Starbucks hopes new drinks can lift profits

Starbucks Corp., which has said it would "fight to the death" to promote its coffee, is getting in on the energy drink business. And the smoothie business. And the as-yet-unnamed-Italian-beverage business.

The Seattle-based coffee chain, which recently decided to stop offering breakfast sandwiches, will also begin offering healthy foods in the fall.

Chief Executive Howard Schultz, who returned to the top post in January, said during an earnings conference call Wednesday that the changes are meant to expand Starbucks' target customer group.

The new products come as the coffee retailer tries to recover from an unprecedented decline in foot traffic at its stores. Starbucks reported Wednesday that its second-quarter profit tumbled 28 percent -- partly because rising food and gas prices are hitting customers in the wallet. Starbucks is suffering, Schultz explained, because it sells affordable luxuries that for some people aren't so affordable lately.

"We are not satisfied with the downturn in traffic in our stores," Schultz said. "We are working diligently to reverse that."

International expansion could help Starbucks buffer a U.S. economic slowdown, Schultz told the Seattle P-I in an interview after the conference call. During the next three years, Starbucks plans to slow its store expansion in the U.S., while ramping up in international markets. By the end of 2011, Starbucks plans to run 21,500 stores worldwide, the company said.

Starbucks will partner with Pepsi-Cola for its "DoubleShot platform" to sell energy drinks through retail channels similar to those used to sell bottled Frappuccino drinks. The company will also sell custom energy drinks in stores. The energy beverage market was worth $4.4 billion in 2007, Schultz said. "Perhaps we should have been in that sooner," he told analysts Wednesday.

A second new offering, "health and wellness" beverages, will be blended out of whey protein and fruit, and available nationwide this summer. Starbucks last summer started selling protein smoothies in six Seattle stores as part of a marketability test. The drinks were called "Protein Smoothies Powered by Kinetix."

Because that test went well, Schultz told the P-I, the company decided to create a beverage of its own. "Of all the things that we talked to our customers about, the areas of health and wellness were of most interest to them."

For the third new category, Starbucks will partner with an Italian supplier to sell a "refreshing low calorie" but "indulgent" frozen smooth drink, Schultz said. The drink will first be sold in California this summer, and nationwide later on.

The third product is "steeped in Italian heritage," Schultz told the P-I. He declined to give details. "A colleague of mine was in Italy and tasted something that he thought was quite unique. From that we took it from there."

In response to questions, Schultz said that Starbucks plans to introduce more products in the future, including coffee products, and that the noncoffee drinks wouldn't deter the company's coffee mission.

Starbucks is in the middle of an overhaul that it calls its "transformation agenda." Among recently announced changes are free Wi-Fi access for loyal customers, a new coffee blend called Pike Place Roast and a reorganization of its entertainment division. It also laid off 220 employees in February.

That agenda, along with changes to its store portfolio, accounted for 3 cents per share of Starbucks' second-quarter profit decline.

Net income for the quarter ended March 30 was $108.7 million, or 15 cents per share, compared with $150.8 million, or 19 cents a share, in the same period last year. That profit figure is in line with Starbucks' warning to Wall Street last week.

Wall Street analysts had been expecting 21 cents per share profit. Quarterly revenue grew 12 percent to $2.53 billion, representing the lowest year-over-year increase to date, Chief Financial Officer Peter Bocian said in the conference call.

Wall Street analysts had expected Starbucks to suffer from a slumping economy, but Starbucks' second-quarter results were surprisingly low, two Morgan Stanley analysts wrote in a research note.

Starbucks' newest initiatives -- including offering fruit drinks -- seems puzzling, and "all over the board" to outsiders, said Bradford Hudson, a marketing professor at Boston University who teaches the Starbucks case study.

"It's interesting to try to figure out what's going on with Starbucks," said Hudson, who has watched the company for 10 years as an academic and as a customer. One of Starbucks' success secrets -- which Schultz is aware of -- was to treat coffee as if it were wine, and to appeal to connoisseurs, Hudson said.

"I don't think most people know the difference between good and bad coffee," Hudson said.

"The reason people think Starbucks coffee is good is because Starbucks tells them it's good. ... In my mind, there's something inherently contradictory between a position based on connoisseurship and 30,000 units."

The stock dropped 11 cents after hours Wednesday to $16.12.