星巴克 (SBUX) 2010 Q2 法說會逐字稿

Good afternoon.

My name is Amanda and I will be your conference operator today.

At this time, I would like to welcome everyone to Starbucks Coffee Company's second-quarter fiscal year 2010 conference call.

(Operator Instructions).

Thank you.

You may begin your conference.

Thank you.

Good afternoon, (technical difficulty) gentlemen.

This is JoAnn DeGrande, Director of Investor Relations at Starbucks Coffee Company.

With me here in Seattle today are Howard Schultz, Chairman, President, and CEO; Troy Alstead, CFO; and John Culver, President of our international business.

Before we get started, I'd like to remind you that this conference call will be containing forward-looking statements.

Forward-looking statements are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements and should be considered in conjunction with cautionary statements in our earnings release and risk factors' discussions in our filings with the SEC, including our last annual report on Form 10-K.

Starbucks assumes no obligation to update any of these forward-looking statements or information.

Please refer to the investor relations section of Starbucks website at www.Starbucks.com and to the financial statements accompanying the earnings release to find disclosures and reconciliations of non-GAAP financial measures mentioned on today's call along with our corresponding GAAP measures.

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

Howard?

Thank you, JoAnn.

Good afternoon and thank you all for joining us this afternoon.

The second-quarter results we announced today demonstrate the success of our efforts over the last two years to dramatically transform Starbucks' business and to position the Company for sustained profitable growth into the future.

I'm pleased to report that our Q2 results reflect the strong underlying fundamentals of our business and the significant improvements in revenues, comp-store sales, operating performance, margins, and earnings per share that we saw sought to achieve.

Our top-to-bottom transformation has created new discipline throughout our Company and a solid foundation from which to grow.

Starbucks today enjoys a leaner, vastly more efficient operating structure; increased operating leverage; a highly (technical difficulty) pipeline of innovative new product offerings, both in the market and yet to be introduced; powerful marketing muscle; a deeper, stronger connection with an increasingly more satisfied customer base; and a renewed, passionate, committed 200,000-partner workforce in 52 countries around the world.

We've learned valuable lessons over the last two years and we are now sharing and integrating these lessons in order to improve our operations across the globe.

Global retail expansion in the future will be achieved by combining our coffee leadership position with cost discipline and operational excellence as unequivocal prerequisites.

We have created an innovative differentiated model to adapt to the changing rules of engagement in traditional marketing, and have embraced social networks and digital media as part of an ongoing 360 (technical difficulty) conversation with our customers all over the world.

The success of these efforts has resulted in our becoming the number one brand on Facebook and one of the (technical difficulty) on Twitter.

We have infused this digital mindset into all of our marketing and communications to leverage our already effective brand voice, enabling a powerful, highly relevant, low-cost customer acquisition vehicle, and we will continue to innovate and strive to be best of class in all aspects of our business, internationally and domestically.

We have also refined our longer-term strategy beyond the retail experience and can now offer consumers innovative new coffee products in multiple brands, form factors, and across new and established categories, formats, and channels.

Taken together, these efforts and initiatives represent a strategy that we believe will provide us with a runway for disciplined, profitable growth long into the future.

The results for Q2 exceeded our expectations in many ways.

Let me just touch on a few.

Consolidated net revenues increased 9% to $2.5 billion.

U.S.

comparable-store sales increased 7%, driven by a 3% increase in traffic and a 5% increase in average ticket.

Importantly, this is the first quarter in 13 in which we saw a return to traffic growth in our U.S.

stores.

International comparable-store sales also increased 7%, driven by a 6% increase in traffic and a 1% increase in average ticket.

Reported consolidated operating margin increased to 13.4% from 1.8% in Q2 of the prior year.

EPS for the quarter increased to $0.28 per share, up from $0.03 per share in the same period last year.

Increasing business momentum over the last four quarters and the operating leverage inherent in our business model have also enabled us to generate a very strong cash flow, which we are investing against our global growth strategy.

At the same time, we are able now to return cash to shareholders in the form of a quarterly dividend and have increased the number of shares authorized for repurchase under our stock repurchase plan.

Together, these programs reflect the strength of Starbucks business today and the confidence we have in the growth and health of Starbucks business over the long term.

Before turning the call over to Troy to discuss in detail the financial results of the quarter, let me share some segment highlights for you from my own perspective.

Our U.S.

business has been completely transformed under the stewardship of Cliff Burrows and his excellent field leadership team and performed well ahead of expectations.

In fact, despite continuing economic headwinds, Q2 turned out to be a record second quarter in our history for our U.S.

segment with revenues up 5%, comp-store sales up 7%, a non-GAAP operating margin of 17%, and an operating income up 80% to $323 million.

Traffic growth in our U.S.

business is being driven by significant qualitative improvement in key customer metrics with scores in the areas of speed of service, accurateness, friendliness, taste of beverage, and overall satisfaction all rising appreciably, a continuing trend that began last year.

Two years ago, we asked our partners to elevate the Starbucks experience in all of our stores and they have responded with passion and enthusiasm.

Once again, Starbucks' success is a direct reflection of our partners' dedication and commitment.

Let me turn your attention to our new loyalty program.

The My Starbucks rewards program has been an overwhelming success, driving unprecedented levels of customer engagement and loyalty as measured by both store-visit frequency and cash loaded.

In fact, the rewards program is cited by core customers as the number one reason for increased visits versus six months ago.

Since relaunching the program in December, registered card users have shown a significant increase in frequency with continued steady ticket performance.

Card reloads were up nearly 45% this quarter versus Q2 2009, driven largely by reloads on the new gold level card, and since the program launched in December we've added over 1 million new accounts.

