Starbucks Corporation — Q1 FY2019 Form 10-Q
Reporting period: Quarter ended December 30, 2018. Financial figures are in millions of U.S. dollars, except per-share data. Comparisons are with the quarter ended December 31, 2017 unless otherwise noted.
Business context
Starbucks operates company-operated and licensed stores and has consumer packaged goods and foodservice activities. Management attributed growth to new stores, comparable-store sales and consolidating East China as a company-operated business. Licensing its CPG and foodservice businesses to Nestlé and selling the Tazo brand reduced Channel Development and other revenue.
Financial performance
| Metric | Q1 FY2019 | Prior period | Change / context |
|---|---|---|---|
| Net revenue | $6,632.7 | $6,073.7 | Up 9.2% |
| Operating income | $1,015.7 | $1,116.1 | Down 9.0% |
| Operating margin | 15.3% | 18.4% | Down 310 basis points |
| Net earnings attributable to Starbucks | $760.6 | $2,250.2 | Prior period included large acquisition and divestiture gains |
| Diluted EPS | $0.61 | $1.57 | Prior-period comparison is distorted by those gains |
| Cash provided by operating activities | $2,379.0 | $1,834.0 | Increase primarily reflected timing of tax payments and refunds |
| Capital expenditures | $431.4 | $429.3 | Quarterly cash outflow |
Revenue growth included $299 million from East China consolidation, 4% consolidated comparable-store sales growth, and net new store openings. Comparable-store sales rose 4% in the Americas and 3% in China/Asia Pacific; EMEA declined 1%. Cost pressure, partner wage and benefit investments, product mix, East China consolidation, and restructuring contributed to lower operating margin. The effective tax rate was 21.2%, versus 25.1%.
Cash, liquidity, debt and capital returns
- Cash and cash equivalents were $4,761.6 at quarter end, down from $8,756.3 at September 30, 2018. Cash and investments together were approximately $5.3 billion.
- Current assets were $7,676.3 and current liabilities $5,427.5. Long-term debt was $9,130.7; no commercial paper borrowings were outstanding. The company reported compliance with debt and credit-facility covenants.
- Financing activities used $5,858.6, principally reflecting a $5.0 billion accelerated share repurchase, plus $446.7 of dividends paid and $350 million of debt repayment. The ASR initially delivered 72.0 million shares; final settlement was expected by March 2019.
- Total shareholders’ equity was negative $2,884.9 at December 30, compared with positive $1,169.5 at September 30. The quarter included the $5.0 billion repurchase; accounting-adoption adjustments also increased opening equity.
- The quarterly dividend declared was $0.36 per share. Management expected fiscal 2019 capital expenditures of approximately $2.0 billion and stated that operating cash flows, existing cash and investments, and borrowing capacity should fund foreseeable capital needs and shareholder distributions.
Material changes, outlook and risks
- Prior-period comparability: Q1 FY2018 included a $1,326.3 million gain from acquiring the remaining East China joint-venture interest and a $501.2 million net divestiture gain. These gains explain much of the sharp year-over-year decline in reported net earnings and EPS.
- Segment trends: Americas revenue increased 8% and operating margin fell 100 basis points to 22.0%. China/Asia Pacific revenue increased 45%, largely from East China consolidation, while margin fell 530 basis points to 18.0%. Channel Development revenue fell 20% and margin fell 810 basis points to 34.8%, primarily following the Nestlé licensing arrangement and Tazo sale. EMEA revenue fell 1% and margin fell 200 basis points to 10.1%.
- Accounting changes: New revenue-recognition guidance changed the presentation of stored-value-card breakage from interest income to store revenue; management said the overall Q1 financial impact was not material. A separate income-tax accounting adoption increased deferred tax assets and reduced opening retained earnings by $227.6 million. The lease standard, expected to be adopted in fiscal 2020, was expected to materially increase balance-sheet assets and liabilities, with likely insignificant earnings impact.
- Deferred revenue: The approximately $7 billion Nestlé upfront payment is being recognized as revenue over an estimated 40-year economic life; $6.7 billion was reported as long-term deferred revenue at quarter end.
- Outlook and risks: No full-year revenue or earnings guidance is provided in the supplied filing text. Management noted that the fiscal second quarter typically has lower revenue and operating income. Key stated risks include coffee, dairy and other commodity prices and availability; foreign currency and economic conditions; competition; execution of initiatives and the Nestlé alliance; technology and food-safety incidents; and legal proceedings.
- Contingency: In California Proposition 65 coffee-warning litigation, the court had ruled adversely on the company’s defenses, but the damages phase was stayed. Starbucks assessed a loss as reasonably possible, not probable, recorded no loss contingency, and said the outcome and financial impact could not be predicted.
Important facts for investors to verify
- How much of reported revenue growth and China/Asia Pacific performance reflects underlying demand versus East China consolidation and store expansion.
- Whether operating-margin pressure persists as partner investments, restructuring, mix changes and the Nestlé transition affect results.
- The final share count and cash or share settlement of the $5.0 billion ASR, and the effect of continued repurchases and dividends on liquidity and equity.
- Progress in recognizing the Nestlé upfront payment and the composition and future conversion of deferred revenue.
- Developments in the California Proposition 65 litigation and any change in the assessment or potential financial exposure.
- The eventual balance-sheet impact of fiscal 2020 lease-standard adoption and any changes to expected capital expenditure or liquidity needs.