STARBUCKS CORP – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Source:

Edgar Online, Inc.

General

  Our fiscal year ends on the Sunday closest to September 30. The fiscal year ended on October 3, 2010 included 53 weeks with the 53rd week falling in the fourth fiscal quarter. The fiscal years ended on October 2, 2011 and September 27, 2009 both included 52 weeks. Comparable store sales percentages for fiscal 2010 are calculated excluding the 53rd week. All references to store counts, including data for new store openings, are reported net of related store closures, unless otherwise noted.  

Financial Highlights

• Consolidated operating income was $1.7 billion for fiscal 2011 compared to

$1.4 billion in fiscal 2010 and operating margin increased to 14.8%

compared to 13.3% in fiscal 2010. The operating margin expansion was driven

by increased sales leverage, partially offset by higher commodity costs.

Comparable store sales growth at company-operated stores was 8% in fiscal

        2011 compared to 7% in fiscal 2010.    

• EPS for fiscal 2011 was $1.62, compared to EPS of $1.24 reported in fiscal

2010, with the increase driven by the improved sales leverage and certain

gains recorded in the fourth quarter of fiscal 2011. We recognized a gain

from a fair market value adjustment resulting from the acquisition of the

remaining ownership interest in our joint venture in Switzerland and

Austria as well as a gain on the sale of corporate real estate. These gains

        contributed approximately $0.10 to EPS in fiscal 2011.    

• Cash flow from operations was $1.6 billion in fiscal 2011 compared to

$1.7 billion in fiscal 2010. Capital expenditures were approximately

$532 million in fiscal 2011 compared to $440 million in fiscal 2010.

Available operating cash flow after capital expenditures during fiscal 2011

was directed at returning approximately $945 million of cash to our

shareholders via share repurchases and dividends.

Overview

Starbucks results for fiscal 2011 reflect the strength and resiliency of our business model, the global power of our brand and the talent and dedication of our employees. Our business has performed well this year despite significant headwinds from commodity costs and a continuingly challenging consumer environment. Strong global comparable stores sales growth of 8% for the full year (US 8% and International 5%) drove increased sales leverage and resulted in higher operating margins and net earnings. This helped mitigate the impact of higher commodity costs, which negatively impacted EPS by approximately $0.20 per share for the year, equivalent to approximately 220 basis points of operating margin. Most of the commodity pressure was related to coffee, with dairy, cocoa, sugar and fuel accounting for the rest.  Our US business continued its strong momentum and contributed 69% of total net revenues in fiscal 2011. We saw benefits from a variety of initiatives including our loyalty program, innovative products such as our Starbucks Petites® platform and other new food and beverage options. We also continued to refine our store efficiency efforts, including the rollout of our new point-of-sale and inventory management systems in our company-operated stores. The combination of these efforts resulted in strong comparable store sales of 8%, which translated to an increase in sales leverage, which more than offset the effect of higher commodity costs.  Our international portfolio, which contributed 22% of total net revenues in fiscal 2011, continues to improve, with an operating margin of 13% for the year. We continue to leverage the valuable lessons learned from the turnaround of our US business, and continue to make progress on scaling the infrastructure of this segment. We are aggressively pursuing the profitable expansion opportunities that exist outside the US, including disciplined growth and scale in our more mature markets, and faster expansion in key emerging markets like China.  Our global consumer products group ("CPG") represents another important profitable growth opportunity for us. During the second quarter, we successfully transitioned our packaged coffee and tea businesses to an in-house direct model, away from the previous distribution arrangement. This model now gives us total control over the sell-in and distribution to retailers of these products. We also aggressively pursued the opportunities beyond our more                                           22

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  traditional store experience to offer consumers new coffee and other products in multiple forms, across new categories, and through diverse channels, leveraging our strong brand and established retail store base. Examples include the ongoing global expansion of our successful Starbucks VIA® Ready Brew product and Starbucks- and Tazo-branded K-Cup® portion packs which were added to the lineup at the start of fiscal 2012. CPG contributed 7% of total net revenues in fiscal 2011.  Looking toward the future, we recently announced a reorganization of our leadership structure that took effect at the beginning of fiscal 2012. The new structure will enable us to accelerate our global, multi-brand, multi-channel strategy, and to leverage the talent, experience and expertise resident in our senior leadership team. In this new structure, one president will oversee all operations within each of three distinct regions with responsibility for the performance of company-operated stores, as well as for working with licensed and joint-venture business partners in each market within their respective region. The region president will also be responsible for working with Starbucks Global Consumer Products and Foodservice teams to further develop those businesses and execute against our growth plan within the region. The three new regions will be 1) Americas, inclusive of the US, Canada, and Latin America, 2) China and Asia Pacific, and 3) Europe, Middle East, and Africa, collectively referred to as the EMEA region.  Fiscal 2012 - The View Ahead  For fiscal year 2012, we expect moderate revenue growth driven by mid single-digit increased comparable store sales, new store openings and strong growth in the CPG business. Licensed stores will comprise between one-half and two-thirds of new store openings in the Americas, EMEA and China and Asia Pacific regions.  We expect modest consolidated operating margin and EPS improvement compared to fiscal 2011, given our current revenue expectations, along with ongoing spend related to our expanding CPG in-house direct distribution model and higher commodity costs.  

We expect increased capital expenditures in fiscal 2012 compared to fiscal 2011, reflecting additional investments in store renovations and in manufacturing capacity.

Operating Segment Overview

  Through the end of fiscal 2011, Starbucks had three reportable operating segments: US, International, and CPG. Our Seattle's Best Coffee operating segment is reported in "Other," along with our Digital Ventures business and unallocated corporate expenses that pertain to corporate administrative functions that support our operating segments but are not specifically attributable to or managed by any segment and are not included in the reported financial results of the operating segments.  The US and International segments both include company-operated stores and licensed retail stores. Licensed stores generally have a higher operating margin than company-operated stores. Under the licensed model, Starbucks receives a reduced share of the total store revenues, but this is more than offset by the reduction in its share of costs as these are primarily borne by the licensee. The International segment has a higher relative share of licensed stores versus company-operated stores compared to the US segment; however, the US 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 more mature US segment has significantly more stores, and higher total revenues than the International segment. Average sales per store are also higher in the US due to various factors including length of time in market and local income levels. Further, certain market costs, particularly occupancy costs, are lower in the US segment compared to the average for the International segment, which comprise a more diverse group of operations. As a result of the relative strength of the brand in the US segment, the number of stores, the higher unit volumes, and the lower market costs, the US segment, despite its higher relative percentage of company-operated stores, has a higher operating margin than the less-developed International segment.  Starbucks International store base continues to expand and we continue to focus on achieving sustainable growth from established international markets while at the same time investing in emerging markets, such as China. Newer                                           23

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international markets require a more extensive support organization, relative to the current levels of revenue and operating income.

