UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the Quarterly Period Ended June 29, 2003
OR
For the transition period from to .
Commission File Number: 0-20322
STARBUCKS CORPORATION
2401 Utah Avenue South, Seattle, Washington 98134
(206) 447-1575
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.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
Table of Contents
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
STARBUCKS CORPORATIONCONSOLIDATED STATEMENTS OF EARNINGS(in thousands, except earnings per share)(unaudited)
See Notes to Consolidated Financial Statements.
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STARBUCKS CORPORATIONCONSOLIDATED BALANCE SHEETS(in thousands, except share data)
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STARBUCKS CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited and in thousands)
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STARBUCKS CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSFor the 13 Weeks and 39 Weeks Ended June 29, 2003 and June 30, 2002
Note 1: Financial Statement Preparation
The consolidated financial statements as of June 29, 2003, and June 30, 2002, and for the 13-week and 39-week periods ended June 29, 2003, and June 30, 2002, have been prepared by Starbucks Corporation (“Starbucks” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The financial information for the 13-week and 39-week periods ended June 29, 2003, and June 30, 2002, is unaudited, but, in the opinion of management, reflects all adjustments and accruals necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods.
The financial information as of September 29, 2002, is derived from the Company’s audited consolidated financial statements and notes thereto for the year ended September 29, 2002, included in Item 8 in the Fiscal 2002 Annual Report to Shareholders on Form 10-K, and should be read in conjunction with such financial statements.
Certain reclassifications of prior year’s balances have been made to conform to the current format.
The results of operations for the 13-week and 39-week periods ended June 29, 2003, are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending September 28, 2003.
Investment Accounting Change
During the second fiscal quarter of 2003, Starbucks reached agreement to acquire its licensed operations in Austria and Switzerland, which enabled the Company to exert significant influence over the operating and financial policies of these entities. As a result, management determined that a change in accounting method, from the cost method to the equity method, was required. This accounting change included adjusting information reported prior to the 13 week period ended March 30, 2003, for the Company’s 19.5% share of net losses as required by Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”
As shown in the table below, the change to the equity method resulted in a $1.6 million reduction of net earnings for the 13 weeks ended December 29, 2002, and reductions of net earnings for the effects of the accounting change prior to fiscal 2003 of $2.3 million and $0.8 million for the 52 weeks ended September 29, 2002 and September 30, 2001, respectively (in thousands, except earnings per share):
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The following table summarizes the effects of the investment accounting change on net earnings and earnings per share for the periods indicated (in thousands, except earnings per share):
During the fiscal third quarter, Starbucks acquired the remaining equity of both Austria and Switzerland for approximately $5.2 million, increasing the Company’s ownership interests from 19.5% to 100%. Subsequent to June 29, 2003, Starbucks sold 50% of its ownership interests to a third party. (See Note 12) Management has continued to apply the equity method of accounting, rather than apply the consolidation method, because the Company’s ability to control the operating and financial policies of these entities was temporary in nature.
Note 2: Summary of Significant Accounting Policies
Goodwill and Other Intangible Assets
Starbucks adopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” on September 30, 2002. As a result, the Company discontinued amortization of its goodwill and indefinite-lived trademarks and determined that provisions for impairment were unnecessary. Impairment tests will be performed on an annual basis and more frequently if facts and circumstances indicate goodwill carrying values exceed estimated reporting unit fair values and if indefinite useful lives are no longer appropriate for the Company’s trademarks. Had the nonamortization provision of SFAS No. 142 been applied to fiscal 2002, as restated per Note 1, net earnings for the 13-week and 39-week periods ended June 30, 2002, would have been $56.1 million and $156.6 million, respectively, versus restated net earnings of $55.7 million and $155.1 million, respectively. Basic and diluted earnings per share would have remained unchanged for the 13-week period ended June 30, 2002. Basic earnings per share for the 39-week period ended June 30, 2002 would have increased to $0.41 per share from $0.40 per share, while diluted earnings per share for the 39-week period ended June 30, 2002 would have remained unchanged. Definite-lived intangibles, which mainly consist of patents and copyrights, will continue to amortize over their estimated useful lives.
Accounting for Stock-Based Compensation
The Company maintains several stock option plans under which incentive stock options and non-qualified stock options may be granted to employees, consultants and non-employee directors. Starbucks accounts for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, because the grant price equals the market price on the date of grant, no compensation expense is recognized by the Company for stock options issued to employees.
On December 31, 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for voluntary change to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 requires more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Starbucks adopted the annual and interim disclosure requirements of SFAS No. 148 as of September 30, 2002.
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Had compensation cost for the Company’s stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology allowed by SFAS No. 123, as amended by SFAS No. 148, the Company’s net earnings and earnings per share would have been as follows (in thousands, except earnings per share):
The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and the Company’s experience.