In addition, more than 200,000 customers have earned their way to gold level by visiting Starbucks 30 times in just eight weeks, illustrating the tremendous traffic-driving power of the card and the ongoing loyalty of our customers.

Early this month, we expanded our Starbucks card mobile payment, a test to 1,000 of our licensed locations in target stores nationwide, allowing cardmembers to load their cards and pay for their Starbucks purchases using their iPhones.

Stay tuned for further announcements of important consumer-facing initiatives that will enable us to leverage mobile payment and other technologies that are ready-made for the Starbucks brand in the months ahead.

A clear highlight of the quarter was our ongoing Bold Coffee promotion, an eight-week campaign offering our customers their favorite proprietary Starbucks Bold Coffee in an engaging way to track their journey with a coffee passport, reaffirming our coffee authority and leadership position in the marketplace.

We've also refreshed our coffee advertising and digital campaign to emphasize value, quality, and differentiation that we offer our customers in our retail stores and in our ongoing growing CPG presence.

The promotion is reigniting coffee passion with both our partners and customers, elevating our brand and serving as a key transaction driver for increasing brewed coffee sales.

The launch of warm paninis in the U.S.

and a new healthy snack platform are helping to drive increased sales and incrementality during key day parts.

We will continue our efforts to improve quality of food and deliver healthier choices for our customers.

Over the last 18 months, we've continued to build a closer connection and an ongoing communication with our customers by addressing issues really relevant to them.

Our latest initiative, rewarding customers for bringing their own tumblers, brought more traffic into our stores while raising consciousness about the issues of recycling waste and environmental stewardship.

We deployed our store partners as well as media, digital, and communication channels to drive the initiative, providing our customers a tangible way to celebrate Earth month with us.

And significantly, this was a global event with stores in over 50 countries participating.

As some of you may remember, we conducted our January earnings call from London.

We were in the UK because with our U.S.

business strengthening, the time has come for us to refocus our efforts and our attention on the tremendous growth and profit opportunities that exist for Starbucks around the world.

Since then, John Culver, President of Starbucks International, and I have traveled to Europe, to the UK for the successful launch of Starbucks VIA, and throughout many countries in Asia as we bring the learnings from the transformation of the U.S.

business to our operations in every country in which we compete.

Though we only have one quarter or so of impact of these efforts behind us, the results to date are very encouraging and I'd like John to share some of the highlights of the progress we are making in key international markets.

Let me introduce to you John Culver.

Thanks, Howard.

Starbucks Coffee International represents an enormous opportunity for Starbucks as we apply the same rigor, discipline, and energy that have enabled us to transform the U.S.

business to all of our markets around the world.

As Howard indicated, the results to date have been very encouraging.

Second-quarter revenues were up 23%.

Comp sales were up 7%.

Non-GAAP operating margin increased significantly to 8.9% and operating income more than doubled to $48 million.

Given the progress we are seeing, we expect our international business to reach sustainable double-digit profit margins beginning in our fiscal 2011.

While we are very pleased with this quarter's performance, I can assure all of you that no one on the international team is close to taking any victory laps.

Quite to the contrary.

We are heads down and sleeves rolled up, addressing the critical issues in identifying key opportunities market by market, so that we can create even more momentum in our global business in the months and the quarters ahead.

With stores in 51 countries internationally, our focus this year is to drive depth in several key markets with stronger partnerships and locally relevant innovation.

Troy will discuss the international financial results with you in greater detail shortly.

But I'd like to take this opportunity to call out a few highlights of the business and performance for you now.

Our Canadian business performed exceptionally well in the quarter, benefiting from the Olympic Games in Vancouver and several highly effective transformational initiatives introduced by the team to drive increased traffic and improve overall operating efficiencies.

UK comps remained positive, and we are seeing continued momentum and incrementality following the successful introduction of Starbucks VIA into all of our stores throughout the UK.

The training that surrounded the introduction of our new flat white beverage has improved the quality of our espresso in the UK overall, and several competitors in the UK are now attempting to play catch-up in our wake.

We are also seeing strong consumer reception to our fair trade partnership across the UK, France, Germany, and throughout Europe, and are maintaining our focus on operational rigor in the development and introduction of improved food programs in each of these markets.

As Howard mentioned, we just returned from a four-country trip to Asia, a trip that reaffirmed our view of the fantastic opportunity that Asia represents for Starbucks.

The foundation of our growth is our partners, and we were once again blown away by the passion and quality of our partners in Seoul, Shanghai, Tokyo, and Hong Kong.

During our visit, we celebrated Starbuck's 10th anniversary in Hong Kong and, in a terrific visit to Shanghai, saw firsthand the excitement of our Shanghai partners and the hard work in which they are engaged as they prepare to host visitors for the World Expo in May.

Our growing presence in both greater China and the Asia-Pacific region represents significant opportunities for us.

We will continue to pursue thoughtful, disciplined, and profitable growth in China, a market we believe will ultimately become the largest market for Starbucks outside the U.S..

Our plan includes rapid, targeted expansion; the introduction of locally-relevant innovations, such as our China Grown south of the blend -- South of the Clouds blend coffee; Starbucks tea; and further development of cross-channel opportunities within our CPG business.

I am particularly pleased to report that our profitable China retail business again delivered strong comp growth during the second quarter.

We have a very clear line of sight to the opportunities in our international markets and we are poised to make significant progress over the coming months as we focus our efforts and intentions on the tremendous growth opportunities that exist for Starbucks globally.

With that, let me now turn it back over to Howard.

Thanks, John.

As John said, Starbucks is in many ways just beginning to scratch the surface of the enormous potential we have around the world.

I would like to share a few of the areas in which our learning is being applied globally.

First, we continue to see a terrific response to our new, highly differentiated store designs in Paris Disney, Tokyo, Conduit Street in the UK, and Seattle, among other places.

