filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
Our fiscal year ends on the Sunday closest to September 30. The fiscal years ended on September 30, 2018 and October 1, 2017 included 52 weeks. The fiscal year ended on October 2, 2016 included 53 weeks, with the extra week falling in our fourth fiscal quarter. Comparable store sales percentages for fiscal 2016 are calculated excluding the 53rd week. All references to store counts, including data for new store openings, are reported net of related store closures, unless otherwise noted.
Financial Highlights
| • | Total net revenues increased 10% to $24.7 billion in fiscal 2018 compared to $22.4 billion in fiscal 2017. |
| • | Global comparable store sales grew 2% driven by a 3% increase in average ticket. |
| • | Consolidated operating income decreased to $3.9 billion in fiscal 2018 compared to operating income of $4.1 billion in fiscal 2017. Fiscal 2018 operating margin was 15.7% compared to 18.5% in fiscal 2017. Operating margin compression in fiscal 2018 was primarily driven by food and beverage-related mix shifts, largely in the Americas segment, the impact of our ownership change in East China at the end of the first quarter of fiscal 2018, higher restructuring and impairment costs and higher salaries and benefits related to digital platforms, technology infrastructure and innovations. |
| • | Restructuring and impairment charges increased to $224 million in fiscal 2018 compared to $154 million in fiscal 2017. Increased costs were primarily related to higher asset impairments associated with the decision to close certain Starbucks® company-operated stores in the U.S. and Canada, higher goodwill impairment charges related to our Switzerland retail reporting unit and EMEA restructuring costs. |
| • | Earnings per share (“EPS”) for fiscal 2018 increased to $3.24, compared to EPS of $1.97 in fiscal 2017. The increase was primarily driven by the gains from the acquisition of our East China joint venture and the sale of our Tazo brand. Additionally, the net favorable impact from the Tax Cuts and Jobs Act (the “Tax Act”) also contributed to the increase. |
| • | Cash flows from operations were $11.9 billion in fiscal 2018 compared to $4.3 billion in fiscal 2017. The change was primarily due to receipt of the upfront payment from Nestlé related to the Global Coffee Alliance. |
| • | Capital expenditures were $2.0 billion in fiscal 2018 compared to $1.5 billion in fiscal 2017. |
| • | We returned $8.9 billion to our shareholders in fiscal 2018 through share repurchases and dividends compared to $3.5 billion in fiscal 2017. |
Overview
Starbucks results for fiscal 2018 reflect the impact of certain restructuring and streamlining efforts, beginning in the fourth quarter of fiscal 2017, to focus on accelerating growth in high-returning businesses and removing non-core, slow growth activities. These efforts primarily include the acquisition of our East China joint venture, the conversion of our Singapore, Taiwan and Brazil operations to licensed models, the closure of TeavanaTM/MC retail stores, the sale of the Tazo brand, the licensing of our CPG and foodservice businesses to Nestlé, and the closure of certain company-operated stores in the U.S. and Canada, among other actions. These streamlining efforts span across all segments and our corporate functions.
On August 26, 2018, our Channel Development segment finalized licensing and distribution agreements with Nestlé to sell and market our CPG and foodservice products. The scope of the arrangement converts the majority of our previously defined Channel Development segment operations, as well as certain smaller businesses previously reported in the Americas, EMEA and Corporate and Other (previously All Other Segment), from company-owned to licensed operations with Nestlé. As a result, we realigned our organizational and operating segment structures in support of the newly established Global Coffee Alliance. Our reportable segments have been restated as if those smaller businesses were previously within our Channel Development segment.
Concurrent with the change in reportable operating segments, we revised our prior period financial information to reflect comparable financial information for the new segment structure. Further, in an effort to report operating expenses in line with the corresponding revenue generating activities, we have changed the classification of certain costs, primarily within our CAP segment and mainly from other operating expenses to general and administrative expenses. This reclassification has been retrospectively applied and was determined to be immaterial.
Starbucks largest acquisition to date affects our CAP segment. As a result of acquiring the remaining interest in our East China joint venture at the end of the first quarter of fiscal 2018, we began recording 100% of its revenues and expenses on our consolidated statements of earnings at the beginning of the second quarter of fiscal 2018. This is in contrast with our previous joint venture model, where we recorded only revenues and expenses from products sales to and royalties received from East China, as well as our proportionate share of the joint venture's net profit. The change from equity method to consolidation
method lowered the operating margin of our Consolidated and CAP segment, primarily due to incremental depreciation and amortization expenses and lower income from equity investees.
Starbucks results for fiscal 2018 continued to demonstrate the strength of our global business model and our ability to successfully make disciplined investments in our business and our partners. Consolidated total net revenues increased 10% to $24.7 billion, primarily driven by incremental revenues from 1,997 net new store openings over the past 12 months, incremental revenues from the impact of our ownership change in East China, 2% growth in global comparable store sales and favorable foreign currency translation. These increases were partially offset by the absence of revenue related to the closure of our TeavanaTM/MC retail stores, initiated in the fourth quarter of fiscal 2017 and substantially ceased during fiscal 2018 and the sale of our Singapore retail operations to a licensed partner in the fourth quarter of fiscal 2017. Consolidated operating income declined $251 million, or 6%, to $3.9 billion. Operating margin declined 280 basis points to 15.7%, primarily due to food and beverage-related mix shifts, largely in the Americas segment, the impact of our ownership change in East China, higher restructuring and impairment costs and higher salaries and benefits related to digital platforms, technology infrastructure and innovations. Earnings per share of $3.24 increased 64% over the prior year earnings per share of $1.97.
Americas revenue grew by 7% to $16.7 billion, primarily driven by incremental revenues from 895 net new store openings over the last 12 months and comparable store sales growth of 2%, partially offset by the absence of revenue related to the conversion of our Brazil retail business to fully licensed operations in the second quarter of fiscal 2018. Operating income declined $39 million to $3.6 billion and operating margin of 21.6% declined 180 basis points from a year ago, primarily due to food and beverage-related mix shifts, increased investments in our store partners and the impact of the May 29th anti-bias training. These increases were partially offset by sales leverage.
In our CAP segment, revenue grew by 38% to $4.5 billion, primarily driven by the impact of our ownership change in East China at the end of the first quarter of fiscal 2018, incremental revenues from 756 net new stores over the past 12 months. These increases were partially offset by the absence of revenue related to the sale of our Singapore retail operations to fully licensed operations in the fourth quarter of fiscal 2017. Operating income grew 13% to $867 million, while operating margin declined 420 basis points to 19.4%, primarily due to the impact of our ownership change in East China. We now operate 8,530 stores in 15 markets in our CAP segment making this our second largest reportable segment.
In our EMEA segment, revenue grew by 9% to $1.0 billion, primarily driven by increased revenues from the opening of 356 net new licensed stores over the past 12 months and favorable foreign currency translation. Operating margin declined 400 basis points to 5.9% primarily due to higher impairment of goodwill related to our Switzerland retail business and restructuring costs, including severance, asset impairments and business process optimization expenses. These decreases were partially offset by lapping of a prior year tax settlement.
Channel Development segment revenues grew by 2% to $2.3 billion, primarily driven by increased sales of packaged coffee and premium single-serve products, lapping a prior year revenue deduction adjustment and favorable foreign currency translation. These increases were partially offset by the net impact from the sale of our Tazo brand in the first quarter of fiscal 2018 and licensing our CPG and foodservice businesses to Nestlé beginning on August 26, 2018. Operating income declined $40 million, or 4%, to $927 million. Operating margin declined 250 basis points to 40.4%, primarily driven by business taxes associated with the upfront payment received from Nestlé, Global Coffee Alliance headcount related costs, including employee bonus and retention costs, and the impact of our ownership changes, including licensing our CPG and foodservice businesses to Nestlé and the sale of our Tazo brand.
Fiscal 2019 — The View Ahead
Turning to fiscal 2019, we expect continued growth through thoughtful long-term investments that create value and reward shareholders. These results are expected to be driven by our three strategic priorities, which include:
| • | Accelerate growth in our targeted, long-term growth markets of the U.S. and China |
| • | Expand the global reach of the Starbucks brand leveraging the Global Coffee Alliance |
| • | Sharpen our focus on increasing shareholder returns |
To successfully achieve these priorities, we will undertake a number of initiatives, including growing our core business in the U.S. through enhancement of the in-store experience, delivery of customer-relevant beverage innovation and digital relationships, and growing our business in China through new store expansion, comparable store sales and business partnerships. Further, we will continue expanding the reach of the Starbucks brand through retail market realignment, including our plans to license the France, Netherlands, Belgium and Luxembourg markets, business simplification and the Global Coffee Alliance. These additional streamlining initiatives will enable us to amplify our focus and resources on core value drivers with the greatest prospect for returns.
We expect moderate revenue growth in fiscal 2019, reflecting implementation of our streamlining activities and driven by comparable store sales growth and the opening of approximately 2,100 net new stores globally.
Consolidated operating margin is expected to decrease slightly in fiscal 2019 when compared to fiscal 2018, and our effective tax rate is expected to increase slightly from fiscal 2018. While GAAP full-year diluted earnings per share is expected to decrease in fiscal 2019, full-year non-GAAP diluted earnings per share is expected to grow when excluding gains from acquisitions and divestitures in fiscal 2018, integration costs related to East China and Japan and restructuring and impairment expenses.
Capital expenditures in fiscal 2019 are expected to be approximately $2.0 billion, primarily related to our retail portfolio including investments in our new and existing stores and strategic store-related initiatives.
Acquisitions and Divestitures
See Note 2, Acquisitions, Divestitures and Strategic Alliance, to the consolidated financial statements included in Item 8 of Part II of this 10-K for information regarding acquisitions and divestitures.