  The CPG and Seattle's Best Coffee segments include packaged coffee and tea and other branded products operations worldwide, as well as the US foodservice business. In prior years through the first several months of fiscal 2011, we sold a selection of Starbucks and Seattle's Best Coffee branded packaged coffees and Tazo® teas in grocery and warehouse club stores throughout the US and to grocery stores in Canada, the UK and other European countries through a distribution arrangement with Kraft Foods Global, Inc.Kraft managed the distribution, marketing, advertising and promotion of these products as a part of that arrangement. Beginning in the second quarter of fiscal 2011, we successfully transitioned these businesses including the marketing, advertising, and promotion of these products, from our previous distribution arrangement with Kraft and began selling these products directly to the grocery and warehouse club stores. Our CPG segment also includes ready-to-drink beverages, which are primarily manufactured and distributed through The North American Coffee Partnership, a joint venture with the Pepsi-Cola Company. The proportionate share of the results of the joint venture is included, on a net basis, in income from equity investees on the consolidated statements of earnings. The US foodservice business sells coffee and other related products to institutional foodservice companies with the majority of its sales through national broad-line distribution networks. The CPG segment reflects relatively lower revenues, a modest cost structure, and a resulting higher operating margin, compared to the other two reporting segments, which consist primarily of retail stores.  

Acquisitions

See Note 17 to the consolidated financial statements in this 10-K.

RESULTS OF OPERATIONS - FISCAL 2011 COMPARED TO FISCAL 2010

Consolidated results of operations (in millions):

 Revenues                                     Oct 2,         Oct 3,          %         Oct 2,       Oct 3,   Fiscal Year Ended               2011           2010        Change        2011         2010                                                                              % of Total Net                                                                                 Revenues   Net revenues:   Company-operated stores      $  9,632.4     $  8,963.5         7.5 %       82.3 %       83.7 %   Licensed stores                 1,007.5          875.2        15.1 %        8.6 %        8.2 %   CPG, foodservice and other      1,060.5          868.7        22.1 %        9.1 %        8.1 %    Total net revenues           $ 11,700.4     $ 10,707.4         9.3 %      100.0 %      100.0 %   Consolidated net revenues were $11.7 billion for fiscal 2011, an increase of 9%, or $993 million over fiscal 2010. The increase was primarily due to an increase in company-operated retail revenues driven by an 8% increase in global comparable stores sales (contributing approximately $672 million). The increase in comparable store sales was due to a 6% increase in number of transactions (contributing approximately $499 million) and a 2% increase in average value per transaction (contributing approximately $173 million). Also contributing to the increase in total net revenues was favorable foreign currency translation (approximately $126 million) resulting from a weakening of the US dollar relative to foreign currencies and an increase in licensed stores revenues (approximately $106 million). This increase was partially offset by the impact of the extra week in fiscal 2010 (approximately $207 million).                                           24

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  Table of Contents  Operating Expenses                                                  Oct 2,          Oct 3,          Oct  2,         Oct  3, Fiscal Year Ended                              2011            2010            2011            2010                                                                                   % of Total Net                                                                                      Revenues

Cost of sales including occupancy costs $ 4,949.3$ 4,458.6

       42.3 %          41.6 % Store operating expenses                       3,665.1         3,551.4            31.3 %          33.2 % Other operating expenses                         402.0           293.2             3.4 %           2.7 % Depreciation and amortization expenses           523.3           510.4             4.5 %           4.8 % General and administrative expenses              636.1           569.5             5.4 %           5.3 % Restructuring charges                              0.0            53.0             0.0 %           0.5 %  Total operating expenses                      10,175.8         9,436.1            87.0 %          88.1 % Gain on sale of properties                        30.2             0.0             0.3 %           0.0 % Income from equity investees                     173.7           148.1             1.5 %           1.4 %  Operating income                            $  1,728.5       $ 1,419.4            14.8 %          13.3 % Supplemental ratios as a % of related revenues: Store operating expenses                                                    

38.0 % 39.6 %

   Cost of sales including occupancy costs as a percentage of total net revenues increased 70 basis points. The increase was primarily due to higher commodity costs (approximately 220 basis points), mainly driven by increased coffee costs. Partially offsetting this increase was lower occupancy costs as a percentage of total net revenues (approximately 70 basis points), driven by increased sales leverage.  

Store operating expenses as a percentage of total net revenues decreased 190 basis points primarily due to increased sales leverage.

  Other operating expenses as a percentage of total net revenues increased 70 basis points primarily due to higher expenses to support the direct distribution model for packaged coffee and tea (approximately 40 basis points) and the impairment of certain assets in our Seattle's Best Coffee business associated with the Borders bankruptcy in April 2011 (approximately 20 basis points).  The above changes contributed to an overall increase in operating margin of 150 basis points for fiscal 2011. Considering the impact from all line items, the primary drivers for the increase in operating margin for fiscal 2011 were increased sales leverage (approximately 300 basis points), the absence of restructuring charges in the current year (approximately 50 basis points) and the gain on the sale of properties (approximately 30 basis points). These increases were partially offset by higher commodity costs (approximately 220 basis points).                                           25 

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Other Income and Expenses

                                                  Oct 2,          Oct 3,          Oct  2,          Oct  3, Fiscal Year Ended                              2011            2010            2011             2010                                                                                      % of Total                                                                                     Net Revenues Operating income                             $ 1,728.5       $ 1,419.4            14.8 %           13.3 % Interest income and other, net                   115.9            50.3             1.0 %            0.5 % Interest expense                                 (33.3 )         (32.7 )    

(0.3 )% (0.3 )%

  Earnings before income taxes                   1,811.1         1,437.0            15.5 %           13.4 % Income taxes                                     563.1           488.7             4.8 %            4.6 %  Net earnings including noncontrolling interests                                      1,248.0           948.3            10.7 %            8.9 %  Net earnings (loss) attributable to noncontrolling interests                           2.3             2.7             0.0 %            0.0 %  

Net earnings attributable to Starbucks$ 1,245.7$ 945.6

       10.6 %            8.8 %  Effective tax rate including noncontrolling interests                                                          31.1 %           34.0 %   Net interest income and other increased $66 million over the prior year. The increase primarily resulted from the gain recorded in the fourth quarter of fiscal 2011 related to our acquisition of the remaining ownership interest in our joint venture operations in Switzerland and Austria (approximately $55 million).  Income taxes for the fiscal year ended 2011 resulted in an effective tax rate of 31.1% compared to 34.0% for fiscal 2010. The lower rate in fiscal 2011 was primarily due to a benefit from the Switzerland and Austria transaction and to an increase in income in foreign jurisdictions having lower tax rates. The effective tax rate for fiscal 2012 is expected to be approximately 33%.  

Operating Segments

  The following tables summarize our results of operations by segment for fiscal 2011 and 2010 (in millions).  United States                                                 Oct 2,          Oct 3,          Oct 2,          Oct 3, Fiscal Year Ended                             2011            2010            2011            2010                                                                                As a % of US Total                                                                                   Net Revenues Total net revenues                          $ 8,038.0       $ 7,560.4           100.0 %        100.0 % Cost of sales including occupancy costs     $ 3,093.9       $ 2,906.1            38.5 %         38.4 % Store operating expenses                      2,891.3         2,831.9            36.0 %         37.5 % Other operating expenses                         62.7            55.6             0.8 %          0.7 % Depreciation and amortization expenses          343.8           350.7             4.3 %          4.6 % General and administrative expenses              83.7            97.8             1.0 %          1.3 % Restructuring charges                             0.0            27.2             0.0 %          0.4 %  Total operating expenses                      6,475.4         6,269.3            80.6 %         82.9 %  Operating income                            $ 1,562.6       $ 1,291.1            19.4 %         17.1 %  Supplemental ratios as a % of related revenues: Store operating expenses                                                         38.8 %         40.3 %                                            26 

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Revenues

Total US net revenues for fiscal 2011 increased 6%, or $478 million. The increase was primarily due to an 8% increase in comparable store sales (contributing approximately $576 million), comprised of a 6% increase in transactions (contributing approximately $420 million), and a 2% increase in average value per transaction (contributing approximately $156 million), partially offset by the absence of the extra week in the current year (approximately $143 million).

