Starbucks 10-K 2009
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)
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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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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. þ
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):
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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 27, 2009 as reported on the NASDAQ Global Select Market was $8.4 billion. As of November 13, 2009, there were approximately 740.2 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 24, 2010 have been incorporated by reference into Part III of this Annual Report on Form 10-K.
For the Fiscal Year Ended September 27, 2009
Starbucks is the premier roaster and retailer of specialty coffee in the world. Starbucks Corporation was formed in 1985 and its common stock trades on the NASDAQ Global Select Market (NASDAQ) under the symbol SBUX. 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 beverage-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 licensees and equity investees, 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 maintain Starbucks standing as one of the most recognized and respected brands in the world. To achieve this goal, the Company plans to continue disciplined global expansion of its retail and licensed store base, to introduce relevant new products in all its channels, and to selectively develop new channels of distribution. The Companys Global Responsibility strategy and commitments related to coffee and the communities it does business in, as well as its focus on being an employer of choice, are also key complements to its business strategies.
Starbucks has three reportable operating segments, and each segment provided the indicated percentage of total net revenues for fiscal year ended September 27, 2009 (fiscal 2009): United States (US) (73%), International (19%) and Global Consumer Products Group (CPG) (8%). In the fourth fiscal quarter of 2009, the Company changed the composition of its reportable segments. The US foodservice business, which was previously reported in the US segment, is now reported in the CPG segment, as a result of internal management realignments within the US and CPG businesses. Segment information for all prior periods presented has been revised to reflect this change.
The US and International segments both include Company-operated retail stores and certain components of specialty operations. Specialty operations within the US include licensed retail stores and other initiatives related to the Companys core business. International specialty operations primarily consist of retail store licensing operations in nearly 40 countries and foodservice accounts in Canada and the United Kingdom (UK). The International segments largest markets, based on number of Company-operated and licensed retail stores, are Canada, Japan and the UK. The CPG segment includes packaged coffee and tea, and other branded products sold worldwide through channels such as grocery stores, warehouse clubs and convenience stores, and US foodservice accounts. CPG operates a significant portion of its business through licensing arrangements and joint ventures 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).
Revenue components as a percentage of total net revenues and related specialty revenues for the fiscal year ended September 27, 2009:
Starbucks mix of Company-operated versus licensed stores in a given market will vary based on several factors. Some of these factors include the ability to access desirable local retail space, the complexity and expected ultimate size of the market for Starbucks, and the ability to leverage the Companys support infrastructure in an existing geographic region.
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 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 disciplined strategy for expanding its global retail business is to increase its market share by selectively opening additional stores in existing markets, opening stores in new markets, and increasing sales in existing stores, to support its long term strategic objectives. Store growth in specific existing markets will vary due to many factors, including the maturity of the market.
As described in more detail in Managements Discussion and Analysis in this 10-K, Starbucks has taken a number of actions in fiscal 2008 and 2009 to rationalize its store portfolio. These actions have included plans (announced in July 2008 and January 2009) to close a total of approximately 800 Company-operated stores in the US, restructure its
Australia market, and close approximately 100 additional Company-operated stores internationally. As of the end of fiscal 2009, nearly all of the approximately 800 US stores, 61 stores in Australia and 41 stores in other International markets have been closed. The remaining International closures are expected to be completed by the end of fiscal 2010.
Starbucks Company-operated retail stores accounted for 84% of total net revenues during fiscal 2009.
Summary of 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. 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 continues to selectively expand development of drive-thru retail stores. At the end of fiscal 2009, the Company operated approximately 2,650 drive-thru locations, representing approximately 35% of Company-operated stores in the US and Canada combined.
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, distinctively packaged roasted whole bean coffees, and its recently launched soluble coffee Starbucks VIAtm Ready Brew (VIA). Starbucks stores also offer a variety of fresh food items, including healthier choice selections focusing on high-quality ingredients, nutritional value and great flavor. Food items include pastries, prepared breakfast and lunch sandwiches, oatmeal, and salads as well as sodas, juices and bottled water. Starbucks continues to expand its food warming program in the US and Canada, with approximately three-quarters of the stores in these markets providing warm food items, primarily breakfast sandwiches, as of September 27, 2009. A selection of beverage-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 smaller selection of coffee and beverage-related accessories.