Over the next 12 to 18 months, we will bring the learning from new store design initiatives to a very aggressive phase of existing store models and refurbishments in the U.S..

We recently reopened our Spring Street store in SoHo, and for those New Yorkers on the call, I encourage you to drop by to see firsthand how we are integrating new designs into our existing store base and significantly elevating the customer experience.

On our recent trip to Tokyo, Shanghai, and Hong Kong, we saw firsthand how these new design elements integrated into refurbishments in these markets with a strong customer response.

At the same time, we are creating new stores, new destination stores in these markets through creative designs such as those incorporated into stores like Duddel Street in Hong Kong, PuDong in China, and Shibuya in Japan.

Another way we are leveraging our learning among U.S.

and international markets is reflected in our approach to the global launch of Starbucks VIA.

After successfully launching VIA in the U.S., Canada, and the UK, last week we went after a very big prize, Japan.

The at-home market in Japan is a $5 billion market, half of which is instant, that hasn't had much innovation in over 50 years.

Last week, John and I participated in truly a fantastic lunch of VIA in Japan in which we incorporated all the learnings from the prior launches and leveraged best-in-class digital media, an integrated marketing and promotional campaign, and passionate store partners to create sampling and a taste challenge localized, highly relevant for the Japanese customer.

The results have been extraordinary.

VIA has been a huge hit in Japan and we have significantly overperformed against our sales projections.

We are convinced we have a big winner with VIA in Japan.

VIA continues to exceed our expectations in every market we've launched, and we remain extremely excited about VIA's prospects in the future as we add new markets during the coming year.

Our global consumer products business, CPG, represents another important growth vehicle for Starbucks as we accelerate both product innovation and distribution.

Starbucks VIA is becoming an increasingly significant platform for us with the CPG channel rollout having begun towards the end of Q2.

We now plan to expand to more than 30,000 points of distribution by the end of Q3 and look forward to offering new form factors and other innovations in the very near term for all things VIA.

The VIA rollout will be supported by a nationwide U.S.

advertising and marketing campaign, both print and broadcast, designed to support the positive customer reaction we continue to experience in our stores.

We're beginning to see improvement in our U.S.

packaged coffee business and are increasing the capabilities of our CPG business globally.

In January, we announced our entry into the ready-to-drink, RTD, coffee category in Europe, a $550 million market, and earlier this month, we launched Starbucks Discoveries chilled coffees and Starbucks Doubleshot espresso milk -- drink in UK grocery and convenience stores.

Also this month, we began offering Starbucks Doubleshot espresso drinks to consumers in Hong Kong.

In addition, we are making significant progress with Seattle's Best Coffee.

By the end of the year, it was Burger King, Subway, and Mac's convenience stores, a Canadian company, now offering SBC as part of their breakfast programs, we will be expanding from 3,000 to 30,000 places where customers can get a cup of Seattle's Best Coffee.

In fact, you may have seen Seattle's Best Coffee on TV or billboards as part of the featured part of the new national Subway ad campaign.

Building a strong retail footprint continues to be part of our strategy, utilizing a franchise, go-to-market model.

We are very encouraged by the deep pipeline we're building and are getting high marks from prospective franchisees as we leverage our coffee and operational expertise.

SBC is also now offering its first line of ready-to-drink iced latte coffee drinks in the U.S.

through major grocery, convenience, and other retail stores, initially on the West Coast.

Looking ahead, Starbucks growth will come through continued expansion of our domestic and international retail store base and through growth in complementary channels of distribution.

We've adopted a disciplined approach to profitable growth in the U.S.

and we will accelerate growth of our international businesses by embracing and sharing the learning from our U.S.

transformation, and we will continue to bring significant breakthrough innovation in order to build on our coffee authority and enhance our leadership position around the world.

Finally, I would like to just from my heart thank all of our Starbucks partners for their strong results we reported today.

Our partners once again demonstrated their resiliency and their commitment to our Company and most importantly to our customers.

While we are gratified and encouraged by today's results, we know that we have much more work to do.

But we also know the strength of our business and the dedication and hard work of our partners ideally positions us to continue to achieve profitable growth well into the future.

Now I'll hand it over to Troy to go through the financials.

Thanks, Howard, and good afternoon, everyone.

As Howard indicated, this was an outstanding quarter by almost any measure and underscores the success of the Company's transformation over the past two years.

Building on the momentum created in the back half of fiscal 2009, we generated the highest second-quarter earnings and operating margin ever recorded in the Company's 39-year history.

This record performance was driven by a significant move back into comparable-store sales growth and by improved operational efficiencies which created powerful sales leverage.

Today, I will provide additional details on our fiscal second-quarter performance, then I will update you on our expectations for the balance of fiscal 2010 given the ongoing improvement in the trajectory of our business.

Second-quarter revenues were $2.5 billion, up 9% from $2.3 billion a year ago.

The revenue increase was primarily driven by a 7% increase in comparable-store sales and favorable foreign exchange, partially offset by a smaller store base.

The 7% comp growth was the strongest comp we've seen in four years and was attributable to a 3% increase in traffic and a 4% increase in the average value per transaction.

We reported consolidated operating income of $340 million in the quarter, including $8 million of restructuring charges.

These restructuring charges were related to lease exit and other costs associated with store closures, nearly all of which were in our international segment.

Excluding those charges, non-GAAP operating income was $348 million.

This compares to second-quarter fiscal 2009 operating income of $41 million and non-GAAP operating income of $193 million.

Consolidated operating margin was 13.4% on a GAAP basis and 13.7% on a non-GAAP basis, which represented a 540 basis-point improvement compared to last year and set an all-time record for our fiscal second quarter.

