Starbucks 10-K 2008
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Commission File Number: 0-20322
2401 Utah Avenue South
Seattle, Washington 98134
(Address of principal executive offices, zip code, telephone number)
Securities Registered Pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation of S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the voting stock held by non-affiliates of the registrant as of the last business day of the registrants most recently completed second fiscal quarter, based upon the closing sale price of the registrants common stock on March 28, 2008 as reported on the NASDAQ Global Select Market was $12.1 billion. As of November 13, 2008, there were approximately 733.3 million shares of the registrants Common Stock outstanding.
Portions of the definitive Proxy Statement for the registrants Annual Meeting of Shareholders to be held on March 18, 2009 have been incorporated by reference into Part III of this Annual Report on Form 10-K.
For the Fiscal Year Ended September 28, 2008
Item 1. Business
Starbucks Corporation was formed in 1985 and today is the worlds leading roaster and retailer of specialty coffee. Starbucks (together with its subsidiaries, Starbucks or the Company) purchases and roasts high-quality whole bean coffees and sells them, along with fresh, rich-brewed coffees, Italian-style espresso beverages, cold blended beverages, a variety of complementary food items, a selection of premium teas, and coffee-related accessories and equipment, primarily through Company-operated retail stores. Starbucks also sells coffee and tea products and licenses its trademark through other channels such as licensed retail stores and, through certain of its equity investees and licensees, Starbucks produces and sells a variety of ready-to-drink beverages. All channels outside the Company-operated retail stores are collectively known as specialty operations.
The Companys objective is to establish Starbucks as one of the most recognized and respected brands in the world. To achieve this goal, the Company plans to continue disciplined expansion of its retail operations, to grow its specialty operations and to selectively pursue other opportunities by introducing new products and developing new channels of distribution.
Starbucks has three reportable operating segments, with each segment providing the indicated percentage of total net revenues for fiscal year ended September 28, 2008 (fiscal 2008): United States (76%), International (20%) and Global Consumer Products Group (CPG) (4%). The United States and International segments both include Company-operated retail stores and certain components of specialty operations. Specialty operations within the United States includes licensed retail stores, foodservice accounts and other initiatives related to the Companys core business. International specialty operations primarily consists of retail store licensing operations in more than 30 countries and foodservice accounts in Canada and the United Kingdom (UK). The International segments largest markets, based on number of retail stores, currently are Canada, Japan and the UK. The CPG segment includes packaged coffee and tea as well as branded products sold worldwide through channels such as grocery stores, warehouse clubs and convenience stores, and operates primarily through joint ventures and licensing arrangements with large consumer products business partners. This operating model leverages the business partners existing infrastructures and as a result, the CPG segment reflects relatively lower revenues, a modest cost structure, and a resulting higher operating margin, compared to the Companys other two reporting segments, which consist primarily of retail stores.
Financial information about Starbucks segments is included in Note 18 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K (10-K or Report).
The following table shows the Companys revenue components as a percentage of total net revenues and related specialty revenues for the fiscal year ended September 28, 2008:
Company-operated Retail Stores
The Companys retail goal is to become the leading retailer and brand of coffee in each of its target markets by selling the finest quality coffee and related products and by providing each customer a unique Starbucks Experience. The Starbucks Experience, or third place beyond home and work, is built upon superior customer service as well as clean and well-maintained Company-operated retail stores that reflect the personalities of the communities in which they operate, thereby building a high degree of customer loyalty.
Starbucks strategy for expanding its retail business is to increase its market share by selectively opening additional stores in existing markets and opening stores in new markets to support its long term strategic objectives. As described in more detail in Managements Discussion and Analysis in this 10-K, the Company committed in June 2008 to close approximately 600 underperforming Company-operated stores in the US. The decision was an integral part of its transformation strategy, first announced in January 2008, and was a result of a rigorous evaluation of the US Company-operated store portfolio. The store closures were initiated in the fourth quarter of fiscal 2008 and are expected to be completed by the end of fiscal 2009.
Starbucks Company-operated retail stores accounted for 84% of total net revenues during fiscal 2008.
The following table summarizes total Company-operated retail store data for the periods indicated:
Starbucks retail stores are typically located in high-traffic, high-visibility locations. Because the Company can vary the size and format, its stores are located in or near a variety of settings, including downtown and suburban retail centers, office buildings and university campuses. While the Company selectively locates stores in shopping malls, it focuses on locations that provide convenient access for both pedestrians and drivers. The Company also locates retail stores in select rural and off-highway locations to serve a broader array of customers outside major metropolitan markets. To provide a greater degree of access and convenience for nonpedestrian customers, the Company has continued to expand development of drive-thru retail stores. At the end of fiscal 2008, the Company operated approximately 2,800 drive-thru locations, compared to approximately 2,300 at the end of fiscal 2007, representing approximately 35% and 31%, respectively, of Company-operated stores in the US and Canada combined.
All Starbucks stores offer a choice of regular and decaffeinated coffee beverages, a broad selection of Italian-style espresso beverages, cold blended beverages, iced shaken refreshment beverages, a selection of premium teas and distinctively packaged roasted whole bean coffees. Starbucks stores also offer a variety of fresh food items, including several healthy choice selections. Food items include pastries, prepared breakfast and lunch sandwiches, and salads as well as sodas, juices, and bottled water. Starbucks continues to expand its food warming program in the United States and Canada, with approximately half of these stores as of September 28, 2008 providing warm food items, primarily breakfast sandwiches. A range of coffee-making equipment and accessories are also sold in the stores. Each Starbucks store varies its product mix depending upon the size of the store and its location. Larger stores carry a broad selection of the Companys whole bean coffees in various sizes and types of packaging, as well as coffee and espresso-making equipment and accessories. Smaller Starbucks stores and kiosks typically sell a full line of coffee beverages, a limited selection of whole bean coffees and a few accessories such as travel tumblers and logo mugs.
Retail sales mix by product type for Company-operated stores was as follows:
Specialty operations strive to develop the Companys brands outside the Company-operated retail store environment through a number of channels. Starbucks strategy is to reach customers where they work, travel, shop and dine by establishing relationships with prominent third parties that share the Companys values and commitment to quality. These relationships take various forms, including licensing arrangements, foodservice accounts and other initiatives related to the Companys core businesses. In certain situations, Starbucks has an equity ownership interest in licensee operations. During fiscal 2008, specialty revenues (which include royalties and fees from licensees, as well as product sales derived from specialty operations) accounted for 16% of total net revenues.
In its licensed retail store operations, the Company leverages the expertise of its local partners and shares Starbucks operating and store development experience. Licensee partners provide improved and, at times, the only access to desirable retail space. Most licensees are prominent retailers with in-depth market knowledge and access. As part of these arrangements, Starbucks receives license fees and royalties and sells coffee, tea and related products for resale in licensed locations. Employees working in licensed retail locations are required to follow Starbucks detailed store operating procedures and attend training classes similar to those given to employees in Company-operated stores.
During fiscal 2008, 438 Starbucks licensed retail stores were opened in the United States and, as of September 28, 2008, the Companys US licensees operated 4,329 stores. During fiscal 2008, 550 International licensed stores were opened. At September 28, 2008, the Companys International operating segment had a total of 3,134 licensed retail stores. Product sales to and royalty and license fee revenues from US and International licensed retail stores accounted for 48% of specialty revenues in fiscal 2008.
At fiscal year end 2008, Starbucks total licensed retail stores by region and specific location were as follows:
Through a licensing relationship with Kraft Foods, Inc. (Kraft), the Company sells a selection of Starbucks and Seattles Best Coffee branded packaged coffees and Tazo® teas in grocery and warehouse club stores throughout the United States. Kraft manages all distribution, marketing, advertising and promotion of these products.
The Company sells packaged coffee and tea internationally both directly to warehouse club customers, such as Costco, and through a licensing relationship with Kraft in Canada and the UK.
By the end of fiscal 2008, the Companys coffees and teas were available in approximately 37,000 grocery and warehouse club stores, with 33,000 in the United States and 4,000 in International markets. Revenues from this category comprised 21% of specialty revenues in fiscal 2008.
The Company licenses the rights to produce and market Starbucks branded products through several partnerships both domestically and internationally. Significant licensing agreements include:
Collectively, the revenues from these branded products accounted for 4% of specialty revenues in fiscal 2008.
The Company sells whole bean and ground coffees, including the Starbucks and Seattles Best Coffee brands, as well as a selection of premium Tazo® teas and other related products, to institutional foodservice companies that service business and industry, education, healthcare, office coffee distributors, hotels, restaurants, airlines and other retailers. The majority of the Companys direct accounts are through national broadline distribution networks with SYSCO Corporation and US Foodservicetm. Starbucks foodservice sales, customer service and support resources are aligned with those of SYSCO Corporation and US Foodservice.
The Companys total foodservice operations had over 19,000 accounts, primarily in the US, at fiscal year end 2008. Revenues from foodservice accounts comprised 25% of total specialty revenues in fiscal 2008.
Starbucks is committed to selling only the finest whole bean coffees and coffee beverages. To ensure compliance with its rigorous coffee standards, Starbucks controls its coffee purchasing, roasting and packaging, and the distribution of coffee used in its operations. The Company purchases green coffee beans from coffee-producing regions around the world and custom roasts them to its exacting standards for its many blends and single origin coffees.