RESULTS OF OPERATIONS — FISCAL 2018 COMPARED TO FISCAL 2017
Consolidated results of operations (in millions):
Revenues
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | % Change | |||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 19,690.3 | $ | 17,650.7 | 11.6 | % | ||||
| Licensed stores | 2,652.2 | 2,355.0 | 12.6 | |||||||
| Other | 2,377.0 | 2,381.1 | (0.2 | ) | ||||||
| Total net revenues | $ | 24,719.5 | $ | 22,386.8 | 10.4 | % |
Total net revenues increased $2.3 billion, or 10%, over fiscal 2017, primarily driven by increased revenues from company-operated stores ($2.0 billion). The growth in company-operated store revenues was driven by incremental revenues from 816 net new Starbucks® company-operated store openings over the past 12 months ($904 million), incremental revenues from the impact of our ownership change in East China ($903 million) and a 2% increase in comparable store sales ($345 million), attributable to a 3% increase in average ticket.
Licensed store revenue growth also contributed to the increase in total net revenues ($297 million), primarily due to increased product and equipment sales to and royalty revenues from our licensees ($298 million), largely due to the opening of 1,181 net new Starbucks® licensed stores over the past 12 months, the conversions of both the Singapore and Taiwan markets to fully licensed in the fourth quarter of fiscal 2017 and the first quarter of fiscal 2018, respectively ($44 million). These increases were partially offset by the impact of our ownership change in East China at the end of the first quarter of fiscal 2018 ($53 million).
Other revenues decreased $4 million, primarily driven by the absence of revenue from the sale of our Tazo brand in the first quarter of fiscal 2018 ($56 million), the closure of our e-commerce business in the fourth quarter of fiscal 2017 ($51 million) and licensing our CPG and foodservice businesses to Nestlé late in the fourth quarter of fiscal 2018 ($50 million). Partially offsetting these decreases were increased sales of packaged coffee and premium single-serve products ($115 million).
Operating Expenses
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of Total Net Revenues | |||||||||||||
| Cost of sales including occupancy costs | $ | 10,174.5 | $ | 9,034.3 | 41.2 | % | 40.4 | % | |||||
| Store operating expenses | 7,193.2 | 6,493.3 | 29.1 | 29.0 | |||||||||
| Other operating expenses | 539.3 | 500.3 | 2.2 | 2.2 | |||||||||
| Depreciation and amortization expenses | 1,247.0 | 1,011.4 | 5.0 | 4.5 | |||||||||
| General and administrative expenses | 1,759.0 | 1,450.7 | 7.1 | 6.5 | |||||||||
| Restructuring and impairments | 224.4 | 153.5 | 0.9 | 0.7 | |||||||||
| Total operating expenses | 21,137.4 | 18,643.5 | 85.5 | 83.3 | |||||||||
| Income from equity investees | 301.2 | 391.4 | 1.2 | 1.7 | |||||||||
| Operating income | $ | 3,883.3 | $ | 4,134.7 | 15.7 | % | 18.5 | % | |||||
| Store operating expenses as a % of related revenues | 36.5 | % | 36.8 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 10.7 | % | 10.6 | % |
Cost of sales including occupancy costs as a percentage of total net revenues increased 80 basis points, primarily due to food and beverage-related mix shifts (approximately 120 basis points), largely in the Americas segment.
Store operating expenses as a percentage of total net revenues increased 10 basis points. Store operating expenses as a percentage of company-operated store revenues decreased 30 basis points, primarily driven by the impact of our ownership change in East China (approximately 60 basis points).
Depreciation and amortization expenses as a percentage of total net revenues increased 50 basis points, primarily due to the impact of our ownership change in East China (approximately 60 basis points).
General and administrative expenses as a percentage of total net revenues increased 60 basis points, primarily due to higher salaries and benefits related to digital platforms, technology infrastructure and innovations (approximately 20 basis points) and the 2018 U.S. stock award (approximately 20 basis points).
Restructuring and impairment expenses increased $71 million, primarily due to higher asset impairments associated with the decision to close certain company-operated stores in the U.S. and Canada ($23 million), higher goodwill impairment charges associated with our Switzerland company-operated retail reporting unit ($20 million) and EMEA restructuring costs, including severance and asset impairments ($18 million).
Income from equity investees decreased $90 million, primarily due to the impact of ownership changes in our East China and Taiwan joint ventures, partially offset by higher South Korea joint venture income.
The combination of these changes resulted in an overall decrease in operating margin of 280 basis points in fiscal 2018 when compared to fiscal 2017.
Other Income and Expenses
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of Total Net Revenues | |||||||||||||
| Operating income | $ | 3,883.3 | $ | 4,134.7 | 15.7 | % | 18.5 | % | |||||
| Gain resulting from acquisition of joint venture | 1,376.4 | — | 5.6 | — | |||||||||
| Net gain resulting from divestiture of certain operations | 499.2 | 93.5 | 2.0 | 0.4 | |||||||||
| Interest income and other, net | 191.4 | 181.8 | 0.8 | 0.8 | |||||||||
| Interest expense | (170.3 | ) | (92.5 | ) | (0.7 | ) | (0.4 | ) | |||||
| Earnings before income taxes | 5,780.0 | 4,317.5 | 23.4 | 19.3 | |||||||||
| Income tax expense | 1,262.0 | 1,432.6 | 5.1 | 6.4 | |||||||||
| Net earnings including noncontrolling interests | 4,518.0 | 2,884.9 | 18.3 | 12.9 | |||||||||
| Net earnings/(loss) attributable to noncontrolling interests | (0.3 | ) | 0.2 | — | — | ||||||||
| Net earnings attributable to Starbucks | $ | 4,518.3 | $ | 2,884.7 | 18.3 | % | 12.9 | % | |||||
| Effective tax rate including noncontrolling interests | 21.8 | % | 33.2 | % |
Gain resulting from acquisition of joint venture was due to remeasuring our preexisting 50% ownership interest in our East China joint venture to fair value upon acquisition.
Net gain resulting from divestiture of certain operations primarily consists of sales of our Tazo brand and Taiwan joint venture, partially offset by the net loss from the sale of our Brazil retail operations in fiscal 2018. The gain in fiscal 2017 was primarily due to the sale of our Singapore retail operations.
Interest income and other, net increased $10 million, primarily due to recognizing higher income on unredeemed stored value card balances, partially offset by lapping the gain on the sale of our investment in Square, Inc. warrants in the prior year period.
Interest expense increased $78 million primarily related to additional interest incurred on long-term debt issued in November 2017, March 2018 and August 2018.
The effective tax rate for fiscal 2018 was 21.8% compared to 33.2% for fiscal 2017. The decrease in the effective tax rate was primarily due to the gain on the purchase of our East China joint venture that is not subject to income tax (approximately 580 basis points) and the Tax Act (approximately 480 basis points). The impact from the Tax Act primarily included favorability from the lower corporate income tax rate applied to our fiscal 2018 results (approximately 760 basis points) and the remeasurement of our net deferred tax liabilities (approximately 130 basis points). This favorability was partially offset by the estimated transition tax on our accumulated undistributed foreign earnings (approximately 400 basis points). See Note 13, Income Taxes, for further discussion.
Segment Information
Results of operations by segment (in millions):
Americas
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of Americas Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 14,905.1 | $ | 13,996.4 | 89.1 | % | 89.6 | % | |||||
| Licensed stores | 1,814.0 | 1,617.3 | 10.8 | 10.4 | |||||||||
| Other | 13.1 | 6.3 | 0.1 | — | |||||||||
| Total net revenues | 16,732.2 | 15,620.0 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 6,301.2 | 5,695.0 | 37.7 | 36.5 | |||||||||
| Store operating expenses | 5,747.9 | 5,320.2 | 34.4 | 34.1 | |||||||||
| Other operating expenses | 150.0 | 130.8 | 0.9 | 0.8 | |||||||||
| Depreciation and amortization expenses | 638.3 | 614.9 | 3.8 | 3.9 | |||||||||
| General and administrative expenses | 247.0 | 201.4 | 1.5 | 1.3 | |||||||||
| Restructuring and impairments | 33.4 | 4.1 | 0.2 | — | |||||||||
| Total operating expenses | 13,117.8 | 11,966.4 | 78.4 | 76.6 | |||||||||
| Operating income | $ | 3,614.4 | $ | 3,653.6 | 21.6 | % | 23.4 | % | |||||
| Store operating expenses as a % of related revenues | 38.6 | % | 38.0 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 8.2 | % | 8.1 | % |
Revenues
Americas total net revenues for fiscal 2018 increased $1.1 billion, or 7%, over fiscal 2017, primarily due to increased revenues from company-operated stores (contributing $909 million) and licensed stores (contributing $197 million).
The increase in company-operated store revenues was driven by incremental revenues from 383 net new Starbucks® company-operated store openings over the past 12 months ($604 million) and a 2% increase in comparable store sales ($319 million), attributable to a 3% increase in average ticket, partially offset by the conversion of our Brazil retail business to fully licensed operations in the second quarter of fiscal 2018 ($40 million).
The increase in licensed store revenues was primarily driven by higher product sales to and royalty revenues from our licensees ($173 million), primarily resulting from the opening of 512 net new Starbucks® licensed stores over the past 12 months.
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues increased 120 basis points, primarily due to food and beverage-related mix shifts (approximately 130 basis points).
Store operating expenses as a percentage of total net revenues increased 30 basis points. As a percentage of company-operated store revenues, store operating expenses increased 60 basis points, primarily driven by increased investments in our store partners (approximately 140 basis points), which included incremental investments funded by the Tax Act, partially offset by sales leverage (approximately 60 basis points).
General and administrative expenses as a percentage of total net revenues increased 20 basis points, primarily driven by the May 29th anti-bias training (approximately 20 basis points).
Restructuring and impairment charges increased $29 million due to higher asset impairments in fiscal 2018 compared to fiscal 2017 associated with the decision to close certain U.S. company-operated stores ($23 million) and costs associated with the closure of certain company-operated stores in the U.S. and Canada ($6 million) in fiscal 2018.
The combination of these changes resulted in an overall decrease in operating margin of 180 basis points in fiscal 2018 when compared to fiscal 2017.
