Starbucks, management discussion

From Starubucks 10-Q, filed 2007-05-11


General
Starbucks Corporation’s fiscal year ends on the Sunday closest to September 30. Fiscal year 2006 had 52 weeks and the fiscal year ending on September 30, 2007 will also include 52 weeks. All references to store counts, including data for new store openings, are reported net of related store closures.
Management Overview
During both the 13 and 26 week periods ended April 1, 2007, the Company’s continued focus on execution in all areas of its business, from U.S. and International Company-operated retail operations to the Company’s specialty operations, delivered solid financial performance. Management believes that its ability to achieve the balance between growing the core business and building the foundation for future growth is the key to increasing long-term shareholder value. Starbucks quarterly and year-to-date fiscal 2007 performance reflects the Company’s ongoing commitment to achieving this balance.
The primary driver of the Company’s revenue growth continues to be the opening of new retail stores, both Company-operated and licensed, in pursuit of the Company’s objective to establish Starbucks as one of the most recognized and respected brands in the world. Starbucks opened 1,288 new stores in the first half of fiscal 2007 and plans to open approximately 2,400 stores in fiscal 2007.
In addition to opening new retail stores, Starbucks works to increase revenues generated at new and existing Company-operated stores by attracting new customers and increasing the frequency of visits by current customers. The strategy is to increase comparable store sales by continuously improving the level of customer service, introducing innovative products and improving speed of service through training, technology and process improvement.
Global comparable store sales for Company-operated markets increased by 4% for the 13-week period ended April 1, 2007, and increased 5% over the first half of fiscal 2007. Comparable store sales growth for fiscal 2007 is expected to be in the target range of 3% to 7%.
In licensed retail operations, Starbucks shares operating and store development experience to help licensees improve the profitability of existing stores and build new stores. Internationally, the Company’s strategy is to selectively increase its equity stake in licensed international operations as these markets develop. In the first quarter of fiscal 2007, the Company purchased a 90% stake in its previously-licensed operations in Beijing and Tianjin, China.

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Starbucks has three reportable segments: United States, International and the Global Consumer Products Group (“CPG”).
The United States and International segments both include Company-operated retail stores, licensed retail stores and foodservice operations. The United States segment has been operating significantly longer than the International segment and has developed deeper awareness of, and attachment to, the Starbucks brand and stores among its customer base. As a result, the United States segment has significantly more stores, higher average sales per store, and higher total revenues than the International segment. Further, certain market costs, particularly occupancy costs, are lower in the United States segment than in the markets of the International segment. As a result of the relative strength of the brand in the United States segment, the number of stores, the higher unit volumes, and the lower market costs, the United States segment has a higher operating margin than the less-developed International segment.
The Company’s International store base continues to increase rapidly and Starbucks is achieving a growing contribution from established international markets while at the same time investing in emerging markets, such as China. The Company’s newer international markets require a more extensive support organization, relative to the current levels of revenue and operating income. The Company’s ongoing investments in International infrastructure can be expected to cause variability in quarterly operating margins for the International segment.
The CPG segment includes the Company’s grocery and warehouse club business as well as branded products operations worldwide. The CPG segment operates primarily through joint ventures and licensing arrangements with large consumer products business partners, most significantly The North American Coffee Partnership with the Pepsi-Cola Company for distribution of ready-to-drink beverages, and with Kraft Foods Inc. for distribution of packaged coffees and teas. This operating model allows the CPG segment to leverage the business partners’ existing infrastructures and to extend the Starbucks brand in an efficient way. Most of the customer revenues from the ready-to-drink and packaged coffee channels are recognized by the joint venture or licensed business partner, not by the CPG segment, and the results of the Company’s joint ventures are included on a net basis in “Income from equity investees” on the consolidated statements of earnings. As a result, the CPG segment reflects relatively lower revenues, a modest cost structure, and a resulting higher operating margin, compared to the Company’s other two reporting segments, which consist primarily of retail stores.
The combination of more retail stores, comparable store sales growth of 4% and growth in other business channels resulted in a 20% increase in total net revenues for the 13-week period ended April 1, 2007, compared to the same period of fiscal 2006. The Company expects consolidated total net revenue growth of approximately 20% in fiscal 2007.
Operating income as a percentage of total net revenues was 10.7% for both the 13 weeks ended April 1, 2007 and April 2, 2006, due to higher cost of sales including occupancy costs offset by lower store operating expenses and lower general and administrative expenses as a percentage of total net revenues. For the second half of fiscal 2007, the Company expects modest improvement in year-over-year operating margin, primarily in the fourth quarter, despite the more challenging cost environment, particularly in labor and dairy costs. Net earnings increased by 18% in the 13-week period ended April 1, 2007, compared to the same period in fiscal 2006.

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Results of Operations for the 13 Weeks Ended April 1, 2007 and April 2, 2006
CONSOLIDATED RESULTS
The following table presents the consolidated statements of earnings as well as the percentage relationship to total net revenues of items included in the Company’s consolidated statements of earnings (amounts in thousands):

13 Weeks Ended 13 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
STATEMENTS OF EARNINGS DATA

As a % of total net revenues
Net revenues:

Company-operated retail
$ 1,922,705 $ 1,599,844 20.2 % 85.2 % 84.8 %
Specialty:

Licensing
234,807 202,354 16.0 10.4 10.7
Foodservice and other
98,082 83,624 17.3 4.4 4.5


Total specialty
332,889 285,978 16.4 14.8 15.2


Total net revenues
2,255,594 1,885,822 19.6 100.0 100.0


Cost of sales including occupancy costs
944,746 760,873 41.9 40.3
Store operating expenses (1)
780,985 665,273 34.6 35.4
Other operating expenses (2)
75,661 63,648 3.4 3.4
Depreciation and amortization expenses
113,385 94,508 5.0 5.0
General and administrative expenses
126,104 119,611 5.6 6.3