In line with recent quarters, we are realizing the benefits from the operational efficiencies which we implemented in our business throughout fiscal 2009 and which we continued to refine in 2010.

As noted earlier, these efficiencies have created additional sales leverage within our business model, which has become more visible with the return of comp sales growth last quarter and the acceleration of that growth this quarter.

Earnings per share was $0.28 for the second quarter, compared to $0.03 per share in last year's fiscal second quarter.

Non-GAAP EPS was $0.29, compared to non-GAAP EPS of $0.16 a year ago.

I will now review the non-GAAP results from our operating segments, beginning with the U.S.

business.

Total U.S.

net revenues for the quarter were $1.8 billion, a 5% increase from a year ago.

Company-operated U.S.

retail revenues increased 5% to $1.7 billion for the quarter, primarily due to a 7% increase in comp sales, offset in part by a reduction in the number of stores.

The comp increase was driven by a 3% increase in transactions and a 5% increase in the average value per transaction.

The 3% increase in transactions marked an important milestone, the first time in 13 quarters we've had positive year-over-year traffic.

This transaction increase is highly correlated with the notable improvement in our customer satisfaction scores over the past year.

Also, as Howard noted, the new Starbucks rewards program launched at the start of the quarter is driving increased frequency among registered cardholders.

Account registrations, dollars loaded to cards, and redemptions are each up significantly over last year.

With respect to the increase in the average value per transaction, the changes we've made to our pricing architecture drove roughly one-third of the increase, while both VIA and the final leg of our warming program rollout also contributed to the increase.

Sequential-quarter comp trends continued the momentum from past quarters with the one-year comp trend improving for the fifth straight quarter and the two-year comp trend improving for the fourth straight quarter.

The improvement was also broad-based across day parts, regions, and product categories.

U.S.

cost of sales, including occupancy, was 38.9% of revenues in the second quarter, a significant improvement of 320 basis points compared to the year-ago period.

Most of the improvement was the result of lower food costs from our redesigned food program, supply-chain efficiencies, and the implementation of in-store programs that have driven measurable reductions in coffee, food, and dairy waste.

Sales leverage in relation to our occupancy costs also contributed to the improvement.

U.S.

store operating expenses were 36.2% of total revenues, a 340 basis-point improvement over last year.

The majority of this improvement was attributable to sales leverage, the closure of underperforming stores, and the continued application of lean principles in our store labor deployment.

Lower benefits expenses related to health and welfare programs, which tend to vary from quarter to quarter, also contributed to the improvement.

As a result of the lean work to date, productivity and customer satisfaction have both improved dramatically compared to last year.

We continue to refine these important activities, as many of them are customer-facing.

In addition, we have other initiatives underway, such as a new labor scheduling tool and a new point-of-sale system that we expect will further increase productivity once fully implemented.

U.S.

operating income was $323 million for the quarter, an 80% increase compared to last year.

The operating margin improved 740 basis points to 17.8% of related revenues from 10.4% a year ago.

This quarter's operating margins set a second-quarter record for the U.S.

operating segment, and it was on par with our fiscal first-quarter operating margin which is typically the highest of the year due to the holiday season.

The impressive U.S.

operating margin results are due to the work we started at the beginning of fiscal 2009 to better align our cost structure to the changing business environment and to become a more efficient operator at the store level.

This work has also allowed us to capitalize on the strength we've seen in comp-store sales growth as the better operating leverage now translates into more dollars flowing through to operating profit.

The progress made over the last two years to transform the U.S.

business is particularly satisfying given the extent of the challenges we faced during that time.

The financial results speak for themselves, but importantly, these results have been achieved as customer satisfaction scores have improved more than at any point in our history.

Customer satisfaction metrics, along with other positive indicators, such as new store performance, provide us with confidence that we've made the right decisions for the long-term health of the business and that the improvement we are seeing is real and sustainable.

The U.S.

segment is critical to the overall well-being of Starbucks, and now that it is healthy and highly profitable again, we are able to focus more attention on areas such as the international business, which I will now discuss.

International total net revenues increased 23% to $534 million in the second quarter of fiscal 2010, driven by favorable foreign currency translation, positive comparable-store sales up 7%, and the acquisition of the France market at the beginning of the fiscal year.

The comp growth was driven by a 6% increase in traffic and a 1% increase in the average value per transaction.

Similar to last quarter, a number of international markets contributed to the solid comp gains with Canada, the UK, and China having the most significant impact.

Also encouraging, this quarter's two-year comp of 4% is the best two-year comp growth in six quarters.

International operating income was $48 million in the second quarter of fiscal 2010, more than double the $21 million posted in last year's comparable.

Operating margin improved by 410 basis points to 8.9%, easily setting a second-quarter record for the international segment.

Key drivers of the margin improvement included reduced food costs, sales leverage in relation to occupancy, and strong operational performance from our largest joint-venture markets.

The continued improvement in the international business is very encouraging as we progress to a double-digit margin target in 2011 on the way to our long-term mid-teens target.

Starbucks has a very small share of the global coffee market, and with roughly one-third of our current global store base and the potential capacity for much more, we recognize the enormous international opportunity in front of us.

We also understand the need for excellent execution and delivery of the Starbucks experience, locally-relevant products and store designs, and strong relationships with key strategic partners across the globe.

Recognizing these factors, our focus as a management team is to position the international business to profitably capture an increasing share of the global coffee market.

I'll now move on to the results from the global consumer products group.

CPG total net revenues increased 4% to $180 million in the second quarter of fiscal 2010, while operating income increased 8% to $68 million for the quarter.

The result was an operating margin increase of 110 basis points to 37.6%.

The increase in both revenues and operating income are primarily due to VIA and the Subway SBC launch which was announced earlier this fiscal year.