Operating Expenses

  Cost of sales including occupancy costs as a percentage of total US net revenues increased by 10 basis points over the prior year. The increase was primarily due to higher commodity costs (approximately 160 basis points) driven by increased coffee costs, mostly offset by increased sales leverage (approximately 130 basis points).  

Store operating expenses as a percentage of total US net revenues decreased 150 basis points primarily due to increased sales leverage.

  The above changes contributed to an overall increase in operating margin of 230 basis points for fiscal 2011. Considering the impact from all line items, the primary drivers for the increase in operating margin were increased sales leverage (approximately 360 basis points) and the absence of restructuring charges in the current year (approximately 40 basis points). These increases were partially offset by higher commodity costs (approximately 160 basis points) driven by increased coffee costs.  International                                                  Oct 2,         Oct 3,          Oct 2,             Oct 3, Fiscal Year Ended                              2011           2010            2011               2010                                                                                     As a % of                                                                                International Total                                                                                    Net Revenues Total net revenues                           $ 2,626.1      $ 2,288.8            100.0 %          100.0 % Cost of sales including occupancy costs      $ 1,259.8      $ 1,078.2             48.0 %           47.1 % Store operating expenses                         773.8          719.5             29.5 %           31.4 % Other operating expenses                          91.9           85.7              3.5 %            3.7 % Depreciation and amortization expenses           118.5          108.6              4.5 %            4.7 % General and administrative expenses              132.9          126.6              5.1 %            5.5 % Restructuring charges                              0.0           25.8              0.0 %            1.1 %  Total operating expenses                       2,376.9        2,144.4             90.5 %           93.7 % Income from equity investees                     100.5           80.8              3.8 %            3.5 %  Operating income                             $   349.7      $   225.2             13.3 %            9.8 %  Supplemental ratios as a % of related revenues: Store operating expenses                                                          35.4 %           37.2 %   Revenues  Total International net revenues for fiscal 2011 increased 15%, or $337 million. The increases were primarily driven by foreign currency translation resulting from the weakening of the US dollar (approximately $126 million), primarily in relation to the Canadian dollar, comparable store sales of 5% (contributing approximately $96 million), and net new company-operated store openings (approximately $57 million). These increases were partially offset by the absence of the extra week in fiscal 2011 (approximately $45 million). The increase in comparable store sales was due to a 4% increase in transactions (contributing approximately $74 million), and a 1% increase in average value per transaction (contributing approximately $22 million).                                           27

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Operating Expenses

  Cost of sales including occupancy costs as a percentage of total International net revenues increased by 90 basis points compared to the prior year. The increase was primarily due to higher commodity costs (approximately 100 basis points), driven primarily by increased coffee costs. Partially offsetting this increase were lower occupancy costs as a percentage of total net revenues (approximately 40 basis points), primarily due to increased sales leverage.  Store operating expenses as a percentage of total International net revenues decreased 190 basis points primarily due to increased sales leverage (approximately 240 basis points) and fewer impairment charges in the current year compared to fiscal 2010 (approximately 80 basis points). These decreases were partially offset by an increase in salaries and benefits expense to support new store openings (approximately 110 basis points).  The above changes contributed to an overall increase in operating margin of 350 basis points for fiscal 2011. Considering the impact from all line items, the primary drivers for the increase in operating margin for fiscal 2011 were increased sales leverage (approximately 330 basis points), the absence of restructuring charges in the current year (approximately 110 basis points), fewer impairment charges in the current year compared to fiscal 2010 (approximately 80 basis points), partially offset by increased salaries and benefits (approximately 110 basis points) and higher commodity costs (approximately 100 basis points).  

Global Consumer Products Group

                                               Oct 2,      Oct 3,       Oct 2,         Oct 3,   Fiscal Year Ended                          2011        2010         2011           2010                                                                          As a % of CPG                                                                       Total Net Revenues   Total net revenues                        $ 860.5     $ 707.4         100.0 %       100.0 %

Cost of sales including occupancy costs $ 492.5$ 384.9 57.2 % 54.4 %

   Other operating expenses                    153.9       117.0          

17.9 % 16.5 %

Depreciation and amortization expenses 2.4 3.7 0.3 % 0.5 %

General and administrative expenses 14.3 11.0 1.7 % 1.6 %

    Total operating expenses                    663.1       516.6          

77.1 % 73.0 %

   Income from equity investees                 75.6        70.6           8.8 %        10.0 %    Operating income                          $ 273.0     $ 261.4          31.7 %        37.0 %    Revenues  Total CPG net revenues for fiscal 2011 increased 22%, or $153 million. The increase was primarily due to the benefit of recognizing full revenue from packaged coffee and tea sales under the direct distribution model for the majority of the year (approximately $70 million). On March 1, 2011, we successfully transitioned to a direct distribution model from our previous distribution arrangement with Kraft for the sale of packaged Starbucks ® and Seattle's Best Coffee® coffee products in grocery and warehouse club stores throughout the US, and to grocery stores in Canada, the UK and other European countries. We successfully transitioned the Tazo® tea business to a direct distribution model in January 2011. Also contributing to the increase were improved revenues from US foodservice (approximately $26 million) and the expanded distribution of Starbucks VIA® Ready Brew in fiscal 2011 (approximately $24 million), partially offset by the extra week in fiscal 2010 (approximately $16 million).  Operating Expenses  Operating margin decreased 530 basis points over the prior year primarily due to increased commodity costs (approximately 830 basis points), driven by higher coffee costs. Partially offsetting the increase in commodity costs were the benefit of price increases (approximately 200 basis points) and lower marketing expenses for Starbucks VIA® Ready Brew in the current year (approximately 120 basis points).                                           28 

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  Table of Contents  Other                                                    Oct 2,        Oct 3,          %       Fiscal Year Ended                          2011          2010        Change       Total net revenues                       $  175.8      $  150.8         16.6 %       Cost of sales                            $  103.1      $   89.4         15.3 %

      Other operating expenses                     93.5          34.9      

167.9 %

Depreciation and amortization expenses 58.6 47.4

23.6 %

General and administrative expenses 405.2 334.1

21.3 %

      Total operating expenses                    660.4         505.8      

30.6 %

      Gain on sale of properties                   30.2           0.0      

nm

      Loss from equity investee                    (2.4 )        (3.3 )    

 (27.3 )%        Operating loss                           $ (456.8 )    $ (358.3 )       27.5 %    Other is comprised of the Seattle's Best Coffee operating segment, the Digital Ventures business, and expenses pertaining to corporate administrative functions that support our 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.  Substantially all net revenues in Other are generated from the Seattle's Best Coffee operating segment. The increase in revenues for Seattle's Best Coffee was primarily due to the recognition of a full year of sales to national accounts added in the latter part of fiscal 2010 as well as new accounts added during fiscal 2011(approximately $20 million). This was partially offset by the impact of the closure of the Seattle's Best Coffee locations in Borders Bookstores.  Total operating expenses in fiscal 2011 increased 31%, or $155 million. This increase is the result of an increase of $71 million in general and administrative expenses due to higher corporate expenses to support growth initiatives and higher donations to the Starbucks Foundation. Also contributing was an increase of $59 million in other operating expenses primarily due to the impairment of certain assets in our Seattle's Best Coffee business associated with the Borders bankruptcy in April 2011 and an increase in marketing expenses. This increase in operating expenses was partially offset by a gain on the sale of corporate real estate in fiscal 2011 (approximately $30 million).  

