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By TMFMattyA
March 23, 2009

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Notes from Starbucks 2009 Annual Meeting

Some brief words of caution. (1) This is very long. (2) I was writing on the backs of several sheets of paper at a furious pace as the meeting went on. Therefore, some of the quotes I've put down below may not be word-for-word accurate, but merely the best I could do from over 8 pages worth of chicken scratches.

On Wednesday, I attended the 18th annual Starbucks shareholder meeting in Seattle, WA. I had the great privilege to join with officers and investees of a private investment company that was actually founded by Starbucks CEO Howard Schultz about a decade ago.

For a modest, humble Motley Fool analyst, I was in rarefied company. Seated exactly next to me at the meeting was Walter Robb, President and COO of Whole Foods (to whom which I expressed my gratitude as a shareholder and satisfied customer). Seated a few seats away from me was Mark Vadon, co-founder of Blue Nile. A few rows directly in front of me was Diego Piacentini, head of the international division at Amazon.com. Seated about 30 feet to my right was an older gentleman who looked remarkably like Jerry Jones, owner of the Dallas Cowboys (but I was never able to verify if that was indeed the case). Finally, I could see the back of Bill Bradley, former Democratic presidential candidate, from his station with the other members of Starbucks' board of directors.

Okay, enough name-dropping. My point here is to illustrate the kind of draw that Starbucks has. Among the thousands of shareholders that packed the McCaw Hall arena on Wednesday morning was a power-packed punch of CEOs plying their trade in various consumer spaces who were all eager to get a taste of what Starbucks was going to deliver. Like me, I don't think they came away disappointed.

Meeting opener: Starbucks is about people

The meeting kicked off with a brief video documenting Starbucks' leadership summit held last year in New Orleans. At the summit, thousands of Starbucks employees (partners), along with Howard Schultz, members of Starbucks' management, and rock-band U2, contributed 50,000 man-hours to rebuilding sections of the city that were still in disrepair after Hurricane Katrina. There were snippets of a speech by Bono, expressions of deeply-felt gratitude from New Orleans citizens, and words from Schultz, who urged Starbucks' employees to never "be bystanders."

It was an emotional and moving way to open the meeting and set the tone for a theme Schultz emphasized in both his opening speech and throughout the meeting: that Starbucks is a company that "balances profitability with a social conscience." Schultz and Starbucks are deeply committed to customers, employees and shareholders, and to the success and satisfaction of each of them. "We spend more money on health care [for our employees] than we do on the coffee we roast."

Starbucks is also a company that is committed to improving its community through volunteerism. These themes, according to Schultz, have been blurred to some extent over the years by the company's remarkable success on the business front.

I thought this quote from Schultz's opening remarks was particularly poignant:

"We are not a coffee company serving coffee to humans. We are a human company serving humans coffee."

I could tell that pretty much everyone at the meeting (including yours truly), saving perhaps only the coldest members of Wall Street's analyst establishment, suddenly forgot about the fact that Starbucks' stock is off some 70% from its all-time high, or that same-store sales have been in the gutter over the past year. The cynic in me tells me that this was a deft move by CEO Schultz, eager to snuff out any embers of shareholder antagonism from the get-go. But the "human" in me tells me that Schultz's remarks were every bit sincere. I believed every word.

"The world has changed"

With the audience now fully engaged, Schultz got down to business -- and business is all about the economy these days. "The world has significantly changed, and no one has a blueprint on what to do to get through this." There have been "seismic" changes to consumer behavior.

Even more so, there has been a shift in social behavior. Customers are shifting to modestly and frugality, with a new sensitivity around values, human connection, and service to others. Schultz believes that consumers will seek out companies that share these new social paradigms. Starbucks, because of its commitment to its employees (health care, shared equity) and community (volunteerism, development) fits that mold.

Schultz made it clear that he doesn't take what's happened to Starbucks' share price lightly and that he was committed to rebuilding shareholder wealth. "Not a day goes by that we are not acutely aware of our fiscal responsibility to restore shareholder value."

"Starbucks will not only survive, but will succeed in this environment"

Why?
- Quality of coffee and people
- 50 million customers per week
- Solid cash flow and balance sheet
- Trusted global brand

More on its brand, Schultz emphasized that Starbucks' brand was built "not so much on the product, but the experience." Reaffirming the company's leadership position in coffee is paramount to Starbucks' strategy moving forward.

