UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended January 2, 2005

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 þ No o

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

Yes þ 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 January 2, 2005

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

STARBUCKS CORPORATION

See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION

See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION

See Notes to Consolidated Financial Statements.

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STARBUCKS CORPORATION

Note 1: Financial Statement Preparation

The unaudited consolidated financial statements as of January 2, 2005, and October 3, 2004, and for the 13-week periods ended January 2, 2005, and December 28, 2003, have been prepared by Starbucks Corporation (“Starbucks” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, in the opinion of management, reflects all adjustments and accruals, which are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods.

The financial information as of October 3, 2004, is derived from the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended October 3, 2004 (“Fiscal 2004”) incorporated by reference in the Fiscal 2004 Annual Report on Form 10-K. The information included in this Form 10-Q should be read in conjunction with management’s discussion and analysis and notes thereto included in the Company’s Fiscal 2004 Annual Report on Form 10-K (see Note 2: Restatement of Financial Statements).

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

The results of operations for the 13-week period ended January 2, 2005, are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending October 2, 2005.

Note 2: Restatement of Financial Statements

On February 7, 2005, the Office of the Chief Accountant of the SEC issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease accounting issues and their application under generally accepted accounting principles in the United States of America (“GAAP”). In light of this letter, the Company’s management initiated a review of its lease-related accounting and determined that its then-current method of accounting for leasehold improvements funded by landlord incentives or allowances under operating leases (tenant improvement allowances) and its then-current method of accounting for rent holidays were not in accordance with GAAP.

The Company had historically accounted for tenant improvement allowances as reductions to the related leasehold improvement asset on the consolidated balance sheets and capital expenditures in investing activities on the consolidated statements of cash flows. Management determined that the appropriate interpretation of Financial Accounting Standards Board (“FASB”) Technical Bulletin No. 88-1, “Issues Relating to Accounting for Leases,” requires these allowances to be recorded as deferred rent liabilities on the consolidated balance sheets and as a component of operating activities on the consolidated statements of cash flows. Additionally, this adjustment results in a reclassification of the deferred rent amortization from “Depreciation and amortization expenses” to “Cost of sales including occupancy costs” on the consolidated statements of earnings.

The Company had historically recognized rent holiday periods on a straight-line basis over the lease term commencing with the initial occupancy date, or Company-operated retail store opening date. The store opening date coincided with the commencement of business operations, which is the intended use of the property. Management re-evaluated FASB Technical Bulletin No. 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” and determined that the lease term should commence on the date the Company takes possession of the leased space for construction purposes, which is generally two months prior to a store opening date. Excluding tax impacts, the correction of this accounting requires the Company to record additional deferred rent in “Accrued occupancy costs” and “Other long-term liabilities” and to adjust “Retained earnings” on the consolidated balance sheets as well as to correct amortization in “Cost of sales including occupancy costs” on the consolidated statements of earnings.

As a result of the above, the Company has restated its consolidated balance sheet as of October 3, 2004, and its consolidated statements of earnings and cash flows for the 13 weeks ended December 28, 2003.

Following is a summary of the effects of the accounting corrections on the Company’s consolidated statements of earnings and cash flows for the 13 weeks ended December 28, 2003 (in thousands, except share data):

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Following is a summary of the effects of the lease accounting corrections on the Company’s consolidated balance sheet as of October 3, 2004 and the retroactive adjustments as discussed in Note 4 from the Company's acquisition of Germany (in thousands):

Note 3: Summary of Significant Accounting Policies

Property, Plant and Equipment

Property, plant and equipment are carried at cost less accumulated depreciation. Depreciation of property, plant and equipment, which includes assets under capital leases, is provided on the straight-line method over estimated useful lives, generally ranging from two to seven years for equipment and 30 to 40 years for buildings. Leasehold improvements are amortized over the shorter of their estimated useful lives or the related lease life, generally 10 years. For leases with renewal periods at the Company’s option, Starbucks generally uses the original lease term, excluding renewal option periods to determine estimated useful lives; if failure to exercise a renewal option imposes an economic penalty to Starbucks, management may determine at the inception of the lease that renewal is reasonably assured and include the renewal option period in the determination of appropriate estimated useful lives. The portion of depreciation expense related to production and distribution facilities is included in “Cost of sales including occupancy costs” on the accompanying consolidated statements of earnings. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. When assets are retired or sold, the asset cost and related accumulated depreciation are eliminated with any remaining gain or loss reflected in net earnings.

