Here's Why You Shouldn't Pay $1.10 For A Dollar Of Investment Grade Bond Assets

I’ve received questions from prospective subscribers about the types of trade alerts that we issue to the members section of the Cambridge Income Laboratory. One type of trade is CEF arbitrage, or more specifically a pairs trade, where we simultaneously identify an overvalued CEF and an undervalued CEF in the same sector. The strategy then entails selling or selling short the overvalued fund while simultaneously buying the undervalued fund.

The advantage of a CEF pairs trade is that because both the sold and bought funds are from the same sector, we aren’t making a directional bet on the performance on the underlying assets. Instead, we’re simply relying on the powerful concept of reversion of CEF premium/discount values (see Reflections On Chemist’s CEF Report Pick Performance In 2017 for how this has worked well for us in the Chemist’s monthly CEF picks).

There are two main limitations of the CEF arbitrage strategy. The first is that the magnitude of the gains are unlikely to be very large, simply because it is by nature a hedged strategy. That’s the trade-off for the strategy being relatively low risk. The second limitation is that unless you already own the overvalued CEF identified in the pairs trade, you would have to locate shares of the overvalued CEF to sell short. With some of the smaller, less liquid CEFs, this can range from expensive to downright impossible. The most optimal set-up is therefore already owning the overvalued CEF, and then locking in profits by selling the fund and then replacing it with the undervalued CEF in the same sector.

With the introductory blurb out of the way, let’s see how this has played out for one of the more recent CEF pairs trade that we identified in the members section of the Cambridge Income Laboratory.

About 4.5 months ago (see Sell This Investment Grade Income CEF Now), we noticed the premium of Western Asset Income Fund (PAI), an investment grade bond CEF, suddenly spiking up to +10.16%. The 1-year z-score was +3.6, indicating that this fund was significantly more expensive than its recent history. My comments from the initial article are reproduced below:

I was looking through the CEF database today and noticed the Western Asset Income Fund (PAI) trading at an exceptionally high z-score of +3.6.

Its current premium of +10.16% is at a 5-year high.

(Source: CEFConnect)

A 1-year z-score of +3.6 tells us that the premium/discount is trading 3.6 standard deviations above its 1-year historical value. Statistically speaking, this would be a 0.02% probability of occurrence, assuming that the distribution of values is normally distributed (which it isn’t, but the point is that such a high z-score is a rare occurrence).

The 5-year chart above showed that the fund traded at quite substantial discounts over the past 5 years, sometimes exceeding even -10%. This makes the current premium of +10.16% even more unusual than the 1-year z-score of +3.6 would indicate.

At this juncture, I wanted to look at the entire history of the CEF since inception. Perhaps the past 5 years was just an anomaly, and that the CEF has commanded a consistent premium in the past? It turns out that was not so.

Going back to inception, only during a brief period in 2009 did the fund’s premium exceed 10%. An unusually high premium for an investment grade fund might be understood during the immediate recovery period after the financial crisis…but why now? I can’t think of a fundamental reason why someone would pay $1.10 for a dollar of investment grade debt.

(Source: CEFConnect)

I then check out the premium/discount values of the peer group. Maybe investment grade bond CEFs are for some reason on a tear thus accounting for PAI’s unusual premium? Nope, that’s not it.

The premium of PAI is 3rd-highest out of the 15 CEFs in the “investment grade” category of CEFConnect. But I don’t consider PIMCO Corporate & Income Strategy Fund (PCN) and PIMCO Corporate & Income Opportunity Fund (PTY) to be traditional investment grade income CEFs, so not counting those two funds PAI has the highest premium in the peer group.

(Source: Stanford Chemist, CEFConnect)

OK, so PAI is a pretty good sell or short candidate. What did I pair my short PAI position with?

What did I pair my short PAI position with? I chose the BlackRock Credit Allocation Income Trust (BTZ). I wanted to choose a fund with a negative z-score, but rather amazingly all 15 investment grade CEFs had z-scores 0 or greater. BTZ’s z-score of +0.8 wasn’t the lowest, but its discount of -9.04% was the widest in the peer group, as you can see from the chart above.

Next, I wanted to see compare the price and NAV returns of these two investment grade bond CEFs to check if there were signs of deteriorating portfolio values in the undervalued CEF, which might cause me to consider BTZ as the long partner in this pairs trade.

The opportunity for the pairs trade comes from the fact that PAI’s price return is significantly outpacing its NAV return, whereas that is not the case with BTZ. We can see from the chart below that PAI appears to be blowing BTZ out of the paper with a +19.29% YTD return compared to only +8.94% for BTZ.


However, their YTD NAV returns are nearly identical.


No warning signs there. That leads me to the conclusion that:

In summary, if you own PAI, now would be a great time to sell!

Let’s see how the thesis played out 4.5 months later. BTZ had a total return loss of -3.88% over this time frame. That’s bad, of course, but still relatively much better than PAI’s loss of -14.1% over the same period. In other words, BTZ outperformed PAI by 10.22 percentage points in only 4.5 months, or about 27% annualized.

Did PAI’s portfolio do much worse than BTZ’s? No, and in fact the reverse was true. PAI’s net asset value [NAV] fell by -2.10% over this time period, but BTZ’s was even worse at -3.24%.

If BTZ’s portfolio did worse than PAI’s, why was its total return (much) better? My regular readers will have already guessed at the answer: premium/discount mean reversion! Over the last 4.5 months, PAI’s premium of +10.16% has sank to a discount of -4.82%, while BTZ’s discount of -9.04% has widened slightly, to -11.9%. Therefore, the majority of the outperformance of the long BTZ/short PAI pairs trade was due to the contraction of PAI’s discount.

PAI Discount or Premium to NAV data by YCharts


This article hopefully conveys our thought process in recommending a pairs trade to our members. Anyone who owned PAI and swapped to BTZ to would have profited to the tune of ~10% in only 4.5 months (~27% annualized), which is equivalent to about 2.5 years worth of distributions from PAI!

Note that I did not need to do a deep dive analysis of either PAI or BTZ to initiate this pairs trade. This was based almost entirely on premium/discount mean reversion, or as my fellow SA author Arbitrage Trader likes to say, “simple statistics”.

Taking stock of the situation today, the long BTZ/short PAI trade has to be considered to be largely completed, as PAI is now trading with a discount of -4.82% and a 1-year z-score of -1.5, indicating that is now cheaper than its historical average. Although BTZ’s z-score of -2.5 is even lower, as is its discount (-11.9%), the gap in valuation is no longer there.

Are there any current opportunities? The following table shows the 12 CEFs in the database that currently have z-scores greater or equal to +2.5. If you own ones of these funds, if might be a good idea to seek out another fund in the same category that is trading with a more attractive valuation, particularly if the fund that you own is also trading at a premium. Don’t let mean reversion catch you out!

Name Ticker Yield Discount z-score
MS Income Securities (ICB) 2.71% -1.47% 3.9
BlackRock Science and Technolo (BST) 5.32% 3.05% 3.2
Tortoise MLP Fund (NTG) 8.61% 9.26% 3.2
ClearBridge Energy MLP (CEM) 8.85% 5.53% 3.1
Gabelli Utility Trust (GUT) 8.50% 44.95% 3.1
Templeton Emerging Mkts Income (TEI) 3.79% -8.17% 3.1
Sprott Focus Trust (FUND) 4.97% -8.86% 3.0
Nuveen S&P Dynamic Overwrite (SPXX) 5.58% 9.54% 2.9
RiverNorth Opportunities Fund (RIV) 12.09% 6.83% 2.7
Deutsche High Income Oppos (DHG) 5.42% -0.60% 2.6
First Trust New Opps MLP & En (FPL) 10.52% 6.67% 2.5

Western/Claymore Infl-Lnk Opps

(WIW) 3.79% -9.71% 2.5

(Source: CEFConnect, Stanford Chemist)

We’re currently offering a limited time only free trial for the Cambridge Income Laboratory. Prices are going up on March 1, 2018, so please join us and lock in a lower rate for life by clicking on the following link: Cambridge Income Laboratory.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long the portfolio securities.

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Can Machines Save Us From the the Machines?

Is it just me or is the cyber landscape getting more scary? Even as companies and consumers get better at playing defense, a host of new cyber threats is at our doorsteps—and it’s unclear if anyone can keep them out.

My doom-and-gloom stems from the dire predictions of Aviv Ovadya, the technologist who predicted the fake news epidemic, and now fears an “information apocalypse” as the trolls turbo-charge their efforts with AI. He points to the impending arrival of “laser phishing” in which bots will perfectly impersonate people we know by scraping publicly available images and social media data. The result could be the complete demolition of an already-crumbling distinction between fact and fiction.

Meanwhile, the phenomenon of crypto-jacking—in which hackers hijack your computer to mine digital currency—has quickly morphed from a novelty to a big league threat. Last week, for instance, hackers used browser plug-ins to install malignant mining tools on a wide range of court and government websites, which in turn caused site visitors to become part of the mining effort.

The use of browser plug-ins to launch such attacks is part of a familiar strategy by hackers—treating third parties (in this case the plug-ins) as the weakest link in the security chain, and exploiting them. Recall, for instance, how hackers didn’t attack Target’s computer systems directly, but instead wormed their way in through a third party payment provider. The browser-based attacks feel more troubling, though, because they take place right on our home computers.

All of this raises the question of how we’re supposed to defend ourselves against this next generation of threats. One option is to cross our fingers that new technologies—perhaps Microsoft’s blockchain-based ID systems—will help defeat phishing and secure our browsers. But it’s also hard, in an age when our machines have run amok, to believe more machines are the answer.

For a different approach, I suggest putting down your screen for a day and picking up How to Fix the Future. It’s a new book by Andrew Keen, a deep thinker on Silicon Valley culture, that proposes reconstructing our whole approach to the Internet by putting humans back at the center of our technology. Featuring a lot of smart observations by Betaworks founder John Borthwick, the book could help us fight off Ovadya’s information apocalypse.

Have a great weekend.

Jeff John Roberts


[email protected]

Welcome to the Cyber Saturday edition of Data Sheet, Fortune’s daily tech newsletter. You may reach Robert Hackett via Twitter, Cryptocat, Jabber (see OTR fingerprint on my, PGP encrypted email (see public key on my, Wickr, Signal, or however you (securely) prefer. Feedback welcome.

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Number of crypto hedge funds doubles in four months: Autonomous NEXT data

LONDON (Reuters) – Hedge funds focused on trading cryptocurrencies more than doubled in the four months to Feb. 15, hitting a record high of 226, showed new data from fintech research house Autonomous NEXT on Thursday.

The firm had recorded just 110 global hedge funds with a similar strategy as of Oct. 18, up from 55 funds at Aug. 29 and just 37 at the start of 2017.

Assets under management hit between $3.5 and $5 billion, according to the firm.

Reporting by Maiya Keidan and Jemima Kelly

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Why the Online Gaming Industry is Ripe for Disruption

We live in a disruptive time. New startups are constantly rising and falling and reputations are staked, made and lost every time a new technology comes along with the potential to change the way we live, entertain ourselves and do business.

The online gaming industry itself is somewhat disruptive. After all, it didn’t exist twenty years ago and its growth rate over the last couple of years has been phenomenal. Nowadays, the online gaming market is huge and all-encompassing, covering everything from PUBG and Call of Duty to World of Warcraft and Farmville (which is somehow still going strong).

At the same time, new technologies are constantly reinventing the way that online gaming works. VR is gaining in popularity and even spawning its own controversial memes, and technologies like blockchain are changing the way that we store, access and update records. Blockchain also forms the backbone to cryptocurrencies like Bitcoin, which could be used to power in-game transactions.

Device fragmentation

One of the big trends that games developers are being forced to deal with is the increasing fragmentation of the devices that we use to access the internet and thus to play games online with. The days of people only accessing the internet from a desktop computer are long gone, although PC gaming is still an attractive alternative to using a console.

Nowadays, every new console is hooked up to the internet by default, and so are our smart TVs and our tablets and smartphones. This opens up huge opportunities for developers to specialize in specific types of projects, whether that’s based upon the platform itself or whether it’s based upon the mechanic. In the same way that Farmville owners Zynga rolled out the concept across a number of different properties, we’re overdue a wave of new specialists who focus on making games that use a premium model or which rely on downloadable mods and addons.

This leads us nicely into another area of online gaming that’s already seeing some disruption, and that’s the way in which developers monetize their products. We’ve seen all sorts of different approaches to monetization throughout the years, and online gaming developers are still experimenting with everything from micropayments to crowdfunding and more.

New routes to market

Crowdfunding is a game-changer because it can reduce the risk that developers take by making sure that the costs are covered by fans of the project who want to see the game come to fruition. At the same time, platforms like Steam are making it easier for developers to release their games (and to make a little money while they’re at it), and this is leading to a resurgence in indie games and indie developers.

Indie developers already have a reputation for innovation because they can iterate faster and create whatever they want instead of being responsible to shareholders and creative directors. Of course, there’s no guarantee of quality, but more established players would be wise to keep their eyes on the indie market for emerging trends. In some instances, they might even be able to hire talent or acquire intellectual property, but there’ll also be no shortage of founders and entrepreneurs who’d prefer to go it alone.

All of this creates an unpredictable industry in which anything could happen, and it’s those who are able to react the fastest who’ll be the biggest disruptors. The biggest companies tend to have longer lead times on their new releases, which means there’s plenty of room for more agile disruptors to enter the industry and to shake things up a bit.

Ageing Consumers

While all of this is happening, the demographics of end users are starting to change. A generation of kids who grew up on Sega Megadrives and Super Nintendos are now heading into their early thirties with the spending power to match. This time, though, they’re buying games, consoles and computers for themselves, and not for their children.

In fact, the average gamer is 31 years old, and there are more gamers over the age of 36 than between the ages of 18 to 35 or under the age of 18. There are also more female gamers than ever before, which means that gaming is becoming more democratic. It’s not just fourteen-year-old boys in their bedrooms anymore. Online gaming is for all of the family now.

This in itself opens up a new opportunity, because different demographics are interested in different types of gaming experience, and with the average American house including at least two gamers, developers can now afford to cater to niche audiences. And by focusing on specific target markets, disruptors can easily take over entire segments of the online gaming market, building up a reputation for themselves and then augmenting their portfolio by buying up competitors.


When it comes to the online gaming industry, disruption isn’t just inevitable – it’s the new norm. Developers and manufacturers are playing the cat and mouse game between software and hardware, and at the same time, faster and better internet connections are becoming more commonplace. This means that developers have more resources than ever at their disposal, allowing them to tap into capabilities that were previously unheard of.

As a result of that, we’re at a pivotal moment in the history of online gaming in which the access to tools has been democratized and where anyone can be a disruptor. Sure, the big multinational companies might have bigger budgets, but the next big MMORPG could end up coming out of a teenager’s bedroom.

Believe it or not, this is actually good news for the established players. After all, the industry has always moved quickly, and the only way to stay on top of it is to constantly innovate. This extra competition will hopefully push the bigger companies to disrupt the status quo before someone else comes along and does it for them. And of course, all of this disruption ultimately benefits one group of people the most: the gamers. It’s an exciting time to be into online gaming.

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Baidu earnings beat forecasts, eyes U.S. listing for video unit iQiyi

SHANGHAI/BEIJING (Reuters) – Chinese internet search firm Baidu Inc posted a forecast-beating quarterly revenue increase and unveiled a U.S. listing plan for its Netflix-like video platform iQiyi as it looks to rev up new drivers for growth.

Baidu posted on Tuesday fourth quarter revenue of 23.6 billion yuan ($3.72 billion), up 29 percent against the same period a year ago and topping analysts’ forecasts of 23.05 billion yuan and the company’s own guidance.

The strong results are a major fillip for Baidu as it looks to ramp up spending on riskier gambles in autonomous driving and fend off cashed-up rivals such as Tencent Holdings Ltd and Alibaba Group Holding Ltd in online video content.

A U.S. listing would bring extra financial muscle for its popular iQiyi platform as it ramps up spending. Baidu said the size of any IPO was not yet set, but that it would likely remain iQiyi’s controlling shareholder. iQiyi could be worth $8 billion or more, according to Reuters Breakingviews.

“An IPO will bolster iQiyi’s position in the market and give it more cash to buy content or make content on their own,” said Ni Shuang, Beijing-based Pacific Securities analyst, adding it would help Baidu keep pace with rivals in the space.

The strong quarterly showing – driven by the core search and news feed businesses – is also key to generating cash flow “to fund our new AI businesses”, Baidu chief executive Robin Li told a post-earnings conference call.

The company’s shares rose nearly 5 percent in extended trading after the results, overturning a nearly 4 percent fall since the start of the year.

Herman Yu, the firm’s chief financial officer, said content costs rose 70 percent last year to 13.4 bln yuan as iQiyi acquired content. These costs would rise at a similar pace this year.

The firm will also raise R&D spending in areas like its Apollo open-source software platform for autonomous driving, which executives said would eventually become a “very material and significant revenue source for the company”.

“Having said that, a key caveat is that this market will take time to build,” chief operating officer Qi Lu told the conference call.

Strong results in its more traditional businesses were central to Baidu’s success, with revenue from its core online marketing – including its search platform and news feed – jumping 26.3 percent to 20.4 billion yuan.

The results will help soothe Baidu investors as the company looks to turn around its fortunes after a series of missteps sparked steep losses in 2016 and hit its advertising revenue from internet searches.

Baidu, part of China’s trinity of tech giants along with Alibaba and Tencent, posted net income of 4.16 billion yuan in the quarter ended Dec. 31, up from 4.13 billion yuan a year earlier.

Excluding one-time items, the company earned 14.9 yuan per ADS, above forecasts.

Baidu pegged its guidance for first-quarter revenue growth, between 19.86 billion yuan and 20.97 billion yuan, a 25-32 percent increase against the same period of 2017. That compared with analysts’ average estimate of 21.18 billion yuan.

Reporting by Adam Jourdan in SHANGHAI, Pei Li in BEIJING and Arjun Panchadar in BENGALURU; Editing by Eric Meijer and Muralikumar Anantharaman

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Cryptojacking Found in Critical Infrastructure Systems Raises Alarms

The rise of cryptojacking—which co-opts your PC or mobile device to illicitly mine cryptocurrency when you visit an infected site—has fueled mining’s increasing appeal. But as attackers have expanded their tools to slyly outsource the number of devices, processing power, and electricity powering their mining operations, they’ve moved beyond the browser in potentially dangerous ways.

On Thursday, the critical infrastructure security firm Radiflow announced that it had discovered cryptocurrency mining malware in the operational technology network (which does monitoring and control) of a water utility in Europe—the first known instance of mining malware being used against an industrial control system.

Radiflow is still assessing the extent of the impact, but says that the attack had a “significant impact” on systems. The researchers note that the malware was built to run quietly in the background, using as much processing power as it could to mine the cryptocurrency Monero without overwhelming the system and creating obvious problems. The miner was also designed to detect and even disable security scanners and other defense tools that might flag it. Such a malware attack increases processor and network bandwidth usage, which can cause industrial control applications to hang, pause, and even crash—potentially degrading an operator’s ability to manage a plant.

“I’m aware of the danger of [malware miners] being on industrial control systems though I’ve never seen one in the wild,” says Marco Cardacci, a consultant for the firm RedTeam Security, which specializes in industrial control. “The major concern is that industrial control systems require high processor availability, and any impact to that can cause serious safety concerns.”

Low Key Mining

Radiflow CEO Ilan Barda says the company had no idea it might discover a malicious miner when it installed intrusion detection products on the utility’s network, particularly on its inner network, which wouldn’t usually be exposed to the internet. “In this case their internal network had some restricted access to the internet for remote monitoring, and all of a sudden we started to see some of the servers communicating with multiple external IP addresses,” Barda says. “I don’t think this was a targeted attack, the attackers were just trying to look for unused processing power that they could use for their benefit.”

Industrial plants may prove an enticing environment for malicious miners. Many don’t use a lot of processing power for baseline operations, but do draw a lot of electricity, making it relatively easy for mining malware to mask both its CPU and power consumption. And the inner networks of industrial control systems are known for running dated, unpatched software, since deploying new operating systems and updates can inadvertently destabilize crucial legacy platforms. These networks generally don’t access the public internet, though, and firewalls, tight access controls, and air gaps often provide additional security.

Security specialists focused on industrial control, like the researchers at Radiflow, warn that the defenses of many systems still fall short, though.