Subtotal operating expenses
2,040,881 1,703,913 19.8 90.5 90.4
Income from equity investees
26,261 19,985 1.2 1.1


Operating income
240,974 201,894 19.4 10.7 10.7
Interest and other income, net
(592 ) 3,063 0.0 0.2


Earnings before income taxes
240,382 204,957 10.7 10.9
Income taxes
89,542 77,641 4.0 4.1


Net earnings
$ 150,840 $ 127,316 18.5 % 6.7 % 6.8 %




(1) As a percentage of related Company-operated retail revenues, store operating expenses were 40.6% for the 13 weeks ended April 1, 2007, and 41.6% for the 13 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 22.7% for the 13 weeks ended April 1, 2007, and 22.3% for the 13 weeks ended April 2, 2006.
Net revenues for the 13 weeks ended April 1, 2007, increased 20% to $2.3 billion from $1.9 billion for the corresponding period of fiscal 2006, driven by increases in both Company-operated retail revenues and specialty operations. Net revenues are expected to grow approximately 20% in fiscal 2007 compared to fiscal 2006.
During the 13-week period ended April 1, 2007, Starbucks derived 85% of total net revenues from its Company-operated retail stores. Company-operated retail revenues increased 20% to $1.9 billion for the 13 weeks ended April 1, 2007, from $1.6 billion for the same period in fiscal 2006. The increase was primarily attributable to the opening of 1,279 new Company-operated retail stores in the last 12 months and comparable store sales growth of 4% for the 13 weeks ended April 1, 2007. The increase in comparable store sales was due to a 3% increase in the average value per transaction and a 1% increase in the number of customer transactions.
The Company derived the remaining 15% of total net revenues from channels outside the Company-operated retail stores, collectively known as specialty operations. Specialty revenues, which include licensing revenues and foodservice and other revenues, increased 16% to $333 million for the 13 weeks ended April 1, 2007, from $286 million for the corresponding period of fiscal 2006.
Licensing revenues, which are derived from retail store licensing arrangements, as well as grocery, warehouse club and certain other branded-product operations, increased 16% to $235 million for the 13 weeks ended April 1, 2007, from $202 million for the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues from the opening of 1,224 new licensed retail stores in the last 12 months.
Foodservice and other revenues increased 17% to $98 million for the 13 weeks ended April 1, 2007, from $84 million for the corresponding period of fiscal 2006. The increase was primarily attributable to growth in new and existing accounts in the U.S. foodservice business.
Cost of sales including occupancy costs increased to 41.9% of total net revenues for the 13 weeks ended April 1,

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2007, compared to 40.3% for the corresponding period of fiscal 2006. The increase was primarily due to a shift in sales to higher cost products, increased distribution costs due to the Company’s expanding store base and food programs, and higher rent expense attributed to growth in higher priced real estate markets.
Store operating expenses as a percentage of Company-operated retail revenues decreased to 40.6% for the 13 weeks ended April 1, 2007, from 41.6% for the corresponding period of fiscal 2006. This decrease was primarily due to higher provisions for incentive compensation in the prior year due to exceptionally strong performance.
Other operating expenses, expenses associated with the Company’s specialty operations, increased to 22.7% of total specialty revenues for the 13 weeks ended April 1, 2007, compared to 22.3% in the corresponding period of fiscal 2006. The increase was primarily due to higher marketing costs related to market expansion of ready-to-drink coffee beverages in the Asia-Pacific region.
Depreciation and amortization expenses increased to $113 million for the 13 weeks ended April 1, 2007, compared to $95 million for the corresponding period of fiscal 2006. The increase was primarily due to the opening of 1,279 new Company-operated retail stores in the last 12 months. As a percentage of total net revenues, depreciation and amortization expenses were 5.0% for both periods.
General and administrative expenses increased to $126 million for the 13 weeks ended April 1, 2007, compared to $120 million for the corresponding period of fiscal 2006. The increase was primarily due to higher payroll-related expenditures and professional fees in support of continued global growth, partially offset by lower provisions for incentive compensation due to exceptional performance in the prior year. As a percentage of total net revenues, general and administrative expenses decreased to 5.6% for the 13 weeks ended April 1, 2007, from 6.3% for the corresponding period of fiscal 2006.
Income from equity investees increased 31% to $26 million for the 13 weeks ended April 1, 2007, compared to $20 million for the corresponding period of fiscal 2006. The increase was primarily from the North American Coffee Partnership, which produces ready-to-drink beverages, including Starbucks bottled Frappuccino® coffee drinks and Starbucks DoubleShot® espresso drinks, and higher equity income from international investees.
Operating income increased 19% to $241 million for the 13 weeks ended April 1, 2007, compared to $202 million for the corresponding period of fiscal 2006. Operating margin was 10.7% of total net revenues for both the 13 weeks ended April 1, 2007, and April 2, 2006. For the 13 weeks ended April 1, 2007, higher cost of sales including occupancy costs were offset by lower store operating expenses and lower general and administrative expenses as a percentage of total net revenues.
Net interest and other income decreased to expense of $0.6 million for the 13 weeks ended April 1, 2007, compared to income of $3.1 million for the corresponding period of fiscal 2006, primarily due to higher borrowings and higher interest rates on the Company’s revolving credit facility.
Income taxes for the 13 weeks ended April 1, 2007, resulted in an effective tax rate of 37.2%, compared to 37.9% for the corresponding period of fiscal 2006. The Company currently estimates that its effective tax rate for fiscal year 2007 will approximate 37%, with quarterly variations.
Net earnings for the 13 weeks ended April 1, 2007, increased 18% to $151 million from $127 million for the same period in fiscal 2006. Diluted earnings per share increased by 19% to $0.19 for the 13 weeks ended April 1, 2007, compared to $0.16 per share for the comparable period in fiscal 2006.

