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Exhibit 13.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General Starbucks presently derives approximately 86% of net revenues from its
Company-operated retail stores. The Company's specialty sales operations, which
include sales to wholesale customers, licensees, and joint ventures, accounted
for approximately 11% of net revenues in fiscal 1996. Direct response operations
account for the remainder of net revenues.
The Company's net revenues have increased from $284.9 million in fiscal 1994 to
$696.5 million in fiscal 1996, due primarily to the Company's store expansion
program and comparable store sales increases. Comparable store sales increased
by 9% and 7% in fiscal 1995 and 1996, respectively. As part of its expansion
strategy of clustering stores in existing markets, Starbucks has experienced a
certain level of cannibalization of existing stores by new stores as the store
concentration has increased, but management believes such cannibalization has
been justified by the incremental sales and return on new store investment. The
Company anticipates that this cannibalization, as well as increased competition
and other factors, may continue to put downward pressure on its comparable store
sales growth in future periods.
The Company's fiscal year ends on the Sunday closest to September 30. Fiscal
years 1996, 1995, and 1994 each had 52 weeks.
The following table sets forth the percentage relationship to total net
revenues, unless otherwise indicated, of certain items included in the Company's
consolidated statements of earnings:
Fiscal year ended: Sept 29, 1996 Oct 1, 1995 Oct 2, 1994
(52 Wks) (52 Wks) (52 Wks)
------------- ----------- -----------
Statements of Earnings Data:
Net revenues
Retail 86.2% 86.6% 87.2%
Specialty Sales 11.3 10.3 9.3
Direct Response 2.5 3.1 3.5
----- ----- -----
Total net revenues 100.0 100.0 100.0
Cost of sales and related occupancy costs 48.2 45.4 45.7
Store operating expenses(1) 35.1 36.9 36.3
Other operating expenses 2.8 3.0 3.1
Depreciation and amortization 5.2 4.8 4.4
General and administrative expenses 5.3 6.2 7.0
Operating income 8.2 8.6 8.2
Interest income 1.6 1.5 0.7
Interest expense (1.3) (0.8) (1.3)
Gain on sale of investment in Noah's 1.3 0.0 0.0
Provision for merger costs 0.0 0.0 (1.4)
----- ----- -----
Earnings before income taxes 9.8 9.3 6.2
Income taxes 3.8 3.7 2.6
----- ----- -----
Net earnings 6.0% 5.6% 3.6%
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(1) Shown as a percentage of retail sales.
(Results of Operations -- Fiscal 1996 Compared to Fiscal 1995)
Revenues Net revenues increased 50% to $696.5 million for fiscal 1996, compared
to $465.2 million for fiscal 1995. Retail sales increased 49% to $600.1 million
from $402.7 million. The increase in retail sales was due primarily to the
addition of new Company-operated stores. In addition, comparable store sales
increased 7% for the 52 weeks ended September 29, 1996 compared to the same
52-week period in fiscal 1995. Comparable store sales increases resulted from an
increase in the number of transactions combined with an increase in the average
dollar value per transaction.
During fiscal 1996, the Company opened 307 Starbucks stores (including four
replacement stores), converted 19 Coffee Connection stores to Starbucks stores,
and closed one store. Licensees opened 26 stores. The Company opened stores in
several new markets including North Carolina, Rhode Island, and Ontario, Canada.
The Company ended the fiscal year with 929 Company-operated stores and 75
licensed stores in North America.
Specialty Sales revenues increased 63% to $78.7 million for fiscal 1996 from
$48.1 million for fiscal 1995. The increase was due primarily to the Company
signing an agreement with a major U.S. airline as well as increased revenues
from several hotels, a chain of wholesale clubs, office coffee distributors, and
restaurants. Direct Response sales increased 23% to $17.8 million for fiscal
1996 from $14.4 million for fiscal 1995.
Costs and Expenses Cost of sales and related occupancy costs as a percentage of
net revenues increased to 48.2% for fiscal 1996 compared to 45.4% for fiscal
1995. This increase was primarily the result of higher green coffee costs as a
percentage of net revenues, partially offset by a shift in retail sales mix
towards higher-margin products. By the end of the first quarter of fiscal 1997,
the Company expects to have sold most of the higher-cost green coffees acquired
subsequent to the 1994 frost in Brazil. Therefore, management expects cost of
sales in fiscal 1997 to show improvement relative to fiscal 1996.