The supply and price of coffee are subject to significant volatility. Although most coffee trades in the commodity market, high-altitude arabica coffee of the quality sought by the Company tends to trade on a negotiated basis at a substantial premium above commodity coffee prices, depending upon the supply and demand at the time of purchase. Supply and price can be affected by multiple factors in the producing countries, including weather, political and economic conditions. In addition, green coffee prices have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations that have historically attempted to influence prices of green coffee through agreements establishing export quotas or by restricting coffee supplies.
To help ensure sustainability and future supply of high-quality green coffees in Central America and to reinforce the Companys leadership role in the coffee industry, Starbucks operates the Starbucks Coffee Agronomy Company
S.R.L., a wholly owned subsidiary located in Costa Rica. Staffed with agronomists and sustainability experts, this first-of-its-kind Farmer Support Center is designed to proactively respond to changes in coffee producing countries that impact farmers and the supply of green coffee. During fiscal 2008, the Company expanded this sustainability program to Africa by establishing a Farmer Support Center in Rwanda.
The Company buys coffee using fixed-price and price-to-be-fixed purchase commitments, depending on market conditions, to secure an adequate supply of quality green coffee. Due to volatility in green coffee commodity prices, the Company has historically used fixed-price purchase contracts in order to bring greater certainty to its cost of sales in future periods and promote sustainability by paying an equitable price to coffee producers. When green coffee commodity prices are high for sustained periods of time, the Company is less likely to enter into fixed-price contracts on favorable terms and more likely to increase the use of price-to-be-fixed contracts to meet its demand for coffee. These types of contracts state the quality, quantity and delivery periods and fix the price relative to a green coffee commodity benchmark, but allow the benchmark price to be established after contract signing. An increased use of price-to-be-fixed contracts instead of fixed-price contracts decreases the predictability of coffee costs in future periods until the price of green coffee becomes fixed by either Starbucks or the seller.
During fiscal 2008 Starbucks more than doubled its volume of price-to-be-fixed purchase commitments when compared to fiscal 2007, as a result of higher green coffee commodity prices. During fiscal 2008, C coffee commodity prices traded on the New York Board of Trade within a price range of $1.18 to $1.67 per pound and prices were, on average, approximately 20% higher than fiscal 2007 and 25% higher than fiscal 2006.
As of September 28, 2008, the Company had $583 million of purchase commitments which, together with existing inventory, is expected to provide an adequate supply of green coffee through calendar 2009. Based on expected coffee delivery dates, approximately 86%, 9% and 5% of these purchase commitments will be received by Starbucks in fiscal years 2009, 2010 and 2011 and later, respectively. Additionally, approximately $246 million of these purchase commitments are price-to-be-fixed contracts, most of which will be received by Starbucks during fiscal 2009.
The Company depends upon its relationships with coffee producers, outside trading companies and exporters for its supply of green coffee. The Company believes, based on relationships established with its suppliers, the risk of non-delivery on such purchase commitments is remote.
In addition to coffee, the Company also purchases significant amounts of dairy products, particularly fluid milk, to support the needs of its Company-operated retail stores. Dairy expense for the US segment represents a large majority of the Companys total dairy expense; therefore significant changes in US dairy prices can have a material impact on total dairy expense. The US segments dairy costs, which closely follow the monthly Class I fluid milk base price as calculated by the US Department of Agriculture, can change significantly in the short term. The Companys US dairy costs remained higher throughout most of fiscal 2008 compared to fiscal 2007, adversely affecting the US segments and the Companys profitability. In the United States, the Company purchases substantially all of its fluid milk requirements from three dairy suppliers. The Company believes, based on relationships established with these suppliers, that the risk of non-delivery of enough fluid milk to support its US retail business is remote.
The Company also purchases a broad range of paper and plastic products, such as cups, lids, cutlery, napkins, straws, shopping bags and corrugated paper boxes from several companies to support the needs of its retail stores as well as its manufacturing and distribution operations. The cost of these materials is dependent in part upon commodity paper and plastic resin costs, but the Company believes it mitigates the effect of short-term raw material price fluctuations through strategic relationships with key suppliers.
Products other than whole bean coffees and coffee beverages sold in Starbucks retail stores are obtained through a number of different channels. Beverage ingredients, other than coffee and milk, including leaf teas and the Companys selection of ready-to-drink beverages, are purchased from several specialty manufacturers, usually under long-term supply contracts. Food products, such as fresh pastries, breakfast sandwiches and lunch items, are generally purchased from both regional and local sources. Coffee-making equipment, such as drip and coffee press coffeemakers, espresso machines and coffee grinders, are generally purchased directly from their manufacturers.
Coffee-related accessories, including items bearing the Companys logos and trademarks, are produced and distributed through contracts with a number of different suppliers.
The Companys primary competitors for coffee beverage sales are quick-service restaurants and specialty coffee shops. In almost all markets in which the Company does business, there are numerous competitors in the specialty coffee beverage business, and management expects this situation to continue. The Company believes that its customers choose among specialty coffee retailers primarily on the basis of product quality, service and convenience, as well as price. Starbucks has been experiencing significantly greater direct competition from large competitors in the United States quick-service restaurant sector, some of whom have substantially greater financial, marketing and operating resources than the Company. Starbucks also faces well-established competitors in many International markets and increased competition in the US ready-to-drink coffee beverage market.
The Companys whole bean coffees compete directly against specialty coffees sold through supermarkets, specialty retailers and a growing number of specialty coffee stores. Both the Companys whole bean coffees and its coffee beverages compete indirectly against all other coffees on the market. Starbucks specialty operations face significant competition from established wholesale and mail order suppliers, some of whom have greater financial and marketing resources than the Company.
Starbucks also faces intense competition from both restaurants and other specialty retailers for prime retail locations and qualified personnel to operate both new and existing stores.
The Company owns and/or has applied to register numerous trademarks and service marks in the United States and in many additional countries throughout the world. Rights to the trademarks and service marks in the United States are generally held by a wholly owned affiliate of the Company and are used by the Company under license. Some of the Companys trademarks, including Starbucks, the Starbucks logo, Frappuccino, Seattles Best Coffee and Tazo are of material importance to the Company. The duration of trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained.
The Company owns numerous copyrights for items such as product packaging, promotional materials, in-store graphics and training materials. The Company also holds patents on certain products, systems and designs. In addition, the Company has registered and maintains numerous Internet domain names, including Starbucks.com and Starbucks.net.
Starbucks research and development efforts are led by the Research and Development department. This team is responsible for the technical development of food and beverage products and new equipment. The Company spent approximately $7.2 million, $7.0 million and $6.5 million during fiscal 2008, 2007 and 2006, respectively, on technical research and development activities, in addition to customary product testing and product and process improvements in all areas of its business.
The Companys business is subject to seasonal fluctuations, including fluctuations resulting from the holiday season. The Companys cash flows from operations are considerably higher in the fiscal first quarter than the remainder of the year. This is largely driven by cash received as Starbucks Cards are purchased and loaded during the holiday season. Since revenues from the Starbucks Card are recognized upon redemption and not when purchased, seasonal fluctuations on the consolidated statements of earnings are much less pronounced. Quarterly results are affected by the timing of the opening of new stores, and the Companys growth may conceal the impact of other seasonal influences. For these reasons, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.
The Company employed approximately 176,000 people worldwide as of September 28, 2008. In the United States, Starbucks employed approximately 143,000 people, with 136,000 in Company-operated retail stores and the remainder in the Companys administrative and regional offices, and store development, roasting and warehousing operations. Approximately 33,000 employees were employed outside of the United States, with 32,000 in Company-operated retail stores and the remainder in the Companys regional support facilities and roasting and warehousing operations. The number of the Companys employees represented by unions is immaterial. Starbucks believes its current relations with its employees are good.
Starbucks 10-K reports, along with all other reports and amendments filed with or furnished to the Securities and Exchange Commission (SEC), are publicly available free of charge on the Investor Relations section of Starbucks website at http://investor.starbucks.com or at www.sec.gov as soon as reasonably practicable after these materials are filed with or furnished to the SEC. The Companys corporate governance policies, ethics code and Board of Directors committee charters are also posted within this section of the website. The information on the Companys website is not part of this or any other report Starbucks files with, or furnishes to, the SEC.
Starbucks is committed to being a deeply responsible company in the communities where it does business around the world. The Companys focus is on ethically sourcing high-quality coffee, reducing its environmental impacts and contributing positively to communities. Starbucks Global Responsibility strategy and commitments are integral to the Companys overall business strategy. As a result, Starbucks believes it delivers benefits to the Company and its stakeholders, including employees, business partners, customers, suppliers, shareholders, community members and others. For an overview of Starbucks Global Responsibility strategy and commitments, please see Starbucks fiscal 2008 Global Responsibility Report, which will be available online at www.starbucks.com/sharedplanet in April 2009.
Item 1A. Risk Factors
Starbucks is including this Cautionary Statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the Act) for forward-looking statements. This 10-K includes forward-looking statements within the meaning of the Act. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as believes, expects, anticipates, estimates, intends, plans, seeks or words of similar meaning, or future or conditional verbs, such as will, should, could, may, aims, intends, or projects. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this Report. These forward-looking statements are all based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. The Companys actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, the risks and uncertainties discussed below.
The Companys failure to meet market expectations going forward, particularly with respect to comparable store sales, net revenues, operating margins, and earnings per share, will likely result in a decline in the market price of Starbucks stock.