CAP
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of China/Asia Pacific Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 4,096.9 | $ | 2,906.0 | 91.6 | % | 89.7 | % | |||||
| Licensed stores | 365.7 | 327.4 | 8.2 | 10.1 | |||||||||
| Other | 11.0 | 6.8 | 0.2 | 0.2 | |||||||||
| Total net revenues | 4,473.6 | 3,240.2 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 1,898.3 | 1,396.2 | 42.4 | 43.1 | |||||||||
| Store operating expenses | 1,148.7 | 845.5 | 25.7 | 26.1 | |||||||||
| Other operating expenses | 22.9 | 21.2 | 0.5 | 0.7 | |||||||||
| Depreciation and amortization expenses | 412.1 | 202.2 | 9.2 | 6.2 | |||||||||
| General and administrative expenses | 241.6 | 207.1 | 5.4 | 6.4 | |||||||||
| Total operating expenses | 3,723.6 | 2,672.2 | 83.2 | 82.5 | |||||||||
| Income from equity investees | 117.4 | 197.0 | 2.6 | 6.1 | |||||||||
| Operating income | $ | 867.4 | $ | 765.0 | 19.4 | % | 23.6 | % | |||||
| Store operating expenses as a % of related revenues | 28.0 | % | 29.1 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 6.1 | % | 6.3 | % |
Discussion of our China/Asia Pacific segment results below reflects the impact of fully consolidating our East China business due to the ownership change from an equity method joint venture to a company-operated market since the acquisition date of December 31, 2017. Under the joint venture model, we recognized royalties and product sales within revenue and related product cost of sales as well as our proportionate share of East China's net earnings, which we recognized within income from equity investees. This resulted in a higher operating margin. Under the company-operated ownership model, East China’s operating results are reflected in most income statement lines of this segment.
Revenues
China/Asia Pacific total net revenues for fiscal 2018 increased $1.2 billion, or 38%, over fiscal 2017, primarily driven by higher company-operated store revenues ($1.2 billion) due to the impact of our ownership change in East China ($903 million) and incremental revenues from 443 net new company-operated store openings over the past 12 months ($300 million). Also contributing were favorable foreign currency translation ($82 million) and a 1% increase in comparable store sales ($26 million). Partially offsetting these increases was the conversion of our Singapore retail business to fully licensed operations in the fourth quarter of fiscal 2017 ($121 million).
Licensed store revenues increased $38 million, primarily driven by increased product sales to and royalty revenues from licensees ($44 million), primarily resulting from the opening of 313 net new licensed stores over the past 12 months, the conversion of our Taiwan joint venture to fully licensed operations at the end of the first quarter of fiscal 2018 ($25 million) and the conversion of our Singapore retail operations to fully licensed operations in the fourth quarter of fiscal 2017 ($20 million). These increases were partially offset by the absence of revenue from our ownership change in East China ($53 million).
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues decreased 70 basis points, primarily due to the ownership change in East China (approximately 60 basis points).
Store operating expenses as a percentage of total net revenues decreased 40 basis points. As a percentage of company-operated store revenues, store operating expenses decreased 110 basis points, primarily due to the ownership change in East China (approximately 90 basis points).
General and administrative expenses as a percentage of total revenues decreased 100 basis points, primarily due to sales leverage on salaries and benefits (approximately 50 basis points) and the impact of ownership change in East China (approximately 30 basis points).
Income from equity investees decreased $80 million, primarily due to the impact of our ownership changes in East China and Taiwan joint ventures, partially offset by higher South Korea joint venture income.
The combination of these changes resulted in an overall decrease in operating margin of 420 basis points in fiscal 2018 when compared to fiscal 2017.
EMEA
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of EMEA Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 575.6 | $ | 551.0 | 54.9 | % | 57.5 | % | |||||
| Licensed stores | 471.3 | 407.7 | 45.0 | 42.5 | |||||||||
| Other | 1.1 | — | 0.1 | — | |||||||||
| Total net revenues | 1,048.0 | 958.7 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 559.2 | 508.6 | 53.4 | 53.1 | |||||||||
| Store operating expenses | 226.0 | 214.1 | 21.6 | 22.3 | |||||||||
| Other operating expenses | 62.8 | 51.3 | 6.0 | 5.4 | |||||||||
| Depreciation and amortization expenses | 31.7 | 30.6 | 3.0 | 3.2 | |||||||||
| General and administrative expenses | 51.7 | 41.7 | 4.9 | 4.3 | |||||||||
| Restructuring and impairments | 55.1 | 17.9 | 5.3 | 1.9 | |||||||||
| Total operating expenses | 986.5 | 864.2 | 94.1 | 90.1 | |||||||||
| Operating income | $ | 61.5 | $ | 94.5 | 5.9 | % | 9.9 | % | |||||
| Store operating expenses as a % of related revenues | 39.3 | % | 38.9 | % | |||||||||
| Other operating expenses as a % of non-company-operated store | 13.3 | % | 12.6 | % |
Revenues
EMEA total net revenues for fiscal 2018 increased $89 million, or 9%, over fiscal 2017, primarily due to higher revenue from licensed stores ($64 million) and company-operated stores ($25 million).
Company-operated stores increased $25 million, or 4%, primarily due to favorable currency translation ($31 million).
Licensed store revenues increased $64 million, or 16%, due to higher product sales to and royalty revenues from our licensees ($56 million), resulting from the opening of 356 net new licensed stores, and favorable foreign currency translation ($4 million).
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues increased 30 basis points, primarily due to growth in our licensed stores which have a lower gross margin (approximately 30 basis points).
Store operating expenses as a percentage of total net revenues decreased 70 basis points. As a percentage of company-operated store revenues, store operating expenses increased 40 basis points, primarily due to sales deleverage on salaries and benefits, largely due to increased minimum wage in certain markets (approximately 140 basis points), partially offset by lapping a prior year tax settlement (approximately 100 basis points).
Other operating expenses as a percentage of total net revenues increased 60 basis points. Excluding the impact of company-operated store revenues, other operating expenses increased 70 basis points, primarily due to business process optimization expenses (approximately 60 basis points).
General and administrative expenses as a percentage of total net revenues increased 60 basis points, primarily due to business process optimization expenses (approximately 50 basis points).
Restructuring and impairment expenses increased $37 million, primarily due to higher goodwill impairment expense associated with our Switzerland retail reporting unit in fiscal 2018 than in the prior year period ($20 million) and EMEA restructuring costs, including severance and asset impairments ($18 million).
The combination of these changes resulted in an overall decrease in operating margin of 400 basis points in fiscal 2018 when compared to fiscal 2017.
Channel Development
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of Channel Development Total Net Revenues | |||||||||||||
| Net revenues | $ | 2,297.3 | $ | 2,256.6 | |||||||||
| Cost of sales | 1,252.3 | 1,209.3 | 54.5 | 53.6 | |||||||||
| Other operating expenses | 286.5 | 260.4 | 12.5 | 11.5 | |||||||||
| Depreciation and amortization expenses | 1.3 | 3.0 | 0.1 | 0.1 | |||||||||
| General and administrative expenses | 13.9 | 11.3 | 0.6 | 0.5 | |||||||||
| Total operating expenses | 1,554.0 | 1,484.0 | 67.6 | 65.8 | |||||||||
| Income from equity investees | 183.8 | 194.4 | 8.0 | 8.6 | |||||||||
| Operating income | $ | 927.1 | $ | 967.0 | 40.4 | % | 42.9 | % |
Discussion of our Channel Development segment results reflect the impact of the licensing of our CPG and foodservice businesses to Nestlé, the sale of Tazo and an immaterial, unfavorable revenue deduction adjustment recorded in the second quarter of fiscal 2017. Late in the fourth quarter of fiscal 2018, we licensed our CPG (Starbucks-, Starbucks Reserve-, Teavana-, Seattle's Best Coffee-, Starbucks VIA- and Torrefazione Italia-branded packaged coffee and tea) and foodservice businesses to Nestlé and formed a Global Coffee Alliance. Eleven months of fiscal 2018 results reflect our CPG and foodservice businesses as company-owned and one month as licensed operations. Our collaborative business relationships for our global ready-to-drink products and the associated revenues remain unchanged due to the Global Coffee Alliance.
Revenues
Channel Development net revenues for fiscal 2018 increased $41 million, or 2%, over fiscal 2017. Revenue growth was driven by an increase in sales of our packaged coffee and premium single-serve products ($115 million), lapping a prior year revenue deduction adjustment ($13 million) and favorable foreign currency translation ($10 million). These increases were partially offset by the absence of revenue from the sale of our Tazo brand in the first quarter of fiscal 2018 ($56 million) and licensing our CPG and foodservice businesses to Nestlé late in the fourth quarter of fiscal 2018 ($50 million).
Operating Expenses
Cost of sales as a percentage of total net revenues increased 90 basis points, primarily driven by the impact of licensing our CPG and foodservice businesses to Nestlé and the sale of our Tazo brand (approximately 120 basis points), partially offset by lapping a revenue deduction adjustment recorded in the second quarter of fiscal 2017 (approximately 30 basis points).
Other operating expenses as a percentage of total net revenues increased 100 basis points, primarily driven by business taxes associated with the upfront payment received from Nestlé (approximately 120 basis points) and Global Coffee Alliance headcount-related costs, including employee bonus and retention costs (approximately 80 basis points). These increases were partially offset by the cost savings related to our ownership changes, including licensing our CPG and foodservice businesses to Nestlé and the sale of our Tazo brand (approximately 40 basis points), and lower marketing expenses (approximately 40 basis points).
Income from equity investees decreased $11 million for fiscal 2018, due to lower income from our North American Coffee Partnership joint venture, driven by decreased sales of Frappuccino®, Starbucks Doubleshot® and Iced Coffee beverages.
The combination of these changes contributed to an overall decrease in operating margin of 250 basis points in fiscal 2018 when compared to fiscal 2017.