RESULTS OF OPERATIONS - FISCAL 2010 COMPARED TO FISCAL 2009

Consolidated results of operations (in millions):

                                    Oct 3,        Sep 27,         %         Oct 3,       Sep 27,   Fiscal Year Ended               2010          2009        Change        2010          2009                                                                             % of Total Net                                                                                Revenues   Net revenues:   Company-operated stores      $  8,963.5     $ 8,180.1         9.6 %       83.7 %        83.7 %   Licensed stores                   875.2         795.0        10.1 %        8.2 %         8.1 %   CPG, foodservice and other        868.7         799.5         8.7 %        8.1 %         8.2 %    Total net revenues           $ 10,707.4     $ 9,774.6         9.5 %      100.0 %       100.0 %   Consolidated net revenues were $10.7 billion for fiscal 2010, an increase of 9.5% over fiscal 2009. The increase was primarily due to an increase in company-operated retail revenues driven by a 7% increase in global comparable stores sales (contributing approximately $551 million). The increase in comparable store sales was due to a 4% increase in number of transactions (contributing approximately $298 million) and a 3% increase in average value per transaction (contributing approximately $253 million). Also contributing to the increase in revenues was the extra week in fiscal 2010 (approximately $207 million), foreign currency translation resulting from the weakening of the US dollar primarily in relation to the Canadian dollar (approximately $101 million), and the effect of consolidating our previous joint venture in France (approximately $87 million). This increase was partially offset by a net decrease of 72 company-operated stores from fiscal 2009 (approximately $119 million).                                           29 

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  Table of Contents                                                     Oct 3,         Sep 27,       Oct 3,         Sep 27, Fiscal Year Ended                                    2010           2009          2010           2009                                                                                      % of Total Net                                                                                         Revenues Cost of sales including occupancy costs            $ 4,458.6      $ 4,324.9         41.6 %          44.2 % Store operating expenses                             3,551.4        3,425.1         33.2 %          35.0 % Other operating expenses                               293.2          264.4          2.7 %           2.7 % Depreciation and amortization expenses                 510.4          534.7          4.8 %           5.5 % General and administrative expenses                    569.5          453.0          5.3 %           4.6 % Restructuring charges                                   53.0          332.4          0.5 %           3.4 %  Total operating expenses                             9,436.1        9,334.5         88.1 %          95.5 % Income from equity investees                           148.1          121.9          1.4 %           1.2 %  Operating income                                   $ 1,419.4      $   562.0         13.3 %           5.7 % Supplemental ratios as a % of related revenues: Store operating expenses                                                    

39.6 % 41.9 %

   Cost of sales including occupancy costs as a percentage of total revenues decreased 260 basis points. The decrease was primarily driven by supply chain efficiencies which contributed to lower food costs (approximately 70 basis points) and lower beverage and paper packaging product costs (approximately 50 basis points). Also contributing to the decrease were lower occupancy costs as a percentage of total net revenues (approximately 80 basis points) primarily due to sales leverage.  

Store operating expenses as a percentage of company-operated retail revenues decreased 230 basis points primarily due to increased sales leverage from increased revenues.

  Restructuring charges include lease exit and related costs associated with the actions to rationalize our global store portfolio and reduce the global cost structure in fiscal 2009 and 2008. The restructuring charges incurred in fiscal 2010 reflect charges incurred on the previously announced store closures. With the previously-announced store closures essentially complete, we do not expect to report any further restructuring costs related to these activities.  Partially offsetting these favorable fluctuations were increased advertising costs included primarily in other operating expenses and higher performance based compensation expenses, which drove the 70 basis point increase in general and administrative expenses as a percentage of revenues.                                                Oct 3,           Sep  27,          Oct  3,           Sep  27, Fiscal Year Ended                            2010              2009             2010               2009                                                                                      % of Total Net                                                                                         Revenues Operating income                           $ 1,419.4        $    562.0             13.3 %              5.7 % Interest income and other, net                  50.3              37.0              0.5 %              0.4 % Interest expense                               (32.7 )           (39.1 )           (0.3 )%            (0.4 )%  Earnings before income taxes                 1,437.0             559.9             13.4 %              5.7 % Income taxes                                   488.7             168.4              4.6 %              1.7 %  Net earnings including noncontrolling interests                                      948.3             391.5              8.9 %              4.0 % Net earnings (loss) attributable to noncontrolling interests                         2.7               0.7              0.0 %              0.0 %  

Net earnings attributable to Starbucks$ 945.6$ 390.8

         8.8 %              4.0 %  Effective tax rate including noncontrolling interests                                                           34.0 %             30.1 %   Net interest income and other increased $13 million over the prior period. The increase was driven by the impact of an accounting gain recorded in the first quarter of fiscal 2010 related to our acquisition of a controlling interest in our previous joint venture operations in France. In accordance with accounting principles generally accepted in the United States of America ("GAAP"), the carrying value of the previously held joint venture interest was adjusted to                                           30 

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  fair value upon the acquisition of the controlling interest. Also contributing to the increase were favorable fluctuations in unrealized holding gains on our trading securities portfolio of approximately $10 million. This favorability was partially offset by unfavorable foreign currency fluctuations (approximately $11 million), which related primarily to the revaluation of certain trade payables and receivables.  Income taxes for the fiscal year ended 2010 resulted in an effective tax rate of 34.0% compared to 30.1% for fiscal 2009. The lower rate in fiscal 2009 was primarily due to the benefits recognized for retroactive tax credits and an audit settlement.  United States                                                        Oct 3,        Sep  27,       Oct 3,         Sep  27, Fiscal Year Ended                                    2010           2009          2010            2009                                                                                     As a % of US Total                                                                                        Net Revenues Total net revenues                                 $ 7,560.4      $ 7,061.7        100.0 %          100.0 % Cost of sales including occupancy costs            $ 2,906.1      $ 2,941.4         38.4 %           41.7 % Store operating expenses                             2,831.9        2,815.1         37.5 %           39.9 % Other operating expenses                                55.6           66.6          0.7 %            0.9 % Depreciation and amortization expenses                 350.7          377.9          4.6 %            5.4 % General and administrative expenses                     97.8           84.8          1.3 %            1.2 % Restructuring charges                                   27.2          246.3          0.4 %            3.5 %  Total operating expenses                             6,269.3        6,532.1         82.9 %           92.5 % Income from equity investees                             0.0            0.5          0.0 %            0.0 %  Operating income                                   $ 1,291.1      $   530.1         17.1 %            7.5 %  Supplemental ratios as a % of related revenues: Store operating expenses                                                            40.3 %           42.8 %   US net revenues increased primarily due to an increase in company-operated retail revenues of 7%. This increase is primarily due to a 7% increase in comparable store sales (contributing approximately $452 million), comprised of a 3% increase in transactions (contributing approximately $222 million), and a 4% increase in average value per transaction (contributing approximately $230 million). Also contributing to the increase in total net revenues was the extra week in fiscal 2010 (approximately $143 million), partially offset by a net decrease of 57 company-operated stores from fiscal 2009 (approximately $125 million).  Cost of sales including occupancy costs as a percentage of total revenues decreased by 330 basis points over the prior year. The decrease was primarily driven by supply chain efficiencies which contributed to lower food costs (approximately 90 basis points) and lower beverage and paper packaging product costs (approximately 60 basis points). Also contributing to the decrease were lower occupancy costs as a percentage of total net revenues (approximately 100 basis points) primarily due to sales leverage.  