Store operating expenses as a percentage of retail sales decreased to 35.1% for
fiscal 1996 from 36.9% for fiscal 1995. This improvement reflected lower retail
advertising expense, store remodel expense, and preopening expense as a
percentage of retail sales.
Other operating expenses (those associated with the Company's specialty sales
and direct response operations as well as the Company's joint ventures)
decreased to 2.8% of net revenues for fiscal 1996 from 3.0% for fiscal 1995
primarily from operational leverage on the Company's net revenue increase.
Depreciation and amortization as a percentage of net revenues increased to 5.2%
for fiscal 1996 from 4.8% for fiscal 1995. This increase was primarily the
result of increased per-
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store buildout costs in recent years relative to earlier history. After several
years of increased per-store buildout costs, average store buildout costs
declined in fiscal 1996 relative to fiscal 1995.
General and administrative expenses as a percentage of net revenues were 5.3%
for fiscal 1996 compared to 6.2% for fiscal 1995. This decrease as a percentage
of revenues was due primarily to lower payroll-related costs and professional
fees as a percentage of net revenues.
Operating Income Operating income for fiscal 1996 increased to $57.0 million
(8.2% of net revenues) from $40.1 million (8.6% of net revenues) for fiscal
1995. Operating income as a percentage of net revenues decreased due to higher
cost of sales and an increase in depreciation and amortization, partially offset
by lower store operating expenses, general and administrative expenses, and
other operating expenses as a percentage of revenues.
Interest Income Interest income for fiscal 1996 was $11.0 million compared to
$6.8 million for fiscal 1995. Average investment balances were higher during
fiscal 1996 as a result of proceeds from the Company's October 1995 offering of
4-1/4% Convertible Subordinated Debentures due 2002 which generated $161.0
million, net of issuance costs.
Gain on Sale of Investment in Noah's In March 1995, the Company invested $11.3
million in cash for shares of Noah's New York Bagel, Inc. ("Noah's") Series B
Preferred Stock. On February 1, 1996, Noah's was merged with Einstein Brothers
Bagels, Inc., a retailer operating primarily in the Eastern United States. In
exchange for its investment in Noah's, the Company received $20.6 million in
cash and recognized a $9.2 million pre-tax gain ($5.7 million, net of tax) on
the transaction.
Interest Expense Interest expense for fiscal 1996 was $8.7 million compared to
$3.8 million for fiscal 1995. The increase in interest expense is due to the
Company's convertible subordinated debentures issued in October 1995.
Income Taxes The Company's effective tax rate for fiscal 1996 was 38.5% compared
to 39.5% for fiscal 1995. The Company's fiscal 1996 effective tax rate was lower
than in fiscal 1995 due primarily to changes in state tax allocations and
apportionment factors as well as the implementation of tax-saving strategies.
Management expects the effective tax rate may increase as the Company expands
activities in higher tax jurisdictions.
(Results of Operations -- Fiscal 1995 Compared to Fiscal 1994)
Revenues Net revenues increased 63% to $465.2 million for fiscal 1995, compared
to $284.9 million for fiscal 1994. Retail sales increased 62% to $402.7 million
from $248.5 million. The increase in retail sales was due primarily to the
addition of new Company-operated stores. In addition, comparable store sales
increased 9% for the 52 weeks ended October 1, 1995 compared to the same 52-week
period in fiscal 1994. Comparable store sales increases resulted from an
increase in the number of transactions combined with an increase in the average
dollar value per transaction. The increase in average dollar value per
transaction included an increase in coffee beverage and whole bean prices which
took place in July 1994.
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During fiscal 1995, the Company opened 230 Starbucks stores (including two
replacement stores), and converted four Coffee Connection stores to Starbucks
stores. Licensees opened 23 new stores. The Company opened stores in several new
markets including Baltimore, Maryland; Las Vegas, Nevada; Cincinnati, Ohio;
Philadelphia and Pittsburgh, Pennsylvania; and Austin, Dallas, Houston, and San
Antonio, Texas. The Company ended the fiscal year with 627 Company-operated
stores and 49 licensed stores. Of the Company-operated stores, 19 were operated
in the Northeast as Coffee Connection stores.
Specialty Sales revenues increased 81% to $48.1 million for fiscal 1995 from
$26.5 million for fiscal 1994. Increased sales to several multi-unit retailers,
hotels, airlines, and a chain of wholesale clubs as well as sales to a greater
number of restaurants and institutions accounted for the increase in revenues.
Direct Response sales increased 46% to $14.4 million for fiscal 1995 from $9.9
million for fiscal 1994.