Corporate and Other
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | % Change | |||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 112.7 | $ | 197.3 | (42.9 | )% | ||||
| Licensed stores | 1.2 | 2.6 | (53.8 | ) | ||||||
| Other | 54.5 | 111.4 | (51.1 | ) | ||||||
| Total net revenues | 168.4 | 311.3 | (45.9 | ) | ||||||
| Cost of sales including occupancy costs | 163.5 | 225.2 | (27.4 | ) | ||||||
| Store operating expenses | 70.6 | 113.5 | (37.8 | ) | ||||||
| Other operating expenses | 17.1 | 36.6 | (53.3 | ) | ||||||
| Depreciation and amortization expenses | 163.6 | 160.7 | 1.8 | |||||||
| General and administrative expenses | 1,204.8 | 989.2 | 21.8 | |||||||
| Restructuring and impairments | 135.9 | 131.5 | 3.3 | |||||||
| Total operating expenses | 1,755.5 | 1,656.7 | 6.0 | |||||||
| Operating loss | $ | (1,587.1 | ) | $ | (1,345.4 | ) | 18.0 | % |
Corporate and Other primarily consists of our unallocated corporate expenses, the results from Siren Retail, as well as Evolution Fresh and the legacy operations of the Teavana retail business, which substantially ceased during fiscal 2018. Unallocated corporate expenses include corporate administrative functions that support the operating segments but are not specifically attributable to or managed by any segment and are not included in the reported financial results of the operating segments.
RESULTS OF OPERATIONS — FISCAL 2017 COMPARED TO FISCAL 2016
Consolidated results of operations (in millions):
Revenues
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | % Change | |||||||
| (52 Weeks Ended) | (53 Weeks Ended) | |||||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 17,650.7 | $ | 16,844.1 | 4.8 | % | ||||
| Licensed stores | 2,355.0 | 2,154.2 | 9.3 | |||||||
| Other | 2,381.1 | 2,317.6 | 2.7 | |||||||
| Total net revenues | $ | 22,386.8 | $ | 21,315.9 | 5.0 | % |
Total net revenues increased $1.1 billion, or 5%, over fiscal 2016, primarily driven by increased revenues from company operated stores ($807 million). The growth in company-operated store revenues was primarily driven by incremental revenues from 768 net new Starbucks® company-operated store openings over the past 12 months ($869 million) and a 3% increase in comparable store sales ($496 million), attributable to a 3% increase in average ticket. Partially offsetting these incremental revenues was the absence of the 53rd week ($324 million), the absence of sales from the conversion of certain company operated stores to licensed stores ($121 million) and the impact of unfavorable foreign currency translation ($70 million).
Licensed store revenue growth also contributed to the increase in total net revenue ($201 million), primarily due to increased product sales to and royalty revenues from our licensees ($260 million), largely due to the opening of 1,552 net new Starbucks® licensed stores and improved comparable store sales, partially offset by the absence of the 53rd week ($41 million) and unfavorable foreign currency translation ($27 million).
Other revenues increased $64 million, primarily driven by increased sales of packaged coffee, tea and premium single-serve products ($73 million), our ready-to-drink beverages ($21 million) and higher foodservice sales ($26 million). Increased sales were partially offset by the absence of the 53rd week ($47 million) and an unfavorable revenue deduction adjustment pertaining to periods prior to 2017 ($13 million).
Operating Expenses
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of Total Net Revenues | |||||||||||||
| Cost of sales including occupancy costs | $ | 9,034.3 | $ | 8,509.0 | 40.4 | % | 39.9 | % | |||||
| Store operating expenses | 6,493.3 | 6,064.3 | 29.0 | 28.4 | |||||||||
| Other operating expenses | 500.3 | 499.2 | 2.2 | 2.3 | |||||||||
| Depreciation and amortization expenses | 1,011.4 | 980.8 | 4.5 | 4.6 | |||||||||
| General and administrative expenses | 1,450.7 | 1,408.9 | 6.5 | 6.6 | |||||||||
| Restructuring and impairments | 153.5 | — | 0.7 | — | |||||||||
| Total operating expenses | 18,643.5 | 17,462.2 | 83.3 | 81.9 | |||||||||
| Income from equity investees | 391.4 | 318.2 | 1.7 | 1.5 | |||||||||
| Operating income | $ | 4,134.7 | $ | 4,171.9 | 18.5 | % | 19.6 | % | |||||
| Store operating expenses as a % of related revenues | 36.8 | % | 36.0 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 10.6 | % | 11.2 | % |
Cost of sales including occupancy costs as a percentage of total net revenues increased 50 basis points, primarily driven by a product mix shift (approximately 70 basis points) largely towards premium food in the Americas segment, partially offset by leverage on cost of sales and occupancy costs (approximately 30 basis points).
Store operating expenses as a percentage of total net revenues increased 60 basis points. Store operating expenses as a percentage of company-operated store revenues increased 80 basis points, primarily driven by higher partner and digital investments, largely in the Americas segment (approximately 150 basis points), partially offset by sales leverage (approximately 90 basis points).
Other operating expenses as a percentage of total net revenues decreased 10 basis points. Excluding the impact of company operated store revenues, other operating expenses decreased 60 basis points, primarily due to lower performance-based compensation (approximately 20 basis points).
General and administrative expenses as a percentage of total net revenues decreased 10 basis points, primarily driven by lower performance-based compensation (approximately 30 basis points), and employment taxes, including the lapping of higher employment taxes resulting from a multiple year audit in the prior year (approximately 20 basis points). These were partially offset by increased salaries and benefits related to digital platforms, technology infrastructure and innovations.
Restructuring and impairments charges in fiscal 2017 were primarily the result of our strategic changes in Teavana. We recorded $130 million of restructuring–related costs, including a partial goodwill impairment charge of $69 million, store asset impairments, and costs related to early store closure obligations and severance. Additionally, we recorded $18 million of partial goodwill impairment relating to our Switzerland retail business.
Income from equity investees increased $73 million, due to higher income from our CAP joint venture operations, primarily China and South Korea, as well as our North American Coffee Partnership.
The combination of these changes resulted in an overall decrease in operating margin of 110 basis points in fiscal 2017 when compared to fiscal 2016.
Other Income and Expenses
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of Total Net Revenues | |||||||||||||
| Operating income | $ | 4,134.7 | $ | 4,171.9 | 18.5 | % | 19.6 | ||||||
| Net gain resulting from divestiture of certain operations | 93.5 | 5.4 | 0.4 | — | |||||||||
| Interest income and other, net | 181.8 | 102.6 | 0.8 | 0.5 | |||||||||
| Interest expense | (92.5 | ) | (81.3 | ) | (0.4 | ) | (0.4 | ) | |||||
| Earnings before income taxes | 4,317.5 | 4,198.6 | 19.3 | 19.7 | |||||||||
| Income tax expense | 1,432.6 | 1,379.7 | 6.4 | 6.5 | |||||||||
| Net earnings including noncontrolling interests | 2,884.9 | 2,818.9 | 12.9 | 13.2 | |||||||||
| Net earnings attributable to noncontrolling interests | 0.2 | 1.2 | — | — | |||||||||
| Net earnings attributable to Starbucks | $ | 2,884.7 | $ | 2,817.7 | 12.9 | % | 13.2 | % | |||||
| Effective tax rate including noncontrolling interests | 33.2 | % | 32.9 | % |
Net gain resulting from divestiture of certain operations increased $88 million, primarily due to the gain from the sale of our Singapore retail operations in the fourth quarter of fiscal 2017 ($84 million).
Interest income and other, net increased $79 million, primarily driven by gain in our investment in Square, Inc. warrants ($41 million) and higher income recognized on unredeemed stored value card balances ($44 million).
Interest expense increased $11 million primarily related to additional interest incurred on long-term debt issued in February 2016, May 2016 and March 2017, partially offset by lower interest expense from the repayment of our December 2016 notes.
The effective tax rate for fiscal 2017 was 33.2% compared to 32.9% for fiscal 2016. The increase in the effective tax rate was primarily due to unfavorability from non-deductible goodwill impairment charges recorded in the third quarter of fiscal 2017 (approximately 70 basis points) and the lapping of the release of certain tax reserves in the third quarter of fiscal 2016, primarily related to statute closures (approximately 30 basis points). The increase was partially offset by the largely non-taxable gain on the sale of our Singapore retail operations in the fourth quarter of fiscal 2017 (approximately 70 basis points).
Segment Information
Results of operations by segment (in millions):
Americas
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of Americas Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 13,996.4 | $ | 13,247.4 | 89.6 | % | 89.7 | % | |||||
| Licensed stores | 1,617.3 | 1,518.5 | 10.4 | 10.3 | |||||||||
| Other | 6.3 | 9.3 | — | 0.1 | |||||||||
| Total net revenues | 15,620.0 | 14,775.2 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 5,695.0 | 5,254.2 | 36.5 | 35.6 | |||||||||
| Store operating expenses | 5,320.2 | 4,909.3 | 34.1 | 33.2 | |||||||||
| Other operating expenses | 130.8 | 97.1 | 0.8 | 0.7 | |||||||||
| Depreciation and amortization expenses | 614.9 | 590.0 | 3.9 | 4.0 | |||||||||
| General and administrative expenses | 201.4 | 186.1 | 1.3 | 1.3 | |||||||||
| Restructuring and impairments | 4.1 | — | — | — | |||||||||
| Total operating expenses | 11,966.4 | 11,036.7 | 76.6 | 74.7 | |||||||||
| Income from equity investees | — | — | — | — | |||||||||
| Operating income | $ | 3,653.6 | $ | 3,738.5 | 23.4 | % | 25.3 | % | |||||
| Store operating expenses as a % of related revenues | 38.0 | % | 37.1 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 8.1 | % | 6.4 | % |
Revenues
Americas total net revenues for fiscal 2017 increased $845 million, or 6%, over fiscal 2016, primarily due to increased revenues from company-operated stores (contributing $749 million) and licensed stores (contributing $99 million).
The increase in company-operated store revenues was driven by incremental revenues from 383 net new Starbucks® company-operated store openings over the past 12 months ($585 million) and a 3% increase in comparable store sales ($426 million), attributable to a 4% increase in average ticket, partially offset by the absence of the 53rd week ($258 million).