Store operating expenses as a percent of related retail revenues decreased 250 basis points primarily due to increased sales leverage.

Restructuring charges include lease exit and related costs associated with the actions to rationalize our global store portfolio. Restructuring charges in fiscal 2010 decreased $219 million from 2009 due to the completion of our restructuring efforts in the US during fiscal 2010.

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   Table of Contents  International                                                        Oct 3,        Sep  27,        Oct 3,         Sep  27, Fiscal Year Ended                                    2010           2009           2010            2009                                                                                          As a % of                                                                                     International Total                                                                                        Net Revenues Total net revenues                                 $ 2,288.8      $ 1,914.3         100.0 %          100.0 % Cost of sales including occupancy costs            $ 1,078.2      $   961.3          47.1 %           50.2 % Store operating expenses                               719.5          610.0          31.4 %           31.9 % Other operating expenses                                85.7           71.2           3.7 %            3.7 % Depreciation and amortization expenses                 108.6          102.2           4.7 %            5.3 % General and administrative expenses                    126.6          105.0           5.5 %            5.5 % Restructuring charges                                   25.8           27.0           1.1 %            1.4 %  Total operating expenses                             2,144.4        1,876.7          93.7 %           98.0 % Income from equity investees                            80.8           53.6           3.5 %            2.8 %  Operating income                                   $   225.2      $    91.2           9.8 %            4.8 %  Supplemental ratios as a % of related revenues: Store operating expenses                                                             37.2 %           37.9 %   International net revenues increased due to foreign currency translation resulting from the weakening of the US dollar primarily in relation to the Canadian dollar (approximately $101 million), comparable store sales of 6% (contributing approximately $99 million), the effect of consolidating our previous joint venture in France (approximately $87 million), and the extra week in fiscal 2010 (approximately $45 million). The increase in comparable store sales was due to a 5% increase in transactions (contributing approximately $78 million), and a 1% increase in average value per transaction (contributing approximately $21 million).  Cost of sales including occupancy costs as a percentage of total revenues decreased by 310 basis points compared to the prior year. The decrease was primarily driven by lower costs for food and beverage components resulting from supply chain efficiencies (approximately 120 basis points). Also contributing to the decrease were lower occupancy costs as a percentage of total net revenues (approximately 120 basis points) primarily due to sales leverage.  Store operating expenses as a percent of related retail revenues decreased 70 basis points primarily due to reduced impairments in fiscal 2010 compared to fiscal 2009.  

Restructuring charges include lease exit and related costs associated with the actions to rationalize our global store portfolio. Restructuring charges in fiscal 2010 decreased slightly from 2009 due to the completion of our restructuring efforts internationally by the end of fiscal 2010.

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Global Consumer Products Group

                                                Oct 3,         Sep  27,          Oct 3,           Sep  27, Fiscal Year Ended                            2010            2009             2010              2009                                                                                   As a % of CPG                                                                                 Total Net Revenues Total net revenues                          $ 707.4       $    674.4            100.0 %           100.0 % 

Cost of sales including occupancy costs $ 384.9$ 350.5

      54.4 %            52.0 % Other operating expenses                      117.0             95.3             16.5 %            14.1 % Depreciation and amortization expenses          3.7              4.8              0.5 %             0.7 % General and administrative expenses            11.0              8.8              1.6 %             1.3 % Restructuring charges                           0.0              1.0              0.0 %             0.1 %  Total operating expenses                      516.6            460.4             73.0 %            68.3 % Income from equity investees                   70.6             67.8             10.0 %            10.1 %  Operating income                            $ 261.4       $    281.8             37.0 %            41.8 %   

CPG net revenues increased primarily due to the launch of Starbucks VIA ® Ready Brew (approximately $22 million) and the extra week in fiscal 2010 (approximately $16 million).

Operating margin decreased 480 basis points over the prior year due primarily to increased Starbucks VIA ® Ready Brew launch expenses.

  Other                                                   Oct 3,       Sep  27,          %      Fiscal Year Ended                          2010          2009          Change      Total net revenues                       $  150.8      $   124.2          21.4 %      Cost of sales                            $   89.4      $    71.7          24.7 %      Other operating expenses                     34.9           31.3          11.5 %      Depreciation and amortization expenses       47.4           49.8          (4.8 )%      General and administrative expenses         334.1          254.4          31.3 %      Restructuring charges                         0.0           58.1      

(100.0 )%

      Total operating expenses                    505.8          465.3           8.7 %      Loss from equity investee                    (3.3 )          0.0            nm       Operating loss                           $ (358.3 )    $  (341.1 )         5.0 %    Substantially all of net revenues in Other are generated from the Seattle's Best Coffee operating segment. The increase in revenues for Seattle's Best Coffee was primarily due to sales to new national accounts (contributing approximately $13 million).  Operating expenses included in Other relate to Seattle's Best Coffee and Digital Ventures as well as expenses pertaining to corporate administrative functions that support our 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. Total operating expenses increased $40.5 million primarily as a result of increased general and administrative expenses ($80 million) primarily due to higher performance-based compensation in 2010. This increase was partially offset by a decrease of $58 million in restructuring charges due to the completion of our restructuring activities within the non-store support organization.                                           33

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  SUMMARIZED QUARTERLY FINANCIAL INFORMATION (unaudited; in millions, except EPS)                                          First         Second          Third         Fourth          Total 2011: Net revenues                        $ 2,950.8      $ 2,785.7      $ 2,932.2      $ 3,031.9      $ 11,700.4 Operating income                        501.9          376.1          402.2          448.3         1,728.5 Net earnings attributable to Starbucks                               346.6          261.6          279.1          358.5         1,245.7 EPS - diluted                       $    0.45      $    0.34      $    0.36      $    0.47      $     1.62 2010: Net revenues                        $ 2,722.7      $ 2,534.7      $ 2,612.0      $ 2,838.0      $ 10,707.4 Operating income(1)                     352.6          339.8          327.7          399.3         1,419.4 Net earnings attributable to Starbucks(1)                            241.5          217.3          207.9          278.9           945.6 EPS - diluted                       $    0.32      $    0.28      $    0.27      $    0.37      $     1.24      

