Starbucks Corporation — Q3 Fiscal 2011 10-Q
Reporting period: Quarter ended July 3, 2011; year-to-date figures cover the first three quarters of fiscal 2011. Comparatives are the quarter and first three quarters ended June 27, 2010. Amounts are in millions except per-share data.
Business context and results
Management reported continued momentum across its store, international, and consumer products businesses, despite higher commodity costs and a challenging consumer environment. Global comparable-store sales increased 8% in the quarter, driven by transactions (+6%) and ticket (+2%).
| Metric | Q3 FY2011 | Q3 FY2010 | First 3 quarters FY2011 | First 3 quarters FY2010 |
|---|---|---|---|---|
| Net revenue | $2,932.2 | $2,612.0 | $8,668.7 | $7,869.4 |
| Operating income | $402.2 | $327.7 | $1,280.3 | $1,020.1 |
| Operating margin | 13.7% | 12.5% | 14.8% | 13.0% |
| Net earnings attributable to Starbucks | $279.1 | $207.9 | $887.4 | $666.7 |
| Diluted EPS | $0.36 | $0.27 | $1.15 | $0.87 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $1,126.7 | $1,375.4 |
Quarterly revenue rose 12.3%, operating income 23%, net earnings 34%, and diluted EPS 33%. For the first three quarters, revenue rose 10.2% and diluted EPS 32%. Quarterly U.S. and International operating margins were 18.8% and 12.2%, respectively; CPG operating income was $66.0 million.
Cash, debt and liquidity
- Cash and cash equivalents were $1,720.8 million at July 3, 2011, up from $1,164.0 million at October 3, 2010. Cash plus short-term investments totaled approximately $2.0 billion, versus $1.4 billion at fiscal 2010 year-end.
- Current assets were $3,587.0 million and current liabilities $1,859.4 million. Long-term debt was $549.4 million; the company also reported $550 million of 6.25% Senior Notes. It had a $500 million unsecured credit facility and stated it was in compliance with applicable covenants.
- Year-to-date investing cash outflow was $217.0 million, including $372.4 million of net capital expenditures. Financing cash outflow was $367.4 million, including $292.1 million of dividends paid and $321.9 million of share repurchases, partly offset by stock issuance proceeds and tax benefits.
- Operating cash flow declined year over year, primarily due to a $308.5 million cash use from inventory changes, partly offset by higher earnings. Inventory was $856.7 million, up from $543.3 million at fiscal 2010 year-end.
Material changes and notable items
- Higher coffee and other commodity costs reduced Q3 EPS by approximately $0.07 and were equivalent to about 280 basis points of operating margin pressure. Sales leverage and the absence of prior-year restructuring charges more than offset these pressures in consolidated margin.
- CPG revenue benefited from the move to direct distribution of packaged coffee and tea, but CPG operating margin declined 130 basis points in the quarter, mainly due to commodity costs.
- Starbucks acquired the remaining 30% interest in its southern China business and sold its 5% Hong Kong interest to its partner. A subsequent July 7, 2011 acquisition of the partner’s 50% interests in Switzerland and Austria cost approximately $70 million.
- Starbucks ended its Kraft distribution arrangement on March 1, 2011 and assumed control of packaged coffee distribution. Kraft disputes the termination and seeks compensation; arbitration was expected in mid-2012. Starbucks said it could not estimate the range of possible outcomes and disclosed possible material adverse outcomes.
- The Borders bankruptcy led to Seattle’s Best Coffee store closures: 228 had closed through Q3, with another 247 expected to close in Q4. Starbucks also reported related asset impairments.
Outlook, risks and contingencies
- FY2011 outlook: Revenue growth of approximately 10%, comparable-store sales growth at the high end of the 3%–7% target range, and approximately 600 net new stores. Management expected continued operating-margin improvement. EPS guidance was $1.50–$1.51 for the year, including expected commodity-cost pressure of about $0.22 per share; Q4 EPS guidance was $0.35–$0.36.
- FY2012 outlook: Revenue growth of approximately 10%, approximately 800 net new stores, operating-margin improvement of 50–100 basis points, and EPS growth of 15%–20%. Expected commodity-cost pressure was about $0.21 per share; capital expenditures were expected to be approximately $700 million. Management expected CPG margin near 25% as it invests in new products and distribution.
- Principal disclosed risks include coffee, dairy and other commodity prices and availability; foreign exchange; economic conditions; execution of growth and distribution plans; competition; and legal proceedings. Green-coffee purchase commitments included $635 million under fixed-price contracts and an estimated $238 million under price-to-be-fixed contracts.
- Management said it expected cash from operations and existing cash and short-term investments to fund foreseeable operating needs and shareholder distributions. It cautioned that quarterly results are seasonal and are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether comparable-store-sales momentum and margin gains persist as coffee costs remain elevated, and whether the FY2011 and FY2012 guidance is achieved.
- The cash-flow impact of higher inventory and planned capital spending, alongside dividends and share repurchases.
- The eventual financial exposure from the Kraft arbitration, for which Starbucks provided no estimable outcome range.
- Whether direct distribution and new CPG products deliver the anticipated growth and margins, particularly given CPG’s year-to-date margin decline.
- Execution and returns from international expansion, including China growth plans and the acquired European markets.