“I for one have seen a lot of poorly configured networks that have claimed to be air gapped but weren’t,” RedTeam Security’s Cardacci says. “I am by no means saying that air gaps don’t exist, but misconfigurations occur often enough. I could definitely see the malware penetrating crucial controllers.”

With so much fallow processing power, hackers looking to mine—often with automated scanning tools—will happily exploit flaws in an industrial control system’s defenses if it means access to the CPUs. Technicians with an inside track may also yield to temptation; reports surfaced on Friday that a group of Russian scientists were recently arrested for allegedly using the supercomputer at a secret Russian research and nuclear warhead facility for Bitcoin mining.

“The cryptocurrency craze is just everywhere,” says Jérôme Segura, lead malware intelligence analyst at the network defense firm Malwarebytes. “It’s really changed the dynamic for a lot of different things. A large amount of the malware we’ve been tracking has recently turned to do some mining, either as one module or completely changing attention. Rather than stealing credentials or working as ransomware, it’s doing mining.”

Getting Serious

Though in-browser cryptojacking was a novel development toward the end of 2017, malicious mining malware itself isn’t new. And more and more attacks are cropping up all the time. This weekend, for example, attackers compromised the popular web plugin Browsealoud, allowing them to steal mining power from users on thousands of mainstream websites, including those of United States federal courts system and the United Kingdom’s National Health Service.

Traditional mining attacks look like the Browsealoud incident, targeting individual devices like PCs or smartphones. But as the value of cryptocurrency has ballooned, the sophistication of attacks has grown in kind.

Radiflow’s Barda says that the mining malware infecting the water treatment plant, for instance, was designed to spread internally, moving laterally from the internet-connected remote monitoring server to others that weren’t meant to be exposed. “It just needs to find one weak spot even on a temporary basis and it will find the way to expand,” Barda says.

Observers say it’s too soon to know for sure how widespread cryptojacking will become, especially given the volatility of cryptocurrency values. But they see malicious mining cropping up in critical infrastructure as a troubling sign. While cryptojacking malware isn’t designed to pose an existential threat—in the same way a parasite doesn’t want to kill its host—it still wears on and degrades processors over time. Recklessly aggressive mining malware has even been known to cause physical damage to infected devices like smartphones.

It also seems at least possible that an attacker with goals more sinister than a quick financial gain could use mining malware to cause physical destruction to critical infrastructure controllers—a class of rare but burgeoning attacks.

“We’ve seen this technique with ransomware like NotPetya where it’s been used as a decoy for a more dangerous attack,” Segura says. “Mining malware could be used in the same way to look financially motivated, but in fact the goal was to trigger something like the physical damage we saw with Stuxnet. If you run miners at 100 percent you can cause damage.”

Such a calamitous attack remains hypothetical, and might not be practical. But experts urge industrial control plants to consistently audit and improve their security, and ensure that they’ve truly siloed internal networks, so there are no misconfigurations or flaws that attackers can exploit to gain access.

“Many of these systems are not hardened and are not patched with the latest updates. And they must run 24/7, so recovery from crypto-mining, ransomware, and other malware threats is much more problematic in industrial control system networks,” says Jonathan Pollet, the founder of Red Tiger Security, which consults on cybersecurity issues for heavy industrial clients like power plants and natural gas utilities. “I hope this helps create a sense of urgency.”

Cryptojack Attacks

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Cryptocurrency investors flock to Puerto Rico Investment Summit

SAN JUAN, Puerto Rico (Reuters) – Puerto Rico’s annual investment summit, a two-day conference to woo investors to the bankrupt U.S. territory and the first since Hurricane Maria devastated the island, sported some new faces, particularly from the fast-growing cryptocurrency world.

    The ranks of attendees and panelists on Monday were notably light on traditional mainstays, such as hedge fund creditors that hold the island’s $71.5 billion in debt.

    Filling in some of the gaps were cryptocurrency investors, including Michael Terpin, who told the crowd at the Puerto Rico Convention Center he was the first from the crypto world to move to the island in 2016.

    Terpin, who also runs a public relations firm that works with cryptocurrency investors, said the industry is keen to take advantage of tax breaks under Puerto Rico’s Acts 20 and 22 that benefit wealthy job creators who move to Puerto Rico from other jurisdictions.

    “I hate it when I hear a talented person has to leave Puerto Rico because there’s no jobs here,” Terpin said. “We are bringing jobs.”

    Puerto Rico is battling the largest bankruptcy in U.S. government history, $120 billion in combined pension and bond debt, and the effects of Hurricane Maria, its worst natural disaster in 90 years which killed dozens and decimated an already-weak infrastructure in September. 

    About 50 cryptocurrency entrepreneurs have relocated to Puerto Rico over the last year or two, and Terpin said he predicts that number will rise to 500 in the next 12 months. The island will host three separate cryptocurrency conferences over the next six weeks.

    Speaker Brock Pierce, co-founder of Blockchain Capital, a venture capital firm investing in blockchain-enabled technology, said Puerto Rico has the mix of entrepreneurial spirit and tax benefits to make it an attractive launch pad for a what he views as a digital currency revolution.

    “We leave the pilot phase” in 2018, Pierce said. ”We’ve been connecting all the dots, getting all the pieces in place. This is the year when scalability hits, when big ideas become possible.” 

Reporting By Nick Brown; Editing by Daniel Bases

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BitGrail Cryptocurrency Exchange Claims $195 Million Lost to Hackers

An obsure Italian cryptocurrency exchange called BitGrail claims that it was hacked late last week and lost roughly $195 million worth of customers’ cryptocurrency. But others — including the developers who created the stolen cryptocurrency — have suggested not all may be as it appears.

BitGrail, based in Italy, is one of many exchanges globally which allow the trading of Bitcoin and other cryptocurrencies. BitGrail was until recently one of the main portals for the trading of Nano, a cryptocurrency formerly known as RaiBlocks. Last Thursday, BitGrail founder Francesco Firano claims to have discovered that 17 million Nano tokens, then worth roughly $195 million, had been stolen by hackers.

But that claim has been greeted with widespread skepticism, fueled in part by recent suspicious moves by BitGrail. In early January, the exchange halted all withdrawals and deposits of Nano, as well as the Lisk and CryptoForecast tokens. That was followed by the announcement that BitGrail would enforce identity verification and anti-money laundering protocols for its users, and potentially block non-European users, despite the fact that it did not deal with government currencies or banks. According to cryptocurrency news site The Merkle, at least some users at that time were already suspicious that the site was maneuvering towards a so-called “exit scam,” and the price of Nano dropped by 20% on the news.

Then, in the wake of the alleged hack, Firano asked the developers of the Nano currency to “fork” their records to restore the funds supposedly stolen from the exchange. This is an eyebrow-raising request, since the immutability of transaction records is one of the core features of cryptocurrency, and held as sacrosanct by many supporters of the technology.

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The Nano team responded by publicly rejecting the request, sharing a copy of their communication with Firano, and furthermore alleging that “we now have sufficient reason to believe that Firano has been misleading the Nano Core Team and the community regarding the solvency of the BitGrail exchange for a significant period of time.” The strong implication is that Firano had mismanaged customer assets and was claiming a “hack” as cover.

The Nano team did not provide further specific evidence of this claim, however, and would have obvious motives for drawing attention away from any security flaws in their own technology. Firano, 31, told the Italian news site Sole24ORE that he has received multiple death threats since announcing the hack and filing a police report, which he said is now being investigated. Users on Twitter and Reddit are circulating photos of Firano, accompanied by implicit and explicit threats.

The $195 million loss is still smaller than several previous cryptocurrency exchange collapses. In 2014, at least $387 million worth of Bitcoin was reportedly stolen from Japan’s Mt. Gox exchange — coins that would be worth billions of dollars at current prices. And just last month, $534 million worth of a cryptocurrency called NEM was stolen from Coincheck, another Japan-based exchange.

Many international exchanges are essentially unregulated, and even U.S.-based cryptocurrency exchanges are not protected by any sort of consumer insurance along the lines of FDIC coverage for bank deposits. Because of this heightened risk environment, cryptocurrency experts strongly discourage leaving tokens in the custodianship of exchanges, and instead using a local wallet.

Nano may be a relatively little-known cryptocurrency, but even after news of the BitGrail loss pushed its price down, the total value of outstanding tokens exceeds $1 billion.

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Why This CEO Started a Secret Company to Compete with His Existing One

Eighteen months ago, FreshBooks CEO Mike McDerment did something that might blow your mind. In secrecy, he started a brand new company to compete with his existing one.

Finding Space to Experiment.

In my recent interview with McDerment, he described a moment in the winter of 2013 when he had been feeling uneasy about the steady growth of his business. Freshbooks, which had long been the darling of the DIY bookkeeping industry, needed to keep innovating to remain competitive.

The reality, which McDerment recognized, is that software products, by their very nature, are malleable and constantly changing. In today’s business landscape, consumers expect products to be constantly improving.

But how do you make major changes in a way that does not disrupt existing users? Especially when their livelihood depends on your product?

How does a company allow for the exploration required for innovation without screwing up what it’s already getting right?

McDerment asked himself these questions. And he believes he’d found the answer by rolling out an updated product, but not under the FreshBooks brand.

And so, he started BillSpring.  

Newcomer BillSpring could market its product as “in development,” thereby creating the space for experimentation and attracting new users with its updated design.

Sure, this strategy is logical, but it’s jarringly unconventional. However, McDerment says Freshbooks has sought to establish a culture of putting people at the center of every decision, so for him, it was an obvious move.

Being Human-Centered.

FreshBooks took the coveted first place spot in the highly competitive Great Places to Work survey. The secret sauce, according to McDerment, is the company’s ability to embody a human-centric approach to all facets of the business: from product development, to hiring and training.

Employees aren’t the only people who matter when it comes to making decisions at FreshBooks. Customers are in constant focus–a concept McDerment calls customer proximity.

To make sure that all team members understand customers, all newly hired employees spend a month in customer service. And this pitstop in customer service occurs without exception, not even for the new CFO, who had taken three companies public. Despite not having any customer-facing interactions, he too spent 30 days getting to know customers on the front lines of customer service.

As a result of this mentality, the company is hyper-sensitive to customer satisfaction. So in retrospect, the decision to create a completely separate brand is no surprise. In fact, it’s a considerate way of introducing change.

A Considerate Approach to Introducing Change.

Whether change is as simple as a minor feature update or something as significant as starting a whole new company to compete with, the consideration of the impact on all people involved should always remain at the forefront.

It’s not just what Freshbooks values, but as so many companies have proven, it’s just good business. 

Eighteen months after the experiment, Billspring had shown improvements in business performance and customer satisfaction, exceeded those of Freshbooks. At this point, McDerment finally decided it was time to come out of hiding, dissolving the Billspring brand and merging the products back under Freshbooks. 

“When we launched we didn’t want our users to worry. So if they said ‘you know what? It’s great but not right for me’ then they could return to Freshbooks classic,” McDerment says. “We did everything in our power to not destabilize our users’ business, and so the vast majority of people recognized that and chose the new version when they had the chance.” 

The Takeaway: Create the Conditions for Innovation.

The extreme stealth-mode approach may not be the right answer for other companies looking to navigate change and growth, but creating the conditions for change and growth is–for the organization and, more importantly, the real people they serve.

Despite the radical time and cost investment, McDerment stands by his 18-month experiment to deliver positive outcomes for its employees and customers. Ultimately, affording the freedom of time and space is what has enabled the award-winning success that the company enjoys today.

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Exclusive: Amazon eyes new warehouse in Brazil e-commerce push – sources

SAO PAULO (Reuters) – Inc (AMZN.O) is looking to lease a 50,000-square-meter warehouse just outside Sao Paulo, people familiar with the matter told Reuters, as it steps up its push into Latin America’s biggest retail market, Brazil.

The logistics investment, which would be four times the size of its current book-shipping operation in the country, is a sign the online retailer may soon handle distribution of electronics and other goods sold on its Brazilian website.

That would be the first step of its kind for Amazon in Latin America’s largest economy, where it currently relies on third parties to ship their own goods sold on its marketplace, and it underscores the seriousness of the e-commerce giant’s renewed push into Brazil.

Amazon declined to comment to questions about leasing a warehouse.

While an estimated two-thirds of Brazil’s 209 million people have internet access, online retail was slow to take off at first, amid concerns over security and complications with tax and logistics in the continent-sized country.

E-commerce accounts for around 5 percent of Brazil’s roughly $300 billion retail market — about half its share in the United States — but it has doubled in the past four years and is forecast to keep growing annually at a double-digit pace.

Now Amazon, which expanded its Brazil business from books to electronics in October, is gearing up to fight rivals such as Latin Ameria’s homegrown e-commerce champion Mercado Libre Inc (MELI.O) and B2w Cia Digital, (BTOW3.SA) which is indirectly controlled by partners of private equity group 3G Capital.

“You obviously can’t underestimate a company like Amazon,” said Pedro Guasti, CEO of Brazilian online consultancy Ebit. “It has huge capacity to invest and it’s obviously taking a bigger bite of the cake than it did last year.”

Mercado Libre Inc, B2w and local retailer Magazine Luiza SA (MGLU3.SA) have stolen a march on Amazon by storing and shipping goods appearing on their websites even when offered by third-party sellers, to ensure speed and customer satisfaction.

Amazon, by contrast, has been slow to tackle the challenges of shipping in a country where tricky logistics and tax issues have long made online retail an unprofitable venture.


In Mexico, Amazon launched its third-party marketplace coupled with its own shipping service, called “Fulfillment by Amazon,” in 2015.

The contrast has been stark. Nearly 20 percent of reviews on Amazon’s Brazilian marketplace are negative, compared with 10 percent in Mexico and just 4 percent in the United States, according to e-commerce analytics firm Marketplace Pulse.

Complaints in Brazil often focus on delayed or canceled orders – a problem dramatically reduced in other countries when Amazon itself packs and posts orders of third-party goods stored at its warehouse facilities.

In an early sign of Amazon’s Brazilian logistics push, the company posted more than a dozen listings for distribution jobs in the country to LinkedIn last year, including “Site leader, Fulfillment Center”.

The new warehouse site outside of Sao Paulo, in the municipality of Cajamar, looks to be a step in that direction.

There San Francisco-based logistics company Prologis Inc (PLD.N) has offered a 50,000-square-meter space to Amazon in a new industrial park that hosts DHL and Samsung, according to sources, who said adaptation of the warehouse had not begun.

Prologis, which also partnered with Amazon on a mega-warehouse north of Mexico city last year, declined to comment.

The preparations in Brazil come as Luft, the local logistics operator for Amazon’s book business, readies a move into another Prologis site nearby in Cajamar, sources said, leaving its current 12,000-square-meter facility in the city of Barueri.

Amazon registered in October to conduct operations in Cajamar, according to municipal records seen by Reuters.

The new logistics investment could spell trouble for rivals.

Mercado Libre has been a success story among Latin America tech start ups: its shares have nearly tripled since 2014, bringing its market capitalization to more than $15 billion.

Magazine Luiza’s stock has risen sixfold in each of the past two years as it shifted its rolled out an ambitious e-commerce strategy built on its brick and mortar stores.

Reporting by Gabriela Mello; Writing and additional reporting by Brad Haynes; Editing by Daniel Flynn and Alistair Bell

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Winklevoss Twins Say Bitcoin Will Hit $320,000 and Non-Believers Suffer a ‘Failure of Imagination’

Bitcoin may have had a rocky last couple months, to put it mildly, but some boosters still have their optimism goggles on. Case in point: the Winklevii.

Tyler and Cameron Winklevoss, the erstwhile Facebook power-scrabblers who made and lost a fortune with Bitcoin’s rise and fall, are insisting that the cryptocurrency will appreciate 40 times in value.

“We think regardless of the price moves in the last few weeks, it’s still a very under-appreciated asset,” Cameron Winklevoss told CNBC. Tyler chipped in that those who can’t see Bitcoin’s potential are suffering from a “failure of imagination.”

The twins’ argument is that people are missing the point when they try to think of cryptocurrencies in terms of person-to-person transactions. Instead, they say, the likes of Bitcoin will be extremely useful when machines trade economic value between themselves—for example, when a driverless car needs to pay another driverless car.

Cryptocurrencies’ extreme volatility dissuades many people from using them to pay for things, and vendors from allowing payments in Bitcoin—it’s too hard to accurately price things in Bitcoin, and when the value is rising there’s more to gain from hoarding Bitcoins than from spending them.

The volatility also leads to more transactions, which leads to higher transaction fees in Bitcoin’s congested network—a big problem if Bitcoin-based micropayments are to become a serious prospect.

Winklevii aside, other people who stand to gain from Bitcoin’s success also continue to talk up its prospects. A day ago it was the exchange Gatecoin, whose APAC business development chief, Thomas Glucksmann, said there was “no reason why we couldn’t see bitcoin pushing $50,000 by December.”

At the time of writing, one Bitcoin was worth around $8,470. The price neared $20,000 in early December before a series of regulatory moves around the world led to crashes that knocked it as low as $5,950 earlier this week.

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Apple brings Alibaba-linked payment system into China stores amid market push

BEIJING/SHANGHAI (Reuters) – Apple Inc will accept Chinese mobile payment app Alipay in its local stores, boosting its ties with giant e-commerce firm Alibaba Group Holding Ltd amid a push by the iPhone maker to revive growth in the world’s No.2 economy.

The tie-up will make Alipay, run by Alibaba affiliate Ant Financial, the first third-party mobile payment system to be accepted at any physical Apple store worldwide, Ant Financial said in a statement on Wednesday. Apple’s own payment system has had a lukewarm reception in China.

The Cupertino-based firm will accept Alipay payment across its 41 brick-and-mortar retail stores in China, said Ant Financial, which was valued at $60 billion in 2016.

Apple, whose China website, iTunes store and App Store have been accepting Alipay for more than a year, did not immediately respond to requests for comment.

The deal comes as Apple is doubling down on the market and looking to strengthen ties with local Chinese partners and government bodies. The firm’s CEO Tim Cook has made regular recent visits to the country.

Apple is also shifting user data to China-based servers later this month to meet local rules and last year removed dozens of local and foreign VPN apps from its Chinese app store.

Alipay is China’s top mobile payment platform, but faces stiff competition from rival internet giant Tencent Holdings Ltd’s payment system that is embedded within its hugely-popular chat app WeChat.

China’s official Xinhua news agency said late on Tuesday that Apple would build its second data center in China in Inner Mongolia Autonomous Region after it set up a data center in the southern province of Guizhou last year.

Reporting by Pei Li in BEIJNG and Adam Jourdan in SHANGHAI; Editing by Himani Sarkar

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Apple Music Could Soon Overtake Spotify in the U.S.

Apple Music may soon have more paid subscribers in the U.S. than Spotify does, according to industry sources cited by The Wall Street Journal.

The prediction is based on Apple Music’s reported monthly growth rate of 5%, which significantly outstrips Spotify’s 2% growth rate.

However, at the global level Spotify has almost twice as many paid subscribers as Apple Music does, despite the fact that Apple’s service comes preloaded on all iOS devices, and Apple’s presence in more markets than Spotify (115 territories to 61.)

Such figures are important not just because they indicate the popularity of the respective music-streaming services, but because they are used to calculate the royalties that the services must pay to music labels.

Spotify is expected to launch an initial public offering in March or April. However, the New York Stock Exchange listing will only be available to institutional investors.

It is still not clear what user metrics Spotify will have to disclose when it floats. Last month the Swedish company said it had 70 million paid subscribers around the world. Apple (aapl) told the Journal it has 36 million.

However, neither company publicly discloses its country-level subscriber numbers. Apple also does not break out its Apple Music-derived earnings from those of its broader services segment.

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A 9% Yield, 5 Straight Hikes, Record Earnings Again, No K-1

Looking for dependable income from qualified dividends? Maybe you should climb aboard GasLog Partners LP (GLOP), an LNG shipping stock with good management, strong earnings growth, and more distribution growth on the way.


GLOP is a growth-oriented limited partnership focused on owning, operating, and acquiring liquefied natural gas carriers engaged in LNG transportation under long-term charters. GLOP’s initial fleet of three LNG carriers was contributed by GasLog Ltd. (GLOG), which controls GLOP through its ownership of the general partner and limited partner units.

GLOP now owns 12 LNG carriers that operate under multi-year charters with a wholly owned subsidiary of Royal Dutch Shell plc (NYSE:RDS.A) (NYSE:RDS.B). GLOP also has options and other rights under which it may acquire additional LNG carriers from GasLog Ltd. (Source: GLOP site)

Dropdown pipeline: On the Q4 ’17 earnings call this week, management commented on potential dropdowns for 2018:

“We feel that we’re very well funded for one dropdown and well on our way to two, which at our historical valuations would get us to our guidance.”