The increase in licensed store revenues was primarily driven by increased product sales to and royalty revenues from our licensees ($127 million), primarily resulting from the opening of 569 net new Starbucks® licensed stores over the past 12 months and improved comparable store sales, partially offset by the absence of the 53rd week ($31 million).
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues increased 90 basis points, primarily due to a product mix shift (approximately 90 basis points) largely towards premium food.
Store operating expenses as a percentage of total net revenues increased 90 basis points. As a percentage of company-operated store revenues, store operating expenses increased 90 basis points, primarily driven by increased partner and digital investments (approximately 180 basis points), partially offset by sales leverage on salaries and benefits (approximately 80 basis points).
Other operating expenses as a percentage of total net revenues increased 10 basis points. Excluding the impact of company-operated store revenues, other operating expenses increased 170 basis points, primarily due to lapping a settlement received in the fourth quarter of fiscal 2016 related to the closure of Target Canada stores in fiscal 2015 (approximately 120 basis points).
Restructuring and impairment charges of $4 million related to asset impairments of certain company-operated stores in Canada.
The combination of these changes resulted in an overall decrease in operating margin of 190 basis points in fiscal 2017 when compared to fiscal 2016.
CAP
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of China/Asia Pacific Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 2,906.0 | $ | 2,640.4 | 89.7 | % | 89.8 | % | |||||
| Licensed stores | 327.4 | 292.3 | 10.1 | 9.9 | |||||||||
| Other | 6.8 | 6.1 | 0.2 | 0.2 | |||||||||
| Total net revenues | 3,240.2 | 2,938.8 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 1,396.2 | 1,298.9 | 43.1 | 44.2 | |||||||||
| Store operating expenses | 845.5 | 779.4 | 26.1 | 26.5 | |||||||||
| Other operating expenses | 21.2 | 24.2 | 0.7 | 0.8 | |||||||||
| Depreciation and amortization expenses | 202.2 | 180.6 | 6.2 | 6.1 | |||||||||
| General and administrative expenses | 207.1 | 174.2 | 6.4 | 5.9 | |||||||||
| Total operating expenses | 2,672.2 | 2,457.3 | 82.5 | 83.6 | |||||||||
| Income from equity investees | 197.0 | 150.1 | 6.1 | 5.1 | |||||||||
| Operating income | $ | 765.0 | $ | 631.6 | 23.6 | % | 21.5 | % | |||||
| Store operating expenses as a % of related revenues | 29.1 | % | 29.5 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 6.3 | % | 8.1 | % |
Revenues
China/Asia Pacific total net revenues for fiscal 2017 increased $301 million, or 10%, over fiscal 2016, primarily from higher company-operated store revenues ($266 million), driven by incremental revenues from 392 net new company-operated store
openings over the past 12 months ($293 million). Also contributing was a 3% increase in comparable store sales ($67 million), partially offset by the absence of the 53rd week ($52 million) and unfavorable foreign currency translation ($40 million).
Licensed store revenues increased $35 million, primarily driven by increased product sales to and royalty revenues from licensees ($39 million), primarily resulting from the opening of 644 net new licensed stores over the past 12 months, partially offset the absence of the 53rd week ($4 million).
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues decreased 110 basis points, primarily driven by favorability from the transition to China's new value added tax structure (approximately 120 basis points).
Store operating expenses as a percentage of total net revenues decreased 40 basis points. As a percentage of company-operated store revenues, store operating expenses decreased 40 basis points, primarily due to sales leverage on salaries and benefits (approximately 30 basis points) and lower performance-based compensation in Japan (approximately 10 basis points).
Other operating expenses as a percentage of total net revenues decreased 10 basis points. Excluding the impact of company operated store revenues, other operating expenses decreased 180 basis points, primarily due to lower performance-based compensation (approximately 100 basis points) and timing of certain reimbursable expenses (approximately 90 basis points).
General and administrative expenses as a percentage of total revenues increased 50 basis points, primarily due to continued focus and investment in product quality and innovation (approximately 20 basis points) and higher salaries and benefits (approximately 20 basis points).
Income from equity investees increased $47 million, driven by higher income from our joint venture operations, primarily in East China and South Korea. Favorability in both regions was attributable to comparable store sales growth and the addition of net new licensed stores over the past 12 months. East China also benefited from the new value added tax structure.
The combination of these changes resulted in an overall increase in operating margin of 210 basis points in fiscal 2017 when compared to fiscal 2016.
EMEA
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of EMEA Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 551.0 | $ | 732.0 | 57.5 | % | 68.3 | % | |||||
| Licensed stores | 407.7 | 339.5 | 42.5 | 31.7 | |||||||||
| Total net revenues | 958.7 | 1,071.5 | 100.0 | 100.0 | |||||||||
| Cost of sales including occupancy costs | 508.6 | 540.7 | 53.1 | 50.5 | |||||||||
| Store operating expenses | 214.1 | 260.6 | 22.3 | 24.3 | |||||||||
| Other operating expenses | 51.3 | 49.4 | 5.4 | 4.6 | |||||||||
| Depreciation and amortization expenses | 30.6 | 39.9 | 3.2 | 3.7 | |||||||||
| General and administrative expenses | 41.7 | 51.4 | 4.3 | 4.8 | |||||||||
| Restructuring and impairments | 17.9 | — | 1.9 | — | |||||||||
| Total operating expenses | 864.2 | 942.0 | 90.1 | 87.9 | |||||||||
| Income from equity investees | — | 1.5 | — | 0.1 | |||||||||
| Operating income | $ | 94.5 | $ | 131.0 | 9.9 | % | 12.2 | % | |||||
| Store operating expenses as a % of related revenues | 38.9 | % | 35.6 | % | |||||||||
| Other operating expenses as a % of non-company-operated store revenues | 12.6 | % | 14.6 | % |
Revenues
EMEA total net revenues for fiscal 2017 decreased $113 million, or 11%, over fiscal 2016. The decrease was primarily due to a decline in company-operated store revenues ($181 million), driven by the shift to more licensed stores in the region ($121 million), which includes the absence of revenues related to the sale of our Germany retail operations in the third quarter of fiscal 2016. Also contributing to the decline was unfavorable foreign currency translation ($43 million) and the absence of the 53rd week ($11 million).
Licensed store revenues increased $68 million, driven by higher product sales to and royalty revenues from our licensees ($95 million), resulting from the opening of 339 net new licensed stores and the transfer of 14 company-operated stores to licensed stores over the past 12 months. These increases were partially offset by unfavorable foreign currency translation ($24 million) and the absence of the 53rd week ($6 million).
Operating Expenses
Cost of sales including occupancy costs as a percentage of total net revenues increased 260 basis points, primarily due to unfavorable foreign currency transactions (approximately 150 basis points) and the shift in the composition of our store portfolio to more licensed stores, which have a lower gross margin (approximately 100 basis points).
Store operating expenses as a percentage of total net revenues decreased 200 basis points. As a percentage of company-operated store revenues, store operating expenses increased 330 basis points, primarily due to sales deleverage in certain company-operated stores (approximately 320 basis points) and the impact of a tax settlement (approximately 100 basis points), partially offset by the shift in the portfolio towards more licensed stores (approximately 140 basis points).
Other operating expenses as a percentage of total net revenues increased 80 basis points. Excluding the impact of company operated store revenues, other operating expenses decreased 200 basis points, primarily due to sales leverage driven by the shift to more licensed stores (approximately 160 basis points).
Depreciation and amortization expenses as a percentage of total net revenues decreased 50 basis points, primarily due to the shift in portfolio towards more licensed stores (approximately 50 basis points).
Restructuring and impairment charges in fiscal 2017 relate to a partial goodwill impairment expense recorded in our Switzerland company-operated retail reporting unit, which we fully acquired in the fourth quarter of fiscal 2011. The overall economic backdrop in Europe, coupled with the strengthening of the Swiss franc when compared to the relatively inexpensive euro in surrounding countries, caused ongoing unfavorable changes in consumer behavior and depressed tourism. Our latest mitigation efforts for our Switzerland retail business are not expected to fully recover the reporting unit's carrying value given
the sustained nature of these and other external factors. As a result, we recorded a goodwill impairment charge of $18 million in the third quarter of fiscal 2017.
The combination of these changes resulted in an overall decrease in operating margin of 230 basis points in fiscal 2017 when compared to fiscal 2016.
Channel Development
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | Oct 1, 2017 | Oct 2, 2016 | |||||||||
| (52 Weeks Ended) | (53 Weeks Ended) | ||||||||||||
| As a % of Channel Development Total Net Revenues | |||||||||||||
| Total net revenues | $ | 2,256.6 | $ | 2,195.1 | |||||||||
| Cost of sales | 1,209.3 | 1,191.8 | 53.6 | 54.3 | |||||||||
| Other operating expenses | 260.4 | 270.7 | 11.5 | 12.3 | |||||||||
| Depreciation and amortization expenses | 3.0 | 3.9 | 0.1 | 0.2 | |||||||||
| General and administrative expenses | 11.3 | 18.0 | 0.5 | 0.8 | |||||||||
| Total operating expenses | 1,484.0 | 1,484.4 | 65.8 | 67.6 | |||||||||
| Income from equity investees | 194.4 | 166.6 | 8.6 | 7.6 | |||||||||
| Operating income | $ | 967.0 | $ | 877.3 | 42.9 | % | 40.0 | % |
Discussion of our Channel Development segment results reflects the impact of an unfavorable revenue deduction adjustment recorded in the second quarter of fiscal 2017. While this adjustment was immaterial, the discussion below quantifies the impact to provide a better understanding of our results for fiscal 2017.
Revenues
Channel Development total net revenues for fiscal 2017 increased $62 million, or 3%, over fiscal 2016. Revenue growth was driven by increased sales of packaged coffee, tea and premium single-serve products ($73 million), our ready-to-drink beverages ($21 million) and higher foodservice sales ($26 million). Higher foodservice sales were primarily the result of a change to a direct distribution model and recognizing the benefit of full revenue from premium single-serve product sales. Increased sales were partially offset by the absence of the 53rd week ($45 million) and an unfavorable revenue deduction adjustment pertaining to prior periods ($13 million).