Costs and Expenses Cost of sales and related occupancy costs as a percentage of
net revenues decreased to 45.4% for fiscal 1995 compared to 45.7% for fiscal
1994. This decrease was primarily the result of higher prices on coffee
beverages and whole bean coffees, and lower packaging costs as a percentage of
net revenues, partially offset by higher green coffee costs.
Store operating expenses as a percentage of retail sales increased to 36.9% for
fiscal 1995 from 36.3% for fiscal 1994. This increase was primarily a result of
higher retail advertising expense. Other operating expenses decreased to 3.0% of
net revenues for fiscal 1995 from 3.1% for fiscal 1994. The decrease was due
primarily to lower direct response promotional costs as a percentage of
revenues, partially offset by start-up costs related to the Company's joint
venture with Pepsi-Cola. Depreciation and amortization as a percentage of net
revenues increased to 4.8% from 4.4% for fiscal 1994. This increase was
primarily the result of higher store buildout and equipment costs.
General and administrative expenses as a percentage of net revenues were 6.2%
for fiscal 1995 compared to 7.0% for fiscal 1994. This decrease as a percentage
of revenues was due to the Company's ability to increase revenues without
proportionally increasing overhead expenses.
Operating Income Operating income for fiscal 1995 increased to $40.1 million
(8.6% of net revenues) from $23.3 million (8.2% of net revenues) for fiscal
1994. Operating income as a percentage of net revenues improved due to higher
gross margin and lower general and administrative expenses as a percentage of
revenues, partially offset by an increase in store operating expenses and
depreciation and amortization as a percentage of revenues.
Interest Income Interest income for fiscal 1995 was $6.8 million compared to
$2.1 million for fiscal 1994. The increase in interest income was due to higher
average investment balances resulting from the Company's public offering of
common stock in November 1994.
Interest Expense Interest expense for fiscal 1995 was $3.8 million, unchanged
from fiscal 1994.
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Income Taxes The Company's effective tax rate for fiscal 1995 was 39.5% compared
to 42.5% for fiscal 1994. The Company's fiscal 1994 effective tax rate was
higher than in fiscal 1995 due to one-time, non-deductible merger costs related
to the Coffee Connection merger in June 1994.
(Liquidity and Capital Resources)
The Company ended fiscal 1996 with $229.4 million in total cash and short-term
investments. Working capital as of September 29, 1996 totaled $238.5 million
compared to $134.3 million at October 1, 1995. Cash provided by operating
activities totaled $136.7 million and resulted primarily from net income before
non-cash charges of $79.0 million, a $40.3 million reduction in inventories, and
a $26.9 million increase in accrued liabilities and expenses.
Cash provided from financing activities for fiscal 1996 totaled $179.8 million
and included net proceeds of $161.0 million from the Company's October 1995
offering of convertible subordinated debentures. Cash provided from financing
activities also included cash generated from the Company's employee stock
purchase plan and from the exercise of employee stock options and the related
income tax benefit available to the Company upon exercise of such options. As
options granted under the Company's stock option plans vest, the Company will
continue to receive proceeds and a tax deduction as a result of option
exercises; however, neither the amounts nor the timing thereof can be predicted.
Cash used by investing activities for fiscal 1996 totaled $211.2 million. This
included capital additions to property, plant, and equipment of $161.8 million
which was used to open 307 new Company-operated retail stores, remodel certain
existing stores, purchase roasting and packaging equipment for the Company's
roasting and distribution facilities, enhance information systems, and expand
existing office space.
The Company also invested in its joint ventures. During fiscal 1996, the Company
made equity investments of $2.4 million in its joint venture with SAZABY, Inc.
and $2.7 million in its joint venture with Pepsi-Cola Company. The Company also
made investments in and advances to its joint venture with Dreyer's Grand Ice
Cream, Inc. totaling $0.9 million. The Company sold its investment in Noah's and
received $20.6 million in proceeds. The Company invested excess cash in
short-term investment-grade marketable debt securities.
Future cash requirements, other than normal operating expenses, are expected to
consist primarily of capital expenditures related to the addition of new
Company-operated retail stores. The Company also anticipates remodeling certain
existing stores and incurring additional expenditures for enhancing its
production capacity and information systems. While there can be no assurance
that current expectations will be realized, and plans are subject to change upon
further review, management expects capital expenditures for fiscal 1997 to be
approximately $170 million.
