Business Context and Reporting Period
Company: Starbucks Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 29, 2008 (Third Quarter of Fiscal 2008)
Business Overview: Starbucks operates company-operated and licensed retail stores globally, along with foodservice and consumer packaged goods (CPG) channels. The reporting period was characterized by declining customer traffic in the U.S. and U.K. due to challenging economic conditions, prompting a major transformation strategy including store closures and workforce reductions.
Key Financial Metrics
| Metric (in millions) | 13 Weeks Ended June 29, 2008 |
13 Weeks Ended July 1, 2007 |
39 Weeks Ended June 29, 2008 |
39 Weeks Ended July 1, 2007 |
|---|---|---|---|---|
| Total Net Revenues | $2,574.0 | $2,359.3 | $7,867.6 | $6,970.6 |
| Operating Income/(Loss) | $(21.6) | $245.2 | $489.7 | $805.9 |
| Net Earnings/(Loss) | $(6.7) | $158.3 | $310.1 | $514.1 |
| Diluted EPS | $(0.01) | $0.21 | $0.42 | $0.66 |
| Operating Margin | (0.8)% | 10.4% | 6.2% | 11.6% |
| Cash from Operating Activities | N/A | N/A | $1,078.7 | $1,039.8 |
| Total Debt | $1,166.4 | N/A | N/A | N/A |
| Cash & Equivalents | $297.0 | N/A | N/A | N/A |
Note: Total Debt includes $615.9 million in commercial paper and short-term borrowings and $549.8 million in long-term debt as of June 29, 2008.
Material Changes vs. Prior Period
- Profitability Decline: The company reported an operating loss of $21.6 million for the quarter, a significant reversal from the $245.2 million operating income in the prior year quarter. This was driven by a $167.7 million restructuring charge and soft U.S. revenues.
- Restructuring Charges: A one-time charge of $167.7 million was recorded for asset impairments related to the planned closure of approximately 600 underperforming U.S. company-operated stores.
- Revenue Growth: Despite traffic declines, total net revenues increased 9.1% year-over-year for the quarter, driven by the opening of 1,128 new company-operated stores in the last 12 months and growth in specialty channels.
- Cost Pressures: Cost of sales and store operating expenses increased as a percentage of revenue due to higher occupancy costs, dairy prices, and payroll expenses relative to lower sales volumes.
- Investment Liquidity: $77.6 million in auction rate securities (ARS) were reclassified to long-term investments due to auction failures, reducing liquid assets.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Transformation Strategy: Management expects challenging economic conditions to persist through fiscal 2008 and into the first half of fiscal 2009. The company is executing a multi-faceted plan including store closures, headcount reductions (approx. 1,000 positions), and new beverage introductions.
- Future Benefits: The company estimates the store closures and headcount reductions will result in a pre-tax benefit to operating income of approximately $200 million to $210 million in fiscal 2009.
- Capital Expenditures: Fiscal 2008 capital expenditures are now expected to be approximately $1.0 billion, reduced from the previously anticipated $1.1 billion.
Risks and Contingencies
- Credit Ratings: Standard & Poor's placed the company's ratings on CreditWatch with negative implications, and Moody's placed the senior unsecured rating on review for possible downgrade following the announcement of store closures.
- Litigation: The company is facing a significant lawsuit in California regarding tip pooling practices (Jou Chau v. Starbucks), where a trial court ordered approximately $87 million in restitution. The company has appealed and believes a loss is reasonably possible but not probable.
- Market Risk: Significant exposure to commodity price volatility (coffee, dairy) and foreign currency exchange rates.
Investor Verification Checklist
- Restructuring Execution: Verify the timeline and actual costs associated with closing 600 U.S. stores and 61 Australian stores, and the realization of the projected $200M+ fiscal 2009 benefit.
- Traffic Trends: Monitor U.S. comparable store sales and customer traffic data to assess if the transformation strategy is reversing the decline in discretionary spending impact.
- Liquidity Status: Confirm the liquidity status of the $77.6 million in auction rate securities and the company's ability to fund operations without relying on illiquid assets.
- Legal Exposure: Track the appellate process of the California tip-pooling lawsuit to determine potential financial impact beyond the initial $87 million judgment.
- Debt Covenants: Ensure continued compliance with the fixed charge coverage ratio (2.5:1) and other covenants in the credit facility and senior notes, especially given the recent credit rating reviews.