Retail sales mix by product type for Company-operated stores:
The Starbucks Card program is designed to increase customer loyalty and the frequency of store visits by cardholders. Starbucks cards can be used in all Company-operated and most licensed stores in North America, and in a growing number of international markets. The cards have no expiration date and do not have any inactivity fees.
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 2009, 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 which include the Starbucks and Seattles Best Coffee brands, the Company leverages the expertise of its local partners and shares the Companys 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 royalties and license fees and sells coffee, tea and related products for resale in licensed locations. Product sales to and royalty and license fee revenues from US and International licensed retail stores accounted for 50% of specialty revenues in fiscal 2009. 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.
Starbucks total licensed retail stores by region and specific location at fiscal year end 2009:
During fiscal 2009, net licensed store openings included 35 in the US and 305 internationally.
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 US. Kraft manages all distribution, marketing, advertising and promotion of these products.
The Company sells packaged coffee and tea internationally both directly to warehouse club stores, such as Costco Wholesale Corporation, and to grocery stores through a licensing relationship with Kraft in Canada, the UK and other European countries.
The Companys coffees and teas are available in approximately 39,000 grocery and warehouse club stores, with 33,500 in the US and 5,500 in International markets. Revenues from this category comprised 23% of specialty revenues in fiscal 2009.
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 2009.
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, VIA 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 sales in this channel come through national broadline distribution networks with SYSCO Corporation, US Foodservicetm, and other distributors. The Companys total foodservice operations had over 21,000 accounts, primarily in the US, at fiscal year end 2009. Revenues from foodservice accounts comprised 23% of total specialty revenues in fiscal 2009.
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 global 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 and to reinforce the Companys leadership role in the coffee industry, Starbucks operates Farmer Support Centers in Costa Rica and Rwanda. The Farmer Support Centers are staffed with agronomists and sustainability experts who work with coffee farming communities to promote best practices in coffee production designed to improve both coffee quality and yields.
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. As of September 27, 2009, the Company had $238 million of purchase commitments which, together with existing inventory, is expected to provide an adequate supply of green coffee through fiscal 2010.
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. The Companys highest volume of dairy purchases are in the US, Canada and the UK. For these markets, Starbucks purchases substantially all of its fluid milk requirements from six dairy suppliers. The Company believes, based on relationships established with these suppliers, the risk of non-delivery of sufficient fluid milk to support these retail businesses is remote.
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 suppliers, usually under long-term supply contracts. Food products, such as fresh pastries, breakfast sandwiches and lunch items, are purchased from national, 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. Beverage-related accessories, including items bearing the Companys logos and trademarks, are produced and distributed through contracts with a number of different suppliers. The Company also purchases a broad range of paper and plastic products, such as cups and cutlery, from several companies to support the needs of its retail stores as well as its manufacturing and distribution operations. The Company believes, based on relationships established with these suppliers and manufacturers, the risk of non-delivery is remote.
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 greater direct competition from large competitors in the US quick-service restaurant sector and continues to face competition from well-established companies in many International markets and in the US ready-to-drink coffee beverage market.
The Companys whole bean coffees and ground packaged coffees compete directly against specialty coffees sold through supermarkets, club stores and specialty retailers. The Companys whole bean coffees, its coffee beverages, and its recently launched soluble coffee VIA, 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 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 has applied to register numerous trademarks and service marks in the US and in many additional countries throughout the world. 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, Starbucks.net, and Seattlesbest.com.
Starbucks research and development teams are responsible for the technical development of food and beverage products and new equipment. The Company spent approximately $6.5 million, $7.2 million and $7.0 million during fiscal 2009, 2008 and 2007, 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 first fiscal 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 closing of existing stores. 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 142,000 people worldwide as of September 27, 2009. In the US, Starbucks employed approximately 111,000 people, with 105,000 in Company-operated retail stores and the remainder in the Companys administrative and regional offices, and store development, roasting and warehousing operations. Approximately 31,000 employees were employed outside of the US, with 30,000 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 not significant. Starbucks believes its current relations with its employees are good.