Operating Expenses
Cost of sales as a percentage of total net revenues decreased 70 basis points, primarily driven by lower coffee costs (approximately 80 basis points) and leverage on cost of sales (approximately 60 basis points), partially offset by a shift toward lower margin products (approximately 80 basis points) and the revenue deduction adjustment pertaining to prior periods (approximately 30 basis points).
Other operating expenses as a percentage of total net revenues decreased 80 basis points, primarily driven by lower performance-based compensation (approximately 40 basis points).
General and administrative expenses as a percentage of total net revenues decreased 30 basis points, primarily driven by lower performance-based compensation (approximately 20 basis points) and salaries and benefits (approximately 10 basis points).
Income from equity investees increased $28 million for fiscal 2017, due to higher income from our North American Coffee Partnership joint venture, driven by increased sales of Frappuccino® and Starbucks Doubleshot® beverages as well as new product launches over the past 12 months.
The combination of these changes contributed to an overall increase in operating margin of 290 basis points in fiscal 2017 when compared to fiscal 2016.
Corporate and Other
| Fiscal Year Ended | Oct 1, 2017 | Oct 2, 2016 | % Change | |||||||
| (52 Weeks Ended) | (53 Weeks Ended) | |||||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 197.3 | $ | 224.3 | (12.0 | )% | ||||
| Licensed stores | 2.6 | 3.9 | (33.3 | )% | ||||||
| Other | 111.4 | 107.1 | 4.0 | |||||||
| Total net revenues | 311.3 | 335.3 | (7.2 | ) | ||||||
| Cost of sales including occupancy costs | 225.2 | 223.4 | 0.8 | |||||||
| Store operating expenses | 113.5 | 115.0 | (1.3 | ) | ||||||
| Other operating expenses | 36.6 | 57.8 | (36.7 | ) | ||||||
| Depreciation and amortization expenses | 160.7 | 166.4 | (3.4 | ) | ||||||
| General and administrative expenses | 989.2 | 979.2 | 1.0 | |||||||
| Restructuring and impairments | 131.5 | — | nm | |||||||
| Total operating expenses | 1,656.7 | 1,541.8 | 7.5 | |||||||
| Operating loss | $ | (1,345.4 | ) | $ | (1,206.5 | ) | 11.5 | % |
Corporate and Other includes the results of our Teavana, Siren Retail, Evolution Fresh and our unallocated corporate expenses. Unallocated corporate expenses include corporate administrative functions that support the operating segments but are not specifically attributable to or managed by any segment and are not included in the reported financial results of the operating segments.
The increase in the operating loss in fiscal 2017 compared to fiscal 2016 was primarily due to restructuring and impairment charges related to our strategy to close TeavanaTM/MC retail stores and focus on TeavanaTM/MC tea within Starbucks® stores. We recorded $69 million for the partial impairment of goodwill and $60 million in restructuring-related costs, including asset impairments, costs associated with the early closure of stores and their related obligations, and severance.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash and Investment Overview
Our cash and investments were $9.2 billion and $3.2 billion as of September 30, 2018 and October 1, 2017, respectively with the increase driven primarily by the upfront payment associated with the Global Coffee Alliance. We actively manage our cash and investments in order to internally fund operating needs, make scheduled interest and principal payments on our borrowings, make acquisitions, and return cash to shareholders through common stock cash dividend payments and share repurchases. Our investment portfolio primarily includes highly liquid available-for-sale securities, including corporate debt securities, government treasury securities (domestic and foreign), mortgage and asset-backed securities, commercial paper, and agency obligations. As of September 30, 2018, approximately $1.3 billion of cash was held in foreign subsidiaries.
Borrowing capacity
Our $2.0 billion unsecured 5-year revolving credit facility (the “2018 credit facility”) and our $1.0 billion unsecured 364-Day credit facility (the “364-day credit facility”) are available for working capital, capital expenditures and other corporate purposes, including acquisitions and share repurchases.
The 2018 credit facility, of which $150 million may be used for issuances of letters of credit, is currently set to mature on October 25, 2022. We have the option, subject to negotiation and agreement with the related banks, to increase the maximum commitment amount by an additional $500 million. Borrowings under the credit facility will bear interest at a variable rate based on LIBOR, and, for U.S. dollar-denominated loans under certain circumstances, a Base Rate (as defined in the credit facility), in each case plus an applicable margin. The applicable margin is based on the better of (i) the Company's long-term credit ratings assigned by Moody's and Standard & Poor's rating agencies and (ii) the Company's fixed charge coverage ratio, pursuant to a pricing grid set forth in the five-year credit agreement. The current applicable margin is 0.680% for Eurocurrency Rate Loans and 0.00% (nil) for Base Rate Loans.
The 364-day credit facility, of which no amount may be used for issuances of letters of credit, was originally set to mature on October 25, 2018. In the first quarter of fiscal 2019, the maturity has been extended to October 23, 2019. We have the option, subject to negotiation and agreement with the related banks, to increase the maximum commitment amount by an additional $500 million. Borrowings under the credit facility will bear interest at a variable rate based on LIBOR, and, for U.S. dollar-
denominated loans under certain circumstances, a Base Rate (as defined in the credit facility), in each case plus an applicable margin. The applicable margin was increased from 0.585% to 0.92% for Eurocurrency Rate Loans and 0.00% (nil) for Base Rate Loans as a result of the extension.
Both credit facilities contain provisions requiring us to maintain compliance with certain covenants, including a minimum fixed charge coverage ratio, which measures our ability to cover financing expenses. As of September 30, 2018, we were in compliance with all applicable credit facility covenants. No amounts were outstanding under our credit facility as of September 30, 2018.
Under our commercial paper program, we may issue unsecured commercial paper notes up to a maximum aggregate amount outstanding at any time of $3 billion, with individual maturities that may vary but not exceed 397 days from the date of issue. Amounts outstanding under the commercial paper program are required to be backstopped by available commitments under our credit facilities discussed above. The proceeds from borrowings under our commercial paper program may be used for working capital needs, capital expenditures and other corporate purposes, including, but not limited to, business expansion, payment of cash dividends on our common stock and share repurchases. As of September 30, 2018, we had no borrowings under our commercial paper program.
In August 2018, we issued long-term debt in an underwritten registered public offering, which consisted of $1.25 billion of 7-year 3.800% Senior Notes (the “2025 notes”) due August 2025, $750 million of 10-year 4.000% Senior Notes (the “2028 notes”) due November 2028 and $1 billion of 30-year 4.500% Senior Notes (the “2048 notes”) due November 2048. Interest on the 2025 notes is payable semi-annually on February 15 and August 15, commencing on February 15, 2019. Interest on the 2028 and 2048 notes is payable semi-annually on May 15 and November 15, commencing on November 15, 2018.
In February 2018, we issued long-term debt in an underwritten registered public offering, which consisted of $1 billion of 5-year 3.100% Senior Notes (the “2023 notes”) due March 2023 and $600 million of 10-year 3.500% Senior Notes (the “2028 notes”) due March 2028. Interest on the 2023 and 2028 notes is payable semi-annually on March 1 and September 1, commencing on September 1, 2018.
In November 2017, we issued long-term debt in an underwritten registered public offering, which consisted of $500 million of 3-year 2.200% Senior Notes (the “2020 notes”) due November 2020 and $500 million of 30-year 3.750% Senior Notes (the “2047 notes”) due December 2047. Interest on the 2020 notes is payable semi-annually on May 22 and November 22, commencing on May 22, 2018 and interest on the 2047 notes is payable semi-annually on June 1 and December 1, commencing on June 1, 2018.
The net proceeds from these offerings are used for general corporate purposes, including repurchases of our common stock under our ongoing share repurchase program and payment of dividends.
See Note 9, Debt, to the consolidated financial statements included in Item 8 of Part II of this 10-K for details of the components of our long-term debt.
The indentures under which all of our Senior Notes were issued require us to maintain compliance with certain covenants, including limits on future liens and sale and leaseback transactions on certain material properties. As of September 30, 2018, we were in compliance with all applicable covenants.
Use of Cash
We expect to use our available cash and investments, including, but not limited to, additional potential future borrowings under the credit facilities, commercial paper program and the issuance of debt, to invest in our core businesses, including capital expenditures, new product innovations, related marketing support and partner and digital investments, return cash to shareholders through common stock cash dividend payments and share repurchases, as well as other new business opportunities related to our core and other developing businesses. Further, we may use our available cash resources to make proportionate capital contributions to our investees. We may also seek strategic acquisitions to leverage existing capabilities and further build our business in support of our growth agenda. Acquisitions may include increasing our ownership interests in our investees. Any decisions to increase such ownership interests will be driven by valuation and fit with our ownership strategy.
We believe that future cash flows generated from operations and existing cash and investments both domestically and internationally combined with our ability to leverage our balance sheet through the issuance of debt will be sufficient to finance capital requirements for our core businesses as well as any shareholder distributions for the foreseeable future. Significant new joint ventures, acquisitions and/or other new business opportunities may require additional outside funding. We have borrowed funds and continue to believe we have the ability to do so at reasonable interest rates; however, additional borrowings would result in increased interest expense in the future. In this regard, we may incur additional debt, within targeted levels, as part of our plans to fund our capital programs, including cash returns to shareholders through dividends and share repurchases.
We have historically considered the majority of undistributed earnings of our foreign subsidiaries and equity investees to be indefinitely reinvested, and, accordingly, no foreign withholding taxes have been provided on such earnings. We continue to
evaluate our plans for reinvestment or repatriation of unremitted foreign earnings and thus have not adjusted our previous indefinite reinvestment assertions for the effects of the Tax Act. We have not, nor do we anticipate the need for, repatriated funds to the U.S. to satisfy domestic liquidity needs. However, the Tax Act requires a one-time transition tax for deemed repatriation of accumulated undistributed earnings of certain foreign investments. This one-time transition tax is payable over eight years, with most of the cash outlay expected to be made in the later years. In connection with our initial analysis, we have estimated a provisional amount of $262 million, of which $237 million of income taxes payable was included in other long-term liabilities on the consolidated balance sheet, as of September 30, 2018. See Note 13, Income Taxes, for further discussion.