In fiscal 2008, the Company undertook the development and implementation of several important strategic initiatives as part of a transformation strategy designed to drive long-term shareholder value and improve Starbucks results of operations, including:
There can be no assurance that the Company will be able to successfully implement its new strategic initiatives or that its transformation plan will result in improved results of operations. If the Company does not successfully implement its new strategic initiatives, or if its transformation plan does not achieve its intended results, the Company may experience a material adverse impact on its business and financial results.
As the recent global financial crisis has broadened and intensified, other sectors of the economy have been adversely impacted and a severe global recession now appears likely. As a retailer that is dependent upon consumer discretionary spending, the Company will face an extremely challenging fiscal 2009 because Starbucks customers may have less money for discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and sharply falling home prices. Any resulting decreases in customer traffic or average value per transaction will negatively impact the Companys financial performance as reduced revenues result in sales de-leveraging which creates downward pressure on margins. Additionally, many of the effects and consequences of the global financial crisis and a broader global economic downturn are currently unknown; any one or all of them could potentially have a material adverse effect on the Companys liquidity and capital resources, including Starbucks ability to issue commercial paper and to raise additional capital if needed, the ability of banks to honor draws on Starbucks credit facility, or otherwise negatively impact the Companys business and financial results.
The Companys financial performance is highly dependent on its United States operating segment, which comprised 76% of consolidated total net revenues in fiscal 2008. The Company experienced a substantial down-turn in traffic in its US stores in fiscal 2008, which adversely affected the operating results of the US segment and the Company as a whole. If the US segment is unable to improve its financial performance, the Companys business and financial results will continue to be adversely affected.
In July 2008, the Company announced several restructuring measures as part of the Companys multi-faceted plan to transform its business and improve results of operations, including a plan to close approximately 600 underperforming Company-operated stores in the US market, a restructuring of the Australia market, and certain leadership and non-store organization changes. There can be no assurance that the Company will fully realize the anticipated positive impacts to future financial results from these restructuring measures. The estimated costs and charges associated with the US store closures are based on managements assumptions and projections and may vary materially based on various factors, including the timing of store closures, the outcome of negotiations with landlords and other third parties, the Companys ability to place affected partners (employees) into available positions at other Starbucks stores, and other changes in managements assumptions and projections. As a result of these events and circumstances, delays and unexpected costs may occur, which could result in the Company not fully realizing the anticipated positive impact to the Companys future financial results from such US store closures. Further, to the extent that the Company is unable to improve its financial performance in fiscal 2009, further restructuring measures may be required in the future.
The Companys future growth will increasingly depend on the growth and sustained profitability of its International operating segment. Some or all of the Companys International market business units (MBUs), which Starbucks generally defines by the countries or regions in which they operate, may not be successful in their operations or in achieving expected growth, which ultimately requires achieving consistent, stable net revenues and earnings. The performance of the International operating segment may be adversely affected by economic downturns in one or more of the Companys large MBUs. Additionally, some factors that will be critical to the success of International MBUs are different than those affecting the Companys US stores and licensees. Tastes naturally vary by region, and consumers in new international markets into which Starbucks and its licensees expand may not embrace Starbucks products to the same extent as consumers in the Companys existing markets. Occupancy costs and store operating expenses are also sometimes higher internationally than in the United States due to higher rents for prime store locations or costs of compliance with country-specific regulatory requirements. Because many of the Companys International operations are in an early phase of development, operating expenses as a percentage of related revenues are often higher compared to US operations. The Companys International operations are also subject to additional inherent risks of conducting business abroad, such as:
Moreover, many of the foregoing risks are particularly acute in developing counties, which are important to the Companys long-term growth prospects.
Starbucks Canada, Japan and UK markets account for a significant portion of the net revenues and profit contribution of the Companys International operating segment. Any significant decline in the financial performance of one of these key markets may have a material adverse impact on the results of operations of the entire Starbucks International segment, if not partially or fully offset by positive financial performance from the other two major markets.
A description of the general competitive conditions in which Starbucks operates appears on page 7 under Competition. In the United States, the continued focus by one or more large competitors in the quick-service restaurant sector on selling high-quality specialty coffee beverages at a low cost has attracted Starbucks customers and could, if the numbers become large enough, adversely affect the Companys sales and results of operations. Similarly, continued competition from well-established competitors in international markets could hinder growth and adversely affect the Companys sales and results of operations in those markets. Increased competition from large competitors with significant resources in the United States packaged coffee and tea, and ready-to-drink coffee beverage market could adversely affect the profitability of the CPG segment and the Companys results of operations. Given its premium brand, Starbucks may be impacted more severely than its competitors by customers trading down to lower priced coffee beverages and related products.
Starbucks believes it has built an excellent reputation globally for the quality of its products, for delivery of a consistently positive consumer experience and for its corporate social responsibility programs. The Starbucks brand has been highly rated in several global brand value studies. Management believes it must preserve and grow the value of the Starbucks brand to be successful in the future, particularly outside of North America, where the Starbucks brand is less well-known. Brand value is based in part on consumer perceptions as to a variety of subjective qualities. Even isolated business incidents that erode consumer trust, particularly if the incidents receive considerable publicity or result in litigation, can significantly reduce brand value. Consumer demand for the Companys products and its brand equity could diminish significantly if Starbucks fails to preserve the quality of its products, is perceived to act in an unethical or socially irresponsible manner or fails to deliver a consistently positive consumer experience in each of its markets.
The Companys success depends substantially on the contributions and abilities of key executives and other employees, and on its ability to recruit and retain high quality employees to work in and manage Starbucks stores. Starbucks must continue to recruit, retain and motivate management and other employees sufficient to maintain its current business and support its projected growth. A loss of key employees or a significant shortage of high quality store employees could jeopardize the Companys ability to meet its financial targets.
The Companys business strategy, including its plans for new stores, foodservice, branded products and other initiatives, relies significantly on a variety of licensee and partnership relationships, particularly in its International markets. Licensees are often authorized to use the Starbucks logo and provide Starbucks-branded beverages, food and other products directly to customers. The Company provides training and support to, and monitors the operations of, these business partners, but the product quality and service they deliver to Starbucks customers may be diminished by any number of factors beyond the Companys control. Management believes customers expect the same quality of products and service from the Companys licensees as they do from Starbucks and the Company strives to ensure customers have the same experience whether they visit a Company-operated or licensed store. Any shortcoming of a Starbucks business partner, particularly an issue affecting the quality of the service experience or the safety of beverages or food, may be attributed by customers to Starbucks, thus damaging the Companys reputation and brand value and potentially affecting the results of operations.
Effectively managing growth can be challenging, particularly as Starbucks expands into new markets internationally, where it must balance the need for flexibility and a degree of autonomy for local management with
consistency with the Companys goals, philosophy and standards. Significant growth can make it increasingly difficult to ensure a consistent supply of high quality raw materials, to locate and hire sufficient numbers of key employees to meet the Companys financial targets, to maintain an effective system of internal controls for a globally dispersed enterprise and to train employees worldwide to deliver a consistently high quality product and customer experience.
Some Starbucks products contain caffeine, dairy products, sugar and other active compounds, the health effects of which are the subject of increasing public scrutiny, including the suggestion that excessive consumption of caffeine, dairy products, sugar and other active compounds can lead to a variety of adverse health effects. There has also been greater public awareness that sedentary lifestyles, combined with excessive consumption of high-calorie foods, have led to a rapidly rising rate of obesity. Particularly in the United States, there is increasing consumer awareness of health risks, including obesity, due in part to increasing publicity and attention from health organizations, as well as increased consumer litigation based on alleged adverse health impacts of consumption of various food products. While Starbucks has a variety of healthy choice beverage and food items, including items that are low in caffeine and calories, an unfavorable report on the health effects of caffeine or other compounds present in the Companys products, or negative publicity or litigation arising from other health risks such as obesity, could significantly reduce the demand for the Companys beverages and food products.
Similarly, instances or reports, whether true or not, of unclean water supply, food-borne illnesses and food tampering have in the past severely injured the reputations of companies in the food processing, grocery and quick-service restaurant sectors and could in the future affect the Company as well. Any report linking Starbucks to the use of unclean water, food-borne illnesses or food tampering could damage its brand value, immediately and severely hurt sales of its beverages and food products, and possibly lead to product liability claims. Clean water is critical to the preparation of specialty coffee beverages. The Companys ability to ensure a clean water supply to its stores is limited, particularly in some International locations. If customers become ill from food-borne illnesses, the Company could also be forced to temporarily close some stores. In addition, instances of food-borne illnesses or food tampering, even those occurring solely at the restaurants or stores of competitors, could, by resulting in negative publicity about the foodservice industry, adversely affect Starbucks sales on a regional or global basis. A decrease in customer traffic as a result of these health concerns or negative publicity, or as a result of a temporary closure of any of the Companys stores, could materially harm the Companys business and results of operations.
A health pandemic is a disease that spreads rapidly and widely by infection and affects many individuals in an area or population at the same time. If a regional or global health pandemic were to occur, depending upon its duration and severity, the Companys business could be severely affected. Starbucks has positioned itself as a third place between home and work where people can gather together for human connection. Customers might avoid public gathering places in the event of a health pandemic, and local, regional or national governments might limit or ban public gatherings to halt or delay the spread of disease. A regional or global health pandemic might also adversely impact the Companys business by disrupting or delaying production and delivery of materials and products in its supply chain and by causing staffing shortages in its stores. The impact of a health pandemic on Starbucks might be disproportionately greater than on other companies that depend less on the gathering of people together for the sale, use or license of their products and services.
