Starbucks Corporation: Q1 Fiscal 2008 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the 13-week period ended December 30, 2007 (Fiscal Q1 2008). Starbucks Corporation operates three reportable segments: United States, International, and Global Consumer Products Group (CPG). The company reported 15,756 total retail stores open as of the period end. In early January 2008, the company announced a strategic transformation plan involving leadership changes and a shift in focus from U.S. store growth to international expansion and customer experience renewal.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2008 | Q1 2007 |
|---|---|---|
| Total Net Revenues | $2,767.6 | $2,355.7 |
| Operating Income | $333.1 | $319.7 |
| Operating Margin | 12.0% | 13.6% |
| Net Earnings | $208.1 | $205.0 |
| Diluted EPS | $0.28 | $0.26 |
| Net Cash from Operating Activities | $807.6 | $678.4 |
| Cash and Cash Equivalents | $349.3 | $281.3 |
| Total Debt (Short-term + Long-term) | $1,079.5 | $1,260.4 |
Note: Total Debt includes $529.5M commercial paper and $550.0M long-term debt as of Dec 30, 2007.
Material Changes vs. Prior Period
- Revenue Growth: Total net revenues increased 17.5% year-over-year, driven by a 17.2% increase in company-operated retail revenues and a 19.3% increase in specialty revenues.
- Margin Compression: Operating margin contracted 160 basis points to 12.0%. This was primarily driven by the U.S. segment, where margins declined 290 basis points to 14.6% due to higher cost of sales (dairy costs) and increased store operating expenses relative to revenue.
- Segment Performance:
- United States: Revenues up 14.3%, but operating income declined 4.4% to $310.9M. Comparable store sales contracted 1% due to a 3% drop in transactions.
- International: Revenues surged 33.5% to $540.8M, and operating income jumped 63.4% to $54.1M. Comparable store sales grew 5%.
- CPG: Revenues increased 10.9% to $100.6M with operating income up 21.6%.
- Interest Expense: Increased significantly to $17.1M from $7.0M due to higher levels of borrowings outstanding, including the issuance of $550M in Senior Notes in late 2007.
Guidance, Outlook, and Risks
- Strategic Shift: Management announced a "transformation agenda" to address U.S. weakness. The company will slow U.S. store openings to approximately 1,175 for the fiscal year (down from 1,600) and increase international openings to approximately 975.
- EPS Outlook: Management expects "low double-digit" EPS expansion for fiscal 2008.
- Metrics Change: The company will no longer report comparable store sales metrics, deeming them ineffective indicators of performance during this transformation.
- Risks:
- Commodity Prices: Primary market risk involves volatility in green coffee and dairy prices.
- Legal Proceedings: Several class-action lawsuits are pending regarding employee classification (overtime) and tip pooling practices. The company cannot estimate potential losses but intends to defend vigorously.
- Execution Risk: Success of the new strategic initiatives and transformation plan is not guaranteed.
Investor Verification Checklist
- U.S. Comparable Store Sales: Verify the sustainability of the 1% contraction in U.S. comparable store sales and the impact of the new transformation plan on future traffic.
- Cost Structure: Monitor the trajectory of cost of sales and store operating expenses as a percentage of revenue, particularly regarding dairy costs and wage increases.
- Capital Allocation: Review the shift in capital expenditure from U.S. store openings to international expansion and the impact on long-term growth rates.
- Legal Exposure: Track the status of the pending class-action lawsuits regarding labor practices and potential financial impact.
- Debt Servicing: Assess the impact of increased interest expense ($17.1M) on future net earnings as the company carries higher debt levels.