Recently Issued Accounting Pronouncements
In January 2003, FASB Interpretation No. 46 (“FIN No. 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” was issued. FIN No. 46 requires identification of the Company’s participation in variable interest entities (“VIE“s), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. For entities identified as VIEs, FIN No. 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN No. 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must be applied for the first interim or annual period beginning after June 15, 2003. FIN No. 46 also sets forth certain disclosures regarding interests in VIEs that are deemed significant, even if consolidation is not required. The adoption of FIN No. 46 on June 30, 2003 did not have an impact on the Company’s consolidated financial statements or disclosures.
In April 2003, SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” was issued. In general, this statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have an impact on the Company’s consolidated financial statements or disclosures.
In May 2003, SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”) was issued, which requires that certain financial instruments must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to the Company’s existing financial instruments effective June 30, 2003, the beginning of the first fiscal period after June 15, 2003. The adoption of SFAS No. 150 on June 30, 2003, did not have an impact on the Company’s consolidated financial statements or disclosures.
In May 2003, the Emerging Issues Task Force (“EITF”) released Issue No. 01-8, “Determining Whether an Arrangement Contains a Lease.” This Issue requires the reporting of revenue as rental or leasing income that would otherwise be reported as part of product sales or services revenue. Issue 01-8 requires both parties to an arrangement to determine whether a service contract or similar arrangement includes a lease within the scope of SFAS No. 13, “Accounting for Leases,” which means identifying agreements conveying the right to use property, plant, or equipment. The new requirements apply to new or modified arrangements beginning after May 28, 2003. The
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Company’s adoption of this Issue did not have an impact on its consolidated financial statements or disclosures.
Note 3: Inventories
Inventories consist of the following (in thousands):
As of June 29, 2003, the Company had committed to fixed-price purchase contracts for green coffee totaling approximately $218.0 million.
Note 4: Derivative Financial Instruments
Cash Flow Hedges
During the 13-week and 39-week periods ended June 29, 2003, and June 30, 2002, the Company had forward foreign exchange contracts that qualify as hedges of portions of anticipated product and royalty revenues denominated in Japanese yen and Canadian dollars. These contracts expire within 27 months. The Company had accumulated net derivative gains of $0.6 million, net of taxes, in other comprehensive income as of June 29, 2003, related to cash flow hedges. Of this amount, $0.4 million of net derivative gains will be reclassified into earnings within 12 months. There was no ineffectiveness related to cash flow hedges for the 13-week and 39-week periods ended June 29, 2003, and June 30, 2002.
Net Investment Hedges
During the 13-week and 39-week periods ended June 29, 2003, and June 30, 2002, the Company had forward foreign exchange contracts that qualify as hedges of the Company’s net investment in Starbucks Coffee Japan, Ltd. These contracts expire within 17 months and are intended to minimize foreign currency exposure to fluctuations in the Japanese yen. As a result of using the spot-to-spot method, the Company recognized net gains of $0.3 million and $1.3 million for the 13-week and 39-week periods ended June 29, 2003, respectively, and net gains of $0.6 million and $0.9 million for the 13-week and 39-week periods ended June 30, 2002, respectively. In addition, the Company had accumulated net derivative losses of $1.3 million, net of taxes, in other comprehensive income as of June 29, 2003.
Note 5: Property, Plant, and Equipment
Property, plant and equipment are recorded at cost and consist of the following (in thousands):
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Note 6: Shareholders’ Equity
In June 2002, the Company’s Board of Directors authorized the repurchase of up to 10.0 million shares of common stock in the open market. In March 2003, the Company’s Board of Directors authorized an additional program to repurchase up to 10.0 million shares of the Company’s common stock. The Board of Directors also authorized management to repurchase shares under any of the Company’s programs pursuant to a contract, instruction or written plan meeting the requirements of Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934. During the 39 weeks ended June 29, 2003, Starbucks acquired 2.8 million shares under these programs at an average price of $22.26 per share, for a total cost of $61.2 million. During fiscal year 2002, the Company acquired 2.1 million shares under the June 2002 program at an average price of $19.81 per share, for a total cost of $42.0 million. All repurchases were effected through Morgan Stanley & Co. Incorporated or Citigroup Global Markets, Inc. As of June 29, 2003, approximately 15.1 million shares remain available for repurchase under these programs.
Note 7: Comprehensive Income
Comprehensive income, net of related tax effects, is as follows (in thousands):
The Company is subject to foreign currency translation adjustments because its international operations use their local currencies as their functional currencies. Assets and liabilities are translated at exchange rates in effect at the balance sheet date, and the resulting translation adjustments are recorded as a separate component of “Accumulated other comprehensive income/(loss)” on the accompanying consolidated balance sheets.