As of September 28, 2008, Starbucks had approximately $5.1 billion in minimum future rental payments under non-cancelable operating leases and $3.2 billion of total liabilities on a consolidated basis. Included in total liabilities are aggregate principal indebtedness of $713 million under outstanding commercial paper and revolving credit facility borrowings, and $550 million under ten-year notes maturing in August 2017. Future increases in the Companys
level of financial obligations, if any, would have several important effects on the Companys future operations, such as:
The Companys ability to satisfy its lease obligations and make payments of principal and interest on its indebtedness depends on its future performance, which will be subject to general economic conditions, industry cycles and financial, business and other factors affecting its consolidated operations, many of which are beyond the Companys control. If Starbucks is unable to generate sufficient cash flow from operations in the future to satisfy its financial obligations, it may be required, among other things:
Such measures might not be sufficient to enable Starbucks to satisfy its financial obligations. In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms.
An increase in leverage could lead to deterioration in Starbucks credit ratings. A reduction in its credit ratings, regardless of the cause, could limit the Companys availability of additional financing and increase its cost of obtaining financing.
Starbucks relies heavily on information technology systems across its operations, including for management of its supply chain, point-of-sale processing in its stores, and various other processes and transactions. The Companys ability to effectively manage its business and coordinate the production, distribution and sale of its products depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product sales and reduced efficiency of the Companys operations, and significant capital investments could be required to remediate the problem.
Starbucks policies and procedures are designed to comply with all applicable laws and regulations, including those imposed by the SEC, NASDAQ, and foreign countries, as well as applicable labor laws. Additional legal and regulatory requirements, such as those arising under the Sarbanes-Oxley Act of 2002, together with the fact that foreign laws occasionally conflict with domestic laws, increase the complexity of the regulatory environment in which the Company operates and the related cost of compliance. Failure to comply with the various laws and regulations may result in damage to Starbucks reputation, civil and criminal liability, fines and penalties, increased cost of regulatory compliance and restatements of the Companys financial statements.
If any of the risks and uncertainties described in the cautionary factors described above actually occurs, Starbucks business, financial condition and results of operations could be materially and adversely affected. The factors listed
above are not exhaustive. Other sections of this 10-K include additional factors that could materially and adversely impact Starbucks business, financial condition and results of operations. Moreover, Starbucks operates in a very competitive and rapidly changing environment. New factors emerge from time to time and it is not possible for management to predict the impact of all these factors on Starbucks business, financial condition or results of operation or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not rely on forward-looking statements as a prediction of actual results. Any or all of the forward-looking statements contained in this 10-K and any other public statement made by Starbucks or its management may turn out to be incorrect. Starbucks expressly disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Item 1B. Unresolved Staff Comments
The following table shows properties used by Starbucks in connection with its roasting and distribution operations:
The Company leases approximately 1.0 million square feet of office space in Seattle, Washington for corporate administrative purposes. Also in Seattle, Washington, the Company owns a 205,000 square foot office building with an adjacent 36,000 square foot plot of land, which is currently under development. The Company is no longer occupying the office building and is currently considering various options for both the building and the adjacent land, including sublease and sale.
As of September 28, 2008, Starbucks had more than 9,000 Company-operated retail stores. The Company also leases space in approximately 170 additional locations for regional, district and other administrative offices, training facilities and storage, not including certain seasonal retail storage locations.
See discussion of Legal Proceedings in Note 17 to the consolidated financial statements included in Item 8 of this Report.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fiscal fourth quarter of 2008.
The executive officers of the Company are as follows:
Howard Schultz is the founder of Starbucks and serves as the Companys chairman, president and chief executive officer. Mr. Schultz has served as chairman of the board since the Companys inception in 1985 and he resumed his role as president and chief executive officer in January 2008. From June 2000 to February 2005, Mr. Schultz held the title of chief global strategist. From November 1985 to June 2000, he served as chief executive officer. From November 1985 to June 1994, Mr. Schultz also served as president.
Cliff Burrows joined Starbucks in April 2001 and has served as president, Starbucks Coffee US since March 2008. Mr. Burrows served as president, Europe, Middle East and Africa (EMEA) from April 2006 to March 2008. He served as vice president and managing director, UK prior to April 2006. Prior to joining Starbucks, Mr. Burrows served in various management positions with Habitat Designs Limited, a furniture and housewares retailer.
Martin P. Coles joined Starbucks in April 2004 as president, Starbucks Coffee International, and, in July 2008, reassumed this role, after having served as chief operating officer from September 2007 to July 2008. Prior to joining Starbucks, Mr. Coles served as an executive vice president of Reebok International, Ltd. a sports and fitness products company, from December 2001 to February 2004. Prior to joining Reebok International, Ltd., Mr. Coles held several executive level management sales and operations positions with NIKE Inc., Letsbuyit.com and Gateway, Inc.
Gerardo I. Lopez joined Starbucks in October 2004 as senior vice president; president, Global Consumer Products and became senior vice president; president, Global Consumer Products, Foodservice and Seattles Best Coffee in November 2007. Prior to joining Starbucks, Mr. Lopez was president of the Handleman Entertainment Resources division of Handleman Company from November 2001 to September 2004 and was senior vice president and general manager from May 2000 to November 2001. Prior to that, Mr. Lopez held a variety of executive management positions with Frito-Lay, Inc., Pepsi-Cola Company and The Procter & Gamble Company.
Arthur Rubinfeld rejoined Starbucks in February 2008 as president, Global Development. Mr. Rubinfeld also serves as president of AIRVISION LLC, an advisory firm specializing in brand positioning that he founded in June 2002. From March 2006 to February 2008, Mr. Rubinfeld served as executive vice president, Corporate Strategy and chief development officer at Potbelly Sandwich Works. Prior to 2002, Mr. Rubinfeld held several positions in Store Development at Starbucks.
Peter J. Bocian joined Starbucks as executive vice president and chief financial officer designate in May 2007 and became executive vice president, chief financial officer and chief administrative officer in October 2007. As previously announced Mr. Bocian will resign as executive vice president, chief financial officer and chief administrative officer at the end of November 2008. Prior to joining Starbucks, Mr. Bocian worked at NCR Corporation a technology and services company. From 2004 to May 2007, Mr. Bocian served as NCRs senior vice president and chief financial officer. From 2003 to 2004, he served as NCRs vice president, finance and interim chief financial officer. From 2002 to 2003, Mr. Bocian was the chief financial officer of NCRs Retail and Financial Group, covering four business units and from 1999 to 2002, he served as the chief financial officer of NCRs Retail Solutions Division.
Troy Alstead joined Starbucks in 1992 and currently serves as the Companys senior vice president, Global Finance, a position he has held since September 2007. As previously announced, Mr. Alstead will succeed Mr. Bocian as executive vice president, chief financial officer and chief administrative officer at the end of November 2008. Mr. Alstead previously served as chief operating officer, Starbucks Greater China from April 2008 to September 2008, senior vice president, Corporate Finance from September 2004 to August 2007, interim president, Starbucks Europe/Middle East/Africa from April 2003 through August 2004, and senior vice president, Starbucks Coffee International from March 2003 through March 2004. Mr. Alstead served in a number of other senior positions with Starbucks prior to 2004.
Paula E. Boggs joined Starbucks in September 2002 as executive vice president, general counsel and secretary. Prior to joining Starbucks, Ms. Boggs served as vice president, legal, for products, operations and information technology at Dell Computer Corporation from 1997 to 2002. From 1995 to 1997, Ms. Boggs was a partner with the law firm of Preston Gates & Ellis (now K&L Gates). Ms. Boggs served in several roles at the Pentagon, White House and US Department of Justice between 1984 and 1995.
Michelle Gass joined Starbucks in 1996 and has served as the Companys senior vice president, Marketing and Category since July 2008. As previously announced, Ms. Gass will assume the role of executive vice president, Marketing and Category beginning December 1, 2008. Ms. Gass previously served as senior vice president, Global Strategy, Office of the ceo from January 2008 to July 2008, senior vice president, Global Product and Brand from August 2007 to January 2008, senior vice president, U.S. Category Management from May 2004 to August 2007 and vice president, U.S. Category Management from October 2003 to April 2004. Ms. Gass served in a number of other positions with Starbucks prior to 2003.
Peter D. Gibbons joined Starbucks in February 2007 and has served as executive vice president, Global Supply Chain Operations since July 2008. From February 2007 to July 2008, Mr. Gibbons served as senior vice president, Global Manufacturing Operations. From March 1999 to February 2007, Mr. Gibbons was executive vice president, Supply Chain, of The Glidden Company, a subsidiary of ICI Americas, Inc.
Dorothy J. Kim joined Starbucks in November 1995 and has served as executive vice president, Global Strategy, Office of the ceo since July 2008. From December 2004 to July 2008, Ms. Kim served as executive vice president, Supply Chain Operations. From April 2003 to December 2004, Ms. Kim served as senior vice president, Global Logistics, Planning and Procurement. Prior to April 2003, Ms. Kim served in various executive roles in Supply Chain and Coffee Operations and also held several positions in retail planning and operations.