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 visit www.starbucks.com.
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, code of ethics and Board committee charters and policies are also posted on the Investor Relations section of Starbucks website at http://investor.starbucks.com. 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 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.
If any of the risks and uncertainties described in the cautionary factors described below actually occurs, Starbucks business, financial condition and results of operations could be materially and adversely affected. The factors listed below 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.
The Companys operating results have been in the past and will continue to be subject to a number of factors, many of which are largely outside the Companys control. Any one or more of the factors set forth below could adversely impact Starbucks business, financial condition and/or results of operations:
There is no assurance that the Company will be able to implement important strategic initiatives in accordance with its expectations, which may result in a material adverse impact on the Companys business and financial results. These strategic initiatives are designed to drive long-term shareholder value and improve Starbucks results of operations, and include:
As a retailer that is dependent upon consumer discretionary spending, the Companys results of operations are sensitive to changes in macro-economic conditions. Starbucks customers may have less money for discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and 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. There is also a risk that if negative economic conditions persist for a long period of time, consumers may make long-lasting changes to their discretionary purchasing behavior, including less frequent discretionary purchases on a more permanent basis.
The Companys failure to meet market expectations going forward, particularly with respect to operating margins, earnings per share, comparable store sales, and net revenues, will likely result in a decline and/or increased volatility in the market price of Starbucks stock.
The Companys financial performance is highly dependent on its US operating segment, which comprised approximately three-quarters of consolidated total net revenues in fiscal 2009. The Company continued to experience negative traffic in its US stores in fiscal 2009, which adversely affected the operating results of the US segment and the Company as a whole. Although the US segments operating results improved in fiscal 2009 compared to fiscal 2008 due to the Companys restructuring efforts, if improvements in its financial performance do not continue, the Companys business and financial results will continue to be adversely affected.
The Companys future growth increasingly depends 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 US 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 countries, 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 International operating 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 under Competition in Item 1. In the US, 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. The Company faces increased competition from larger well-known competitors which have greater resources. Increasing competition from the US packaged coffee and tea and ready-to-drink coffee beverage markets 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.
A health pandemic is a disease outbreak 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.
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. To be successful in the future, particularly outside of US, where the Starbucks brand is less well-known, management believes it must preserve, grow and leverage the value of the Starbucks brand across its sales channels. 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 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, including financial pressures. 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.
The Companys products and in particular, its coffee and tea products, are sourced from a wide variety of domestic and international vendors. The Company relies on international vendors to provide high quality product that comply with applicable laws. The Companys ability to find qualified vendors who meet our standards and supply products in a timely and efficient manner is a significant challenge, especially with respect to goods sourced from outside the US. These issues could negatively impact the Companys business and profitability.
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.
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 against the need for consistency with the Companys goals, philosophy and standards. 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 US, 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 healthier 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.
Any reduction in cash flow relative to the level of the Companys financial obligations would result in an increase in leverage. Any increase in leverage could lead to deterioration in Starbucks credit ratings, which could limit the availability of additional financing and increase its cost of obtaining financing. In addition, an increase in leverage could raise the likelihood of a financial covenant breach which in turn could limit the Companys access to existing funding under its credit facility.
The Companys ability to satisfy its operating lease obligations and make payments of principal and interest on its indebtedness depends on its future performance. Should the Company experience deterioration in operating performance, it will have less cash flow available to meet these obligations. In addition, if such deterioration were to lead to the closure of underperforming stores, the Company would need to fund the costs of terminating store leases. If Starbucks is unable to generate sufficient cash flow from operations in the future to satisfy these financial obligations, it may be required to, 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.
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, 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.
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 (previously occupied by the Company, but now leased to other parties) and an adjacent 285,000 square foot office building, which is currently being marketed for lease.
As of September 27, 2009, Starbucks had more than 8,800 Company-operated retail stores, almost all of which are leased. The Company also leases space in approximately 130 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.
No matters were submitted to a vote of security holders during the fourth fiscal quarter of 2009.
Executive officers of the Company:
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.