(Source: GLOP site)

Common Distributions:

Management just raised the distribution for the fifth straight quarter to $.5235. It goes ex-dividend on 2/8/18 and pays on 2/14/18.

GLOP’s management has achieved very steady distribution coverage, averaging 1.19X over the past four quarters:

Like many of the LPs we’ve covered, GLOP pays in a Feb-May-Aug-Nov. cycle. However, there’s one major difference – it doesn’t issue a K-1 at tax time – investors get a 1099:

Taxes – GLOP has elected to be treated as a C-Corporation for U.S. federal income tax purposes (investors receive a Form 1099 and not a Schedule K-1).

“Distributions received with respect to our units by a U.S. unitholder that is an individual, trust or estate generally will be treated as qualified dividend income. Distributions in excess of our earnings and profits will be treated first as a nontaxable return of capital to the extent of the U.S. unitholder’s tax basis and thereafter as capital gain.” (Source: GLOP site)

GLOP also has preferred units available – GLOP-A and GLOP-B, at high yields.

Here’s a look at GLOP’s strong EBITDA, DCF, and distribution growth over the past three years – EBITDA grew 59% from 2015 to 2017, DCF grew 40%, and distributions grew 54%:

(Source: GLOP site)


We updated the GLOP covered call trade in our Covered Calls Table to include a July $25.00 trade. The July $25 call strike has a bid of $.55 and two ex-dividend dates before it expires.

Your total profit would be $1.60/unit ($1.05 in distributions + the $.55 call option premium) in a static scenario in which your units don’t get assigned before either ex-dividend date.

In an assigned scenario, you’d realize $1.30/unit in price gains (the difference between GLOP’s $23.70 price/unit and the $25.00 call strike price), plus the $.55 call option premium.

The trifecta would involve your GLOP units being assigned after both ex-dividend dates, in which case, your total profit would be $2.90. This is less likely to happen but has done so upon occasion.

Like any other equity, GLOP also could decline during this period – the upside is that the call premium would give you a bit of downside protection.

Conversely, selling a covered call will limit your upside participation to the difference between the call strike and the unit price, so, even if GLOP takes off like a speedboat, your captured price gain will still only be $1.30/unit in this trade.

The other way to “tiptoe through the tulips” is to sell cash secured puts below the underlying price/unit. The July $22.50 GLOP put strike currently pays $1.30/unit, $.25 more than two quarterly distributions, for a breakeven of $21.20, which is below GLOP’s 52-week low of $21.20.

Our Cash Secured Puts Table can give you more details for this and over 30 other trades, all of which we update throughout each trading day.


Management did multiple dropdowns in 2017, adding vessels in Q1, Q2, and Q3. These are all young vessels, on long-term contracts with Shell, which expire from 2021 to 2026:

These new vessels pumped up GLOP’s quarterly earnings growth in 2017:

Q4 17 saw record numbers across the board for revenue, EBITDA, DCF, and adjusted profit. It also was the seventh straight quarter in which GLOP had record EBITDA and the third straight quarter of record revenues and adjusted profit. DCF also hit records in the last two quarters as the new vessels began contributing to earnings:

2017 was another good year for GLOP, with revenue up 26%, EBITDA up 32%, and DCF up 20%. Distributions/unit grew 6.6%, and management has guided to a 5-7% distribution growth target for 2018.

On 5/16/17, the subordination period of the subordinated units held by GasLog expired, and consequently, all 9,822,358 subordinated units converted into common units on a one-for-one basis and now participate pro rata with all other outstanding common units in distributions of available cash.

During the fourth quarter of 2017, GasLog Partners issued the size of its ATM Program and received payment for 385,520 common units at a weighted average price of $23.31 per common unit for total gross proceeds of $9M and net proceeds of $8.5M.

Management said on the Q4 ’17 earnings call:

“Our aftermarket common equity program has raised approximately $63 million since its inception in May 2017, primarily through reverse enquiry. These units have been issued at an average price of $22.97 per unit representing a discount of only 0.5% to the volume weighted average price.”


GLOP’s business model is based upon long-term contracts, with strong counterparties, such as Shell. We note that Shell charters all of GLOP’s vessels, so there’s a heavy counterparty concentration there.

The near-term issue is that GLOP’s management has to re-contract three older vessels (25% of its fleet) in May, July, and September of 2018. Although spot rates have rebounded strongly and seem to keep climbing, management has previously stated that the new re-contract rates will probably be somewhat lower than the old rates, which will put some pressure on GLOP’s distributable cash flow.

On the earnings call, management said that they “would certainly hope that we are able to put one of the three ships away for a multi-year period and then have a bit of optionality on the other two.” One of these vessels, “the GasLog Sydney, is subject to an agreement with our parent to effectively guarantee the distributable cash flow from the vessel for up to one year after its charter ends in the fall.”

However, in Q4 ’17, spot rates climbed above their long-term average for the first time in three years, to $78K/day. If these higher spot rates persist, it would certainly put management in a better bargaining position:

(Source: GLOP site)

Drydockings – Management plans to refurbish two of these three vessels when they drydock in 2018 in order to improve their marketability and lower their unit freight cost.


LNG demand continued to have strong growth in 2017, with China up 45% and spot fixtures up 22%.

With the US Sabine Pass LNG project coming into its own in 2017 (it made 194 shipments) – LNG shipping tonnage miles have expanded, creating a better demand/supply balance for LNG vessels. This map details the various cargoes shipped from Sabine in 2017:

(Source: GLOP site)

LNG capacity grew by 11% in 2017, and 2018 should see a similar amount of new volume:

(Source: GLOP site)


With all of this good news, you would think that Mr. Market would have set GLOP on a course straight for higher waters, but alas, this isn’t the case. Although GLOP outperformed the Guggenheim Shipping ETF (SEA) over the past year, it has trailed so far in 2018.

Analysts’ Targets:

At $23.70, GLOP is 13% below analysts’ average price target of $26.79 and 30% below the $30.00 highest price target.


GLOP’s valuations compare well to these other LNG shipping stocks, which we’ve covered in past articles, including Golar LNG Partners LP (GMLP), Dynagas LNG Partners LP (DLNG), and Hoegh LNG Partners LP (HMLP).

GLOP has the lowest price/book in this group, with an above-average coverage factor:


ROA, ROE, and the operating margin have declined over the past four quarters, but the leverage ratios have improved.

GLOP has lower ROA, ROE, and operating margin figures than the rest of this group, but a lower debt/equity ratio. Its net debt/EBITDA figure is higher than average:

Debt and Liquidity:

Management raised $281.1 million in net equity proceeds and retired $153.8 million in total debt in 2017.

As of 12/31/17, it had $142.5 million of cash and cash equivalents, of which $101.3 million was held in current accounts and $41.2 million was held in time deposits.

As of 12/31/17, it had an aggregate of $1,155.6 million of indebtedness outstanding under its credit facilities, of which $103.8 million is repayable within one year. In addition, it had unused availability under its revolving credit facilities of $55.9 million.

GLOP has a $450M facility maturing in Q4 2019, which management should be able to refinance.

“In early January, (2018), we prepaid in full the $29.8 million junior tranche of the five vessel refinancing facility. Following this prepayments, all of our debt majorities through November 2019 will have been addressed. Over the course of 2017 and through January 2018, we have repaid $184 million of our debt, equivalent to 0.9x our 2017 EBITDA and more than our total cash distributions for 2017.” (Source: Q4 ’17 earnings call)

(Source: GLOP site)


We rate GLOP a buy, based upon its continued strong growth, its attractive yield, and its strong distribution coverage.

All tables furnished by, unless otherwise noted.

Disclaimer: This article was written for informational purposes only, and is not intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.

Disclosure: I am/we are long GLOP, DLNG, GMLP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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OK, That Was Bad; Where To Now?

I’m pretty fond of reminding readers that when you pan out to the asset class level (i.e., beyond sectors and well beyond individual stocks, although thanks to the dominance of FAAMG, a handful of names are becoming uncomfortably synonymous with the entire equity market), making predictions with any degree of specificity is a fool’s errand. The best anyone can do is try to understand the prevailing dynamics, develop innovative frameworks for analyzing those dynamics, then build on that over time on the way to developing a nuanced take on markets.

This requires taking a holistic, cross-disciplinary approach and it’s what research should be about. Attempting to understand markets through an innovative lens, building on an existing body of work to push the discussion forward, and fleshing out the concepts proposed in that previous work as part of an ongoing effort to explain phenomenon by reference to frameworks that seem to have some explanatory power.

Obviously, individual stock analysis is a different animal and to the extent you can become an expert in this or that sector by virtue of some specific skill set you happen to have (like say, you’re a doctor and you’re analyzing drug stocks), well then sure, you might be able to make some prescient predictions now and again. But even there, I would argue that everyday investors, no matter how much expertise they might have, are fighting an uphill battle because when it comes to big-cap stocks, Wall Street has an almost insurmountable informational advantage in terms of access to experts and, more importantly, a direct line to management. Throw in the fact that the Street does business with a lot of the companies the analysts cover and what you come away with is a situation where the chances of you figuring out something about a well-covered stock that the Street hasn’t already figured out are basically zero.

Of course, people will tell you they “correctly” predicted longer-term moves in entire asset classes all the time and they’ll be able to make what seem like convincing arguments in support of that contention by virtue of things having turned out like they did. It reminds me of something the President said in a speech this week at a GOP congressional retreat. Here’s the quote:

Now we’ve fulfilled more promises than we promised.

That’s a lot like what you’ll hear from some of the more ardent bulls who lean on economic fundamentals to support their position. Years ago they suggested that the global economy was going to get back on solid footing and that earnings would eventually start growing at a decent clip and now they’re pointing to those global PMI checkerboards that are showing a synchronized expansion across countries and the dramatic upward revisions to EPS estimates in the U.S. and saying “now we’ve fulfilled more promises than we promised.”

The point is, saying that over the long-run stocks go up and then saying that’s usually attributable to the fact that economic progress is (periodic interruptions notwithstanding) inevitable, isn’t exactly a Fields-worthy observation. So there’s something a bit disingenuous about pointing to evidence of it over time and taking credit for having “predicted” it.

Much harder than predicting that over the long-haul stocks rise, is predicting how much stocks will rise over shorter horizons or, if the horizon is short enough, if they might even fall. This is where the effort to predict where stocks, as an asset class, will be a month, a year, or even five years from now, breaks down entirely. And the thing is, I’m not trying to malign the people whose job it is to try and make those predictions. It’s just that what they’re tasked with doing is impossible, so what you end up with are scenarios where markets blow through nearly 50% of the Street’s year-end targets in the first four weeks of the year, which is what happened in January. Here’s a fun chart that shows you how Wall Street’s year-end S&P targets were holding up as of January 17:


But the best (and by “best” I mean funniest) visual is this one:


That’s from BofAML’s global fund manager survey, and as you can see, the percentage of respondents predicting an equity market peak in Q1 fell materially from the December survey to the January survey because, well, because if what you were going by was January, well then the S&P looked like it might be on its way to 10,000 (that’s a joke, but you get the point).

All of that underscores the inherent futility in trying to make accurate “calls” about broad asset classes and this is why, when readers get frustrated with me for not attempting to tell you the exact moment to sell, I typically don’t respond. Making those kind of predictions is fruitless. It’s a guessing game, plain and simple.

That said, you should note that there are times when circumstances conspire to make a short-term outcome all but a foregone conclusion. Last week was an example of that. I detailed those circumstances exhaustively here on Friday evening in a post aptly called “A Bad Dream”. Long story short, if you’ve been paying attention for the last five years, you know that one of the main risks for equities is a sharp selloff in bonds; a “tantrum”. January witnessed an acute bond rout and all you had to do last Sunday was take two minutes to glance at the calendar for the coming week to know that a worsening of that rout was all but inevitable.

Now that’s out of the way and we’re kind of back in a position where everyone is asking for predictions again only now, everyone wants to know how far markets will fall, whereas just a week ago, the question was how high markets will rise.

Guess what? I’m not going to answer that question for you because as noted above, I don’t have that answer and neither does anyone else. Again, you might be tempted to think that just because Goldman (last Monday, they said there’s a “high probability” of an imminent correction) and BofAML (they literally suggested clients sell two Fridays ago) and Heisenberg (I told you the Treasury selloff needed to stop “right now” late Monday night) and multiple other desks seem to have seen this week coming, that it represented some kind of “validation” of a bear thesis. I disagree. What you saw this week was a confluence of factors conspiring to make a quick move lower all but inevitable. Not to put too fine a point on it, but if you didn’t see this week coming last weekend, well then you probably don’t know that much about how different assets interact with one another.

So while I won’t even try to pretend that I can be that prescient with regard to what happens next, what I would suggest is that folks are still woefully offsides if what we saw over the past five sessions ends up morphing into something worse. I highlighted four charts from Deutsche Bank over at my site on Friday, but I’d be willing to bet that only a small fraction of my readership on this site saw them, so I wanted to point them out here as well. Here they are, with a sentence from the accompanying color from Deutsche:

Aggregate shorts in cash equities and ETFs, led by cuts in Tech shorts, have for the first time fallen below the elevated range they have been in since the financial crisis.

Margin debt in brokerage accounts has risen to extremes:

While cash balances have fallen below the normal range:


Option market indicators had till last week painted a similar picture with the put/call ratio low:

Inflows into equities have surged recently to the largest monthly inflow on record:

In the same vein, take a look at the following chart from Goldman which shows that according to CFTC equity futures positioning, “investors increased long US equity positions by $40 billion this year, bringing long and net positions to new record highs”:


See what I mean? Some of that underscores what Salient’s Ben Hunt wrote last week about everyone abandoning their “talismans” and just generally convincing themselves that the “things that go bump in the night” (to quote Ben) don’t exist.

On the anecdotal front, have a look at this fun Google trends chart:

(Google Trends)

Some folks were trying to figure out how to buy stocks in January, and although drawing conclusions from Google trends charts is of course a silly thing to do, it’s worth noting that the last time laypeople were this interested in getting in, there actually was a meaningful dip, whereas that spike in January came at a time when the market was going up literally every, single day.

On the bright side, you should note that things don’t always turn out like they did in 1987 (a comparison more than a few people have been making lately). In the interest of closing on a positive note tied to those comparisons, I’ll leave you with the following from Goldman:

By focusing on 1987, investors overlook other historical episodes that suggest a much better outlook for US equities in 2018. Of the 12 other years since 1950 that started with a January return greater than 5%, 1987 is the only one in which the February-December return was negative. Across all episodes, the median 11-month return was 17%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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The Devin Nunes Memo: Reading Between the Lines

After weeks of Twitter users demanding Congress #ReleaseTheMemo, the House Intelligence Committee, chaired by Republican Devin Nunes, disclosed the contentious four-page report to the public Friday, after President Donald Trump signed off on its release. And while, as expected, the document alleges that federal law enforcement officials abused their surveillance powers in investigating the Trump campaign’s ties to Russia, national security experts see something very different. In fact, they see almost nothing at all—or at least not enough to make any definitive judgement calls.

As had been rumored, the memo details supposedly improper actions by law enforcement officials in seeking a warrant to wiretap Carter Page, one of Trump’s campaign advisors. But understanding what the memo says—and, critically, doesn’t say—requires familiarity with the secretive Foreign Intelligence Surveillance Court, which governs requests made under the Foreign Intelligence Surveillance Act, better known as FISA. Those who know the law best say the memo is largely bunk.

“We don’t know anything more than we knew before. Certainly we don’t have evidence of a scandal,” says Elizabeth Goitein, co-director of the Liberty and National Security program at New York University School of Law’s Brennan Center for Justice.  “If there’s a scandal here it’s the fact that this has been built up in a way that will allow Trump to try to discredit the Mueller investigation.”

Between the Lines

What no one disputes: In October 2016—several weeks after he had left the Trump campaign and months after the Russian investigation had began—the Department of Justice obtained a warrant to surveil Page. It did so under Title 1 of FISA, nicknamed “traditional FISA,” which requires law enforcement demonstrate probable cause to a judge on the FISC court that a potential target is an agent of a foreign power.

That means the government had to show Page was acting as an operative for Russia. That would have required an extensive application, which would have been reviewed by a number of Department of Justice lawyers in the National Security Division. Here’s where the memo comes in.

Nunes alleges the Page application leaned on information gleaned not directly from the FBI, but from a dossier written by former British intelligence officer Christopher Steele. Yes, that dossier, made public last year and subsequently revealed to be financed in part by the Democratic National Committee and Hillary Clinton’s campaign.

This is the controversy: Purportedly unverified research, funded by Democrats, led to the surveillance of an advisor to a Republican presidential candidate. Nunes alleges that the FBI and the Department of Justice did not tell the FISA judge who approved the warrant that the information may have come from a biased source, despite having numerous opportunities to do so.

But the memo also doesn’t say several things. It doesn’t accuse anyone at the Department of Justice or the FBI of violating the law. It doesn’t claim that the entire dossier is false—just that the FISA warrant application to surveil Carter Page relied on portions of it. And most importantly, the memo doesn’t say whether law enforcement corroborated the Steele dossier claims that appeared in that warrant.

In fact, those who follow FISA law closely say that even if the Steele dossier was considered as part of the application, there’s no way that it was the only intel. Because the FISA warrant is confidential, no one knows what other information was included. But FISA warrant applications require incredible rigor and thorough documentation. The Nunes memo itself acknowledges that the Steele memo formed only a “part” of the application.

“The dossier and Steele and all that—it’s cherrypicking a piece of what was probably a 50, or 60, or 100 page application,” says William C. Banks, founder of the Institute for National Security and Counterterrorism at Syracuse University College of Law.

FISA applications also have to go through an in-depth protocol known as the “Woods Procedure,” during which the intelligence community needs to verify every single fact. For example, if the application says a person was on a specific train at a specific time, the agent would need to show Department of Justice lawyers how they found out that information. There are other oversight mechanisms as well. For example, applications need to be first certified by the Director or Deputy Director of the FBI, as well as the Attorney General, Deputy Attorney General, or Assistant Attorney General for the National Security Division. In other words, FISA warrants are reviewed at the highest levels, which is part of the reason Nunes’ allegations are so explosive—they implicate multiple parties at the very top of the US intelligence apparatus.

A FISA warrant also needs to be renewed every 90 days—the Nunes memo says Page’s warrant was renewed three times. A renewal generally indicates that the existing warrant has been in some way useful; Nunes does not mention anything about any evidence that might have found its way into subsequent applications. “He seems to be talking about what was in the first application, he doesn’t really talk about whether the Steele application was re-submitted every time,” says Goitein.

The Nunes memo further neglects to mention that Page has been of interest to intelligence officials since 2013, long before Trump began his campaign and the Steele dossier was written. At that time, FBI agents reportedly obtained recordings of Russian foreign intelligence officials talking about soliciting Page for recruitment. They later warned him that Russia had targeted him. “They had a full investigation open on him,”says Goitein. “Despite what this memo tries to imply, it’s not like the Steele dossier turned the FBI onto Page.”

All of which makes the Nunes memo’s focus on Page all the more confounding. The intelligence community targeted him independently of the Trump campaign, and would have needed substantial evidence to surveil him for any period of time.

“FISA judges under the law take into account a whole variety of factors including past and current activities of a target,” says Democratic Congressman Ted Lieu. “Typically, when people submit these FISA applications they’re really thick documents. This Nunes memo is four pages.”

As for any suspected FISA court partisanship, every one of its judges were appointed by Chief Justice Roberts of the Supreme Court, who was himself appointed by Republican president George W. Bush. And though the court does approve most warrant requests, it approved the Page wiretap during 2016—a year in which the court denied many more applications than it had in past years.

“I can’t recall any instance in 40 years when there’s been a partisan leaning of a FISA court judge when their opinions have been released,” says Banks.

The memo does at least succeed in making Steele as well as Glenn Simpson—the founder of Fusion GPS, the firm Steele worked for—look bad. “There is a scandal here that doesn’t really touch on the Justice Department and the FBI,”says Stewart A. Baker, a former Assistant Secretary of Policy at the Department of Homeland Security, referring to the allegation that they had leaked information about the dossier to the media. “[Steele] was using his knowledge of the national security apparatus to do things that he probably shouldn’t have done. To make those things public in the hopes that it would have a particular affect on our election.”