Part of that involves dispelling the current media perception of the company, which Schultz believes has treated Starbucks' cup as consistently half-empty.

"The media says we're no longer cool. Well, we never set out to be cool. We just want to be relevant."

According to Schultz, the company can no longer be quiet about pervasive "myths" like the $4 cup of coffee (in fact, more than half of Starbucks' beverages cost less than $3). Beginning last fall, Starbucks embarked on a new advertising campaign. Whereas before the company never advertised nationally, consistently relying on customer experience and word-of-mouth for most of its marketing, Starbucks finally realized that it needed to get its message out.

This began with the company's "Starbucks and You. It's Bigger than Coffee" campaign which rolled out a single-run 60 second spot during what turned out to be the second-highest rated episode of Saturday Night Live of the season, a few days prior to the Presidential election. The ad, in which Starbucks offers free cups of coffee to each voter, was a hit on YouTube:

http://www.youtube.com/watch?v=a2J8KJDsqqY

Starbucks ended up giving away 2 million cups of coffee on Election Day, but made a profit according to Schultz because of all the incremental business the company received that day. This ad was followed with another great spot on the Weather Channel the day before Thanksgiving, the most traveled day in the country, and another spot emphasizing volunteerism and partnered with an Oprah Winfrey campaign on Inauguration Day.

According to Schultz, this kind of relevant, targeted advertising will continue as the company seeks to grow its brand while emphasizing the titanic shift in social conscience that has taken place over the last year or so.

Also mentioned was the company's mystarbucksidea.com initiative which gives customers and Starbucks' enthusiasts the chance to make suggestions directly to the company on ways it can improve their experience. The company has also been conducting "town hall meetings" in various cities and talking directly to customers. Schultz wants Starbucks' customers to feel that they have a real connection to the company, that they feel valued. "This trumps the economic problems."

Proof is in the Cup

Starbucks has also made great strides in its coffee bean sourcing and technology over the last year. These are real competitive advantages that Schultz says the company will no longer be silent about. Among the new technologies are the Mastrena, a new machine makes "consistently great espresso drinks" with the highest efficiency the company has ever had, and the Clover, the "maker of the perfect cup of coffee."

In addition, Starbucks continues to expand its relationships with Conservation International, and grow its Fair Trade partnerships. "We are on the ground with farmers every day buying only the best coffee from the most equitable and environmentally friendly places." According to Schultz, studies show that "customers will pay more to companies that do good in the world." Walter Robb, Whole Foods' president, shifted excitedly in his chair upon hearing this.

Delivering Value

"Great companies will do everything they can to grow the business and evolve, while maintaining its core customer group."

One of Starbucks' recent successes was its new distribution agreement with Costco. Costco members can now buy bundles of $10 Starbucks' cards with a total face value of $100 for $80. Starbucks and Costco introduced this new agreement in October, expecting that the initial 2 million card roll out would sell out by the end of the holiday season. Turns out, the cards sold out in 2 weeks and Costco was back begging for more. Now that, according to Schultz, is "brand power."

Staying with the card theme, Schultz touted the success of its Red and Gold cards. Each card offers a discount to frequent purchasers, while the Red card also donates a percentage of each to sale to humanitarian efforts in Africa. Over $1 billion worth of Starbucks products were transacted on these cards last year, and there is currently $600 million sitting on the cards as of last quarter waiting to be used (that's deferred revenue to Starbucks). According to Schultz, the company's card platforms are driving massive incremental revenue to the company, and they will continue to introduce them in more and more markets.

Operational Excellence

At this point in the meeting, Schultz took a break and introduced new Chief Financial Officer Troy Alstead to go over the company's financials and projections. I'll spare everyone from detailing all the numbers, and just focus on the highlights. The company has identified more than $500 million in cost savings -- costs that, according to Alstead and Schultz, will not come back even when the economy improves and Starbucks resumes a faster growth trajectory. Newer stores will be both cheaper to open and maintain, and be more environmentally friendly.

Looking forward, Starbucks expects cash flow from operations in Fiscal 2009 to reach $1.1 billion, and free cash flow to reach $500 million -- the highest in the company's history.