John Culver joined Starbucks in August 2002 and has served as president, Global Consumer Products and Foodservice since September 2009. Mr. Culver served as executive vice president; president, Global Consumer Products, Foodservice and Seattles Best Coffee from February 2009 to September 2009. He previously served as senior vice president; president, Starbucks Coffee Asia Pacific from January 2007 to February 2009, and vice president; general manager, Foodservice from August 2002 to January 2007.
Michelle Gass joined Starbucks in 1996 and has served as the Companys president, Seattles Best Coffee since September 2009. Ms. Gass served as senior vice president, Marketing and Category from July 2008 to November 2008, and then as executive vice president, Marketing and Category from December 2008 to September 2009. 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, and U.S. Category Management from May 2004 to August 2007. Ms. Gass served in a number of other positions with Starbucks prior to 2004.
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.
Annie Young-Scrivner joined Starbucks in September 2009 as chief marketing officer. Prior to joining Starbucks, Ms. Young-Scrivner served as Chief Marketing Officer and Vice President of Sales for Quaker Foods and Snacks, a division of PepsiCo, Inc. From October 2006 to November 2008, she served as Region President of PepsiCo Foods for Greater China. From 2005 to 2006, Ms. Young-Scrivner served as Vice President of Sales for PepsiCo Beverages in Greater China. She also served in a number of other leadership roles at PepsiCo prior to 2005.
Troy Alstead joined Starbucks in 1992 and has served as executive vice president, chief financial officer and chief administrative officer since November 2008. Mr. Alstead previously served as chief operating officer, Starbucks Greater China from April 2008 to October 2008, senior vice president, Global Finance and Business Operations from August 2007 to April 2008, and senior vice president, Corporate Finance from September 2004 to August 2007. 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.
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.
Kalen Holmes joined Starbucks in November 2009 as executive vice president, Partner Resources. Prior to joining Starbucks, Ms. Holmes served as HR General Manager for the Entertainment and Devices division at Microsoft Corporation, a worldwide provider of software, services and solutions, from December 2007 to November 2009. From December 2005 to December 2007, Ms. Holmes was HR General Manager for Microsofts Server and Tools Division. From September 2003 to December 2005, she served as HR General Manager for Microsofts Corporate Staff business unit. Prior to 2003, Ms. Holmes served as an HR leader at companies such as Bristol-Myers Squibb Company, PepsiCo, Inc., Enron Corporation, pcOrder.com, Inc., and Trilogy Inc., managing multiple geographies and diverse business units.
Olden Lee has served as interim executive vice president, Partner Resources since April 2009. Mr. Lee has been a Starbucks director since June 2003. Mr. Lee undertook the role of interim head of Partner Resources while the Company searched for an executive vice president, Partner Resources. Mr. Lee will continue with the Company on an interim basis to assist Ms. Holmes and ensure a smooth transition. Prior to serving in his current role, Mr. Lee worked with PepsiCo, Inc. for 28 years in a variety of positions, including serving as senior vice president of human resources of its Taco Bell division and senior vice president and chief personnel officer of its KFC division.
There are no family relationships among any directors or executive officers of the Company.
The Companys common stock is traded on NASDAQ, under the symbol SBUX.
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, 2009, the Company had approximately 21,600 shareholders of record. This does not include persons whose stock is in nominee or street name accounts through brokers.
Starbucks has never paid any dividends on its common stock. Any future decision to pay cash dividends will be at the discretion of the Companys Board of Directors and will be dependent on the Companys operating performance, financial condition, capital expenditure requirements, and other such factors that the Board of Directors considers relevant.
The following table provides information regarding repurchases by the Company of its common stock during the 13-week period ended September 27, 2009:
The following graph depicts the Companys total return to shareholders from October 3, 2004 through September 27, 2009, 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 October 3, 2004, 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.
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.
Starbucks Corporations fiscal year ends on the Sunday closest to September 30. The fiscal years ended on September 27, 2009, September 28, 2008 and September 30, 2007 all included 52 weeks. Starbucks 2010 fiscal year will include 53 weeks, with the 53rd week falling in its fourth fiscal quarter. All references to store counts, including data for new store openings, are reported net of related store closures, unless otherwise noted.