(1) Includes pretax restructuring charges of $18.3 million, $7.9 million,

$20.4 million and $6.4 million for the first, second, third and fourth

fiscal quarters respectively.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Investment Overview

Starbucks cash and short-term investments were $2.1 billion and $1.4 billion and as of October 2, 2011 and October 3, 2010, respectively. As of October 2, 2011, approximately $367.5 million of cash was held in foreign subsidiaries. Of our cash held in foreign subsidiaries, $69.5 million is denominated in the US dollar. We actively manage our cash and short-term investments in order to internally fund operating needs domestically and internationally, make scheduled interest and principal payments on our borrowings, and return cash to shareholders through common stock cash dividend payments and share repurchases. Our short-term investments consisted predominantly of US Treasury securities, commercial paper, corporate bonds, and US Agency securities. Also included in our short-term investment portfolio are certificates of deposit placed through an account registry service ("CDARS"), with maturities ranging from 91 days to one year, which we began investing into during the fourth quarter of fiscal year 2011. The principal amounts of the individual certificates of deposit do not exceed the Federal Deposit Insurance Corporation limits.  Our portfolio of long-term available for sale securities consists predominantly of high investment-grade corporate bonds, diversified among industries and individual issuers, as well as certificates of deposits placed through CDARS with maturities greater than 1 year. We also have investments in auction rate securities ("ARS"), all of which are classified as long-term. ARS totaling $28 million and $41 million were outstanding as of October 2, 2011 and October 3, 2010, respectively. The reduction in ARS was due to $16 million in redemptions during the fiscal year, with all redemptions done at par. While the ongoing auction failures will limit the liquidity of these ARS investments for some period of time, we do not believe this will materially impact our ability to fund our working capital needs, capital expenditures, shareholder dividends or other business requirements.  

Borrowing capacity

Starbucks previous $1 billion unsecured credit facility (the "2005 credit facility") was available through November of 2010, when we replaced the 2005 credit facility with a new $500 million unsecured credit facility (the "2010 credit facility") with various banks, of which $100 million may be used for issuances of letters of credit.  The 2010 credit facility is available for working capital, capital expenditures and other corporate purposes, including acquisitions and share repurchases and is currently set to mature in November 2014. Starbucks has the option, subject to negotiation and agreement with the related banks, to increase the maximum commitment amount by an additional $500 million. The interest rate for any borrowings under the credit facility, based on Starbucks current ratings and fixed charge coverage ratio, is 1.075% over LIBOR. The specific spread over LIBOR will depend upon                                           34 

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  our long-term credit ratings assigned by Moody's and Standard & Poor's rating agencies and our fixed charge coverage ratio. As with the 2005 credit facility, the 2010 credit facility contains 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 October 2, 2011 and October 3, 2010, we were in compliance with each of these covenants.  Under Starbucks commercial paper program we may issue unsecured commercial paper notes, up to a maximum aggregate amount outstanding at any time of $500 million</money>, with individual maturities that may vary, but not exceed 397 days from the date of issue. The program is backstopped by the 2010 credit facility, and the combined borrowing limit is $500 million for the commercial paper program and the credit facility. Starbucks may issue commercial paper from time to time, and the proceeds of the commercial paper financing will be used for working capital needs, capital expenditures and other corporate purposes, including acquisitions and share repurchases. The 2005 credit facility was also paired with a commercial paper program whereby we could issue unsecured commercial paper notes, up to a maximum amount outstanding at any time of $1 billion. The commercial paper program was secured by the 2005 credit facility, and the combined borrowing limit was $1 billion for the commercial paper program and the credit facility. During fiscal 2011 and fiscal 2010, there were no borrowings under the credit facilities or commercial paper programs. As of October 2, 2011 and October 3, 2010, a total of $17 million and $15 million in letters of credit were outstanding under the respective revolving credit facility.  The $550 million of 10-year 6.25% Senior Notes also require us to maintain compliance with certain covenants, including limits on future liens and sale and leaseback transactions on certain material properties. As of October 2, 2011 and October 3, 2010, we were in compliance with each of these covenants.  

Use of Cash

  We expect to use our cash and short-term investments, including any potential future borrowings under the credit facility and commercial paper program, to invest in our core businesses, including new product innovations and related marketing support, as well as other new business opportunities related to our core businesses. We believe that future cash flows generated from operations and existing cash and short-term investments both domestically and internationally will be sufficient to finance capital requirements for our core businesses in those respective markets as well as shareholder distributions for the foreseeable future. However, in the event that we need to repatriate all or a portion of our international cash to the US we would be subject to additional US income taxes.  We may use our available cash resources to make proportionate capital contributions to our equity method and cost method 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 equity method and cost method investees. Any decisions to increase such ownership interests will be driven by valuation and fit with our ownership strategy. Significant new joint ventures, acquisitions and/or other new business opportunities may require additional outside funding.  Other than normal operating expenses, cash requirements for fiscal 2012 are expected to consist primarily of capital expenditures for remodeling and refurbishment of, and equipment upgrades for, existing company-operated stores; systems and technology investments in the stores and in the support infrastructure; new company-operated stores; and additional investments in manufacturing capacity. Total capital expenditures for fiscal 2012 are expected to be in the range of approximately $800 million to $900 million.  During the second quarter of fiscal 2010, we declared our first ever cash dividend to shareholders of $0.10 per share. During the third quarter of fiscal 2010 and each subsequent quarter through the third quarter of fiscal 2011, we declared and paid a cash dividend to shareholders of $0.13 per share totaling $390 million and $171 million paid in fiscal 2011 and 2010, respectively. In the fourth quarter, we declared a cash dividend of $0.17 per share to be paid on December 2, 2011 with an expected payout of $127 million.  

During fiscal years 2011 and 2010, we repurchased 16 million and 11 million shares of common stock ($556 million and $286 million, respectively) under share repurchase authorizations. The number of remaining shares authorized for repurchase at October 2, 2011 totaled 24 million.

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Cash Flows

  Cash provided by operating activities was $1.6 billion for fiscal year 2011, compared to $1.7 billion for fiscal year 2010. The slight decrease was primarily attributable to an increase in inventories, resulting in part from higher coffee prices, partially offset by higher net earnings for the period and an increase in payables, primarily related to green coffee purchases.  Cash used by investing activities for fiscal year 2011 totaled $1.0 billion, compared to $790 million for fiscal year 2010. The increase was primarily due to increased purchases of available-for-sale securities and increased capital expenditures for remodeling and renovating existing company-operated stores, opening new retail stores and investments in information technology systems. The increase was partially offset by increased maturities and calls of available-for-sale securities and cash proceeds from the sale of corporate real estate during the year.  Cash used by financing activities for fiscal year 2011 totaled $608 million, compared to $346 million for fiscal year 2010. The increase was primarily due to an increase in cash returned to shareholders through dividend payments and common share repurchases in fiscal 2011. The increase was partially offset by increased proceeds from the exercise of stock options and the related excess tax benefits, resulting from more stock option exercises during the period.  The following table summarizes our contractual obligations and borrowings as of October 2, 2011, 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                                                     Less than 1         1 - 3          3 - 5        More than Contractual Obligations(1)            Total            Year             Years          Years         5 Years Operating lease obligations(2)      $ 4,057.9      $       751.2      $ 1,330.6      $   988.1      $    988.0 Purchase obligations(3)               1,099.5            1,018.9           74.6            6.0             0.0 Debt obligations(4)                     756.3               34.4           68.8           68.8           584.3 Other obligations(5)                    125.1               22.3           19.7           11.4            71.7  Total                               $ 6,038.8      $     1,826.8      $ 1,493.7      $ 1,074.3      $  1,644.0        (1)  Income tax liabilities for uncertain tax positions were excluded as we are 

not able to make a reasonably reliable estimate of the amount and period of

     related future payments. As of October 2, 2011, we had $52.9 million of      gross unrecognized tax benefits for uncertain tax positions.    