Operating Leases

Starbucks leases retail stores, roasting and distribution facilities and office space under operating leases. Most lease agreements contain tenant improvement allowances funded by landlord incentives, rent holidays, lease premiums, rent escalation clauses and/or contingent rent provisions. For purposes of recognizing incentives, premiums and minimum rental expenses on a straight-line basis over the terms of the leases, the Company uses the date of initial possession to begin amortization, which is generally when the Company enters the space and begins to make improvements in preparation of intended use.

For tenant improvement allowances funded by landlord incentives and rent holidays, the Company records a deferred rent liability in “Accrued occupancy costs” and “Other long-term liabilities” on the consolidated balance sheets and amortizes the deferred rent over the terms of the leases as reductions to rent expense on the consolidated statements of earnings.

For premiums paid upfront to enter a lease agreement, the Company records a deferred rent asset in “Prepaid expenses and other current assets” and “Other assets” on the consolidated balance sheets and then amortizes the deferred rent over the terms of the leases as additional rent expense on the consolidated statements of earnings.

For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial occupancy, the Company records minimum rental expenses on a straight-line basis over the terms of the leases on the consolidated statements of earnings.

Certain leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability in “Accrued occupancy costs” on the consolidated balance sheets and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable.

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 (“APB”) 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.

Had compensation cost been recognized based upon the estimated fair value on the grant date of stock options in accordance with 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 by using the Black-Scholes option valuation model 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 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123R will require Starbucks to, among other things, measure all employee stock-based compensation awards using a fair value method and record such expense in the Company’s consolidated financial statements. The provisions of SFAS 123R are effective for the first interim or annual reporting period that begins after June 15, 2005; therefore, Starbucks will adopt the new requirements no later than the beginning of its fourth quarter of fiscal 2005. Adoption of the expensing requirements will reduce the Company’s reported earnings. Management is currently evaluating the specific impacts of adoption, which include whether the Company should adopt the requirements on a retrospective basis and which valuation model is most appropriate.

In November 2004, the FASB issued Statement No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of

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SFAS 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.

In December 2004, the FASB issued Staff Position No. FAS 109-1, “Application of SFAS No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities provided by the American Jobs Creation Act of 2004” (“FSP 109-1”). FSP 109-1 states that qualified domestic production activities should be accounted for as a special deduction under SFAS No. 109, “Accounting for Income Taxes,” and not be treated as a rate reduction. The provisions of FSP 109-1 are effective immediately. The Company is currently evaluating the impact of the new Act, which will allow Starbucks to qualify for a benefit beginning in fiscal 2006.

In December 2004, the FASB issued Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”). The American Jobs Creation Act allows a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. The Company may elect to repatriate earnings in either fiscal 2005 or fiscal 2006. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. Although FSP 109-2 is effective immediately, it allows companies additional time beyond the enactment date to evaluate the effects of the provision on its plan for investment or repatriation of unremitted foreign earnings. The Company is currently evaluating the impact of the new Act to determine whether it will repatriate foreign earnings and the impact, if any, this pronouncement will have on its consolidated financial statements. In addition, the U.S. Treasury Department is expected to provide additional clarifying guidance on key elements of the repatriation provision. Earnings under consideration for repatriation range from $0 to $100 million and the related income tax effects from such repatriation cannot be reasonably estimated at this time. As provided in FSP 109-2, Starbucks has not adjusted its tax expense or deferred tax liability to reflect the repatriation provision.