Fiscal 2009 was a challenging year for Starbucks. The Company was confronted with extraordinary economic and operating challenges in addition to facing an increasingly competitive landscape. Although the global economy has shown some signs of improvement recently, management recognizes the difficult economic situation that many consumers are still facing and does not expect that to significantly change over the course of fiscal 2010. This challenging economic environment has strained consumer discretionary spending in the US and internationally, which in turn has impacted Company revenues, comparable store sales, operating income and operating margins. Starbucks responded to this difficult environment with a more disciplined focus on operations and the introduction of initiatives to permanently improve the Companys cost structure. The result is an underlying business model that is less reliant on high revenue growth to drive profitability, and that still preserves the fundamental strengths and values of the Starbucks brand. The primary initiatives in this strategy include rationalizing the global Company-operated store portfolio, right-sizing the non-retail support organization, and reducing the Companys cost structure, while renewing the focus on service excellence in the stores and delivering relevant innovation.
Starbucks actions to rationalize its global store portfolio have included the planned closure of nearly 1,000 Company-operated stores globally. At the end of fiscal 2009, nearly all of the approximately 800 US Company-operated stores, 61 stores in Australia and 41 Company-operated stores in other International markets had been closed. The remaining International store closures are expected to be completed by the end of fiscal 2010.
Initiatives targeting reductions in the Companys cost structure in fiscal 2009 proceeded as planned, with full-year costs of $580 million removed from the Companys cost structure. These targeted cost reductions and associated operational efficiency efforts, along with a more profitable Company-operated store base, have moved Starbucks toward a more sustainable business model, while preserving the fundamental strengths and values of the brand. The operational efficiency efforts are primarily focused on store level execution and include improved staffing models and better management of waste in coffee, dairy and food.
Starbucks actions to improve the customer experience have resulted in a more focused effort toward in-store offerings, and simplifying the demands on store partners (employees), while concurrently raising already-high standards for beverage and food offerings, customer service and the overall in-store experience. The effects of these efforts have already been seen in the Companys improved customer satisfaction scores.
Starbucks has a renewed focus on relevant product innovation and the disciplined expansion and leveraging of its existing products and sales channels. For example, Starbucks VIAtm Ready Brew coffee was launched in fiscal 2009 and is designed to capture a significant share of both the $21 billion global instant coffee category and the single-serve market. The Company intends to drive sales within the retail store base and CPG channels, both in the US and internationally.
The Company continues to maintain a solid financial foundation, with no short term debt outstanding at the end of fiscal 2009 and with cash and liquid investments totaling more than $650 million. This solid financial position and continued strong cash flow generation have provided Starbucks with the financial flexibility to implement its restructuring efforts as well as make ongoing investments in its core business.
For fiscal 2010, the Company expects revenues to grow in the low-to-mid single digits compared to fiscal 2009, driven by modestly positive comparable store sales, a 53rd fiscal week, and approximately 100 planned net new
stores in the US and approximately 200 net new stores in International markets. Both the US and International net new additions are expected to be primarily licensed stores.
Given these revenue expectations, combined with the Companys reduced cost structure, in-store operating efficiencies, and lower restructuring charges, Starbucks currently expects significant improvement in its consolidated operating margin in fiscal 2010. Operating cash flow for fiscal 2010 is currently expected to reach approximately $1.4 billion and capital expenditures are expected to range from $500 million to $550 million.
Starbucks has three reportable operating segments: US, International and CPG. The US foodservice business, which was previously reported in the US segment, is now reported in the CPG segment, as a result of internal management realignments within the US and CPG businesses. Segment information for all prior periods presented has been revised to reflect this change.
The US and International segments both include Company-operated retail stores and licensed retail stores. 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 expand and Starbucks has been focusing on achieving sustainable growth 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, and other branded products operations worldwide, and the US foodservice business. For the packaged coffee and tea and branded products, Starbucks operates primarily through licensing arrangements and joint ventures with large consumer products business partners, most significantly with Kraft for distribution of packaged coffees and teas, and The North American Coffee Partnership with the Pepsi-Cola Company for manufacturing and distribution of ready-to-drink beverages. 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 packaged coffee and ready-to-drink products are recognized as revenues by the licensed or joint venture business partner, not by the CPG segment. Royalties and payments from our licensing agreements are recorded under licensing revenue, 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. The US foodservice business sells coffee and other related products to institutional foodservice companies with the majority of its sales through national broadline distribution networks. 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, corporate restructuring charges and amounts included in Net interest income and other and Interest expense on the consolidated statements of earnings.
