SBUX » Topics » Overview

This excerpt taken from the SBUX 10-K filed Nov 20, 2009.
Overview
 
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 Company’s 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 Company’s 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 Company’s cost structure in fiscal 2009 proceeded as planned, with full-year costs of $580 million removed from the Company’s 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 Company’s 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.
 
Fiscal 2010 — The View Ahead
 
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


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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 Company’s 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.
 
Operating Segment Overview
 
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 Company’s 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 Company’s 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 Company’s 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 Company’s 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.


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This excerpt taken from the SBUX DEF 14A filed Jan 22, 2009.
Overview
 
Our stock price has experienced a significant decline during the last few years due in large part to the continued weak economy as well as other factors within our control that have negatively impacted customer traffic in our stores and thus adversely affected our financial results. Like many retailers, Starbucks business has been, and continues to be, adversely impacted by the global financial and economic crises. Our business depends heavily on the amount of discretionary income our customers have to spend, and they have less to spend on our beverages and food as a result of job losses, foreclosures, bankruptcies, reduced access to credit, and sharply falling home values. We have taken a number of actions since January 2008 to transform and reinvigorate our business and improve our performance. However, our efforts have not yet had a significant impact on our stock price, which remains at a relatively low level. Consequently, the Company’s partners hold a significant number of stock options with exercise prices that greatly exceed both the current market price of Starbucks common stock and the average market price of our stock over the prior 12 months. Further, there can be no assurance that our efforts to transform and reinvigorate our business and improve our performance will ultimately result in significant increases in our stock price in the near-term, if at all. Thus, the board and the Compensation Committee believe these underwater options no longer provide the long-term incentive and retention objectives that they were intended to provide. The board and the Compensation Committee believe the exchange program is an important component in our strategy to align partner and shareholder interests through our equity compensation programs. We believe that the exchange program is important for the Company because it will permit us to:
 
  •  Provide renewed incentives to our partners who participate in the exchange program. As of December 5, 2008, approximately 62% of our outstanding stock options were underwater. The weighted average exercise price of these underwater options was $23.12 as compared to a $9.12 closing price of our common stock on December 5, 2008. As a result, these stock options do not currently provide meaningful retention or incentive value to our partners. We believe the exchange program will enable us to enhance long-term shareholder value by providing greater assurance that the Company will be able to retain experienced and productive partners, by improving the morale of our partners generally, and by aligning the interests of our partners more fully with the interests of our shareholders.
 
  •  Meaningfully reduce our total number of outstanding stock options, or “overhang,” represented by outstanding options that have high exercise prices and may no longer provide adequate incentives to our partners. These underwater stock options currently create an equity award overhang to our shareholders of approximately 52.2 million shares (based on the $9.12 closing price of our common stock on December 5, 2008). As of December 5, 2008, the total number of shares of Starbucks common stock outstanding was 733.4 million. Keeping these underwater options outstanding does not serve the interests of our shareholders and does not provide the benefits intended by our equity compensation program. By replacing the eligible options with a lesser number of options with a lower exercise price, our overhang will be decreased. The overhang represented by the options granted pursuant to the exchange program will reflect an appropriate balance between the Company’s goals for its equity compensation program and our interest in minimizing our overhang and the dilution of our shareholders’ interests.
 
  •  Recapture value from compensation costs that we already are incurring with respect to outstanding underwater stock options. These options were granted at the then fair market value of our common stock. Under applicable accounting rules, we will have to recognize a total of approximately $299.0 million in compensation expense related to these underwater options, $232.3 million of which has already been expensed as of September 28, 2008 and $66.7 million of which we will continue to be obligated to expense, even if these options are never exercised because the majority remain underwater. We believe it is not an efficient use of the Company’s resources to recognize compensation expense on options that are not perceived by our partners as providing value. By replacing options that have little or no retention or incentive value with options that will provide both retention and incentive value while not creating additional compensation expense (other than immaterial expense that might result from fluctuations in our stock price after the exchange ratios have been set but before the exchange actually occurs), the Company will be making efficient use of its resources.


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For reference purposes, the following table summarizes information regarding outstanding equity awards issued pursuant to the Company’s 2005 Long-Term Equity Incentive Plan (the “2005 Plan”), Amended and Restated Key Employee Stock Option Plan-1994 (the “1994 Plan”) and 1991 Company-Wide Stock Option Plan (the “1991 Plan,” and together with the 2005 Plan and 1994 Plan, the “Equity Plans”) and shares of common stock available for future grants under the Equity Plans as of December 5, 2008:
 
         
Shares available for future grant under existing plans
    19,712,910  
Shares issuable pursuant to outstanding stock options
    84,463,929  
Weighted average exercise price of all outstanding stock options
    $17.48  
Weighted average remaining term of all outstanding stock options
    7.3 years  
Shares issuable pursuant to all other outstanding equity awards(1)
    5,033,257  
 
 
(1) Consists solely of restricted stock units.
 
If our shareholders do not approve the equity plan amendments authorizing the exchange program, eligible options will remain outstanding and in effect in accordance with their existing terms. We will continue to recognize compensation expense for these eligible options, even though the options may have little or no retention or incentive value.
 
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