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. All references to store counts, including data for new store openings, are reported net of related store closures, unless otherwise noted.
Overview
Starbucks results for fiscal 2019 reflect the impacts of continued streamlining efforts, initiated during the fourth quarter of fiscal 2017, to focus on accelerating growth in high-returning businesses and converting several market operations, including Thailand, France, and the Netherlands, to fully licensed models in fiscal 2019. Additionally, in fiscal 2019, we saw the full impact from the licensing of the majority of our CPG and Foodservice businesses to Nestlé in the fourth quarter of fiscal 2018.
In the fourth quarter of fiscal 2019, we realigned our operating segment reporting structure to better reflect the cumulative effect of our streamlining efforts. Specifically, our previous China/Asia Pacific ("CAP") segment and Europe, Middle East, and Africa ("EMEA") segment have been combined into one International segment. Results of Siren Retail, a non-reportable operating segment consisting of Starbucks ReserveTM Roastery & Tasting Rooms, certain stores under the Starbucks Reserve brand and Princi operations, which were previously included within Corporate and Other, are now reported within the Americas and International segments based on the geographical location of the operations. As a result, we have three reportable operating segments: Americas, International and Channel Development. Non-reportable operating segments and unallocated corporate expenses are reported within Corporate and Other.
Further, to better support the review of our results, we have changed the classification of certain costs. The most significant change was the reclassification of company-owned store occupancy costs from cost of sales to store operating expenses. We also made certain other immaterial changes.
Concurrent with the change in reportable segments and realignment of certain operating expenses noted above, we revised our prior period financial information to be consistent with the current period presentation. There was no impact on consolidated net revenues, total operating expenses, operating income, or net earnings per share as a result of these changes.
In December 2017, the U.S. government enacted comprehensive tax legislation into law H.R. 1, commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), which significantly changed existing U.S. tax law and included numerous provisions that affect our business. Our U.S. corporate income tax rate for fiscal 2019 and future years is 21%, while a blended rate of 24.5% was applied in fiscal 2018.
Financial Highlights
| • | Total net revenues increased 7% to $26.5 billion in fiscal 2019 compared to $24.7 billion in fiscal 2018. |
| • | Consolidated operating income increased to $4.1 billion in fiscal 2019 compared to operating income of $3.9 billion in fiscal 2018. Fiscal 2019 operating margin was 15.4% compared to 15.7% in fiscal 2018. Operating margin compression in fiscal 2019 was primarily driven by partner (employee) investments and growth in wages and benefits, licensing our CPG and Foodservice businesses to Nestlé and other strategic investments. These decreases were partially offset by sales leverage, cost savings initiatives, lower restructuring and impairment costs and the impact of the adoption of new revenue recognition guidance on stored value card breakage. |
| • | Earnings per share (“EPS”) for fiscal 2019 decreased to $2.92, compared to EPS of $3.24 in fiscal 2018. The decrease was primarily driven by lapping the prior year gains from the acquisition of our East China joint venture and the sale of our Tazo brand, partially offset by the gain from the sale of our Thailand retail operations during fiscal 2019. |
| • | Capital expenditures were $1.8 billion in fiscal 2019 compared to $2.0 billion in fiscal 2018. |
| • | We returned $12.0 billion to our shareholders in fiscal 2019 through share repurchases and dividends compared to $8.9 billion in fiscal 2018. |
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 2019 COMPARED TO FISCAL 2018
Consolidated results of operations (in millions)****:
Revenues
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | % Change | |||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 21,544.4 | $ | 19,690.3 | 9.4 | % | ||||
| Licensed stores | 2,875.0 | 2,652.2 | 8.4 | |||||||
| Other | 2,089.2 | 2,377.0 | (12.1 | ) | ||||||
| Total net revenues | $ | 26,508.6 | $ | 24,719.5 | 7.2 | % |
Total net revenues increased $1.8 billion, or 7%, over fiscal 2018, primarily driven by higher revenues from company-operated stores ($1.9 billion). The growth in company-operated store revenues was driven by incremental revenues from 947 net new Starbucks® company-operated store openings over the past 12 months ($957 million) and a 5% increase in comparable store sales ($879 million), attributable to a 3% increase in average ticket and a 2% increase in comparable transactions. These increases were partially offset by unfavorable foreign currency translation ($189 million) and the conversion of our Thailand, France, and the Netherlands retail businesses to fully licensed markets during fiscal 2019 ($161 million).