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SEGMENT RESULTS
Segment information is prepared on the basis that the Company’s management reviews financial information for operational decision-making purposes. The following tables summarize the Company’s results of operations by segment (in thousands):
United States

13 Weeks Ended 13 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of U.S. total net
revenues
Net revenues:

Company-operated retail
$ 1,595,389 $ 1,351,563 18.0 % 89.2 % 89.5 %
Specialty:

Licensing
104,790 81,451 28.7 5.8 5.4
Foodservice and other
89,251 76,584 16.5 5.0 5.1

Total specialty
194,041 158,035 22.8 10.8 10.5

Total net revenues
1,789,430 1,509,598 18.5 100.0 100.0


Cost of sales including occupancy costs
707,957 569,264 39.6 37.7
Store operating expenses (1)
653,791 568,088 36.5 37.6
Other operating expenses (2)
52,020 48,109 2.9 3.2
Depreciation and amortization expenses
84,429 69,534 4.7 4.6
General and administrative expenses
23,651 23,587 1.3 1.6

Subtotal operating expenses
1,521,848 1,278,582 19.0 85.0 84.7


Income from equity investees
— 27 0.0 0.0

Operating income
$ 267,582 $ 231,043 15.8 % 15.0 % 15.3 %



(1) As a percentage of related Company-operated retail revenues, store operating expenses were 41.0% for the 13 weeks ended April 1, 2007, and 42.0% for the 13 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 26.8% for the 13 weeks ended April 1, 2007, and 30.4% for the 13 weeks ended April 2, 2006.
The United States operating segment (“United States”) sells coffee and other beverages, whole bean coffees, complementary food, coffee brewing equipment and merchandise primarily through Company-operated retail stores. Specialty operations within the United States include licensed retail stores, foodservice accounts and other initiatives related to the Company’s core business.
United States total net revenues increased 19% to $1.8 billion for the 13 weeks ended April 1, 2007, compared to $1.5 billion for the corresponding period of fiscal 2006.
United States Company-operated retail revenues increased 18% to $1.6 billion for the 13 weeks ended April 1, 2007, compared to $1.4 billion for the corresponding period of fiscal 2006, primarily due to the opening of 1,042 new Company-operated retail stores in the last 12 months and comparable store sales growth of 3% for the quarter resulting from a 3% increase in the average value per transaction.
Total United States specialty revenues increased 23% to $194 million for the 13 weeks ended April 1, 2007, compared to $158 million in the corresponding period of fiscal 2006. United States licensing revenues increased 29% to $105 million, compared to $81 million for the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues as a result of opening 768 new licensed retail stores in the last 12 months. United States foodservice and other revenues increased 17% to $89 million, from $77 million in fiscal 2006, primarily due to growth in new and existing foodservice accounts.
United States operating income increased 16% to $268 million for the 13 weeks ended April 1, 2007, compared to $231 million for the same period in fiscal 2006. Operating margin decreased to 15.0% of related revenues from a record second quarter high of 15.3% in the corresponding period of fiscal 2006. The decrease was due to higher cost of sales including occupancy costs, primarily due to a shift in sales to higher cost products, such as food and merchandise, higher rent expenses and increased distribution costs due to expansion of the Company’s store base

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and food programs. Partially offsetting this was lower store operating expenses as a percentage of total net revenues, primarily resulting from higher provisions for incentive compensation in the prior year due to exceptionally strong performance.
International

13 Weeks Ended 13 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of International total
net revenues
Net revenues:

Company-operated retail
$ 327,316 $ 248,281 31.8 % 84.5 % 83.3 %
Specialty:

Licensing
51,205 42,725 19.8 13.2 14.3
Foodservice and other
8,831 7,040 25.4 2.3 2.4

Total specialty
60,036 49,765 20.6 15.5 16.7

Total net revenues
387,352 298,046 30.0 100.0 100.0


Cost of sales including occupancy costs
189,184 144,816 48.8 48.6
Store operating expenses (1)
127,194 97,185 32.9 32.6
Other operating expenses (2)
16,769 11,376 4.3 3.8
Depreciation and amortization expenses
20,649 16,286 5.3 5.5
General and administrative expenses
25,342 18,184 6.5 6.1

Subtotal operating expenses
379,138 287,847 31.7 97.8 96.6


Income from equity investees
12,916 9,125 3.3 3.1

Operating income
$ 21,130 $ 19,324 9.3 % 5.5 % 6.5 %



(1) As a percentage of related Company-operated retail revenues, store operating expenses were 38.9% for the 13 weeks ended April 1, 2007, and 39.1% for the 13 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 27.9% for the 13 weeks ended April 1, 2007, and 22.9% for the 13 weeks ended April 2, 2006.
The International operating segment (“International”) sells coffee and other beverages, whole bean coffees, complementary food, coffee brewing equipment and merchandise through Company-operated retail stores in Canada, the United Kingdom, China, Thailand, Australia, Germany, Singapore, Puerto Rico, Chile and Ireland. Specialty operations in International primarily include retail store licensing operations in more than 25 other countries and foodservice accounts in Canada and the United Kingdom. The Company’s International store base continues to increase rapidly and Starbucks is achieving a growing contribution from established areas of the business while at the same time investing in emerging markets and channels. Many of the Company’s International operations are in early stages of development that require a more extensive support organization, relative to the current levels of revenue and operating income, than in the United States. This continuing investment is part of the Company’s long-term, balanced plan for profitable growth.
International total net revenues increased 30% to $387 million for the 13 weeks ended April 1, 2007, compared to $298 million for the corresponding period of fiscal 2006.
International Company-operated retail revenues increased 32% to $327 million for the 13 weeks ended April 1, 2007, compared to $248 million for the corresponding period of fiscal 2006. The increase was primarily due to the opening of 237 new Company-operated retail stores in the last 12 months, comparable store sales growth of 7% for the quarter and favorable foreign currency exchange for the British pound sterling. The increase in comparable store sales resulted from a 5% increase in the number of customer transactions coupled with a 2% increase in the average value per transaction.
Total International specialty revenues increased 21% to $60 million for the 13 weeks ended April 1, 2007, compared to $50 million in the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues from opening 456 new licensed retail stores in the last 12 months and growth in new and existing foodservice accounts.
International operating income increased 9% to $21 million for the 13 weeks ended April 1, 2007, compared to $19