The VIA impact is partially due to sales into grocery, as we are in the very early stages of filling this channel for the broader third-quarter launch and marketing campaign.

I will provide an update on our overall outlook for the balance of fiscal 2010 in a moment, but I wanted to take this opportunity to elaborate more on the CPG segment in particular.

As we move through the balance of the year in CPG, we expect to see accelerated revenue growth in relation to the second quarter, driven by both VIA and the SBC QSR expansion.

However, we do not expect the year-over-year operating income growth that we recorded in the second quarter to continue, as we will be investing heavily in two areas.

First, we will officially launch VIA into the grocery channel in the third quarter, and there will be significant levels of advertising to support that launch, much of which will not pay off until later periods.

Second, we plan to continue to invest more into our packaged coffee business in order to protect market share as that business has become increasingly competitive.

Recent investments into packaged coffee are starting to show results already, as February and March Nielsen data showed year-over-year market share gains for the first time since March 2007.

While these two areas of investment will suppress CPG margins in the near term, they are necessary to build on Starbucks coffee leadership and to support the growth of this high-margin business segment.

As Howard mentioned, Starbucks announced its first-ever dividend at our annual shareholder meeting in late March, initiated as a quarterly distribution of $0.10 per share with the first payment scheduled for this Friday.

We have targeted a 35% to 40% payout ratio going forward.

At that time, we also announced a resumption of our share repurchase program with 15 million newly authorized shares, bringing the total available for repurchase to 21 million shares.

To date, we've not executed any buybacks out of this pool due to our quarterly blackout period.

Both the dividend and share repurchase programs are strong signals of the financial health of the Company, which has never been stronger than it is today, and they reinforce our commitment to thoughtful, disciplined growth.

There are abundant profitable growth opportunities ahead for Starbucks and the powerful cash flow that we generate will allow us to go after those opportunities while still returning cash to our shareholders.

We believe this is part of our evolution into a more diversified growth company and that investors will benefit from this multipronged approach to shareholder returns.

Given the improving trajectory of our comparable-store sales growth and the significant flowthrough on those sales, we're updating our outlook in a few key targets for the balance of fiscal 2010.

We now expect mid single-digit revenue growth over the comparable 52-week period and high single-digit revenue growth with the inclusion of a 53rd week, driven by mid single-digit comparable-store sales growth.

We have been pleased by the resiliency of our customers in the first half of this fiscal year.

With that said, we are still aware of the pain that many face given stubbornly high unemployment, rising gas prices, and continued problems in the housing market.

We have become more confident in the potential for recovery and we are clearly seeing some signs of it in our business.

But we also recognize that there are several risks that still exist and that continue to create an uncertain future for the economy.

We now expect fiscal 2010 non-GAAP operating margins of 15% to 17% in the U.S.

segment and 8% to 10% in the international segment.

We continue to expect the operating margin from the CPG segment to be approximately 35%, in line with our prior outlook.

Altogether, we expect this will get us to a consolidated non-GAAP operating margin in the range of 12% to 13%.

We now expect earnings per share to be in the range of $1.19 to $1.22 per share on a non-GAAP basis.

This range includes roughly $0.04 per share benefit in Q4 from the addition of a 53rd fiscal week and excludes roughly $0.03 in restructuring expenses, mostly related to international store closings.

And finally for fiscal 2010, we expect cash flow from operations to be at least $1.5 billion and free cash flow to be more than $1 billion.

As I have stated before, earnings comparisons become more difficult as we move into the back half of the fiscal year and lap significantly higher incremental cost savings and better comp trends from fiscal 2009.

Also as I pointed out on the first-quarter earnings call, we are making significant investments back into the business as we move through the balance of fiscal 2010, including increased investment in marketing, and our partners, and in our existing store base.

With respect to the marketing expenses, our outlook on last quarter's call included a significant investment over the balance of the year, with much of this in the second and third quarters.

In fact, we ultimately shifted much of that expected investment in second-quarter marketing spend into the third quarter, which provided some benefit to our Q2 results compared to our expectations.

For the remainder of the year, we now expect the incremental marketing expenditure to be roughly $0.05 per share compared to the last two quarters of fiscal 2009, with the majority of the increase coming in the third quarter in support of the customizable frappuccino rollout and the VIA launch in the broader CPG channels.

With respect to VIA, we now expect a slightly positive contribution to profit for the full fiscal year based on the strong performance year to date.

As I mentioned earlier, we plan to aggressively launch VIA into our traditional CPG channels during the third quarter, supported by that significant marketing investment.

As a result of the planned third-quarter marketing expenditures, combined with the addition of an extra week in the fourth quarter, we expect stronger margins in the fourth quarter than in the third quarter.

We continue to believe that these are the right investments for the future health of the business, and while the impact surpresses this year's result, the potential long-term return is significant.

The second quarter was an outstanding quarter, but we continue to believe that the best days for Starbucks lie ahead of us.

With a reinvigorated and healthy U.S.

business as a foundation, the stage is set for profitable growth ahead.

We will continue to execute our plan in the U.S., focusing on the customer experience, operational excellence, and delivering innovative products.

Internationally, we are intensely focused on improving the health of that portfolio in much the same manner that we improved the U.S.

and on capitalizing on the enormous expansion possibilities that exist abroad.

Finally, outside of the traditional store channels, we are aggressively pursuing significant opportunities to take great coffee to more customers in more places with products such as VIA and our complementary SBC brand.

With that, now let me turn the call back over to the operator to begin Q&A.

Amanda?

(Operator Instructions).

John Glass, Morgan Stanley.

Thanks very much.

A bigger picture question.

As you look out over the next few years, where do you see the greatest growth coming from of your three major segments, that is to say domestic, international, and CPG?