We regularly review our cash positions and our determination of permanent reinvestment of foreign earnings. In the event we determine that all or a portion of such foreign earnings are no longer indefinitely reinvested, we may be subject to additional foreign withholding taxes and U.S. state income taxes, beyond the Tax Act's one-time transition tax, which could be material.
During each of the first three quarters of fiscal 2017, we declared a cash dividend to shareholders of $0.25 per share. In the fourth quarter of fiscal 2017 and each of the first two quarters of fiscal 2018, we declared a cash dividend of $0.30 per share, and we declared $0.36 per share in the last two quarters of fiscal 2018. Dividends are paid in the quarter following the declaration date. Cash returned to shareholders through dividends in fiscal 2018 and 2017 totaled $1.7 billion and $1.5 billion, respectively. In the fourth quarter of fiscal 2018, we declared a cash dividend of $0.36 per share to be paid on November 30, 2018 with an expected payout of approximately $445 million.
During fiscal years 2018 and 2017, we repurchased 131.5 million and 37.5 million shares of common stock, respectively, or $7.2 billion and $2.1 billion, respectively, under our ongoing share repurchase program. In early fiscal 2019, we commenced the repurchase of $5.0 billion of our common stock under accelerated share repurchase agreements.
Other than normal operating expenses, cash requirements for fiscal 2019 are expected to consist primarily of capital expenditures for investments in our new and existing stores, our developing Siren Retail business and our supply chain and corporate facilities. Total capital expenditures for fiscal 2019 are expected to be approximately $2 billion.
Cash Flows
Cash provided by operating activities was $11.9 billion for fiscal 2018, compared to $4.3 billion for fiscal 2017. The change was primarily due to receipt of the upfront payment from Nestlé in the fourth quarter of fiscal 2018.
Cash used by investing activities totaled $2.4 billion for fiscal 2018, compared to $0.9 billion for fiscal 2017. The change was primarily due to cash used to acquire the 50% ownership interest in our East China joint venture in the first quarter of fiscal 2018 and additions to property, plant and equipment driven by new store openings and increased store renovations, partially offset by the net proceeds from the divestiture of certain operations.
Cash used by financing activities for fiscal 2018 totaled $3.2 billion, compared to $3.1 billion for fiscal 2017. The change was primarily due to an increase in cash returned to shareholders through share repurchases and dividend payments, partially offset by higher proceeds from the issuance of long-term debt.
Contractual Obligations
The following table summarizes our contractual obligations and borrowings as of September 30, 2018, and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods (in millions):
| Payments Due by Period | |||||||||||||||||||
| Contractual Obligations (1) | Total | Less than 1 Year | 1 - 3 Years | 3 - 5 Years | More than 5 Years | ||||||||||||||
| Operating lease obligations(2) | $ | 9,353.8 | $ | 1,340.6 | $ | 2,463.4 | $ | 2,045.4 | $ | 3,504.4 | |||||||||
| Financing lease obligations | 58.0 | 4.4 | 8.7 | 8.3 | 36.6 | ||||||||||||||
| Debt obligations | |||||||||||||||||||
| Principal payments | 9,548.4 | 350.0 | 1,250.0 | 1,500.0 | 6,448.4 | ||||||||||||||
| Interest payments | 3,698.0 | 278.9 | 586.0 | 488.0 | 2,345.1 | ||||||||||||||
| Purchase obligations(3) | 1,267.1 | 806.6 | 342.9 | 101.0 | 16.6 | ||||||||||||||
| Other obligations(4) | 417.7 | 31.0 | 64.3 | 98.8 | 223.6 | ||||||||||||||
| Total | $ | 24,343.0 | $ | 2,811.5 | $ | 4,715.3 | $ | 4,241.5 | $ | 12,574.7 |
| (1) | We have excluded long-term gross unrecognized tax benefits for uncertain tax positions, including interest and penalties of $237.2 million from the amounts presented as the timing of these obligations is uncertain. |
| (2) | Amounts include direct lease obligations, excluding any taxes, insurance and other related expenses. |
| (3) | Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on Starbucks and that specify all significant terms. Green coffee purchase commitments comprise 92% of total purchase obligations. |
| (4) | Other obligations include other long-term liabilities primarily consisting of the Tax Act transition tax, asset retirement obligations and hedging instruments. |
Starbucks currently expects to fund these commitments primarily with operating cash flows generated in the normal course of business.
Off-Balance Sheet Arrangements
Off-balance sheet arrangements relate to operating lease and purchase commitments detailed in the footnotes to the consolidated financial statements included in Item 8 of Part II of this 10-K.
COMMODITY PRICES, AVAILABILITY AND GENERAL RISK CONDITIONS
Commodity price risk represents Starbucks primary market risk, generated by our purchases of green coffee and dairy products, among other items. We purchase, roast and sell high-quality arabica coffee and related products and risk arises from the price volatility of green coffee. In addition to coffee, we also purchase significant amounts of dairy products to support the needs of our company-operated stores. The price and availability of these commodities directly impacts our results of operations, and we expect commodity prices, particularly coffee, to impact future results of operations. For additional details see Product Supply in Item 1, as well as Risk Factors in Item 1A of this 10-K.
FINANCIAL RISK MANAGEMENT
Market risk is defined as the risk of losses due to changes in commodity prices, foreign currency exchange rates, equity security prices and interest rates. We manage our exposure to various market-based risks according to a market price risk management policy. Under this policy, market-based risks are quantified and evaluated for potential mitigation strategies, such as entering into hedging transactions. The market price risk management policy governs how hedging instruments may be used to mitigate risk. Risk limits are set annually and prohibit speculative trading activity. We also monitor and limit the amount of associated counterparty credit risk, which we consider to be low. Excluding interest rate swaps, hedging instruments generally do not have maturities in excess of three years. Refer to Note 1, Summary of Significant Accounting Policies, and Note 3, Derivative Financial Instruments, to the consolidated financial statements included in Item 8 of Part II of this 10-K for further discussion of our hedging instruments.
The sensitivity analyses disclosed below provide only a limited, point-in-time view of the market risk of the financial instruments discussed. The actual impact of the respective underlying rates and price changes on the financial instruments may differ significantly from those shown in the sensitivity analyses.
Commodity Price Risk
We purchase commodity inputs, primarily coffee, dairy products, diesel, cocoa, sugar and other commodities, that are used in our operations and are subject to price fluctuations that impact our financial results. We use a combination of pricing features embedded within supply contracts, such as fixed-price and price-to-be-fixed contracts for coffee purchases, and financial derivatives to manage our commodity price risk exposure.
The following table summarizes the potential impact as of September 30, 2018 to Starbucks future net earnings and other comprehensive income (“OCI”) from changes in commodity prices. The information provided below relates only to the hedging instruments and does not represent the corresponding changes in the underlying hedged items (in millions):
| Increase/(Decrease) to Net Earnings | Increase/(Decrease) to OCI | ||||||||||||||
| 10% Increase in Underlying Rate | 10% Decrease in Underlying Rate | 10% Increase in Underlying Rate | 10% Decrease in Underlying Rate | ||||||||||||
| Commodity hedges | $ | 4 | $ | (4 | ) | $ | — | $ | — |
Foreign Currency Exchange Risk
The majority of our revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, because a portion of our operations consists of activities outside of the U.S., we have transactions in other currencies, primarily the Chinese renminbi, Japanese yen, Canadian dollar, British pound, South Korean won and euro. To reduce cash flow volatility from foreign currency fluctuations, we enter into derivative instruments to hedge portions of cash flows of anticipated intercompany royalty payments, inventory purchases, intercompany borrowing and lending activities and certain other transactions in currencies other than the functional currency of the entity that enters into the arrangements, as well as the translation risk of certain balance sheet items. See Note 3, Derivative Financial Instruments, to the consolidated financial statements included in Item 8 of Part II of this 10-K for further discussion.
The following table summarizes the potential impact as of September 30, 2018 to Starbucks future net earnings and other comprehensive income from changes in the fair value of these derivative financial instruments due to a change in the value of the U.S. dollar as compared to foreign exchange rates. The information provided below relates only to the hedging instruments and does not represent the corresponding changes in the underlying hedged items (in millions):
| Increase/(Decrease) to Net Earnings | Increase/(Decrease) to OCI | ||||||||||||||
| 10% Increase in Underlying Rate | 10% Decrease in Underlying Rate | 10% Increase in Underlying Rate | 10% Decrease in Underlying Rate | ||||||||||||
| Foreign currency hedges | $ | 27 | $ | (27 | ) | $ | 108 | $ | (108 | ) |
Equity Security Price Risk
We have minimal exposure to price fluctuations on equity mutual funds and equity exchange-traded funds within our trading securities portfolio. Trading securities are recorded at fair value and approximates a portion of our liability under our Management Deferred Compensation Plan (“MDCP”). Gains and losses from the portfolio and the change in our MDCP liability are recorded in our consolidated statements of earnings.
We performed a sensitivity analysis based on a 10% change in the underlying equity prices of our investments as of September 30, 2018 and determined that such a change would not have a significant impact on the fair value of these instruments.
Interest Rate Risk
Long-term Debt
We utilize short-term and long-term financing and may use interest rate hedges to manage our overall interest expense related to our existing fixed-rate debt, as well as to hedge the variability in cash flows due to changes in benchmark interest rates related to anticipated debt issuances. See Note 3, Derivative Financial Instruments and Note 9, Debt, to the consolidated financial statements included in Item 8 of Part II of this 10-K for further discussion of our interest rate hedge agreements and details of the components of our long-term debt, respectively, as of September 30, 2018.