Licensed store revenue growth also contributed to the increase in total net revenues ($223 million), primarily due to higher product and equipment sales to and royalty revenues from our licensees ($228 million), largely due to the opening of 992 net new Starbucks® licensed stores over the past 12 months, and the conversion of our Thailand, France, and the Netherlands retail businesses to fully licensed markets ($35 million), partially offset by unfavorable foreign currency translation ($41 million).
Other revenues decreased $288 million, primarily driven by the licensing of our CPG and Foodservice businesses to Nestlé. Partially offsetting this decrease was growth in product revenue, primarily premium single-serve products, in connection with the Global Coffee Alliance.
Operating Expenses
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | Sep 29, 2019 | Sep 30, 2018 | |||||||||
| As a % of Total Net Revenues | |||||||||||||
| Cost of sales | $ | 8,526.9 | $ | 7,930.7 | 32.2 | % | 32.1 | % | |||||
| Store operating expenses | 10,493.6 | 9,472.2 | 39.6 | 38.3 | |||||||||
| Other operating expenses | 371.0 | 554.9 | 1.4 | 2.2 | |||||||||
| Depreciation and amortization expenses | 1,377.3 | 1,247.0 | 5.2 | 5.0 | |||||||||
| General and administrative expenses | 1,824.1 | 1,708.2 | 6.9 | 6.9 | |||||||||
| Restructuring and impairments | 135.8 | 224.4 | 0.5 | 0.9 | |||||||||
| Total operating expenses | 22,728.7 | 21,137.4 | 85.7 | 85.5 | |||||||||
| Income from equity investees | 298.0 | 301.2 | 1.1 | 1.2 | |||||||||
| Operating income | $ | 4,077.9 | $ | 3,883.3 | 15.4 | % | 15.7 | % | |||||
| Store operating expenses as a % of related revenues | 48.7 | % | 48.1 | % |
Cost of sales as a percentage of total net revenues increased 10 basis points, primarily due to licensing our CPG and Foodservice businesses to Nestlé (approximately 80 basis points), partially offset by cost savings initiatives (approximately 70 basis points) and leverage on cost of sales, largely driven by price increases.
Store operating expenses as a percentage of total net revenues increased 130 basis points. Store operating expenses as a percentage of company-operated store revenues increased 60 basis points, primarily driven by investments in our store partners that are funded by savings from the Tax Act and growth in wages and benefits (approximately 120 basis points), largely in the Americas segment, partially offset by sales leverage driven by price increases and the impact of the adoption of new revenue recognition guidance on stored value card breakage.
Other operating expenses decreased $184 million, primarily due to cost savings related to licensing our CPG and Foodservice businesses to Nestlé ($176 million) and lapping prior year costs associated with the establishment of the Global Coffee Alliance ($34 million), including business taxes associated with the up-front prepaid royalty from Nestlé and headcount-related costs, primarily relating to employee bonus and retention costs.
Depreciation and amortization expenses as a percentage of total net revenues increased 20 basis points, primarily due to the impact of our ownership change in East China (approximately 20 basis points).
General and administrative expenses increased $116 million, primarily driven by higher performance-based compensation ($89 million) and the 2019 Starbucks Leadership Experience in Chicago, heavily concentrated in our fiscal fourth quarter ($52 million).
Restructuring and impairment expenses decreased $89 million, primarily due to lower restructuring and impairment costs related to TeavanaTM/MC retail store closures ($128 million) and lower impairments related to our Switzerland retail market ($27 million), partially offset by higher exit costs associated with the closure of certain Starbucks® company-operated stores ($32 million) and severance costs ($25 million).
Income from equity investees decreased $3 million, primarily due to the impact of our ownership changes in East China. This decrease was partially offset by improved comparable store sales from our joint venture in South Korea and higher income from our North American Coffee Partnership joint venture.
The combination of these changes resulted in an overall decrease in operating margin of 30 basis points in fiscal 2019 when compared to fiscal 2018.
