Starbucks Corporation — Q2 FY2018 Form 10-Q
Reporting period: Quarter and first two quarters ended April 1, 2018. Dollar amounts are in millions unless noted. Results are unaudited.
Business context and results
Quarterly revenue growth reflected East China’s transition to company-operated reporting, new store openings, 2% comparable-store sales growth and favorable currency effects. Starbucks acquired the remaining 50% of its East China joint venture in December 2017 and began consolidating its results in Q2. The shift increased reported revenue but reduced operating margin versus the prior joint-venture accounting.
| Metric | Q2 FY2018 | Q2 FY2017 | First two quarters FY2018 | First two quarters FY2017 |
|---|---|---|---|---|
| Net revenue | $6,031.8 | $5,294.0 | $12,105.5 | $11,027.0 |
| Operating income | $772.5 | $935.4 | $1,888.6 | $2,068.3 |
| Operating margin | 12.8% | 17.7% | 15.6% | 18.8% |
| Net earnings attributable to Starbucks | $660.1 | $652.8 | $2,910.3 | $1,404.9 |
| Diluted EPS | $0.47 | $0.45 | $2.05 | $0.96 |
| Operating cash flow | Not separately reported for the quarter | $2,288.5 | $1,991.7 |
Financial position, cash flow and capital returns
- Cash and cash equivalents were $2,142.0 at April 1, 2018; cash plus short- and long-term investments totaled approximately $2.5 billion, versus $3.2 billion at October 1, 2017. About $1.2 billion of cash and investments was held in foreign subsidiaries.
- Total debt was $6,534.8, including $349.7 current and $6,185.1 long-term, compared with $3,932.6 long-term debt at October 1, 2017. Starbucks reported no commercial paper outstanding at quarter-end and said it was in compliance with debt and credit-facility covenants.
- For the first two quarters, investing cash outflow was $1,238.9, including $1,311.3 for East China and $896.7 of capital expenditures, partly offset by $608.2 of divestiture proceeds. Financing cash outflow was $1,412.5, including $3,192.1 of share repurchases and $847.9 of dividends, offset in part by $2,596.5 of long-term debt issuance.
- Starbucks repurchased 55.9 million shares for $3.2 billion in the first two quarters and declared a quarterly dividend of $0.30 per share. On April 26, 2018, the board authorized an additional 100 million shares for repurchase.
Material changes and unusual items
- Q2 operating income fell 17.4% year over year and operating margin declined 490 basis points. Management cited restructuring and impairment costs, a food-related mix shift, higher investments in store partners and East China’s lower-margin consolidated retail results.
- Q2 included $134.7 of restructuring and impairment expense, including $105.3 related to Teavana store closures and $28.5 of goodwill impairment for the Switzerland retail reporting unit. Management said Teavana lease-exit costs were expected to total approximately $134.5.
- First-two-quarter earnings included a $1,373.9 gain from remeasuring Starbucks’ pre-existing East China interest upon acquisition, plus $496.3 of net divestiture gains. These items materially affected year-over-year reported earnings; Q2 included a further $47.6 East China acquisition-gain adjustment.
- The company sold its Tazo brand, Taiwan joint-venture interest and Brazil company-operated store operations, converting Brazil to a licensed market. East China contributed $301.6 of consolidated Q2 revenue and $26.2 of net earnings.
- The Tax Act lowered the blended fiscal 2018 U.S. corporate tax rate to 24.5% from 35%. The company reported a 23.9% effective tax rate for the first two quarters, including tax effects of the East China gain and the Tax Act. Transition-tax and deferred-tax estimates remained provisional and subject to change.
Guidance, commentary and risks
- For FY2018, management forecast revenue growth of 9%–11%, including approximately 4% from East China and approximately 2% of offsets from streamlining activities. It expected about 2,300 net new stores and comparable-store sales growth near the low end of its 3%–5% long-term target.
- Full-year diluted EPS guidance was $3.32–$3.36, including a $0.98 benefit from the East China acquisition gain. Management expected moderate operating-margin decline, excluding specified transaction, integration, restructuring and impairment costs. Expected capital expenditures were approximately $2.0 billion.
- Key risks include commodity price and availability volatility, foreign exchange movements, execution and integration of East China, Teavana closures and other streamlining actions, competition, and the effects of the Tax Act and legal proceedings.
- In the California Proposition 65 coffee-warning litigation, the court issued a proposed ruling adverse to defendants on a remaining liability defense. Starbucks disputed the claims and said it could not estimate a potential loss; the court could impose no penalties or significant statutory penalties. A final ruling and remedies phase remained outstanding.
- Management said disclosure controls were effective. East China was excluded from the quarter’s internal-control evaluation while the company documented and tested its controls.
Important facts for investors to verify
- How much of future revenue and earnings growth is attributable to East China consolidation, new stores and comparable-store performance, rather than underlying same-store demand.
- Whether operating margins recover as East China integration progresses and Teavana restructuring and other streamlining costs subside.
- The sustainability of cash generation relative to capital spending, dividends and substantial share repurchases, given the increase in debt.
- Final tax effects under the Tax Act, including transition-tax payments and any revisions to provisional estimates.
- Developments and potential remedies in the Proposition 65 litigation, for which the filing provides no clear estimate of financial exposure.