The following table summarizes the impact of a change in interest rates as of September 30, 2018 on the fair value of Starbucks debt (in millions):
| Change in Fair Value | ||||||||||||||
| Stated Interest Rate | Fair Value | 100 Basis Point Increase in Underlying Rate | 100 Basis Point Decrease in Underlying Rate | |||||||||||
| 2018 notes | 2.000 | % | $ | 350 | $ | (1 | ) | $ | 1 | |||||
| 2020 notes | 2.200 | % | $ | 490 | $ | (10 | ) | $ | 10 | |||||
| 2021 notes | 2.100 | % | $ | 733 | $ | (17 | ) | $ | 17 | |||||
| 2022 notes | 2.700 | % | $ | 486 | $ | (17 | ) | $ | 17 | |||||
| 2023 notes(1) | 3.850 | % | $ | 759 | $ | — | $ | — | ||||||
| 2023 notes | 3.100 | % | $ | 986 | $ | (40 | ) | $ | 40 | |||||
| 2024 notes | 0.372 | % | $ | 743 | $ | (40 | ) | $ | 40 | |||||
| 2025 notes | 3.800 | % | $ | 1,249 | $ | (74 | ) | $ | 74 | |||||
| 2026 notes | 2.450 | % | $ | 451 | $ | (34 | ) | $ | 34 | |||||
| 2028 notes | 3.500 | % | $ | 576 | $ | (47 | ) | $ | 47 | |||||
| 2028 notes | 4.000 | % | $ | 754 | $ | (61 | ) | $ | 61 | |||||
| 2045 notes | 4.300 | % | $ | 330 | $ | (53 | ) | $ | 53 | |||||
| 2047 notes | 3.750 | % | $ | 438 | $ | (81 | ) | $ | 81 | |||||
| 2048 notes | 4.500 | % | $ | 977 | $ | (159 | ) | $ | 159 |
| (1) | Amount disclosed is net of ($32 million) change in the fair value of our designated interest rate swap. Refer to Note 3, Derivative Financial Instruments, for additional information on our interest rate swap designated as a fair value hedge. |
Available-for-Sale Securities
Our available-for-sale securities comprise a diversified portfolio consisting mainly of investment-grade debt securities. The primary objective of these investments is to preserve capital and liquidity. Available-for-sale securities are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income. We do not hedge the interest rate exposure on our available-for-sale securities. We performed a sensitivity analysis based on a 100 basis point change in the underlying interest rate of our available-for-sale securities as of September 30, 2018 and determined that such a change would not have a significant impact on the fair value of these instruments.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those that management believes are both most important to the portrayal of our financial condition and results and require the most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions.
Our significant accounting policies are discussed in Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements included in Item 8 of Part II of this 10-K. We believe that of our significant accounting policies, the following policies involve a higher degree of judgment and/or complexity.
We consider financial reporting and disclosure practices and accounting policies quarterly to ensure that they provide accurate and transparent information relative to the current economic and business environment. During the past five fiscal years, we have not made any material changes to the accounting methodologies used to assess the areas discussed below, unless noted otherwise.
Property, Plant and Equipment and Other Finite-Lived Assets
We evaluate property, plant and equipment and other finite-lived assets for impairment when facts and circumstances indicate that the carrying values of such assets may not be recoverable. When evaluating for impairment, we first compare the carrying value of the asset to the asset’s estimated future undiscounted cash flows. If the estimated undiscounted future cash flows are less than the carrying value of the asset, we determine if we have an impairment loss by comparing the carrying value of the asset to the asset's estimated fair value and recognize an impairment charge when the asset’s carrying value exceeds its estimated fair value. The adjusted carrying amount of the asset becomes its new cost basis and is depreciated over the asset's remaining useful life.
Long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For company-operated store assets, the impairment test is performed at the individual store asset group level. The fair value of a store’s assets is estimated using a discounted cash flow model. For other long-lived assets, fair value is determined using an approach that is appropriate based on the relevant facts and circumstances, which may include discounted cash flows, comparable transactions, or comparable company analyses.
Our impairment calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values. Key assumptions used in estimating future cash flows and asset fair values include projected revenue growth and operating expenses, as well as forecasting asset useful lives and selecting an appropriate discount rate. For company-operated stores, estimates of revenue growth and operating expenses are based on internal projections and consider the store’s historical performance, the local market economics and the business environment impacting the store’s performance. The discount rate is selected based on what we believe a buyer would assume when determining a purchase price for the store. These estimates are subjective and our ability to realize future cash flows and asset fair values is affected by factors such as ongoing maintenance and improvement of the assets, changes in economic conditions, and changes in operating performance.
During fiscal 2018, there were no significant changes in any of our estimates or assumptions, aside from those related to the decision to close certain company-operated stores in the U.S. and Canada, which had a material impact on the outcome of our impairment calculations. However, as we periodically reassess estimated future cash flows and asset fair values, changes in our estimates and assumptions may cause us to realize material impairment charges in the future.
Goodwill and Indefinite-Lived Intangible Assets
We evaluate goodwill and indefinite-lived intangible assets for impairment annually during our third fiscal quarter, or more frequently if an event occurs or circumstances change that would indicate that impairment may exist. When evaluating these assets for impairment, we may first perform a qualitative assessment to determine whether it is more likely than not that a reporting unit is impaired. If we do not perform a qualitative assessment, or if we determine that it is not more likely than not that the fair value of the reporting unit exceeds its carrying amount, we calculate the estimated fair value of the reporting unit using discounted cash flows or a combination of discounted cash flow and market approaches.
When assessing goodwill for impairment, our decision to perform a qualitative impairment assessment for an individual reporting unit in a given year is influenced by a number of factors, inclusive of the size of the reporting unit's goodwill, the significance of the excess of the reporting unit's estimated fair value over carrying value at the last quantitative assessment date, the amount of time in between quantitative fair value assessments and the date of acquisition. If we perform a quantitative assessment of an individual reporting unit’s goodwill, our impairment calculations contain uncertainties because they require management to make assumptions and to apply judgment when estimating future cash flows and asset fair values, including projected revenue growth and operating expenses related to existing businesses, product innovation and new store concepts, as well as utilizing valuation multiples of similar publicly traded companies and selecting an appropriate discount rate. Estimates of revenue growth and operating expenses are based on internal projections considering the reporting unit’s past performance and forecasted growth, strategic initiatives, local market economics and the local business environment impacting the reporting unit’s performance. The discount rate is selected based on the estimated cost of capital for a market participant to operate the reporting unit in the region. These estimates, as well as the selection of comparable companies and valuation multiples used in the market approaches are highly subjective, and our ability to realize the future cash flows used in our fair value calculations is affected by factors such as the success of strategic initiatives, changes in economic conditions, changes in our operating performance and changes in our business strategies, including retail initiatives and international expansion.
When assessing indefinite-lived intangible assets for impairment, where we perform a qualitative assessment, we evaluate if changes in events or circumstances have occurred that indicate that impairment may exist. If we do not perform a qualitative impairment assessment or if changes in events and circumstances indicate that a quantitative assessment should be performed, management is required to calculate the fair value of the intangible asset group. The fair value calculation includes estimates of revenue growth, which are based on past performance and internal projections for the intangible asset group's forecasted growth, and royalty rates, which are adjusted for our particular facts and circumstances. The discount rate is selected based on the estimated cost of capital that reflects the risk profile of the related business. These estimates are highly subjective, and our
ability to achieve the forecasted cash flows used in our fair value calculations is affected by factors such as the success of strategic initiatives, changes in economic conditions, changes in our operating performance and changes in our business strategies, including retail initiatives and international expansion.
The goodwill impairment charges related to the Switzerland reporting unit are discussed in Note 8, Other Intangible Assets and Goodwill, to the consolidated financial statements included in Item 8 of Part II of this 10-K.
Income Taxes
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the respective tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using current enacted tax rates expected to apply to taxable income in the years in which we expect the temporary differences to reverse. We routinely evaluate the likelihood of realizing the benefit of our deferred tax assets and may record a valuation allowance if, based on all available evidence, we determine that some portion of the tax benefit will not be realized.
In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of operations. In projecting future taxable income, we consider historical results and incorporate assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. Our assumptions regarding future taxable income are consistent with the plans and estimates we use to manage our underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income/(loss).
In addition, our income tax returns are periodically audited by domestic and foreign tax authorities. These audits include review of our tax filing positions, including the timing and amount of deductions taken and the allocation of income between tax jurisdictions. We evaluate our exposures associated with our various tax filing positions and recognize a tax benefit only if it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities, including resolutions of any related appeals or litigation processes, based on the technical merits of our position. For uncertain tax positions that do not meet this threshold, we record a related liability. We adjust our unrecognized tax benefit liability and income tax expense in the period in which the uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when new information becomes available. As discussed in Note 13, Income Taxes, to the consolidated financial statements included in Item 8 of Part II of this 10-K, there is a reasonable possibility that our unrecognized tax benefit liability will be adjusted within 12 months due to the expiration of a statute of limitations and/or resolution of examinations with taxing authorities.
We have generated income in certain foreign jurisdictions that may be subject to additional income or withholding taxes. We have historically asserted our intent to reinvest these earnings for the foreseeable future. The Company continues to evaluate its plans for reinvestment or repatriation of unremitted foreign earnings and thus has not adjusted its previous indefinite reinvestment assertions for the effects of the Tax Act. While we do not expect to repatriate cash to the U.S. to satisfy domestic liquidity needs, if these amounts were distributed to the U.S., in the form of dividends or otherwise, we may be subject to additional income or withholding taxes, which could be material.
Our income tax expense, deferred tax assets and liabilities and liabilities for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. Deferred tax asset valuation allowances and our liabilities for unrecognized tax benefits require significant management judgment regarding applicable statutes and their related interpretation, the status of various income tax audits and our particular facts and circumstances. Although we believe that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material. To the extent we prevail in matters for which a liability has been established or are required to pay amounts in excess of our established liability, our effective income tax rate in a given financial statement period could be materially affected.
Refer to Note 13, Income Taxes, to the consolidated financial statements included in Item 8 of Part II of this 10-K, for additional discussion surrounding the changes as a result of the Tax Act.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1, Summary of Significant Accounting Policies, to the consolidated financial statements included in Item 8 of Part II of this 10-K for a detailed description of recent accounting pronouncements.
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