Chet Kuchinad joined Starbucks in April 2003 and has served as executive vice president, Partner Resources since January 2008. Mr. Kuchinad served as senior vice president, Total Pay from April 2003 to January 2008. Prior to joining Starbucks, Mr. Kuchinad held a number of positions in the field of human resources with NIKE, Inc., McDonalds Corporation and Towers Perrin.
There are no family relationships among any directors or executive officers of the Company.
The Companys common stock is traded on the NASDAQ Global Select Market (NASDAQ), under the symbol SBUX. The following table shows the quarterly high and low closing sale prices per share of the Companys common stock as reported by NASDAQ for each quarter during the last two fiscal years:
As of November 13, 2008, the Company had approximately 21,000 shareholders of record. Starbucks has never paid any dividends on its common stock and does not currently anticipate paying a cash dividend in the near future.
The Company did not repurchase any shares during the fourth quarter of fiscal 2008. As of the end of the quarter, the maximum number of shares that may yet be purchased under publicly announced stock repurchase plans was 6,272,128 shares.
The following graph depicts the Companys total return to shareholders from September 28, 2003 through September 28, 2008, relative to the performance of the Standard & Poors 500 Index, the NASDAQ Composite Index, and the Standard & Poors 500 Consumer Discretionary Sector, a peer group that includes Starbucks. All indices shown in the graph have been reset to a base of 100 as of September 28, 2003, and assume an investment of $100 on that date and the reinvestment of dividends paid since that date. Starbucks has never paid a dividend on its common stock. The stock price performance shown in the graph is not necessarily indicative of future price performance.
Item 6. Selected Financial Data
In millions, except earnings per share and store information
The following selected financial data are derived from the consolidated financial statements of the Company. The data below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations, Risk Factors, and the Companys consolidated financial statements and notes. In particular, see Note 1 to the consolidated financial statements included in Item 8 of this Report for a description of accounting changes that materially affect the comparability of the data presented below.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
Starbucks Corporations fiscal year ends on the Sunday closest to September 30. Some fiscal years include 53 weeks. The fiscal years ended on September 28, 2008, September 30, 2007 and October 1, 2006 all included 52 weeks. All references to store counts, including data for new store openings, are reported net of related store closures, unless otherwise noted.
Throughout fiscal 2008, Starbucks continued to experience declining comparable store sales in its US stores, primarily due to lower customer traffic. With the US segment representing 76% of consolidated revenues, the impact of this decline on the Companys financial results for fiscal 2008 was significant. For fiscal year 2008 comparable store sales declined 5% in the US, with a declining trend over the course of the year, ending with a decline of 8% in the fourth quarter. The Company also experienced declining comparable sales in Canada and the UK, its two largest Company-operated International markets, primarily due to lower traffic. The Company believes that the weaker traffic has been caused by a number of ongoing factors in the global economies that have negatively impacted consumers discretionary spending, as well as factors within the Companys control with respect to the pace of store openings in the US and store level execution. In the US, the economic factors included the higher cost of such basic consumer staples as gas and food, rising levels of unemployment and personal debt, reduced access to consumer credit, and lower home values as well as increased foreclosure activity in certain areas of the country (California and Florida) where Starbucks has a high concentration of Company-operated stores. These developments combined with recent and ongoing unprecedented shocks to the global financial system and capital markets have all contributed to sharp declines in consumer confidence in the US.
Starbucks business is highly sensitive to increases and decreases in customer traffic. Increased customer visits create sales leverage, meaning that fixed expenses, such as occupancy costs, are spread across a greater revenue base, thereby improving operating margins. But the reverse is also true sales de-leveraging creates downward pressure on margins. The softness in US revenues during fiscal 2008 impacted nearly all consolidated and US segment operating expense line items when viewed as a percentage of sales.
Since January 2008, when Company founder Howard Schultz reassumed the role of president and chief executive officer in addition to his role as chairman, Starbucks has taken steps to address the deterioration in the US retail environment and address its global support structure. These included the development and implementation of several important strategic initiatives as part of a transformation strategy designed to reinvigorate the Starbucks Experience for the Companys customers, increase customer traffic in its US stores, reduce infrastructure expenses, and improve the Companys results of operations. These significant actions have been designed to structure the Companys business for long-term profitable growth.
As a result of the continued weak economy and decreased customer traffic, as well as the costs associated with the store closures and other actions in its transformation strategy, the Companys fiscal 2008 results were negatively impacted in the following ways:
The more significant actions taken by Starbucks in fiscal 2008 to transform and reinvigorate its business included:
Management expects the Company to continue to face a very difficult economic environment throughout fiscal 2009, both in the US and internationally, including in its two largest Company-operated markets of Canada and the UK. As the global financial crisis has broadened and intensified, other sectors of the global economy have been adversely impacted and a severe global recession of uncertain length now appears likely. As a retailer that is dependent upon consumer discretionary spending, the Company expects to face an extremely challenging fiscal 2009 because of these economic conditions. Accordingly, Starbucks expects to report negative comparable store sales for fiscal 2009. Additionally, the Companys earnings for fiscal 2009 will be impacted by lease termination and severance costs from the US and Australia store closures, totaling up to an estimated $0.12 of EPS for fiscal 2009. The Company estimates that the combination of the US and Australia store closures and head count reductions will result in a pre-tax benefit to operating income of approximately $200 million to $210 million in fiscal 2009, which equates to approximately $0.17 to $0.18 of EPS.
Starbucks plans to be disciplined in its approach to new store openings, in both Company-operated and licensed markets, and adjust as needed in response to further worsening in the global economy. Starbucks fiscal 2009 US store opening target is approximately a negative 20 net new stores, which includes a nearly 225 Company-operated store decline and approximately 205 net new licensed stores. Internationally, Starbucks is planning to open approximately 700 net new stores in fiscal 2009, two-thirds of which are expected to be licensed, as it factors in the current global economic climate, with a more cautious approach in the UK and western Europe.
Starbucks has three reportable operating segments: United States, International and CPG.
The United States and International segments both include Company-operated retail stores, licensed retail stores and foodservice operations. Licensed stores frequently have a higher operating margin than Company-operated stores. Under the licensed model, Starbucks receives a reduced share of the total store revenues, but this is more than offset by the reduction in its share of costs as these are primarily borne by the licensee. The International segment has a higher relative share of licensed stores versus Company-operated compared to the US segment; however, the US segment has been operating significantly longer than the International segment and has developed deeper awareness of, and attachment to, the Starbucks brand and stores among its customer base. As a result, the more mature US segment has significantly more stores, and higher total revenues than the International segment. Average sales per store are also higher in the US due to various factors including length of time in market and local income levels. Further, certain market costs, particularly occupancy costs, are lower in the US segment compared to the average for the International segment, which comprises a more diverse group of operations. As a result of the relative strength of the brand in the US segment, the number of stores, the higher unit volumes, and the lower market costs, the US segment, despite its higher relative percentage of Company-operated stores, has a higher operating margin, excluding restructuring costs, than the less-developed International segment.
The Companys International store base continues to increase and Starbucks has been achieving a growing contribution from established international markets while at the same time investing in emerging markets, such as China, Brazil and Russia. The Companys newer international markets require a more extensive support organization, relative to the current levels of revenue and operating income.
The CPG segment includes packaged coffee and tea as well as branded products operations worldwide. The CPG segment operates primarily through joint ventures and licensing arrangements with large consumer products business partners, most significantly The North American Coffee Partnership with the Pepsi-Cola Company for distribution of ready-to-drink beverages, and with Kraft Foods Inc. for distribution of packaged coffees and teas. This operating model allows the CPG segment to leverage the business partners existing infrastructures and to extend the Starbucks brand in an efficient way. Most of the customer revenues from the ready-to-drink and packaged coffee channels are recognized as revenues by the joint venture or licensed business partner, not by the CPG segment, and the proportionate share of the results of the Companys joint ventures are included on a net basis in Income from equity investees on the consolidated statements of earnings. As a result, the CPG segment reflects relatively lower revenues, a modest cost structure, and a resulting higher operating margin, compared to the Companys other two reporting segments, which consist primarily of retail stores.
Expenses pertaining to corporate administrative functions that support the operating segments but are not specifically attributable to or managed by any segment are not included in the reported financial results of the operating segments. These unallocated corporate expenses include certain general and administrative expenses, related depreciation and amortization expenses, restructuring charges and amounts included in Interest income and other, net and Interest expense on the consolidated statements of earnings.
See Note 2 to the consolidated financial statements in this 10-K.
RESULTS OF OPERATIONS FISCAL 2008 COMPARED TO FISCAL 2007
Consolidated results of operations (in millions):
Net revenues for the fiscal year ended 2008 increased due to growth in both Company-operated retail revenues and specialty operations.
During fiscal 2008, Starbucks derived 84% of total net revenues from its Company-operated retail stores. Company-operated retail revenues increased, primarily attributable to the opening of 681 new Company-operated retail stores in the last 12 months, offset by negative 3% comparable store sales for the same period. Revenue growth was slower than in previous years due to a combination of declining comparable store sales and a decrease in the number of net new stores opened during fiscal 2008. The weakness in consolidated comparable store sales was driven by the US segment, which posted a comparable store sales decline of 5% for the year. Partially offsetting this was 2% comparable store sales growth in the International segment. Within fiscal 2008, consolidated quarterly revenue
growth decelerated each quarter and comparable store sales declined each quarter, reflecting the ongoing challenging economic conditions in the US.