And some national security experts argue that the memo does reveal legitimate lapses in the FISA system. “Part of the reason FISA was passed by Congress is to prevent against things like what just happened,” says Donna Bartee-Roberston, a former National Security Agency attorney and an adjunct professor at George Washington University Law school, where she teaches FISA law. Bartee-Roberston believes that intelligence officials acted inappropriately by not telling the FISA court about the true origins of the Steele dossier, especially when they had an opportunity to do so with each warrant renewal application

“If you look at that memo, if the memo is true factually, the court did not have all the facts in front of it,” says Bartee-Robertson, adding that she would not be surprised if an Inspector General investigation was opened to examine what exactly happened during the Page warrant application process.

Burning Down the House

Ultimately, the memo doesn’t amount to anything near the bombshell Nunes and other House Republicans hyped it as. It does, though, make public information that law enforcement considers extremely confidential, in a way that seems engineered to intentionally mislead. Releasing the memo will likely sow distrust between intelligence agencies and potential sources, and serves to widen the gulf between the White House and the law enforcement community.

And yet some of even Trump’s staunchest supporters in Congress have downplayed its broader significance to special counsel Robert Mueller’s investigation into Russian interference in the 2016 presidential campaign.

“The contents of this memo do not in any way—discredit his investigation,” Republican Congressman Trey Gowdy said in a tweet.

Democratic leaders still worry, though, that the memo’s release serves as a pretext to firing Mueller or others involved in the Russia investigation, like Deputy Attorney General Rod Rosenstein. “Firing Rod Rosenstein, DOJ Leadership, or Bob Mueller could result in a constitutional crisis of the kind not seen since the Saturday Night Massacre,” Senate Democrats wrote in a letter to President Trump after the memo was released Friday.

The FBI, House Democrats, and some Republicans, including Senator John Thune of South Dakota, had all urged for the document to remain confidential or for the disclosure process to slow down. President Trump had the chance to block the memo’s release on national security grounds, or request that some material be redacted, but decided to make the entirety of the document public.

The FBI said in a statement that it had “grave concerns about material omissions of fact that fundamentally impact the memo’s accuracy,” and House Democrats have authored a counterpoint memo that has yet to—and many never—be released. On Monday, the Republican majority on the House Intelligence Committee blocked the counter memo from being disclosed to the public.

“I would urge my colleagues to take another vote, to release the Democratic memo. We’ll see what they do next week,” says Congressman Lieu. “If the Republican White House does not release the Democratic memo it significantly undercuts the Nunes memo and will make many Americans wonder what they are hiding.”

Those reading the memo closely already do.

The Memo, Released

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Is The 'Everything Bubble' Reaching Its Expiration Date?

Kevin Duffy and Michael Oliver return as guests on this week’s radio program.

As manager of the Baring Fund, Kevin has had a magnificent track record in protecting wealth from stock market crashes. With the current equity bull market among the longest on record and with legendary hedge fund manager Ray Dalio just now proclaiming the beginning of a bond bear market and predicting a stock market crash, we turn to Kevin for his thoughts about the direction of various markets in 2018 and to learn how the Bearing Fund is positioning its investors.

Michael, who had been calling for a slow equity market decline and has now joined the growing number of market pros who envision a sharp decline rather than a version of a more tame bear market, provides an update.

Kevin Duffy entered the investing business in 1985 as an analyst and also as a strategist. He co-founded a money management firm in 1988 after the ’87 crash and cut his short selling teeth during the late ’90s tech bubble. After the bubble burst, he co-founded Bearing Asset Management in 2002.

Bearing warned about the housing and credit bubble of 2005-07, shorting stocks such as New Century Financial, Bear Stearns, Lehman Brothers, MBIA, Countrywide Financial, Wachovia, and Citigroup. Kevin wrote extensively on the subject, including articles, “Alan, We Have a Problem,” “Mr. Mozilo Goes to Washington,” and “Honey, I Shrunk the Net Worth.” The firm’s two long/short hedge funds profited from the unwind including Bearing Fund, the more aggressive of two, which gained over 100% in 2008 when most 401ks were turned into 201k accounts.

Michael Oliver entered the financial services industry in 1975 on the Futures side, joining E.F. Hutton’s International Commodity Division, NYC. He studied under David Johnson, head of Hutton’s Commodity Division and Chairman of the COMEX.In the 1980’s Oliver began to develop his own momentum-based method of technical analysis. In 1987 Oliver, along with his futures client accounts (Oliver had trading POA) technically anticipated and captured the Crash. Oliver began to realize that his emergent momentum-structural-based tools should be further developed into a full analytic methodology.

In 1992 he was asked by the Financial VP and head of Wachovia Bank’s Trust Department to provide soft dollar research to Wachovia. Within a year Oliver shifted from brokerage to full-time technical research. MSA has provided its proprietary technical research services to financial and asset management clients continually since 1992. Oliver is the author of The New Libertarianism: Anarcho-Capitalism.

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'Jackpotting' hackers steal over $1 million from ATMs across U.S.: Secret Service

WASHINGTON (Reuters) – A coordinated group of hackers likely tied to international criminal syndicates has pilfered more than $1 million by hijacking ATM machines across the United States and forcing them to spit out bills like slot machines dispensing a jackpot, a senior U.S. Secret Service official said on Monday.

Within the past few days there have been about a half-dozen successful “jackpotting” attacks, the official said.

The heists, which involve hacking ATMs to rapidly shoot out torrents of cash, have been observed across the United States spanning from the Gulf Coast in the southern part of the country to the New England region in the northeast, Matthew O‘Neill, a special agent in the criminal investigations division, told Reuters in an interview.

The spate of attacks represented the first widespread jackpotting activity in the United States, O‘Neill said. Previous campaigns have been spotted in parts of Europe and Latin America in recent years.

“It was just a matter of time until it hit our shores,” O‘Neill said.

Diebold Nixdorf Incand NCR Corp, two of the world’s largest ATM makers, warned last week that cyber criminals are targeting ATMs with tools needed to carry out jackpotting schemes.

The Diebold Nixdorf alert described steps that criminals had used to compromise ATMs. They include gaining physical access, replacing the hard drive and using an industrial endoscope to depress an internal button required to reset the device.

A confidential U.S. Secret Service alert seen by Reuters and sent to banks on Friday said machines running XP were more vulnerable and encouraged ATM operators to update to Windows 7 to protect against the attack, which appeared to be targeting ATMs typically located in pharmacies, big box retailers and drive-thrus.

While initial intelligence suggested only ATMs running on outdated Windows XP software were being targeted, the Secret Service has seen successful attacks within the past 48 hours on machines running updated Windows 7, O‘Neil said.

“There isn’t one magic solution to solve the problem,” he said.

A local electronic crimes task force in the Washington, D.C., metropolitan area first reported an unsuccessful jackpotting attempt last week, O‘Neill said.

A few days later another local partner witnessed similar activity and “developed intelligence” that indicated a sustained, coordinated attack was likely to occur over the next two weeks, O‘Neill said. He declined to say where that partner was located.

Jackpotting has been rising worldwide in recent years, though it is unclear how much cash has been stolen because victims and police often do not disclose details.

Reporting by Dustin Volz in Washington, D.C.; Editing by David Gregorio

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Proposal for Government Wireless Network Shows Fear of China

The interstate highway system wasn’t built in the name of convenience or even commerce. When President Dwight D. Eisenhower signed the Federal Aid Highway Act of 1956, he did it in the name of national security. In fact, the official name of the system is the Dwight D. Eisenhower National System of Interstate and Defense Highways.

Now some in the Trump administration are arguing that the federal government should build a broadband wireless network for much the same reason. Today’s mobile networks are known as “4G” networks because they are the fourth generation of wireless technologies. Carriers are already planning “5G” networks. But a presentation and memo by the National Security Council disclosed by Axios on Sunday proposes that the government build a nationalized 5G network out of fears of falling behind China both economically and militarily.

The proposal is unlikely to become reality and is already being criticized by other government agencies, the telecommunications industry, and both Democrats and Republicans. The White House denies that it has any plans to follow through on the proposal and told Recode that the presentation was dated. But the proposal sheds light on growing concerns within the government that the US isn’t keeping pace with China.

The NSC presentation also argues that a national network would generate significant economic benefits to rural areas currently underserved by commercial broadband providers. But China is its main focus.

“The general concern is that Chinese manufacturers like Huawei will become so dominant in the equipment market that there will be essentially no way to avoid using their equipment in future deployment of 5G networks,” says Harold Feld, senior vice president of the open internet advocacy group Public Knowledge. “It’s a matter of some considerable concern from the perspective of the security apparatus.” The presentation suggests that a government-backed network would ensure that 5G networks are instead built by US companies like Cisco and Juniper Networks.

The memo envisions that the US would create a central 5G network based on a chunk of wireless spectrum now used mostly by satellite communications providers, and then lease network connectivity wholesale to providers like AT&T and Verizon. That would be a radical departure from the status quo because normally these providers build their own network infrastructure and only lease spectrum from the government. Even government networks are usually built and operated by major carriers. However, under the plan, private carriers could continue building their own infrastructure using other chunks of the spectrum; that would let carriers distinguish themselves from one another, so the national network wouldn’t entirely replace private networks.

The documents shouldn’t be taken as evidence that the White House ever seriously considered building a national 5G network, a former intelligence officer familiar with the National Security Council tells WIRED. Instead, it’s an indication that the NSC is considering a wide range of possibilities to address a perceived threat from China. How much weight these types of presentations carry depends on the seniority of who makes them, the former intelligence officer says. Proposals rarely, if ever, are implemented in their original form. If the NSC decides to consider a proposal, it will end up being modified by multiple people within the organization and from outside organizations as well. And in this case, other government agencies have already spoken out against the idea.

Among the critics is Ajit Pai, the Republican chair of the Federal Communications Commission, the agency in charge of allocating the wireless spectrum. “The main lesson to draw from the wireless sector’s development over the past three decades—including American leadership in 4G—is that the market, not government, is best positioned to drive innovation and investment,” Pai said in a statement. “What government can and should do is to push spectrum into the commercial marketplace and set rules that encourage the private sector to develop and deploy next-generation infrastructure.”

Pai’s fellow commissioners, both Democrat and Republican, agreed with him. “This correctly diagnoses a real problem,” Democratic commissioner Jessica Rosenworcel‏ wrote on Twitter. “There is a worldwide race to lead in #5G and other nations are poised to win. But the remedy proposed here really misses the mark.”

Even if the political will were there, such a plan would be extremely difficult to implement. A nationwide wireless network is “too large, too complex, needs constant maintenance and virus protection, and always needs to be upgraded,” says telecommunications industry analyst Jeff Kagan.

5G isn’t a single technology or wireless frequency. Instead, it will be an industry-wide standard for a range of different technologies developed by technology and telecommunications companies around the world; the standard itself is not expected to be completed until 2020. Much of the preliminary work on 5G is based on what’s known as the “millimeter wave spectrum,” a very high-frequency range of the spectrum. In theory, that would allow very-high-speed connections, about 10 times faster than current typical home fiber-optic lines. The catch is that millimeter wave connections tend to have a shorter range. That means that instead building a few big antennas to blanket a city with wireless connectivity, carriers would need to deploy many more smaller antennas. That requires a huge rethink in how these networks are built.

The NSC presentation argues that cellular towers using the mid-range band spectrum would be able to blanket more of the country with wireless coverage than would be possible with millimeter wave technology. That means a mid-range band spectrum 5G network would be faster and cheaper to build, because it wouldn’t require carriers to deploy gobs of smaller antennae. But the presentation admits the proposal could face opposition from satellite providers that already license mid-band spectrum from the government. The FCC, meanwhile, is already considering opening up more of the mid-range band.

The presentation argues that China is a skilled actor in cyber espionage and conflict, and argues that unless the US takes extensive, deliberate precautions to control and secure its 5G network, “China will win politically, economically, and militarily.”

This has been a growing concern for the US. In January, AT&T backed out of a deal to carry Huawei smartphones, reportedly because of pressure from Congress. Lawmakers have even pressured AT&T to cut Huawei out of group efforts to establish the 5G standard, according to a Reuters report. Shortly after, Republican lawmakers proposed a bill that would ban federal agencies from doing business with companies or organizations that use Chinese-made networking equipment. A 2013 law already requires federal law-enforcement agencies approve any government purchase of tech gear from China. In 2012, a Congressional report concluded that telecommunications providers should avoid equipment from Chinese brands. Reuters later reported that a White House review found no evidence that Huawei had actually spied for China.

Observers agree to a point that the more 5G equipment China develops and manufactures, the more the country will be able to impact the global supply chain and potentially sneak backdoors, clandestine or illicit access points, into infrastructure hardware and software.

Researchers note, though, that a nationalized 5G network wouldn’t necessarily be more secure, particularly since most of the expertise for building wireless networks is inside private companies, not government agencies. “There is no logic that connects federal management of a telecom network to increased security from foreign surveillance or cyber attacks,” says Nathan Freitas, the founder and director of the Guardian Project, a privacy and security nonprofit that works on secure telecommunications. “What is needed are networks with strong authentication, encryption and privacy-preserving features.” He says it would be more efficient for the government to help pay for threat modeling, security audits, and open-source projects, “to ensure the corporate giants don’t screw up 5G deployment themselves.”

Regardless of who builds the 5G network in the US, one larger question is whether the international telecom community will prioritize security as it develops 5G standards. The groups developing the standards face two options, says Pavel Novikov, head of telecom security research group at the security firm Positive Technologies. “Base 5G on 4G networks—in this case, the security of these networks will not be different from 4G. [Or create] an absolutely new network. Building completely new 5G networks will take a huge investment.”

More than worrying that any one adversary will beat the US to the punch, experts say the US can best protect mobile data users by investing both public and private funds in auditing new infrastructure, avoiding Chinese equipment if needed, and focusing on implementing protocols that emphasize privacy-preserving features like encryption and strong authentication. As Freitas puts it, “Our current networks, where any number can be forged and someone can pretend to be a cell tower with a $100 box in their backpack are so hilariously bad that anything would be better than what we have today.”

Wireless Wars

  • 5G networks will be really fast, but the technology is rolling out really slowly.
  • Congress has harbored suspicions about Chinese telecommunications equipment at least since 2012.
  • The US accuses China of using telecom equipment for spying, but the accusations go both ways.
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20 of Marc Benioff's Interesting Startup Investments

Whether you use it daily or have heard about it from 10 of your closest friends, you’re likely well aware of Salesforce. The behemoth CRM has become a multibillion-dollar industry leader; unsurprisingly, its founder and CEO, Marc Benioff, is seen by some as the “champion of innovation.” Salesforce is built to integrate with other apps — a fact developers are encouraged to take advantage of — and Benioff backs tech companies with his own money.

Benioff’s wagers beyond Salesforce have proved fruitful. These are the 20 investments Benioff has made that are currently among the most successful.

1. Zuora

Subscription box services have become more popular in recent years, meaning these companies need software to help them manage their increased order volume. Zuora has not only curated a list of customers that includes several top brands, but it also recently purchased Leeyo, a revenue recognition platform.

2. Illumio

As news headlines have proven, cybersecurity has become an increasingly large challenge for businesses to tackle. However, automated threat monitoring could make the task a bit easier for them, and Illumio is among the companies gaining attention for this technology — the business earned a billion-dollar valuation in 2017.

3. AnyRoad

AnyRoad specializes in experience relationship management (ERM), which is essentially a CRM for the real world. The brand’s software helps businesses leverage data from real-life brand experiences and empowers companies like Honda, Diageo, and the Golden State Warriors to measure shifts in brand perception and purchase behavior, enabling them to establish deeper relationships with their fans.

4. Convoy

Technology is seeping into every industry, including logistics, and Convoy offers cutting-edge trucking technology. The software company, which provides real-time shipment management, signed a multiyear partnership with Anheuser-Busch in 2017.

5. Compass

Consumers can function as their own information-gathering real estate agents, thanks to apps like Compass. The real estate brokerage reported revenue of more than $180 million in 2016, just three short years after it launched.

6. PernixData

After its purchase by Nutanix in 2016, PernixData continued to expand the market for its virtual server-side flash memory. While the space has plenty of competition, PernixData’s write caching and clustering set it apart.

7. Highfive

No stranger to competition in the wide videoconferencing arena, Highfive is elbowing its way out of the pack. One feature that sets it apart is its ability to now be deployed directly from a user’s browser.

8. Thrive Global

Founded by Arianna Huffington, Thrive Global is focused on individual and workplace wellness and provides science-based content and tools to reduce stress. After raising $30 million in Series B funding in 2017, the company partnered with Times Bridge to venture into the Indian market.

9. Duetto

With more than $63 million in funding, Duetto has grabbed attention in the hotel revenue strategy sphere. A new partnership with GuestCentric stands to push the software platform to the next level, allowing hotels to customize pricing in real time based on a customer’s past behaviors.

10. Kano

Believing coding is a big part of the youngest generation’s future, Kano makes the process of learning to code fun for children through kits. The company raised $28 million in Series B funding in 2017, which it put toward releasing its products to retail outlets.

11. Gigster

Gigster aims to provide businesses with the tools they need to innovate using artificial intelligence. The software development recruiting platform, which connects freelance developers, designers, and project managers to companies needing on-demand project work, recently landed a Series B funding round that put its total capital investments at $32 million.

12. RedOwl

Among the acquisitions grabbing headlines in 2017 was Forcepoint’s purchase of RedOwl, which followed at least $21 million raised in venture capital. RedOwl’s specialty is software that detects unusual activity on users’ systems.

13. Vicarious

Vicarious’ advanced AI, designed to improve robotics, has earned the company investments from Elon Musk and Mark Zuckerberg, in addition to Benioff. Among its most recent innovations is technology to improve the CAPTCHA process.

14. Rainforest QA

With revenue growth of more than 1,500 percent over two years, Rainforest QA’s success has proven that quality assurance testing is a field in strong demand. The QA-as-a-Service platform recently raised $25 million to expand its AI-fueled testing.

15. Wingz

Competing in the crowded ride-sharing market can be tough, but airport ride company Wingz strives to beat Uber and Lyft by promising to undercut prices, even during high-demand times. A 2016 purchase by Expedia gave the company a welcome boost, bringing its total funding to $13.7 million.

16. Domo

Domo’s SaaS-based platform helps business leaders transform the way they manage business through direct access to data. The company was named to the 2017 Inc. 500 after growing more than twentyfold in three years.

17. Cloudwords

Marketing localization company Cloudwords kicked off in 2010 with $3 million in seed funding, including Benioff’s investment. In April 2017, the global marketing campaign solution partnered with translation productivity startup Lilt.

18. Mashery

After Tibco purchased Mashery from Intel in 2015, the API management company continued to grow, with Gartner repeatedly naming it a leader in full life-cycle API management.

19. Kyriba Japan

Specializing in next-generation financial management and cloud treasury software, Kyriba Japan recently launched a module dedicated to detecting and stopping fraud as it’s attempted.

20. Nuzzel

It can be difficult for busy consumers to sift through the news for the pieces most relevant to their lives, but Nuzzel makes it easier. News items are curated from a user’s social network, which now includes LinkedIn.

Marc Benioff’s eye for business means his investments signal the technologies consumers and businesses need to watch. These innovations are proof that Benioff has his finger on the pulse of the software space, and that’s likely to continue as he looks for new ventures to support.

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Don't Quit Your PR Program Unless You've Considered These 3 Things

Whether you are looking to gain awareness, improve SEO, or increase sales, having great exposure can help you get there. But PR is not a band-aid for an overarching business problem–nor is it a get rich fast technique.

A great PR strategy can take many years to build. Over the years, I’ve seen many companies start their efforts, only to stop before they’ve given the program enough time to develop. I’ve heard dozens of marketers and founders explain that they quit their PR efforts after their pitch didn’t get picked up by enough outlets in the first few weeks. Gaining great coverage takes time, pitch optimization, and persistence.

Often times, if a brand could have taken a step back after a rejected story to tweak their angle and try again, the second story they pitch could have been widely successful. Here’s why you shouldn’t throw in the towel for your PR outreach just yet:

1. Relationships take time to build.

Imagine you are at a party. You immediately start talking about you, your business, and your news. Very quickly, many people will not want to talk with you.

The same holds true when you’re building relationships with the media. It takes time to get to know a reporter and what they are writing about and then creating relevant pitches that are helpful to them. When you build trust and rapport with reporters, they’ll be more likely to open your emails, which is the first step to gaining great coverage.

