Business Context and Reporting Period
Company: Starbucks Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2006 (13 weeks)
Business Overview: Starbucks operates company-operated and licensed retail stores globally, selling coffee, beverages, and food. The company also engages in specialty operations including licensing, foodservice, and consumer packaged goods (CPG). During the quarter, the company opened 728 new stores globally and acquired a 90% stake in its previously licensed operations in Beijing and Tianjin, China.
Key Financial Metrics
| Metric | Q1 2007 (Dec 31, 2006) | Q1 2006 (Jan 1, 2006) |
|---|---|---|
| Total Net Revenues | $2,355,723 | $1,934,092 |
| Operating Income | $319,724 | $279,847 |
| Net Earnings | $204,952 | $174,156 |
| Diluted EPS | $0.26 | $0.22 |
| Operating Margin | 13.6% | 14.5% |
| Net Cash from Operating Activities | $678,409 | $608,862 |
| Cash and Cash Equivalents | $270,873 | $312,606 |
| Short-term Borrowings | $365,000 | $700,000 |
Note: All figures in thousands except per share data and percentages.
Material Changes vs. Prior Period
- Revenue Growth: Total net revenues increased 22% year-over-year, driven by a 23% increase in company-operated retail revenues and a 14% increase in specialty operations. This was fueled by the opening of 1,177 new company-operated stores in the last 12 months and 6% global comparable store sales growth.
- Profitability: Net earnings rose 18% to $205 million. However, the operating margin declined to 13.6% from 14.5% due to higher costs of sales (including occupancy) and store operating expenses, partially offset by lower general and administrative expenses.
- Cost Pressures: Cost of sales increased to 41.8% of revenues (from 40.2%) due to higher rent, a shift to higher-cost products, and increased distribution costs. Store operating expenses rose due to higher average hourly wage rates for retail partners.
- Balance Sheet: Short-term borrowings decreased by $335 million as the company repaid debt. Inventory levels decreased by approximately $89 million compared to the prior fiscal year-end.
Guidance, Outlook, and Risks
- Guidance: Management expects consolidated total net revenue growth of approximately 20% for fiscal 2007. Comparable store sales growth for the remainder of fiscal 2007 is targeted between 3% and 7%. Capital expenditures are expected to range from $950 million to $1.0 billion.
- Outlook: The company plans to open approximately 2,400 new stores globally in fiscal 2007. Management anticipates a modest improvement in operating income margins in the second half of fiscal 2007 compared to the prior year.
- Risks and Contingencies:
- Legal Proceedings: The company is defending three significant class-action lawsuits regarding employee classification (overtime exemptions) and tip pooling practices. Management believes a loss is unlikely but cannot estimate potential damages.
- Commodity Prices: Results are sensitive to the price and availability of coffee and dairy products. The company has $507 million in committed fixed-price purchase contracts for green coffee.
- Foreign Exchange: The company uses derivative instruments to hedge currency exposure. A 10% devaluation of the U.S. dollar could reduce the fair value of hedging instruments by approximately $45 million.
Investor Verification Checklist
- Margin Compression: Verify the sustainability of the 13.6% operating margin given rising labor and commodity costs.
- Comparable Store Sales: Monitor if the 6% comparable store sales growth can be maintained within the 3-7% guidance range for the full year.
- Legal Exposure: Track the status of the FLSA class-action lawsuits (Pendlebury, Falcon, Chau) for potential liability impacts.
- Capital Allocation: Review the balance between aggressive store expansion (2,400 planned openings) and share repurchases ($115 million used in the quarter).
- China Acquisition: Assess the integration and performance of the newly acquired 90% stake in Beijing and Tianjin operations.