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million in the corresponding period of fiscal 2006. Operating margin decreased to 5.5% of related revenues from 6.5% in the corresponding period of fiscal 2006, primarily due to higher other operating expenses and general and administrative expenses as a percentage of total net revenues resulting from increased payroll-related expenditures to support continued rapid international store growth.
Global Consumer Products Group

13 Weeks Ended 13 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of CPG total net
revenues
Net revenues:

Specialty:

Licensing
$ 78,812 $ 78,178 0.8 % 100.0 % 100.0 %

Total specialty
78,812 78,178 0.8 100.0 100.0

Total net revenues
78,812 78,178 0.8 100.0 100.0


Cost of sales
47,605 46,793 60.4 59.9
Other operating expenses
6,872 4,163 8.7 5.3
Depreciation and amortization expenses
21 27 0.0 0.0

Subtotal operating expenses
54,498 50,983 6.9 69.1 65.2


Income from equity investees
13,345 10,833 16.9 13.8

Operating income
$ 37,659 $ 38,028 (1.0 %) 47.8 % 48.6 %

The Global Consumer Products Group (“CPG”) sells a selection of whole bean and ground coffees as well as a selection of premium Tazo® teas through licensing arrangements in United States and international markets. CPG also produces and sells ready-to-drink beverages which include, among others, Starbucks bottled Frappuccino® coffee drinks, Starbucks DoubleShot® espresso drinks, Discoveries™ products, Starbucks® superpremium ice creams and Starbucks™ Coffee and Cream Liqueurs through its joint ventures and marketing and distribution agreements.
CPG total net revenues increased 1% to $79 million for the 13 weeks ended April 1, 2007, compared to $78 million for the corresponding period of fiscal 2006. The increase was primarily due to increased product sales and royalties in the International ready-to-drink business. Partially offsetting this was decreased shipments into the U.S. packaged coffee and tea distribution system, despite higher sales to grocery retailers, resulting in lower inventory levels throughout the system.
CPG operating income was $38 million for the 13 weeks ended April 1, 2007, relatively flat with the corresponding period of fiscal 2006. Operating margin decreased to 47.8% of related revenues, from 48.6% in fiscal 2006, primarily due to increased other operating expenses. The increase in other operating expenses was due to higher marketing expenditures to support continued international expansion of ready-to-drink beverages. Partially offsetting the increase in other operating expenses was higher income from equity investees attributable to the ready-to-drink beverage business in the U.S.
Unallocated Corporate

13 Weeks Ended 13 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of total net
revenues
Depreciation and amortization expenses
$ 8,286 $ 8,661 0.4 % 0.5 %
General and administrative expenses
77,111 77,840 3.4 4.1

Operating loss
$ (85,397 ) $ (86,501 ) 1.3 % (3.8 %) (4.6 %)

Unallocated corporate expenses pertain to corporate administrative functions that support but are not specifically attributable to the Company’s operating segments, and include related depreciation and amortization expenses.
Unallocated corporate expenses decreased to $85 million for the 13 weeks ended April 1, 2007, compared to $87 million in the corresponding period of fiscal 2006. The decrease was primarily due to higher provisions for incentive

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compensation in the prior year due to exceptional performance. Total unallocated corporate expenses as a percentage of total net revenues decreased to 3.8% for the 13 weeks ended April 1, 2007, from 4.6% for the 13 weeks ended April 2, 2006.
Results of Operations for the 26 Weeks Ended April 1, 2007 and April 2, 2006
CONSOLIDATED RESULTS
The following table presents the consolidated statements of earnings as well as the percentage relationship to total net revenues of items included in the Company’s consolidated statements of earnings (amounts in thousands):

26 Weeks Ended 26 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
STATEMENTS OF EARNINGS DATA

As a % of total net revenues
Net revenues:

Company-operated retail
$ 3,929,516 $ 3,227,827 21.7 % 85.2 % 84.5 %
Specialty:

Licensing
488,729 421,504 15.9 10.6 11.0
Foodservice and other
193,072 170,583 13.2 4.2 4.5


Total specialty
681,801 592,087 15.2 14.8 15.5


Total net revenues
4,611,317 3,819,914 20.7 100.0 100.0


Cost of sales including occupancy costs
1,929,569 1,538,911 41.8 40.3
Store operating expenses (1)
1,552,952 1,287,439 33.7 33.6
Other operating expenses (2)
148,199 122,796 3.3 3.2
Depreciation and amortization expenses
223,581 185,796 4.8 4.9
General and administrative expenses
241,332 242,936 5.2 6.4


Subtotal operating expenses
4,095,633 3,377,878 21.2 88.8 88.4
Income from equity investees
45,014 39,705 1.0 1.0


Operating income
560,698 481,741 16.4 12.2 12.6
Interest and other income, net
5,847 3,411 0.1 0.1


