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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended December 28, 2003

OR

For the transition period from            to            .

Commission File Number: 0-20322

STARBUCKS CORPORATION

2401 Utah Avenue South, Seattle, Washington 98134
(Address of principal executive offices)

(206) 447-1575
(Registrant’s Telephone Number, including Area Code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x          No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Yes x          No  o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

STARBUCKS CORPORATION

FORM 10-Q

For the Quarterly Period Ended December 28, 2003

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

STARBUCKS CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except earnings per share)
(unaudited)

See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)

       See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the 13 Weeks Ended December 28, 2003

Note 1: Financial Statement Preparation

The consolidated financial statements as of December 28, 2003, and September 28, 2003, and for the 13-week periods ended December 28, 2003, and December 29, 2002, have been prepared by Starbucks Corporation (“Starbucks” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The financial information for the 13-week periods ended December 28, 2003, and December 29, 2002, is unaudited, but, in the opinion of management, reflects all adjustments and accruals necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods.

The financial information as of September 28, 2003, is derived from the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended September 28, 2003 (“Fiscal 2003”), included in Item 8 in the Fiscal 2003 Annual Report on Form 10-K, and should be read in conjunction with such financial statements.

Certain reclassifications of prior year’s balances have been made to conform to the current format.

The results of operations for the 13-week period ended December 28, 2003, are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending October 3, 2004.

Note 2: Summary of Significant Accounting Policies

Revenue Recognition

In most instances, Company-operated retail store revenues are recognized when payment is tendered at the point of sale. Revenues from stored value cards are recognized upon redemption. Until the redemption of stored value cards, outstanding customer balances on such cards are included in “Deferred revenue” on the accompanying consolidated balance sheets. Specialty revenues consist primarily of product sales to customers other than through Company-operated retail stores, as well as royalties and other fees generated from licensing operations. Sales of coffee, tea and related products are generally recognized upon shipment to customers. Initial non-refundable development fees required under licensing agreements are recognized upon substantial performance of services for new market business development activities, such as initial business, real estate and store development planning as well as providing operational materials and functional training courses for opening new licensed retail markets. Additional store licensing fees are recognized when new licensed stores are opened. Royalty revenues based upon a percentage of reported sales and other continuing fees, such as marketing and service fees, are recognized on a monthly basis when earned. Arrangements involving multiple elements and deliverables are individually evaluated for revenue recognition. Cash payments received in advance of product or service revenue are recorded as deferred revenue. Consolidated revenues are net of all intercompany eliminations for wholly owned subsidiaries and for licensees accounted for under the equity method based on the Company’s percentage ownership. All revenues are recognized net of any discounts.

Accounting for Stock-Based Compensation

The Company maintains several stock option plans under which incentive stock options and non-qualified stock options may be granted to employees, consultants and non-employee directors. Starbucks accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, because the grant price equals the market price on the date of grant, no compensation expense is recognized by the Company for stock options issued to employees.

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Had compensation cost for the Company’s stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology allowed by Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure,” the Company’s net earnings and earnings per share would have been as follows (in thousands, except earnings per share):

The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and the Company’s experience.

Recently Issued Accounting Pronouncements

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 Revised, “Consolidation of Variable Interest Entities – an Interpretation of ARB No. 51” (“FIN No. 46R”), which provided, among other things, immediate deferral of the application of FIN No. 46 for entities which did not originally qualify as special purpose entities, and provided additional scope exceptions for joint ventures with business operations and franchises. The Company’s adoption of FIN No. 46R did not have an impact on its consolidated financial statements.

Note 3: Inventories

Inventories consist of the following (in thousands):

As of December 28, 2003, the Company had committed to fixed-price purchase contracts for green coffee totaling approximately $391.4 million.

Note 4: Derivative Financial Instruments

Cash Flow Hedges

Cash flow derivative instruments hedge portions of anticipated revenue streams and purchases denominated in Japanese yen, Canadian dollars and/or United States dollars. These contracts expire within 21 months. During the 13-week periods ended December 28, 2003, and December 29, 2002, derivative losses of $0.5 million and $0.2 million were reclassified into revenues, respectively. During the 13-week period ended December 28, 2003, derivative losses of $0.2 million were reclassified into cost of sales. The Company had accumulated net derivative losses of $2.8 million, net of taxes, in other comprehensive income as of December 28, 2003, related to cash flow hedges. Of this amount, $2.0 million of net derivative losses will be reclassified into earnings within 12 months. No significant cash flow hedges were discontinued during the 13-week periods ended December 28, 2003, and

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December 29, 2002.

Net Investment Hedges

Net investment derivative instruments hedge the Company’s equity method investment in Starbucks Coffee Japan, Ltd. These contracts expire within 11 months and are intended to minimize foreign currency exposure to fluctuations in the Japanese yen. As a result of using the spot-to-spot method, the Company recognized net gains of $0.1 million and $0.4 million for the 13-week periods ended December 28, 2003, and December 29, 2002, respectively. In addition, the Company had accumulated net derivative losses of $5.3 million, net of taxes, in other comprehensive income as of December 28, 2003.

Note 5: Property, Plant, and Equipment

Property, plant and equipment are recorded at cost and consist of the following (in thousands):

Note 6: Shareholders’ Equity

Pursuant to the Company’s authorized share repurchase programs, Starbucks acquired 1.5 million shares at an average price of $20.62 for a total cost of $29.9 million during the 13-week period ended December 29, 2002. No shares were repurchased during the 13-week period ended December 28, 2003. As of December 28, 2003, there were approximately 14.6 million additional shares authorized for repurchase. Share repurchases are funded through cash, cash equivalents and available-for-sale securities.

Note 7: Comprehensive Income

Comprehensive income, net of related tax effects, is as follows (in thousands):

The increase in the translation adjustment for the 13 weeks ended December 28, 2003, was primarily due to the weakening of the United States dollar against the Euro, pound sterling and Japanese yen.

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Note 8: Earnings Per Share

The following table represents the calculation of net earnings per common share – basic (in thousands, except earnings per share):

The following table represents the calculation of net earnings per common and common equivalent share – diluted (in thousands, except earnings per share):

Options with exercise prices greater than the average market price were not included in the computation of diluted earnings per share. For the 13-week period ended December 28, 2003, these options totaled 44,320 and for the 13-week period ended December 29, 2002, these options totaled 1.8 million, during which periods the average market price of the Company’s common stock was $31.52 and $21.90, respectively.

Note 9: Commitments and Contingencies

The Company has unconditionally guaranteed the repayment of certain yen-denominated bank loans and related interest and fees of an unconsolidated equity investee, Starbucks Coffee Japan, Ltd. The guarantees continue until the loans, including accrued interest and fees, have been paid in full. The maximum amount is limited to the sum of unpaid principal and interest amounts, as well as other related expenses. These amounts will vary based on fluctuations in the yen foreign exchange rate. As of December 28, 2003, the maximum amount of the guarantees was approximately $12.3 million.

Additionally, Starbucks has unconditionally guaranteed 5% of a Chinese renminbi-denominated credit facility of Shanghai President Coffee Co., an unconsolidated equity investee. The guarantee amount will vary based on fluctuations in the Chinese renminbi foreign exchange rate. As of December 28, 2003, the outstanding amount of the guarantee was approximately $42,000.

Coffee brewing and espresso equipment sold to customers through Company-operated and licensed retail stores as well as equipment sold to the Company’s licensees for use in retail licensing operations are under warranty for defects in materials and workmanship for a period ranging from 12 months to 24 months. The Company establishes an accrual for estimated warranty costs at the time of sale, based on historical experience. Product warranty costs and changes to the related accrual were not significant for the 13 weeks ended December 28, 2003.

The Company is party to various legal proceedings arising in the ordinary course of its business, but it is not currently a party to any legal proceeding that management believes would have a material adverse effect on the financial position or results of operations of the Company.

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Note 10: Segment Reporting

Segment information is prepared on the same basis that the Company’s management internally reviews financial information for operational decision making purposes. The tables below present information by operating segment for the 13 weeks ended (in thousands):

		(1) For purposes of internal management and segment reporting, licensed operations in Hawaii and Puerto Rico are included in the International segment, although geographically they are part of the United States.
		(2) Unallocated corporate includes certain general and administrative expenses, related depreciation and amortization expenses and amounts included in “Interest and other income, net” on the accompanying consolidated statements of earnings.

The tables below represent information by geographic area (in thousands):

Revenues from foreign countries are based on the geographic location of the customers and consist primarily of revenues from the United Kingdom and Canada, which together account for approximately 82% of these revenues, as well as specialty revenues generated from product sales to international licensees. No customer accounts for 10% or more of the Company’s revenues.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements herein, including anticipated store openings, trends in or expectations regarding Starbucks Corporation’s revenue growth, operating expenses, capital expenditures, and net earnings, all constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, coffee, dairy and other raw materials prices and availability, successful execution of internal performance and expansion plans, fluctuations in United States and international economies, ramifications from the war on terrorism, or other international events or developments, the impact of competitors’ initiatives, the effect of legal proceedings, and other risks detailed herein and in Starbucks Corporation’s other filings with the Securities and Exchange Commission, including the “Certain Additional Risks and Uncertainties” section of the Starbucks Annual Report on Form 10-K for the fiscal year ended September 28, 2003.

A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Users should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. The Company is under no obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.

This information should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 28, 2003.

General

Starbucks Corporation’s fiscal year ends on the Sunday closest to September 30. Fiscal year 2003 had 52 weeks. The fiscal year ending on October 3, 2004, will include 53 weeks, with the 53rd week falling entirely in the fourth fiscal quarter.

Management’s Overview

During the 13 weeks ended December 28, 2003, Starbucks established a strong foundation for achieving its full year operational targets, which include: (1) opening 1,300 new retail stores on a global basis, (2) increasing total net revenues by approximately 20%, and (3) increasing earnings per share by 20-25% compared to fiscal year 2003.

Historically, the primary driver of the Company’s revenue growth has been the opening of new retail stores, both Company-operated and licensed, in the United States. Since entering Japan in 1996, Starbucks first retail market outside of North America, the Company accelerated its international expansion plans for both Company-operated and licensed retail stores to pursue the Company’s objective to establish Starbucks as the most recognized and respected brand in the world. With a presence today in more than 30 countries, management believes that the Company’s long term goal of operating at least 25,000 Starbucks retail locations throughout the United States and in International markets is achievable. Management also believes the Company has the personnel and the financial resources to continue to open retail stores at or above the current rate for the foreseeable future.

In addition to opening new retail stores, Starbucks is targeting to increase revenues generated at Company-operated stores open for 13 months or longer (comparable store sales growth) by 3-7% by attracting new customers and increasing the frequency of visits by current customers. The strategy to achieve this target is to continuously improve the level of customer service, maintain a steady stream of product innovation and improve the speed of service through training, technology and process improvement. In the first quarter of fiscal 2004, comparable store sales in Company-operated markets increased by 10% as a result of these efforts. Most noteworthy were the strong holiday sales of seasonal products and the increased usage of the Starbucks stored value card. In licensed markets, Starbucks shared operating and store development experience to help licensees improve the profitability of existing stores and build new stores, which generated additional royalty income and product sales.

The combination of more retail stores, higher revenues from existing stores, and growth in other related activities in both the United States and International segments resulted in a 27.7% increase in total net revenues in the first

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quarter of fiscal 2004 compared to the first quarter of fiscal 2003, which was well above the Company’s target. Since additional retail stores can leverage existing support organizations and facilities, that infrastructure can be expanded more slowly than the rate of revenue growth and generate margin improvement. In the first quarter of fiscal 2004, operating income as a percentage of total net revenues increased to 13.7% from 12.0% in the comparable period of fiscal 2003, and net earnings increased by 41.4%, compared to the first quarter of fiscal 2003.

Management realizes that comparable store sales growth at the current level is not sustainable over the long term. However, management believes that new store development opportunities on a global basis are sufficient for the Company to maintain a high level of unit growth for the foreseeable future and that the execution of the current retail operating strategy can achieve 3-7% comparable store sales growth. These revenue growth opportunities, coupled with continuous focus on controlling both operating and capital costs, should allow Starbucks to continue to leverage the existing infrastructure, improve margins and achieve annual earnings per share growth of 20-25%

Results of Operations for the 13 Weeks Ended December 28, 2003 and December 29, 2002

CONSOLIDATED RESULTS

Net revenues for the 13 weeks ended December 28, 2003, increased 27.7% to $1.3 billion from $1.0 billion for the corresponding period of fiscal 2003. During the 13-week period ended December 28, 2003, Starbucks derived approximately 84.3% of total net revenues from its Company-operated retail stores. Company-operated retail revenues increased 27.2% to $1.1 billion for the 13 weeks ended December 28, 2003, from $849.5 million for the same period in fiscal 2003. The increase was primarily attributable to the opening of 670 new Company-operated retail stores in the last 12 months and comparable store sales growth of 10% for the 13 weeks ended December 28, 2003. The increase in comparable store sales was due almost entirely to an increase in the number of customer transactions. Management believes increased traffic in Company-operated retail stores continues to be driven by new product innovation, continued popularity of core products, a high level of customer satisfaction and improved speed of service through enhanced technology, training and execution at retail stores.

The Company derived the remaining 15.7% of total net revenues from its specialty operations. Specialty revenues, which include licensing revenues and foodservice and other revenues, increased 30.3% to $200.7 million for the 13 weeks ended December 28, 2003, from $154.0 million for the corresponding period of fiscal 2003.

Licensing revenues, which are derived from retail store licensing arrangements, grocery and warehouse club licensing, and certain other branded-product operations, increased 34.9% to $133.5 million for the 13 weeks ended December 28, 2003, from $99.0 million for the corresponding period of fiscal 2003. The increase was primarily attributable to the opening of 704 new licensed retail stores in the last 12 months, increased grocery revenues as a result of the acquisition of Seattle Coffee Company in the fourth quarter of fiscal 2003 and increased warehouse club revenues due to growth in existing accounts.

Foodservice and other revenues increased 22.0% to $67.2 million for the 13 weeks ended December 28, 2003, from $55.1 million for the corresponding period of fiscal 2003. The increase was primarily attributable to the growth of the foodservice business as a result of the acquisition of Seattle Coffee Company in the fourth quarter of fiscal 2003 and the addition of new Starbucks foodservice accounts.

Cost of sales and related occupancy costs were 41.4% of total net revenues for the 13 weeks ended December 28, 2003, compared to 41.8% for the corresponding period of fiscal 2003. This decrease was primarily due to efficiencies gained in the Company’s international supply chain operations and leverage gained on fixed occupancy costs distributed over an expanded revenue base, partially offset by a shift in sales mix in the Company’s United States operating segment. United States Company-operated retail sales, which include higher margin, handcrafted beverages, comprised a lower proportion of total United States net revenues compared to the corresponding period of fiscal 2003.

Store operating expenses as a percentage of Company-operated retail revenues decreased to 37.6% for the 13 weeks ended December 28, 2003, from 37.7% for the corresponding period of fiscal 2003. This decrease was primarily due to leverage gained on fixed expenditures spread over an expanded revenue base, partially offset by higher holiday marketing expenditures.

Other operating expenses (expenses associated with the Company’s specialty operations) increased to 22.0% of total specialty revenues for the 13 weeks ended December 28, 2003, compared to 20.5% in the corresponding period of fiscal 2003, primarily attributable to expanding the foodservice distribution network and maintaining new and

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existing customer accounts.

Depreciation and amortization expenses increased to $65.9 million for the 13 weeks ended December 28, 2003, compared to $57.4 million for the corresponding period of fiscal 2003. The increase was primarily due to the opening of 670 Company-operated retail stores and refurbishment of certain existing Company-operated retail stores. As a percentage of total net revenues, depreciation and amortization decreased to 5.1% for the 13 weeks ended December 28, 2003, from 5.7% for the same period in fiscal 2003.

General and administrative expenses increased to $69.6 million for the 13 weeks ended December 28, 2003, compared to $60.9 million for the corresponding period of fiscal 2003. The increase was primarily due to higher payroll-related expenditures. However, as a percentage of total net revenues, general and administrative expenses decreased to 5.4% for the 13 weeks ended December 28, 2003, from 6.1% for the same period in fiscal 2003.

Income from equity investees increased $3.8 million to $10.4 million for the 13 weeks ended December 28, 2003, from $6.6 million for the same period in fiscal 2003. The increase was primarily the result of new international licensed retail store openings, improved operating results due to reduced administrative costs in several international markets, and the July 2003 increase in the Company’s ownership interest from 5% to 50% for the Taiwan and Shanghai licensed operations.

Operating income increased 45.3% to $175.5 million for the 13 weeks ended December 28, 2003, compared to $120.8 million for the same period in fiscal 2003. Operating margin increased to 13.7% of total net revenues in the 13 weeks ended December 28, 2003, compared to 12.0% in the corresponding period of fiscal 2003, primarily due to the leverage gained in most operating expense line items from strong revenue growth as described above.

Interest and other income decreased to $3.2 million for the 13 weeks ended December 28, 2003, from $4.5 million in the corresponding period of fiscal 2003, primarily due to lower foreign currency exchange gains in the 13 weeks ended December 28, 2003, related to the Company’s application of the spot-to-spot method for net investment hedges, and a small loss this year compared to a small gain last year related to transactions based in currencies other than the United States dollar.

Income taxes for the 13 weeks ended December 28, 2003, were based on an effective tax rate of 38.0%, compared to 37.5% in the corresponding period of fiscal 2003. For the full fiscal year 2003, the effective tax rate was 38.5%. During fiscal 2003, operations based in the United States were more profitable and international operations, which are in various phases of development, generated greater non-deductible losses than had been anticipated. The decrease in the effective tax rate from 38.5% at the end of fiscal 2003, to 38.0% for the 13 weeks ended December 28, 2003, was primarily attributed to improved operating results from international businesses.

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SEGMENT RESULTS

Segment information is prepared on the same basis that the Company’s management internally reviews financial information for operational decision making purposes. The following table summarizes the Company’s results of operations by segment for the 13 weeks ended (in thousands):