Note 8: Earnings Per Share
The following table represents the calculation of net earnings per common share — basic (in thousands, except earnings per share):
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The following table represents the calculation of net earnings per common and common equivalent share – diluted (in thousands, except earnings per share):
Options with exercise prices greater than the average market price were not included in the computation of diluted earnings per share. For the 13-week periods ended June 29, 2003, and June 30, 2002, these options totaled 0.4 million and 0.5 million, respectively, during which periods the average market price of the Company’s common stock was $24.38 and $24.01, respectively. For the 39-week periods ended June 29, 2003, and June 30, 2002, these options totaled 0.8 million and 1.5 million, respectively, during which periods the average market price of the Company’s common stock was $22.96 and $21.43, respectively.
Note 9: Guarantees
In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN No. 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” which elaborates on existing disclosure of most guarantees, and clarifies when a company must recognize an initial liability for the fair value of obligations it assumes under guarantee agreements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN No. 45 on September 30, 2002.
The Company has unconditionally guaranteed the repayment of certain yen denominated bank loans and related interest and fees of an unconsolidated equity investee, Starbucks Coffee Japan, Ltd. The guarantees continue until the loans, including accrued interest and fees, have been paid in full. The maximum amount is limited to the sum of unpaid principal and interest amounts, as well as other related expenses. These amounts will vary based on fluctuations in the yen foreign exchange rate. As of June 29, 2003, the maximum amount of the guarantees was approximately $11.7 million.
Note 10: Commitments and Contingencies
The Company is party to various legal proceedings arising in the ordinary course of its business, but it is not currently a party to any legal proceeding that management believes would have a material adverse effect on the financial position or results of operations of the Company.
Note 11: Segment Reporting
Starbucks is organized into a number of business units, which correspond to the Company’s operating segments. Revenues from these segments include both sales to unaffiliated customers and sales between segments, which are accounted for on a basis consistent with sales to unaffiliated customers. Segment information has been prepared using a management approach that is consistent with the basis and manner in which the Company’s management internally reviews financial information for operational decision making purposes. Included in the information below are intersegment transactions, consisting primarily of product sales and related cost of sales to and from subsidiaries and equity method investees. However, these intersegment transactions have been eliminated on the accompanying consolidated financial statements.
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The tables below present information by operating segment (in thousands):
The tables below represent information by geographic area (in thousands):
Revenues from foreign countries are based on the geographic location of the customers and consist primarily of retail revenues from the United Kingdom and Canada, which together account for approximately 80% of these revenues, as well as specialty revenues generated from product sales to international licensees. No customer accounts for 10% or more of the Company’s revenues.
Note 12: Subsequent Events
On June 30, 2003, Starbucks paid approximately $24 million to acquire additional equity ownership in both its Taiwan and Shanghai licensed operations, increasing the Company’s ownership interests from 5% to 50%. Retroactive application of the equity method of accounting for these investments, which were previously accounted for under the cost method, is not expected to significantly impact the Company’s previously reported financial positions or results of operations.
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On July 1, 2003, Starbucks sold 50% of its ownership interests in Austria and Switzerland operations to a third party for approximately $10 million. The Company’s ownership interests were reduced from 100% to 50% following the sale.
On July 14, 2003, Starbucks completed its previously announced acquisition of the outstanding common stock of Seattle Coffee Company (“SCC”) from AFC Enterprises, Inc. in a $72 million, all cash transaction. SCC includes the Seattle’s Best Coffee® and Torrefazione Italia Coffee® brands. The Company expects to continue to incur certain systems and other integration costs related to the acquisition during the fourth quarter of fiscal 2003.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements herein, including anticipated store openings, comparable store sales expectations, trends in or expectations regarding the Company’s revenue growth, capital expenditures, effective tax rate, and net earnings and earnings per share results, all constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, coffee and other raw materials prices and availability, successful execution of internal performance and expansion plans, fluctuations in United States and international economies, ramifications from the war on terrorism, or other international events or developments, the impact of competition, the effect of legal proceedings, and other risks detailed herein and in Starbucks Corporation’s other filings with the Securities and Exchange Commission.
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. Users should not place undue reliance on the forward-looking statements, which speak only as of the date of this Report. The Company is under no obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
General
Starbucks Corporation’s fiscal year ends on the Sunday closest to September 30. Fiscal year 2002 had 52 weeks. The fiscal year ending on September 28, 2003, will also include 52 weeks. The fiscal year ending on September 27, 2004, will include 53 weeks.
Starbucks Corporation (together with its subsidiaries, “Starbucks” or the “Company”) is organized into a number of business units, which correspond to the Company’s operating segments. Revenues from these segments include both sales to unaffiliated customers and sales between segments, which are accounted for on a basis consistent with sales to unaffiliated customers. Segment information has been prepared using a management approach that is consistent with the basis and manner in which the Company’s management internally reviews financial information for operational decision making purposes. However, intersegment revenues, consisting primarily of product sales to and from subsidiaries and equity method investees, and other intersegment transactions have been eliminated for Management’s Discussion & Analysis to comply with accounting principles generally accepted in the United States of America.