Note 4: Business Acquisition

In November 2004, Starbucks increased its equity ownership from 18% to 100% for its licensed operations in Germany. As a result, management determined that a change in accounting method, from the cost method to the consolidation method, was necessary and included adjusting previously reported information for the Company’s proportionate share of net losses of 18% as required by APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” The cumulative effect of the accounting change for prior periods resulted in a reduction of retained earnings of $3.6 million as of October 4, 2004. See Note 18 in the Company’s Annual Report on Form 10-K for the fiscal year ended October 3, 2004, for additional information.

Note 5: Inventories

Inventories consist of the following (in thousands):

As of January 2, 2005, the Company had committed to fixed-price purchase contracts for green coffee totaling $458 million. The Company believes, based on relationships established with its suppliers in the past, the risk of nondelivery on such purchase commitments is low.

Note 6: Derivative Financial Instruments

The Company manages its exposure to foreign currency risk within the consolidated financial statements according to a hedging policy. Under this policy, Starbucks may engage in transactions involving various derivative instruments with maturities generally not longer than five years, to hedge assets, liabilities, revenues and purchases.

Cash Flow Hedges

Starbucks and its subsidiaries, which include entities that use their local currency as their functional currency, enter into cash flow derivative instruments to hedge portions of anticipated revenue streams and purchases. Current forward

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contracts hedge forecasted transactions denominated in Japanese yen and Canadian dollars, as well as in U.S. dollars for foreign operations. During the 13 weeks ended January 2, 2005, and December 28, 2003, derivative losses of $0.4 million and $0.5 million were reclassified into revenues, respectively. For hedges of foreign denominated purchases, derivative losses of $1.0 million and $0.2 million were reclassified into cost of sales during the 13-week periods ended January 2, 2005, and December 28, 2003, respectively.

During the 13 weeks ended January 2, 2005, the Company entered into a swap contract to hedge a small portion of its forecasted U.S. fluid milk purchases through calendar year 2005. The effect of the swap will fix the price paid by Starbucks for the monthly volume of milk purchases covered under the contract. There were no realized gains or losses related to the swap contract during the 13-week period ended January 2, 2005. Management intends to seek opportunities to expand this hedging program.

The Company had accumulated net derivative losses of $7.5 million, net of taxes, in other comprehensive income as of January 2, 2005, related to cash flow hedges. Of this amount, $4.7 million of net derivative losses will be reclassified into earnings within 12 months. No cash flow hedges were discontinued during the 13-week periods ended January 2, 2005, and December 28, 2003. Current contracts will expire within 21 months.

Net Investment Hedges

Net investment derivative instruments hedge the Company’s equity method investment in Starbucks Coffee Japan, Ltd. These forward foreign exchange contracts expire within 27 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 $0.2 million and $0.1 million for the 13 weeks ended January 2, 2005, and December 28, 2003, respectively. In addition, the Company had accumulated net derivative losses of $6.4 million, net of taxes, in other comprehensive income as of January 2, 2005.

The following table presents the fair value of the Company’s derivative financial instruments as of January 2, 2005, for the consolidated balance sheet line items indicated (in thousands):

Note 7: Property, Plant, and Equipment

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

Note 8: Shareholders’ Equity

Pursuant to the Company’s authorized share repurchase program and depending on market conditions, Starbucks may acquire shares of its common stock. Share repurchases are funded through cash, cash equivalents and available-for-sale

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securities. There were no share repurchases during the 13-week periods ended January 2, 2005, and December 28, 2003. As of January 2, 2005, the Company had 18.6 million additional shares authorized for repurchase.

Note 9: Comprehensive Income

Comprehensive income includes all changes in equity during the period, except those resulting from transactions with shareholders and subsidiaries of the Company. It has two components: net earnings and other comprehensive income. Accumulated other comprehensive income reported on the Company’s consolidated balance sheets consists of foreign currency translation adjustments and the unrealized gains and losses, net of applicable taxes, on available-for-sale securities and on derivative instruments designated and qualifying as cash flow and net investment hedges. Comprehensive income, net of related tax effects, is as follows (in thousands):