Other Income and Expenses
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | Sep 29, 2019 | Sep 30, 2018 | |||||||||
| As a % of Total Net Revenues | |||||||||||||
| Operating income | $ | 4,077.9 | $ | 3,883.3 | 15.4 | % | 15.7 | % | |||||
| Gain resulting from acquisition of joint venture | — | 1,376.4 | — | 5.6 | |||||||||
| Net gain resulting from divestiture of certain operations | 622.8 | 499.2 | 2.3 | 2.0 | |||||||||
| Interest income and other, net | 96.5 | 191.4 | 0.4 | 0.8 | |||||||||
| Interest expense | (331.0 | ) | (170.3 | ) | (1.2 | ) | (0.7 | ) | |||||
| Earnings before income taxes | 4,466.2 | 5,780.0 | 16.8 | 23.4 | |||||||||
| Income tax expense | 871.6 | 1,262.0 | 3.3 | 5.1 | |||||||||
| Net earnings including noncontrolling interests | 3,594.6 | 4,518.0 | 13.6 | 18.3 | |||||||||
| Net earnings/(loss) attributable to noncontrolling interests | (4.6 | ) | (0.3 | ) | — | — | |||||||
| Net earnings attributable to Starbucks | $ | 3,599.2 | $ | 4,518.3 | 13.6 | % | 18.3 | % | |||||
| Effective tax rate including noncontrolling interests | 19.5 | % | 21.8 | % |
Gain resulting from acquisition of joint venture in fiscal 2018 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 was primarily due to the sale of our Thailand, France and the Netherlands retail operations in fiscal 2019. The gain in fiscal 2018 was primarily due to the sale 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.
Interest income and other, net decreased $95 million, primarily due to the adoption of the new revenue recognition guidance on a prospective basis, which required estimated breakage on unredeemed store value cards to be recorded as revenue. We recorded store value card breakage in interest income and other, net in the prior year.
Interest expense increased $161 million primarily due to additional interest incurred on long-term debt issued in November 2017, March 2018, August 2018 and May 2019.
The effective tax rate for fiscal 2019 was 19.5% compared to 21.8% for fiscal 2018. The decrease in the effective tax rate was primarily due to the lower corporate tax rate as a result of the Tax Act (approximately 350 basis points), lapping prior year's transition tax on our accumulated undistributed foreign earnings and remeasurement of our deferred tax liabilities (approximately 300 basis points), higher stock-based compensation excess tax benefit (approximately 140 basis points), the release of income tax reserves related to the settlement of a U.S. tax examination and the expiration of statute of limitations (approximately 130 basis points) and the tax impacts of the gain on the sale of our Thailand retail operations (approximately 130 basis points). These favorable impacts were partially offset by the lapping of prior year's gain on the purchase of our East China joint venture that was not subject to income tax (approximately 580 basis points) and the impact of changes in indefinite reinvestment assertions for certain foreign subsidiaries during the first quarter of fiscal 2019 (approximately 170 basis points). See Note 13, Income Taxes, for further discussion.
Segment Information
Results of operations by segment (in millions):
Americas
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | Sep 29, 2019 | Sep 30, 2018 | |||||||||
| As a % of Americas Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 16,288.2 | $ | 14,921.5 | 89.2 | % | 89.1 | % | |||||
| Licensed stores | 1,958.0 | 1,814.0 | 10.7 | 10.8 | |||||||||
| Other | 12.8 | 13.1 | 0.1 | 0.1 | |||||||||
| Total net revenues | 18,259.0 | 16,748.6 | 100.0 | 100.0 | |||||||||
| Cost of sales | 5,174.7 | 4,884.1 | 28.3 | 29.2 | |||||||||
| Store operating expenses | 8,064.8 | 7,248.6 | 44.2 | 43.3 | |||||||||
| Other operating expenses | 159.8 | 151.2 | 0.9 | 0.9 | |||||||||
| Depreciation and amortization expenses | 696.1 | 641.0 | 3.8 | 3.8 | |||||||||
| General and administrative expenses | 323.9 | 305.1 | 1.8 | 1.8 | |||||||||
| Restructuring and impairments | 56.9 | 33.4 | 0.3 | 0.2 | |||||||||
| Total operating expenses | 14,476.2 | 13,263.4 | 79.3 | 79.2 | |||||||||
| Operating income | $ | 3,782.8 | $ | 3,485.2 | 20.7 | % | 20.8 | % |
Revenues
Americas total net revenues for fiscal 2019 increased $1.5 billion, or 9%, primarily driven by a 5% increase in comparable store sales ($744 million) and 282 net new Starbucks® company-operated stores, or a 3% increase, over the past 12 months ($580 million). Also contributing were higher product sales to and royalty revenues from our licensees ($144 million), primarily resulting from comparable store sales growth and the opening of 323 net new Starbucks® licensed stores, or 4% increase, over the past 12 months and the impact of the adoption of revenue recognition guidance on stored value card breakage ($119 million).