During the second fiscal quarter of 2003, Starbucks reached agreement to acquire its licensed operations in Austria and Switzerland, which concurrently enabled the Company to exert significant influence over the operating and financial policies of these entities. As a result, management determined that a change in accounting method, from the cost method to the equity method, was required. This accounting change included adjusting information reported prior to the 13 week period ended March 30, 2003, for the Company’s 19.5% share of net losses as required by Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”
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During the fiscal third quarter, Starbucks acquired the remaining equity of both Austria and Switzerland for approximately $5.2 million, increasing the Company’s ownership interests from 19.5% to 100%. Subsequent to June 29, 2003, Starbucks sold 50% of its ownership interests to a third party. (See “Subsequent Events”) Management has continued to apply the equity method of accounting, rather than apply the consolidation method, because the Company’s ability to control the operating and financial policies of these entities was temporary in nature.
Results of Operations for the 13 Weeks Ended June 29, 2003, and June 30, 2002
CONSOLIDATED RESULTS
Net revenues for the 13 weeks ended June 29, 2003, increased 24.1% to $1.0 billion from $835.2 million for the corresponding period in fiscal 2002. During the 13-week period ended June 29, 2003, Starbucks derived approximately 85% of net revenues from its Company-operated retail stores. Retail revenues, which include North American Retail and international retail business units, increased 23.3% to $877.8 million for the 13 weeks ended June 29, 2003, from $711.8 million for the corresponding period of fiscal 2002. This increase was due primarily to the opening of 525 new Company-operated retail stores in the last 12 months and comparable store sales growth of 8%, driven almost entirely by increased transactions.
The Company derived the remaining 15% of net revenues from its specialty operations, or non-retail business units. Specialty revenues increased 28.9% to $159.0 million for the 13 weeks ended June 29, 2003, from $123.3 million for the corresponding period in fiscal 2002, primarily due to growth in domestic and international retail licensing and foodservice accounts. Specialty operations include Business Alliances, which consists of the North American licensing channel and foodservice accounts, as well as international retail store licensing, grocery channel licensing,
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warehouse club accounts, interactive operations, equity investees and other initiatives related to the Company’s core businesses.
Cost of sales and related occupancy costs were 41.1% of net revenues for the 13 weeks ended June 29, 2003, as compared to 40.4% for the corresponding period of fiscal 2002. This increase was primarily due to higher green coffee costs, partially offset by lower food and dairy expenses. The Company’s green coffee costs reached a seven-year low in the second and third fiscal quarters of 2002 and have increased gradually since then.
Store operating expenses as a percentage of retail revenues increased to 41.2% for the 13 weeks ended June 29, 2003, from 40.9% for the corresponding period of fiscal 2002. The increase was primarily due to higher marketing expenditures, and to a lesser extent, additional expenses incurred to support the Starbucks Card for North American Retail operations. Partially offsetting these increases were lower provisions recorded in the current quarter for asset impairment for international Company-operated retail operations, when compared to the corresponding period in the prior year.
Other operating expenses (expenses associated with the Company’s specialty operations) increased to 26.4% of net specialty revenues for the 13 weeks ended June 29, 2003, compared to 23.7% in the corresponding period of fiscal 2002. The increase is mainly attributable to continued infrastructure development of the domestic licensing and foodservice channels, including expanding field organizations, restructuring its distribution channels and expanding marketing support of new and existing accounts.
Depreciation and amortization expenses increased to $59.8 million for the 13 weeks ended June 29, 2003, from the $50.9 million in the corresponding period of fiscal 2002 due to the opening of additional North American and international Company-operated retail stores.
General and administrative expenses increased to $49.3 million for the 13 weeks ended June 29, 2003, from $47.0 million in the corresponding period of fiscal 2002. The increase was attributable to higher payroll-related expenditures. However, as a percentage of total net revenues, general and administrative expenses decreased to 4.8% from 5.6%.
Income from equity investees was $7.9 million for the 13 weeks ended June 29, 2003, compared to $8.0 million in the corresponding period of fiscal 2002. The decrease was mainly attributable to sustained negative comparable store sales growth adversely affecting the net earnings of Starbucks Coffee Japan, Ltd., as well as losses sustained by the Switzerland and Austria equity investees, which are in the start-up phase. Partially offsetting these losses were continued strong results experienced by The North American Coffee Partnership, the Company’s 50% owned ready-to-drink partnership with the Pepsi-Cola Company, and the Starbucks Ice Cream Partnership with Dreyer’s Grand Ice Cream, Inc., from expanded product lines, lower direct costs and manufacturing efficiencies.
