STARBUCKS CORP quarterly report, Q3 FY2012

Business context and reporting period

Starbucks Corporation filed this unaudited Form 10-Q for the third quarter and first three quarters of fiscal 2012, ended July 1, 2012. The comparable quarter ended July 3, 2011; the balance-sheet comparison is with October 2, 2011. Starbucks operates company-managed and licensed stores and sells packaged coffee, beverages, food and related products through its Channel Development business.

Financial results and liquidity

• Quarterly revenue rose 12.7%, operating income 22%, net earnings 19%, and diluted EPS 19%. Global comparable-store sales increased 6%, reflecting 5% transaction growth and 2% higher average ticket (components may not sum due to rounding).
• For the first three quarters, revenue increased 14.6%, net earnings 15.5%, and diluted EPS 15.7%. Operating margin was up 10 basis points.
• Quarterly revenue growth included Channel Development revenue growth of 45%, supported by K-Cup portion packs and packaged coffee. Americas comparable sales rose 7%, China/Asia Pacific 12%, and EMEA was flat.
• Higher commodity costs, primarily coffee, reduced quarterly operating income by approximately $38 million and operating margin by about 110 basis points. Cost of sales as a share of revenue rose 160 basis points for the quarter.
• Operating cash flow for the first three quarters was $1.127 billion, essentially unchanged from the prior-year period. Capital expenditures were $516.5 million. Cash and cash equivalents were $1.501 billion and short-term investments $996.3 million at July 1.
• Long-term debt was $549.6 million, primarily $550 million of 6.25% senior notes. Starbucks also had a $500 million unsecured credit facility and reported compliance with its debt covenants. Total current liabilities were $2.018 billion.
• Cash dividends paid in the first three quarters were $384.0 million; the quarterly dividend declared was $0.17 per share. Share repurchases totaled $15.7 million in the first three quarters.

Material changes, outlook and commentary

• Channel Development drove significant growth, while its operating margin fell to 27.3% in the quarter from 31.7%, largely because of higher commodity costs. EMEA operating income was $2.6 million, with a 0.9% margin, amid regional investment and economic headwinds. China/Asia Pacific revenue grew 31%, and operating margin improved to 33.8%.
• Management cited a weaker consumer environment and slower sales and traffic growth in June, while saying growth remained within its target range. It expects continued growth from store efficiencies, new products, store openings and Channel Development.
• Fiscal 2012 outlook: revenue growth from mid-single-digit comparable-store sales, net new stores and Channel Development; modest consolidated operating-margin and EPS improvement versus fiscal 2011; capital expenditures of approximately $900 million.
• Fiscal 2013 outlook: approximately 1,200 net new stores, 50–100 basis points of consolidated operating-margin improvement, EPS growth of 15%–20% versus fiscal 2012, and approximately $1 billion of capital expenditures.
• Key risks include volatile coffee, dairy and other commodity prices, foreign currency movements, economic conditions, execution of growth initiatives and legal proceedings. Management said it believed operating cash flows and existing cash and investments would fund foreseeable needs, but repatriating foreign cash to the U.S. could incur additional taxes.
• The Kraft distribution-contract arbitration began July 11, 2012. Starbucks claimed up to $62.9 million in damages; Kraft claimed up to $2.9 billion plus attorney fees. Starbucks said an unfavorable outcome was reasonably possible but not probable, could not reasonably estimate a potential loss, and recorded no loss contingency.
• Unusual items included approximately $29 million of income recognized in the second quarter from unredeemed gift cards following a court ruling. Starbucks acquired Evolution Fresh for $30 million in fiscal 2012 and, after quarter-end, acquired La Boulange for $100 million; accounting for the latter acquisition was still in process.

Important facts for investors to verify

• Whether comparable-store sales and traffic trends remain resilient, particularly given the June slowdown noted by management.
• Whether coffee and other commodity costs ease, and whether Starbucks can offset cost pressure without weakening margins.
• Progress in EMEA’s turnaround and the operating returns from growth investments in China/Asia Pacific and Channel Development.
• Developments and potential financial exposure in the Kraft arbitration; the filing says the possible loss cannot be reasonably estimated.
• Execution of fiscal 2012–2013 store-opening and capital-spending plans, and the assumptions underlying the company’s margin and EPS outlook.