(2) Amounts include the 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 94% of total

     purchase obligations.    

(4) Debt amounts include principal maturities and scheduled interest payments on

     our long-term debt.    

(5) Other obligations include other long-term liabilities primarily consisting

of asset retirement obligations, capital lease obligations and hedging

instruments.

Starbucks currently expects to fund these commitments with operating cash flows generated in the normal course of business.

Off-Balance Sheet Arrangement

Off-balance sheet arrangements relate to certain guarantees and are detailed in Note 15 to the consolidated financial statements in this 10-K.

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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 things. We purchase, roast and sell high-quality whole bean 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 can be expected to impact our 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 an umbrella risk management policy. Under this policy, market-based risks are quantified and evaluated for potential mitigation strategies, such as entering into hedging transactions. The umbrella risk management policy governs the hedging instruments the business may use and limits the risk to net earnings. We also monitor and limit the amount of associated counterparty credit risk. Additionally, this policy restricts, among other things, the amount of market-based risk we will tolerate before implementing approved hedging strategies and prohibits speculative trading activity. In general, hedging instruments do not have maturities in excess of five years.  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, including coffee, dairy products and diesel that are used in our operations and are subject to price fluctuations that impact our financial results. In addition to fixed-price and price-to-be-fixed contracts for coffee purchases, we have entered into commodity hedges to manage commodity price risk using financial derivative instruments. We performed a sensitivity analysis based on a 10% change in the underlying commodity prices of our commodity hedges, as of October 2, 2011, and determined that such a change would not have a significant impact on the fair value of these instruments.  

Foreign Currency Exchange Risk

  The majority of our revenue, expense and capital purchasing activities are transacted in US dollars. However, because a portion of our operations consists of activities outside of the US, we have transactions in other currencies, primarily the Canadian dollar, British pound, euro, and Japanese yen. As a result, we may engage in transactions involving various derivative instruments to hedge revenues, inventory purchases, assets, and liabilities denominated in foreign currencies.  As of October 2, 2011, we had forward foreign exchange contracts that hedge portions of anticipated international revenue streams and inventory purchases. In addition, we had forward foreign exchange contracts that qualify as accounting hedges of our net investment in Starbucks Japan to minimize foreign currency exposure.  Starbucks also had forward foreign exchange contracts that are not designated as hedging instruments for accounting purposes (free standing derivatives), but which largely offset the financial impact of translating certain foreign currency denominated payables and receivables. Increases or decreases in the fair value of these derivatives are generally offset by corresponding decreases or increases in the US dollar value of our foreign currency denominated payables and receivables (i.e. "hedged items") that would occur within the period.                                           37

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  The following table summarizes the potential impact as of October 2, 2011 to Starbucks future net earnings and other comprehensive income ("OCI") from changes in the fair value of these derivative financial instruments due in turn to a change in the value of the US dollar as compared to the level of 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               10% Decrease  in             10% Increase  in                10% Decrease  in                                 Underlying Rate                 Underlying Rate             Underlying Rate                  Underlying Rate

Foreign currency hedges        $               35              $             (35 )         $               15             $                 (15 )    Equity Security Price Risk  We have minimal exposure to price fluctuations on equity mutual funds and equity exchange-traded funds within our trading portfolio. The trading securities approximate a portion of our liability under the Management Deferred Compensation Plan ("MDCP"). A corresponding liability is included in accrued compensation and related costs on the consolidated balance sheets. These investments are recorded at fair value with unrealized gains and losses recognized in net interest income and other in the consolidated statements of earnings. The offsetting changes in the MDCP liability are recorded in general and administrative expenses. We performed a sensitivity analysis based on a 10% change in the underlying equity prices of our investments as of October 2, 2011 and determined that such a change would not have a significant impact on the fair value of these instruments.  

Interest Rate Risk

  We utilize short-term and long-term financing and may use interest rate hedges to manage the effect of interest rate changes on our existing debt as well as the anticipated issuance of new debt. As of October 2, 2011 and October 3, 2010, we did not have any interest rate hedge agreements outstanding.  

The following table summarizes the impact of a change in interest rates as of October 2, 2011 on the fair value of Starbucks debt (in millions):

                                                                               Change in Fair Value                                                     100 Basis Point Increase in               100 Basis Point Decrease in                             Fair Value                    Underlying Rate                           Underlying Rate Debt                       $        648            $                         (33 )            $                         33    Our available-for-sale securities comprise a diversified portfolio consisting mainly of fixed income instruments. The primary objectives of these investments are to preserve capital and liquidity. Available-for-sale securities are recorded on the consolidated balance sheets at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income. We do not hedge the interest rate exposure on our available-for-sale securities. We performed a sensitivity analysis based on a 100 basis point change in the underlying interest rate of our available-for-sale securities as of October 2, 2011, 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.                                           38

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  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. We believe that of our significant accounting policies, the following policies involve a higher degree of judgment and/or complexity:  

Asset Impairment

  When facts and circumstances indicate that the carrying values of long-lived assets may not be recoverable, we evaluate long-lived assets for impairment. We first compare the carrying value of the asset to the asset's estimated future undiscounted cash flows. If the estimated future cash flows are less than the carrying value of the asset, we measure an impairment loss based on the asset's estimated fair value. For retail 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 based on internal projections. Key assumptions used in this calculation include revenue growth, operating expenses and a discount rate that we believe a buyer would assume when determining a purchase price for the store. Estimates of revenue growth and operating expenses are based on internal projections and consider a store's historical performance, local market economics and the business environment impacting the store's performance. These estimates are subjective and can be significantly impacted by changes in the business or economic conditions. For non-retail 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 loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values, including forecasting asset useful lives. Further, our ability to realize undiscounted cash flows in excess of the carrying values of our assets is affected by factors such as the ongoing maintenance and improvement of the assets, changes in economic conditions, and changes in operating performance. During the past three fiscal years, we have not made any material changes in the accounting methodology that we use to assess long-lived asset impairment loss. For the foreseeable future, we do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions that we use to calculate long-lived asset impairment losses. 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 Impairment