Operating income increased 21.7% to $106.1 million for the 13 weeks ended June 29, 2003, from $87.2 million in the corresponding period of fiscal 2002, mainly due to revenue growth. The operating margin decreased to 10.2% of total net revenues in the 13 weeks ended June 29, 2003, compared to 10.4% in the corresponding period of fiscal 2002, primarily due to higher green coffee costs.
Interest and other income increased to $5.1 million in the 13 weeks ended June 29, 2003, compared to $1.5 million in the corresponding period of fiscal 2002, primarily due to gains realized on market revaluations of the Company’s trading securities, compared to realized losses on this portfolio in the same period last year.
Income taxes for the 13 weeks ended June 29, 2003, were based on an effective tax rate of 38.5%, compared to 37.2% in the corresponding period of fiscal 2002, as a result of a shift in the composition of the Company’s pre-tax earnings in fiscal 2003. Operations based in the United States were more profitable than expected, and international operations, which are in various phases of development, generated greater non-deductible losses than anticipated. Management expects the effective tax rate to be 38.5% for the remainder of fiscal 2003.
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SEGMENT RESULTS
The table below presents total net revenues and operating income by operating segment, net of intersegment eliminations (in thousands):
North American Retail
North American Retail sells coffee and other beverages, whole bean coffees, complementary food, coffee brewing equipment and merchandise through Company-operated retail stores in the United States and Canada. North American Retail revenues increased by $144.3 million, or 21.9%, to $803.2 million for the 13 weeks ended June 29, 2003, from $658.9 million for the corresponding period of fiscal 2002, primarily due to the opening of new retail stores and an increase in comparable store sales of 9% for the period. The increase in comparable store sales was almost entirely due to higher transaction volume. Management believes increased customer traffic continues to be driven by new product innovation, customer satisfaction and improved speed of service through enhanced technology, training and execution at retail stores.
Operating income for North American Retail increased 14.0% to $128.0 million for the 13 weeks ended June 29, 2003, from $112.3 million in the corresponding period in fiscal 2002. The North American Retail operating margin decreased from a record third quarter high of 17.0% in the prior year, to 15.9% primarily due to higher green coffee costs, higher marketing expenditures and slight increases as a percentage of related revenues in most store operating expenses, except payroll-related expenditures. The Company’s green coffee costs reached a seven-year low in the second and third fiscal quarters of 2002 and have increased gradually since then.
Business Alliances
Business Alliances sells whole bean and ground coffees to foodservice accounts. In addition, Business Alliances sells coffee and related products for resale through North American retail store licensing agreements and receives license fees and royalties. Business Alliances revenues increased 38.2%, to $77.9 million for the 13 weeks ended June 29, 2003, from $56.3 million in the corresponding period in fiscal 2002, primarily due to the opening of new licensed stores and increased product sales to and royalty revenues from new and existing licensees. Growth in the food service channel also contributed to the increase.
Operating income for Business Alliances increased by 1.8% to $16.3 million for the 13 weeks ended June 29, 2003, from $16.0 million in the corresponding period in fiscal 2002. The segment’s operating margin decreased to 20.9% of related revenues from 28.4% in the prior year due to the change in sales mix to lower margin products and continued investments to restructure distribution channels and expand the marketing support of new and existing accounts.
All other business units (including international retail, net of related intersegment eliminations)
The remainder of the Company’s business units include international retail (comprised of international Company-operated retail stores), international retail store licensing, grocery channel licensing, warehouse club accounts, interactive operations, equity investees and other initiatives related to the Company’s core businesses. Revenues for all other business units increased by $35.8 million, or 29.9%, to $155.7 million for the 13 weeks ended June 29,
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2003, from $119.9 million in the corresponding period in fiscal 2002. This increase was mainly related to growth in the number of international licensed and Company-operated retail stores.
Operating income for all other business units increased to $19.3 million for the 13 weeks ended June 29, 2003, from $13.2 million in the corresponding period in fiscal 2002. The segment’s operating margin increased to 12.4% of related revenues from 11.0% in the prior year, primarily due to lower provisions recorded in the current quarter for asset impairment for international Company-operated retail stores, when compared to the corresponding period in the prior year. This decrease was partially offset by higher green coffee and distribution costs.
Results of Operations for the 39 Weeks Ended June 29, 2003, and June 30, 2002
Net revenues for the 39 weeks ended June 29, 2003, increased 23.6% to $3.0 billion from $2.4 billion for the corresponding period in fiscal 2002. During the 39-week period ended June 29, 2003, Starbucks derived approximately 85% of net revenues from its Company-operated retail stores. Retail revenues, which include North American Retail and international retail business units, increased 23.2% to $2.5 billion for the 39 weeks ended June 29, 2003, from $2.1 billion for the corresponding period of fiscal 2002. This increase was due primarily to the opening of 525 new Company-operated retail stores in the last 12 months and comparable store sales growth of 8%, driven almost entirely by increased transactions.