Operating Margin
Americas operating income for fiscal 2019 increased 9% to $3.8 billion, compared to $3.5 billion in fiscal 2018. Operating margin decreased 10 basis points to 20.7%, primarily driven by higher partner investments, largely funded by savings from the Tax Act, growth in wages and benefits (approximately 130 basis points) and to a much lesser extent, investments in labor hours heavily concentrated in our fiscal fourth quarter. Partially offsetting these were cost savings initiatives, primarily in cost of sales (approximately 90 basis points), the impact of the adoption of revenue recognition guidance on stored value card breakage (approximately 50 basis points) and sales leverage.
International
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | Sep 29, 2019 | Sep 30, 2018 | |||||||||
| As a % of International Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 5,256.2 | $ | 4,702.1 | 84.9 | % | 84.7 | % | |||||
| Licensed stores | 917.0 | 837.0 | 14.8 | 15.1 | |||||||||
| Other | 17.5 | 12.1 | 0.3 | 0.2 | |||||||||
| Total net revenues | 6,190.7 | 5,551.2 | 100.0 | 100.0 | |||||||||
| Cost of sales | 1,894.9 | 1,709.4 | 30.6 | 30.8 | |||||||||
| Store operating expenses | 2,428.5 | 2,182.3 | 39.2 | 39.3 | |||||||||
| Other operating expenses | 116.4 | 98.9 | 1.9 | 1.8 | |||||||||
| Depreciation and amortization expenses | 511.5 | 447.6 | 8.3 | 8.1 | |||||||||
| General and administrative expenses | 317.9 | 302.5 | 5.1 | 5.4 | |||||||||
| Restructuring and impairments | 59.2 | 55.1 | 1.0 | 1.0 | |||||||||
| Total operating expenses | 5,328.4 | 4,795.8 | 86.1 | 86.4 | |||||||||
| Income from equity investees | 102.4 | 117.4 | 1.7 | 2.1 | |||||||||
| Operating income | $ | 964.7 | $ | 872.8 | 15.6 | % | 15.7 | % |
Discussion of our International segment results below reflects the impact of fully consolidating our East China business 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 resulted in a higher margin business. Under the company-operated ownership model, East China’s operating results are reflected in most income statement lines of this segment.
Revenues
International total net revenues for fiscal 2019 increased $640 million, or 12%, primarily driven by 665 net new Starbucks® company-operated stores, or a 12% increase, over the past 12 months ($377 million), the ownership change in East China ($280 million) and a 3% increase in comparable store sales ($135 million). Also contributing were increased product sales to and royalty revenues from licensees ($84 million), primarily resulting from opening of 669 net new Starbucks® licensed stores, or an 11% increase, over the past 12 months and the impact of the adoption of revenue recognition guidance on stored value card breakage ($20 million). These increases were partially offset by unfavorable foreign currency translation ($183 million) and the conversion of our Thailand, France, and the Netherlands retail businesses to fully licensed markets ($126 million).
Operating Margin
International operating income for fiscal 2019 increased 11% to $965 million, compared to $873 million in fiscal 2018. Operating margin decreased 10 basis points to 15.6%, primarily driven by strategic investments to support growth in China (approximately 80 basis points) and growth in wages and benefits (approximately 70 basis points), primarily offset by cost savings initiatives (approximately 80 basis points) and labor efficiencies (approximately 70 basis points).
Channel Development
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | Sep 29, 2019 | Sep 30, 2018 | |||||||||
| As a % of Channel Development Total Net Revenues | |||||||||||||
| Net revenues | $ | 1,992.6 | $ | 2,297.3 | |||||||||
| Cost of sales | 1,390.0 | 1,252.3 | 69.8 | 54.5 | |||||||||
| Other operating expenses | 76.2 | 286.5 | 3.8 | 12.5 | |||||||||
| Depreciation and amortization expenses | 13.0 | 1.3 | 0.7 | 0.1 | |||||||||
| General and administrative expenses | 11.5 | 13.9 | 0.6 | 0.6 | |||||||||
| Total operating expenses | 1,490.7 | 1,554.0 | 74.8 | 67.6 | |||||||||
| Income from equity investees | 195.6 | 183.8 | 9.8 | 8.0 | |||||||||
| Operating income | $ | 697.5 | $ | 927.1 | 35.0 | % | 40.4 | % |
Our Channel Development segment results reflect the impact of the licensing of our CPG and Foodservice businesses to Nestlé late in the fourth quarter of fiscal 2018, which we lapped late in the fourth quarter of fiscal 2019. 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 2019 decreased $305 million, or 13%, when compared to the prior year period, primarily driven by licensing our CPG and Foodservice businesses to Nestlé ($329 million), offset by growth in product revenue, primarily premium single-serve products, in connection with our Global Coffee Alliance ($25 million).