The Company derived the remaining 16% of total net revenues from channels outside the Company-operated retail stores, collectively known as specialty operations. Licensing revenues, which are derived from retail store licensing arrangements as well as grocery, warehouse club and certain other branded-product operations, increased primarily due to higher product sales and royalty revenues from the opening of 988 new licensed retail stores in the last 12 months. The increase in Foodservice and other revenues was primarily driven by growth in new and existing accounts in the US foodservice business.
For fiscal 2009, the Company expects total revenues to be relatively flat compared to fiscal 2008, with variations driven by the level of comparable store sales.
As discussed in the Management Overview section above, many of the Companys operating expenses are fixed in nature. As a result, the softness in US revenues during fiscal 2008 impacted nearly all consolidated and US segment operating expense line items when viewed as a percentage of sales, and pressured operating margins.
Cost of sales including occupancy costs increased primarily due to higher distribution costs and higher rent expenses as a percentage of revenues. Store operating expenses as a percentage of Company-operated retail revenues increased primarily due to higher payroll expenditures as a percentage of revenues coupled with impairment provisions in the US business, primarily driven by the slowdown in projected store openings. Depreciation and amortization expenses increased primarily due to the opening of 681 new Company-operated retail stores in the last 12 months. General and administrative expenses decreased primarily due to lower payroll-related expenses. Restructuring charges include asset impairment, lease exit and severance costs. These costs are associated with the closure of underperforming stores in the US and Australia, and the rationalization of the Companys leadership structure and non-store organization. See Note 3 to the consolidated financial statements for further discussion.
Operating margin compression was primarily due to lower revenues; in addition, restructuring charges accounted for approximately 40% of the decrease.
Interest income and other net, decreased due primarily to unrealized market value losses on the Companys trading securities portfolio. As described in more detail in Note 4 to the consolidated financial statements, the trading securities approximate a portion of the Companys liability under its Management Deferred Compensation Plan (MDCP). The MDCP liability also increases and decreases with changes in investment performance, with this offsetting impact recorded in General and administrative expenses on the consolidated statements of earnings. Interest expense increased due to the Companys issuance of $550 million of 10-year 6.25% Senior Notes in August of fiscal 2007.
Income taxes for the fiscal year ended 2008 resulted in an effective tax rate of 31.3% compared to 36.3% for fiscal 2007. The lower rate is due to the higher proportion of income earned in foreign jurisdictions which have lower tax rates, as well as an increase in the domestic manufacturing deduction for manufacturing activities in the US.
Segment information is prepared on the same basis that the Companys management reviews financial information for operational decision-making purposes. Starbucks has three reportable operating segments: United States, International and CPG. Unallocated Corporate includes expenses pertaining to corporate administrative functions that support the operating segments but are not specifically attributable to or managed by any segment and are not included in the reported financial results of the operating segments. Operating income represents earnings before Interest income and other, net, Interest expense and Income taxes. The following tables summarize the Companys results of operations by segment for fiscal 2008 and 2007 (in millions).
The United States operating segment sells coffee and other beverages, complementary food, whole bean coffees, and coffee brewing equipment and merchandise primarily through Company-operated retail stores. Specialty operations within the United States include licensed retail stores, foodservice accounts and other initiatives related to the Companys core business.
Company-operated retail revenues increased primarily due to the opening of 445 new Company-operated retail stores in the last 12 months, partially offset by a 5% decrease in comparable store sales for fiscal 2008. The US Company-operated retail business continued to experience deteriorating trends in transactions during the year, driven by the US economic slowdown.
Licensing revenues increased primarily due to higher product sales and royalty revenues as a result of opening 438 new licensed retail stores in the last 12 months. Foodservice and other revenues increased primarily due to growth in new and existing foodservice accounts.
Operating margin contracted significantly primarily due to restructuring charges incurred and to softer revenues due to weak traffic, as well as higher cost of sales including occupancy costs and higher store operating expenses as a percentage of revenues. Restructuring charges of $210.9 million had a 270 basis point impact on the operating margin. The increase in cost of sales including occupancy costs was primarily due to higher distribution costs and higher rent expenses as a percentage of revenues. Higher store operating expenses was due to the softer sales, higher payroll-related expenditures, and charges from canceling future store sites and asset impairments.
The International operating segment sells coffee and other beverages, complementary food, whole bean coffees, and coffee brewing equipment and merchandise through Company-operated retail stores in Canada, the UK and nine other markets. Specialty operations primarily include retail store licensing operations in nearly forty other countries and foodservice accounts, primarily in Canada and Japan. The Companys International store base continues to increase and Starbucks expects to achieve a growing contribution from established areas of the business while at the same time investing in emerging markets and channels. Many of the Companys International operations are in early stages of development that require a more extensive support organization, relative to the current levels of revenue and operating income, than in the United States. This continuing investment is part of the Companys long-term, balanced plan for profitable growth.
Company-operated retail revenues increased due to the opening of 236 new Company-operated retail stores in the last 12 months, favorable foreign currency exchange rates, primarily on the Canadian dollar, and comparable store sales growth of 2% for fiscal 2008. In the fourth quarter of fiscal 2008, Company-operated retail revenues grew at a slower rate year-over-year of 12% and comparable store sales were flat compared to the same quarter in fiscal 2007, both driven by slowdowns in the UK and Canada, due to the weakening global economy.
Specialty revenues increased primarily due to higher product sales and royalty revenues from opening 550 new licensed retail stores in the last 12 months.
Operating margin decreased primarily due to higher cost of sales including occupancy costs driven by continued expansion of lunch and warming programs in Canada, higher distribution costs, and higher building maintenance expense due to store renovation activities. In addition, restructuring charges of $19.2 million recognized in fiscal 2008 had a 90 basis point impact on the operating margin, nearly all due to the closure of 61 Company-operated stores in Australia.
The CPG operating segment sells a selection of whole bean and ground coffees and premium Tazo® teas through licensing arrangements in United States and international markets. CPG also produces and sells a variety of ready-to-drink beverages through its joint ventures and marketing and distribution agreements.
Total net revenues increased primarily due to higher royalties and product sales in the international ready-to-drink business and increased sales of US packaged tea and International club packaged coffee.
Growth of operating margin was primarily due to lower cost of sales as a percentage of related revenues, partially offset by lower income from equity investees. Lower cost of sales was primarily due to a sales mix shift to more profitable products.
Unallocated corporate expenses pertain to corporate administrative functions that support, but are not specifically attributable to the Companys operating segments.
Total unallocated corporate expenses remained relatively flat due to lower payroll-related expenditures, which were offset by restructuring charges incurred for corporate office facilities that were no longer occupied by the Company due to the reduction in positions within Starbucks leadership structure and non-store organization.
RESULTS OF OPERATIONS FISCAL 2007 COMPARED TO FISCAL 2006
Consolidated Results of Operations (in millions):
Net revenues for the fiscal year ended 2007 increased from fiscal 2006, driven by increases in both Company-operated retail revenues and specialty operations.
During the fiscal year ended 2007, Starbucks derived 85% of total net revenues from its Company-operated retail stores. Company-operated retail revenues increased primarily due to the opening of 1,342 new Company-operated retail stores in the last 12 months and comparable store sales growth of 5% for the fiscal year ended 2007. The increase in comparable store sales was due to a 4% increase in the average value per transaction and a 1% increase in the number of customer transactions.
The Company derived the remaining 15% of total net revenues from channels outside the Company-operated retail stores, collectively known as specialty operations. Licensing revenues, which are derived from retail store licensing arrangements as well as grocery, warehouse club and certain other branded-product operations, increased primarily due to higher product sales and royalty revenues from the opening of 1,229 new licensed retail stores in the last 12 months and a 20% increase in licensing revenues from the Companys CPG business. Foodservice and other revenues increased due to growth in new and existing accounts in the US foodservice business.
Cost of sales including occupancy costs increased primarily due to a shift in sales mix to higher cost products, the rise in distribution costs, higher rent expense and higher dairy costs. Dairy expense for the US segment represents approximately 75% of the total Companys dairy expense. For the US segment the average dairy costs per gallon rose 10% in fiscal 2007 compared to fiscal 2006, resulting in approximately $20 million of additional expense.
Store operating expenses as a percentage of Company-operated retail revenues decreased primarily due to higher provisions for incentive compensation in the prior year due to exceptionally strong performance as well as leverage on regional overhead costs in fiscal 2007. Other operating expenses decreased primarily as a result of controlled discretionary spending in fiscal 2007. Depreciation and amortization expenses increased primarily due to the opening of 1,342 new Company-operated retail stores in the last 12 months. General and administrative expenses increased primarily due to higher payroll-related expenditures in support of continued global growth, offset in part by unusually high charitable contributions in fiscal 2006. Income from equity investees increased primarily due to higher equity income from international investees.
Operating margin compression was due to higher costs of sales and occupancy costs as a percentage of total net revenues due to a shift in sales to higher cost products and higher distribution costs, rent expense and dairy costs. These cost pressures were offset in part by leveraging general and administrative expenses, store operating expenses, and other operating expenses as a percentage of total net revenues.
Interest income and other, net, increased due to a higher amount of income recognized on unredeemed stored value card and gift certificate balances in fiscal 2007 compared to fiscal 2006. Interest expense increased due to a higher level of borrowings outstanding, which included the $550 million of Senior Notes issued in August 2007.