The Company derived the remaining 15% of net revenues from its specialty operations, or non-retail business units. Specialty revenues increased 25.3% to $457.9 million for the 39 weeks ended June 29, 2003, from $365.3 million for the corresponding period in fiscal 2002, primarily due to growth in domestic and international retail licensing. Specialty operations include Business Alliances, which consists of the North American licensing channel and foodservice accounts, as well as international retail store licensing, grocery channel licensing, warehouse club accounts, interactive operations, equity investees and other initiatives related to the Company’s core businesses.
Cost of sales and related occupancy costs were 41.3% of net revenues for the first 39 weeks of fiscal 2003 compared to 41.0% for the corresponding period in fiscal 2002. The increase was primarily due to higher green coffee and distribution costs, partially offset by lower packaged food costs. The Company’s green coffee costs reached a seven-year low in the second and third fiscal quarters of 2002 and have increased gradually since then.
Store operating expenses as a percentage of retail revenues increased 40.1% for the 39 weeks ended June 29, 2003, compared to 40.0% for the corresponding period in fiscal 2002. The increase was primarily due to higher marketing expenditures, and to a lesser extent, additional expenses incurred to support the Starbucks Card for North American Retail operations. Partially offsetting these increases were lower provisions for asset impairment for international Company-operated retail operations.
Other operating expenses (expenses associated with the Company’s specialty operations) increased to 27.1% of specialty revenues for the 39 weeks ended June 29, 2003, compared to 25.5% for the corresponding period in fiscal 2002. The increase was mainly attributable to continued infrastructure development of the domestic licensing and foodservice channels, including expanding field organizations, and restructuring distribution channels, as well as costs associated with dissolving the Company’s licensed Israel operations.
Depreciation and amortization expenses increased to $175.1 million for the 39 weeks ended June 29, 2003, from $151.1 million in the corresponding period in fiscal 2002 primarily due to a net increase of an additional 460 North American and 65 international Company-operated retail stores in the last 12 months.
General and administrative expenses decreased to $150.8 million for the 39 weeks ended June 29, 2003, from $155.4 million in the same period in fiscal 2002, which included an $18.0 million charge for the litigation settlement of two California class action lawsuits. Excluding the litigation charge, general and administrative expenses increased over the comparable period in fiscal 2002 due to higher payroll-related expenditures.
Income from equity investees was $21.2 million for the 39 weeks ended June 29, 2003, compared to $21.1 million in the corresponding period of fiscal 2002. The increase was primarily due to continued strong results experienced by The North American Coffee Partnership, the Company’s 50% owned ready-to-drink partnership with the Pepsi-Cola Company, and the Starbucks Ice Cream Partnership with Dreyer’s Grand Ice Cream, Inc., from expanded product lines, lower direct costs and manufacturing efficiencies. These increases were partially offset by sustained negative comparable store sales growth adversely affecting the net earnings of Starbucks Coffee Japan, Ltd., as well as losses
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sustained by the Switzerland and Austria equity investees, which are in the start-up phase.
Operating income increased to $312.5 million for the 39 weeks ended June 29, 2003, from $227.6 million in the corresponding period in fiscal 2002. The operating margin increased to 10.4% of total net revenues in the 39 weeks ended June 29, 2003, compared to 9.4% in the same period in fiscal 2002, primarily due to revenue growth as discussed above and the impact of the $18.0 million litigation settlement charge recorded in the prior year.
Interest and other income increased to $10.9 million for the 39 weeks ended June 29, 2003, from $6.1 million in the same period of fiscal 2002. The increase was primarily due to higher interest income generated from increased cash, cash equivalents and short-term investments, and to a lesser extent, gains realized on market revaluations of the Company’s trading securities, compared to realized lossses on this portfolio in the same period last year.
A gain on the sale of the Company’s investment in Starbucks Coffee Japan, Ltd. of $13.4 million was recorded in the first quarter of fiscal 2002. There was no similar transaction in the 39-week period ended June 29, 2003.
Income taxes for the 39 weeks ended June 29, 2003, were based on an effective tax rate of 38.5% compared to 37.2% in the corresponding period of fiscal 2002 as a result of a shift in the composition of the Company’s pre-tax earnings in fiscal 2003. Operations based in the United States were more profitable than expected, and international operations, which are in various phases of development, generated greater non-deductible losses than anticipated. Management expects the effective tax rate to be 38.5% for the remainder of fiscal 2003. Starbucks is targeting an effective tax rate of 38.0% for fiscal 2004.