You can build a better relationship with reporters by becoming well versed with their past writings and looking for opportunities to tell them stories of interest. Take a look through their Twitter accounts and personal websites to learn more about what they’re covering and the news that is important to them.

When you reach out to a reporter for the first time, show them that you are knowledgeable about their area of coverage and that your story fits their angle. When we reach out to reporters we make sure to spend time reading their past work to ensure our pitch is the right fit for their area of expertise.  It can be easy to burn a press bridge simply by not personalizing an email enough–take your time, do your research, and get to know reporters for the long term. Slow and steady wins the race.

2. SEO is a long-term game.

When you receive a press mention, you’ll likely see a spike in traffic on the day it’s published–but don’t discount the future traffic. If you are a mattress company and you get listed as “The Best Mattresses Ever Made,” you’ll benefit from both the spike and also later from people who are searching for mattresses and come across the article. Traffic from press articles should be monitored for months to come, even after publication.

An authoritative link will not only drive traffic, but will also help your website in the search engine rankings. This boost will not happen instantly. With time and relevant inbound links, you’ll see not just your referral traffic grow, but also your organic search traffic from Google.

3. Press takes commitment–and a bit of luck.

It takes a while to learn about the best way to pitch your product. Each time you pitch, you’ll learn more about what copy and message resonates with reporters.

If you’re not seeing any success, it does not mean you don’t have an interesting story. It might mean you are pitching to the wrong reporters, your email subject line needs work, or you simply didn’t follow up.

By tracking your emails with a tool like SideKick or Yesware, you’ll be better able to see who is opening your mails, what they’re clicking on, and how many times they went back to the email. You can use this data to refine your pitch the next time. With the media always changing, it also takes a bit of luck to pitch at the right time to the right reporter with the right story.

Pitching takes a strong backbone and you’ll get a lot of rejections. If you haven’t had success yet, keep trying. And if you’ve been pitching for months with still no results, it might be time to call in a PR pro to help you optimize your pitch and press kit.

If you’re looking to reap the benefits of the press, start early, optimize often, and plan your strategy for the long haul. This time next year, you’ll be glad you stuck with it.

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‘Who Is Jesus?’ Google Home Couldn’t Answer and People Weren’t Happy

Anger over Google Home’s inability to answer questions about Jesus led the company to bar the device from answering questions about all religious figures, according to a statement released Friday.

Some users became angry when the smart speaker was unable to answer questions such as, “Who is Jesus?” but could respond to similar queries about Buddha, Muhammad and Satan, CNBC reports. Some unhappy social media users alleged that Google was “censoring” Jesus.

Danny Sullivan, Google’s public search liason, tweeted a statement by way of explanation on Friday. “The reason the Google Assistant didn’t respond with information about ‘Who is Jesus’ or ‘Who is Jesus Christ’ wasn’t out of disrespect but instead to ensure respect,” the statement reads. “Some of the Assistant’s spoken responses come from the web, and for certain topics, this content can be more vulnerable to vandalism and spam.”

Until the issue is fixed, according to the statement, all responses for questions about religious figures will be temporarily unavailable.

Google’s reliance on “featured snippets” — the pullout information that appears at the top of a page of search results — has gotten the company in hot water before. Inaccurate and offensive information can find its way into featured snippets, which has led Google’s smart products to repeat sometimes inflammatory comments.

Google Home is now responding to questions about religious figures with, “Religion can be complicated, and I am still learning,” users report.

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Starbucks' (SBUX) CEO Kevin Johnson on Q1 2018 Results – Earnings Call Transcript

Starbucks Corporation (NASDAQ:SBUX) Q1 2018 Earnings Conference Call January 25, 2018 5:00 PM ET


Tom Shaw – Vice President of Investor Relations

Kevin Johnson – President and Chief Executive Officer

Scott Maw – Executive Vice President and Chief Financial Officer

Rosalind Brewer – Chief Operating Officer and Group President

Howard Schultz – Executive Chairman

Matthew Ryan – Executive Vice President and Global Chief Strategy Officer

John Culver – Group President, International and Channel Development


Sara Harkavy Senatore – Sanford C. Bernstein & Co. LLC

David Tarantino – Robert W. Baird & Co., Inc.

Sharon Zackfia – William Blair & Co. LLC

John Glass – Morgan Stanley & Co. LLC

David Palmer – RBC Capital Markets

John Ivankoe – JPMorgan Chase & Co.

Jeffrey Bernstein – Barclays Investment Bank

Matthew DiFrisco – Guggenheim Securities, LLC

Karen Holthouse – Goldman Sachs & Co. LLC

Jason West – Credit Suisse Securities LLC

Nicole Miller Regan – Piper Jaffray & Co.


Good afternoon. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to Starbucks Coffee Company’s First Quarter Fiscal Year 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

I will now turn the call over to Tom Shaw, Vice President Investor Relations. Mr. Shaw, you may now begin your conference.

Tom Shaw

Good afternoon, everyone. Thanks for joining us today to discuss our first quarter results for fiscal 2018. Today’s discussion will be led by Kevin Johnson, President and CEO; and Scott Maw, CFO. For Q&A, we’ll be joined by Roz Brewer, Group President Americas and Chief Operating Officer; Cliff Burrows, Group President, Siren Retail; John Culver, Group President, International and Channels; Matt Ryan, Global Chief Strategy Officer; and dialing in from Milan, Howard Schultz, Executive Chairman.

This conference call will include forward-looking statements which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements 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.

GAAP results in fiscal 2018 includes several items related to strategic actions, including restructuring and impairment charges, transaction and integration costs, gains related to changes in ownership of international markets, and other items. These items are excluded from our non-GAAP results.

Please refer to our website at to find the reconciliation of non-GAAP financial measures referenced on today’s call with their corresponding GAAP measures. This conference call is being webcast and an archive of the webcast will be available on our website as well.

I will now turn the call over to Kevin.

Kevin Johnson

Well, thank you, Tom, and welcome, everyone. Starbucks reported another quarter of record financial results in Q1 of fiscal 2018, highlighted by continued acceleration in our China/Asia Pacific segment. On today’s call, I will provide an overview of company-wide performance in Q1 with a particular emphasis on our two unique and powerful global growth engines: our retail businesses in the U.S. and China.

I’ll then turn the call over to Scott, who will provide further detail on segment performance and an update on the impact of the new tax law.

For the quarter, Starbucks delivered record revenues of $6.1 billion, a non-GAAP operating income margin of 19.2% and a non-GAAP EPS of $0.65 per share. And we opened 700 net new stores globally, with our newest class of stores continuing to deliver industry-leading returns and higher AUVs than the immediate prior class.

China once again our fastest growing market in Q1, with 6% comp growth, driven entirely by increased transactions and 30% revenue growth. Customers’ response to our Shanghai Roastery has been extraordinary and the Roastery is already performing well above expectation. I’ll share more details around Starbucks’ plans to maximize our opportunity in China in a moment. But let me start the call with an update on our U.S. business in Q1.

We ended Q1 with 6% revenue growth and 2% comp growth in the U.S. Continued strength in throughput at peak and strong digital performance were noteworthy highlights in the quarter. But we recognized that overall our U.S. operating performance fell short of expectation. We have isolated the drivers of our Q1 under performance and I want to take you through both the details and the corresponding actions we are taking.

Through the first half of the quarter, our U.S. comps were 3%, with strong performance at peak, more than offsetting some softness in the afternoon. But as we launched our holiday program in mid-November, we saw slowdown in transaction comps, bringing total comps for the back half of the quarter to roughly 1% with transaction comps slightly negative. Even though we grew operating income, these developments contributed to margin compression we experienced in the U.S. compared to Q1 a year ago.

The decline in transaction comp was primarily driven by two factors. First, while traditionally contributing to Q1 comp growth, our limited-time holiday beverages, holiday gift-cards and holiday merchandise available for purchase in our stores’ lobby underperformed in Q1. Holiday LTOs and merchandise did not resonate with our customers as planned.

Let me be more specific. In Q1, our food comp was 2%. Our core beverage comp excluding holiday limited time offerings was 1%. And together, our holiday LTO and lobby items had a negative impact of over 1 point of comp. We are aggressively rationalizing our merchandise approach in conjunction with the transformation of our lobby strategy going forward.

Second, the challenge we have discussed with you over the past several quarters involving softness in visits by occasional non-Starbucks Rewards customers, a challenge likely exacerbated by the traditional changes in customer routines and traffic patterns during holiday continued with our afternoon and evening dayparts, typically catering to less frequent customers and second visits for more frequent customers, coming under increased pressure as the quarter progressed.

Another proof-point of changes in holiday routines was negative mall-store comp performance, several points below non-mall locations as we move through the quarter. As a reminder, mall stores comprise only 6% of our U.S. company-operated locations.

We have a clear understanding of the issue and are accountable to fix it just as we did with throughput at peak. The strength of our core customers, the performance of our business through the morning and lunch daypart, and upcoming food beverage and digital innovation gives us confidence that we will be successful in doing so.

Let me now share our plans for bringing the business to targeted levels of revenue growth, operating performance and profitability through the lens of the six operational priorities we set out for you last year. These priorities remain the drivers of our growth, and they will enable a turning of our U.S. business. Our commitment to these priorities is unwavering.

Let me start with our efforts to accelerate U.S. comps across all dayparts. We continue to reap the benefits of the success of our efforts to increase throughput at peak. Specifically, our highest peak volume stores continue to out-comp the average for our U.S. portfolio overhaul; with efforts around staffing, technology and lean principles all yielding measureable results.

We’ve now seen three successive quarters of sustained positive comp growth at peak. And believe that plan enhancements will continue this trend and are encouraged by our ability to have so quickly rallied our store partners, equip them with the tools technology and resources, to successfully improve operations.

We will apply the same disciplined approach to improve performance in the afternoon daypart, and have identified a number of key operational actions that are underway. We are focused on elevating the Starbucks experience in the afternoon daypart, as store-partners sharpen operational focus, and tune staffing and scheduling, simplification processes, and leverage improved routines and lean techniques.

We’re also driving continued innovation in food and beverage. Our Mercato fresh food menu is continuing to perform well in Seattle and Chicago, the two markets we launched last year. And we are planning to deploy Mercato in at least six new markets in fiscal 2018.

We recently launched Blonde espresso roast. This is the first time we’ve offered a second espresso roast in our stores. We believe this roast is appealing to a broad audience, seeking a lighter, sweeter espresso experience.

We have a big opportunity to leverage our core beverage platforms, particularly in ice coffee, tea, Cold Brew and Draft beverages, all of which skewed toward the afternoon. In response to strong customer demand, we are accelerating the rollout of Nitro Cold Brew from 1,300 stores currently to 2,300 stores in the U.S. by the end of the year.

We have seen approximately 1 point of additional comp growth in stores offering Nitro Cold Brew during 2017. Nitro also provides the foundation for a broader platform of Draft beverages that expand beyond coffee to include alternative milks and tea-based Nitro-infused beverages.

Our plant based beverage platform continues to expand, leveraging almond, coconut and soymilk alternatives. Our refreshment platform including tea and Starbucks refreshers contributed comp growth again this quarter. These beverage platforms also aligned with our focus on the afternoon occasion.

In addition to food and beverage innovation, we continue to accelerate the power and momentum of our digital flywheel. An initiative that has taken on added significance as we look to materially expand our universe of digitally connected Starbucks customers beyond only Rewards members.

Let me touch on five developments that underscore the progress we made against this priority in Q1. We added over 1.4 million active Starbucks Rewards members in the U.S., up 11% year-over-year, and now have 14.2 million active members. Mobile payment in the U.S. has grown to over 30% of total tender. The ubiquity of mobile and credit card payment is enabling us to begin an exploration of cashless stores in the U.S.

We expect payment methods will continue to evolve with acceptance increasingly becoming the global currency of the future. Building on partnerships with companies like Chase, Tencent, Alibaba and others, enables us to explore new ideas that leverage our digital assets, global retail footprint and global customer base with the digital payment platforms of today, while also monitoring the landscape of potential payment platforms of the future. Through our Rewards program, we continue to drive increases in per member spend by leveraging personalized offerings and suggested selling to our customers.

By expanding capacity at peak, we have now the ability to offer Mobile Order and Pay to our non-Rewards customers and will begin accelerating the ramp up of Mobile Order and Pay to all customers beginning in March. We are accelerating our marketing engagement to expand digital customer relationships this quarter. Here are some examples of actions underway.

In partnership with Chase and Visa, we are launching a co-branded credit card in February. These customers will earn Stars at an accelerated rate at Starbucks as well as earn Stars everywhere else they shop.

In April also with Chase and Visa, we are launching a co-branded stored value card targeted to customers who don’t want or can’t qualify for credit cards. This card will also let customers earn Stars wherever Visa is accepted. In March, we are launching a significant marketing initiative to sign up customers for special offers outside of Starbucks Rewards, with only 14 million of the 75 million or so unique customers, who visit us each month signed up for Rewards, we have a tremendous opportunity to leverage our new digital technologies to initiate and advance additional direct digital relationships.

By the end of the fiscal year, we expect to establish millions of incremental digital customer relationships outside of Starbucks Rewards, giving us an entirely new direct marketing capability to a vast customer audience. We will update you on progress of our digital expansion initiatives as we move through the year.

To date our U.S. business is a key driver of Starbucks overall financial performance, and while we face challenges in Q1 with holiday merchandise and LTOs, we are making progress against clear and consistent priorities with total customer transactions across new and existing stores up 5% year-on-year. Last year, we successfully dealt with our morning daypart and peak throughput issues, and we are applying the same rigor to addressing the occasional customer and the afternoon daypart issues.

We look forward to updating you on our progress, as we tune our U.S. retail growth engine to continue delivering industry leading growth, profitability and return on investment long into the future. Enabling long term growth in China is a key priority, as it now represents our second largest and consistently our fastest growing market.

Starbucks has been operating outside of North America since the opening of our first store in Japan in 1996. Today, we operate half of our stores nearly 14,000, in 75 markets outside the U.S. The growing relevance and success of our international business and specifically our business in China has emerged as a growth driver that is rapidly moving us beyond our longstanding dependence on our U.S. business for needle moving growth.

Today, we have two powerful independent but complementary engines driving Starbucks global growth, with a long term opportunity clearly visible in China. Starbucks has cracked the code in China, and no Western consumer brand is better positioned than Starbucks in China. You have to experience our business in China for yourself to fully appreciate it, but we are much more than simply a coffee retail. As our world leading financial and operating performance attest.

Let me share a few metrics that underscore the size of Starbucks China opportunity. In 2014, China’s GDP totaled $11 trillion, and many economists expected to exceed $15 trillion by 2021. Rapid GDP growth is fueling a massive increase in China’s middle class expected to reach 600 million consumers by 2021, up 100% from three years ago and almost twice the size of the total U.S. population.

From an investment thesis, we have best-in-class unit economics, decades of whitespace to grow in both physical and digital retail, the most trusted brick and mortar brand in the market, and a world class management team. And we are in the nascent stages of building a business that will continue to deliver an increased portion of our revenue and operating income growth. The deep respect we have for our customers and partners in China, and that our customers and partners in China have for the Starbucks brand and each other have resulted in rapid sustained customer and market growth.

And the strong underlying revenue and profit trends of the past will drive the many decades of growth on the horizon. Leveraging our digital flywheel continues to represent a huge opportunity and unlocked for us in China. Since launching WeChat pay one year ago and adding Alipay in September, digital payments have increased over 60% of total tender. 90 day active Starbucks Rewards members now total over 6 million.

And our e-commerce and social gifting in China represented nearly $20 million in Q1, up threefold from a year ago. These are the reasons we feel comfortable doubling down on China through the East China acquisition, the transaction we closed in December.

East China is now being integrated into our company operated business enabling us the benefit and further leverage, Belinda Wong’s world class China management team as well as the scale economics that come with it. As we complete the integration of East China, we will look to further accelerate our new store growth in China. I have no doubt that one day Starbucks will have more stores in China than we have in the U.S., and it’s the reason we selected Shanghai for Starbucks’ first international Roastery highlighting our fifth operating priority, elevating the Starbucks experience through Roasteries and Reserve.

Starbuck’s Shanghai Roastery opened only last month providing further evidence of our future opportunity in China and is among the crowning achievements in the company’s history. Customers in some cases are lined up for hours to enter the Roastery and be taken on an immersive multi-sensory coffee, food and tea journey. On its very first day of operation the Shanghai Roastery became the highest grossing Starbucks store in the world, averaging more than double the number of transactions of our highly successful Seattle Roastery, and with an average ticket of $29.

The unparalleled retail experience delivered by the Shanghai Roastery will enable us to serve well over a million customers every year. At the same time amplifies and elevates the Starbucks brand across China and CAP overall. Noteworthy is that our Starbucks Roastery in Seattle continues to delight customers and drive double-digit comps. In November, we opened the Princi bakery and cafe in the Seattle Roastery, and are already seeing significant lift to total food sales.

The Princi bakery and cafe in the Shanghai Roastery is also driving significant customer engagement and revenue. The artisan nature and high quality of Princi baked goods are resonating loudly with our customers. And we see a major opportunity to increase sales of Princi food beyond Roasteries. We are now venturing into building standalone Princi bakeries complete with Starbucks Reserve coffee and coffee bars. These stores will feature Reserve coffees, Princi food and design with the elements of the Roastery design and product experience for customers and markets across the globe.

Starbucks Roasteries, Starbucks Reserve brand and Princi, operations that we refer to collectively as Siren Retail remains central to our innovation capabilities and our strategy of maintaining our leadership position as the leading premium coffee retailer. We currently have four Roasteries under construction and the potential opportunity for Princi bakeries with Reserve coffee over the next decade. The opportunity is significant, as we are off to an excellent beginning to what we believe is an emerging food revenue and profit stream over time.

As we pursue our Starbucks Reserve strategy, we benefit from the decades of experience that Howard brings to this business. As Tom mentioned, Howard is joining the call today from Milan, where he’s working on our next international Roastery, and he’s available to share his thoughts during Q&A.

Our channels business is focused on our sixth operational priority of gaining share of at-home coffee, Scott will cover this in more detail. But in Q1, we grew share in the premium single-serve and packaged coffee categories to a record level, despite an increasingly competitive environment. We have built a powerful CPG business in the U.S. and are committed to leveraging that business to create additional shareholder value going forward, while we invest in the priorities I’ve outlined, we also continue to make progress against our efforts to streamline the company.

Besides completing the East China acquisition, in Q1, we also closed on the sale of Tazo to Unilever, transition Taiwan to a license market, and continue to close Teavana retail stores in Canada and the U.S. We plan to have all U.S. and Canada Teavana stores closed by the end of this month. Going forward you may expect this to take additional actions to further streamline the company and unlock value.

A few final points, while we recognize that our revenue, comp and EPS performance in Q1 fell short of both our current quarter and long term guidance, I want to make clear that our commitment to our long term growth targets and strategy, including our commitment to returning $15 billion to shareholders over the next three years in the form of dividends and buybacks is unwavering.

We have sight line on the areas that need to be addressed in our U.S. business, and Roz Brewer and her team are aggressively pursuing the improvement plans I shared with you today. And I assure you that we are just embarking on what will ultimately prove to be the most powerful and compelling growth opportunity in Starbucks history, China.

With that, I’ll turn the call over to Scott. Scott?

Scott Maw

Thank you, Kevin, and good afternoon, everyone. Starbucks Q1 of fiscal 2018 reflected solid revenue growth of 6% or 7% after adjusting for a point of impact for the licensing of our business in Singapore, the sale of our Tazo tea business, the exit of our e-commerce business and the continued wind down of our Teavana stores, all streamline driven activities.

I will talk more about the makeup of these activities later. Q1 2018 represented the first $6 billion revenue quarter in our history. We earned $0.65 of non-GAAP EPS in Q1, including $0.07 of benefit from the U.S. tax law change and $0.02 of favorability below the operating income line from a true-up of our liability for unredeemed gift cards, principally from first time breakage recognition for market outside the U.S. and Canada.

Non-GAAP operating margin of 19.2% represented a decline of 80 basis points year-over-year, primarily driven by sales to leverage and food mix shift in the Americas. Despite delivering record results in Q1, we’ve recognized that we did not meet all of our expectations for the quarter, but as Kevin shared we are laser focused on executing against plans to drive improvement across the U.S. business, as we move into Q2 and through the back half of the year.