Can you talk about where the incremental growth is coming from in each of those segments as you map it out?

And as part of the answer, I think VIA will be mentioned.

Can you talk about where VIA's sales are today or give us a sense of where you think those should be by the end of this fiscal year?

Thanks.

I think, John, as we indicated on the call, I think there's a number of things going on with regard to the growth of the Company.

We still believe that there's a fair amount of growth domestically, but we're going to take the next 12 to 18 months and focus on refurbishing a significant amount of the portfolio, given the fact that we see incrementality in some of the remodels that we've gone through already.

But clearly, the lion's share of the growth of the Company on a long-term basis is international retail stores and specifically looking at the core footprint today, that has to be Asia, and the number one market is going to be China.

When we were in China last week and we were talking to some of the journalists, we also mentioned that there's two markets that we are not in that we are intrigued by, and that's India and Vietnam.

But in addition to that, we now believe that we have a go-to-market strategy leveraging the retail footprint of our store base to go to the CPG channel in a unique way.

And what I mean by that specifically is I think VIA is a great case study for the outside world to kind of model in terms of what we're capable of doing, and that is introducing a new product or a sub brand in our retail stores, gaining awareness, gaining trial and ultimately loyalty, and as a result of that, benefiting from the core base of customers using it -- in this case, VIA, and then taking it to the grocery channel.

The grocery channel is responding to VIA in a unique way, and that is because of the margin opportunities and the momentum built in from our retail stores, it's being embraced by that channel in a unique fashion, unlike other new products.

We think we can do that countless times domestically and we are beginning to build a competency to do that internationally.

And so, this is the beginning of leveraging our retail store footprint to benefit the CPG business, and at the same time significantly focusing on the learning and transformation that we've gone through in the U.S.

and applying it with great rigor and discipline on our international business, and taking advantage of the core business we now have in China that's profitable and the customer base is local Chinese, which makes us very, very happy.

Sharon Zackfia, William Blair & Company.

I'm intrigued by what you were saying about the refurbishment program in the U.S..

Maybe if you could give us some more parameters around how many stores are you looking to touch, are these really like the normal refreshes that we would see but just with a more kind of comprehensive look to them, and what you've seen kind of in the past with -- when you've done these refurbishments, which I guess is a relatively new program.

I'm going to introduce you to Cliff Burrows, the President of Starbucks U.S.

business.

Cliff?

Yes, Sharon, hi.

As we open stores, we always plan a phased refurbishment after five and after 10 years, depending on the details of the lease.

What we're doing at this time is taking that opportunity to do a more comprehensive refresh, certainly with a major refurbishment, and as Howard said earlier, I think a great example is the total transformation we've made of Spring Street in Soho.

And to a similar or lesser degree, we are investing in our new palettes and taking the opportunity to really refresh our stores in a major way like we haven't done before.

We're taking the opportunity while we are not opening so many stores to try and bring forward some of those refurbishments and we will accelerate that rate as we see the returns in those investments.

Not only does it give us a chance to refresh it from a customer point of view, but also to increase -- include new developments such as our Clover brewed coffee, which we've introduced our first store in New York in Spring Street, and it's a much better way for us to give a total comprehensive upgrade to the Starbucks offer.

And the reaction of the customers so far has been fantastic.

Sara Senatore, Sanford C.

Bernstein & Company, Inc..

I just have a question on the margins, which obviously -- huge material improvement, but I guess I want to get a sense of how much of the investment going on now, like you talked about, is sort of behind product launches and how much of it is a run rate that we should expect.

Because if I assume that, for example, you allowed all of the incremental cost cuts to flow through this quarter, I think that would show up as something like 30 basis points of leverage on each of your points of comp.

Is that right?

Are you sort of overinvesting now and the kind of steady-state leverage would look better than what we saw in this quarter?

Or can you just give us a sense of as we get to a more normalized operating model, what kind of margin expansion we should think about?

Sure, Sara, I'll tackle that.

I think the one thing I would say is, and you're quite familiar with all the work we've done over the past year, and that has really come to bear now on this second quarter.

We saw it in the first quarter.

It's more apparent in the second quarter where we have U.S.

operating margins moving to record levels.

We have now moved past the highest points in our history in terms of margin-level attainment, both at the total Company level in the second quarter, and particularly within the U.S.

segment, which has really been the dramatic engine of that profit growth over the past year and particularly this fiscal year.

The margins that I would expect going forward are sustainable with all the work that we've done, and I would also say that we will invest against the brand to drive growth into the future.

Recognizing that we don't have our eyes set on any one quarter, but we have our eyes set on the significant growth pillars that we have in the years ahead.

So that's why I specifically mentioned that while the second quarter did not have as much of, for example, this marketing investment that we will see in the third quarter, Frappuccino is a multibillion-dollar brand for us and we will spend appropriately and heavily against that very long-standing profitable brand in the second quarter.

VIA will be one of our billion-dollar brands in the future.

So we will appropriately invest against that and balance these investments at the same time with driving improved margins.

So, as I've said over the past year, while we have delivered significant cost saves, not all those cost savings will flow to the bottom line.

We take care of our partners, we fund health care, and we invest for the future.

Joe Buckley, BofA Merrill Lynch.

It's actually Steven Barlow for Joe.

I'm wondering if you could talk more about the traffic and comp momentum.

I guess you noted that it was more broadly driven across daypart and categories, so what piece do you think is maybe macro-driven and maybe across the specialty coffee category?

Go ahead, Howard.

I think -- I'm going to anticipate a comment from someone about McDonald's.

So let me hit that first, in terms of macro trends and the noise in the marketplace.