North American Retail sells coffee and other beverages, whole bean coffees, complementary food, coffee brewing equipment and merchandise through Company-operated retail stores in the United States and Canada. North American Retail revenues increased by $417.5 million, or 21.9% to $2.3 billion for the 39 weeks ended June 29, 2003, from $1.9 billion for the corresponding period of fiscal 2002, due to the opening of new retail stores and an increase in comparable store sales of 8% for the period. The increase in comparable store sales was almost entirely due to higher transaction volume. Management believes increased customer traffic continues to be driven by new product innovation, customer satisfaction and improved speed of service through enhanced technology, training and execution at retail stores.
Operating income for North American Retail increased by 21.9% to $393.8 million for the 39 weeks ended June 29, 2003, from $323.1 million in the corresponding period in fiscal 2002. The North American Retail operating margin for the 39 weeks ended June 30, 2003 remained at 16.9% of related revenues.
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Business Alliances sells whole bean and ground coffees to foodservice accounts. In addition, Business Alliances sells coffee and related products for resale through North American retail store licensing agreements and receives license fees and royalties. Business Alliances revenues increased by $57.1 million, or 34.9%, to $220.8 million for the 39 weeks ended June 29, 2003, from $163.7 million in the corresponding period in fiscal 2002, primarily due to the opening of new licensed stores and increased royalty revenues from and product sales to new and existing licensees.
Operating income for Business Alliances increased by 8.1% to $45.5 million for the 39 weeks ended June 29, 2003, from $42.1 million in the corresponding period in fiscal 2002. The segment’s operating margin decreased to 20.6% of related revenues from 25.7% in the prior year due to the change in sales mix to lower margin products and continued investments to restucture distribution channels and expand marketing support of new and existing accounts.
The remainder of the Company’s business units include international retail (comprised of international Company-operated retail stores), international retail store licensing, grocery channel licensing, warehouse club accounts, interactive operations, equity investees and other initiatives related to the Company’s core businesses. Revenues for all other business units increased by $96.2 million, or 27.4%, to $446.8 million for the 39 weeks ended June 29, 2003, from $350.6 million in the corresponding period in fiscal 2002. This increase was mainly related to growth in the number of international licensed and Company-operated retail stores.
Operating income for all other business units increased to $46.9 million for the 39 weeks ended June 29, 2003, from $43.0 million in the corresponding period in fiscal 2002. The segment’s operating margin decreased to 10.5% of related revenues from 12.3% in the prior year, primarily due to higher green coffee and distribution costs.
Store Data
The following table summarizes the Company’s systemwide retail store information as of and for the 39-week periods ended:
For the 52 weeks ending September 28, 2003, Starbucks currently expects to open approximately 1,200 new stores. In fiscal 2004, Starbucks plans to open approximately 1,300 new stores, including approximately 575 Company-operated and 375 licensed locations in continental North America, and approximately 50 Company-operated and 300 licensed international locations.
Liquidity and Capital Resources
Cash and cash equivalents increased by $164.0 million for the 39 weeks ended June 29, 2003, to $263.6 million. The Company ended the period with $565.3 million in total cash and cash equivalents and short-term investments. Working capital as of June 29, 2003, totaled $464.4 million compared to $357.7 million as of June 30, 2002. The Company intends to use its available cash resources to invest in its core businesses and other new business opportunities related to its core businesses, such as the acquisition of Seattle Coffee Company and increasing ownership interests in the Company’s Taiwan and Shanghai licensed operations (See “Subsequent Events”). Depending on market conditions, Starbucks may acquire additional shares of its common stock pursuant to its stock
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repurchase programs.
Cash provided by operating activities totaled $487.6 million for the first 39 weeks of fiscal 2003, resulting primarily from net earnings of $198.9 million and non-cash items of $211.6 million. The change in accounts payable resulting from differences in the timing of purchases and payments provided $40.2 million, and the increase in deferred revenue due to the growth of Starbucks card balances not yet redeemed provided $32.0 million. The change in other accrued expenses in the prior year included the $18.0 million litigation settlement charge.
Cash used by investing activities for the first 39 weeks of fiscal 2003 totaled $337.8 million. This included capital additions to property, plant and equipment of $259.2 million related to opening 406 new Company-operated retail stores and remodeling certain existing stores, acquiring a corporate aircraft and the construction of the Company’s roasting and distribution facility in Nevada. The net activity in the Company’s portfolio of available-for-sale securities during the 39-week period used $69.8 million.
Cash provided by financing activities for the first 39 weeks of fiscal 2003 totaled $10.5 million. The exercise of stock options and sale of stock under the Company’s employee stock purchase plan provided $72.3 million. During the period, the Company repurchased 2.8 million shares of its common stock at an average price of $22.26 per share in accordance with repurchase programs authorized in June 2002 and March 2003, using $61.2 million of cash. These repurchases were effected through Morgan Stanley & Co. Incorporated or Citigroup Global Markets, Inc. Approximately 15.1 million shares remain authorized for repurchase under these programs as of June 29, 2003. Share repurchases are at the discretion of management and depend on market conditions, capital requirements and such other factors as the Company may consider relevant.