Operating Margin
Channel Development operating income for fiscal 2019 decreased 25% to $698 million, compared to $927 million in fiscal 2018. Operating margin decreased 540 basis points to 35.0%, primarily driven by licensing our CPG and Foodservice businesses to Nestlé (approximately 640 basis points), partially offset by lapping prior year costs associated with the establishment of the Global Coffee Alliance (approximately 140 basis points), including business taxes associated with the up-front prepaid royalty and headcount-related costs, primarily related to employee bonus and retention costs.
Corporate and Other
| Fiscal Year Ended | Sep 29, 2019 | Sep 30, 2018 | % Change | |||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | — | $ | 66.7 | (100.0 | )% | ||||
| Licensed stores | — | 1.2 | (100.0 | ) | ||||||
| Other | 66.3 | 54.5 | 21.7 | |||||||
| Total net revenues | 66.3 | 122.4 | (45.8 | ) | ||||||
| Cost of sales | 67.3 | 84.9 | (20.7 | ) | ||||||
| Store operating expenses | 0.3 | 41.3 | (99.3 | ) | ||||||
| Other operating expenses | 18.6 | 18.3 | 1.6 | |||||||
| Depreciation and amortization expenses | 156.7 | 157.1 | (0.3 | ) | ||||||
| General and administrative expenses | 1,170.8 | 1,086.7 | 7.7 | |||||||
| Restructuring and impairments | 19.7 | 135.9 | (85.5 | ) | ||||||
| Total operating expenses | 1,433.4 | 1,524.2 | (6.0 | ) | ||||||
| Operating loss | $ | (1,367.1 | ) | $ | (1,401.8 | ) | (2.5 | )% |
Corporate and Other primarily consists of our unallocated corporate expenses, 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 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 and 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 due to 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 | $ | 7,930.7 | $ | 7,065.8 | 32.1 | % | 31.6 | % | |||||
| Store operating expenses | 9,472.2 | 8,486.4 | 38.3 | 37.9 | |||||||||
| Other operating expenses | 554.9 | 518.0 | 2.2 | 2.3 | |||||||||
| Depreciation and amortization expenses | 1,247.0 | 1,011.4 | 5.0 | 4.5 | |||||||||
| General and administrative expenses | 1,708.2 | 1,408.4 | 6.9 | 6.3 | |||||||||
| 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 | 48.1 | % | 48.1 | % |
Cost of sales as a percentage of total net revenues increased 50 basis points, primarily due to food and beverage-related mix shifts (approximately 120 basis points), largely in the Americas segment, partially offset by the impact of our ownership change in East China (approximately 40 basis points).
Store operating expenses, which include occupancy costs, as a percentage of total net revenues increased 40 basis points. Store operating expenses as a percentage of company-operated store revenues were flat, primarily driven by the impact of our ownership change in East China (approximately 40 basis points), partially offset by increased partner investments, largely in the Americas segment.
Other operating expenses increased $37 million, primarily driven by business taxes associated with the up-front payment received from Nestlé.
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 increased $300 million, primarily due to higher salaries and benefits related to digital platforms, technology infrastructure and innovations and the 2018 U.S. stock award granted in the third quarter of fiscal 2018, which was funded by savings from the Tax Act and vests over one year.
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 International 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 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 consisted 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 the lapping of prior year's 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 was 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 | $ | 14,921.5 | $ | 14,005.8 | 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 | 16,748.6 | 15,629.4 | 100.0 | 100.0 | |||||||||
| Cost of sales | 4,884.1 | 4,371.0 | 29.2 | 28.0 | |||||||||
| Store operating expenses | 7,248.6 | 6,673.1 | 43.3 | 42.7 | |||||||||
| Other operating expenses | 151.2 | 131.6 | 0.9 | 0.8 | |||||||||
| Depreciation and amortization expenses | 641.0 | 616.1 | 3.8 | 3.9 | |||||||||
| General and administrative expenses | 305.1 | 256.3 | 1.8 | 1.6 | |||||||||
| Restructuring and impairments | 33.4 | 4.1 | 0.2 | — | |||||||||
| Total operating expenses | 13,263.4 | 12,052.2 | 79.2 | 77.1 | |||||||||
| Operating income | $ | 3,485.2 | $ | 3,577.2 | 20.8 | % | 22.9 | % |
Revenues
Americas total net revenues for fiscal 2018 increased $1.1 billion, or 7%, primarily driven by 383 net new Starbucks® company-operated store openings, or a 4.1% increase, over the past 12 months ($604 million) and a 2% increase in comparable store sales ($319 million). Also contributing were higher product sales to and royalty revenues from our licensees ($173 million), primarily resulting from the opening of 512 net new Starbucks® licensed stores, or a 7.2% increase, over the past 12 months.