Income taxes for the fiscal year ended 2007 resulted in an effective tax rate of 36.3%, compared to 35.8% for fiscal 2006.
Operating Segments (in millions):
Company-operated retail revenues increased primarily due to the opening of 1,065 new Company-operated retail stores in the last 12 months and comparable store sales growth of 4% for fiscal 2007, nearly all resulting from an increase in the average value per transaction. The US Company-operated retail business experienced deteriorating trends in transactions late in the year, driven by, management believes, the US economic slowdown combined with two price increases in US retail stores implemented in fiscal 2007.
Licensing revenues increased primarily due to higher product sales and royalty revenues as a result of opening 723 new licensed retail stores in the last 12 months. Foodservice and other revenues increased primarily due to growth in new and existing foodservice accounts.
Operating margin decreased due to higher cost of sales including occupancy costs, primarily due to a shift in sales mix to higher cost products such as food and merchandise, higher distribution costs, higher rent expense and higher dairy costs. Partially offsetting these were lower store operating expenses, lower general and administrative expenses, and lower other operating expenses as a percentage of total net revenues. The decline in store operating expenses as a percentage of total net revenues was primarily due to higher provisions for incentive compensation in the prior year as well as leverage on regional overhead costs in fiscal 2007. General and administrative expenses were lower primarily due to decreased salary and related benefits expense as well as lower professional fees. The
decline in other operating expenses as a percentage of total net revenues was primarily due to controlled discretionary spending in the current year.
Company-operated retail revenues increased due to the opening of 277 new Company-operated retail stores in the last 12 months, comparable store sales growth of 7% for fiscal 2007 and favorable foreign currency exchange for the British pound sterling. The increase in comparable store sales resulted from a 5% increase in the number of customer transactions coupled with a 2% increase in the average value per transaction.
Total specialty revenues increased primarily due to higher product sales and royalty revenues from opening 506 new licensed retail stores in the last 12 months.
Operating margin decreased primarily due to higher cost of sales including occupancy costs due in part to a shift in sales mix to higher cost products such as food and merchandise and higher distribution costs. Partially offsetting this increase was lower general and administrative expenses as a percentage of total net revenues.
Total net revenues increased primarily due to increased sales of US packaged coffee and tea as well as increased product sales and royalties in the international ready-to-drink business.
Operating margin contraction was primarily due to slower growth in income from The North American Coffee Partnership, an equity investee, which produces ready-to-drink beverages.
Unallocated corporate expenses as a percentage of total net revenues decreased primarily as a result of leveraging of the Companys scale and infrastructure against global growth.
LIQUIDITY AND CAPITAL RESOURCES
The Companys existing cash and liquid investments were $322.3 million and $459.7 million as of September 28, 2008 and September 30, 2007, respectively. The decrease in liquid investments was driven primarily by $59.8 million of auction rate securities, nearly all of which are held within the Companys wholly owned captive insurance company, that are not currently considered liquid and were reclassified to long-term investments in the second quarter of fiscal 2008.
Included in the cash and liquid investment balances are the following:
As described in more detail in Note 4 to the consolidated financial statements, as of September 28, 2008, the Company had $74.4 million invested in available-for-sale securities, consisting primarily of auction rate securities. While the ongoing auction failures will limit the liquidity of these investments for some period of time, the Company does not believe the auction failures will materially impact its ability to fund its working capital needs, capital expenditures or other business requirements.
The Company manages the balance of its cash and liquid investments in order to internally fund operating needs and make scheduled interest and principal payments on its borrowings.
Following the Companys announcement on July 1, 2008 that it planned to close approximately 600 underperforming US Company-operated stores and reduce new store growth in fiscal year 2009, Standard & Poors placed the BBB+ long-term rating and A-2 short term ratings for Starbucks on CreditWatch with negative implications. On July 3, 2008, Moodys placed the Baa1 senior unsecured rating for Starbucks on review for possible downgrade, however Moodys reaffirmed the Companys Prime-2 short-term rating for commercial paper. Standard and Poors and Moodys subsequently downgraded the long-term ratings as of September 4, 2008 and November 17, 2008, respectively.
Credit rating agencies currently rate the Companys borrowings as follows:
Factors that may affect credit ratings include changes in the Companys operating performance, the economic environment and the Companys capital structure. In order to maintain its credit ratings, there is an expectation that the Company will modestly reduce its leverage during fiscal 2009. The Company expects to improve its leverage ratio below a certain target level primarily through the reduction in short term borrowings. Credit rating downgrades can adversely impact, among other things, future borrowing costs, access to capital markets, and future operating lease terms. If either of the Companys short-term ratings were downgraded, it would likely make the issuance of commercial paper difficult. In these circumstances the Company could draw upon its credit facility.
In normal market conditions, it is generally more favorable for the Company to issue commercial paper rather than borrow against the credit facility. However, as described in Item 1A Risk Factors the ongoing global financial crisis may result in conditions where commercial paper is not available at reasonable rates. In such situations the Company is more likely to draw on its credit facility. During the fourth quarter of fiscal 2008, the Company borrowed against the credit facility as liquidity conditions in the commercial paper market deteriorated. As of September 28, 2008, borrowings outstanding under the credit facility totaled $300 million.
The Companys credit facility contains provisions requiring Starbucks to maintain compliance with certain covenants, including a minimum fixed charge coverage ratio. As of September 28, 2008 and September 30, 2007, the Company was in compliance with each of these covenants. On October 31, 2008, the Company entered into an amendment to the credit facility to exclude up to $130 million of lease termination expenses and lease exit costs incurred during the period beginning on June 30, 2008 and ending September 27, 2009 from the agreements Operating Lease and Rental Expense definition. The purpose of the amendment was to limit the short-term effects of lease-related restructuring expenses from the Companys store closure actions on the fixed charge coverage ratio. These expenses would have otherwise put pressure on the coverage ratio and raised the risk of the Company losing access to liquidity. Over the long term, the reduction in lease expense and improvement in operating cash flows resulting from these store closures are expected to have a favorable effect on this coverage ratio. The amendment also increased the cost to borrow under the facility by an additional 0.10% to 0.40%, depending on the Companys fixed charge ratio and its senior unsecured debt rating.
The $550 million of 10-year 6.25% Senior Notes, issued in the fourth quarter of fiscal 2007, also require Starbucks to maintain compliance with certain covenants that limit future liens and sale and leaseback transactions on certain material properties. As of September 28, 2008 and September 30, 2007, the Company was in compliance with each of these covenants.
The Company expects to use its cash and liquid investments, including any borrowings under its revolving credit facility and commercial paper program to invest in its core businesses, including new beverage innovations, as well as other new business opportunities related to its core businesses. The Company may use its available cash resources to make proportionate capital contributions to its equity method and cost method investees. Any decisions to increase its ownership interest in its equity method investees or licensed operations will be driven by valuation and fit with the Companys ownership strategy and are likely to be infrequent.
Depending on market conditions and within the constraint of maintaining an appropriate capital structure, Starbucks may repurchase shares of its common stock under its authorized share repurchase program. Due to the current challenging operating and economic environment, the Company continues to be conservative in its uses of cash and did not repurchase any shares in the second, third or fourth quarters of fiscal 2008. Management also does not currently anticipate any share repurchases in fiscal 2009. Management believes that cash flows generated from operations and existing cash and liquid investments should be sufficient to finance capital requirements for its core businesses for the foreseeable future, as well as to fund the cost of lease termination and severance costs from the US and Australia store closures. As a result, the Company expects to decrease short-term borrowings in fiscal 2009. Significant new joint ventures, acquisitions and/or other new business opportunities may require additional outside funding.
Other than normal operating expenses, cash requirements for fiscal 2009 are expected to consist primarily of capital expenditures for new Company-operated retail stores, remodeling and refurbishment of existing Company-operated retail stores, and new equipment to support enhanced quality standards and expanded offerings in the stores. Other capital expenditures in fiscal 2009 are expected to consist principally of investments in information technology systems and in the Companys global supply chain operations. Total expenditures for fiscal 2009 are expected to be approximately $700 million.
Cash provided by operating activities decreased by $72.5 million to $1.3 billion for fiscal 2008 compared to the corresponding period of fiscal 2007. The modest decrease was primarily due to the slowing pace of store construction which led to a decline in the balance in accounts payable year-over-year.
Cash used by investing activities for fiscal 2008 totaled $1.1 billion. Net capital additions to property, plant and equipment used $984.5 million, primarily from opening new Company-operated retail stores and remodeling certain existing stores during fiscal 2008. In addition, the sale and maturity of available-for-sale securities provided $75.9 million and $20.0 million, respectively, for fiscal 2008, consisting primarily of auction rate securities and agency notes. The auction rate securities were sold through the normal auction process prior to the auction failures that began in mid-February 2008, as described in Note 4 to the consolidated financial statements, and the agency notes, issued by government-sponsored enterprises, were called in the first half of fiscal 2008.