Earnings before income taxes
566,545 485,152 12.3 12.7
Income taxes
210,753 183,680 4.6 4.8


Net earnings
$ 355,792 $ 301,472 18.0 % 7.7 % 7.9 %




(1) As a percentage of related Company-operated retail revenues, store operating expenses were 39.5% for the 26 weeks ended April 1, 2007, and 39.9% for the 26 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 21.7% for the 26 weeks ended April 1, 2007, and 20.7% for the 26 weeks ended April 2, 2006.
Net revenues for the 26 weeks ended April 1, 2007, increased 21% to $4.6 billion from $3.8 billion for the corresponding period of fiscal 2006, driven by increases in both Company-operated retail revenues and specialty operations. Net revenues are expected to grow approximately 20% in fiscal 2007 compared to fiscal 2006.
During the 26-week period ended April 1, 2007, Starbucks derived 85% of total net revenues from its Company-operated retail stores. Company-operated retail revenues increased 22% to $3.9 billion for the 26 weeks ended April 1, 2007, from $3.2 billion for the same period in fiscal 2006. The increase was primarily attributable to the opening of 1,279 new Company-operated retail stores in the last 12 months and comparable store sales growth of 5% for the 26 weeks ended April 1, 2007. The increase in comparable store sales was due to a 3% increase in the average value per transaction and a 2% increase in the number of customer transactions.
The Company derived the remaining 15% of total net revenues from its specialty operations. Specialty revenues, which include licensing revenues and foodservice and other revenues, increased 15% to $682 million for the 26 weeks ended April 1, 2007, from $592 million for the corresponding period of fiscal 2006.
Licensing revenues, which are derived from retail store licensing arrangements, as well as grocery, warehouse club and certain other branded-product operations, increased 16% to $489 million for the 26 weeks ended April 1, 2007, from $422 million for the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues from the opening of 1,224 new licensed retail stores in the last 12 months.

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Foodservice and other revenues increased 13% to $193 million for the 26 weeks ended April 1, 2007, from $171 million for the corresponding period of fiscal 2006. The increase was primarily attributable to growth in new and existing accounts in the U.S. foodservice business.
Cost of sales including occupancy costs increased to 41.8% of total net revenues for the 26 weeks ended April 1, 2007, compared to 40.3% for the corresponding period of fiscal 2006. The increase was primarily due to a shift in sales to higher cost products, increased distribution costs due to the Company’s expanding store base and food programs, and higher rent expense attributed to growth in higher priced real estate markets.
Store operating expenses as a percentage of Company-operated retail revenues decreased to 39.5% for the 26 weeks ended April 1, 2007, from 39.9% for the corresponding period of fiscal 2006. The decrease was primarily due to higher provisions for incentive compensation in the prior year due to exceptionally strong performance.
Other operating expenses, expenses associated with the Company’s specialty operations, increased to 21.7% of total specialty revenues for the 26 weeks ended April 1, 2007, compared to 20.7% in the corresponding period of fiscal 2006. The increase was primarily due to increased payroll-related expenditures to support the growth in the International licensed stores operations as well as higher marketing costs related to expansion of ready-to-drink coffee beverages in the Asia-Pacific region.
Depreciation and amortization expenses increased to $224 million for the 26 weeks ended April 1, 2007, compared to $186 million for the corresponding period of fiscal 2006. The increase was primarily due to the opening of 1,279 new Company-operated retail stores in the last 12 months. As a percentage of total net revenues, depreciation and amortization expenses decreased to 4.8% for the 26 weeks ended April 1, 2007, from 4.9% for the corresponding period of fiscal 2006.
General and administrative expenses decreased to $241 million for the 26 weeks ended April 1, 2007, compared to $243 million for the corresponding period of fiscal 2006. This decrease was primarily due to lower provisions for incentive compensation compared to exceptional performance in the prior year and unusually high charitable contributions in the prior year. These were partially offset by increased payroll-related expenditures and higher professional fees in support of continued global growth and systems infrastructure development in the current year. As a percentage of total net revenues, general and administrative expenses decreased to 5.2% for the 26 weeks ended April 1, 2007, from 6.4% for the corresponding period of fiscal 2006.
Income from equity investees increased 13% to $45 million for the 26 weeks ended April 1, 2007, compared to $40 million for the corresponding period of fiscal 2006. The increase was primarily due to higher equity income from international investees, and higher income from the North American Coffee Partnership, which produces ready-to-drink beverages, including Starbucks bottled Frappuccino® coffee drinks and Starbucks DoubleShot® espresso drinks.
Operating income increased 16% to $561 million for the 26 weeks ended April 1, 2007, compared to $482 million for the corresponding period of fiscal 2006. Operating margin decreased to 12.2% of total net revenues for the 26 weeks ended April 1, 2007, compared to 12.6% for the corresponding period of fiscal 2006, primarily due to higher cost of sales including occupancy costs, partially offset by lower general and administrative expenses.
Net interest and other income increased to $5.8 million for the 26 weeks ended April 1, 2007, compared to $3.4 million in the corresponding period of fiscal 2006, primarily due to foreign exchange gains in the current year compared to foreign exchange losses in the prior year and higher income recognized from unredeemed stored value cards. These were partially offset by increased interest expense due to higher borrowings and higher interest rates on the Company’s revolving credit facility.
Income taxes for the 26 weeks ended April 1, 2007, resulted in an effective tax rate of 37.2%, compared to 37.9% for the corresponding period of fiscal 2006. The Company currently estimates that its effective tax rate for fiscal year 2007 will approximate 37%, with quarterly variations.
Net earnings for the 26 weeks ended April 1, 2007, increased 18% to $356 million from $301 million for the same period of fiscal 2006. Diluted earnings per share increased by 21% to $0.46 for the 26 weeks ended April 1, 2007, compared to $0.38 per share for the comparable period in fiscal 2006.