See Note 19 to the consolidated financial statements in this 10-K.
RESULTS OF OPERATIONS FISCAL 2009 COMPARED TO FISCAL 2008
Consolidated results of operations (in millions):
Company-operated retail revenues decreased from fiscal 2008, primarily attributable to a 6% decline in comparable store sales, comprised of a 4% decline in transactions and a 2% decline in the average value per transaction. Foreign currency translation also contributed to the decline with the effects of a stronger US dollar relative to the British pound and Canadian dollar. The weakness in consolidated comparable store sales was driven by the US segment, with a comparable store sales decline of 6% for the year. The International segment experienced a 2% decline in comparable store sales.
The Company derived 16% of total net revenues from channels outside the Company-operated retail stores, collectively known as specialty operations. The decrease in Foodservice and other revenue was primarily due to the softness in the hospitality industry.
Cost of sales including occupancy costs decreased as a percentage of revenues primarily due to the implementation of in-store operational efficiencies designed to reduce product waste, and due to lower dairy costs in the US, partially offset by higher coffee costs.
Store operating expenses as a percentage of Company-operated retail revenues decreased primarily due to reduced headcount and spending in the regional support organization as a result of Starbucks restructuring efforts, and the effect of initiatives to improve store labor efficiencies.
Restructuring charges include lease exit and related costs associated with the actions to rationalize the Companys global store portfolio and reduce the global cost structure. See Note 2 to the consolidated financial statements for further discussion.
Operating margin expansion was primarily due to the improved labor efficiency and reduced product waste in Company-operated stores, partially offset by increased restructuring charges.
Net interest income and other increased due primarily to the impact of foreign currency fluctuations on certain balance sheet amounts. Also contributing to the increase were lower unrealized market value losses on the Companys trading securities portfolio compared to fiscal 2008. As described in more detail in Note 3 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 decreased due to a lower average balance of short term
borrowings and lower average short term borrowing rates in fiscal 2009 compared to the prior year. At the end of fiscal 2009, the Company had no short term debt.
The relatively low 2009 effective tax rate was primarily due to a tax benefit recognized for retroactive tax credits and an income tax credit related to the settlement of an employment tax audit in fiscal 2009. As a result of the audit settlement, approximately $17 million of expense was recorded in Store operating expenses, with an offsetting income tax credit and no impact to net earnings. The effective tax rate for fiscal 2010 is expected to be in the range of 34% to 35%.
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: US, 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 Net interest income and other, Interest expense and Income taxes.
The US foodservice business, which was previously reported in the US segment, is now reported in the CPG segment, as a result of internal management realignments within the US and CPG businesses. Segment information for all prior periods presented has been revised to reflect this change.
The following tables summarize the Companys results of operations by segment for fiscal 2009 and 2008 (in millions).
The US 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 US include licensed retail stores and other initiatives related to the Companys core business.
Company-operated retail revenues decreased year over year primarily due to a 6% decrease in comparable store sales, comprised of a 4% decrease in transactions, and a 2% decrease in average value per transaction.
Operating margin expanded primarily due to lower store operating expenses, lower cost of sales including occupancy costs, and lower other operating expenses as a percentage of total revenues. This improvement was primarily due to operational changes designed to improve labor efficiency and reduce product waste in Company-operated stores, and to lower non-store support costs. Partially offsetting the favorability were higher restructuring charges during the year. The Company incurred higher lease exit and related costs due to the higher number of actual store closures compared to the prior year period.
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 several other markets. Specialty operations primarily include retail store licensing operations in nearly 40 other countries and foodservice accounts, primarily in Canada and the UK. The Companys International store base continues to expand 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 US. This continuing investment is part of the Companys long-term, balanced plan for profitable growth.
Company-operated retail revenues decreased primarily due to unfavorable foreign currency exchange rates, particularly for the British pound and Canadian dollar. Partially offsetting the decrease were the net new store openings of 89 Company-operated stores.