First off, in terms of the economy and the issues that we're all facing, I think there is some evidence that consumer spending on the margin is better than it's been, but I don't think any of us who are operating a consumer brand or retail business is assuming that the economy is going to get much better.

So I think the credit that we deserve is that the operational people of Starbucks, the marketing, and all the efforts on a comprehensive basis are driving traffic into the store because of the service levels and the fact that we are exceeding expectations around all things coffee and the brand.

With regard to McDonald's, we certainly saw their numbers today and the things they are saying about coffee.

If they are getting incrementality on coffee, they are not getting it from us.

And the numbers speak for itself.

And as we said last year, when they spent a fair amount of advertising dollars, we benefited from that because of the level of awareness that was created in the marketplace and the significant differentiation between our experience in the cup, in the store between they and us.

So on a go-forward basis, we feel very comfortable that we can operate and navigate through the headwinds of the economy at this point, and we're certainly feeling no effects from what McDonald's is doing or saying.

It's a non-factor.

John Ivankoe, JPMorgan.

I just wanted to get back to the U.S.

margins.

As we've kind of talked about, you're very close to -- I guess at peak margins now, and I do understand some of the specific investments that you have coming up for the U.S., but you're obviously not spending money just to spend it.

You're spending it for a return in the future.

That would be a fairly obvious comment.

To further editorialize, U.S.

total employment year over year hasn't even bottomed, and yet your traffic is up 3%.

So I guess I'm asking -- the question is, is there anything that really prevents the U.S.

margins from continuing to march up?

Are you -- internally have a number like 18 or 19 or 20 that you don't want to get us beyond, that you'll just reinvest to take market share?

And then, if we could just continue on with that, talk about potential benefits from things like new point-of-sale system and continued supply-chain work and even ERP that may help your margins in the future.

So just the overall question is about what we could expect the U.S.

margins assuming continued recovery in the U.S.

economy.

Thanks, John.

There's a lot there, so let me try to tackle it.

In terms of the U.S., yes, we've recovered that business back to peak margins and as I've said very clearly over the last year, we expect that the U.S.

has not seen its peak.

So where two, three, four years ago the U.S.

hit its peak margins, I've been very clear that I expect that business, with the benefit of the work that's been done led by Cliff and his team over the past year, to be able to exceed that.

And I typically said I expect that business to settle in somewhere in that mid to upper teens range.

And I still believe that's the appropriate place for that business.

I'm not going to put out a specific percentage target today, but suffice it to say that we're very confident that we have a healthy U.S.

business that can sustainably deliver that kind of margin performance.

Now, to try to push it beyond that would be not appropriate in terms of investing back into the health of our store base, our people, and the growth opportunities that we see, and so we'll always strive to find that right balance between investing in our future and delivering results now.

And you're right, the investments we make now, we fully expect to pay off or we wouldn't be spending them.

But they tend to pay off over the longer term and that's the basis for them.

So, that speaks to that issue.

What I will tell you in terms of point-of-sale, I'm going to turn that over to Cliff here in just a moment to speak a little bit more in detail about, supply chain has been over the past year and continues to be an area that is delivering efficiencies to us.

That is something that I would expect to continue to see in the coming years as we continue to improve procurement, distribution, and manufacturing efficiencies.

John, hi, this is Cliff.

We are in the midst of our deployment of our new POS system and our ERP systems, and as you can imagine, that's quite a major workstream with our U.S.

company-operated store base.

And all of these new systems, combined with the work of lean, the store designs, and new products as we bring them onstream, are all designed to help us build capacity in the stores and build efficiency to give us time to concentrate on building our relationships with our customers and delivering the Starbucks experience with obviously the longer-term goal of delivering great satisfaction for our customers and, with the help of our rewards program, to encourage people to come more frequently, and these are a lot of investments and a lot of time going on to making the process improvements which will help support the longer-term profitability and margin enhancements in the U.S.

business.

So, again, as Troy said, no specifics, but lots of work programs against it, and we are encouraged by the early deployment that we've done so far.

Matt DiFrisco, Oppenheimer & Co..

My question is with -- sort of following onto that supply-chain efficiency and how it might relate to food.

In our checks, I guess we've noticed -- we are kind of spoiled in New York and it's considered, I guess internally, what is referred to sometimes as a fresh market where we have the full array of food, and I've noticed in travels that you're starting to see more and more of the TurboChef ovens showing up in the Midwest markets, and they are getting now the lunch as it's rolled out.

Can you give us an update where you stand as far as those markets that do have the full array of food?

And what's the timetable before you have the entire Company-owned store base -- I'm strictly talking about Company-owned, not the Target stores and the licensed stores -- when you could have -- the potential to have the full array of products and we could maybe see food cross into the 20% or better as a percentage of overall sales?

Matt, it's Cliff here, just to say we have now this national recipe here in the U.S., or program recipes.

Some of those markets are fresh, some of those markets because of the logistics are frozen.

And we have focused in recent years on deployment of our warming oven, and really by the end of this year, we will have covered the vast majority of our portfolio.

I'm talking 90%-plus of stores will have been reached, and that most probably because of lease details or in (technical difficulty) issues to remote markets will be just about the program rolled out.

In terms of the growth of food, we are focused on better quality food, on improving the units of the assortment, and also serving better day parts.

It's not about seeing food increase to the levels you describe as a percentage of sales.

We are focused on helping customers justify another visit or another occasion.

We do see food playing a more strategic part in different day parts, as well as supporting the overall growth of our business.

And then, how does that 90% compared to where you stand now?

We're getting pretty close.

This is my, I suppose, catch-up year to reach that portfolio.

So we're getting pretty close to that number.

Jeffrey Bernstein, Barclays Capital.

Actually just two follow-up questions, one as it relates to VIA.