  We test goodwill for impairment on an annual basis during our third fiscal quarter, or more frequently if circumstances, such as material deterioration in performance or a significant number of store closures, indicate reporting unit carrying values may exceed their fair values. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge is recorded to reduce the carrying value to the implied estimated fair value. The fair value of our reporting units is the price a willing buyer would pay for the reporting unit and is typically calculated using a discounted cash flow model. Key assumptions used in this calculation include revenue growth, operating expenses and discount rate that we believe a buyer would assume when determining a purchase price for the reporting unit. Estimates of revenue growth and operating expenses are based on internal projections considering a reporting unit's past performance and forecasted growth, local market economics and the local business environment impacting the reporting unit's performance. The discount rate is calculated using an estimated cost of capital for a retail operator to operate the reporting unit in the region. These estimates are highly subjective judgments and can be significantly impacted by changes in the business or economic conditions.  Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate the fair value of our reporting units, including estimating future cash flows, and if necessary, the fair value of a reporting units' assets and liabilities. Further, our ability to realize the future cash flows used in our fair value calculations is affected by factors such as changes in economic conditions, changes in our operating performance, and changes in our business strategies.                                           39

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  As a part of our ongoing operations, we may close certain stores within a reporting unit containing goodwill due to underperformance of the store or inability to renew our lease, among other reasons. We abandon certain assets associated with a closed store including leasehold improvements and other non-transferrable assets. Under GAAP, when a portion of a reporting unit that constitutes a business is to be disposed of, goodwill associated with the business is included in the carrying amount of the business in determining any loss on disposal. Our evaluation of whether the portion of a reporting unit being disposed of constitutes a business occurs on the date of abandonment. Although an operating store meets the accounting definition of a business prior to abandonment, it does not constitute a business on the closure date because the remaining assets on that date do not constitute an integrated set of assets that are capable of being conducted and managed for the purpose of providing a return to investors. As a result, when closing individual stores, we do not include goodwill in the calculation of any loss on disposal of the related assets. As noted above, if store closures are indicative of potential impairment of goodwill at the reporting unit level, we perform an evaluation of our reporting unit goodwill when such closures occur.  During the past three fiscal years, we have not made any material changes in the accounting methodology that we use to assess goodwill impairment loss. For fiscal 2011, we determined the fair value of our reporting units was substantially in excess of their carrying values. Accordingly, we did not recognize any goodwill impairments during the current fiscal year. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions that we use to test for impairment losses on goodwill in the foreseeable future. However, as we periodically reassess our fair value calculations, including estimated future cash flows, changes in our estimates and assumptions may cause us to realize material impairment charges in the future.  Stock-based Compensation  We measure the fair value of stock awards at the grant date based on the fair value of the award and recognize the expense over the related service period. For stock option awards we use the Black-Scholes-Merton option pricing model which requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their stock options before exercising them ("expected term"), the estimated volatility of our common stock price over the expected term and the expected dividend yield. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those stock awards expected to vest. We estimate the forfeiture rate based on historical experience. Changes in our assumptions could materially affect the estimate of fair value of stock-based compensation.  We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions that we use to calculate stock-based compensation expense for the foreseeable future. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in stock-based compensation expense that could be material in the future. For fiscal 2011, a 10% change in our critical assumptions, including volatility and expected term, would have changed stock-based compensation expense by approximately $15 million for fiscal 2011.  

Operating Leases

  We lease retail stores, roasting and distribution facilities and office space under operating leases. We provide for an estimate of our asset retirement obligation ("ARO") at the lease inception date for operating leases with requirements to remove leasehold improvements at the end of the lease term. Our estimates of AROs involve assumptions regarding both the amount and timing of actual future retirement costs. The initial ARO asset and liability represent the present value of the estimated future costs to complete the required work. The ARO asset is depreciated over the same timeframe as the associate leasehold improvements, and the liability is accreted over time. Future actual costs could differ significantly from amounts initially estimated.  We occasionally vacate stores and other locations prior to the expiration of the related lease. For vacated locations with remaining lease commitments, we record an expense for the difference between the present value of our future lease payments and related costs (e.g., real estate taxes and common area maintenance) from the date of closure through the end of the remaining lease term, net of expected future sublease rental income. Key assumptions in our                                           40

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  estimate of future cash flows include estimated sublease income and lease termination costs. These estimates are based on historical experience; our analysis of the specific real estate market, including input from independent real estate firms; and economic conditions that can be difficult to predict. Cash flows are discounted using a rate that coincides with the remaining lease term.  The liability recorded for location closures contains uncertainties because management is required to make assumptions and to apply judgment to estimate the duration of future vacancy periods, the amount and timing of future settlement payments, and the amount and timing of potential sublease rental income.  During the past three fiscal years, we have not made any material changes in the accounting methodology that we use to calculate our lease abandonment accrual. For the foreseeable future, we do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions that we use to calculate our lease abandonment accrual. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.  

A 10% change in our key assumptions for our lease abandonment accrual at October 2, 2011, would not have had a significant impact on net earnings for fiscal 2011.

  Self Insurance Reserves  We use a combination of insurance and self-insurance mechanisms, including a wholly owned captive insurance entity and participation in a reinsurance treaty, to provide for the potential liabilities for certain risks, including workers' compensation, healthcare benefits, general liability, property insurance, and director and officers' liability insurance. Key assumptions used in the estimate of our self insurance reserves include the amount of claims incurred but not reported at the balance sheet date. These liabilities, which are associated with the risks that are retained by Starbucks are not discounted and are estimated, in part, by considering historical claims experience, demographic, exposure and severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.  Our self-insured liabilities contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported at the balance sheet date. Periodically, we review our assumptions to determine the adequacy of our self-insured liabilities.  During the past three fiscal years, we have not made any material changes in the accounting methodology that we use to calculate our self-insurance liabilities. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions that we use to calculate our self-insurance liabilities for the foreseeable future. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.  

A 10% change in our self-insurance reserves at October 2, 2011 would have affected net earnings by approximately $13 million in fiscal 2011.

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 addition, our income tax returns are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions taken and the allocation of income among various tax jurisdictions. We evaluate our exposures associated with our various tax filing positions and record a related liability. We adjust our liability for unrecognized tax benefits and income tax provision in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position, or when more information becomes available.                                           41

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  Deferred tax asset valuation allowances and our liability 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.  

Litigation Accruals

  We are involved in various claims and legal actions that arise in the ordinary course of business. Legal and other contingency reserves and related disclosures are based on our assessment of the likelihood of a potential loss and our ability to estimate the loss or range of loss, which includes consultation with outside legal counsel and advisors. We record reserves related to legal matters when it is probable that a loss has been incurred and the range of such loss can be reasonably estimated. Such assessments are reviewed each period and revised, based on current facts and circumstances and historical experience with similar claims, as necessary.  Our disclosures of and accruals for litigation claims, if any, contain uncertainties because management is required to use judgment to estimate the probability of a loss and a range of possible losses related to each claim. Footnote 15 to the consolidated financial statements describes the Company's legal and other contingent liability matters.  As we periodically review our assessments of litigation accruals, we may change our assumptions with respect to loss probabilities and ranges of potential losses. Any changes in these assumptions could have a material impact on our future results of operations.  

RECENT ACCOUNTING PRONOUNCEMENTS

  See Note 1 to the consolidated financial statements in this 10-K for a detailed description of recent accounting pronouncements. We do not expect these recently issued accounting pronouncements to have a material impact on our results of operations, financial condition, or liquidity in future periods. 

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