Cash used by financing activities for fiscal 2008 totaled $184.5 million. Cash used to repurchase shares of the Companys common stock totaled $311.4 million, all in the first quarter of fiscal 2008. This amount includes the
effect of the net change in unsettled trades from September 30, 2007 of $16.1 million. Net repayments of commercial paper were $297.2 million and net borrowings under short term borrowings were $299.4 million for fiscal 2008. As of September 28, 2008, a total of $713.2 million in borrowings were outstanding under the combined commercial paper program and revolving credit facility, as well as $15.9 million in letters of credit which were outstanding under the credit facility, leaving $270.9 million of capacity available under the $1 billion combined commercial paper program and revolving credit facility. Partially offsetting cash used for share repurchases were proceeds of $112.3 million from the exercise of employee stock options and the sale of the Companys common stock from employee stock purchase plans. As options granted are exercised, Starbucks will continue to receive proceeds and a tax deduction, but the amount and the timing of these cash flows cannot be reliably predicted as option holders decisions to exercise options will be largely driven by movements in the Companys stock price.
The following table summarizes the Companys contractual obligations and borrowings as of September 28, 2008, and the timing and effect that such commitments are expected to have on the Companys liquidity and capital requirements in future periods (in millions):
Starbucks expects to fund these commitments primarily with operating cash flows generated in the normal course of business, as well as ongoing borrowings under the combined commercial paper program and revolving credit facility.
The Companys off-balance sheet arrangements relate to certain guarantees and are detailed in Note 17 to the consolidated financial statements in this 10-K.
Commodity price risk represents the Companys primary market risk, generated by its purchases of green coffee and dairy products. The Company purchases, roasts and sells high-quality whole bean arabica coffee and related products and risk arises from the price volatility of green coffee. In addition to coffee, the Company also purchases significant amounts of dairy products to support the needs of its Company-operated retail stores. The price and availability of these commodities directly impacts the Companys results of operations and can be expected to impact its future results of operations. For additional details see Product Supply in Item 1, as well as Risk Factors in Item 1A of this 10-K.
Market risk is defined as the risk of losses due to changes in commodity prices, foreign currency exchange rates, equity prices, and interest rates. The Company manages its exposure to various market-based risks according to an umbrella risk management policy. Under this policy, market-based risks are quantified and evaluated for potential mitigation strategies, such as entering into hedging transactions. The umbrella risk management policy governs the hedging instruments the business may use and limits the dollar risk to net earnings. The Company also monitors and limits the amount of associated counterparty credit risk. Additionally, this policy restricts, among other things, the amount of market-based risk the Company will tolerate before implementing approved hedging strategies and prohibits speculative trading activity. In general, hedge instruments do not have maturities in excess of five years.
The sensitivity analyses performed below provide only a limited, point-in-time view of the market risk of the financial instruments discussed. The actual impact of the respective underlying rates and price changes on the financial instruments may differ significantly from those shown in the sensitivity analyses.
The Company purchases commodity inputs, including coffee and dairy products that are used in its operations and are subject to price fluctuations that impact its financial results. In addition to fixed-priced contracts and price-to-be-fixed contracts for coffee purchases, the Company may enter into commodity hedges to manage commodity price risk using financial derivative instruments. The Company performed a sensitivity analysis based on a 10% change in the underlying commodity prices of its commodity hedges, as of the end of fiscal 2008, and determined that such a change would not have a significant effect on the fair value of these instruments.
The majority of the Companys revenue, expense and capital purchasing activities are transacted in US dollars. However, because a portion of the Companys operations consists of activities outside of the United States, the Company has transactions in other currencies, primarily the Canadian dollar, British pound sterling, euro, and Japanese yen. As a result, Starbucks may engage in transactions involving various derivative instruments to hedge revenues, inventory purchases, assets, and liabilities denominated in foreign currencies.
As of September 28, 2008, the Company had forward foreign exchange contracts that hedge portions of anticipated international revenue streams and inventory purchases. In addition, Starbucks had forward foreign exchange contracts that qualify as accounting hedges of its net investment in Starbucks Japan, as well as the Companys net investments in its Canada, UK, and China subsidiaries, to minimize foreign currency exposure.
The Company also had forward foreign exchange contracts that are not designated as hedging instruments for accounting purposes (free standing derivatives), but which largely offset the financial impact of translating certain foreign currency denominated payables and receivables. Increases or decreases in the fair value of these hedges are generally offset by corresponding decreases or increases in the US dollar value of the Companys foreign currency denominated payables and receivables (i.e. hedged items) that would occur within the hedging period.
The following table summarizes the potential impact to the Companys future net earnings and other comprehensive income (OCI) from changes in the fair value of these derivative financial instruments due in turn to a change in the value of the US dollar as compared to the level of foreign exchange rates. The information provided below relates only to the hedging instruments and does not represent the corresponding changes in the underlying hedged items (in millions):
September 28, 2008
The Company has minimal exposure to price fluctuations on equity mutual funds within its trading portfolio. The trading securities approximate a portion of the Companys liability under the MDCP. A corresponding liability is included in Accrued compensation and related costs on the consolidated balance sheets. These investments are recorded at fair value with unrealized gains and losses recognized in Interest income and other, net in the consolidated statements of earnings. The offsetting changes in the MDCP liability are recorded in General and administrative expenses. The Company performed a sensitivity analysis based on a 10% change in the underlying equity prices of its investments, as of the end of fiscal 2008, and determined that such a change would not have a significant effect on the fair value of these instruments.
The Company utilizes short-term and long-term financing and may use interest rate hedges to manage the effect of interest rate changes on its existing debt as well as the anticipated issuance of new debt. At the end of fiscal years 2008 and 2007, the Company did not have any interest rate hedge agreements outstanding.
The following table summarizes the impact of a change in interest rates on the fair value of the Companys debt (in millions):
September 28, 2008
The Companys available-for-sale securities comprise a diversified portfolio consisting mainly of fixed income instruments. The primary objectives of these investments are to preserve capital and liquidity. Available-for-sale securities are investment grade and are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a separate component of Accumulated other comprehensive income. The Company does not hedge the interest rate exposure on its available-for-sale securities. The Company performed a sensitivity analysis based on a 100 basis point change in the underlying interest rate of its available-for-sale securities as of the end of fiscal 2008, and determined that such a change would not have a significant effect on the fair value of these instruments.
Critical accounting policies are those that management believes are both most important to the portrayal of the Companys financial condition and results, and require managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions.
Starbucks considers its policies on asset impairment, stock-based compensation, operating leases, self insurance reserves and income taxes to be the most critical in understanding the judgments that are involved in preparing its consolidated financial statements.
When facts and circumstances indicate that the carrying values of long-lived assets may be impaired, an evaluation of recoverability is performed by comparing the carrying values of the assets to projected future cash flows, in addition to other quantitative and qualitative analyses. For goodwill and other intangible assets, impairment tests are performed annually and more frequently if facts and circumstances indicate goodwill carrying values exceed estimated reporting unit fair values and if indefinite useful lives are no longer appropriate for the Companys trademarks. Upon indication that the carrying values of such assets may not be recoverable, the Company recognizes an impairment loss as a charge against current operations. Judgments made by the Company related to
the expected useful lives of long-lived assets and the ability of the Company to realize undiscounted cash flows in excess of the carrying amounts of such assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions and changes in operating performance. As the Company assesses the ongoing expected cash flows and carrying amounts of its long-lived assets, these factors could cause the Company to realize material impairment charges.
Starbucks accounts for stock-based compensation in accordance with the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment. The Company uses the Black-Scholes-Merton option pricing model which requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their stock options before exercising them (expected term), the estimated volatility of the Companys common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (forfeitures). Changes in the subjective assumptions could materially affect the estimate of fair value of stock-based compensation; however based on an analysis using changes in certain assumptions that could be reasonably possible in the near term, management believes the effect on the expense recognized for fiscal 2008 would not have been material.
Starbucks leases retail stores, roasting and distribution facilities and office space under operating leases. The Company provides for an estimate of asset retirement obligation (ARO) expense at the lease inception date for operating leases with requirements to remove leasehold improvements at the end of the lease term. Estimating AROs involves subjective assumptions regarding both the amount and timing of actual future retirement costs. Future actual costs could differ significantly from amounts initially estimated. In addition, the large number of operating leases and the significant number of international markets in which the Company has operating leases adds administrative complexity to the calculation of ARO expense, as well as to the other technical accounting requirements of operating leases such as contingent rent. Starbucks accounts for lease contract termination costs in accordance with SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. Estimating the cost of certain lease exit costs involves subjective assumptions, including the time it would take to sublease the leased location and the related potential sublease income. The estimated accruals for these costs could be significantly affected if future experience differs from that used in the initial estimate.
The Company uses a combination of insurance and self-insurance mechanisms, including a wholly owned captive insurance entity and participation in a reinsurance pool, to provide for the potential liabilities for workers compensation, healthcare benefits, general liability, property insurance, director and officers liability insurance and vehicle liability. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.
Starbucks accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Accruals for uncertain tax positions are accounted for under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). Deferred tax assets and liabilities are measured using current enacted tax rates in effect for the years in which those temporary differences are expected to reverse. Judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. These include establishing a valuation allowance related to the realizability of certain deferred tax assets. Accounting for uncertain tax positions requires significant judgments, including estimating the amount, timing and likelihood of ultimate settlement. Although the Company believes that its estimates are reasonable, actual results could differ from these estimates.
See Note 1 to the Consolidated Financial Statements in this 10-K.
The information required by this item is incorporated by reference to the section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations Commodity Prices, Availability and General Risk Conditions and Managements Discussion and Analysis of Financial Condition and Results of Operations Financial Risk Management in Item 7 of this Report.
CONSOLIDATED STATEMENTS OF EARNINGS
In millions, except earnings per share
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
In millions, except per share data
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY