Starbucks 2003 Annual Report Download - page 10

22฀ Fiscal฀2003฀Annual฀Report
Fiscal฀2003฀Annual฀Report฀ 23
฀
COFFEE฀PRICES,฀AVAILABILITY฀AND฀
GENERAL฀RISK฀CONDITIONS
The฀ supply฀ and฀ price฀ of฀ coffee฀ are฀ subject฀ to฀ significant฀
volatility.฀ Although฀ most฀ coffee฀ trades฀ in฀ the฀ commodity฀
market,฀ coffee฀ of฀ the฀ quality฀ sought฀ by฀ Starbucks฀ tends฀ to฀
trade฀ on฀ a฀ negotiated฀ basis฀ at฀ a฀ substantial฀ premium฀ above฀
commodity฀ coffee฀ prices,฀ depending฀ upon฀ the฀ supply฀ and฀
demand฀ at฀ the฀ time฀ of฀ purchase.฀ Supply฀ and฀ price฀ can฀ be฀
affected฀ by฀ multiple฀ factors฀ in฀ the฀ producing฀ countries,฀
including฀ weather,฀ political฀ and฀ economic฀ conditions.฀ In฀
addition,฀ green฀ coffee฀ prices฀ have฀ been฀ affected฀ in฀ the฀ past฀
and฀may฀ be฀ affected฀ in฀ the฀ future฀ by฀ the฀actions฀ of฀ certain฀
organizations฀and฀associations฀that฀have฀historically฀attempted฀
to฀ inf luence฀ commodity฀ prices฀ of฀ green฀ coffee฀ through฀
agreements฀ establishing฀ export฀ quotas฀ or฀ restricting฀ coffee฀
supplies฀ worldwide.฀ The฀ Company’s฀ ability฀ to฀ raise฀ sales฀
prices฀in฀response฀to฀rising฀coffee฀prices฀may฀be฀limited,฀and฀
the฀ Company’s฀ profitability฀ could฀ be฀ adversely฀ affected฀ if฀
coffee฀prices฀were฀to฀rise฀substantially.฀
The฀Company฀enters฀into฀fixed-price฀purchase฀commitments฀
in฀order฀to฀secure฀an฀adequate฀supply฀of฀quality฀green฀coffee฀
and฀bring฀greater฀certainty฀to฀the฀cost฀of฀sales฀in฀future฀periods.฀
As฀of฀September฀28,฀2003,฀the฀Company฀had฀approximately฀
$287.2฀million฀in฀fixed-price฀purchase฀commitments฀which,฀
together฀ with฀ existing฀ inventory,฀ is฀ expected฀ to฀ provide฀ an฀
adequate฀supply฀of฀green฀coffee฀through฀calendar฀2004.฀The฀
Company฀believes,฀based฀on฀relationships฀established฀with฀its฀
suppliers฀ in฀ the฀ past,฀ that฀ the฀ risk฀ of฀ non-delivery฀ on฀ such฀
purchase฀commitments฀is฀low.฀
In฀ addition฀ to฀ f luctuating฀ coffee฀ prices,฀ management฀
believes฀that฀the฀Company’s฀future฀results฀of฀operations฀and฀
earnings฀ could฀ be฀ significantly฀ impacted฀ by฀ other฀ factors฀
such฀ as฀ increased฀ competition฀ within฀ the฀ specialty฀ coffee฀
industry,฀ fluctuating฀ dairy฀ prices,฀ the฀ Company’s฀ ability฀
to฀ find฀ optimal฀ store฀ locations฀ at฀ favorable฀ lease฀ rates,฀
increased฀costs฀associated฀ with฀ opening฀and฀operating฀retail฀
stores฀ and฀ the฀ Company’s฀ continued฀ ability฀ to฀ hire,฀ train฀
and฀ retain฀ qualified฀ personnel,฀ and฀ other฀ factors฀ discussed฀
under฀ “Certain฀ Additional฀ Risks฀ and฀ Uncertainties”฀ in฀ the฀
“Business”฀section฀of฀the฀Company’s฀annual฀report฀on฀Form฀
10-K฀for฀the฀fiscal฀year฀ended฀September฀28,฀2003.฀
FINANCIAL฀RISK฀MANAGEMENT฀
The฀ Company฀ is฀ exposed฀ to฀ market฀ risk฀ related฀ to฀ foreign฀
currency฀exchange฀rates,฀equity฀security฀prices฀and฀changes฀
in฀interest฀rates.
Foreign฀Currency฀Exchange฀Risk
The฀majority฀of฀the฀Company’s฀revenue,฀expense฀and฀capital฀
purchasing฀activities฀ are฀ transacted฀ in฀ United฀States฀dollars.฀
However,฀ because฀ a฀ portion฀ of฀ the฀ Company’s฀ operations฀
consists฀of฀activities฀outside฀of฀the฀United฀States,฀the฀Company฀
has฀transactions฀in฀other฀currencies,฀primarily฀the฀Canadian฀
dollar,฀British฀pound,฀ Euro฀and฀Japanese฀yen.฀As฀ part฀of฀its฀
risk฀management฀strategy,฀the฀Company฀frequently฀evaluates฀
its฀ foreign฀ currency฀ exchange฀ risk฀ by฀ monitoring฀ market฀
data฀ and฀ external฀ factors฀ that฀ may฀ inf luence฀ exchange฀ rate฀
fluctuations.฀As฀a฀result,฀Starbucks฀may฀engage฀in฀transactions฀
involving฀ various฀ derivative฀ instruments,฀ with฀ maturities฀
generally฀not฀exceeding฀five฀years,฀to฀hedge฀assets,฀liabilities,฀
revenues฀ and฀ purchases฀ denominated฀ in฀ foreign฀ currencies.฀
As฀of฀September฀28,฀2003,฀the฀Company฀had฀forward฀foreign฀
exchange฀ contracts฀ that฀ qualify฀ as฀ cash฀ f low฀ hedges฀ under฀
SFAS฀ No.฀ 133,฀ “Accounting฀ for฀ Derivative฀ Instruments฀
and฀ Hedging฀ Activities,”฀ to฀ hedge฀ a฀ portion฀ of฀ anticipated฀
international฀ revenue.฀ In฀ addition,฀ Starbucks฀ had฀ forward฀
foreign฀exchange฀contracts฀that฀qualify฀as฀a฀hedge฀of฀its฀net฀
investment฀ in฀ Starbucks฀ Coffee฀ Japan,฀ Ltd.฀ These฀ contracts฀
expire฀within฀24฀months.฀
Based฀ on฀ the฀ foreign฀ exchange฀ contracts฀ outstanding฀ as฀ of฀
September฀28,฀2003,฀a฀10%฀devaluation฀of฀the฀United฀States฀
dollar฀as฀compared฀to฀the฀level฀of฀foreign฀exchange฀rates฀for฀
currencies฀under฀ contract฀ as฀ of฀September฀ 28,฀ 2003,฀would฀
result฀ in฀ a฀ reduction฀ in฀ the฀ fair฀ value฀ of฀ these฀ derivative฀
financial฀ instruments฀ of฀ approximately฀ $17฀ million,฀ of฀
which฀ $7฀ million฀ may฀ reduce฀ the฀ Company’s฀ future฀ net฀
earnings.฀Conversely,฀a฀10%฀appreciation฀of฀the฀United฀States฀
dollar฀ would฀ result฀ in฀ an฀ increase฀ in฀ the฀ fair฀ value฀ of฀ these฀
instruments฀of฀approximately฀$6฀million,฀of฀which฀$4฀million฀
may฀increase฀the฀Company’s฀future฀net฀earnings.฀Consistent฀
with฀ the฀ nature฀ of฀ the฀ economic฀ hedges฀ provided฀ by฀ these฀
foreign฀exchange฀contracts,฀increases฀or฀decreases฀in฀the฀fair฀
value฀would฀be฀mostly฀offset฀by฀corresponding฀decreases฀or฀
increases,฀respectively,฀in฀the฀dollar฀value฀of฀the฀Company’s฀
foreign฀ investment฀ and฀ future฀ foreign฀ currency฀ royalty฀ and฀
license฀ fee฀ payments฀ that฀ would฀ be฀ received฀ within฀ the฀
hedging฀period.
Equity฀Security฀Price฀Risk
The฀Company฀has฀minimal฀exposure฀to฀price฀fluctuations฀on฀
equity฀mutual฀funds฀within฀its฀trading฀portfolio.฀The฀trading฀
securities฀ are฀ designated฀ to฀ approximate฀ the฀ Company’s฀
liability฀under฀the฀Management฀Deferred฀Compensation฀Plan฀
(“MDCP”).฀A฀corresponding฀liability฀is฀included฀in฀“Accrued฀
compensation฀ and฀ related฀ costs”฀ on฀ the฀ accompanying฀
consolidated฀balance฀sheets.฀These฀investments฀are฀recorded฀
at฀fair฀ value฀with฀ unrealized฀gains฀ and฀losses฀ recognized฀in฀
“Interest฀ and฀ other฀ income,฀ net.”฀ The฀ offsetting฀ changes฀
in฀ the฀ MDCP฀ liability฀ are฀ recorded฀ in฀ “General฀ and฀
administrative฀expenses”฀on฀the฀accompanying฀consolidated฀
statements฀of฀earnings.฀
Interest฀Rate฀Risk
The฀ Company’s฀ diversified฀ available-for-sale฀ portfolios฀
consist฀ mainly฀ of฀ fixed฀ income฀ instruments.฀ The฀ primary฀
objectives฀ of฀ these฀ investments฀ are฀ to฀ preserve฀ capital฀ and฀
liquidity.฀ Available-for-sale฀ securities฀ are฀ of฀ investment฀
grade฀and฀are฀recorded฀on฀the฀balance฀sheet฀at฀fair฀value฀with฀
unrealized฀gains฀and฀losses฀reported฀as฀a฀separate฀component฀
of฀ “Accumulated฀ other฀ comprehensive฀ income/(loss).”฀ The฀
Company฀ does฀ not฀ hedge฀ its฀ interest฀ rate฀ exposure.฀ The฀
Company฀ performed฀ a฀ sensitivity฀ analysis฀ based฀ on฀ a฀ 10%฀
change฀in฀the฀underlying฀interest฀rate฀of฀its฀interest฀bearing฀
financial฀ instruments฀ held฀ at฀ the฀ end฀ of฀ fiscal฀ 2003฀ and฀
determined฀ that฀ such฀ a฀ change฀ would฀ not฀ have฀ a฀ material฀
effect฀on฀the฀fair฀value฀of฀these฀instruments.
SEASONALITY฀AND฀QUARTERLY฀RESULTS
The฀ Company’s฀ business฀ is฀ subject฀ to฀ seasonal฀ f luctuations.฀
Significant฀ portions฀ of฀ the฀ Company’s฀ net฀ revenues฀ and฀
profits฀are฀realized฀during฀the฀first฀quarter฀of฀the฀Company’s฀
fiscal฀year,฀which฀includes฀the฀December฀holiday฀season.฀In฀
addition,฀ quarterly฀ results฀ are฀ affected฀ by฀ the฀ timing฀ of฀ the฀
opening฀of฀new฀stores,฀and฀the฀Company’s฀rapid฀growth฀may฀
conceal฀ the฀ impact฀ of฀ other฀ seasonal฀ inf luences.฀ 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.฀
APPLICATION฀OF฀CRITICAL฀ACCOUNTING฀POLICIES
Critical฀accounting฀policies฀are฀those฀that฀management฀believes฀
are฀both฀most฀important฀to฀ the฀portrayal฀of฀the฀Company’s฀
financial฀ condition฀ and฀ results,฀ and฀ require฀ management’s฀
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.฀
Starbucks฀ considers฀ its฀ policies฀ on฀ impairment฀ of฀ long-
lived฀ assets฀ to฀ be฀ most฀ critical฀ in฀ understanding฀ the฀
judgments฀that฀are฀involved฀in฀preparing฀its฀consolidated฀
financial฀statements.฀
Impairment฀of฀Long-Lived฀Assets
When฀ facts฀ and฀ circumstances฀ indicate฀ that฀ the฀ carrying฀
values฀ of฀ long-lived฀ assets฀ may฀ be฀ impaired,฀ an฀ evaluation฀
of฀ recoverability฀ is฀ performed฀ by฀ comparing฀ the฀ carrying฀
value฀of฀the฀assets฀to฀projected฀future฀cash฀f lows฀in฀addition฀
to฀other฀quantitative฀and฀qualitative฀analyses.฀For฀goodwill฀
and฀other฀ intangible฀assets,฀impairment฀tests฀ are฀performed฀