the most disciplined and prudent decision to slow the US growth down and to rationalize the store base.

I think that's going to help us in terms of -- on a number of issues.

Arthur was the initial architect for both store design, real estate selection, construction and, really, I think, is the right person to come back and really author this new strategy for the Company.

The thing that he is working on is no longer domestic, but he's working on the global portfolio of the Company.

And the areas that we're focused on, in addition to the rationalization of the stores, more importantly than that is the future of the Company.

And we're looking at different store formats, new store designs, and ways in which we can create a local relevance to offset the growth and perhaps the ubiquity of the Company.

That's what Arthur's strength is.

And there's lots of learnings that we have that we think we can bring to the marketplace.

We have not talked about the innovation in terms of store design and what we have planned; that will be for future calls.

But we do believe strongly that this is the prudent thing to do at this time, to slow down US growth.

Colin Guheen, Cowen & Co.

On the international investment, as you increase the number of stores, is there any change in where you're investing in Company-owned stores, any markets that are getting extra stores?

I think for the next three years the major Company-operated markets will be Canada, UK, China.

And then, Japan is a big market that is a licensed partner.

So, no real dramatic change in where the investment in.

If we looked at Canada and UK, we've talked about before probably 30, 40% built out of what we think is the potential.

So we'll continue to invest in those countries, stepping through the horizon.

But no dramatic change, though you do see 5 points higher licensed content.

So there will be some movement between Company-owned and licensed over time.

Marc Greenberg, Deutsche Bank.

Back to the research question.

I'm wondering, looking either just exclusively at research, or perhaps broadening out to deteriorating financial metrics, is there anything that you would see from a data standpoint that would cause you to think that perhaps store saturation and competition were responsible for some of the decline in comp store sales?

And if that were the case, would you begin again to redress your store plan, specifically, actually cutting the overall store base?

There is no evidence, based on the research that we just completed, that the issue is based on competition, which I've already stated.

So I can't speak to the hypothetical, because it doesn't exist.

What we view right now is something I've been saying since I returned as CEO -- and it's not with arrogance or hubris -- this is about Starbucks.

This is about our ability to create excitement and demand in our stores, and do the things we've always done really well that unfortunately we haven't done all that well over the last year, year and a half.

But, the experience that we create in our stores has been the brand.

We don't believe that when we are at our best that we are second to anyone, and we are going to get back to doing what we've always done well, and that is create a differentiation in the marketplace around coffee, the coffee experience, and innovation.

So, we don't view the competitive landscape, or what you cited about saturation, as the issue.

The primary issue that we are facing, which we have not faced before, and that's new, is the fact that this downturn in the economy, unlike anything else that we have experienced before, which we have been able to manage through other downturns and economic cycles, this is one that has affected us, and we're managing through it in the best way we can.

And we're not alone.

We're a part of a lot of other retail companies and consumer brands that are facing similar things.

When we look at mid single-digit negative traffic, although that's a number that we are not accustomed to, and make no mistake about it, not satisfied with, in the landscape of other retailers, we are faring much better than most.

The only other thing I would add is that we're going to continue to look hard at the performance of the stores.

When you look at the 100 that we've talked about for this year in the US, that's way above historical trends in terms of what we have been looking to close in a year or looking at.

And you couple that with the international discussion we have had throughout the call; we'll continue to take a hard look at the store performance, trying to factor in the relative economic environment and the long-term viability of that store.

We'll take one more question.

David Palmer, UBS.

Howard, just to beat on this horse a little longer, the Starbucks same-store sales have been slowing more than what we see, for instance, in the casual dining segment, which one would think is a fairly discretionary occasion for the consumer.

In fact, the same-store sales now are trending worse than that entire industry.

What I'm wondering is do you think -- and maybe you see a correlation with the type of stores, whether they're near shopping.

Is it the fact that perhaps you just -- your stores tend to get that type of traffic, shopping traffic, and that's what you're linking to the problem as much as or more than a $3.50 drink is too much for somebody at any one point?

Let me try and answer this in a way that hopefully will relieve the concerns that you have.

First and foremost, please make it crystal clear, we are not satisfied with the downturn in traffic in our stores, and we are working diligently to reverse that.

We're not using the economy as an excuse.

But clearly, the headwind of the economy has had a significant effect on our business.

And you just have to look to South Florida and California.

There is a direct correlation in terms of the downturn in our business and the acuteness of the compression in traffic in those markets, and specifically those markets are the ones that have been most drastically affected by the sub-prime mortgage issue.

Conversely, if you look at the Northeast, New England and New York, where we are continuing to have strong comp store sales, those are markets that have not been affected.

And then, if you look at the landscape of traditional retailers, not casual dining -- we're not in the casual dining business, nor do I think that's a good correlation.

If you look at the high-end retailers, or premium brands that are retailing product -- whether it's Coach, Nordstrom, Crate and Barrel, Williams Sonoma -- if you look at those numbers, many of those businesses are at negative double-digit comps.

So we're looking at so much data as a company, and trying to understand where we fit into all this.

We don't have empirical analysis, but we strongly believe it is not the competition.

The research strongly suggests that.

We don't believe that we've saturated the market, but we do believe that we have a headwind the likes of which we've never seen.

It's not short-term in nature.

There's a deep concern that the consumer has -- and we're being affected by the fact that Starbucks coffee and premium coffee experience has over time been an affordable luxury.

And at this time, it isn't for some people, and they're cutting out the occasion, or less frequent.

And that's why we're bringing the kind of innovation we are to address multiple need states, multiple dayparts, and new categories that are exactly what our customers have told us, in terms of health and wellness, energy, and a new product that we're pretty excited about that doesn't exist in the US.

And I also say, this is just the beginning of the innovation.

We haven't talked about a lot of things that are going to come in calendar '09.

With that, we'll conclude the call.

I'll give it to JoAnn to close it.

Thanks, Howard.

Thank you for joining us today.

That does close down our second-quarter earnings conference call.

We hope you'll join us on Wednesday July 30th when we announce our Q3 earnings and have our call that afternoon as well.

Thanks again.

Ladies and gentlemen, this concludes today's Starbucks Coffee Company conference call.

You may now disconnect.