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SEGMENT RESULTS
Segment information is prepared on the basis that the Company’s management reviews financial information for operational decision-making purposes. The following tables summarize the Company’s results of operations by segment (in thousands):
United States

26 Weeks Ended 26 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of U.S. total net
revenues
Net revenues:

Company-operated retail
$ 3,255,652 $ 2,722,250 19.6 % 89.2 % 89.1 %
Specialty:

Licensing
218,099 177,734 22.7 6.0 5.8
Foodservice and other
175,578 156,955 11.9 4.8 5.1

Total specialty
393,677 334,689 17.6 10.8 10.9

Total net revenues
3,649,329 3,056,939 19.4 100.0 100.0


Cost of sales including occupancy costs
1,439,078 1,156,710 39.4 37.8
Store operating expenses (1)
1,302,168 1,096,863 35.7 35.9
Other operating expenses (2)
104,145 92,216 2.9 3.0
Depreciation and amortization expenses
165,792 137,218 4.5 4.5
General and administrative expenses
45,410 45,120 1.3 1.5

Subtotal operating expenses
3,056,593 2,528,127 20.9 83.8 82.7


Income from equity investees
— 151 0.0 0.0

Operating income
$ 592,736 $ 528,963 12.1 % 16.2 % 17.3 %



(1) As a percentage of related Company-operated retail revenues, store operating expenses were 40.0% for the 26 weeks ended April 1, 2007, and 40.3% for the 26 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 26.5% for the 26 weeks ended April 1, 2007, and 27.6% for the 26 weeks ended April 2, 2006.
United States total net revenues increased 19% to $3.6 billion for the 26 weeks ended April 1, 2007, compared to $3.1 billion for the corresponding period of fiscal 2006.
United States Company-operated retail revenues increased 20% to $3.3 billion for the 26 weeks ended April 1, 2007, compared to $2.7 billion for the corresponding period of fiscal 2006, primarily due to the opening of 1,042 new Company-operated retail stores in the last 12 months and comparable store sales growth of 4% for the 26 weeks ended April 1, 2007. The increase in comparable store sales was due to a 3% increase in the average value per transaction and a 1% increase in the number of customer transactions.
Total United States specialty revenues increased 18% to $394 million for the 26 weeks ended April 1, 2007, compared to $335 million in the corresponding period of fiscal 2006. United States licensing revenues increased 23% to $218 million, compared to $178 million for the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues as a result of opening 768 new licensed retail stores in the last 12 months. United States foodservice and other revenues increased 12% to $176 million, from $157 million in fiscal 2006, primarily due to growth in new and existing foodservice accounts.
United States operating income increased by 12% to $593 million for the 26 weeks ended April 1, 2007, compared to $529 million for the same period in fiscal 2006. Operating margin decreased to 16.2% of related revenues from 17.3% in the corresponding period of fiscal 2006, primarily due to higher cost of sales including occupancy costs. Cost of sales including occupancy costs increased primarily due to a shift in sales to higher cost products such as food and merchandise, increased distribution costs due to the expansion of the Company’s store base and food programs, and higher rent expense. Partially offsetting this was lower store operating expenses and lower general and administrative expenses as a percentage of total net revenues, primarily resulting from higher provisions for incentive compensation in the prior year due to exceptionally strong performance.

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International

26 Weeks Ended 26 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of International total
net revenues
Net revenues:

Company-operated retail
$ 673,864 $ 505,577 33.3 % 85.0 % 83.7 %
Specialty:

Licensing
101,069 85,034 18.9 12.8 14.1
Foodservice and other
17,494 13,628 28.4 2.2 2.2

Total specialty
118,563 98,662 20.2 15.0 16.3

Total net revenues
792,427 604,239 31.1 100.0 100.0


Cost of sales including occupancy costs
389,295 290,244 49.1 48.0
Store operating expenses (1)
250,784 190,576 31.7 31.6
Other operating expenses (2)
30,918 21,816 3.9 3.6
Depreciation and amortization expenses
41,114 31,295 5.2 5.2
General and administrative expenses
47,053 34,371 5.9 5.7

Subtotal operating expenses
759,164 568,302 33.6 95.8 94.1


Income from equity investees
20,940 16,903 2.6 2.8

Operating income
$ 54,203 $ 52,840 2.6 % 6.8 % 8.7 %



(1) As a percentage of related Company-operated retail revenues, store operating expenses were 37.2% for the 26 weeks ended April 1, 2007, and 37.7% for the 26 weeks ended April 2, 2006.

(2) As a percentage of related total specialty revenues, other operating expenses were 26.1% for the 26 weeks ended April 1, 2007, and 22.1% for the 26 weeks ended April 2, 2006.
International total net revenues increased 31% to $792 million for the 26 weeks ended April 1, 2007, compared to $604 million for the corresponding period of fiscal 2006.
International Company-operated retail revenues increased 33% to $674 million for the 26 weeks ended April 1, 2007, compared to $506 million for the corresponding period of fiscal 2006. The increase was primarily due to the opening of 237 new Company-operated retail stores in the last 12 months, comparable store sales growth of 8% for the 26 weeks ended April 1, 2007 and favorable foreign currency exchange for the British pound sterling. The increase in comparable store sales resulted from a 6% increase in the number of customer transactions coupled with a 2% increase in the average value per transaction.
Total International specialty revenues increased 20% to $119 million for the 26 weeks ended April 1, 2007, compared to $99 million in the corresponding period of fiscal 2006. The increase was primarily due to higher product sales and royalty revenues from opening 456 new licensed retail stores in the last 12 months and growth in new and existing foodservice accounts.
International operating income increased 3% to $54 million for the 26 weeks ended April 1, 2007, compared to $53 million in the corresponding period of fiscal 2006. Operating margin decreased to 6.8% of related revenues from 8.7% in the corresponding period of fiscal 2006, primarily due to higher cost of sales including occupancy costs, higher other operating expenses and higher general and administrative expenses. The increase in cost of sales including occupancy costs was primarily due to accounting corrections totaling $3.4 million in the first fiscal quarter, and to increased distribution costs due to the Company’s expanding store base and food programs. Higher other operating expenses and general and administrative expenses as a percentage of total net revenues resulted from increased payroll-related expenditures to support continued rapid international store growth.