Operating Income
Americas operating income for fiscal 2018 decreased 3% to $3.5 billion, compared to $3.6 billion in fiscal 2017. Operating margin decreased 210 basis points to 20.8%, primarily due to food and beverage-related mix shifts (approximately 130 basis points), increased partner investments (approximately 120 basis points) which included incremental investments funded by the Tax Act, increased strategic investments (approximately 30 basis points), the impact of the May 29th anti-bias training (approximately 20 basis points) and higher restructuring costs, including asset impairments and severance (approximately 20 basis points), partially offset by sales leverage.
International
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | Sep 30, 2018 | Oct 1, 2017 | |||||||||
| As a % of International Total Net Revenues | |||||||||||||
| Net revenues: | |||||||||||||
| Company-operated stores | $ | 4,702.1 | $ | 3,462.5 | 84.7 | % | 82.4 | % | |||||
| Licensed stores | 837.0 | 735.0 | 15.1 | 17.5 | |||||||||
| Other | 12.1 | 6.8 | 0.2 | 0.2 | |||||||||
| Total net revenues | 5,551.2 | 4,204.3 | 100.0 | 100.0 | |||||||||
| Cost of sales | 1,709.4 | 1,324.2 | 30.8 | 31.5 | |||||||||
| Store operating expenses | 2,182.3 | 1,664.8 | 39.3 | 39.6 | |||||||||
| Other operating expenses | 98.9 | 89.2 | 1.8 | 2.1 | |||||||||
| Depreciation and amortization expenses | 447.6 | 233.2 | 8.1 | 5.5 | |||||||||
| General and administrative expenses | 302.5 | 236.4 | 5.4 | 5.6 | |||||||||
| Restructuring and impairments | 55.1 | 17.9 | 1.0 | 0.4 | |||||||||
| Total operating expenses | 4,795.8 | 3,565.7 | 86.4 | 84.8 | |||||||||
| Income from equity investees | 117.4 | 197.0 | 2.1 | 4.7 | |||||||||
| Operating income | $ | 872.8 | $ | 835.6 | 15.7 | % | 19.9 | % |
Discussion of our International segment results below reflects the impact of fully consolidating our East China business 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 resulted in a higher margin business. Under a company-operated ownership model, East China's operating results are reflected in most line items on the statements of earnings.
Revenues
International total net revenues for fiscal 2018 increased $1.3 billion, or 32%, primarily driven by the impact of our ownership change in East China ($850 million), 433 net new Starbucks® company-operated store openings, or a 12.1% increase, over the past 12 months ($298 million), and favorable foreign currency translation ($121 million). Also contributing were higher product sales to and royalty revenues from our licensees ($100 million), primarily resulting from the opening of 669 net new Starbucks licensed stores, or a 13.6% increase, over the past 12 months and the conversion of our Taiwan joint venture to fully licensed operations at the end of the first quarter of fiscal 2018 ($25 million).
Operating Margin
International operating income for fiscal 2018 increased 4% to $872.8 million, compared to $835.6 million in fiscal 2017. Operating margin decreased 420 basis points to 15.7%, primarily due to the impact of our ownership change in East China (approximately 350 basis points). Also contributing were higher goodwill impairment charges associated with our Switzerland retail reporting unit (approximately 40 basis points) and restructuring costs, including severance and asset impairments (approximately 40 basis points).
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 | |||||||||||||
| Total 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 reflects the impact of the licensing of our CPG and Foodservice businesses to Nestlé and the sale of the Tazo brand. 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 the 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 Margin
Channel Development operating income for fiscal 2018 decreased 4% to $927.1 million, compared to $967.0 million in fiscal 2017. Operating margin decreased 250 basis points to 40.4%, primarily driven by business taxes associated with the up-front payment received from Nestlé (approximately 120 basis points), Global Coffee Alliance headcount-related costs, including employee bonus and retention costs (approximately 80 basis points), and the impact of our ownership changes, including licensing our CPG and Foodservice businesses to Nestlé and the sale of our Tazo brand.