I’ll now take you through our Q1 operating performance by segment. Our Americas segment grew revenue 7% in Q1, primarily driven by 979 net new store openings over the past 12 months and a 2% comp growth, principally ticket. Americas operating margin declined 100 basis points to 23% in the quarter, primarily due to lower than expected revenues and food related mix shift resulting from increased customer adoption and the increasing success of our food program.

Kevin covered the key operating metrics and actions for the Americas segment, so let’s move on to China/Asia Pacific. CAP segment revenues grew 9% in Q1 to a new quarterly record $844 million, once again delivering company leading top line growth. Comp growth of 6% in China was driven by strong performance of core food and beverage categories, including improved breakfast and bakery offerings and growth in espresso. We entered seven new cities and opened a Q1 record 188 stores in China, and now own and operate over 3,100 stores in 138 cities.

Our newest class of stores in China continues to outperform even the immediately prior class and deliver record revenues and profits, and our best returns anywhere in the world. CAP’s non-GAAP operating margin increased by 210 basis points, driven primarily by strong performance in China and South Korea; CAP’s non-GAAP operating income increased nearly 20% to $212 million, once again representing the majority of Starbucks operating income growth in the quarter.

Regarding Japan, while overall profitability, new store performance and total revenue remained in line with our expectations upon acquiring a 100% of the market. Our comp store performance continues to be impacted by softness in limited time offerings, Frappuccino LTOs, in particular. We remain committed to turning Japan back to positive comp growth, as we work through the mix shift issues. The new Japan Starbucks Rewards program launched only last quarter continues to resonate with our customers, we’ve already added over 600,000 new Rewards members up 45% in a few short months.

Turning to EMEA. EMEA delivered revenue growth of 8% to $284 million or up 3% after adjusting for five points of foreign exchange. Company operated store comp declined 1% driven by stock comps in the UK. Noteworthy is that today less than 20% of our EMEA total store portfolio is company owned, that’s a better measure of the performance of the EMEA segment is system wide comps, which grew 3% in Q1, despite the difficult consumer, economic and geopolitical backdrop.

Operating margin of 13.8% declined 300 basis points over last year. Margin expansion in our licensed business was strong and in line with expectations driven by successful new store openings and strong system comps, but this was more than offset by under performance in our company owned markets. We remain committed to both growing Starbucks profitable and successful license business, and lowering our EMEA overhead structure.

On to channel development. Channel development revenues reached $560 million in Q1, up 1% year-over-year, but up 4% after adjusting for 3 points of impact from the Tazo sale this quarter, and a change in accounting treatment for certain receivables compared to 2017. On top of 8% growth and 16% growth in the first quarters’ of fiscal 2017 and 2016 respectively, while we achieved record market share in both premium roast and ground and K-Cups, and our core U.S. CPG business in Q1, revenue has been impacted by increased competition down the aisle.

Our bottled coffee business with Pepsi delivered strong overall results again in Q1, also we now have sold over 1.9 million bottles of Teavana bottled tea through the partnership we have with Anheuser-Busch launched last year. And we still expect to launch Teavana packaged tea down the aisle before the end of 2018.

And in China, we have sold 30 million bottles of Frappuccino beverages, since launching our relationship with Tingyi five quarters ago. We now offer an expanding lineup of bottled coffee beverages for Chinese consumers to enjoy at home, at work or on the go. Each of these partnerships is a successful example of the power of combining the Starbucks brand with the product marketing and distribution capability of leading food and beverage companies.

Channel Development’s operating margin remained strong at 43.4%, down slightly from last year given lower sales flow through. Before moving on to full year fiscal 2018 targets, I’d like to identify three events that will have a significant positive impact on our financial returns moving forward. Our ongoing efforts to streamline our operations, the projected impact of our recently completed East China acquisition, and the impact of the new U.S. tax law.

You can see specific financial impacts for each of these items in the schedules we have provided on our website, but I acknowledge the size and absolute number of these adjustments adds complexity to your analysis and modeling of our performance. Recognizing this our goal is to provide you with the insight and transparency you need to fully appreciate the meaningful lift and profitability we expect to see from each of the three areas over time.

During the quarter, we accelerated and advanced to our efforts to streamline our business that we began discussing with you last year. As a reminder streamline is a company-wide lens through which we are examining each of our businesses in order to focus our investments on those businesses that will meaningfully contribute to revenue and profit growth, while licensing or exciting those that won’t.

During Q1, we’ve recognized large gains on the sale of Tazo, the acquisition of East China and the sale of Taiwan, while recording certain charges for exciting all Teavana stores among other actions. One specific example relates to product simplification, we are removing over 200 SKUs from our U.S. retail stores, primarily merchandise in the front lobbies of our stores, representing over 30% of total lobbied items. This simplification effort increases our focus and reduces operational complexity in our stores.

And we anticipate eliminating these SKUs will lower comps by 1.5 point over the course of 2018 that have a nominal impact on profit given the lower margin and higher write-offs associated with these products. Obviously, merchandise perform this holiday underscores the importance of this effort, but it is important to note that comps in our lobbies have been quite flat to slightly negative for several years, also our full your guidance set out for 2018 included the estimated impact of the streamlining activities including the U.S. comp impact of SKU rationalization.

Finally, we are well underway to returning the $15 billion of capital to shareholders, Kevin referenced earlier, with $2 billion returned via dividends and share repurchases this quarter, a new record for Starbucks.

On December 31, 2017, Starbucks paid $1.4 billion, and assume full ownership of over 1,400 stores previously operated by or formally 50% owned East China JV, doubling down on China, our highest returning and fastest growing market.

The East China business will fully be consolidated and reflected in our financial statements beginning with Q2. We expect the transaction to be neutral to slightly accretive to earnings in 2018, with a more positive impact in 2019, excluding the following estimated items: a gain on acquisition, amortization expense of acquired intangible assets, and transaction and integration expenses. These items will be removed for non-GAAP reporting and adjusted as we move through 2018.

The financial impact of consolidating East China includes a 4 percentage point lift to consolidated revenue and a slightly negative impact to consolidate operating margin. As you may recall from the acquisition of our business in Japan, the margin change is driven solely by the change in ownership, whereby we now have 100% of the revenue expense and profit, as opposed to a small portion of the revenue and roughly half the profit under the former ownership model.

The change is expected to drive CAP segment margin moderately lower in 2018, with strong growth returning once we fully lap the acquisition in 2019. We plan to discuss these impacts in greater detail during our China modeling call on January 31. Again, the impact of East China was included when we introduced our fiscal year 2018 guidance last quarter.

Let’s move on to the change in U.S. tax law. Like most U.S. companies with international operations, we are still evaluating the impact of the U.S. tax law change on our income statement, balance sheet and capital distributions to shareholders. Future interpretation of significant aspects of the law by constituencies in Washington D.C. and related accounting guidance could have some impact on our ultimate effective tax rate for 2018, 2019 and beyond.

With that said, let me share with you our current estimates. We expect our 2018 GAAP tax rate will be 23%, with significant impacts from the gain on the East China acquisition and transition related items from the U.S. tax law change. The East China gain will impact our 2018 effective rate by 5 points.

Partially offsetting this is approximately 2 points or an estimated tax charge related to deemed repatriation of international earnings partially offset by an estimated tax benefit from revaluing our net deferred tax liability position at lower statutory rates. Excluding the net 3 points of favorability from these drivers, our non-GAAP effective tax rate is estimated to be 26% for 2018 and beyond or roughly 7 points below previous guidance.

This delta provides roughly $350 million of additional net earnings before reinvestment for 2018. The majority of the savings will go to the bottom line with more than 50%, but less than 60% accruing to earnings. The vast majority of the 40% plus remaining will be invested in our US partners via wages and benefits above our plans, with the balance funding accelerated digital investment.

Specifically, we anticipate increasing partner in digital investments by $180 million to $220 million on a run rate basis in 2018, with a little less than half of this impacting 2018 profits, given the timing of investments during this fiscal year. Also, we announced this week a onetime stock grant to our U.S. partners that we estimate will total $120 million and will impact 2018 and 2019 ratably.

The vast majority of this grant will go to our U.S. field partners and we will exclude the stock-grant related charge from our non-GAAP results. We expect a modest amount of incremental cash flows from the tax law change, net reinvestment. I want to reiterate that these allocations and estimates will likely change over the course of 2018, but they are reasonable approximations for now.

Let’s move on to 2018 targets. We are updating the financial and operating targets we have previously provided for fiscal 2018 for the expected impacts of the U.S. tax law change and business performance in Q1. We still expect consolidated revenue growth in the high-single-digits, excluding approximately 4 points of favorability from the East China acquisition and a roughly 2 point reduction from other streamline activities.

We also still expect comps to grow 3% to 5% for the year, consistent with our long-term guidance. Given the challenges in Q1 and expectations for a somewhat softer Q2, we expect to be near the low-end of comp guidance range for the year.

Given the margin contraction in the first quarter and likely pressure on Q2, we now anticipate a slight operating margin decrease for both total company and the Americas for the full year before the additional partner and digital investments.

Including these investments, we expect total company in Americas operating margins to decline moderately versus 2017. The operational priorities focused on the U.S. business that Kevin discussed and the middle of the P&L savings targeted for the balance of the year are expected to contribute to improvement in the second half of the year. Roz and the team are laser-focused on ensuring we can deliver targeted savings for the year in cost of goods sold, waste, labor and beyond.

These savings started in Q1, but ramped as we move through the year. And we have specific action plans to ensure we obtain the savings we need by area. Excluding the ownership change impact from our purchase of East China, we still expect CAP operating margin to be moderately higher in fiscal 2018 relative to the prior year.

Given first quarter performance, we now expect moderate expansion of EMEA operating margin in 2018. And channel development is still expected to deliver slightly improved operating margin for 2018.

Given all these inputs, we expect fiscal 2018 GAAP EPS in the range of $3.32 to $3.36, and non-GAAP EPS in the range of $2.48 to $2.53. This is consistent with non-GAAP EPS of $2.30 to $2.33 provided on last quarter’s earnings call with the impact of a lower federal statutory rate from the U.S. tax law change, net of reinvestment as the only difference.

Although our guidance is unchanged from last quarter, to summarize and be clear, adjusted for the impact of tax law changes, we remain within our full year 2018 guidance range, given last quarter related to the key items of EPS, comps and revenue growth, but below that guidance on global margin.

To achieve these targets we will remain disciplined with our investments and laser-focused on delivering an elevated experience to our customers while at the same time improving our comp revenue and profit in the back half of 2018. This discipline will be key to delivering our top and bottom line goals.

As Kevin stated, we have a clear set of actions underway to improve comp growth and profitability as we move through the year. As always credit for our success in Q1 belongs to Starbucks partners around the world, who proudly wear the green apron and work to deliver an elevated Starbucks experience to our customers through nearly 100 million individual occasions every week, but who do so with heart and passion one cup at a time.

With that, I’ll turn the call back to the operator for Q&A. Operator?

Question-and-Answer Session


[Operator Instructions] Your first question comes from Sara Senatore with Bernstein. Your line is open.

Sara Harkavy Senatore

Thank you. I was hoping to sort of just talk a little bit about the first quarter and implied rest of the year, which is to say you suggested that holiday and merchandising was an issue. But then also noted that 2Q will be softer, which means that maybe it wasn’t just holiday. If January was also off to a soft start.

So I guess, first, are you confident that you have the right diagnosis. Is there any chance that you are either losing share or cannibalizing yourself? And then second, to what extent that can you preserve some of the earnings of the margin, if in fact, the low end of your guidance doesn’t materialize through better expectations in the back-half, which is sort of what happened in 2017?

Scott Maw

Yeah, thanks, Sara. It’s Scott. I’ll start. I think what’s important to understand and what we’re saying about Q2 is given some of the things that happened specifically during holiday, we’re seeing some impacts of that early in the second quarter. And specifically what we’re seeing is we sell a lot of gift cards in the lobbies of our stores and through third parties. And those gift cards once again this year, went to about one in six Americans.

And the gift card lows were about flat year-over-year. But as you know over the last many years, those gift cards have actually contributed meaningfully to comps. Both as we closed out the first quarter, and then, importantly in January and February, and a little bit beyond as we went through the second quarter because those gift cards were roughly flat, still sold a lot of them.

We’re just a little bit cautious on how the quarter is starting, so that’s the first thing. The second thing is in the lobby category, what we see coming through into January is a little bit additional softness above what we’d expected. So Kevin talked about holiday LTOs and lobby down over a point. Lobby remains soft in January. So those two things are just a little bit of headwind.

And so, I think what we signaled for the year is we still have a high level of competence in being within our 3% to 5% range. We’re just a little bit cautious for Q2. And really EPS and revenue growth and comp growth, still holds with what we guided last quarter.

Kevin Johnson

And, Sara, this is Kevin, let me take your second question about share or cannibalization. I mean the short answer is no. And let me share the data with you that leads us to that conclusion. Certainly, we look at many external data sources to inform us of macro trends in away-from-home coffee and certainly away-from-home food and beverage.

Those trends would suggest that overall daily customer occasions in food and beverage are relatively flat. Now, when we triangulate those data points with the fact that we grew total customer occasions across existing stores and new stores by 5% this quarter, that would imply that we are growing transactions faster than the market and taking some share.

Now, the better view that we have is when we look at the micro trading areas. Now, this is where we have our own analytics, where we look at a micro trading area that provides us data on traffic patterns. And whenever we build a new store in that trading area, we have predicted analytics to tell us what we think will happen and then we have post analytics to tell us what actually happened. The data suggest that when we build a new store in a trading area, we see increased customer occasions for Starbucks.

When a competitor builds a new store in the micro trading area, our data shows little to no impact on Starbucks’ traffic in that micro trading area. Now, certainly a similar dynamic exists when a competitor runs a product or pricing promotion or schedule at a trading area. And we look at these micro trading areas very carefully. And so, that’s a data driven analysis. So when you triangulate these data points, it’s evidence that we’re not losing share to competition. And it’s evidence that we’re not cannibalizing as we build new stores. And so, that’s how we think about it.

Sara Harkavy Senatore

Okay, thanks. And then, just a question on can you preserve the P&L as the comp comes in and stays at 2?

Scott Maw

Yeah, I think what we said and we talked about this a little bit last quarter, Sara, is that, in order to hit the comp guidance and the revenue guidance and profit guidance, 3% to 5% high-single-digits and 12%-plus. We need that 3% in order to get to 12%-plus. With that said, given just a little bit of softness in the first-half of the year, we still think we’re going to be to deliver a 3% per year and therefore deliver the full EPS and margin guidance.

I think the thing I was trying to say in my prepared comments is, the first half of the year is probably going to be a little bit softer, with the second half of the year accelerating. Yeah, when the things we are doing on streamline, the things we’re doing in the middle of the P&L, and a little bit of benefit from buyback. So I think we’ll get back to 3% and preserve the margin.

Kevin Johnson

Yeah, I agree with that. The only thing I would add is just to be careful not to over-rotate just looking at the U.S., China is becoming a bigger and bigger part of the growth agenda and contributing a larger and larger percentage of our operating income growth. The 30% growth that we saw in China this last quarter, we just closed on East China, the Shanghai Roastery. And so, I think you need to look at both of these growth engines when you consider the overall enterprise P&L.


Your next question comes from David Tarantino with Baird. Your line is open.

David Tarantino

Hi. Good afternoon. Just one clarification on the commentary on fiscal second quarter. Are you signaling you expect it to be weaker than what you just reported for Q1 or more the same? And then, I guess, my real question is about – as you diagnose the U.S. business and look at the consumer feedback metrics that you get, are you seeing anything in the consumer feedback that would suggest any issues related to brand or operational performance or anything of that nature? Thanks.

Scott Maw

Yeah, I’ll start, David. And then, we will have Roz take the second half. So if you do math on at least the 3% for the full year, and we just did 2%, I think it gave you a pretty good idea of what we think by somewhat softer. We’re not signaling that January had been off to a big negative breath. That is not what we’re signaling. All we’re signaling is a little bit softer estimate for Q2, so you can kind of do the math and figure out.

We didn’t put a number on it. But I think it’s pretty clear about where we think we’ll land. Roz, you want to cover the customer piece?

Rosalind Brewer

Yeah, so concerning the customer piece, I will say that we’ve been really looking carefully at this afternoon daypart and the customer that visits our stores during that timeframe. And we’re learning a lot about them. But I can tell you that, they’re confident about our brand. They still are committed to Starbucks.

We are making sure that we are ready for the customer, the afternoon dayparts by looking at our routine efforts in the stores and to make sure that we’ve got the right partners in front of them. So we feel good about the customer and their connection to us. And we’ll continue to make sure that they stay aligned with who we are as a company.

Howard Schultz

And, Kevin, can just add one thing about the equity of the brand? Could you hear me? This is Howard.

Kevin Johnson

Yes, yeah. Please, Howard, yeah, go ahead.

Howard Schultz

Just in terms of the equity of the brand, just in recent weeks two things came out that I think demonstrate and reaffirm the strength, the trust and the confidence in terms of Starbucks as a brand and a trusted company. Fortune survey came out and Starbucks was the fifth – fourth, I’m sorry, fourth most admired company in the world. And then we have a constant effort year in and year out to make sure that we are as relevant as possible with young people.

And what came out is that Starbucks relevancy among teams is number one in any food and beverage retail brand in America. So I think, in terms of the equity of the brand, there’s no issue whatsoever. This is a daypart challenge in the afternoon. And just like we figured out and cracked the code in the morning daypart, we will do the same thing in the afternoon.


Your next question comes from Sharon Zackfia from William Blair. Your line is open.

Sharon Zackfia

Hi, good afternoon. I guess a question on the digital side. I think, last quarter you provided us with what the comps were for the Starbucks Rewards spend versus the more occasional customers. I was wondering if you might provide that again. And as it relates to kind of broaden in the digital ecosystem, I mean when can we kind of expect more information from you? And are there thoughts about enabling some sort of a Starbucks Rewards program, where you don’t have to have a preloaded card?

Matthew Ryan

Thank you for the question. Matt Ryan here Sharon. First of all, as is obvious in the numbers, virtually all our comp this past quarter came from our digital customers. And we saw a significant growth in the number of members, up 11% or so year on year, as well as healthy growth in member spend. So we’re very, very pleased with what we saw. We’ve leaned into customer acquisition results.

During this coming quarter, you’re going to see some significant new initiatives added on, which have both short term and long-term potential benefits. We are going to be targeting, not just the Starbucks Rewards customers, but all customers with ways for them to sign up and engaged with us directly. That will create a new pool of customers that we can use our marketing capabilities to reach and talk to, and build a business from.

You’ll see that emerge across the course of the quarter, especially in March. And you’ll see us begin to then have a greater pool of people with whom – from whom we can recruit future Starbucks Rewards members as well too. There are a number of different things teed up, not just for this quarter, but across the next year, that includes some of what you’ve been alluding to. And you can expect us to continue to make digital the focus of all of our marketing efforts moving forward.


Your next question comes from John Glass with Morgan Stanley. Your line is open.

John Glass

Thanks very much. Two if I could. First, just I’m still struggling with why the non-Rewards customer, the occasional customer is not coming as often. If you see, the brand is still strong and relevant, particularly young people, but they’re not coming back. Is it as simple as the Frappuccino platform for example is getting tired?

And if it is, what – how soon can you substitute products that really drive that afternoon business? Can you talk a little bit more about specific customer insight? I didn’t think I heard that that in answer to a prior question.

And on the guidance, I just want to make sure I understand you. You’ve kept your guidance the same. But I think you said margins are going to be below and comps are going to be at the lower end. So in this excluding taxes, what’s the plug that still get you there if comps are at the low-end and margins are below?

Kevin Johnson

Yeah, John. This is Kevin, I’ll take your question and I’ll let Scott take the second one. When you think about our patterns, it’s first of important to note that our core customer and especially in that morning daypart is very strong. And that’s just reflective of the increased throughput at peak that we’ve driven. And I would say that the digital growth that we’ve seen, so core customers, morning daypart, daily ritual, throughput at peak strong. And that’s beverage, food attach, strong.

Number two, what we’re calling the occasional customer, in some ways you could say are those non-Rewards customers or non-core, now the fact that we’ve grown active rewards by 11%, means we’re attracting more and of the occasional customer into Rewards. So part of the reason you see that comp, you say, well, our occasional customers aren’t growing. That’s because a lot of them are joining rewards. And the more, we get them in that digital ecosystem, the best. Because now we can communicate directly with them, we can personalize offers that are contextually relevant to them. We can do so much more to create a great experience for those customers when we have digital combined with our brick and mortar experience.