Cash requirements for the remainder of fiscal 2003, other than normal operating expenses, are expected to consist primarily of capital expenditures related to the addition of new Company-operated retail stores. The Company also anticipates incurring additional expenditures for remodeling certain existing stores and enhancing its production capacity and information systems. Management expects capital expenditures for fiscal year 2003 to be approximately $410 million. Capital expenditures are expected to be in the range of $450 to $475 million for fiscal year 2004.
Management believes that existing cash and investments plus cash generated from operations will be sufficient to finance capital requirements for its existing core businesses through fiscal 2004, as well as $72 million for the acquisition of Seattle Coffee Company and $24 million to acquire additional equity ownership in both Taiwan and Shanghai licensed operations (See “Subsequent Events”).
Guarantees of Indebtedness of Others
In November, 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45 (“FIN No. 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” which elaborates on existing disclosure of most guarantees, and clarifies when a company must recognize an initial liability for the fair value of obligations it assumes under guarantee agreements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN No. 45 on September 30, 2002.
Coffee Prices, Availability and General Risk Conditions
The supply and price of coffee are subject to significant volatility. Although most coffee trades in the commodity market, 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 commodity prices of green coffee through agreements establishing export quotas or restricting coffee supplies worldwide. The Company’s ability to
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raise sales prices in response to rising coffee prices may be limited and the Company’s profitability could be adversely affected if coffee prices were to rise substantially.
The Company enters into fixed-price purchase commitments in order to secure an adequate supply of quality green coffee and bring greater certainty to the cost of sales in future periods. As of June 29, 2003, the Company had approximately $218.0 million in fixed-price purchase commitments which, together with existing inventory, is expected to provide an adequate supply of green coffee through 2004. The Company believes, based on relationships established with its suppliers in the past, that the risk of non-delivery on such purchase commitments is low.
In addition to fluctuating coffee prices, management believes that the Company’s future results of operations and earnings could be significantly impacted by other factors such as increased competition within the specialty coffee industry, fluctuating dairy prices, the Company’s ability to find optimal store locations at favorable lease rates, increased costs associated with opening and operating retail stores in new markets and the Company’s continued ability to hire, train and retain qualified personnel.
Seasonality and Quarterly Results
The Company’s business is subject to seasonal fluctuations. Significant portions of the Company’s net revenues and profits are realized during the first quarter of the Company’s fiscal year, which includes the December holiday season. In addition, quarterly results are affected by the timing of the opening of new stores, and the Company’s rapid growth may conceal the impact of other seasonal influences. Because of the seasonality of the Company’s business, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.
On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for voluntary change to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 requires more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Starbucks adopted the annual and interim disclosure requirements of SFAS No. 148 as of September 30, 2002.
In January 2003, FASB Interpretation No. 46 (“FIN No. 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” was issued. FIN No. 46 requires identification of the Company’s participation in variable interest entities (“VIE“s), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. For entities identified as VIEs, FIN No. 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN No. 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must be applied for the first interim or annual period beginning after June 15, 2003. FIN 46 also sets forth certain disclosures regarding interests in VIEs that are deemed significant, even if consolidation is not required. The adoption of FIN No. 46 on June 30, 2003 did not have an impact on the
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Company’s consolidated financial statements or disclosures.
In May 2003, SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”) was issued, which requires that certain financial instruments must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to the Company’s existing financial instruments effective June 30, 2003, the beginning of the first fiscal period after June 15, 2003. The adoption of SFAS 150 on June 30, 2003, did not have an impact on the Company’s consolidated financial statements or disclosures.
In May 2003, the Emerging Issues Task Force (“EITF”) released Issue No. 01-8, “Determining Whether an Arrangement Contains a Lease.” This Issue requires the reporting of revenue as rental or leasing income that would otherwise be reported as part of product sales or services revenue. Issue 01-8 requires both parties to an arrangement to determine whether a service contract or similar arrangement includes a lease within the scope of SFAS No. 13, “Accounting for Leases,” which means identifying agreements conveying the right to use property, plant, or equipment. The new requirements apply to new or modified arrangements beginning after May 28, 2003. The Company’s adoption of this Issue did not have an impact on its consolidated financial statements or disclosures.
Subsequent Events
On July 1, 2003, Starbucks sold 50% of its ownership interests in its Austria and Switzerland operations to a third party for approximately $10 million. The Company’s ownership interests were reduced from 100% to 50% following the sale.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to Item 7A in the Fiscal 2002 Annual Report to Shareholders on Form 10-K for the year ended September 30, 2002, regarding this matter.
Item 4. Controls and Procedures
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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INDEX TO EXHIBITS
E1