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Global Consumer Products Group

26 Weeks Ended 26 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of CPG total net
revenues
Net revenues:

Specialty:

Licensing
$ 169,561 $ 158,736 6.8 % 100.0 % 100.0 %

Total specialty
169,561 158,736 6.8 100.0 100.0

Total net revenues
169,561 158,736 6.8 100.0 100.0


Cost of sales
101,196 91,957 59.7 57.9
Other operating expenses
13,136 8,764 7.8 5.6
Depreciation and amortization expenses
43 61 0.0 0.0

Subtotal operating expenses
114,375 100,782 13.5 67.5 63.5


Income from equity investees
24,074 22,651 14.2 14.3

Operating income
$ 79,260 $ 80,605 (1.7 %) 46.7 % 50.8 %

CPG total net revenues increased 7% to $170 million for the 26 weeks ended April 1, 2007, compared to $159 million for the corresponding period of fiscal 2006. The increase was primarily due to increased product sales and royalties in the International ready-to-drink business as well as an increase in product sales in the International packaged coffee and tea business through grocery and warehouse club channels.
CPG operating income decreased slightly to $79 million for the 26 weeks ended April 1, 2007, compared to $81 million for the corresponding period of fiscal 2006. Operating margin decreased to 46.7% of related revenues, from 50.8% in fiscal 2006, primarily due to higher other operating expenses and higher cost of sales. Other operating expenses increased primarily due to higher marketing expenditures to support continued international expansion of ready-to-drink beverages. Cost of sales increased primarily due to a shift in sales to higher cost products.
Unallocated Corporate

26 Weeks Ended 26 Weeks Ended
April 1, April 2, % April 1, April 2,
2007 2006 Change 2007 2006
As a % of total net
revenues
Depreciation and amortization expenses
$ 16,632 $ 17,222 0.4 % 0.4 %
General and administrative expenses
148,869 163,445 3.2 4.3

Operating loss
$ (165,501 ) $ (180,667 ) 8.4 % (3.6 %) (4.7 %)

Unallocated corporate expenses decreased to $166 million for the 26 weeks ended April 1, 2007, compared to $181 million in the corresponding period of fiscal 2006. The decrease was primarily due to higher provisions for incentive compensation in the prior year due to exceptional performance and unusually high charitable contributions in the prior year. These were partially offset by increased payroll-related expenditures and higher professional fees in support of continued global growth and systems infrastructure development. Total unallocated corporate expenses as a percentage of total net revenues decreased to 3.6% for the 26 weeks ended April 1, 2007, from 4.7% for the corresponding period of fiscal 2006.

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Liquidity and Capital Resources
The following table represents components of the Company’s most liquid assets (in thousands):

April 1, October 1,
2007 2006
Cash and cash equivalents
$ 200,179 $ 312,606
Short-term investments – available-for-sale securities
77,872 87,542
Short-term investments – trading securities
65,780 53,496
Long-term investments – available-for-sale securities
20,994 5,811



Total cash, cash equivalents and liquid investments
$ 364,825 $ 459,455


The Company manages its cash and cash equivalents, and liquid investments in order to internally fund operating needs and make scheduled payments on short-term borrowings.
The Company intends to use its cash and liquid investments, including any borrowings under its $1 billion commercial paper program, which is backstopped by the existing revolving credit facility, to invest in its core businesses and other new business opportunities related to its core businesses. The Company may use its available cash resources to make proportionate capital contributions to its equity method and cost method investees, as well as purchase larger ownership interests in selected equity method investees and licensed operations, particularly in international markets. Management believes that strong cash flow generated from operations, existing cash and liquid investments, as well as borrowing capacity under the commercial paper program should be sufficient to finance capital requirements for its core businesses for the foreseeable future. Depending on available liquidity and market conditions, Starbucks may repurchase shares of its common stock under its authorized share repurchase program. A portion of share repurchases in the past have been funded using the Company’s $1 billion credit facility. Outstanding borrowings under the facility were $847 million and letters of credit given were $13 million as of April 1, 2007, leaving $140 million of capacity under the facility. Accordingly, significant additional share repurchases in excess of cash flow will be limited in the absence of additional borrowing authorizations. Significant new joint ventures, acquisitions, and/or other new business opportunities may also require additional outside funding.
Other than for normal operating expenses, cash requirements for fiscal 2007 are expected to consist primarily of capital expenditures for new Company-operated retail stores and the remodeling and refurbishment of existing Company-operated retail stores, as well as potential increased investments in International licensees and for additional share repurchases, if any. Management expects capital expenditures to be in the range of $950 million to $1.0 billion in fiscal 2007, primarily driven by new store development and existing store renovations.
Cash provided by operating activities totaled $738 million for the 26 weeks ended April 1, 2007. Net earnings provided $356 million and the effect of noncash depreciation and amortization expenses further increased cash provided by operating activities by $235 million. In addition, growth in Starbucks Card balances provided $69 million in deferred revenue.
Cash used by investing activities for the 26 weeks ended April 1, 2007 totaled $591 million. Net capital additions to property, plant and equipment used $507 million, primarily from opening 671 new Company-operated retail stores and remodeling certain existing stores during the first half of fiscal 2007. This amount includes the effect of the net change in non-cash capital accruals totaling $54 million. During the 26 weeks ended April 1, 2007, the Company used $47 million, net of cash acquired, to purchase 90% equity ownership in the Company’s previously licensed operations in Beijing and Tianjin, China.
Cash used by financing activities for the 26 weeks ended April 1, 2007 totaled $262 million. Cash used to repurchase shares of the Company’s common stock totaled $563 million. This amount, and the effect of the net change in unsettled trades totaling $31 million from October 1, 2006, together represent the total accrual-based cost of the share repurchase program for the first half of fiscal 2007. Share repurchases, up to the limit authorized by the Board of Directors, are at the discretion of management and depend on market conditions, capital requirements and other factors. On May 1, 2007, the Starbucks Board of Directors authorized the repurchase of up to 25 million additional shares of the Company’s common stock. As of May 1, 2007, a total of up to 26.1 million shares remained available for repurchase, under the current and previous authorizations.
Partially offsetting cash used for share repurchases, were net borrowings under the Company’s revolving credit facility of $147 million during the 26 weeks ended April 1, 2007, which consisted of additional gross borrowings of $576 million offset by gross principal repayments of $429 million. In addition, there were proceeds of $108 million