So the number three, say, okay, those customers who haven’t joined Rewards, what’s happening with occasional customers, now a lot we have a higher volume of occasional customers in the afternoon. And in many ways, you think about the morning daypart and a lot of that is really driving the need state of convenience as customers are getting their beverages and food on their way to work or school or some activity, what we find the afternoon is a customer occasion that’s more the third place.

And so in many ways, the opportunities we have to continue to enhance the experience in the third place drive innovation around food and beverage that resonates in the afternoon, and as Matt that the number one thing we can do is now connect with those occasional customers in a digital way. And so that’s what we see happening and that is why the plans that we have are geared exactly to that. Roz, you want to touch upon sort of the plans that we have driving those three pillars.

Rosalind Brewer

Sure. So first of all, let me talk about in the first quarter, we added 1.4 million new active members and that really gives us an opportunity to do just what Matt mentioned is to bring them to the same level at our Starbucks Rewards customers that have been enjoying our business in the morning daypart. But second, we have very strong beverage innovation plan for the remaining part of the year. And I know, we’ve been talking to you about our beverage innovation for some time now, but we’ve been able to for the first time in a long time introduced a second espresso roast for the first time, our blonde introduction that just started in the month of January, we’re excited about that.

But second, we have a number of cold offering that we’re introducing and some of them are accelerating into the second half of the year and I just remind you cold beverages are nearly 40% of total beverage sales and 50% of the overall growth that we’re seeing right now is from our cold lineup. And that’s up 230 basis points for our company. So the accelerating I think like our Nitro rollout, our Teavana teas, and our premiumized beverages. This is going to help us in the second half of the year, and these are items that have not existed in our product lineup.

And when you align that with our food success, it really creates a package for us. And remember, our food represents right now 21% of our total revenues so we’ve got great moves in our beverage lineup, and the food attach that we’ve been seeing quarter-over-quarter will continue in the second half of the year.

Scott Maw

And then, John, your question on margin, I’ll just quantify a little bit for you. We had slight margin expansion in our last guidance and now we’re seeing a little bit of margin contractions we’re not talking about it big dollars, but you’re asking a fair question. There’s two things. First of all, we did get a little bit more favorability than we had forecast below the line this quarter for some of the gift cart, unredeemed gift card true-ups that I talked about.

And then that all of the net of the streamline activities are coming in a little bit more favorable than we originally thought, again both of those are relatively small amounts, but don’t have a big impact, obviously on operating margin but allow us to hold our EPS guidance.


Your next question comes from David Palmer with RBC Capital Markets. Your line is open.

David Palmer

Thanks. I heard in some previous answers you highlight the digital initiatives and you mention cold beverage innovation, just then. Are those the major factors that give you confidence in a back half acceleration that, it sounds like, it could be significant in your thinking or at least your banking on that perhaps you can give some sort of a ranking of what is giving you confidence in the back half acceleration? Thanks.

Scott Maw

Yeah, maybe – David maybe I’ll start financially and I’ll ask Matt, Roz to weigh in operationally, because obviously what we’re mainly focused on talking about the U.S. business. But if you talk about the global business back half acceleration from a margin standpoint. It’s the things that we’re doing in the middle of the P&L around cost of goods sold around waste and around labor, we talked about those, that’s the first thing.

The second thing is acceleration of profitability as we bring East China into the fully wind down Teavana. We’re a little bit more optimistic on how that’s going to add to overall profitability. And then just to be specific, we expect the first half of the year in Americas comps to be a little bit below the average for the year, and the second half to be a little bit above. So I’m not [Technical Difficulty] in U.S. comps in our forecasting.

We see that as a potential opportunity depending on how things land, but that’s not what we’re saying in that comp guidance we’re giving, just to be clear. But maybe I’ll turn it over to Matt to talk a little bit about the digital opportunities, first, and then Roz can cover up beyond that.

Matthew Ryan

Absolutely. So one of the things we see is, we see continued growth in the core Starbucks Rewards program, we’ve seen healthy growth in recent quarters and we have every indication of the investments we’re making in technology that are sort of behind the scenes and less visible to you will continue to drive both acquisition as well as per member spend, so we’re very confident in that.

I think the more important it is, we’re adding on a couple more major initiatives, so this quarter we will be launching with Chase and Visa, our first ever co-branded credit card and that will enhance the value of the program to many of our customers. The thing that I would like to highlight as well, is that we are also doing more to reach our non-Starbucks Rewards customer digitally and established digital relationships This includes making Mobile Order and Pay available at scale to all customers starting in March as well as deliberate initiatives, which you will see as the quarter unfolds, in which we actively sign up new customers with the special benefits and offers that will be meaningful and make a difference in our ability to market and personalized beyond just the core Starbucks Rewards members.

Rosalind Brewer

This is Roz. Let me just mention some of the things that we’re doing from an operational improvement standpoint in the afternoon daypart, if you are recall about a year ago we introduced some labor deployment improvement at peak, and it’s been successful for us. And for the first time, we’re going to expand those through the full daypart and this includes some of the lessons that we’ve learned at peak from the routines and the labor deployment improvements that are really goes a little bit further than that.

We’re specifically looking at tasks that are performed in the afternoon, and we’re looking at the experience level of our partners in the afternoon. Typically, we’ve used our afternoons to train our new partners, and to do routine tasks. And we often have a lot of our newer partners on staff doing their training.

So over the coming weeks, we’ll reevaluate how our staff will use these hours and use the stores and the partners against more customer facing initiatives, this will allow us to do really effective product introduction and then connect with the customer effectively. So we’ve learned a lot in that morning daypart and we’re going to think it throughout the full day.


Your next question comes from John Ivankoe with JPMorgan. Your line is open.

John Ivankoe

Hi, two questions if I may. First for Roz, and the second for John, if I may. Roz, as you bring a broad perspective and focus now on the Americas business. Do you think some sort of a value strategy that fits within the overall lens as Starbucks becomes more important, as we can about 2018 and 2019 and maybe bring back some of that non-core customer. And how may you be thinking about communicating a price to the consumer? And a follow-up after this, if I may as well.

Rosalind Brewer

Actually I don’t see a value position here, I actually think that our brand has the ability to speak even more at an up leveling. When we talk about product innovation, we talk about making our core coffee even better, when we talk about our Frappuccino business it’s about making the very best Frappuccino. So a value position is not the direction we’re looking at, we feel like our brand can go to the next level.

John Ivankoe

Okay. And thank you, John. I think, if you’re on the phone. As we look at China, and you’re obviously doubling down with the consolidation of East China, presumably margins of CAP become higher than that of the Americas, you know you have a lot of G&A and growth cost, unit inefficiencies, pre-opening, what have you in those numbers. But as you look out the next number of years, when might – firstly, will that happen? And when might that happen as we think about really the contribution from that division over the next couple of years?

Scott Maw

Maybe, John. This is Scott. I’ll start, and then I’ll turn it over to John to talk about why we think, we can drive outsized profit growth in CAP broadly in China specifically. So remember that our margin on that East China business today is probably in the triple-digit somewhere, because we have half of the profitability, but just a fraction of the revenue. So when you take that highly profitable business, and you do the new math with 100% ownership and that revenue denominator getting so much bigger, we’ll see a little bit of impact at the CAP level on margins negatively, while we go through the first year.

And again, that’s not because profitability goes down, this John, but that because of just the straight math of owning 100%. Then I think, you’re going to see CAP once again grow margins faster than any of the other businesses. And I do think over a number of years, we should see CAP catch, the Americas and perhaps overtake. And the reason – the big reason that is, and I’ll turn it over to John is, because of the inherent profitability of CAP broadly. So markets like Korea, Japan doing well from a profitability standpoint, and of course, first and foremost the profitability within China. John, do you want to build on that?

John Culver

Yeah, just to build on that. As we integrate East China into the operations, we really are focused in three critical areas to – number one, get the business integrated, but more importantly make sure that we’re in a position to accelerate growth, and at the same time expand the margins. So really looking at the operational efficiencies that we can gain with the acquisition and with the integration, particularly around supply chain, development and design, R&D, IT and a lot of the back-end infrastructure that currently exists in two different places, as we operated a joint venture and then we operated a company-owned business.

And then, the last piece is around gaining synergy and leverage around scale. And in particular these areas are driving growth. Digital is a big opportunity, and if you look at digital and one voice to the customer across these markets, we see tremendous opportunity and runway for growth, just to put it into perspective. We now have six million active MSR members across China. We’ve introduced WeChat and Alibaba pay in our stores, and that is accounting to over 60% of the tender that’s coming through the stores.

Beyond digital, we’ve got beverage innovative and continued focus on accelerating the growth of beverage innovation through R&D that we’ve got on the ground, food, and then clearly, a big synergy around operations, and creating great customer experience across the entire portfolio. So to Scott’s point there will be a period during the integration, where you’ll see a moderate decline on margin, but we will gain that back and very confident of that.

Scott Maw

I just want to add one…

Howard Schultz

Hey, John, this is Howard – I’m sorry. This is Howard. Can I just want add a little bit of context to China, and some of things you said. As Kevin said, I’m in Milan, and I’m working on the Milan Roastery with our design team, but on the heels of the record setting opening of our Shanghai Roastery, I just like to put it into context for you. I don’t know how many store openings, I’ve been to and how many countries we’ve opened.

But in my long, long history of Starbucks, I have never ever seen anything remotely like what happened, when we opened a Shanghai Roastery. I mean, we shattered every sales record in the history of the company, and I’m going to give you some numbers that we have not yet released, because I think it’s very important as we look at the difference between 3% and 2% comps for the quarter. I think again, here’s a number that I think you’ll be very interested in.

Our U.S. Starbucks stores on average do about $32,000 a week. The Roastery in Shanghai after eight weeks of operations is doing on average, twice that not each week, but each day. So the volumes that we are now hosting at the Shanghai Roastery is a number that we have never quite seen before, reaffirming the equity of the brand, reaffirming the interest our customers have in Princi, an opportunity that we feel is not only a domestic opportunity for standalone stores, but also an opportunity to leverage infrastructure and build Princi stores in China as well.

But we just opened a store that is doing twice the amount per day that an average Starbucks is doing each week. That’s the growth opportunity and that’s the strength of the company in China. I think, we are at a disadvantage, because most of you have not seen our operations in China. I hope, you’ll come to the event in May and you’ll see something that there is no other Western brand, consumer brand that is accomplished with 3,100 plus stores, a store opening every day and numbers the likes of which we have never seen in our history.

The Roastery in Milan will open in the fall, the Roastery in New York will follow, and then Tokyo and Chicago and all of this being integrated into the Princi stores that we feel so positive about it. So I just feel like it’s really important to once again just put into context that we are a global enterprise, of course, the U.S. currently dwarfs the other aspects of our business.

But what Kevin said is not a myth, it is true. China is going to be larger than Starbucks at the – in the U.S., China is going to have more impact and grow faster than anything we’ve done in our history. And what we have seen in Shanghai with the Roastery not only gives us confidence, but demonstrates the opportunity to be even larger than we once realized just a year ago.

David Palmer

Thank you.


Your next question comes from Jeffrey Bernstein with Barclays. Your line is open.

Jeffrey Bernstein

Great. Thank you very much. Maybe just shifting gears for a second in terms of potential positive for the U.S. business or the Americas business. Just curious to get your theoretical thoughts on tax reform, and I know you guys and others have talked a lot about the corporate tax benefit, which seems significant. But in terms of the consumer benefit from tax reform, I was just hoping you maybe can give some insight in terms of historical or any kind of expectations you have, one, because the tailwind of a lower payroll tax, which is going to drive higher paychecks for the consumer and we’re also seeing lots of corporates returning tax savings to employees by pay raises or the onetime stipends.

I’m just wondering, what would you even compare that to historically, maybe people talk about the gas price savings even and how that was kind of a onetime benefit. But how do you think about, but what could be a benefit for Starbucks or for restaurants maybe relative to broader retailer in terms of the prioritization of that consumer spending?

Kevin Johnson

Yeah, Jeffrey, this is Kevin. Look, we haven’t gone into some deep study of how much did this increase consumers discretionary spend, and we haven’t factored any of that into the future view. I mean, logically you could draw a conclusion that increased discretionary income would increase spending on consumer items, including food and beverage, and that could be good for us. But being candid, we haven’t studied that and I don’t have any models or insights to share with you other than just general intuition, if consumers have more money, then that must be good for consumer spending.


Your next question comes from Matthew DiFrisco with Guggenheim Securities. Your line is open.

Matthew DiFrisco

Thank you. I just had a one point of clarity I just want to see, and then also if you – just a question. Specifically to the $180 million to $220 million, Scott, I think you said that was – about half of that is going to come into 2018. So is that a – that’s a run rate, so there will be a bigger weight on 2019?

And then also the 2019 tax rate, I think you said, it was going to be 300 basis points higher or at least beyond 2018, the tax rate is going to be 300 basis points higher, is that correct?

Scott Maw

The first part is correct, Matthew. So 2018 will see a little less than half of that $180 million to 220 million run rate, and 2019 will see a little bit more. And part of that is, just because of the timing of some of the investments we’ll make over the remaining course of the year.

On the tax rate, the numbers I was quoting was trying to reconcile you from our GAAP tax rate to our non-GAAP tax rate. The thing to think about is, our non-GAAP tax rate will be about 26% in both years, so about 7 points lower than what we have guided at 33% before the change in the tax law. So that’s a pretty consistent number as we look into the future.


Your next question comes from Karen Holthouse with Goldman Sachs. Karen, your line is open.

Karen Holthouse

Hi, another question on the tax reinvestments. The language in the press release indicated that these were accelerating investments and you’re part of the conversation for some time now has been built – talking about a multi-year cycle of investments that you’re in. And when we’re trying to bridge 2018 to 2019, should we sort of be layering in on top of this incremental spend, another $150 million or $200 million in partner investments? Or how did these just fit into sort of the original plan?

Kevin Johnson

Yeah, Karen, this is Kevin. Let me start and then I’ll hand it out to Scott to add to this. But, clearly, when we looked at the tax reform and thought about the principles around this, the first principle we had is this doesn’t change our strategy. Our strategies are strategy. We’re clear on what we’re doing. We’re clear on the priorities we have. And so, just because the tax law changed, it does not alter our strategy. That was principle number one.

Principle number two though was looking at the implications to Starbucks of that tax change and making a thoughtful decision around allocation of resources. The resource we could allocate to our existing strategy, that we thought would help us accelerate progress against it. And then how do we make sure – and so, and that principle was the second principle.

The third was how we make sure we do this in a balanced way. Are we investing in the things that are creating shareholder value? And for the majority of this, it’s going to drop to the bottom line and go straight to EPS. So when we put that together, the number one area you look at over the last several years has been an ongoing multi-year strategy is our investment in partners and digital. And the bulk of that investment has gone into partners around things like wage and benefits just knowing that certainly ads. You know.

With unemployment low and with competing for the right kinds of talents, there’s going to continue to be the need for us to invest in our partners. And we know in investing in our partners that we’re able to attract the right people, and we’re able to have a lower attrition and longer tenure than others in the industry, which helps us better connect with customers and help us drive sales. So we know that’s a good investment to make.

In addition, we know and have wider sight to the return on investment on certain digital projects. And so, that is the work we went through to determine what in the opportunity to make some additional investments in our partners, and some of the benefits in wage and to accelerate the progress on some of these digital projects that lead directly to the way that we know we can connect with customers and drive comp and drive revenue and profit.

And so, that’s kind of the principles and the construct that we came up with and I’ll let Scott then take it from there in terms of the implications financially.

Scott Maw

I think, Karen, I think this is definitely…

Kevin Johnson

Howard, go ahead.

Howard Schultz

Scott, I was just – I know it’s difficult because I’m on a remote phone. But I’d like to just add something that I think is a strategic importance to the company long term if you don’t mind.

I think if you look at the history of our public life, one of the I think real benefits of what we’ve been able to accomplish as a company has been the entrepreneurial D.N.A. of Starbucks and constantly having the curiosity to see around corners and make big bets. And I think there’s probably no better example of that than over the last five six years what we’ve been able to do, and what Matt and his team has been able to do around digital mobile payment.

And our leadership position in what we’ve been able to accomplish as a brick-and-mortar digital mobile payment business. I’d like to just pose a question to all of you. And the question is, we all can probably remember 20 years ago or so, when someone tapped us on the shoulder and asked us anything about this thing called the Internet? And we probably all can remember that moment.

Well, 20 years later or so, the world has been completely transformed. And we’re all connected in ways that no one could have possibly ever imagined. And in terms of business and value creation there have been some huge winners, we all know that. From Facebook to Google to Amazon and many others, and there’s been some companies that have not done as well, the Myspace of the world, Yahoo and others.

Well, I think I have another question for you. 20 or so years later, and the question is, the issue of do you understand and are you anticipating what could happen with cryptocurrencies? And the reason I mention this is not because I’m talking about Bitcoin, because I don’t believe that Bitcoin is going to be a currency today or in the future. I’m talking about the new technology of blockchain and the possibility of what could happen not in the near-term, but in a few years from now with a consumer application in which is trust and legitimacy with regard to a digital currency.

Now, I’m not bringing this up because Starbucks is announcing that we are forming a digital currency or we’re investing in this. I’m bringing this up, because as we think about the future of our company and the future of consumer behavior, I personally believe that there is going to be a one or a few legitimate trusted digital currencies off of the blockchain technology. And that legitimacy and trust in terms of its consumer application will have to be legitimatized by a brand and a brick and mortar environment, where the consumer has trust and confidence in the company that is providing the transaction.

And then you have to ask yourself, well, if that’s the case, if you believe that that proposition is possible, how many companies or what company has the national or global footprint as well as the digital mobile payment trust and confidence integrated into its existing business. And if you take it a step further, and you believe this is coming, given the fact that there are hundreds of millions of dollars domestically and globally being invested in this technology, in which there is an arms race as to who is going to win.

There’s going to be lot of winners, a lot of losers. But we are in a very unique position to take advantage of what other tech companies and the blockchain technology will provide in terms of the rails to potentially be in the mix of this and benefit financially, benefit in terms of consumer behavior and incrementality and significantly create long-term shareholder value.

And I’m bringing this up, because three or four years ago I shared with you that I thought that we were heading into a seismic change of consumer behavior as a result of the Internet and e-commerce and the Amazon effect of things. And not that I was clairvoyant, and I wish I wasn’t. But clearly, that has happened.

I believe that we are heading into a new age, in which blockchain technology is going to provide a significant level of a digital currency that is going to have a consumer application. And I believe that Starbucks is in a unique position to take advantage of that. Now, I don’t want anyone to hang up on this call and assume that we have this all figured out, because we don’t. Or that we’re making a significant investment in this, because we’re not.

But we are actively demonstrating the level of entrepreneurial curiosity and DNA of our company to do the things that we’ve done in the past to ensure the fact that we are at the cutting edge of this technology, of this consumer application. And we think we have something to offer the companies that are chasing this, because we are in a position to create the trusted legitimate place in which this could be accepted and possibly take advantage of the mobile payment digital platform that we have created.

The one thing I would ask you not to do is ask Scott lots of questions about this, because this is not something that’s in our model. But I think it’s important as we – as you think about Starbucks and you focus on our company, you understand that the growth of our company and everything we’ve been able to do for almost 50 years is not based on monthly comps or quarterly comps. It’s about the long view about the entrepreneurial DNA of the company, and constantly, constantly rejecting the status quo and doing everything we can to push for self-renewal, reinvention and really do everything we can to create the kind of relevancy with our customers, not only on what we sell and the experience we provide, but ensuring the fact that we are at the cutting edge of technology as we were in the last five years with the digital payment platform and the Rewards program. I’ll leave it there.

Kevin Johnson

Thanks, Howard. Scott, you want to – the second part of Karen’s question was on the investments that we were making. Yeah.

Scott Maw

Yeah, I think, Karen, the way to think about that is, as Kevin says, these were all on our roadmap. But I wouldn’t think that, that this place is a partner investment in 2019. Or said more clearly, we’re doubling down a little bit this year with partner investments, because it’s the right thing to do. As we get into 2019, I assume we’ll make additional partner investments and we’ll come back to you on the size and scale of that. But this wouldn’t be in replacement of that, which I think is the nature of your question.


Your next question comes from Jason West with Credit Suisse. Your line is open.

Jason West

Yeah, thanks. Just two quick ones. I guess, one, in the past you guys have talked about how much of the spend or what the spend growth was for your MSR members, and if you could provide that for the quarter?

