In our previous post, we outlined how Starbuck's UK subsidiary would still have been loss-making last year if two of the three tax beneficial strategies mentioned in the press were reversed. This does not, however, get to one of the biggest sticking points of the story for a lot of people. Namely that the company has made statements that allude to its UK business actually being attractive. From the original October 15th, 2012 Reuters investigation that kicked off the sound and fury about Starbucks not paying corporation tax in the UK (emphasis ours): ...transcripts of investor and analyst calls over 12 years show Starbucks officials regularly talked about the UK business as "profitable," said they were very pleased with it, or even cited it as an example to follow for operations back home in the United States. That's a lot of investigated calls. More detail on them: In the 2007 financial year to end-September, Starbucks" UK unit's accounts showed its tenth consecutive annual loss. Yet that November, Chief Operating Officer Martin Coles told analysts on the fourth-quarter earnings call that the UK unit's profits were funding Starbucks" expansion in other overseas markets. Then-Chief Financial Officer Peter Bocian said the unit had enjoyed operating profit margins of almost 15 percent that year - equivalent to a profit of almost 50 million pounds. There are actually three really important things to dissect in that one paragraph. Let's summarise and number them. #1 Starbucks UK historically made losses and yet the COO said the unit's profits were funding expansion, #2 thereby implying that the UK unit was in fact profitable. #3 The UK unit had operating profit margins of almost 15 per cent in the year ending September 30th, 2007 (or however you interpret "then" in the above). Over to the earnings transcript for what COO Martin Coles said: So today, our international business spans 42 countries but it is really the maturity and scale of our developed markets - in this case, Canada and the U.K. - that fuel the revenue growth, allowing the smaller countries to gain experience and gradually build out scale over time. FT Alphaville heard "the maturity and the scale of markets like the UK that fuel revenue growth internationally," did you? So we're not sure about the "profits" angle in #1 - at least if the context is that call. Mr Coles continues, unknowingly addressing #2: When we look at profit contribution, Japan's performance joins Canada and the U.K., with the three markets providing the financial flexibility to balance our investment in expansion with profitability. On the one hand "financial flexibility," on the other, balance "expansion with profitability." That makes #2 look like a toss up initially. There is also this to consider, from the written evidence Starbucks submitted to the Public Accounts Committee (that Reuters obviously wouldn't have had access to when they published their report as indeed their report probably promptly the committee itself): It has been discussed that Starbucks financial reporting in the US has suggested a different level of profitability in the UK compared to that declared to HMRC by the UK business. This is simply and entirely due the different requirements that American and UK tax authorities place upon the way we file our accounts. Specifically, US accounting rules (US GAAP) require us to exclude intra-company royalty payments and loans interest for tax filing purposes whereas UK rules require us to include them. Starbucks UK, as a subsidiary of a US multi-national company, is obliged to follow US GAAP principles. That's an important (and kinda basic) distinction to make, between US and UK accounting. A lot of confusion may well stem from this. Let's look at the accounts of Starbucks Coffee Company (UK) Limited for the period ended September 30th, 2007, to see how plausible it is that the exclusion of "intra-company royalty payments and loans interest" could have made the unit look profitable back then: That's a £1.4m loss before tax under UK accounting principles, but one would need to reverse out the £20.9m "royalties and license fees" and £1.3m in intra-company interest to get something that looks more like the UK unit's appearance under US accounting principles. Even with the £15.5m deferred tax asset from the previous year (on the UK unit's Company House accounts - not shown in the tables above), it looks like Starbucks UK was indeed profitable in 2007 when viewed through a US accounting lens. Indeed, Starbucks also reported this in its written evidence to the Public Accounts Committee: Under the rules we are required to follow when reporting our US results, which exclude royalty payments and interest expense, our most profitable year (2007) in the UK had an operating margin of only 6%. That should be enough for you to draw your own conclusions about #2. We continue with the written evidence to address #3: It has been stated several times in the press recently that our UK operating margin using our US reporting method has reached 15%. This is categorically incorrect and we have never stated publicly or in our internal records that our UK profit margin has been near 15%. The bit from Reuters again: It's pretty integral to the story that Starbucks UK appears profitable to the tune of £50m, and this hinges on the 15 per cent. We don't think Reuters will have magicked this out of thin air and a spokesperson told FT Alphaville that "Reuters stands by its story." So, the hunt is on for where the "almost 15" could come from. The story implies it's from the same 2007 results transcript. That transcript has this: International operating income increased to $51 million in the fourth quarter of fiscal 2007 compared to $21 million in fiscal 2006. Favorable foreign exchange was not a significant contributor to the increase. We delivered strong operating margin improvement to 10.8% of revenues from 7.3% in fiscal 2006, primarily due to lower general and administrative expenses and store operating expenses as a percent of net revenues, as well as higher in come from equity investees. That's 10.8 per cent operating margin for all international business. Not that helpful. Maybe by writing "then" Reuters meant near that earnings call, but not that exact one? How about the January 8th, 2008 business update: So it really is probably two stories within the international story, but we believe that the large markets like a Canada, like a UK, like a China where we can operationally perform, we can deliver the kind of margins we saw in the US. Ambitions for a more US-like margin, but not that they are already that. Then there was this, from the January 30th, 2008 first quarter earnings call: U.S. operating income declined to $311 million during the quarter from $325 million in Q1 of fiscal "07. Operating margins came in at 14.6% of total revenues for the first quarter of fiscal 2008, from 17.5% a year ago, primarily driven by higher cost of sales including occupancy and higher store operating expenses, partially offset by lower G&A as a percentage of total net revenues. Hmm, 14.6 per cent (for the US) looks quite "almost 15 per cent" and if the UK unit could do that, it would be delivering "the kind of margins [seen] in the US." Lastly, this from the April, 2008 earnings call on the second quarter: What I've talked about before is that - and this will be against an "07 U.S., is that Canada is approaching the U.S. kind of margins. There is still more challenges around the spread. From a company-owned market, the U.K. is improving but behind Canada,... Again, it just sounds like ambition. All in, we aren't convinced by #3. If you spot something we missed here, please let us know. This has frustrated FT Alphaville, because there are statements that Starbucks did make where one could be forgiven for being a bit "hey, wait a minute there, buddy" from a UK taxpayer perspective. From the 2009 full-year transcript: Canada, the UK, China and Japan are our largest international markets and drive the majority of the segment's revenue in operating profits. Each of these markets is profitable to Starbucks. Each is a priority for future investment, and each is a key component of future growth. Translation: when reported under Starbucks group accounts, following US accounting principles, the four international Starbucks markets are driving the majority of profits and the UK is among them. Is this American optimism for you, or what?! Frankly, this whole story has gotten less and less sexy the longer we've looked into it. And it would have stayed that way... if Starbucks hadn't announced changes to its UK tax accounting last week. They seemingly did this after UK Uncut took the baton from the press and made their voices heard by committing to protest against the coffee chain. Join us for that episode in our next installment.