Corporate and Other
| Fiscal Year Ended | Sep 30, 2018 | Oct 1, 2017 | % Change | |||||||
| Net revenues: | ||||||||||
| Company-operated stores | $ | 66.7 | $ | 182.4 | (63.4 | )% | ||||
| Licensed stores | 1.2 | 2.7 | (55.6 | ) | ||||||
| Other | 54.5 | 111.4 | (51.1 | ) | ||||||
| Total net revenues | 122.4 | 296.5 | (58.7 | ) | ||||||
| Cost of sales | 84.9 | 161.3 | (47.4 | ) | ||||||
| Store operating expenses | 41.3 | 148.5 | (72.2 | ) | ||||||
| Other operating expenses | 18.3 | 36.8 | (50.3 | ) | ||||||
| Depreciation and amortization expenses | 157.1 | 159.1 | (1.3 | ) | ||||||
| General and administrative expenses | 1,086.7 | 904.4 | 20.2 | |||||||
| Restructuring and impairments | 135.9 | 131.5 | 3.3 | |||||||
| Total operating expenses | 1,524.2 | 1,541.6 | (1.1 | ) | ||||||
| Operating loss | $ | (1,401.8 | ) | $ | (1,245.1 | ) | 12.6 | % |
Corporate and Other primarily consists of our unallocated corporate expenses, 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.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash and Investment Overview
Our cash and investments were $3.0 billion and $9.2 billion as of September 29, 2019 and September 30, 2018, respectively, with the decrease driven by the usage of the up-front prepaid royalty associated with the Global Coffee Alliance primarily for share repurchases. 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 government treasury securities (domestic and foreign) and corporate debt securities. As of September 29, 2019, approximately $1.7 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 0.910% for Eurocurrency Rate Loans and 0.000% (nil) for Base Rate Loans.
The 364-day credit facility, of which no amount may be used for issuances of letters of credit, was set to mature on October 23, 2019. In the first quarter of fiscal 2020, the maturity has been extended to October 21, 2020. 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 0.920% for Eurocurrency Rate Loans and 0.000% (nil) for Base Rate Loans.
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 29, 2019, we were in
compliance with all applicable credit facility covenants. No amounts were outstanding under our credit facility as of September 29, 2019.
Under our commercial paper program, we may issue unsecured commercial paper notes up to a maximum aggregate amount outstanding at any time of $3.0 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 29, 2019, we had no borrowings under our commercial paper program.
In May 2019, we issued long-term debt in an underwritten registered public offering, which consisted of $1.0 billion of 10-year 3.550% Senior Notes (the “2029 notes”) due August 2029 and $1.0 billion of 30-year 4.450% Senior Notes (the “2049 notes”) due August 2049. Interest on the 2029 notes and the 2049 notes is payable semi-annually on February 15 and August 15, commencing on August 15, 2019.
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 $1.0 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.
We will use the net proceeds from the offering of the 2049 notes to enhance our sustainability programs. We will use the net proceeds from these remaining offerings for general corporate purposes, including the repurchases of our common stock under our ongoing share repurchase program, business expansion 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 29, 2019, 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 regularly review our cash positions and our determination of indefinite 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, which could be material. We have revised our indefinite reinvestment assertions for prior years' cumulative earnings from certain foreign subsidiaries. This change did not have a material impact to our financial results. We have not, nor do we anticipate the need for, repatriated funds to the U.S. to satisfy domestic liquidity needs. See Note 13, Income Taxes, for further discussion.
During each of the first two quarters of fiscal 2018, we declared a cash dividend to shareholders of $0.30 per share. In the last two quarters of fiscal 2018 and each of the first three quarters of fiscal 2019, we declared a cash dividend of $0.36 per share. Dividends are paid in the quarter following the declaration date. Cash returned to shareholders through dividends in fiscal 2019 and 2018 totaled $1.8 billion and $1.7 billion, respectively. In the fourth quarter of fiscal 2019, we declared a cash dividend of $0.41 per share to be paid on November 29, 2019 with an expected payout of approximately $486 million.
We entered into accelerated share repurchase agreements (“ASR agreements”) with third-party financial institutions totaling $5.0 billion, effective October 1, 2018. We made a $5.0 billion up-front payment to the financial institutions and received an initial delivery of 72.0 million shares of our common stock. In March 2019, we received an additional 4.9 million shares upon the completion of the program based on a volume-weighted average share price (less discount) of $65.03.
Additionally, we entered into ASR agreements with third-party financial institutions totaling $2.0 billion, effective March 22, 2019. We made a $2.0 billion up-front payment to the financial institutions and received an initial delivery of 22.2 million shares of our common stock. In June 2019, we received an additional 3.9 million shares upon the completion of the program based on a volume-weighted average share price (less discount) of $76.50.