Specialty revenues decreased primarily due to continued softness in the hospitality industry and unfavorable foreign currency exchange rates.
Operating margin decreased primarily due to higher restructuring charges and higher store operating expenses as a percentage of total revenues. Restructuring charges of $27.0 million recognized during the year had a 50 basis point impact on operating margin compared to the prior year, due to the previously announced store closures. Higher store operating expenses as of percentage of Company-operated retail revenues were driven by an increase in store impairment charges and a decline in sales leverage impacting salaries and benefits. Partially offsetting the decrease in operating margin were lower other operating expenses due to headcount reductions in the non-store support functions.
CPGs licensing revenue is from selling a selection of whole bean and ground coffees and premium Tazo® teas through licensing arrangements in US and international markets, and also producing and selling a variety of ready-to-drink beverages through its joint ventures and marketing and distribution agreements. The foodservice revenue is from the US foodservice business, which sells coffee and other related products to institutional foodservice companies with the majority of its sales through national broadline distribution networks.
Total net revenues increased primarily due to higher revenues from packaged coffees, partially offset by lower foodservice revenues caused by continued softness in the hospitality industry.
Growth of operating margin was primarily due to lower other operating expenses in the foodservice business due to lower compensation costs and lower marketing expenses.
Unallocated corporate expenses pertain to corporate administrative functions that support, but are not specifically attributable to the Companys operating segments.
Total unallocated corporate expenses increased primarily as a result of restructuring charges incurred for corporate office facilities that were no longer occupied by the Company due to the reduction in positions within the non-store support organization.
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 fiscal 2008, 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 specialty operations. Licensing revenues increased primarily due to higher product sales and royalty revenues from the opening of 988 new licensed retail stores in fiscal 2008. The increase in Foodservice and other revenues was primarily driven by growth in new and existing accounts in the foodservice business in the US.
Since many of the Companys operating expenses are fixed in nature, 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 fiscal 2008. 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.
Operating margin compression was primarily due to lower revenues; in addition, restructuring charges accounted for approximately 40% of the decrease.
Net interest income and other decreased due primarily to unrealized market value losses on the Companys trading securities portfolio. The trading securities approximate a portion of the Companys liability under its MDCP plan. 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 fiscal 2008 resulted in an effective tax rate of 31.3% compared to 36.3% for fiscal 2007. The lower rate was 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.
Company-operated retail revenues increased primarily due to the opening of 445 new Company-operated retail stores in fiscal 2008, 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 fiscal 2008.
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 280 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.
Company-operated retail revenues increased due to the opening of 236 new Company-operated retail stores in fiscal 2008, 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 fiscal 2008.
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.
Foodservice revenues increased primarily due to growth in new and existing foodservice accounts, and licensing revenue increased 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 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.
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.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Companys existing cash and liquid investments were $666.1 million and $322.3 million as of September 27, 2009 and September 28, 2008, respectively.
The Company manages its cash and liquid investments in order to internally fund operating needs and make scheduled interest and principal payments on its borrowings.
Included in the cash and liquid investment balances are the following:
As of September 27, 2009, the Company had $92.7 million invested in available-for-sale securities. Included in available-for-sale securities were $55.7 million of auction rate securities (ARS), compared with $59.8 million of ARS held as of September 28, 2008, with the decrease due to calls of individual securities. As described in more detail in Note 3, 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.
Credit rating agencies currently rate the Companys borrowings as follows:
On August 28, 2009, Standard and Poors Ratings Services revised its outlook on the Companys credit ratings to stable from negative based on improved credit metrics and stabilizing performance. The rating agency also affirmed the BBB corporate credit rating on the Company and raised the short-term rating to A-2 from A-3 to conform with the stable rating outlook. As a result of the Moodys P-3 short-term rating issued in May 2009, commercial paper has become less liquid and more expensive than borrowing under the Companys credit facility. Consequently, the Company utilized its credit facility for almost all short-term borrowing needs subsequent to May 2009. In the latter half of the year the Company reduced its total short-term borrowings to a zero balance due to strong operating cash flows and lower capital spending on new Company-operated stores. Management is unlikely to make significant use of its commercial paper program until its Moodys short-term ratings improve.