The Via Opportunity

After a brief video interlude featuring a rather hysterical prank by Ellen Degeneres at a Starbucks store, Schultz introduced Via. And when I say introduced, I'm talking a Steve Jobs introducing the next version of the iPhone type of introduction. The lights in the arena went haywire; a resounding drum roll of sound reached a crescendo; and on came Schultz, pushing a cart stacked with jars and packets of the company's new instant coffee -- Via.

"We've cracked the code" Schultz said to thunderous applause.

To be honest, as only an occasional coffee drinker, and not having ever tried a cup of instant coffee, I found it difficult to appreciate the enthusiasm for this new product. That is, until Schultz shared the story behind Via, and the incredible opportunity it has created for Starbucks.

This was one fascinating story. For years, Starbucks invested millions and countless man-hours in an attempt to make an instant version of its signature coffee. Yet unbelievably, the breakthrough would originate from the home kitchen of one of the company's ardent customers.

Several years ago, Don Valencia, an immunologist from California, stopped by Starbucks' first ever store in Seattle's Pike Place Market. He asked the manager, who had an understandably bewildered look on her face, to try his instant coffee. She agreed, and shuttered in amazement. The coffee that Mr. Valencia had just stirred from a packet of instant grinds tasted exactly like the Starbucks coffee her baristas were brewing every day at the store.

Apparently, Valencia, frustrated that his favorite Starbucks coffee could not go with him on his many travels and foreign destinations, took it upon himself to create an instant version of the coffee and though he'd share it with the company. Within a few days, Valencia was seated in front of Howard Schultz, agreeing to leave his job move his family from California and head up Starbucks' research teams.

Unfortunately, Valencia died nearly two years ago, just as he and his research team were putting the finishing touches on a commercially viable version of his instant Starbucks coffee.

Today, Via (named for Valencia) is finally here and represents a compelling new opportunity for Starbucks. "The size of this prize is huge," says Schultz. Approximately 40% of the world's coffee market is instant coffee -- a $17 billion opportunity. Schultz believes Via can be a game changer (a Rule Breaker in true David Gardner fashion). It's portable, great for offices and kitchen shelves everywhere. Schultz believes customers will gravitate to a higher quality instant, and bemoans the fact that the media is treating Via's creation as a sign of desperation for Starbucks.

Right now, Starbucks, despite its ubiquity, accounts for only 4% of the 65 billion cups of coffee brewed each year in the U.S. alone. A third of those 65 billion cups are instant coffee. With Via, Schultz believes Starbucks has an "instant" opportunity to gain an incredible amount of market share.

In Conclusion

With the Via presentation over, Schultz moved to conclude the meeting.

"I am not happy about our stock price, but we have to take the long view. The stock market is a quarter-to-quarter instrument. We must resist the temptation to make short-term decisions. We will do everything in our power to create value and build trust for our shareholders."

Thunderous applause, standing ovation. It was a brilliant presentation through and through, delivered by a well-spoken, confident, and inspiring Howard Schultz. The gentleman to my right, a CEO of a small web-based company, went instantly to his Apple iPhone. To check email I presumed. No, he confirmed later, he was placing an order for Starbucks stock.

Q&A

The Q&A session lasted only about 30 minutes, and there weren't really many memorable discourses. Nearly half of the shareholders who spoke just got up there to thank Schultz and say how much they appreciate the company and its tasty beverages. There was an investment analyst who asked a question about the company's recently-purchased private jet. Schultz responded by saying that the jet is currently up for sale, but also added that the company's travel arrangement have always been above-board and responsible from a cost perspective. Schultz also reminded shareholders at one point during the Q&A that he was taking no salary for the balance of the year, and that executive bonuses had been slashed considerably.

Foolish Bottom Line

I hope Starbucks' shareholders and members find these notes useful. There is no denying that the past 18 months have been difficult for Starbucks, and times could get more difficult still. To a certain extent, the winds pushing this fast-growing ship have died down considerably and may not ever get back up to full speed. How can they? But I walked away from the meeting with the deepest confidence in Howard Schultz and genuine excitement about the company's future. I may not understand this as well as the coffee-enthusiast who frequents the company's many stores, but the Starbucks brand is much deeper and richer than its tasty beverages. It's an experience that millions of people around the world truly enjoy and choose to make part of their regular routine. The current economic slowdown won't make much more than a slight dent in that experience. Meanwhile, Starbucks is making great strides in restoring its brand, marketing its many social and community commitments, and delivering real value to its customers. I think it's safe to say that Starbucks' cup is much more than half full.