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from the exercise of employee stock options and the sale of the Company’s common stock from employee stock purchase plans. As options granted are exercised, the Company will continue to receive proceeds and a tax deduction; however, the amounts and the timing cannot be predicted.
Store Data
The following table summarizes the Company’s retail store information:

Net stores opened during the period
13-week period 26-week period Stores open as of
April 1, April 2, April 1, April 2, April 1, April 2,
2007 2006 2007 2006 2007 2006
United States:

Company-operated stores (1)
271 157 553 321 6,281 5,239
Licensed stores
142 132 365 330 3,533 2,765



413 289 918 651 9,814 8,004




International:

Company-operated stores (1)
42 54 118 114 1,553 1,316
Licensed stores (1)
105 81 252 219 2,361 1,905



147 135 370 333 3,914 3,221




Total
560 424 1,288 984 13,728 11,225




(1) International store data has been adjusted for the acquisition of the Beijing operations by reclassifying historical information from Licensed Stores to Company-operated Stores. United States store data was also adjusted to align with the Hawaii operations segment change by reclassifying historical information from International Company-operated stores to the United States.
Starbucks plans to open approximately 2,400 new stores on a global basis in fiscal 2007. In the United States, Starbucks plans to open approximately 1,000 Company-operated locations and 700 licensed locations. In International markets, Starbucks plans to open approximately 300 Company-operated stores and 400 licensed stores.
Contractual Obligations
There have been no material changes during the period covered by this report, outside of the ordinary course of the Company’s business, to the contractual obligations specified in the table of contractual obligations included in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the 10-K.
Off-Balance Sheet Arrangement
The Company has unconditionally guaranteed the repayment of certain Japanese yen-denominated bank loans and related interest and fees of an unconsolidated equity investee, Starbucks Japan. The guarantees continue until the loans, including accrued interest and fees, have been paid in full, with the final loan amount due in 2014. The maximum amount is limited to the sum of unpaid principal and interest amounts, as well as other related expenses. These amounts will vary based on fluctuations in the yen foreign exchange rate. As of April 1, 2007, the maximum amount of the guarantees was approximately $5.4 million. Since there has been no modification of these loan guarantees subsequent to the Company’s adoption of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indebtedness of Others,” Starbucks has applied the disclosure provisions only and has not recorded the guarantees on its balance sheet.
Commodity Prices, Availability and General Risk Conditions
The Company manages its exposure to various risks within the consolidated financial statements according to an umbrella risk management policy. Under this policy, market-based risks, including commodity costs and foreign currency exchange rates, are quantified and evaluated for potential mitigation strategies, such as entering into hedging transactions. Additionally, this policy restricts, among other things, the amount of market-based risk the Company will tolerate before implementing approved hedging strategies and prohibits speculative trading activity.

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The Company purchases significant amounts of coffee and dairy products to support the needs of its Company-operated retail stores. The price and availability of these commodities directly impacts the Company’s results of operations and can be expected to impact its future results of operations. For additional details see “Product Supply” in Item 1, as well as “Risk Factors” in Item 1A of the 10-K.
Seasonality and Quarterly Results
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 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), which seeks to reduce the diversity in practice associated with the accounting and reporting for uncertainty in income tax positions. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006 and the Company will adopt the new requirements in its fiscal first quarter of 2008. The cumulative effects, if any, of adopting FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact, if any, of adopting FIN 48 on its consolidated financial statements.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. Starbucks must adopt these new requirements no later than its first fiscal quarter of 2009. Starbucks has not yet determined the effect on the Company’s consolidated financial statements, if any, upon adoption of SFAS 157, or if it will adopt the requirements prior to the first fiscal quarter of 2009.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). The intent of SAB 108 is to reduce diversity in practice for the method companies use to quantify financial statement misstatements, including the effect of prior year uncorrected errors. SAB 108 establishes an approach that requires quantification of financial statement errors using both an income statement and a cumulative balance sheet approach. SAB 108 is effective for annual financial statements for fiscal years ending after November 15, 2006. The adoption of SAB 108 is not expected to have a significant impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, or Starbucks first fiscal quarter of 2009. Early adoption is permitted. Starbucks has not yet determined if it will elect to apply any of the provisions of SFAS 159 and what the effect of adoption of the statement would have, if any, on its consolidated financial statements.