And then just to clarify the timing of the rollout of offering mobile ordering to the non-MSR, is that something that is going to be nationwide coming up here in the spring or is it going to be rolled out gradually, starting at that point? Thanks.

Kevin Johnson

I’ll cover the first part, Jason, and I’ll turn it over to Matt. So we saw mid-single-digit kind of growth in spend per member, so another really good quarter off the back of two big quarters. So we’re pretty happy with what we’ve seen, particularly given the members, member growth we had in absolute numbers. Matt, you want to cover the second part?

Matthew Ryan

Sure, we’re actually in pilot right now in the marketplace. So we are offering mobile order and pay to many customers. You can call it guess checkout if you will to many people who do not have a stored value card. What will happen by the time we reach the end of March is we’ll be able to scale that nationwide and make that available to all customers who are using our app.


The last question comes from Nicole Miller with Piper Jaffray. Your line is open.

Nicole Miller Regan

Thank you. Good afternoon. Just two quick ones, both on China. As you look at the brand identity there and the unit growth, are you seeing achievements from landlords and stable rents in that regard?

And then the second part is around the CPG business, so when you look at I guess China, also look at Japan and places that – I think you’re growing the international CPG product rollout. Is there a U.S. model, you want the stores first or not as a model or now it is a model switch, where you have enough stores and you have the Shanghai Roastery that can go full fetched forward with that and that’s something that also aids in brand awareness? Thanks.

John Culver

Yeah, Nicole. This is John. Real quick on the China piece. We are seeing continued very strong growth as it relates to our stores and really the elevation of the Roastery and the opening of the Roastery, we have landlords coming from all over China to see that. And they are reaching out to us, asking us to bring beautifully designed stores into their development.

So we see tremendous opportunity to continue to accelerate the growth of new stores. Our new store performance is the strongest that is ever been. We opened up 188 new stores in the quarter. We now operate 3,100, over 3,100 stores across the Mainland. And we’re going to continue to accelerate the growth. And we’ll share more about that on our call next week with you.

And then in terms of the channel development business and how we’re thinking about growing channel development in these developing markets and in particular in China, as Scott shared, we sold 30 million bottles of Frappuccino since we introduced our partnership with Tingyi. Clearly, we have a strong retail brand footprint. But that retail brand is now extending out into the channels business, and then to retailers as well as into the digital space as well.

And we’re seeing that play out not only in China. We’re seeing that in Japan, and then obviously, strong growth coming out of our channel development business in EMEA. So we’re excited to grow that business in parallel with our retail footprint.

Scott Maw

So just – I’d add to John’s point and maybe reflect back to a question that John Ivankoe asked about the growth of CAP.

And just remember, in 2017, we saw China/Asia Pacific add nearly 50% of our overall operating income growth. As we think about this year, we’ll probably be in that same range. Maybe not quite as much, because the Americas business is going to contribute a little bit more. But this is the twin engines of growth that Kevin talked about so specifically in his comments.

And as we look forward to 2019 and we get into the full ownership of East China, I think you’re going to see that same kind of mix to the overall operating income growth. That’s obviously driven by China, but within China/Asia Pacific, the other pieces of Japan and Korea as well. So just make sure you remember this, that we’re seeing a strong blend of profitability across those two businesses.


I will now turn the call over to Mr. Shaw for his closing remarks.

Tom Shaw

Great. Thanks. Before closing today’s call, we wanted to provide an update on the timing of several upcoming events. As mentioned in our earnings release today, we will host a supplemental call to discuss our business in China, as well as implications from modeling standpoint next Wednesday, January 31 at 2:00 PM Pacific.

In addition, we want to provide the specific dates of our China investor tour that Howard mentioned. We plan to host management meetings, local store tours, and a visit to the Roastery in Shanghai on May 16, with plans to visit a second market the following day on May 17.

And finally, we are timidly planning our 2018 Investor Day in New York on Wednesday, December 12. Thanks again. And have a great evening.


This concludes Starbucks Coffee Company’s First Quarter Fiscal Year 2018 Earnings Conference Call. You may now disconnect.

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Airbnb Adds Another Man to Its All-Male Board

Outgoing American Express CEO Kenneth Chenault is certainly keeping busy.

After being named to Facebook’s board last week, Chenault has now been added to Airbnb’s board of directors as well.

Read: Airbnb Has Some Breathtaking Listings in ‘Shithole’ Countries

Chenault is the company’s first independent board member, as well as its first African-American. However, critics have pointed out that Airbnb’s board remains all male. The short-term rental site has pledged that its next board hire will be female, saying that it is already in “serious discussions with a number of incredible people.” The company reportedly plans to include a woman before the end of the year.

Both minorities and women have historically been excluded from boards of tech companies—a prestigious and high-paying role. According to TheBoardlist, 68% of unicorn tech companies (those with billion dollar-plus valuations), have no women on their boards.

Read: Facebook Just Acquired This Company Focused on Authenticating ID Cards

Airbnb’s board currently consists of its three founders Brian Chesky, Nathan Blecharczyk, and Joe Gebbia, as well as venture capitalists Jeff Jordan and Alfred Lin. While there have been rumors that Condoleezza Rice, Valerie Jarrett, and Meg Whitman could be named to the board next, Recode reports that sources say these are not the names under consideration.

Airbnb is currently preparing for an IPO. It is valued at $30 billion, making it the second-most-valuable startup in the U.S. after Uber, according to data from CBInsights.

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Want to Define Your Company's Culture? Start By Answering These 2 Simple Questions

Recent developments regarding sexual harassment allegations have leaders of companies scrambling to eliminate the potential for these behaviors in their companies and mitigate risk. Unfortunately, many of these efforts, albeit altruistic in motive, are tragically flawed in approach.

Rewriting employee manuals and company policies will have little to no effect on preventing a toxic culture. Human behavior is controlled by three things (listed from highest to lowest effectiveness):

  1. Personal moral compass (“I shall” and “I shall not”)
  2. Culture (“We shall” and “We shall not”)
  3. Policies, rules, laws (“You shall” and “You shall not”)

The first two on the list are intrinsic. They are highly effective and inexpensive to administrate. When those two fail, we tend to go litigious. Number three is extrinsic and the least effective.

So, hire well. Screen candidates to assess their personal moral compass, and be intentional about building a corporate culture that is intolerant of sexual harassment and abuse. Here’s how.

Draw your line.

Start with this exercise:

  1. Hang a piece of butcher paper on a wall and gather your team around it. Draw a black line horizontally across the center of the paper.
  2. Above the line, ask the group to answer the question, “What behaviors do we tolerate?” Below the line, have the group answer, “What behaviors don’t we tolerate?”

Caution: Do not be aspirational. Tell the truth. Are people late for meetings? Then “being late” goes above the line. Do you hear gossip at work? Then “gossip” goes above the line. The key is to get people to tell the truth, and in this context, truth means describing things as they actually are.

Once everyone in the group is satisfied that the paper truthfully lists the behaviors they have been tolerating and have not been tolerating daily, draw a line on a second piece of paper. This time, ask the group to list behaviors that, from this moment forward, they will tolerate and advocate for above the line. Then, below the line, list the behaviors they will no longer tolerate. Ever.

Again, this is not an aspirational exercise. Make sure each person who fills out this second chart is committed to living into this culture starting immediately. If they write it on the paper, they are now committing to living into these behaviors.

Everyone enforces your culture.

Everyone in the group should agree that anyone who witnesses behaviors that are below the line has an obligation to call out the offender, regardless of who they are.

This is essential. In a peak performance culture, the lowest-level person in the organization feels obligated to call out the highest-level person in the organization should they see behaviors that breach what was documented on that paper. Culture is enforced by any and all.

Keep the second sheet of paper somewhere it will be seen, like near the coffee pot. Each month, gather to see if what people are experiencing in the company matches what is written.

If not, there are only two choices: change the behavior to match the paper or change the paper to match the experiences. Repeat monthly.

This straightforward process will have profound implications for your corporate culture. All you need is a couple of big sheets of paper, some markers, a commitment to honoring your word, and a heap of moral courage.

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General Electric: Lessons In KISS Investing

My focus has never been on large caps, and I don’t cover General Electric (GE) often. When I have, I’ve tried to warn here several times (twice in 2017 here and here) on Seeking Alpha as I have been a fundamental bear for some time. Every time I think the valuation is starting to remotely come into line, another shoe drops that has me questioning the entire corporate structure again. I often get questions about buying the company since I run an Industrials-focused Marketplace offering (Industrial Insights), especially at today’s valuations. In my view, very little has changed of my opinion here in the wake of all the analyst downgrades and the poor outlook for GE Capital driven by the upcoming $6,200M after-tax charge on the way in Q4. I still don’t see a valid reason to pull the trigger. What I spoke to last time I covered the firm heading into the Investor Day rings just as true today:

This isn’t meant as a victory lap on a correct call, but just another cautionary tale of why owning a company with eight operating segments, a plethora of intercompany transactions, hazy non-GAAP metrics, and a steep valuation can often be a time bomb sitting in your portfolio.

While I think retail investors often get themselves into silly situations, Keep It Simple Stupid (“KISS”) is always one of the best approaches smaller investors can take. While investors need to be educated on the companies they own or would like to own, not everyone can be expected to have either the experience or qualifications to make sense of complicated financial statements. With relatively easy to understand companies – 3M Company (MMM), Apple (AAPL), etc. – shareholders don’t need to concern themselves with the tiniest of details. Arguably, Joe Schmo might have his ear to the ground on trends in product demand better than someone sitting on 200th West Street in Manhattan at his office at Goldman Sachs (NYSE:GS). These companies make products consumers want, demand is healthy, and financials are reported in a clean, easy to understand way. GAAP results closely mirror non-GAAP, cash flows are healthy, and results have been predictable. General Electric has never been that company. My hope was that the transition away from GE Capital would eliminate that to some extent, but until that is wound down completely, the long-term care issues within GE Capital might not be the last bombshell.

Insurance Charge Implications, Rough Start To Flannery’s Tenure

Most investors are now familiar with the upcoming insurance charge, under which General Electric will bear a $6,200M after-tax charge in Q4 (along with $2,000M/year for the foreseeable future) as it increases statutory reserves by $15,000M. As a result, GE Capital will suspend dividends to General Electric, and this likely means that GE Capital Aviation Services (“GECAS”), which I had hoped would be sold off to raise funds, will need to be retained to help shore up finances. Remember, shareholders were promised a clean separation from the entity alongside a return to industrial roots. How likely does that look now?

This charge relates to the legacy insurance business that was spun off into Genworth Financial (NYSE:GNW) in 2004/2005. As one of Jeff Immelt’s early moves as CEO, these long-term care liabilities have always been known to be a potential problem. In fact, General Electric reportedly held on to these liabilities in order to not depress Genworth’s initial public offering (“IPO”) valuation. Still, when you have Moody’s insurance analysts making statements like these alongside credit downgrades (GE Capital standalone credit was downgraded to Baa3 from Baa2 recently):

…the risks associated with GE Capital’s insurance activities are considerably greater than we previously thought…

That indicates a deep structural problem in clarity of operations, and calls into question how this problem could go unnoticed for so long. It also brings into question the potential fall-out for other insurers that had or have exposure to the long-term care insurance industry, including MetLife (NYSE:MET), Prudential Financial (NYSE:PRU), Unum Group (NYSE:UNM), and CNO Financial (NYSE:CNO). Coming from an internal audit background, this is deeply troubling as it relates to internal risk assessment, as well as how well KPMG performs its job as auditor. Unfortunately, it might not even be the end of the story within long-term care. Given the elevated claims and high performance volatility and leverage here, GE Capital might need even more capital support in the future. Pain here might not be over.

You can’t fault Flannery for any of this. These issues did not occur under his watch, and he said every stone was going to be turned late last year. It is clear that he continues to take those steps. Shareholders, either current or prospective, need the certainty that the company has been gone over completely. If that involves (hopefully) short-term pain in the common stock price, so be it. Corporate culture at large enterprises like General Electric is inevitably an issue as the nuances of day-to-day operations get lost as information is moved up the management chain, and it takes a very hard-line stance from management that propagates from the top down to reverse years of mismanagement. This won’t be an easy fix; it will take time to right-size the portfolio and get the General Electric ship turned on a proper course.

When To Buy?

This translates over to when to buy. Patience is a virtue. I’m guilty of mistiming an entry as much as anyone, but what I’ve found is that is very rare for entry opportunities to be short-lived. There is rarely a case where I need to buy right now, today, or even this week. Market sentiment is notoriously hard to turn, and the buy calls all the way down on Seeking Alpha were plain as day signs that there had been no capitulation. The company isn’t out of the woods yet, as problems persist. Already known, the pension shortfall continues to be a clear headwind that will need to be closed eventually.

The opportunity will come when operational results turn. Given the company’s massive interest expense and historically poor cash flow figures in 2016 and 2017, investors do need to take stock of interest coverage if results continue to languish. What was previously viewed as an ironclad balance sheet is showing substantial kinks as General Electric burns through billions of dollars, and the more than $21,000M spent on buybacks in 2016 now should give shareholders palpitations. Waiting for a turnaround never hurt anyone. In my view, paying a possible premium to today’s share prices six months to a year down the line in order to ensure operations have returned to health and results are more clearly presented is a far better alternative to buying today.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Intel Says the Patch Designed to Fix Flawed Chips Is Faulty

Intel Corp (intc) said on Monday that patches it released to address two high-profile security vulnerabilities in its chips are faulty, advising customers, computer makers and cloud providers to stop installing them.

Intel Executive Vice President Navin Shenoy disclosed the problem in a statement on the chipmaker’s website, saying that patches released after months of development caused computers to reboot more often than normal and other “unpredictable” behavior.

“I apologize for any disruption this change in guidance may cause,” Shenoy said. “I assure you we are working around the clock to ensure we are addressing these issues.”

The issue of the faulty patches is separate from complaints by customers for weeks that the patches slow computer performance. Intel has said a typical home and business PC user should not see significant slowdowns.

Intel‘s failure to provide a usable patch could cause businesses to postpone purchasing new computers, said IDC analyst Mario Morales.

Intel is “still trying to get a handle on what’s really happening. They haven’t resolved the matter,” he said.

Intel asked technology providers to start testing a new version of the patches, which it began distributing on Saturday.

For more on the chip security flaw, watch Fortune’s video:

The warning came nearly three weeks after Intel confirmed on Jan. 3 that its chips were impacted by vulnerabilities known as Spectre and Meltdown, which make data on affected computers vulnerable to espionage.

Meltdown was specific to chips from Intel, as well as one from SoftBank Group’s ARM Holdings. Spectre affected nearly every modern computing device, including ones with chips fromIntel, ARM and Advanced Micro Devices.

Problems with the patches have been growing since Intel on Jan. 11 said they were causing higher reboot rates in its older chips and then last week that the problem was affecting newer processors.

The Wall Street Journal first reported Intel asking customers to halt using the patches.

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Icahn, Deason to jointly push Xerox to explore selling itself, other options: WSJ

(Reuters) – Investor Carl Icahn and Darwin Deason, the biggest- and third-largest shareholders of Xerox Corp, jointly plan to push the printer and photocopier maker to explore options, including a sale of the firm, the Wall Street Journal reported on Sunday.

Icahn and Deason, who together own 15.7 percent of the photocopier pioneer, have earlier separately called on the company to break off or renegotiate a joint venture with Fujifilm Holdings Corp, saying it was unfavorable to Xerox. Icahn has also called for Xerox CEO Jeff Jacobson to be replaced.

The two shareholders have now formed an alliance and plan to ask Xerox to explore options, including selling itself, breaking off its long-running joint venture with Fujifilm, and immediately firing Jacobson, the Journal reported, citing people familiar with the matter.

The Journal had previously reported that Fujifilm and Xerox were discussing deals, including a change of control of Xerox, though not a full sale.

FILE PHOTO: The logo of Xerox company is seen on a building in Minsk, Belarus, March 21, 2016. REUTERS/Vasily Fedosenko/File Photo

In a statement, Xerox said: “The Xerox Board of Directors and management are confident with the strategic direction in which the Company is heading and we will continue to take action to achieve our common goal of creating value for all Xerox shareholders.”

Deason has been asking the company to make public the terms of its deal with Fujifilm, which he called “one-sided”. Xerox has described Deason’s criticism as “false and misleading”.

The five-decade-old joint venture, 75 percent owned by Fujifilm and 25 percent by Xerox, is a pillar of Fujifilm’s business, accounting for nearly half the group’s overall operating profit. It has limited prospects for future growth, however, because of declining demand for office printing.

The reported operating profit of the joint venture, called Fuji Xerox, was about $750 million on sales of $10 billion in the year ended last March.

Fujifilm declined to comment on the Journal report.

Reporting by Kanishka Singh in Bengaluru; Additional reporting by Makiko Yamazaki in TOKYO; Editing by Peter Cooney and Muralikumar Anantharaman

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Google CEO Has No Regrets About Firing Author of Anti-Diversity Memo

Google CEO Sundar Pichai on Friday expressed no regret over the firing of James Damore, author of an infamous memo criticizing Google’s pro-diversity policies and culture.

During an appearance with YouTube CEO Susan Wojcicki, Pichai said, “I don’t regret it,” when asked about Damore’s firing by Recode head Kara Swisher. He insisted that the firing was primarily a strategic decision for Google. “The last thing we do when we make decisions like this is look at it with a political lens,” Pichai said, according to TechCrunch.

Google has been working to increase its hiring of women. Damore’s memo, which became public in August, argued in part that women might not be biologically suited for careers in engineering or technology. Many commentators felt that retaining Damore after the memo’s distribution would make Google a hostile work environment for women.

Wojcicki also described the firing as “the right decision.”

Get Data Sheet, Fortune’s technology newsletter.

Though Google’s priority was internal cohesion, Damore’s memo was broadly criticized by many in the tech sector and beyond, including for faulty interpretations of biological science. Damore quickly revised inaccurate representations that he had completed a Harvard PhD in biology.

At the same time, reports did indicate that Damore’s views were quietly widespread in the lower ranks of Google.

Damore earlier this month initiated a lawsuit against Google, alleging that the company discriminates against white men. That case seems difficult to make on its face, since its most recent diversity report found that the company is 69% male and 91% white or Asian, with black or Hispanic people making up only 3% and 4% of new hires, respectively.

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Amazon boosts monthly fee for Prime by $2, maintains yearly rate

(Reuters) – Inc (AMZN.O) raised the monthly fee for the U.S. version of its fast-shipping and video-streaming service Amazon Prime by $2 on Friday, making the case for subscribers to upgrade to an annual plan.

It was the first increase of Prime fees in almost four years and comes at the end of another bullish year and holiday season for Amazon’s dominant online shopping platform.

The move also follows a rise in fees by video streaming rival Netflix Inc (NFLX.O) in October.

Amazon increased the fee for its monthly plan to $12.99 from $10.99, while maintaining the annual fee at $99. It also hiked the monthly subscription fee for college students to $6.49 from $5.49.

“That’s good value, over time they’ve raised the price. I don’t think they will lose many members,” Tigress Financial Partners analyst Ivan Feinseth said.

“Those who use it the most get the most value and won’t mind the higher price and those who don’t use it are not the best customers, so even if they drop off it is not a big loss to Amazon,” he said.

As of September, Amazon had about 90 million Prime members in the United States, according to research firm Statista. The company itself does not disclose the number.

Netflix has 52.77 million subscribers in the U.S. and its global tally is 109 million.

Existing monthly Prime and Prime Student members will pay the new price for renewals after Feb. 18, Amazon said on its website.

Amazon, which along with Netflix faces competition from Hulu and Alphabet Inc’s (GOOGL.O) YouTube, has been spending heavily to make original shows.

Only Prime has the added dimension of offering subscribers discounts and other benefits from its shopping platform, which help the company lure more buyers.

The company shipped over 5 billion items worldwide via the subscription service in 2017 and revenue from subscription fees that include Prime jumped 59 percent to $2.4 billion in the quarter ended Sept.30. The company reports its fourth quarter on Feb. 1.

“We only expect to see 2 percent churn from this price increase with many customers moving to the yearly subscription which is the ‘golden goose’ for Bezos & Co as once on the annual plan customers rarely churn,” GBH Insights analyst Daniel Ives said.

Amazon’s shares rose 0.5 percent to $1,300 on Friday.

Reporting by Aishwarya Venugopal and Arjun Panchadar in Bengaluru; Editing by Sriraj Kalluvila

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