I'm wondering if you can give some updated color in terms of -- it seems like it's continuing to go very well, but the contribution to the comp versus margins and mix shift, and just wondering whether -- how you go about even measuring cannibalization of that product or the competitive threats that are coming into that market around that product.

And then, the other one was related to China, which I know you guys have periodically said is the largest market outside of the U.S..

Just wondering if you can talk about the -- perhaps the pace of development.

I know you said comps were strong, but relative to international how are they faring and what's the food and beverage mix on the China business?

Thanks.

Let me try and take VIA first.

Troy mentioned in his remarks that we believe we are sitting on at least two new billion-dollar new-growth vehicles for the Company.

One is Seattle's Best Coffee and the other is VIA.

To frame the VIA opportunity and the size of the prize, it's a $23 billion global instant coffee and at-home market with only $1 billion or so coming from North America.

So the big opportunity is outside of the U.S..

Having said that, we're not really competing with existing instant coffee.

We are reinventing an existing category and changing behavior.

We went into VIA in our U.S.

retail business assuming that we would have some level of cannibalization.

The truth is we have seen no cannibalization to VIA, and in fact all ships have risen around things for coffee at home.

That's been a big win for us.

What we're seeing is that VIA is changing behavior because of the mobility of the product, being able to take it on the go, and the fact that we went from two SKUs and added decaf, which is almost 20% of the specialty coffee market overall, and as I said in my remarks we are just getting started with VIA.

VIA is not a product or a promotion.

It is a significant new platform for the Company which will have multiple varietals, multiple blends, multiple form factors, and ubiquitous levels of distribution domestically and internationally.

It is -- it will be a competitive environment, but we've got the brand and most importantly we've cracked the code in terms of quality and being able to replicate the taste of coffee, and we have our store base to be able to tell a story and sample the product.

So, what we've decided internally, though, is we are no longer going to break VIA out in terms of its contribution to comps.

Because of competitive issues, we just don't want that information out.

But we can tell you it is driving incrementality, it's not cannibalistic, and it's creating new behaviors, and we think the best is yet to come because we're just getting started with three SKUs and we only have it in existing retail stores.

Within this quarter, you'll see it in 30,000 points of distribution, supported by a major marketing campaign.

With regard to China, I'll just give it to John.

Yes, thanks for the question, Jeffrey.

First off, as we said, China represents a tremendous opportunity for us and we had strong momentum in the second quarter.

We have a very profitable business there and we are poised to grow.

We are going to do it in a way that brings the Starbucks experience to life for the Chinese consumer, and the good news is that our customers in China are responding very favorably to not only our beverage offerings, but then also to our food offerings and our new newly-designed stores.

What we will continue to do is look at how we create locally-relevant products, whether it be in food or whether it be in beverage, that will speak to the Chinese customers and resonate with them and ultimately drive traffic in the stores.

But we see huge opportunity there.

We're going to continue to grow the store base, and then in addition to that, we're going to look at other channels to grow in, whether it be the packaged goods business, whether it be food service, or whether it be with SBC.

So we see huge opportunity in China and we are going to go all-out for that opportunity.

Nicole Miller, Piper Jaffray & Co..

On the topic of VIA, extremely interested about what other form factors could mean, just generally.

And then, it was very helpful to understand Japan is a $5 billion market.

What would be the next biggest market that you would target and how fast could you get distribution there?

I don't mean to in any way try and evade the question, but we're not going to get into what markets we might go into next.

There is a big, big prize outside of North America where soluble instant coffee is more than half of consumption in most of the markets outside of America.

With quality of coffee that hasn't really -- really doesn't taste like coffee.

So we've got a big opportunity.

I can't get into other form factors, other than to tell you that we have been studying VIA for quite some time and we believe we've got a big, big opportunity.

If you look at what we've done in Japan in just a quick period of time, we used our retail stores in Japan to tell the story, to replicate the taste challenge.

We have enormous press and interest, and as a result of that, be in a position to take advantage of the fact that that market is 80% instant with over 50 years of coffee that doesn't taste like coffee.

We've got the brand, we've got the story, and we've got the national footprint in order to be able to execute a strategy that no one else can do, and we can do that in many, many markets around the world.

So, you will see an array of product, an array of form factors as we believe we can take a significant share of a $23 billion category that has seen no innovation, that is still growing.

It's just a very, very big opportunity for us.

Mitch Speiser, Buckingham Research Group.

On -- in general, it seems like the focus -- or the increasing focus is on the CPG segment, and of course VIA, and they do tie in to the at-home market.

And one thing that I think you've talked about over the years, and have, is brewing equipment for the at-home market?

Just wondering on a go-forward basis, is that an opportunity for you as it seems that at-home is becoming an increasing focus, yet brewing equipment has not been a big part of the Starbucks story.

Thank you.

Mitch, thanks for the question.

We are certainly well aware as the leading specialty coffee brand of what's going on around single-serve and specifically at home, and have had a watchful eye on what Green Mountain and Keurig have been able to do, and they've done a fantastic job.

We're looking at this in two ways.

One, we think that VIA has an interesting opportunity to position itself in a way against what Keurig is doing at home, because there is no waste, there's no cost of equipment, and you can take VIA anywhere, and the quality of the coffee is significantly better, and we're going to have multiple SKUs and form factors that will create a portfolio product.

However, I think the market needs to stay tuned that we have every intention of understanding what single-serve can be and we're not going to sit back and just watch Green Mountain and Keurig march their way into 20% to 30% household penetration without Starbucks not doing anything.

So, just stay tuned.

Thank you very much.

That concludes Starbucks' call for the quarter.

We'll talk to you in July.

Have a great afternoon.

This concludes today's Starbucks Coffee Company's conference call.

You may now disconnect.