Outside of the ASR agreements noted above, during fiscal 2019 and 2018, we repurchased 36.6 million and 131.5 million shares of common stock, respectively, or $3.1 billion and $7.2 billion, respectively, on the open market. For fiscal 2019, in connection with the ASR agreements and other open market transactions, we repurchased 139.6 million shares of common stock at a total cost of $10.1 billion. In the first quarter 2019, we announced that our Board of Directors approved an increase of 120 million shares to our ongoing share repurchase program. As of September 29, 2019, 29.2 million shares remained available for repurchase under current authorizations.
Other than normal operating expenses, cash requirements for fiscal 2020 are expected to consist primarily of capital expenditures for investments in our new and existing stores and our supply chain and corporate facilities. Total capital expenditures for fiscal 2020 are expected to be approximately $1.8 billion.
Cash Flows
Cash provided by operating activities was $5.0 billion for fiscal 2019, compared to $11.9 billion for fiscal 2018. The change was primarily driven by lapping the prior year receipt of the up-front payment from Nestlé in the fourth quarter of fiscal 2018.
Cash used by investing activities totaled $1.0 billion for fiscal 2019, compared to $2.4 billion for fiscal 2018. The change was primarily driven by lapping the prior year payment to acquire the 50% ownership interest in our East China joint venture and higher proceeds from the divestiture of certain operations.
Cash used by financing activities for fiscal 2019 totaled $10.1 billion, compared to $3.2 billion for fiscal 2018. The change was primarily due to lower proceeds from issuance of long-term debt and higher repurchases of our common stock under accelerated share repurchase agreements in fiscal 2019.
Contractual Obligations
The following table summarizes our contractual obligations and borrowings as of September 29, 2019, 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) | $ | 10,230.9 | $ | 1,432.9 | $ | 2,589.6 | $ | 2,120.7 | $ | 4,087.7 | |||||||||
| Financing lease obligations | 67.9 | 5.2 | 10.2 | 9.9 | 42.6 | ||||||||||||||
| Debt obligations | |||||||||||||||||||
| Principal payments | 11,238.3 | — | 1,750.0 | 2,538.3 | 6,950.0 | ||||||||||||||
| Interest payments | 5,109.7 | 372.6 | 705.1 | 602.3 | 3,429.7 | ||||||||||||||
| Purchase obligations (3) | 1,135.4 | 665.3 | 411.1 | 59.0 | — | ||||||||||||||
| Other obligations (4) | 454.6 | 109.4 | 63.2 | 85.3 | 196.7 | ||||||||||||||
| Total | $ | 28,236.8 | $ | 2,585.4 | $ | 5,529.2 | $ | 5,415.5 | $ | 14,706.7 |
| (1) | We have excluded long-term gross unrecognized tax benefits for uncertain tax positions, including interest and penalties of $140.1 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 93% of total purchase obligations. |
| (4) | Other obligations include other long-term liabilities primarily consisting of the Tax Act transition tax, asset retirement obligations, Valor Siren Ventures I L.P. (VSV) investment 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 29, 2019 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 | $ | 2 | $ | (2 | ) | $ | 5 | $ | (5 | ) |
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 29, 2019 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 | $ | 35 | $ | (35 | ) | $ | 109 | $ | (109 | ) |
Equity Security Price Risk
We have minimal exposure to price fluctuations on equity mutual funds and equity exchange-traded funds within our marketable equity securities portfolio. Marketable equity 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 29, 2019 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 29, 2019.
The following table summarizes the impact of a change in interest rates as of September 29, 2019 on the fair value of Starbucks debt (in millions):
| Change in Fair Value | ||||||||||||
| Fair Value | 100 Basis Point Increase in Underlying Rate | 100 Basis Point Decrease in Underlying Rate | ||||||||||
| Long-term debt (1) | $ | 12,033 | $ | 846 | $ | (846 | ) |
| (1) | Amount disclosed is net of ($26 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 Debt 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 investments. 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 29, 2019 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 2019, there were no significant changes in any of our estimates or assumptions that 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 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 foreign withholding taxes and U.S. state income taxes. We have revised our indefinite reinvestment assertions for prior years’ cumulative earnings from certain foreign subsidiaries. We regularly review our plans for reinvestment or repatriation of unremitted foreign earnings. 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 foreign withholding taxes and U.S. state income 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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