Despite limited access to the commercial paper markets, management believes that cash flow from operations and its existing cash and liquid investments, supplemented as needed by the $1 billion in short-term borrowing capacity under the Companys revolving credit facility, will 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 related costs from the remaining international store closures. Significant new joint ventures, acquisitions and/or other new business opportunities may require additional outside funding.
The Companys credit facility contains provisions requiring Starbucks to maintain compliance with certain covenants, including a minimum fixed charge coverage ratio. On June 8, 2009, the credit facility was amended to more accurately reflect the parties intent with respect to Amendment No. 4 to the credit facility. Amendment No. 5 to the credit facility did not impact the Companys borrowing terms, facility size, or covenant ratio, and was completed at minimal cost to the Company. As of September 27, 2009 and September 28, 2008, the Company was in compliance with each of these covenants.
The $550 million of 10-year 6.25% Senior Notes, issued in 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 27, 2009 and September 28, 2008, the Company was in compliance with each of these covenants.
The Company generated strong operating cash flow during the year ended September 27, 2009 and used its free cash flow to reduce its short-term borrowings from $713.0 million at the end of fiscal 2008 to a zero balance at the end of fiscal 2009 and to increase the balance of its cash and liquid investments.
The Company expects to use its cash and liquid investments, including any borrowings under its credit facility and commercial paper program, to invest in its core businesses, including new beverage and product 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. Starbucks
did not repurchase any shares in fiscal 2009 under the Companys share repurchase program; however, the Company will continue to evaluate share repurchases and cash dividends in the future as a use for excess cash generated by the business.
Other than normal operating expenses, cash requirements for fiscal 2010 are expected to consist primarily of capital expenditures for remodeling and refurbishment of, and equipment upgrades for, existing Company-operated retail stores; systems and technology investments in the stores and in the support infrastructure; and new Company-operated retail stores. Total capital expenditures for fiscal 2010 are expected to range from $500 million to $550 million.
Cash provided by operating activities was $1.4 billion for fiscal 2009 compared to $1.3 billion for fiscal 2008. Cash used by investing activities for fiscal 2009 totaled $421.1 million compared to $1.1 billion in fiscal 2008. The decrease was due to lower capital expenditures in fiscal 2009 compared to fiscal 2008 due to opening significantly fewer new Company-operated stores.
Cash used by financing activities for the year ended September 27, 2009 totaled $642.2 million, with net repayments of commercial paper and short-term borrowings under the credit facility totaling $713.1 million. As of September 27, 2009, a total of $14.1 million in letters of credit were outstanding under the credit facility, leaving $985.9 million of capacity available under the $1 billion combined commercial paper program and revolving credit facility.
The following table summarizes the Companys contractual obligations and borrowings as of September 27, 2009, 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, among other things. 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 security 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 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, hedging instruments do not have maturities in excess of five years.
The sensitivity analyses disclosed 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, dairy products and diesel that are used in its operations and are subject to price fluctuations that impact its financial results. In addition to fixed-price contracts and price-to-be-fixed contracts for coffee purchases, the Company has entered 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 2009, 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 US, the Company has transactions in other currencies, primarily the Canadian dollar, British pound, 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 27, 2009, 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 subsidiary, 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 27, 2009
The Company has minimal exposure to price fluctuations on equity mutual funds and equity exchange-traded 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 Net interest income and other 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 2009, 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 2009 and 2008, 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 27, 2009
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. As of September 27, 2009, the Companys long-term available-for-sale securities included ARS. Please see Note 3 for further information. Available-for-sale securities are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a 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 2009, 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 indefinite-lived intangible assets, impairment tests are performed annually and more frequently if facts and circumstances indicate carrying values exceed estimated fair values and if indefinite useful lives are no longer appropriate for the Companys trademarks. Upon determination that the carrying values of such assets are in excess of their estimated fair values, 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 fair value recognition provisions, under which 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. 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 2009 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. 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 certain risks, including workers compensation, healthcare benefits, general liability, property insurance, and director and officers liability insurance. 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 recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities and accrues for uncertain tax positions. 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 ability to realize 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