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The Company currently anticipates additional cash requirements of approximately
$20 million for its domestic joint ventures and international expansion during
fiscal 1997. In addition, under the terms of the Company's corporate office
lease, the Company has agreed to provide financing to the building owner to be
used exclusively for facilities and leasehold development costs to accommodate
the Company. During fiscal 1996, the Company provided approximately $4.3 million
under this agreement, bringing the total amount provided to date to $4.6 million
as of September 29, 1996. During fiscal 1997, the Company intends to provide
additional funds of approximately $3.8 million under this agreement. The maximum
amount available under the agreement is $17 million. Any funds advanced by the
Company will be repaid with interest over a term not to exceed 20 years.
Management believes that existing cash and investments plus cash generated from
operations should be sufficient to finance capital requirements for its core
businesses through fiscal 1997. Any new joint ventures, other new business
opportunities, or store expansion rates substantially in excess of that
presently planned may require outside funding.
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(Coffee Prices, Availability, and General Risk Conditions)
Some of the information in this Annual Report, including anticipated store
openings, planned capital expenditures, and trends in the Company's operations,
are forward-looking statements which are subject to risks and uncertainties.
Actual future results and trends may differ materially depending on a variety of
factors, including, but not limited to, coffee and other raw materials prices
and availability, successful execution of internal performance and expansion
plans, impact of competition, availability of financing, legal proceedings, and
other risks detailed in the Company's Securities and Exchange Commission
filings, including the Company's Annual Report on Form 10-K for the year ended
September 29, 1996.
Green coffee commodity prices are subject to substantial price fluctuations,
generally a result of reports of adverse growing conditions in certain
coffee-producing countries. Due to green coffee commodity price increases, the
Company effected sales price increases during fiscal 1994 and 1995 to mitigate
the effects of anticipated increases in its cost of goods sold. Because the
Company had established fixed purchase prices for some of its supply of green
coffees, the Company's margins were favorably impacted by such sales price
increases during much of fiscal 1995. During the latter part of fiscal 1995 and
throughout fiscal 1996, gross margins were negatively impacted relative to the
prior year by the sell-through of higher-cost coffee inventories. The Company
expects to have sold most of these higher-cost coffees by the end of the first
quarter of fiscal 1997.
The Company enters into fixed price purchase commitments in order to secure an
adequate supply of quality green coffee and fix costs for future periods. As of
September 29, 1996 the Company had approximately $47 million in fixed price
purchase commitments which, together with existing inventory, is expected to
provide an adequate supply of green coffee well into fiscal 1997. The Company
believes, based on relationships established with its suppliers in the past,
that the risk of non-delivery on such purchase commitments is remote.
In addition to fluctuating coffee prices, management believes that the Company's
future results of operations and earnings could be significantly impacted by
other factors such as increased competition within the specialty coffee
industry, the Company's ability to find optimal store locations at favorable
lease rates, the increased costs associated with opening and operating retail
stores in new markets, the Company's continued ability to hire, train and retain
qualified personnel, and the Company's ability to obtain adequate capital to
finance its planned expansion.
Due to the factors noted above, the Company's future earnings and the prices of
the Company's securities may be subject to volatility. There can be no assurance
that the Company will continue to generate increases in net revenues and net
earnings, or growth in comparable store sales. Any variance in the factors noted
above, or other areas, from what is expected by investors could have an
immediate and adverse effect on the trading prices of the Company's securities.
(Seasonality and Quarterly Results)
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The Company's business is subject to seasonal fluctuations. Significant portions
of the Company's net revenues and profits are realized during the first quarter
of the Company's fiscal year, which includes the December holiday season. In
addition, quarterly results are affected by the timing of the opening of new
stores, and the Company's rapid growth may conceal the impact of other seasonal
influences. Because of the seasonality of the Company's business, results for
any quarter are not necessarily indicative of the results that may be achieved
for the full fiscal year.
(New Accounting Standard)
In October 1995, the Financial Accounting Standards Board issued Statement No.
123, "Accounting for Stock-Based Compensation". This pronouncement establishes
the accounting and reporting requirements using a fair value-based method of
accounting for stock-based employee compensation plans. Under the new standard,
the Company may either adopt the new fair value-based measurement method or
continue using the intrinsic value-based method for employee stock-based
compensation and provide pro forma disclosures of net income and earnings per
share as if the measurement provisions of SFAS No. 123 had been adopted. The
Company plans to adopt only the disclosure requirements of SFAS No. 123;
therefore the adoption will have no effect on the Company's consolidated net
earnings or cash flows.